Ground Rules for Qualifying Sponsorship Payments

Corporate sponsorships have had their fair share of controversy. In the 1990s, the IRS took the audit position that Mobil Oil’s sponsorship payment to the Cotton Bowl constituted taxable unrelated advertising income for the nonprofit that organized the event. In subsequent years, the IRS took varying positions on the matter until 1997 when Congress weighed in with Internal Revenue Code (IRC) section 513(i). This specific section provides a safe harbor for certain payments that are deemed “qualified sponsorship payments” and, therefore, are not subject to the unrelated business income tax (UBIT).

What defines a “safe harbor”? A safe harbor is just that, i.e., if you are in the safe harbor you are automatically safe. Yet just because you fall outside the safe harbor does not necessarily mean that a payment is subject to UBIT, it just means that the organization may have to look to another IRC section to determine if the payment is subject to UBIT.

Organizations all over the United States receive significant revenue from sponsorships, so I thought it might be a good idea to go over a few of the ground rules:

1. Qualified sponsorship: IRC 513(i) provides that a tax exempt organization’s solicitation or receipt of a “qualified sponsorship payment” (QSP) is not subject to unrelated trade or business. A QSP is a payment made by a business where there is no “substantial return benefit” other than acknowledgement or certain insubstantial benefits. The safe harbor is not applicable to payments made where sponsors are acknowledged in periodicals, nor is the QSP safe harbor applicable to trade shows.

2. Insubstantial Benefits: Benefits are disregarded in determining whether a payment results in UBIT if the annual fair market value of all benefits to the sponsor in return for sponsorship payment is not more than 2% of the amount of the payment to the tax-exempt organization. If the benefits the sponsor receives exceed 2% of the payment, then there is a substantial return benefit, the fair market value of which may be taxable to the organization.

It is important that each element of the sponsorship contract is analyzed on its own. For example, if a sponsor receives a certain number of “free” tickets in return for sponsorship there may be a substantial return benefit. However, if the performance is in furtherance of the organization’s exempt function then the sale of the tickets would not create UBI and therefore the organization would not be subject to UBIT.

3. Acknowledgement or Advertising: A payment will typically be treated as a qualified sponsorship payment if the sponsor is merely acknowledged for making the payment. Anything considered acknowledgement will not result in a substantial benefit being given to the sponsor. On the other hand, advertising is a substantial return benefit, and has a broad definition. The regulations around advertising vs. acknowledgement provide that if a message contains both advertising and acknowledgement the entire message is deemed to be advertising.

Do you have any gray areas in your sponsorship agreement that might not be considered a qualified sponsorship payment?  

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