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Q: Can our nonprofit organization loose its tax exempt status if we have too much advertising sales success?

Answer: Generally speaking, your organization’s tax exemption covers any activity that is substantially related to the charitable, educational or other purpose that forms the basis upon which the IRS granted the exemption, even if the activity is a business activity. However, if the organization regularly carries on a business that’s not substantially related to its exempt purpose, the organization is subject to income tax on any profits from that activity.

As a default, IRS considers that advertising sales is unrelated business income and imposes a tax on your profits from ad sales. But in many cases, you can argue that advertising sales is actually related to your mission. Running car ads in your member newsletter is probably not related business income, but running ads from language schools in your career magazine for immigrants certainly is related.

You can lose your tax-exempt status by having too much unrelated business income (UBI), but unfortunately, the IRS has not issued any specific guidelines as to how much is too much. We know publishers who deliberately limit their advertising income to 25% of total annual receipts, but we also know of cases where more than 50% of income was derived from UBI and exempt status was upheld. It might be impossible to defend your tax status if you earned nearly 100% of your operating funds through unrelated business activities.

All unrelated business profits are taxable, including profits from advertising sales. The UBI tax law distinguishes between advertising, which involves the promotion of goods and services (UBIT applies), and donor recognition, which involves a mere acknowledgement of a donor's support (UBIT does not apply). That's why an ad in a conference directory generally doesn't give rise to UBIT liability. There are also special rules concerning the type of expenses that can be deducted against the advertising sales revenue for purposes of figuring the UBIT liability

Failure to identify and pay UBIT can result in your nonprofit being assessed back taxes, interest and penalties. Organizations operating an unrelated business must file form 990-T, Exempt Organization Business Income Tax Return, whether a tax is due or not.

This topic is covered in our new book from Nolo Press published in May 2007, Every Nonprofit's Guide to Publishing. You can email us if you have other questions we should answer.

 

 
 

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