Corporate Partnerships & The Law: Unrelated Business Income Tax (UBIT) ⚖️
This is the final part of a four-part series on the four key legal issues you - my readers! - requested guidance on in the Selfish Giving / Accelerist Partnership Law Survey you completed last year.
Advertising Disclosures [Released 10/02/19]
Registration & Reporting Requirements [Released 12/4/19]
Contracts [Released 02/29/20]
UBIT [It’s here!]
Today, our legal expert, Karen Wu of Perlman & Perlman, is answering your questions on unrelated business income tax (UBIT).
Corporate Partnerships & Unrelated Business Income Tax (UBIT)
This FAQ explains key considerations for evaluating whether and when a nonprofit must pay “unrelated business income tax” (UBIT) on the payments it receives in connection with its corporate partnerships. UBIT affects traditional corporate sponsorships (e.g., $X payment to sponsor a charity event, in exchange for a list of benefits) as well as a range of activities that fall under the broader concept of “corporate partnerships,” through which companies help generate funds and awareness for organizations (including charitable sales promotions, social media campaigns, and other public engagement initiatives).
Question #1: My organization, Charity Corp., has a corporate partner, Cool Products Co., that is conducting a charitable sales promotion in which it will advertise that it is donating to Charity Corp. a portion of the purchase price from sales of a particular product. Cool Products has asked us to promote their sales campaign to our members and donors through email and social media. I heard that charities aren’t allowed to promote these types of campaigns because it might subject the charity to a tax called UBIT. What is UBIT, and why and when is it a potential problem? How do we avoid creating taxable income?
Unrelated business income tax, known as “UBIT,” is the tax imposed on income generated from certain business activities undertaken by a tax-exempt organization.[1] In the context of corporate partnerships, the most significant potential source of UBIT is an arrangement or expectation that the charity will provide advertising or marketing services in exchange for all or part of the payment.
In order to determine if a particular corporate partnership arrangement could trigger UBIT, the organization must determine: (1) whether the activity being undertaken by the charity constitutes an “unrelated business” as defined in the federal tax code, and if so, (2) whether the arrangement fits into any exceptions in the law that would prevent the income from being taxed. Understanding whether an “arrangement or expectation” between a company and nonprofit is subject to UBIT requires looking at both the terms of any agreement as well as the reality of the relationship.
UBIT is assessed at the standard corporate tax rate, which is currently 21%.[2] In a worst case scenario, a nonprofit that engages in too much unrelated trade or business activities may risk losing its tax-exempt status.[3]
In order to understand how to assess an organization’s UBIT exposure, let’s start by looking at the basic definitional framework. An activity is an “unrelated business” (and therefore is generally subject to UBIT) if it meets three requirements:
1. It is a trade or business [4],
2. It is regularly carried on, and
3. It is not substantially related to furthering the exempt purpose of the organization.
There are a number of modifications, exclusions, and exceptions to unrelated business income. In other words, by virtue of certain statutory provisions, income generated from certain activities that would otherwise meet the basic definition of an “unrelated business” are not subject to tax. One such exception is the passive licensing of an exempt organization’s intellectual property to a for-profit business in exchange for a royalty payment.
Below is a brief overview of the most common concepts that are fundamental to understanding UBIT, and that affect whether or not a tax-exempt organization must pay UBIT when it is considering providing advertising or marketing services to a corporate partner in exchange for a payment.
(a) Regularly carried on
To be subject to UBIT, the business activity must be “regularly carried on.” An organization’s business activities are considered “regularly carried on” if they “manifest a frequency and continuity, and are pursued in a manner, generally similar to comparable commercial activities of nonexempt organizations.”[5] Where unrelated business activities are systematically and consistently promoted and carried on by the organization, they will be considered “regularly carried on.”
Conversely, the IRS has noted that certain intermittent income producing activities are engaged in so “discontinuously or periodically” and “without the competitive and promotional efforts typical of commercial endeavors” that they will not be regarded as “regularly carried on.”[6] Here is how this concept is explained in the Treasury Regulations that define “unrelated trade or business”:
Certain intermittent income producing activities occur so infrequently that neither their recurrence nor the manner of their conduct will cause them to be regarded as trade or business regularly carried on. For example, income producing or fund raising activities lasting only a short period of time will not ordinarily be treated as regularly carried on if they recur only occasionally or sporadically. Furthermore, such activities will not be regarded as regularly carried on merely because they are conducted on an annually recurrent basis. Accordingly, income derived from the conduct of an annual dance or similar fund raising event for charity would not be income from trade or business regularly carried on.
. . .
