Corporate Sponsorships: Considerations for Tax-exempt Organizations

This is an article I wrote for the NYSSCPA Tax Stringer Magazine

Corporate Sponsorships: Considerations for Tax-exempt Organizations By John Vazzana, CPA Link to Article In this time of economic uncertainty and reduced funding, tax-exempt organizations have been scouring for additional funding sources in order to maintain their programs and services and have been turning to corporate sponsorships to fill the gaps. With corporate sponsorships, tax-exempt organizations obtain funds to pay for expenses of an event or program. In return, the sponsor gets exposure, low cost marketing and image benefits, such as being viewed as a good corporate citizen. Soliciting and receiving a qualified sponsorship payment (QSP) is not an unrelated trade or business, and those payments are not subject to unrelated business income tax (UBIT). When dealing with sponsors, organizations will often see the “business approach” of the sponsoring corporation; when spending sponsorship dollars, companies want to maximize the exposure benefits they receive and therefore the exposure to their products or services. Because any small changes in wording or actions can easily turn a QSP into a payment for advertising, corporate sponsorship income has been the subject of scrutiny by the IRS. Organization must exercise prudence when structuring sponsorship arrangement. The rules defining what can be classified as a QSP are set forth in IRC section 513(3)(i) and clarified in Regulations 1.513-4. These statutes define a QSP as any payment made by a business (to an exempt organization) when there is not a substantial return benefit (SRB) to the sponsor except for an acknowledgement. Because advertising is considered a SRB, acknowledgements need to adhere to the parameters, explained in regulations 1.513-4(c)(2)(iv), to not be considered advertising. Displaying names, logos and slogans of the sponsor are acceptable ifthey do not contain “qualitative or comparative descriptions.” Any endorsement or inducement to buy or use the sponsor’s products would be considered for advertising. To demonstrate, these below acknowledgements would be deemed acceptable to classify as a QSP: CCV Corporation is a proud sponsor of ABC Organization. MRV Corporation, a workshop partner, is now a proud sponsor of the Feed the Hungry Program. PJV Inc. provides generous funding to support military families through our Connect Initiative, as well as new programming to help our country's most vulnerable children and families stay healthy and eat well on a limited budget. In contrast, the following acknowledgements would be deemed to be advertising, because they have advertising components: Tony’s Pizzeria, Brooklyn’s best, is a generous supporter of ABC organization’s Youth Programs. Restaurant Italiano is a proud support of ABC Organization. Be sure to stop by for their lunch specials. Logos or slogans that contain qualitative or comparative descriptions, that are an established part of the sponsor’s identity, would not be considered advertising as in the following example: The Hunger Program is sponsored by Brooklyn’s Best Car Service (where Brooklyn’s Best Car Service is the sponsor’s known business name). In acknowledging a sponsor, displaying a list of the sponsor’s locations, telephone numbers and their internet address will not prohibit a payment from being a QSP. Online acknowledgements that contain a hyperlink to a sponsor’s website will not be considered an endorsement and therefore will not normally disqualify a payment from being a QSP. The regulations, however, give an example where a tax-exempt organization provides a link to the sponsor’s website and on the sponsor’s webpage there is language which implies that the organization endorses the sponsor’s products. If that was done with the tax-exempt organization’s knowledge, it is considered advertising. Acknowledging a company as an “exclusive sponsor” does not exclude the payments from being a QSP (e.g., ABC Corp is the exclusive sponsor of this year’s Hungerthon). “Exclusive provider arrangements,” which place a limitation on the sale of competing products or services, will be considered a SRB, however. Nevertheless, the regulations specify that merely displaying or distributing a sponsor’s products (including free giveaways) are not considered exclusive provider arrangements. In addition to advertising, a sponsor could receive a SRB from receiving goods, services or other privileges from the exempt organization (e.g. tickets to an event or use of an organization’s facilities). For this, there is a de minimis exception which entitles any organization to provide a sponsor with benefits that have a fair market value of 2 percent or less of the amount of the sponsor’s payment. Allocating a Payment between QSP and Advertising If there is a SRB, only the portion of the sponsor’s payment equal to the fair market value (FMV) of the SRB would not be considered a QSP. In the event that an acknowledgement does not meet the parameters set forth in the IRC and is classified as advertising, only a portion of the sponsor’s payment equal to the FMV of that advertising would not be a QSP, such as when a company sponsors an event by giving an organization $5,000.In that example, an acknowledgement on the organization’s website contained qualitative language and therefore the acknowledgement was considered a SRB of advertising. If a similar-sized web advertisement would cost $200, then $4,800 of the $5,000 sponsorship payment would be a QSP and $200 would be advertising revenue. If the FMV of the advertising is greater than the sponsor’s payment, none of the payments would be considered QSP. The same would be true if the sponsor received another SRB, such as tickets to an event. In the case when the FMV of the SRB received by the sponsor is over the de minimis exception amount of 2 percent, the QSP amount is reduced by the entire FMV of the SRB (not just the excess). Payments that don’t not fall under the QSP safe harbor rules are not automatically subject to UBIT. The UBIT determination of any payments that are not QSPs is then is determined under IRC 512, 513, and 514 (i.e., the volunteer labor or convenience exceptions may apply). QSPs are also treated as contributions received when determining public support under section 70(b)(1)(A)(iv) (see Form 990 Schedule A part 2) or under section 509(a)(2) (see Form 990 Schedule A part 3). With proper planning, unintentionally having sponsorship payments become taxable can be avoided. Organizations can prepare written corporate sponsorship agreements that limit acknowledgments to within the guidelines of the QSP rules. If a sponsorship does trigger UBIT, tax preparers need to be aware of 990T reporting requirements. Additionally, auditors of tax-exempt organizations should also be aware of these rules for reporting liabilities for the associated taxes on the organization’s financial statements. Accountants serving tax-exempt organizations are in the best position to provide value added services by reviewing sponsorship arrangements to help manage and understand UBIT implications. John Vazzana, CPA, is the principal at John Vazzana CPA PLLC, a boutique accounting firm specializing in serving not-for-profit and tax-exempt organizations. Vazzana is a member of the NYSSCPA, NJSCPA and the AICPA. He currently serves on two NYSSCPA committees: Exempt Organizations and Not-for-Profit Organizations. Vazzana holds a BS in accounting from CUNY Brooklyn College and an MS in taxation from CUNY Baruch College. More information and contact details can be found at www.JVCPAPLLC.com. Copyright 2012 New York State Society of Certified Public Accountants.

