When planning a major conference for a nonprofit charity client, you negotiated a lucrative sponsorship arrangement that named a major corporation "platinum sponsor" for a $50,000 fee. In return, you agreed to provide the sponsor with several benefits, including two full-page ads in the conference brochure and an ad on the charity's website. You proudly informed your client that due to your shrewd negotiations, the client is now $50,000 richer.
Two years later, you get an angry call from the same client informing you that the IRS has imposed back taxes, interest, and penalties on the nonprofit for failing to pay tax on the $50,000 sponsorship income. The client summarily fires you and hangs up the phone. You suddenly don't feel so shrewd anymore. If only you'd known: With just a few simple modifications to the advertisements you offered to the sponsor, the entire $50,000 sponsorship fee could have been tax-free.
General Background on Donations to Tax-Exempt Organizations
A charity or other tax-exempt organization may receive a donation from any donor, and such donations are normally a form of tax-free income. Tax-free donations can include sponsorship payments from a corporation to sponsor an event, provided that the payments meet certain criteria discussed below. It is also permissible for a charity to "recognize" the donor or sponsor and express appreciation for the donation or sponsorship payment.
On the other hand, income to a tax-exempt organization from "advertising" that it publishes (including sponsor advertisements) is almost always a form of taxable income. This comes as a huge surprise to many people, who wrongly assume that the term "tax-exempt" means that charities and other nonprofits never need to worry about paying tax.
When Are Sponsorship Payments Taxable and When Are They Tax-Free?
Section 513(i) of the Internal Revenue Code provides that "qualified sponsorship payments" received by a nonprofit are not subject to tax. A "qualified sponsorship payment" is defined as a payment made by a sponsor where there is "no arrangement or expectation that such [sponsor] will receive any substantial return benefit."
One of the key types of "substantial return benefit" to be avoided is the advertising of a sponsor's products or services. But not every message about a sponsor is an advertisement. Advertisements are defined as "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."
Permissible Sponsor Recognition
In light of the law outlined above, it's critical to ensure that the benefits given to the sponsor include as much "recognition" as the sponsor desires, without crossing the line and constituting an "advertisement" for the sponsor's products. If you cross that line, the IRS will characterize the normally tax-free sponsorship payment as a taxable advertising payment.
Fortunately, there are several types of recognition that can be provided to a corporate sponsor without making its sponsorship payment taxable to the nonprofit recipient. For example, it is permissible to widely display a sponsor's name, logo, mailing address, and website address at a conference. Those items of sponsor recognition are not deemed to constitute a substantial return benefit equivalent to advertising. In addition, the sponsor may set up product displays at the conference site, provided that the displays do not contain qualitative or comparative language, price information, inducements to purchase, or similar advertising statements.
There are many other nuances in the law of corporate sponsorships that are too numerous to detail here. The point is that through careful prior planning, and the help of a knowledgeable nonprofit tax advisor, you can offer conference sponsors an innovative set of sponsorship benefits, including recognition of the sponsor that has nearly the same promotional effect as an advertisement, without subjecting your nonprofit client to needless tax, interest, and penalties.