Exempt organizations, despite their tax-preferred status, often still have tax liabilities when income is derived from unrelated trade or business activities. Obvious examples, like merchandise sales, tend to be easier to interpret than certain fundraising activities, like corporate sponsorships and advertisements.
The line between what’s taxable and what’s exempt can become blurred depending on the situation and language used. Even if this income is used primarily to support the organization’s mission, there are still instances where it is taxable.
At a glance:
- Advertising usually triggers unrelated business income tax for exempt organizations.
- Corporate sponsorships usually remain exempt income unless there is a substantial return benefit.
- Issues in practice, like a charity fundraiser event or walk-a-thon, are examined.
- Sponsorship contracts may need to be examined for evidence of language or deliverables that could trigger tax liability.
Unrelated Business Income
Most nonprofit income sources, like individual or corporate donations and grants, are exempt. Unrelated business income, which is derived from a trade or business, regularly carried on, and not substantially related to the organization’s mission, triggers tax liability. When a nonprofit incurs unrelated business income, it must follow specific calculating and reporting requirements.
Two of the more common forms of unrelated business income are advertising and corporate sponsorships. Advertising is usually taxable income whereas sponsorships are usually exempt, but this isn’t always the case. The question becomes, when does a corporate sponsorship become advertising subject to unrelated business income tax?
Advertising for Nonprofits Defined
In general, the IRS views advertising as taxable unrelated trade or business activity to the exempt organization.
Advertising includes messages containing qualitative or comparative language, price information or other indications of savings or value, an endorsement, or an inducement to purchase, sell, or use any company, service, facility, or product. A single message that contains both advertising and an acknowledgement is advertising.
Non-Taxable Advertising Activities
Some types of related advertising activities are still non-taxable income.
IRS Regulation 1.513-4 does not apply to income derived from the sale of advertising or acknowledgments in exempt organization periodicals. The term periodical means 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. This also includes material that is published electronically.
The IRS has special rules for printed publications depending on whether the periodical readership costs exceed the circulation income. If Circulation income exceeds readership costs, then the advertising would be taxable. For further information, read our article on our article on Exempt Organization Periodicals.
See IRS Regulation 1.512(a)-1(f) for more detailed information.
Trade Shows and Conventions
Qualified convention and trade show activities are also usually exempt from tax if:
- The activities are designed to drive attendance to a show for the purpose of either stimulating interest in or educating attendees on products or matters important to that industry, and
- The organization sponsoring the event is exempt and regularly conducts tradeshows as part of its core purpose.
Tradeshow income may be taxable if the organization is not hosting it along with an annual meeting or if the show’s purpose is to bring buyers and sellers together.
The IRS Regulation 1.513-3 governs qualified convention and trade show activity.
Differences between Sponsorships and Advertising
When exempt organizations receive qualified sponsorship payments, it does not constitute unrelated trade or business income except with respect to payments made in connection with qualified convention and trade show activities, noted above.
A Qualified Sponsorship Payment is any payment by any person or entity wherein they will not receive any substantial benefit in return except for a use or acknowledgment. A Substantial Return Benefit is any benefit other than use of a name, logo, or product lines or an acknowledgment of the payment.
Certain benefits may be disregarded if those benefits received during the organization’s taxable year are not more than two percent of the amount of the sponsorship payment.
Corporate sponsorships must always have a quantitative nature. If language becomes qualitative, the sponsorship crosses over to advertising. The wording matters.
For example, if a local business donates $5,000 to be a sponsor of a charity’s annual fundraising dinner, and in return the charity posts the corporate name and logo on a sign that says, “Thank you to our sponsor, Acme Company!” that is a corporate sponsorship, which is nontaxable. However, if the sign says “Acme Company is the best at what they do! Thank you for your support!” then the sponsorship would be taxable.
An arrangement that acknowledges the payor as the exclusive sponsor of an exempt organization’s activity, or the exclusive sponsor representing a particular trade, business, or industry, generally does not, by itself, result in a substantial return benefit. If an organization announces that the event is sponsored exclusively by the payor and does not provide any advertising or other substantial return benefit to the payor, the payor has not received a substantial return benefit.
On the other hand, being the exclusive provider, an arrangement that limits the sale, distribution, availability, or use of competing products, services, or facilities in connection with an exempt organization’s activity, generally results in a substantial return benefit.
For example, if in exchange for a payment, the exempt organization agrees to allow only the payor’s products to be sold in connection with an activity, the payor has received a substantial return benefit.
Nonprofit Advertising and Sponsorship in Practice
Example 1: A symphony orchestra (“the organization”) maintains a website containing pertinent information and its performance schedule. The local music shop makes a payment to the organization to fund a concert series, and the organization posts a list of its sponsors on its website, including the local music shop’s name and internet address. The organization does not promote the local music shop or advertise its merchandise. The local music shop’s internet address appears as a hyperlink from the organization’s website to the local music shop’s website.
This constitutes an acknowledgment of the sponsorship. The entire payment is a qualified sponsorship payment, which is not income from an unrelated trade or business.
Example 2: A local charity organizes a walkathon and fun run at which it serves drinks and other refreshments provided free of charge by a beverage corporation. The beverage corporation also gives the charity prizes to be awarded to winners of the event. The charity recognizes the assistance of the corporation by listing the beverage corporation’s name in promotional fliers, in the newspaper advertising the event, and on participant T-shirts. The charity changes the name of its event to include the name of the beverage corporation. The charity’s activities constitute acknowledgment of the sponsorship.
The drinks, refreshments and prizes provided by the beverage corporation are a qualified sponsorship payment, which is not income from an unrelated trade or business.
Example 3: An art museum organizes an exhibition and receives a large payment from a corporation to help fund the exhibitions. The museum recognized the corporation’s support by using the corporate name and logo in materials publicizing the exhibition. The museum also hosts a dinner for the corporation’s executives. The fair market value of the dinner exceeds two percent of the total payments. The museum’s use of the corporate name and logo in connection with the exhibition constitutes acknowledgment of the sponsorship.
However, because the fair market value of the dinner exceeds two percent of the total payment, the dinner is a substantial return benefit. Only the portion of the payment that exceeds the fair market value of the dinner is a qualified sponsorship payment.
Issues to Look For
It can be complicated to differentiate between a corporate sponsorship and advertising. Nonprofits can have very similar situations that end up with different tax treatment due to the substantial return benefits received.
Nonprofit leaders will want to review sponsorship contracts for any evidence of:
- Substantial return benefit or payments contingent on attendance
- Payment based on acknowledgement
- An exclusive provider arrangement
If an acknowledgement is part of the contract, nonprofits need to be aware that if there is any mention of qualitative or comparative language, pricing, indications of savings or value, or an endorsement of any kind, the sponsorship would trigger unrelated business income tax.
If you have questions about your specific situation, contact Tax Partner Ed Yoder or your tax advisor at PBMares.