Corporate Sponsorship Regulations.

IRS-proposed regulations limit what qualifies as tax-free for exempt organizations.

ON MARCH 1, 2000, THE INTERNAL Revenue Service issued a revised set of proposed regulations to address the taxation of corporate sponsorship payments made to exempt organizations, including associations. The proposed regulations include new and burdensome requirements on associations, which might otherwise have expected to avoid tax on these nondues revenue sources. Although the proposed regulations will not become effective until they are published in the Federal Register, as a practical matter, the proposed rules should be the basis for association compliance efforts in this area until the IRS provides more definitive guidance.

Background on corporate sponsorship

The issue of corporate sponsorship has been of interest to associations since the early 1990s, when the IRS first attempted to tax certain kinds of corporate sponsorship revenues received by tax-exempt organizations. For instance, the IRS characterized some sponsorship payments as advertising, which has long been subject to unrelated business income tax. In 1993, after much controversy, the IRS proposed that funds received solely for use in acknowledging and recognizing corporate sponsors would not be subject to UBIT, although even a minor amount of advertising would taint the entire sponsorship payment and subject it to tax.

In 1997, Congress passed the Taxpayer Relief Act. This law amended the Internal Revenue Code by adding Section 513(i) to address corporate sponsorship payments. The law exempts qualified corporate sponsorship payments from tax, but it defines the safe harbor for these payments in such a way that the payments are protected from tax only if the corporate sponsor had no expectation of a substantial return benefit, other than use of the sponsor's name, logo, or established slogan. Any advertising would still generate UBIT for the exempt organization.

Proposed corporate sponsorship rules

The IRS's proposed regulations address Section 513(i) and its treatment of corporate sponsorship payments. The proposal establishes a safe harbor for determining whether corporate sponsorship payments are free from UBIT for the recipient organization. The proposal defines a qualified sponsorship payment as "any payment of money, transfer of property, or performance of services by any person engaged in a trade or business with respect to which there is no arrangement or expectation that the person will receive any substantial return benefit." In determining whether a payment is a qualified sponsorship payment and thus tax-free to the recipient, it is irrelevant whether 1) the sponsored activity is related to the recipient organization's exempt purpose or 2) the sponsored activity is temporary or permanent.

The proposed regulations also provide a definition of a substantial return benefit that is not included in the statute. According to the IRS-proposed regulations, a substantial return benefit to the sponsor is 1) any benefit other than goods, services, or other benefits of insubstantial value or 2) use or acknowledgment of the sponsor's name or logo as defined in the rules. The proposed rules explain in very technical fashion that certain benefits to the sponsor have an insubstantial value only if they have an aggregate fair market value of not more than 2 percent of the amount of the payment, or $74, whichever amount is the least. Token items such as bookmarks, calendars, key chains, mugs, and so forth that bear the name and logo of the sponsor will generally not be considered a substantial return benefit. However, the exempt organization has the burden of establishing the fair market value of these token benefits.

Trade shows and periodicals

The safe harbor provided by the law and the proposed regulations does not apply to payments received in connection with trade shows or periodicals. Qualified trade show payments are considered separately as to whether they are exempt from UBIT. However, the proposed regulations state that the safe harbor does not apply to "income derived from the sale of advertising or acknowledgments in exempt organization periodicals." The proposed regulations define a periodical as regularly scheduled and printed material published by or on behalf of the exempt organization that is not related to and primarily distributed in connection with a specific event conducted by the exempt organization.

As a practical matter, if an association makes reference in a sponsorship agreement to providing a sponsor with "recognition in the association magazine," or uses similar language, this could be interpreted as an entitlement of the sponsor. In such a case, the recognition falls outside safe harbor parameters and is taxable. Unfortunately, nothing in the proposed regulations states that recognition and acknowledgment of sponsors are not subject to UBIT.

Advertising and UBIT

Under the proposed regulations, payments constituting advertising--as opposed to mere acknowledgments--are not considered a qualified sponsorship payment but rather would be subject to UBIT rules. While the line of demarcation between advertising and use or acknowledgment is not always clear, the proposed regulations provide examples of situations in which a payment would be considered a qualified sponsorship payment. Examples include using logos and slogans that do not contain qualitative or comparative descriptions of the sponsor's products, services, facilities, or company; listing the sponsor's location, telephone number, or Internet address; providing value-neutral descriptions, including displays or visual depictions, of the sponsor's product line or services; and using the sponsor's brand or trade names and product or service listings.

