Your church's annual fall festival is two months away, and you are looking for creative and appropriate ways to generate income from it. You get a call from a local car dealer who is familiar with your festival. The dealership offers to be the exclusive sponsor of the event by paying your church $20,000, so long as you recognize it as the exclusive sponsor by placing a large sign at the entrance with the following message: "Tri-City Motor Company; Exclusive Sponsor; tricitymotorcompany.com." The dealer also wants to display six new vehicles at the entrance of the festival as a part of the arrangement.
Can you accept the dealer's offer without jeopardizing the church's tax-exempt status? If you do, is the $20,000 payment taxable as unrelated business income to the church? You may be surprised by the answers to this and other questions about the often misunderstood world of unrelated business income.
Section 1: Unrelated Business Income—The General Rules
Federal law imposes an income tax on a church if the church generates net income from one or more unrelated business activities. Congress adopted the tax on unrelated business income ("UBI") primarily for the purpose of eliminating unfair competition between nonprofit, tax-exempt organizations and for-profit, taxable businesses.
An unrelated business activity is a revenue- generating activity that:
- Constitutes a trade or business;
- Is regularly carried on; and
- Is not substantially related to the church's exempt purposes.
The law also considers the activity of generating income from "debt-financed property" to constitute an unrelated business activity. (See Section 3 for additional information on this topic.)