Jen Lindstrom - The Journal Record
Jan 9, 2023
A 501(c)(3) tax-exempt organization that regularly carries on a trade or business, unrelated to its tax-exempt purpose, is subject to unrelated business income tax, or UBIT. Although this sounds straightforward, there are common situations that are easily overlooked. To avoid unwelcome surprises at tax time, here are some common ways to avoid UBIT.
A 501(c)(3) tax-exempt organization that regularly carries on a trade or business, unrelated to its tax-exempt purpose, is subject to unrelated business income tax, or UBIT. Although this sounds straightforward, there are common situations that are easily overlooked. To avoid unwelcome surprises at tax time, here are some common ways to avoid UBIT.
The most common oversight is crossing the line between sponsorship and advertising. Sponsorship income is tax-exempt, while advertising income is subject to UBIT. Sponsorship income is defined as when the sponsor receives no financial benefit from the contribution.
When a nonprofit receives sponsorship income, it is natural to want to thank the sponsors, but this is where you have to be careful. For instance, it’s acceptable and customary to thank sponsors for their gift by listing their names in a newsletter or logo on the back of an event T-shirt.
However, it crosses the line into advertising if the thank-you includes a call to action to support the businesses of the sponsors. For example, allowing a sponsor to give a speech about its business changes the nature of the income from nontaxable sponsorship to taxable advertising.
Another overlooked example of a taxable action is publishing a list of sponsors on the nonprofit’s website and including a link to the sponsor’s website. The act of linking to the sponsor’s website gives the sponsor a potential financial benefit, which turns it into advertising. It’s important to be aware of the differences between sponsorship income and advertising revenue.
Another easily overlooked taxable event is certain rental income. In general, rental income from real property is excluded from tax. However, it’s important to understand those instances where the exclusion does not apply. The most common is debt-financed property. With debt-financed property, rental income becomes taxable when less than 85% of the property is used for the organization’s exempt purpose.
Additionally, rental income becomes taxable if the rent charged is based on a percentage of the profits of the renter. Finally, renting space to a for-profit entity may result in a revocation of the property tax exemption for charitable entities.
To avoid unexpected tax bills, it is important for tax-exempt organizations to understand the difference between sponsorship and advertising and be aware of what can cause rental income to become taxable.
Jen Lindstrom, CPA, is a tax senior manager at Arledge, an Edmond-based public accounting firm.