Many tax-exempt organizations publish magazines or other periodicals that contain editorial material related to the organization’s exempt purpose. Often, these periodicals also contain commercial advertising.
When the advertising activity constitutes a trade or business regularly carried on by the organization, the sale of advertising represents an unrelated business activity. The organization will pay Federal (and likely state) income tax on this income if there is a net profit from the activity.
To determine the amount of unrelated business taxable income (UBTI) attributable to the sale of advertising, it is necessary to determine the following:
If direct advertising costs exceed gross advertising income, the excess is allowable as a deduction in determining the UBTI of an organization that has income from other unrelated trade or business activities (or can be carried forward to be used as a deduction in future years where there is taxable income).
However, from a practical perspective, it is rare for the direct costs of advertising to exceed the advertising revenue.
If gross advertising income exceeds the direct advertising costs, the items of deduction attributable to the production and distribution of the readership content of the periodical – to the extent such deductions exceed circulation income – may be deducted from the excess advertising income in calculating UBTI from the advertising activity.
However, no overall loss may result from this deduction, meaning that an organization cannot use the excess readership costs to “shelter” any UBTI from other activities. In essence, the advertising income is subject to tax only if the periodical produces an overall profit for the year.
If the circulation income of the periodical equals or exceeds the readership costs, the organization is not required to use circulation income and readership costs in calculating UBTI. Instead, UBTI is only the excess of the gross advertising income over direct advertising costs.
If an exempt organization publishes two or more periodicals, it may be able to consolidate the results for all periodicals.
Example: An exempt organization produces a monthly periodical that contains advertising in each issue. The periodical generates $50,000 of advertising revenue. In selling the advertising, the organization incurs $10,000 of commissions related to the sale of the ads.
The cost of printing, postage and distribution of the periodical is $100,000. Ten percent of the total periodical pages contained advertising. The organization also incurs an additional $15,000 of costs associated with producing the educational content of the periodical.
Circulation income (as calculated in the example below) is $50,000.
The UBI from this activity is calculated as follows:
Member Dues Allocation
When the payment of a membership fee entitles the member to receive a periodical, circulation income includes an allocable portion of the membership fee, using one of three allocation methods:
Assuming the same facts as above, A has costs incurred for other exempt expenditures of $500,000 and total member dues of $250,000. Total expenses for the journal are $125,000 ($10,000 commissions, plus $100,000 distribution plus $15,000 for the educational content). Dues allocated to circulation income (under #3 above) are calculated as follows:
$125,000/$625,000 ($500,000 plus $125,000) or 20 percent times $250,000 (member dues) = $50,000.