Is it sponsorship or advertising?
Know the difference between tax-free and taxable income

As a nonprofit you’re generally not taxed on your income, unless that money comes from a trade or business — operating a restaurant or managing a gift shop, for example — that is unrelated to your exempt purpose.

An important exception to the unrelated business income tax (UBIT) rule is sponsorship income. If income is derived from a qualified sponsorship, it’s tax-exempt. However, if the income comes from advertising, it’s taxable. Thus, knowing the difference between sponsorship and advertising income can help you better evaluate when to accept a sponsorship and ensure that you comply with tax law, protecting your exempt status.

What qualifies as sponsorship

If a nonprofit receives income from a sponsor and there’s no arrangement, or expectation, for the sponsor to get any substantial benefit in return, it’s a qualified sponsorship payment (QSP). The simple acknowledgment of a sponsor isn’t considered a substantial benefit. Some examples include:

• Listing the sponsor’s name, brand names, logos or product line,
• Listing the sponsor’s locations, phone numbers and Internet address, and
• Describing the sponsor’s products or services, as long as the description is value-neutral.

Mere display or distribution of the sponsor’s products to the general public at a sponsored activity also isn’t considered a substantial benefit. So, for example, you could pass out free toothbrushes from a dental company sponsor at one of your events.

To be a QSP, a sponsorship cannot be an agreement for a contingent payment, such as one that relies on an attendance level or another factor indicating a degree of public exposure. For example, the sponsorship payment could not be contingent on how many people attend a hospital’s health fair. Also, the QSP designation wouldn’t apply to a name’s or logo’s use in a periodical published by or for the nonprofit.

What counts as advertising

If a nonprofit promotes the sponsor’s products or services, the sponsor is receiving a substantial benefit, and thus the payment may be considered advertising income, subject to UBIT. Advertising contains qualitative or comparative language and is an inducement to purchase or use a product or service. Thus, going beyond just listing a product to also listing the prices or providing indications of savings or value would be advertising. For example, a nonprofit theater group that acknowledges its sponsors in its program, but also includes product and price information for those sponsors, would have advertising income subject to UBIT.

Actions that produce substantial benefit include not just advertising but also designating a sponsor as an exclusive provider; providing facilities, services or other privileges to the sponsor that are not insubstantial; or granting rights (such as licensing) to an intangible asset of the nonprofit organization.

Payment size vs. sponsor benefit

If a sponsor receives a benefit but its fair market value is less than 2% of the payment, it doesn’t count as substantial. For example, if a company pays $5,000 to sponsor an event and receives $75 worth of advertising, the advertising isn’t a substantial benefit because it’s less than 2% of $5,000 ($100).

Alternatively, if a sponsor receives a substantial benefit (2% or greater) but the payment to the exempt organization exceeds the benefit’s fair market value, the payment in excess of the benefit is treated as a QSP. In the example above, if the sponsoring company received advertising with a $200 value, $200 would be considered advertising and be subject to UBIT, but $4,800 (the amount beyond the advertising benefit’s fair market value) would be treated as a QSP and not taxable to the nonprofit.

Exclusive provider agreements

A common, lucrative arrangement for the nonprofit organization is an exclusive provider agreement. For example, a college may enter into a multiyear contract with a soft drink company to be the exclusive provider of soft drinks on campus and at all campus events. These arrangements are not QSPs.

However, that does not automatically make the income derived from the arrangements taxable.

You need to run through the other UBIT tests — “trade or business,” “regularly carried on” and “not substantially related” — to determine whether such an activity constitutes a taxable trade or business.

Tax Implications

Common QSPs, such as naming rights (for example, a $1-million sponsorship payment for the right to put the sponsor’s name on a building) or event sponsorships, can be a good source of tax-exempt revenue. But you also may benefit from advertising income, even if it will be subject to UBIT. The important thing is to properly assess the potential tax implications before entering into a relationship with a sponsor. •