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IRS issues corporate sponsorship prop. regs.

On March 1, the IRS published proposed regulations on the income tax treatment of corporate sponsorship payments received by exempt organizations. Corporate sponsorship payments are a significant source of revenue for many exempt organizations and often provide much-needed funding for exempt activities. The proposed regulations contain some surprises that could significantly increase exempt organizations' tax burden from sponsorship arrangements, especially when the payments are from "exclusivity arrangements."


In 1991, the Service issued Letter Ruling (TAM) 9147007, dealing with the tax treatment of corporate sponsorship payments in connection with a major college bowl game, and subsequently issued proposed audit guidelines for corporate sponsorship payments (Ann. 92-15). The TAM and the audit guidelines, which would have treated most sponsorship payments as unrelated business income (UBI), were widely criticized and created much controversy. The IRS responded in 1993 with proposed regulations under Sets. 511-513 that were more "taxpayer-friendly" generally treating corporate sponsorship arrangements as nontaxable events, by focusing on the distinction between "acknowledgments" and "advertising." Acknowledgments were defined as recognition or identification of the sponsor; advertising was defined as a communication that promoted or marketed a company, service, facility or product. Under the 1993 proposed regulations, acknowledgements were not UBI; however, advertising was. The 1993 proposed regulations included a tainting rule that would treat an entire sponsorship payment as advertising if any portion of the activity or message was advertising.

Sec. 513(i)

The 1993 proposed regulations under Sec. 513 were never finalized. Sec. 513(i) was added to the Code by the Taxpayer Relief Act of 1997, and generally codifies many of the provisions of the 1993 proposed regulations. Sec. 513(i) provides that an exempt organization's UBI does not include any amount that is a qualified sponsorship payment (QSP). A QSP is a payment in which there is no expectation that the payor will receive any substantial return benefit other than the use or acknowledgement of its name or logo. A substantial return benefit includes advertising. The proposed regulations define advertising as a message or other programming materials that promote or market any trade or business or any service, facility or product. A substantial return benefit also includes providing services, facilities or an exclusive or nonexclusive right to use an intangible asset, to the payor or the payor's designees.

Exclusivity Arrangements

The most significant aspect of the new proposed regulations is the treatment of exclusivity arrangements. Prop. Regs. Sec. 1.513-4(c)(2)(v) distinguishes between two types of exclusivity arrangements: exclusive sponsor arrangements and exclusive provider arrangements. Exclusive sponsor arrangements, in which an exempt organization acknowledges the payor as the exclusive sponsor of the organization's activity or as representing a particular trade or business, does not, by itself, constitute a substantial return benefit. Exclusive provider arrangements that limit the use, sale, distribution or availability of competing products generally do result in a substantial return benefit and, therefore, would not be QSPs.

Exclusive provider arrangements are common for colleges and universities and other large exempt organizations, and include athletic apparel and soft drink "pouring rights" contracts. These contracts can be a significant source of revenue to fund both athletic and academic programs. Although the exclusion from QSP treatment does not necessarily result in UBI, some Service officials have indicated informally that these types of substantial return benefits ought to be subject to tax.

Payment Allocation Rules

Prop. Regs. Sec. 1.513-4(d) eliminated the tainting rule and allows for allocation of a payment between the value of the substantial return benefit and the QSP portion. To the extent a payment is not a QSP, the non-QSP portion must be evaluated separately, to determine if it is UBI (and, therefore, taxable to the exempt organization). To avail itself of the allocation rule, the burden is on the organization to establish that the payment exceeds the fair market value of the substantial return benefit. Failure to do so will result in the entire payment being characterized as a non-QSP. Further, if the taxpayer fails to make a "reasonable and good faith valuation," the IRS may determine the Portion of a payment that is the substantial return benefit under an anti-abuse provision.

The payment allocation rules place a premium on the establishment and documentation of the value of any substantial return benefit. Lack of contemporaneous documentation by exempt organizations can lead to the same result as the old tainting rule--the entire payment being treated as UBI.

UBI Expense Allocations

The new proposed regulations also significantly affect the ability of exempt organizations to use expenses from exempt activities to offset income from unrelated activities. An example included in the 1993 proposed regulations, on activities associated with the conduct of a college bowl game, allowed the exempt organization to offset net income from an unrelated business activity (selling clothing with the bowl name and logo) with excess expenses of an exempt activity (conducting a bowl game). The Service states in the new proposed regulations that this example interprets Regs. Sec. 1.512(a)-1(d) too broadly. The new proposed regulations disallow the offset of income from an unrelated business activity with expenses from an exempt activity, unless the unrelated and exempt activities are "closely connected" (i.e., a taxable entity conducting the same business activity would also normally conduct the exempt activity). Therefore, if the exempt and unrelated activities conducted by an organization result in an overall loss, the organization will still pay tax on any net income from the unrelated activity, unless the exempt and unrelated activities meet the higher "closely connected" standard set forth in the new proposed regulations.

The new proposed regulations follow the old proposed regulations and the legislative history of Sec. 513(i) in many respects. However, the new proposed regulations significantly curtail the favorable treatment of the 1993 proposed regulations by treating exclusive provider arrangements as a non-QSP, placing the burden on the exempt organization to establish and document the substantial return benefit, and narrowing the expense allocation rules. The new proposed regulations will likely result in more UBI from corporate sponsorship arrangements. Exempt organizations with corporate sponsorship arrangements need to be aware of the effect the new proposed regulations will have on their operations and fundraising activities. The IRS is requesting comments on these regulations and has scheduled a public hearing for June 21, 2000. Exempt organizations are strongly encouraged to participate in this process.

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Title Annotation:IRS proposed regulations concerning tax-exempt organizations
Author:Locastro, Richard J.
Publication:The Tax Adviser
Geographic Code:1USA
Date:Jun 1, 2000
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