By Edward Yoder, CPA, MSA

Electronic or printed newsletters and magazines remain popular methods to keep constituents up to date on current activities and programs, and for good reason – they work. When organizations feature paid advertisements in those materials, the associated income is often taxable. Considered an unrelated trade or business activity, these advertising sales could be taxable. It comes down to a few key concepts in IRS Regulation 1.512(f).

At a glance:

  • Some nonprofit advertising revenue is unrelated business taxable income (UBTI).
  • Advertising in periodicals, like newsletters and magazines, can generate UBTI.
  • Key definitions to be aware of are excess advertising costs, excess advertising income, gross advertising income, circulation income, and readership costs.

Key Definitions for Nonprofit Periodical Advertising

Determining whether an ad in a periodical generates UBTI depends on the nature of costs to income. Nonprofit financial leaders need to be aware of what these concepts mean. Even though selling ads in periodicals tends to qualify as an unrelated business activity, relaxed rules allowing deductions may lower or eliminate taxable income from such sources.

Gross advertising income: all amounts derived from the unrelated advertising activities of an exempt organization periodical.

Excess advertising costs: if the direct advertising costs of an exempt organization periodical exceed gross advertising income, such excess is allowable as a deduction in determining UBTI from any unrelated trade or business activity.

Excess advertising income: If the gross advertising income is higher than the direct advertising costs, deductions related to creating and distributing periodical content can be considered deductions directly associated with unrelated advertising activity. These deductions can be used to calculate the amount of UBTI generated from advertising activity, but only if they surpass the income derived from or related to the production and distribution of such content. However, these deductions cannot result in a loss from the advertising activity.

Circulation income: The income from producing, distributing, or circulating a periodical includes all amounts obtained from selling or distributing its content. If a membership or similar status in an exempt organization is required to receive the periodical, the income from circulation also includes the portion of membership fees that can be attributed to the periodical. This portion is determined based on what would be charged if (a) the periodical belonged to a taxable organization, (b) the periodical was published for profit, and (c) the member was an unrelated party dealing with the taxable organization at arm’s length.

If the circulation income of the periodical exceeds the readership costs of such periodical, the UBTI attributable to the periodical is the excess of the gross advertising income of the periodical over direct advertising costs.

However, if the readership costs of an exempt organization periodical exceed the circulation income of the periodical, the UBTI is the excess, if any, of the total income attributable to the periodical over the total periodical costs.

In general, the total income attributable to an exempt organization periodical is the sum of its gross advertising income and its circulation income.

When Is Nonprofit Advertising Income in a Periodical Taxable?

The IRS lays this concept out in several examples provided in the regulations.

An exempt trade association publishes a periodical with advertising. During the year, the organization realizes a total of $40,000 from the sale of advertising and $60,000 from the periodical sales to members and nonmembers (circulation income). The total periodical costs are $90,000 of which $50,000 is directly connected with the sale and publication of advertising (direct advertising costs) and $40,000 is attributable to the production and distribution of the readership content (readership costs).

Since the direct advertising costs of the periodical ($50,000) exceed gross advertising income ($40,000), the UBTI attributable to advertising is determined solely on the basis of the income and deduction directly connected to the production and sale of the advertising:

Gross advertising revenue                             $40,000

Direct advertising costs                                ($50,000)

Loss attributable to advertising                  ($10,000)

Thus, the unrelated taxable income from the advertising in the exempt organization’s periodical is non-taxable.

Assume the same facts as above, except that the circulation income of the periodical is $100,000 instead of $60,000, and of the total periodical costs, $25,000 are direct advertising costs, and $65,000 are readership costs.  Since the circulation income ($100,000) exceeds the total readership costs ($65,000), the UBTI attributable to the advertising activity is $15,000, the excess of gross advertising income ($40,000) or direct advertising costs ($25,000).

Assume the same facts from Example 1, except that the total periodical costs ($20,000) are direct advertising costs, and $70,000 are readership costs. Since the readership costs of the periodical ($70,000), exceed the circulation income of $60,000, the excess of the total income attributable to the periodical over the total periodical costs is taxable. The UBTI attributable to the advertising activity is $10,000: $100,000 (total income) less the periodical costs of $90,000.

Assume the same facts from Example 1, except that the total periodical costs are $120,000 of which $30,000 are direct advertising costs and $90,000 are readership costs. Since the readership costs of the periodical ($90,000) exceed the circulation income of $60,000, the UBTI attributable to advertising is the excess of the total income attributable to the periodical over the total periodical costs.

Since the total income of the periodical ($100,000) does not exceed the total periodical costs ($120,000), the organization has not derived any UBTI from the advertising activity.

There are also certain rules that nonprofits must follow for subscription prices and member or non-member dues associated with periodicals.

Conclusion

The IRS rules and regulations governing advertising in periodicals of exempt organizations can be confusing and complex. You should be sure that your exempt organization is complying with these regulations and filing a Form 990T to report Unrelated Business Activity correctly.

If you have any questions or concerns about this IRS guidance, reach out to your PBMares Tax Advisor today to learn more, or contact Tax Partner Ed Yoder, CPA, MSA.