IRS: Exempt Organizations Examinations - Significant Diversion of Assets

http://www.irs.gov/charities/article/0,,id=258222,00.html

The governance section (Part VI) of Form 990 asks whether there has been a significant diversion of assets. A diversion of assets includes any unauthorized conversion or use of the organization's assets, other than for the organization's authorized purposes, including embezzlement or theft. In some cases, a significant diversion of assets may be inurement of the organization's net earnings. In the case of section 501(c)(3) and 501(c)(4) organizations, it can also be an excess benefit transaction taxable under Code section 4958 and reportable onSchedule L.

Exempt Organizations (EO) Examinations has done some preliminary research in this area, reviewing tax filings and publicly available information on the 285 organizations that reported a significant diversion of assets in 2009. This initial research showed:

• Roughly $170 million in significant diversions was identified.
• Many of the cases involved theft or embezzlement, though there were many other cases where the taxpayer didn't explain the significance, as Schedule O requires.
• A handful involved Ponzi schemes.
• 82 cases resulted in civil or criminal charges against the responsible party. These are charges that were brought by the organizations involved, or by local authorities, who were outraged by the activity. They are not IRS charges.
• 47 individuals were incarcerated or served probation for the diversion of the assets. Again, this did not arise from IRS actions.
• In 9 cases restitution was paid in full.
• In 11 cases there was partial restitution.

We are now going to conduct an examination program in this area. While organizations aren't normally selected for exam based on the answer to any particular question on the Form 990, a significant diversion of assets is noteworthy. By examining these organizations we will be able to identify common indicators of serious cases and common indicators of cases where the organization was able to self-correct. The benefits of this are two-fold: First, as always, we will also report out on these results, and this will allow us to advise organizations generally on how to avoid these events. Second, it will help us refine our risk models to better target our examination resources.

