Are there any tax implications for our church to set up a vegetarian café to serve the community during the week?
Church activities are usually considered tax-exempt. As exempt organizations, churches are not taxed on activities that are related to their charitable, educational, or other exempt purposes. However, if a church is engaged in a trade or business that is not related to the church’s exempt purpose, income derived from those activities could be taxable. Income from these activities is subject to the unrelated business income tax (UBIT). Churches will have to pay the UBIT if they earn $1,000 or more from these unrelated activities. Additionally, if a church earns too much income from unrelated activities it risks losing its tax-exempt status.
There are three questions to consider in determining if a church’s activities are subject to UBIT:
Is the income derived from a trade or business? Trade or business has been broadly defined as any time the sale of goods or the provision of services generates income.
Is the church regularly engaged in trade or business? This does not apply to activities that only occur on an infrequent or sporadic basis.
Is the activity unrelated to the church’s exempt purpose? If a church can show that the activity furthers its tax-exempt purpose, then the income is not considered taxable. However, income used to support an exempt purpose is still subject to UBIT if the activity isn’t related to the church’s exempt purpose.
If the answers to the three questions above are yes, UBIT generally applies. However, there are some exceptions. For example, income derived from labor that is substantially provided by volunteers or by selling donated items are not subject to UBIT. Based on this exception, income from bake sales and thrift shops isn’t treated as taxable. Additionally, UBIT doesn’t typically apply to income from the rent of real property, such as a church renting its building space, if the property is fully owned (not financed with borrowed money, such as a mortgage), and most of the church’s property continues to be used for the church’s exempt purposes.
As you can see, determining whether your church’s activity is subject to UBIT requires a factual analysis. For example, under the IRS exception if a church rents its parking lot to a third party the income is not considered UBIT since income from rent is excluded from UBIT. However, if a church instead decides to directly charge fees to the public for use of its parking lot during the week this would be subject to UBIT since this activity is not substantially related to the church’s tax-exempt purpose and isn’t considered rental income.
The bottom line is that churches should be mindful of UBIT when planning fundraisers or other income-generating activities.
Jennifer Gray Woods is the lawyer for the Lake Union Conference, as well as the Public Affairs and Religious Liberty director.
