A controversy over corporate sponsorship developed in the early 1990s when the IRS took the audit position that Mobil Oil’s sponsorship payment to the Cotton Bowl constituted taxable unrelated advertising income to the nonprofit that organized the Cotton Bowl. In subsequent years the IRS took varying positions on the matter until 1997 when Congress weighed in with Internal Revenue Code (IRC) section 513(i). Section 513(i) provides a safe harbor for certain payments that are deemed to be “qualified sponsorship payments” and, therefore, not subject to the unrelated business income tax (UBIT). A safe harbor is just that, i.e., if you are in the safe harbor you are automatically safe. However, just because you fall outside of the safe harbor does not necessarily mean that a payment is subject to UBIT, it just means that the organization may have to look to another IRC section to determine if the payment is subject to UBIT.
Today, many organizations receive significant revenue from sponsorships, so we thought it would be a good idea to go over the rules.
IRC 513(i) provides that a tax-exempt organization’s solicitation or receipt of a “qualified sponsorship payment” (QSP) is not an unrelated trade or business. A “qualified sponsorship payment” is a payment made by a business where there is no “substantial return benefit” other than (1) acknowledgement of the sponsor or (2) certain insubstantial benefits. The safe harbor is not applicable to payments made where sponsors are acknowledged in periodicals (either print or electronic), nor is the QSP safe harbor applicable to trade shows. Whether or not the sponsor deducts the payment as a charitable contribution or a business expense is not relevant as to how it is treated by the donor organization. The organization should report QSPs as contributions.
If a payment to an organization is dependent upon ratings or attendance at an event, it is not a qualified sponsorship payment under this provision. Even though a payment is not a qualified sponsorship payment it may be excluded from UBIT under other exceptions to UBIT, including for example, the rent, royalty or “not regularly carried on” exceptions.
Benefits are disregarded in determining whether a payment results in UBIT if the annual fair market value of all the benefits to the sponsor in return for the sponsorship payment is not more than 2% of the amount of the payment to the tax-exempt organization. The burden of showing the fair market value of the benefits rests on the tax-exempt organization.
If the benefits the sponsor receives exceed 2% of the payment, then there is a substantial return benefit, the fair market value of which may be taxable to the organization if another exception to UBIT does not apply. Examples in the regulations describe a range of benefits that a sponsor could conceivably receive in return for a payment including, for example: advertising, tickets to events, free use of facilities, services or rights to use intangible assets such as the organization’s name, logo, patents, etc.
It is important that each element of the sponsorship contract is analyzed on its own. For example, if a sponsor of an event gets a certain number of “free” tickets in return for the sponsorship there may be a substantial return benefit. However, if the performance is in furtherance of the organization’s exempt function then the sale of the tickets would not create UBI and therefore the organization would not be subject to UBIT for the ticket sales income. On the other hand, if in addition to the “mere acknowledgement” in the event program the sponsor also receives a full page color ad in the organization’s periodical, then a determination must be made of the fair market value of the advertising and that amount will most likely be subject to UBIT.
Acknowledgement Or Advertising
A payment will typically be treated as a qualified sponsorship payment if the sponsor is merely acknowledged for making the payment. The regulations provide that the following will be considered acknowledgement and will not result in a substantial benefit being given to the sponsor:
Exclusive sponsorship arrangements; logos and slogans that do not contain qualitative or comparative descriptions of the payor’s products, services, facilities or company; a list of the payor’s locations, telephone numbers or Internet address; value-neutral descriptions, including displays or visual depictions, of the payor’s product line or services; and the payor’s brand or trade names and product or service listings.
The regulations also contain examples related to web-based sponsorships which are becoming increasingly popular. A hyperlink to the sponsor’s commercial website and posting of its name on the organization’s website are considered to be sponsor acknowledgement and not advertising. However, if the organization endorses the sponsor or its products, either on its own website or on the sponsor’s website, the sponsorship will be considered advertising.
On the other hand, advertising is a substantial return benefit. Advertising is defined as:
Any message or other programming material which is broadcast or otherwise transmitted, published, displayed or distributed, and which promotes or markets any trade or business, or any service, facility or product. Advertising includes messages containing qualitative or comparative language, price information or other indications of savings or value, an endorsement or an inducement to purchase, sell or use any company, service, facility or product.
The regulations provide that if a message contains both advertising and acknowledgement the entire message will be deemed to be advertising.
Sponsorships from businesses are a good source of funds for many tax-exempt organizations. Many companies are very willing to enter into sponsorship arrangements structured so that there is no advertising component. In order to report the amounts received properly it is necessary to look at the entire agreement between the sponsor and the organization and analyze each element of consideration. Although each element of a contract may not meet the qualified sponsorship payment safe harbor, there may be other exceptions available that exclude the payments from UBI.
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