The proposed regulations define advertising as any message or other programming material that is broadcast or otherwise transmitted, published, displayed, or distributed, and that promotes or markets any trade, business, service, facility, or product. Messages with qualitative or comparative language, price information, or any other purchasing inducement would be considered advertising, and any related revenue treated as taxable. However, the proposed regulations do provide two specific exceptions for which a message is not considered advertising and would not affect the determination of whether a payment is a qualified sponsorship payment: 1) using logos or slogans that are an established part of a sponsor's identity; and 2) merely displaying or distributing a product by the corporate sponsor or the exempt organization at the sponsored activity.

Likewise, the proposed regulations, which clarify the scope of the allocation rule that Congress eventually adopted, would eliminate the strict tainting rule from the 1993 rules. This means that if a tax-exempt organization receives a combined payment consisting of qualified sponsorship payments and advertising (or any other payment that provides a substantial return benefit), the entire payment would not be considered income subject to UBIT. Only the portion of the payment to exceed the fair market value of the substantial return benefit would be considered a qualified sponsorship payment and would qualify for the safe harbor. For the portion of the payment that provides a substantial return benefit, a standard UBIT analysis would apply, and the taxability of that portion of the payment would be determined in accordance with existing IRS rules.

Exclusivity arrangements

One controversial aspect of the proposed regulations involves exclusivity arrangements. The proposed rules state that being the sole sponsor of an activity or the only sponsor representing a particular trade, business, or industry generally does not merit a substantial return benefit. Payments attributable to the exclusive sponsorship arrangement would be covered as qualified sponsorship payments. However, the proposed rules prohibit arrangements for which the sole sponsor is further designated as the exclusive provider of products or services. For example, if the organization agrees not to provide certain products or services that compete with the sponsor's products or services, the sponsor would be considered as having received a substantial return benefit and the payment would not be a qualified sponsorship payment. (It is unclear what the result would be if an exempt organization received a sponsorship payment from a vendor with which the organization separately has an exclusive affinity program arrangeme nt.)

The proposed regulations include numerous examples of exempt organization activities that may or may not lead to qualified sponsorship income. The examples suggest that certain activities will not give rise to UBIT: a corporate sponsor exclusively sponsoring a bowl game or similar athletic event, providing samples or refreshments in connection with a charitable event, or supplying uniforms to an amateur sports team. However, among the activities considered to provide a substantial return benefit are promoting sponsors in programs and flyers or providing admission passes to sponsored events.

Finally, it is important to keep in mind that even though a particular benefit may not be eligible for safe harbor treatment as a qualified sponsorship, it still may be exempt from UBIT under separate tax principles. For example, providing a corporate sponsor with complimentary conference registrations is considered a substantial return benefit that takes the payment out of the qualified corporate sponsorship safe harbor. However, conference registration fees are free from tax as qualified convention and trade show revenue under a separate exemption, Section 513(d) of the Internal Revenue Code, as are fees for exhibit space.

Jerald A. Jacobs is a partner at the law firm of Shaw Pittman, Washington, D.C., and is general counsel to ASAE.

ASAE Comments on Corporate Sponsorship Regulations

ASAE filed written comments with the IRS on May 30 that addressed specific areas of concern regarding the proposed regulations as they would apply to exempt organizations. ASAE disagrees with the IRS's presumption that an exclusive provider arrangement would per se be a substantial return benefit. ASAE also noted that the proposed regulations would impose an extra burden of proof for an exempt organization to show the fair market value of any given substantial return benefit. In addition, ASAE recommended removing the section from the regulations that deals with exploited exempt activity.

Jefferson C. Glassie, a partner with Shaw Pittman, Washington, D.C. summarized ASAE's written comments at an IRS corporate sponsorship hearing June 21. Among the items he highlighted was the question of whether and exempt organization can acknowledge sponsors in a periodical. He suggested that the regulations allow acknowledgement as long as they are legitimately done voluntarily by the exempt organization.

Glassie and witnesses from 13 other organizations represented at the hearing focused on the exempt organization community's opposition to the IRS exclusive provider provisions. Witnesses generally expressed concern with the IRS proposal.