In many cases like this, an exam will focus narrowly on the details of the transaction. The goal will be to pursue excess benefit transaction actions against the person(s) committing them. The examinations won't necessarily result in tax consequences to the organization itself. In some cases, the taxpayer simply didn't provide the required explanation on Schedule O. In some situations, the taxpayer did not complete Schedule O at all.

Going forward, we plan to conduct these examinations to gather more information about significant diversions and get the information we need to address the excess benefit transactions. We also will determine--

• What internal controls or good governance practices, if any, were present before the significant diversion and
• Whether and how internal controls and governance practices have been modified in order to ensure the charities' assets are properly safeguarded in the future.

IRS Examination and Compliance Check Processes For Exempt Organizations

http://www.irs.gov/newsroom/article/0,,id=178242,00.html
FS-2008-14, February 2008 The Internal Revenue Service has a variety of tools at its disposal to make certain that tax-exempt organizations comply with federal law designed to ensure they are entitled to any tax exemption they may claim. The responsibility for administering these procedures belongs to the Exempt Organizations (EO) function, which is part of the IRS’s Tax Exempt and Government Entities (TE/GE) Operating Division. Examinations vs. Compliance Checks A review of a tax exempt organization falls into two broad categories: compliance checks and examinations. The IRS conducts examinations, also known as audits, which are authorized under Section 7602 of the Internal Revenue Code.  An examination is a review of a taxpayer’s books and records to determine tax liability, and may involve the questioning of third parties. For exempt organizations, an examination also determines an organization’s qualification for tax-exempt status.  EO conducts two different types of examinations: correspondence and field examinations. A compliance check is a review to determine whether an organization is adhering to recordkeeping and information reporting requirements and is not an examination since it does not directly relate to determining a tax liability for any particular period. Correspondence Examinations Correspondence examinations are limited in scope and focus on only one or two items on a return. An EO specialist typically conducts the examination through letters and phone calls with the organization’s officers or representatives.  If the issues become complex, or if the organization does not respond to a letter or call, EO may require the officers or representatives to bring records to an IRS office.  EO may also convert a correspondence examination into a field examination. Field Examinations A field examination is one conducted by a revenue agent at the organization’s place of business. Generally, these audits are the most comprehensive. There are two distinct types of EO field examinations – EO Team Examination Program (TEP) and EO General Program. EO TEP examinations are field examinations of large, complex organizations that may require a team of specialized revenue agents, as well as coordination between IRS functions and other governmental agencies. They are often conducted using coordinated team examination approaches and procedures. EO General Program examinations are typically performed by individual revenue agents. They usually do not require a team of specialists. A field examination usually begins when the revenue agent notifies the organization that its return has been selected for examination.  This initial contact is by telephone or by letter to schedule an initial appointment.  The organization receives Publication 1, Your Rights as a Taxpayer, with the appointment letter. In the appointment contact, the revenue agent will typically request the following documents to begin the audit: Governing instruments (articles of incorporation, charter or constitution, including all amendments; and bylaws, including all amendments), Pamphlets, brochures, and other printed literature describing the organization’s activities, Copies of the organization’s Forms 990 for the years before and after the year under examination, For the year under examination (at a minimum): Minutes of meetings of the board of directors and standing committees or councils, All books and records of assets, liabilities, receipts and disbursements, Auditor’s report, if any, Copies of other federal tax returns filed and any related workpapers (Form 990-T for taxable income, Form 1120-POL for political activity, etc.), Copies of employment tax returns and any related workpapers (Forms W-2, W-3, 941, 1096, 1099). (Note:  Many of these records may also be required for a correspondence examination.) During an opening conference with the organization’s officers or representatives, the revenue agent explains the audit plan and the reason the organization has been selected for examination.  The revenue agent usually conducts a comprehensive interview and tours the organization’s facilities to gain a basic understanding of the organization’s purposes and activities. The examination of a tax-exempt organization is multifaceted and includes a review of its operation and activities to verify the existence of an exempt purpose, as well as a review of financial records. The length of the examination will depend upon a variety of factors, such as the size of the organization, the complexity of its activities and the issues that may arise during the examination.  Some audits can be completed in just a few days; others can last for a year or more. A field examination typically concludes with a closing conference.  The revenue agent will discuss the audit with the organization’s representatives, and if necessary, furnish a report explaining proposed adjustments to the organization’s returns or exempt status.  If the revenue agent and the organization’s representatives disagree on the findings, the organization may request a meeting with the revenue agent’s manager to discuss the disagreement. If the manager cannot resolve the differences, the organization may pursue its case through the IRS appeals process.  For additional information on the appeals process, see Publication 892, EO Appeal Procedures for Unagreed Issues. Compliance Checks Exempt Organizations also maintains an active compliance check program.  EO specialists conduct the checks by corresponding with or telephoning exempt organization representatives.  A specialist may inquire about an item on a return, determine if specific reporting requirements have been met or whether an organization’s activities are consistent with its stated tax-exempt purpose. An officer or representative of an exempt organization may refuse to participate in a compliance check without penalty.  However, EO has the option of opening a formal examination, whether or not the organization agrees to participate in a compliance check.  At the beginning of a compliance check, the specialist will inform the officer or director that the review is a compliance check and not an examination. The specialist will not ask to examine any books or records or ask questions regarding tax liabilities. The specialist may ask whether the organization understands or has questions about filing obligations for required forms. The specialist may also ask questions about the organization’s activities.   If, during a compliance check, the specialist decides an examination is appropriate, he or she will notify the organization that EO is commencing an examination before asking questions related to tax liability. Because a compliance check only reviews whether an organization is adhering to record keeping and information reporting requirements or whether an organization’s activities are consistent with its stated tax-exempt purpose and is not an examination, it is possible to have more than one compliance check for a tax year if facts and circumstances warrant.  For more information, see Publication 4386, Compliance Checks. Selecting Organizations for Examination or Compliance Checks EO strives to ensure consistency and fairness in its examination and compliance check processes.  In its annual Implementing Guidelines,which are available on the IRS website at www.irs.gov/eo, EO describes its proposed examination and compliance check activities for the year. EO designs and implements comprehensive projects to address issues that carry the most non-compliance risk.  To determine which organizations should be targeted, experienced specialists analyze information from Forms 990 and other sources.  This analysis will usually result in the selection of a group of returns for examination or compliance check. EO also reviews media reports and receives complaints from the general public and Congress about potential non-compliance by exempt organizations.  After confirming the information, and when appropriate, these organizations may be selected for examination or to receive a compliance check.  For details on how EO handles complaints about exempt organizations, see Fact Sheet 2008-13. Regardless of the process used to select returns, EO does not presume that an organization is violating the tax laws before it begins the examination or sends a compliance check letter.

