Question: Can we loose our nonprofit status if we have too much advertising sales success?

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.

Question: What kind of ads are we prohibited from selling and why?

You advertising sales program is impacted by three factors that might limit what ads you can sell: your organization’s policies, your US Postal Service permit status, and the total income you report to the IRS. All three are covered in our new book due for publication in Spring 2007. Here’s a quick summary.

Organizational prohibitions – most nonprofit organizations reject ‘sin’ ads such as tobacco, alcohol and pornography, and your organization may have other ethical or mission-driven conflicts with certain advertisers. Ask your organization’s leadership to draw up a list of products that would compliment your mission and sell ads to those companies.

Postal restrictions – the post office charges higher prices for advertising material than for editorial content. No matter what kind of mailing permit you obtain, you will pay more postage if you carry ads. But that extra postage is generally easy to recover from ad income. In addition, if you mail by one specific permit category – nonprofit standard mail – then you are prohibited from running any ads for financial services, travel, or insurance. All of the postal regulations are available in the Domestic Mail Manual on their website. You can also get help with this question from your printer or circulation consultant.

IRS restrictions – ALL advertising income is classified ad ‘unrelated business income’ by the IRS, but it does not directly prohibit any kinds of ads from nonprofit publications or websites. You will pay taxes on your profits from advertising sales (meaning any ad dollars that exceed your publishing costs). The IRS provides explicit instructions for calculating advertising sales profits at their website: General Rules for UBIT and for more information on IRS rules about UBIT, read IRS Publication 598, Tax on Unrelated Income of Exempt Organizations, available online at www.irs.gov, or by calling the IRS at 800-829-3676. You should share these documents with your accountant.