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Charities Beware of Hidden Taxes: Planning
for Corporate Sponsorship
Date: Summer 1998
In recent years, corporate
sponsorship of particular activities and events of exempt
organizations has emerged as a new and important form of fundraising.
While the benefits of corporate sponsorship are clear, the tax
consequences are not. Without careful planning, such sponsorship can result in
taxable income to the exempt organization because it may be treated by
the IRS as payment for commercial-type advertising.
Mere recognition or acknowledgment of
a contribution from a corporate sponsor is generally considered
incidental to an exempt organization’s activities and does not cause
the contribution to be treated as a payment for advertising services.
If the sponsorship payment is, however, made as a quid pro quo for advertising or promotional services provided by the
exempt organization, the payment may be deemed advertising subject to
unrelated business taxable income under Section 511(a) of the Internal
Revenue Code. Proper
negotiation and drafting of sponsorship agreements may determine the
manner in which a payment is treated for tax purposes, with a
corresponding impact on the financial benefits of the fundraising
activity. Excessive
amounts of taxable income can even jeopardize a charity’s tax exempt
status.
Years of uncertainty as to the proper
tax treatment of corporate sponsorship led to the recent codification
of Section 513(i) of the Internal Revenue Code.
This new law provides that certain types of payments, known as
“qualified sponsorship payments,” will not be treated as taxable
income. A “qualified sponsorship payment” is any payment from
which the donor/sponsor does not expect any substantial return benefit
other than the use or acknowledgment of the sponsor’s name, logo, or
product line in connection with an exempt organization’s activities.
Beware, however, of a payment for which the sponsor is entitled
to advertising, such as messages that contain qualitative or
comparative language, price information, an endorsement, or an
inducement to buy, sell, or use the sponsor’s products or services.
Payments entitling a donor to these types of benefits will
likely be deemed taxable income to the exempt organization. Interestingly, distribution by an exempt organization of a
sponsor’s product at an event, whether for free or for remuneration,
is permissible as a “use or acknowledgment” of the sponsor’s
name, logo or product line, and is not treated as an inducement to buy
the sponsor’s products. This
interpretation demonstrates a realistic understanding by Congress of
how corporate sponsorship arrangements generally work.
For example, if a health food manufacturer sponsors a
triathlon, and in addition to providing substantial funding for the
race also donates its health food bars for distribution to all
participants during and after the race, it makes little sense to
impose a tax penalty on the exempt organization for accepting this
donation.
A payment will not be considered a
“qualified sponsorship payment” (and will therefore be taxable) if
the amount is contingent upon the level of attendance at an event,
broadcast ratings, or other indicia of public exposure.
On the other hand, a payment which is contingent on the event
actually taking place is not necessarily subject to tax.
One situation which frequently arises
with our clients is the “mixed purpose payment.”
For example, a corporate sponsor may make one lump sum payment
to the exempt organization reflecting both a straight donation and
payment for advertising of the sponsor’s products.
Ideally, only the portion of the payment related to the
advertising should be taxable. Under
prior law, however, it was uncertain whether the advertising component
would “taint” the payment, making the entire amount subject to
tax. The legislative
history of Section 513(i) clarifies that, in the case of mixed purpose
payments, the payment should be allocated among its various components
on a fair market value basis. Accordingly,
the fair market value of the advertising component may be subject to
tax and the remainder of the payment may constitute a “qualified
sponsorship payment.”
Exempt organizations should keep
Section 513(i) in mind whenever entering into an agreement with a
corporate sponsor. Fairly
subtle modifications to the description of services or benefits
provided by the exempt organization in exchange for the payment can
determine whether or not the payment results in taxable income.
In the case of a mixed purpose payment, specific allocations
based on fair market value between the taxable advertising component
and the nontaxable “qualified sponsorship payment” should be
substantiated and documented by the exempt organization.
We frequently recommend that, in the case of such mixed purpose
payments, the various components be documented in entirely separate
agreements to minimize any potential confusion on the part of the IRS
as to the proper allocation of funds.
With proper application of the law
and drafting of agreements, charities can avoid paying unnecessary
taxes.
Our
Tax Department handles a wide range of federal, state and
international tax matters involving tax planning for high net worth
individuals, partnerships and corporations with particular emphasis on
the entertainment industry. We have extensive experience in
structuring real estate transactions, motion picture financings,
partnerships and syndications, structuring the purchase, sale and
reorganization of companies, and executive compensation arrangements.
Rosenfeld,
Meyer & Susman was founded in 1957. The firm's areas of expertise
include: Tax, Litigation, Corporate, Entertainment, Estate Planning,
Trusts and Probate, Labor and Employment Law, Real Estate, Family Law,
Insurance Coverage and Defense, Real Estate and Employee Benefits Law.
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