The distinction between advertising and sponsorship income is extremely important, since net advertisement revenue is generally subject to the unrelated business income tax (UBIT), while sponsorship revenue is tax-free. Here’s how to make the distinction less confusing.
The revenue received by nonprofit organizations, including associations, must be classified as either income related to the organization’s exempt purposes and exempt from tax, or as unrelated business income and taxable. Many times, that distinction is difficult to make.
Simply put, the revenue from a for-profit business paid to an association is either the purchase of advertisements to support the for-profit business or sponsorship revenue to support the association. The distinction is extremely important, since net advertisement revenue is generally subject to the unrelated business income tax (UBIT), while the sponsorship revenue is tax-free.
Furthermore, even if the association determines that the revenue is a sponsorship, the IRS may not agree. Therefore, it is essential that the advertisement agreement or the sponsorship agreement clearly set forth the expectations of both parties.
Sponsorships—No Specific Benefit Allowed
A corporate sponsorship is defined as a payment received by a nonprofit for the purpose of sponsoring that nonprofit’s activities. The corporate sponsor receives an acknowledgement for the sponsorship, rather than any promotion of its services or products.
Corporate sponsorships are excluded from the general rules of unrelated business income and are exempt from tax. A qualified sponsorship payment is any payment from a business to a nonprofit where there is no substantial return benefit. The law defines substantial return benefit as a benefit that is more than a mere acknowledgement that the corporation provided funds to the association.
However, if the corporate sponsor receives benefits in return for its sponsorship payment that amount to more than 2 percent of the sponsorship payment, then the entire amount of the payment will be UBIT, assuming it is from an unrelated, regular business activity of the association.
Benefits provided to the corporate sponsor include advertising, rights to use the nonprofit’s intangible property including mailing or membership lists, use of facilities, an exclusive provider arrangement (e.g., the nonprofit will sell only the products of the corporate sponsor), and other privileges provided to the sponsor that are not provided to the general public.
Advertising income compensates the association for services it provides to the corporation, including the association’s promotion of the corporation’s goods and services. Net advertising income is generally subject to UBIT.
The term advertising means any message or programing material, which is broadcast or otherwise published, that promotes any business, service, facility, or product. The term includes messages containing qualitative or comparative language; price information or other indications of savings or value; and an endorsement or an inducement to purchase, sell, or use any company, service, facility, or product.
Advertising income may escape taxation if the economic activity is not regularly carried on or if the economic activity is carried on only by volunteers. For example, advertising revenue accepted in connection with an event that is held only once would not result in UBIT. Also, if the advertising is accepted in connection with an event organized and operated by volunteers, the revenue would not be subject to UBIT. Another exception is if the advertising is related to the association’s exempt purpose.
The corporate sponsorship exception for acknowledgements is generally not available for regularly published periodicals, including online publications. Even a mere acknowledgement is still advertising. However, in a ruling issued in 2003, the IRS stated that an online banner with just the corporation’s name is not advertising. The key distinction is whether the corporate acknowledgement is part of an online periodical or just a link. If just a link, then it may qualify as a corporate sponsorship. However, if the link takes the reader to an endorsement from the association on the for-profit’s website, then that revenue will be classified as advertising income.
Bottom line: The understanding of corporate sponsorships versus advertising is filled with unexpected twists and turns, so consult Treasury regulations or a tax professional for guidance.
About the Author
Nancy Ortmeyer Kuhn is director and partner of Washington, DC-law firm Jackson & Campbell. This article is not intended to be legal advice, and the comments are general in nature. The specific facts of any situation must be separately analyzed and classified accordingly. The full article on this topic appears in the July/August 2014 issue of Signature magazine.