Corporate Sponsorship Regulations Finalized

In April 2002, the IRS released final corporate sponsorship regulations (Regs. Sec. 1.513-4). Effective as of April 25, 2002, they apply to payments received or solicited after 1997. Overall, the final regulations modify and clarify the previous proposed regulations. However, they also change the insubstantial-benefit standard and clarify the treatment of hyperlinks on an organization’s website.

Background

After a highly controversial decision in Technical Advice Memorandum (TAM) 9147007, which ruled that payments to the Cotton Bowl Athletic Association from its corporate sponsor were unrelated business taxable income (UBTI) under Sec. 512 because they were advertising income, the Service issued proposed regulations in 1993, allowing exempt organizations to receive sponsorship payments without incurring UBTI. Payments would be exempt if they did not rise to the level of advertising.

The 1993 proposed regulations distinguished advertising, which is an unrelated trade or business activity, from acknowledgments, which are merely recognitions of a sponsor’s payment. To accommodate this position in the Code, the Taxpayer Relief Act of 1997 added Sec. 513(i), which defines "qualified sponsorship payments" as payments made by a person engaged in a trade or business for which no arrangement or expectation exists that such person will receive any substantial return benefit other than the use or acknowledgment of the name or logo (or product lines) of the person’s trade or business in exempt-organization activities.

Sec. 513(i) provides further that use or acknowledgment does not include advertising (including messages containing qualitative or comparative language, price information or other indications of savings or value, or an endorsement or other inducement to purchase, sell or use a sponsor’s products or services). In general, Sec. 513(i) codified the 1993 proposed regulations, with some minor differences. To reflect these differences and to respond to comments submitted on the 1993 proposed regulations, the IRS issued new proposed regulations in March 2000.

2000 Proposed Regulations

Under the proposed regulations released in 2000, qualified sponsorship payments are not UBTI. A qualified sponsorship payment is a payment of money, a transfer of property or the performance of services, by any person engaged in a trade or business, when no arrangement or expectation exists that such person will receive any substantial return benefit in exchange for the payment (Regs. Sec. 1.513-4(c)(1)). A substantial return benefit is any benefit other than (1) a use or acknowledgment of the payor’s name or logo for exempt-organization activities (Regs. Sec. 1.513-4(c)(2)(i)) or (2) certain goods or services that have an insubstantial value (Regs. Sec. 1.513-4(c)(2)(ii)).

Any portion of a payment that exceeds the fair market value (FMV) of a substantial return benefit is a qualified sponsorship payment. The exempt organization has the burden of establishing FMV and making a reasonable, good-faith effort to do so. For example, if a sponsorship arrangement entitles a sponsor to both product advertising and use or acknowledgment of the sponsor’s name or logo by the organization, only the amount of the payment that exceeds the FMV of the product advertising provided to the sponsor (if any) is a qualified sponsorship payment (Regs. Sec. 1.513-4(d)).

The term "use or acknowledgment" includes logos and slogans that do not contain qualitative or comparative descriptions, store locations, phone numbers or Internet addresses. Use or acknowledgment of the name or logo is not a substantial return benefit to the payor (Regs. Sec. 1.513-4(c)(2)(iii)).

An arrangement that acknowledges the payor as the "exclusive sponsor" of an exempt organization’s activity does not alone result in a substantial return benefit (Regs. Sec. 1.513-4(c)(2)(v)(A)). However, an arrangement that limits the sale, distribution, availability or use of competing products, services or facilities for exempt-organization activities generally results in a substantial return benefit.

The portion of the payment attributable to the "exclusive provider" arrangement is not a qualified sponsorship payment (Regs. Sec. 1.513-4(c)(2)(v)(B)). Also, qualified sponsorship payments do not include payments contingent on attendance levels, broadcast ratings or other factors indicating the degree of public exposure of the sponsored activity (Regs. Sec. 1.513-4(e)(2)).

Final Regulations

In the final regulations, the definition of "substantial return benefit" is basically the same as in the proposed regulations. Despite numerous comments, the final regulations (like the proposed regulations) provide that the IRS will not consider exclusive provider arrangements as qualified sponsorship payments. However, if in return for a payment, an exempt organization agrees not to sell products or services that compete with the sponsor’s, the sponsor will have a substantial return benefit.

The final regulations also provide two new examples addressing Internet links. An exempt organization’s website link to a sponsor’s web page is an acknowledgment, not advertising, unless the sponsor’s website shows an endorsement of its products by the exempt organization.

Example 1: A symphony maintains a website containing information and its performance schedule. Corporate sponsors help to fund the symphony’s performances. The symphony posts a list of sponsors on its website (including their names and web addresses), but does not promote its sponsors or advertise their merchandise. Users can link to the sponsors’ websites. The symphony’s posting of sponsors’ names and addresses is an acknowledgment of the sponsorships, not advertising. Payments for sponsorships are not UBTI (Regs. Sec. 1.513-4(f), Example 1).

Example 2: An exempt organization’s website has a link to a corporate sponsor. When users jump to the sponsor’s website they read an endorsement of the sponsor’s product by the exempt organization. The endorsement suggests that readers use the product. The exempt organization reviewed and approved the endorsement. The en-dorsement is advertising and the payment for sponsorship is UBTI (Regs. Sec. 1.513-4(f), Example 12).

The final regulations clarify that if a business receives advertising or other benefits in exchange for making a payment, the payment could be considered payment for the advertising or other benefits (Regs. Sec. 1.513-4(d)). In that case, only the portion of the payment that exceeds the benefits’ FMV (if any) is a qualified sponsorship payment.

For purposes of applying these rules, benefits provided to a sponsor may be disregarded if their aggregate FMV does not exceed 2% of the sponsor’s total payment. Under the regulations, a substantial return benefit is any benefit other than certain goods or services with an insubstantial value. Under the prior regulations, "insubstantial value" was defined as the lesser of 2% of the sponsorship payment or $79 (adjusted for inflation). The final regulations eliminate the $79 ceiling (Regs. Sec. 1.513-4(c)(2)(ii)).

The final regulations also clarify that when allocating a sponsorship payment, the FMV of the substantial return benefit is to be determined on the date the parties enter into the sponsorship contract (Regs. Sec. 1.513-4(d)(1)(iii)). This rule benefits exempt organizations in that the organization will only need to value the substantial return benefits once, even if the value of the substantial return benefit increases over the contract’s term. If a material change is made to the contract, the contract is treated as a new contract as of the date the material change is effective. A material change is an extension or renewal of the contract, or a more-than-incidental change to any amount payable under the contract. If a binding, written contract does not exist, the FMV of the substantial return benefit would be determined when the benefit is provided. This allows smaller organizations to arrange sponsorship informally on a year-to-year basis, valuing the benefits as they occur.

As noted, the final regulations generally modify and clarify the previous proposed regulations to help charities and other tax-exempt organizations determine the proper tax treatment of payments received from corporations and other businesses.

From Susan L. Gray, CPA, Merrillville, IN