Where income producing activities are of a kind normally conducted by nonexempt commercial organizations on a year-round basis, the conduct of such activities by an exempt organization over a period of only a few weeks does not constitute the regular carrying on of trade or business. . . . Where income producing activities are of a kind normally undertaken by nonexempt commercial organizations only on a seasonal basis, the conduct of such activities by an exempt organization during a significant portion of the season ordinarily constitutes the regular conduct of trade or business.[7]
Many cause marketing partnerships involve charitable sales promotions that last for a brief period of time, e.g., from two weeks to two months. If a product is only being sold for a limited period of time, then, similar to the guidance relating to seasonal sales, promoting the product sales during a significant portion of the promotion period may be considered “regularly carried on” for UBIT purposes. On the other hand, if promotional communications are done only “occasionally or sporadically,” they should not trigger UBIT.
Whether a business activity is “regularly carried on” is determined based on all the facts and circumstances, and therefore can be a tricky part of the UBIT definition to apply. Organizations also need to consider the impact of their corporate partnership strategy not only at a per-partner or per-promotion level, but also at a more holistic corporate partnership program level. For example, a charity with numerous corporate partners that permits an “occasional” promotional communication for each corporate partner could end up inadvertently engaging in year-round, unrelated marketing activities when those promotional communications are viewed in the aggregate. Organizations should work closely with their legal counsel, taking into account the existing guidance available, to determine if there are appropriate, limited instances when certain promotional communications may be provided in a manner that will not be considered “regularly carried on,” and therefore not subject the corporate partner’s payment to tax.
(b) Substantially related
A business activity is “substantially related” to an organization’s exempt purposes only when the conduct of the business activities has a substantial causal relationship to achieving exempt purposes other than through the production of income.[8] Put another way, the activities that generate the income must contribute importantly to accomplishing the organization’s exempt purposes.[9] It is not sufficient that the profits generated from the activity (or a portion of the purchase price from sales) will be exclusively used to support the organization’s exempt purpose.
In most cases, promoting the sale of a corporate partner’s products or services will not be considered “substantially related” to the achievement of a charity’s tax-exempt purposes, even if those sales trigger donations to the charity. Organizations should seek the advice of counsel to understand how this analysis applies to their specific circumstances before making a determination that marketing a corporate partner’s products or services is substantially related to the accomplishment of its charitable purposes.
Question #2: How can our organization appropriately communicate about a corporate partnership to our donors/members/social followers without crossing over the line into marketing for the corporate partner?
The above question from a respondent to the 2019 Selfish Giving cause marketing law survey is a great segue into another key statutory exception to UBIT:
Acknowledgments vs. Advertising
One of the exceptions to UBIT involves the provision of “acknowledgments” to corporate sponsors or partners, as distinguishable from “advertising.”[10] Payments received from a corporate partner for which only acknowledgements are provided will not be subject to UBIT. This distinction between acknowledgments and advertising arises from federal tax rules governing “qualified sponsorship payments.”
Below is a summary of the types of communications that, according to Treasury Regulations, would constitute “acknowledgments,” along with an example of each:
Below is a summary of the types of communications that, according to Treasury Regulations, would constitute “advertising,” along with some examples:
When considering the language your organization is planning to use in its public communications, it may be helpful to refer to the guidance outlined in the left-hand column of the above charts to see how the proposed language compares with these descriptors, as a cross-check on whether the communication is more in the nature of an acknowledgment vs. advertising.
Question #3: The UBIT rules make our corporate partnerships team feel very constrained in our partner cultivation strategy. What options does our organization have to provide value to our corporate partners?
First of all, consider why most companies want to partner with your organization to begin with. Your organization has something they lack – an exclusive dedication and commitment to a charitable cause. Partnering with a reputable charity allows the corporate partner to benefit from the charity’s strong brand recognition and proven record of making a real impact on a charitable issue. Some charities have the mindset that the only value they can offer a company is to directly help promote sales of the company’s products or services. Having observed hundreds of cause marketing campaigns conducted successfully over the years that did not require active marketing services by the charity beneficiary, I am confident that promotional services is not the key to success (though I won’t deny that it is sometimes requested, especially by companies that are newer to the corporate partnership space). In fact, many of the leading national charities have had great success with their corporate partnerships program even while having an explicit “no marketing” policy. These organizations typically focus on other ways that they can collaborate to create a win-win partnership. With this framework in mind, here are some ways that organizations can provide value to their corporate partners, while carefully navigating the rules regarding UBIT.
Engagement Strategies That Avoid Incurring UBIT
1. Many companies are looking for their partnerships with charities to generate meaningful social impact. As such, it is paramount that organizations be able to articulate or demonstrate their social impact. Some charities are able to find ways to quantify the social impact achieved in connection with specific customer actions. Consider, for example, Feeding America’s commitment to helping provide a meal to a person in need.
2. Provide meaningful content and assets that allow companies to activate around the charity’s mission and cause. