Sponsorships Can Create Tax Hazards for Charitable Organizations
March 2, 2020
Nonprofits can be Taxed if Corporate Sponsorships are Not Structured Properly
Corporate sponsorship for concerts, fairs, conferences, and other venues highly benefit non-profits. Corporations get free advertising and public recognition while non-profits receive tax-exempt revenue. But if done improperly, nonprofits can be subject to an unrelated business income tax.
Nonprofits Are Not Immune to Federal Income Tax
If the sponsored activities are not related to a nonprofit’s exempt purposes, an unrelated business income tax (UBIT) is imposed. Twenty-one percent, the regular corporate tax rate, along with other state income taxes, can be a sizable chunk of a nonprofit’s taxable revenue. Another situation where a non-profit can be taxed at 21 percent, or at the corporate rate, is when a corporation receives a benefit from the nonprofit for its donation which exceeds what the IRS calls a ‘qualified sponsorship payment’ exemption. This exemption allows nonprofits to acknowledge payment or donation by sponsors with different types of recognition and benefits. This recognition and benefit can be accomplished without being taxed for the entire donation by following the 2% rule.
IRS Code ‘Qualified Sponsorship Payment’ or the 2% Rule Explained
A qualified sponsorship payment, which is not taxable by the IRS, is made by a sponsor with no expectation of a ‘substantial return benefit’ from the nonprofit. But under federal law, any substantial return benefit made to the sponsor that exceeds 2 percent of the sponsor’s donation can be taxed. Keep in mind that this 2 percent rule does not include the sponsor’s name on signage, mugs, t-shirts, etc.. But how that sponsor name appears can be a fine line.
If the whole fair market value of benefits received by a sponsor in exchange for a payment made to a nonprofit does not exceed 2 percent of the sponsorship value, then any benefits including goods or services can be waived. An example of this would be if a nonprofit receives payment for corporate sponsorship to a benefit concert in the amount of $20,000. The nonprofit can give the sponsor return benefits at the fair market value of $400 or less without incurring the unrelated business income tax (UBIT). Not only are the benefits waived, but the entire donation by the corporation of $20,000 is a qualified sponsorship payment and is exempt from UBIT. Return benefits can include the following:
The corporate sponsor is the nonprofit’s exclusive provider. For instance, the nonprofit can say that the corporate sponsor, who happens to make laptops, is their exclusive ‘computer hardware’ provider.
Allowing the corporate sponsor to use an intangible asset belonging to the nonprofit like a copyright or logo.
Allowing privileges to sponsors for services or facilities belonging to the nonprofit. (Priority to event tickets)
If it is beyond the 2% rule, only the amount that surpasses the fair market value of the substantial return beneﬁt is counted as a qualiﬁed sponsorship payment. For example, the nonprofit decides to pay for an overnight stay for executives of the corporation the night of the concert. The cost of the overnight stay and the concert tickets are valued at $900. Under the 2% rule, the entire $900, a substantial return benefit, is considered taxable not just the $500 in excess of the 2 percent limit. If it does not qualify as an exemption, the ‘donation’ or payment from the sponsor that exceeds the fair market value of the concert tickets and the overnight stay at a hotel, in this case, $900, would reduce the non-taxable amount of the donation or qualified sponsorship payment to $19,100.
However, it’s not to say that the hotel stay and concert tickets could fall under another exemption under the UBIT rule. This is where the highly complex rules of UBIT need a review by a qualified tax professional.
Permitted Use and Acknowledgement Allowed by the IRS
The nonprofit can use the corporate sponsor’s logo or products or acknowledge their public ‘thanks’ to the sponsor because it is not considered a ‘substantial return benefit’ by the nonprofit. It is also NOT recognized as part of the 2 percent value of the sponsorship payment. The following is identified as permitted forms of use and acknowledgment by the IRS:
A list of the sponsor’s locations, phone numbers and websites
Displays or visuals of the sponsor’s product lines or services without promotional descriptions
The sponsor’s trade or brand name
The sponsor’s product line or services
Allow a sponsor to be the sole ‘exclusive’ sponsor for an event
The use of slogans and logos
Links to the sponsor’s website (but cannot directly link to a product or service sales page)
How to Recognize Your Sponsors and Avoid Taxable Advertising
Anything beyond the above categories for Use and Acknowledgement can be considered advertising. Low-key acknowledgments such as a vocal thank you during a speech can reach overly abundant promotion when there are personal endorsements or other inducements to buy from the corporate sponsor. Acknowledgment to advertising is a fine line. Advertising means any message from the nonprofit that markets any business, trade, service facility or product belonging to the corporate sponsor and can include:
Comparative or qualitative descriptions of a corporate sponsor’s product or service. (No other company can meet your networking needs like ABC Computing.)
Personal endorsements of the corporate sponsor’s service or product or facility. (I highly recommend ABC Computing, their service and pricing has helped us immensely.)
Indications of value or savings when buying from a sponsor. (ABC Computing has the best value for the price in the area.)
Enticements to purchase or use any of the sponsor’s products, service or facilities. (Use ABC Computing for your next hardware or network upgrade.)
Any advertising arrangement is reviewed under the 2% rule. For example, a message that states both an acknowledgment and advertising is considered fully advertising. But, the advertising rule only applies to advertising done by the nonprofit and not the corporate sponsor. Corporate sponsors can advertise their support of a nonprofit in any manner they deem fit.
Overall, every payment should be reviewed extensively for a qualified sponsorship exemption under UBIT. These rules include exceptions and are highly complex. Careful analysis of the payment and activities tied to it are required to avoid tax obligations.
The simplest way to adhere to these standards is to create policies and practices that proactively evaluate the requests for sponsorship and preventatively review the money that comes in. Reach out to the Lynch Law Firm regarding the functional way to institute these and other compliance considerations!