Unrelated Business Income is generally defined as income from a trade or business that is regularly carried on and which is not substantially related to the organization’s exempt purpose. Many special rules exist to exempt certain types of income from UBIT. Some of the major exemptions are for passive types of income (interest, dividends, royalties) and for activities where substantially all the work in generating the revenue is done by volunteers.

The IRS has much concern in the area of sponsorships and advertising. They believe that many sponsors are paying the sponsorship in exchange for receiving certain benefits from the exempt organization. Rules and regulations exist under IRC §513 that describe definitions and safe harbors for sponsorship payments and any benefits received. In 1997, Congress added §513(i) to the Internal Revenue Code which provided a safe harbor from UBIT for “qualified sponsorship payments”. The IRS then added regulation §1.513-4 in 2002 to further clarify the sponsorship safe harbor.

Under these regulations, the term “qualified sponsorship payment” means any payment made to which there is no arrangement that the person making the payment will receive a substantial return benefit. A “substantial return benefit” is defined to be a benefit other than a use or acknowledgement of the company’s name or logo or a disregarded benefit (benefit with a fair market value of less than 2% of payment amount). Benefits can include advertising, exclusive provider arrangements, goods, facilities, services, or other privileges, and exclusive or nonexclusive rights to use intangible assets.

Advertising is defined in these rules as “any message broadcast or otherwise transmitted, published, displayed, or distributed which promotes or markets any trade or business, or any service, facility or product.” Advertising generally includes comparative language, price information, and an endorsement of a product or service.

On the other hand, an acknowledgement is just recognition of a person or company for their contribution. No qualitative or comparative language is included. Under the IRS rules, an organization can list the name, phone number, location, website, and general product or service line in an acknowledgement.

If a substantial return benefit exists, whether it is advertising, goods, or other services, the amount of the qualified sponsorship payment is the excess of the payment received over the fair market value of substantial return benefits received. If the benefits received exceed the amount of payment, then no portion is a qualified sponsorship payment.

Even if a payment does not meet the safe harbor for qualified sponsorship payments, it is not automatically considered unrelated business income. The payments may qualify under another UBIT exception. The key is to be cautious when setting up the sponsorship opportunities to make sure that there are no unexpected tax consequences.