As the economy struggles, tax-exempt organizations are facing financial challenges. With declining endowments and decreasing charitable contributions, many exempt organizations are considering creative ways to obtain funding. Corporate sponsorships remain one excellent opportunity. If structured correctly, corporate sponsorship arrangements can provide an organization with tax-free income that counts as public support to the organization while giving the corporate sponsor a tax-deductible expense and an opportunity to keep its name before the public.
Qualified Sponsorship Payments
Sec. 513(i) provides that a tax-exempt organization’s solicitation and receipt of “qualified sponsorship payments” does not constitute an unrelated trade or business and hence does not trigger unrelated business income tax. A qualified sponsorship payment is any payment made by a person engaged in a trade or business for which there is no arrangement or expectation that such person will receive any substantial return benefit other than the use or acknowledgment of the name, logo, or product lines of the person’s trade or business in connection with the recipient organization’s activities.
Evaluating Return Benefits
Generally, when acknowledging a corporate sponsor, organizations may list the sponsor’s location, telephone number, or internet address, and may provide a link to the sponsor’s website. Value-neutral descriptions, including displays or visual depictions, of the sponsor’s product line or services are permitted. Distribution, whether free or for remuneration, of a sponsor’s product at the sponsored activity also will not result in a substantial return benefit.
Organizations should avoid using any wording that could turn an intended acknowledgment into advertising. Advertising includes messages containing qualitative or comparative language, price information, or other indications of savings or value, endorsements, and inducements to purchase, sell, or use particular products or services.
Organizations should also carefully consider any exclusivity arrangements. If an organization allows a business to be the exclusive sponsor of an event, the mere acknowledgment as exclusive sponsor generally does not result in a substantial return benefit. However, allowing the corporation to be an exclusive provider generally would result in a substantial return benefit. Exclusive provider arrangements generally include those that limit the sale, distribution, availability, or use of competing products, services, or facilities in connection with an exempt organization’s activity.
Corporate sponsorship arrangements structured with a contingent payment also fall outside the definition of qualified sponsorship payment. If a payment is contingent upon the level of attendance at one or more events, broadcast ratings, or other factors indicating the degree of public exposure to the sponsored activity, it will not satisfy that definition. Other substantial return benefits include exclusive or nonexclusive rights to use goods, facilities, services, intangible assets such as trademarks or logos, and other privileges.
In evaluating whether a tax-exempt organization has received a substantial return benefit, all benefits other than the sponsor acknowledgment must be taken into account. However, if the aggregate fair market value of all benefits provided to the sponsor is not more than 2% of the total amount of the payment, the benefits will be disregarded.
What Happens If the Sec. 513(i) Exclusion Does Not Apply?
Tax-exempt organizations would prefer that the Sec. 513(i) exclusion from unrelated business taxable income apply to all revenue received from corporate sponsorship arrangements. However, if a substantial return benefit is deemed provided, all may not be lost.
- Regs. Sec. 1.513-4(d) provides for an allocation where a portion of a payment would, if made as a separate payment, constitute a qualified sponsorship payment and the other portion would not, thus allowing the organization to treat each such portion as a separate payment.
- If certain activities of the tax-exempt organization cannot be treated as permissible acknowledgments, the normal rules under Secs. 512–514 should be applied to determine whether such activities constitute an unrelated trade or business that is regularly carried on.
- If the tax-exempt organization recognizes unrelated business income as a result of certain corporate sponsor activities, the organization should identify and capture expenses that it can deduct from the revenue to arrive at net unrelated business taxable income. Only expenses that are directly connected with carrying on an unrelated trade or business are permissible deductions, but expenses can be allocated between exempt and nonexempt uses on a reasonable basis (Regs. Sec. 1.512(a)-1(c)).
Tax Treatment to Sponsoring Corporation
By partnering with tax-exempt organizations, for-profit corporations may gain access to a valuable marketing opportunity, allowing them to reach target audiences while supporting the important efforts of tax-exempt entities. Depending on the particular facts, a corporate sponsorship payment may be deductible under Sec. 162 as an ordinary and necessary business expense or under Sec. 170 as a charitable contribution. According to Regs. Sec. 1.513-4(e)(3), the fact that a payment is a qualified sponsorship payment treated as a contribution to the payee organization does not determine whether the payment is deductible by the payer under Sec. 162 or Sec. 170.
Deduction as a charitable contribution requires an intent to make a gift. A corporation’s expectation of a return benefit may suggest a lack of gratuitous intent and could disqualify the deduction under Sec. 170. Deduction as a business expense requires that the payment must be an ordinary and necessary expense of carrying on the taxpayer’s trade or business. Regs. Sec. 1.162-20(a)(2) provides that expenditures for institutional or goodwill advertising, which keep the taxpayer’s name before the public, generally are deductible as ordinary and necessary business expenses if the expenditures are related to the patronage the taxpayer might reasonably expect in the future.
If a payment appears potentially eligible for deduction under either provision, the corporation may be able to evaluate which provision affords it the greatest tax savings. When making this determination, corporations should take into consideration the limits on charitable contributions. Corporate charitable contribution deductions are limited to 10% of taxable income (as computed under Sec. 170(b) (2)(C)).
Each year businesses spend significant amounts for cause-related event sponsorships and similar expenses. These partnerships can be beneficial to both the sponsoring corporation and the tax-exempt organization. With the proper structuring, these arrangements can provide tax advantages to both parties.
When structuring corporate sponsorship arrangements, in order to avoid having the arrangement treated as an unrelated trade or business, tax-exempt organizations should be careful to limit any provision of goods or services in return for a sponsorship payment such that the return benefits do not exceed 2% of the total payment. To stay under this threshold, organizations must ensure that they are properly assessing all the return benefits provided.
For corporations, choosing the right organization with which to partner can have a significant impact on marketing efforts. During a down economy, taxexempt organizations and corporations can look for corporate sponsorship opportunities that can benefit both parties.
Annette Smith is with Price-waterhouseCoopers LLP, Washington National Tax Services, in Washington, DC.
Unless otherwise noted, contributors are members of or associated with Pricewater-houseCoopers LLP.
For additional information about these items, contact Ms. Smith at (202) 414-1048 or email@example.com.