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Not-for-Profit Sports Organizations Should Be Up to Date on Sponsorship Tax Regulations

November 26, 2024

With universities, amateur sports bodies, bowl games, golf tournaments and other nonprofit organizations attracting an increasing number of partnership dollars, those rights holders and their sponsors would be wise to ensure they understand how sponsorship income is viewed by the U.S. tax authorities.

At the heart of the matter, the Internal Revenue Service’s interest in sponsorship income is to determine whether or not payments for specific sponsorship benefits constitute revenue to a nonprofit that is allowed within its tax-exempt status, or whether such revenue should be defined as unrelated business income, which is taxable.

The key to making that determination lies in defining the benefits provided to the sponsor as either insubstantial or substantial.

Insubstantial benefits qualify as allowable ways to recognize and express appreciation to the sponsor. Substantial benefits could be viewed as the provision of advertising or related services to the sponsor.

The IRS released its first proposed sponsorship guidelines in 1993. Following nearly a decade of public and Congressional debate over what constituted “qualified sponsorship payments”–revenue not subject to unrelated business income tax (UBIT) because it does not carry the expectation of “substantial return benefit”–the IRS in April 2002 issued its final regulations.

The key development during that nine-year period was the passage by Congress of the Taxpayer Relief Act of 1997, which addressed the sponsorship issue by adding section 513(i) to the Internal Revenue Code. The new section effectively defined payments for most traditional sponsorship benefits as not subject to tax and the final regulations maintained that safe harbor for the most common types of sponsorship benefits.

The regulations also address the division between qualified payments and payments for substantial benefits within a single sponsorship. When a sponsorship provides both insubstantial and substantial benefits, the IRS requires the nonprofit to determine the portion of the fee that is a qualified payment, as well as the fair market value of the substantial benefits.

The regulations state that the IRS will accept “reasonable and good faith” valuations, but they also make it clear that if the property does not establish a value for substantial benefits, “no portion of the payment constitutes a qualified sponsorship payment.”

It is important to note that even for those benefits that are defined as providing substantial return to sponsors, the regulations do not say that payments for those benefits are automatically taxable.

The determination that a payment is non-qualified only means that it cannot be excluded from UBIT. Whether it should be included as unrelated business income is evaluated separately under the tax code’s UBIT rules.

For example, granting a sponsor the right to use a nonprofit’s trademarks is defined under the sponsorship regulations as a substantial benefit. However, under the UBIT regulations, most payments for that benefit will not be taxable because they will qualify as an allowable royalty payment.

On the one hand, it is relatively simple for nonprofits that want to avoid even the possibility of triggering UBIT to stay out of harm’s way by only offering sponsors the benefits the IRS defines as insubstantial.

However, many nonprofit properties want to offer some substantial benefits, and the IRS regulations can be daunting, confusing and burdensome when it comes time to calculate how much, if any, of a sponsorship payment is then at risk for UBIT.

In particular, the rules regarding the provision to sponsors of tangible benefits such as complimentary tickets, receptions, pro-am spots and private viewings, as well as those dealing with category exclusive sales rights have caused the most consternation among nonprofits.

Tickets, pro-am spots, receptions, etc. IRS regulations treat such deliverables as insubstantial only if the total “fair market value” of those benefits is less than two percent of the total fee paid by the sponsor during an organization’s taxable year.

If a property provides other types of substantial benefits, such as advertising or the right to use its marks, the IRS will look at whether the combined value of those benefits exceeds two percent, essentially lowering the ceiling on the acceptable amount of tickets or other inventory.

If the value exceeds two percent, the total value of the substantial benefits is potentially subject to UBIT, not merely the difference between the total amount and the two-percent level.

Category-exclusive sales rights. What the IRS terms an “exclusive provider arrangement” is defined as a substantial benefit to the sponsor and thus the portion of the sponsorship payment attributable to those rights may be taxable under UBIT. The regulations do offer an exception “when the nature of the goods and services to be provided necessitates the use of only one provider because of limited space or because the competitive bidding process requires only the lowest bid be accepted.”

The real challenge for properties is that the regulations put the burden of establishing the dollar value of sales rights and other substantial benefits on the nonprofit.

In the case of tangible benefits with face values, such as tickets, valuations are not difficult. The IRS even allows the use of equivalents–for example, the average cost of a restaurant dinner may be used to estimate the value of an evening reception.

But valuing benefits such as the value of a property’s trademarks or of its exclusive sales rights is another matter. The regulations themselves note that “the Treasury Department and the IRS appreciate the difficulty” in determining those values but stop short of offering advice on how it should be done.

An updated IRS document regarding its sponsorship guidelines can be found here.

Below is a summary of sponsorship benefits and whether they are considered substantial or insubstantial.

Insubstantial (Payment not considered taxable income)

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