Generally, net income from unrelated business activities will be subject to the unrelated business income tax (”UBIT”) if the activity constitutes (1) a trade or business, (2) that is regularly carried on, and (3) is not substantially related to the furtherance of the organization’s exempt purpose. The IRS considers soliciting, selling, and publishing commercial advertising to constitute a trade or business that, if regularly carried on and not substantially related to the organization’s exempt purpose, may produce income subject to UBIT. In contrast to advertising, however, qualified sponsorship payments (“QSPs”) are specifically excluded from the definition of unrelated trade or business. Accordingly, income generated from QSPs is not subject to UBIT. So what’s the difference between advertising and QSPs and how can your organization plan accordingly?
Advertising includes endorsements; inducements to use, sell, or purchase certain products or services; and messages that contain qualitative or comparative language, indications of value, or price information. For example, if a nonprofit issues a monthly newsletter in which it sells space to companies to use to describe and encourage readers to purchase their goods or services, this will constitute advertising and such sales will likely generate unrelated business income potentially subject to UBIT. Moreover, the fact that commercial advertising is included in a publication, such as a journal, that otherwise contains material related to the publishing organization’s exempt purpose will not lead to the advertising itself being considered related and income generated from such advertising will likely be considered unrelated business income. However, keep in mind that advertisements that are contained in a publication related to a one-time event, such as a program at a fundraising gala, are not likely to be considered regularly carried on. Therefore, the income generated from such advertising activities will not be subject to UBIT.
Qualified Sponsorship Payments
In contrast to advertising, a qualified sponsorship payment is any payment made to a nonprofit by an individual or company without an arrangement or expectation that the payer will receive a benefit in return. The nonprofit may provide minor benefits in connection with a QSP without turning the QSP into advertising. These minor benefits may include acknowledgement of the sponsorship through use of the donor’s name or logo, or goods or services of an insubstantial value. If the nonprofit does provide the use or acknowledgment of a donor’s sponsorship, it should not include qualitative statements regarding or endorsements of the donor’s goods or services in the acknowledgment. However, a use or acknowledgment may include a list of the donor’s locations, contact numbers, or website; a logo or established slogan; and value-neutral descriptions, displays, or depictions of products or services. In general, the content of the use or acknowledgment should be controlled by the nonprofit and not by the entity making the payment.
For example, let’s assume that a local pizza chain agrees to sponsor an amateur soccer team organized by a local nonprofit and the nonprofit in exchange agrees to acknowledge the sponsorship by placing the pizza chain’s name and logo (and no other qualitative or comparative statements) on the back of the team jerseys. In this example, the payment provided by the pizza chain will be a QSP and will not be subject to UBIT. However, one additional separate exception to be aware of is that a payment for the use or acknowledgment of a business name, logo, or product in a nonprofit’s periodical (which generally includes any regularly scheduled and printed material published by or on behalf of a nonprofit) will be treated under the rules that apply to income derived from advertising activities, even if the payment otherwise seems to qualify as a QSP.
Payments that are Both for Advertising and Qualified Sponsorship Payments
Sometimes, a payment to a nonprofit can constitute both a payment for advertising and a qualified sponsorship payment. Using the example above, this may be the case if the pizza chain agrees to make a payment to the local nonprofit in exchange for both having its name and logo placed on the back of the team jerseys and for running an ad of the pizza chain’s design on the nonprofit’s website on a regular basis. In this case, the IRS will treat the payment as two separate payments and UBIT will only be applied to the part of the payment that represents the fair market value of the website advertising that the pizza chain is receiving in return. However, in instances in which a nonprofit is accepting a payment that is both for advertising and constitutes a qualified sponsorship payment, it may be wise for the organization to separate out the payments into two separate transactions and to document them separately in order to more clearly establish whether and to what extent any portion of the payment is subject to UBIT.
For more information, see IRS Publication 598.