Tax implications of advertising and sponsorships on association Web sites.

Associations are well aware that revenue from advertising in their magazines and newsletters is usually subject to taxation as unrelated business income. But what about revenue from advertising on exempt-organization Web sites? And how can advertising be distinguished from sponsorships? These issues are not yet entirely clear. However, an Internal Revenue Service ruling, explained by Elizabeth Teira in this column, provides some insight into the tax implications of online advertising and sponsorships.

A tax-exempt organization is subject to unrelated business income tax on net income derived from an unrelated trade or business. UBIT is imposed in cases where nondues revenue represents income that is generated from an ongoing trade or business that is not substantially related to the tax-exempt purposes of the organization. Based on Internal Revenue Service (IRS) regulations and on a 1986 U.S. Supreme Court case (United States v. American College of Physicians, 475 U.S. 834), revenue from nearly all kinds of advertising published in print periodicals of exempt organizations is subject to UBIT. The regulations are not so clear, however, when it comes to advertising on an association's Web site. In addition, a fine line differentiates advertising from sponsorship acknowledgment, particularly when the acknowledgment occurs on an association's Web site.

Determining tax status of sponsorships

The IRS corporate sponsorship rules give two examples of ways in which nonprofit organizations acknowledge sponsorship payments on the Internet,

The first example is an orchestra that has used sponsorship payments to fund a concert series and acknowledges its sponsors by posting their names and Internet addresses on its Web site. This example demonstrates an acceptable form of acknowledgment; and the sponsorship payment is not considered advertising revenue subject to UBIT.

The second example is a charity that sponsors an initiative to educate the public about a medical condition. A large pharmaceutical company provides funding for this initiative. The charity's Web site has a hyperlink to the pharmaceutical company's Web site on which the company states that the charity endorses the use of one of the company's products, This endorsement on the company's Web site is considered advertising. Hence, the payment made by the company to the charity may not be considered a tax-exempt sponsorship payment but, rather, is deemed taxable advertising revenue.

Further clarification

These two examples have left many associations questioning the tax consequences of sponsorship acknowledgment and advertising on nonprofit organizations' Web sites. Fortunately, a private-letter ruling issued by the IRS (Private Letter Ruling Number 200303062, October 22, 2002) provides further guidance. While a private-letter ruling is specific to the particular entity that has approached the IRS for an opinion, the letter may foreshadow the more formal guidance that the IRS has indicated it will soon issue.

The letter is addressed to a tax-exempt Section 501(c)(5) agricultural organization. Typical of many associations, the organization maintains relationships, through contract as well as through affiliation, with several service providers that offer benefits and services to members of the organization, such as insurance programs, rebate arrangements, discounted prescription eyewear, discounted farm and ranch equipment, discounted tires and batteries, and discounted movie and amusement park tickets. To inform its members of the arrangements with these service providers, the organization lists each service provider on its Web site and provides a description of the provider's services with a hyperlink to the provider's Web site. The letter addresses the tax status of any revenues that may result from different payment and advertising models related to the service providers' programs. Following are four of the more common arrangements:

1. Gratis listings. The letter states that in circumstances where the service providers make no payment to the organization for their Web site listings, the activity is not subject to UBIT. The letter notes that listing the availability of member benefits and providing contact information is consistent with the goals of the organization. The organization enters into arrangements with service providers to secure services that are beneficial to its members to "attract and retain members who are interested in and who support the purposes of the [organization] and to create a strong membership base that actively participates in the [organization's] exempt activities."

2. Licensing fees, The letter also addresses the issue of whether the activity would be subject to UBIT if the organization receives licensing revenues from the service providers as compensation for the listing and hyperlink. The letter states that where the organization does not provide any personal or other sewices to the service providers in connection with the agreement, the payments are considered royalty payments and are exempt from tax.

3. Banner advertising. Another question addressed by the letter is whether the revenues would still be exempt from tax if the organization also provided banner advertising on its Web site for the service providers in addition to the listing, description, and hyperlink. The IRS essentially concluded that value of banner ads would have to be treated as subject to UBIT.

4. Sponsorship payments. Finally, the language included in the IRS letter confirms the validity of the example of the orchestra sponsorship discussed earlier by stating that a sponsorship payment will not be subject to UBIT when the organization simply acknowledges the sponsor by providing a hyperlink to the sponsor's Web site.

The message from this IRS letter, while not binding legal precedent for other organizations, is that associations have a number of options for avoiding UBIT when providing information on their Web sites regarding the products and services of sponsors or vendor firms. This seems to be the case even where royalty-type payments are received in return. On the other hand, endorsements of products or services--whether appearing on the association's Web site or that of the vendor--and conventional advertising such as banner ads are likely features that will trigger UBIT treatment of the related net revenue generated for the association.

Elizabeth Teira is an associate in the Corporate Group and Jerald A. Jacobs is a partner in the Nonprofit Organizations Practice at Shaw Pittman, Washington, D.C. Jacobs edits this column and is general counsel to ASAE.