IRS Advisory Committee on Tax Exempt and Government Entities Releases Report

http://www.irs.gov/pub/irs-tege/tege_act_rpt11.pdf

GENERAL REPORT OF THE ADVISORY COMMITTEE ON TAX EXEMPT AND GOVERNMENT ENTITIES

This General Report is presented in connection with the 11th annual public meeting of the IRS Advisory Committee on Tax Exempt and Government Entities (ACT). The members of the ACT appreciate the ongoing opportunity to engage with and report to the Internal Revenue Service on items of importance to the Tax Exempt and Government Entities (TE/GE) division and its stakeholders. The individual reports from ACT subcommittees representing Employee Plans, Exempt Organizations, Federal State and Local Governments, Indian Tribal Governments, and Tax Exempt Bonds reflect the diligent efforts of the subcommittees, the TE/GE directors and staff, and stakeholders in the community over the past 12 months.

This year there are five reports:

 Employee Plans: Analysis and Recommendations Regarding the Scope of the EP Examination Process

 Exempt Organizations: Form 1023 – Updating It for the Future

 Federal, State and Local Governments: TIN Matching as an Effective Online Business Tool to Improve Compliance

 Indian Tribal Governments: Report on the General Welfare Doctrine as Applied to Indian Tribal Governments and Their Members

 Tax Exempt Bonds: A Survey of IRS Forms for Information Reporting

The collaborative efforts of the ACT members, the Service, and the various stakeholder groups combined make these insights possible.