Church Taxed on Funds Raised?

By Chaston Asbury

“Can my ministry sell items or charge money for events?” 

At StartCHURCH, many pastors and ministry leaders call us asking this question. The simplest answer to that question is yes, churches and ministries can make a profit on items they sell or events they host. However, the way in which that income is viewed from the perspective of the IRS makes a big difference on whether or not the church or ministry has to pay taxes. 

Income is either related or unrelated to the tax-exempt purpose of an organization. If the activity of a church is incidental to its purpose, then the income derived from that activity is related to the purpose and not subject to taxes. However, if the activity is unrelated to the purpose, then the income derived from that activity will be subject to unrelated business income tax (UBIT).

What is unrelated business income?

The IRS defines what unrelated business income is in Publication 598.

Unrelated business income is the income from a trade or business regularly conducted by an exempt organization and not substantially related to the performance by the organization of its exempt purpose or function.

Let’s unpack that statement:

• “trade or business” is defined as any activity that is conducted with the intent to make a profit.
• “regularly conducted” refers to the frequency and continuity of the activity.
• “not substantially related” means any activity that doesn’t contribute to accomplishing the purpose of a tax-exempt organization. 

Now, let’s consider what “activity frequency” looks like.

Years ago, when I was a member of my church’s youth group, we made plans to go on a mission trip to New York. We decided to host a car-washing event to help cover the cost of the trip. The car wash was held on one Saturday, and the youth group volunteered to wash all the cars with the income going toward our trip. 

The income derived from this specific activity helped to further the purpose of the church and thus, is not considered unrelated business income. However, if a church were to hold a car wash every single weekend as a means of generating additional income for the church, then the IRS would consider that activity to be regularly conducted. This kind of ongoing activity would fall within the unrelated business category, and the church would be required to pay taxes on the income.

“Not substantially related” is the most vague portion of this definition and takes into account many different aspects. Two of the main aspects in determining whether activities are substantially related to the tax-exempt purpose of the organization are the size and the extent of the activity. 

Publication 598 states that, “To the extent an activity is conducted on a scale larger than is reasonably necessary to perform an exempt purpose, it doesn’t contribute importantly to the accomplishment of the exempt purpose.” 

Exceptions:

Even if an activity meets the above-mentioned criteria of an unrelated trade or business, if any one of the following three exceptions are met, according to section 513(a), that activity will not be considered an unrelated trade or business. The three exceptions are as follows:

1. Substantially all the work in operating the trade or business is performed by unpaid volunteers.
2. The activity conducted by your church is conducted primarily for the benefit of your members.
3. The trade or business being conducted involves the selling of merchandise, substantially all of which has been received by your church as gifts or donations.

Create income without paying taxes

Now that we have a more in-depth understanding of the IRS’s definition of unrelated business income, let’s look at some more examples of what your ministry can do to make additional income.

Many churches today have coffee stations where congregants can purchase beverages before or after services. As long as the coffee station is strictly operated during and around service times and is primarily conducted for the benefit of church members, the income from that activity will not be considered unrelated business income. 

Another form of additional income is the sale of worship and sermons CDs. Ministries might also hold events like conferences or concerts in which a registration fee is required. As long as these events are centered around furthering the tax-exempt purpose for the ministry, the registration fees will not but subject to unrelated business income tax.

Each of these activities listed above, if operated correctly (following the definition that we laid out earlier), is an excellent option for churches to create additional income. Another excellent way for a church to generate income is to start a for-profit arm. In short, a for-profit arm is a business venture in which your church is a majority shareholder. In return, the for-profit arm pays the church profits in the form of tax-free dividends. If you have questions about how StartCHURCH can help you set up a for-profit arm, then give us a call at 877-494-4655. One of our church planting specialists will be happy to help!

Understanding quid pro quo contributions

A separate but equally important aspect of churches making an income by selling items is understanding what quid pro quo contributions are.

Quid pro quo contributions are payments that are made partly as a contribution to a nonprofit organization and partly in exchange for goods or services. For example, if a church has a food sale one Sunday after service and charges $10 for each plate of food, a congregant may want to make an additional donation to the church and give the church $25 for the plate of food. The additional $15 would be considered a charitable contribution to the church since the fair market value of the food was $10.

This is important to keep in mind if you are a donor wanting to give to a charitable organization but will also be receiving some type of good or service in return for your gift. But what about the ministry? Does the ministry itself have to do anything when it comes to quid pro quo contributions?

If the donor’s payment to the ministry is more than $75, a disclosure statement must be issued by the ministry to the donor. 

For example, let’s say a church is throwing a concert, and attendees can buy a ticket at the valued price of $40. Attendees can also give more money than the ticket’s actual cost for the sake of the fundraiser. If a donor gives the church $100 instead of just $40, this donation is considered as a quid pro quo contribution. The charitable contribution of this donation is $60. It should be noted that although the deductible part of the payment is less than $75, a disclosure statement must be given to the donor because the donor gave more than $75. If the church fails to provide this disclosure to the donor, it could risk a penalty from the IRS. 

According to the IRS, written disclosure statements must:

1. Notify the donor that the amount of the contribution that is deductible for federal income tax purposes is limited to the excess of any money (and the value of any property other than money) contributed by the donor over the fair market value of goods or services provided by the charity.
2. Provide the donor with a good faith estimate of the fair market value of the goods or services that the donor received. The church or ministry must provide the statement at the time that the donor receives a receipt of his or her quid pro quo contribution.

When determining the fair market value of goods or services rendered, an organization may use any reasonable method to estimate that value, as long as it applies the method in good faith.

Don’t run the risk of paying taxes

If your church or ministry is involved in any activity that you think may be generating unrelated business income, give us a call at 877-494-4655. One of our specialists would be happy to talk with you about how you can be in compliance. 

You no longer have to depend on tithes and offerings to sustain your church. And you also don’t have to run the risk of paying taxes for your church. You have the unique opportunity to develop a plan that will generate real income for your ministry by establishing a legitimate for-profit business owned by your church. Call at 877-494-4655 to find out how your church can create a for-profit arm. 

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