The Business of Charity
EXECUTIVE SUMMARY * THE TREASURY DEPARTMENT ISSUED PROPOSED regulations in 2000 that are the latest round in the sponsorship payment debate between the IRS and NPOs. The regulations replace those proposed in 1993. Although they provide helpful guidance, they may also increase an organization's risk of incurring the unrelated business tax. * THE MAIN ISSUE NPOs FACE IS WHETHER a payment received from a sponsor constitutes advertising or sponsor acknowledgement. Advertising is normally taxed as unrelated business income, while qualified sponsorship payments escape tax. * NPOs SHOULD STRUCTURE THEIR RECEIPTS as qualified sponsorship payments whenever possible. However, when NPOs also provide taxable substantial return benefits to sponsors, the NPO has the burden of valuing these benefits to avoid taxation of the entire sponsorship payment. * THE PROPOSED REGULATIONS INTRODUCE a controversial interpretation for exclusive provider arrangements. When an NPO accepts sponsorship payments for an event and agrees to limit products or services offered to the sponsors, the exclusive provider arrangement will result in a substantial return benefit to the sponsor and taxable income to the NPO. This will likely affect the way NPOs structure sponsor agreements. * THE NEW RULES ELIMINATE THE PRACTICE of allocating excess deductions between one unrelated business activity and sponsored events with substantial return benefits. Prior proposed regulations allowed an offset of profits and losses; the new regulations would require the two activities to be closely connected. NPOs must structure corporate sponsorship payments carefully. Corporate sponsorships are big business. Charities and other not-for-profit organizations increasingly rely on these payments to support their missions. In fact, today it is unusual to find a charitable activity--large or small--that does not have a corporate sponsor. The Cotton Bowl is now the Southwestern Bell Cotton Bowl. The Bob Hope Desert Classic today is called the Bob Hope Chrysler Classic. Local businesses provide uniforms for little league baseball teams. Banks sponsor two-mile fun runs. CPAs need to know the tax implications of corporate sponsorship payments and proposed regulations regarding those payments. Those who advise or work for NPOs should be aware of the effect these rules will have on corporate sponsorship of charitable activities and events. TAXABLE OR NOT? The IRS and NPOs have debated the taxability of corporate sponsorship payments for the last decade. The debate began when the IRS, noting the growth of lucrative sponsorship agreements between corporate America and NPOs, held that sponsorship payments Mobil Corp. made to the Cotton Bowl Athletic Association were considered advertising and thus taxable as unrelated business taxable income (UBTI). The Treasury Department issued proposed regulations in 1993 which provided initial guidance on when payments were taxable. Congress amended the law in 1997 to exempt certain sponsorship payments from the unrelated business income tax. The proposed regulations the Treasury issued in 2000 will replace the 1993 regulations. An initial review suggests that more NPOs may now have payments taxed as UBTI under these new guidelines. A BREAK IN THE CLOUDS Even with the proposed regulations, the distinction between taxable advertising and tax-free sponsor acknowledgements remains clouded. Advertising, which is normally taxable to an NPO as UBTI, is defined as any message or programming material presented to the general public that promotes a business, service or product in exchange for a payment. On the other hand, an acknowledgement that can be characterized as a qualified sponsorship payment (QSP) is tax-free to the NPO. QSPs are payments a business sponsor makes to an NPO that do not result in a "substantial return benefit" to the sponsor. …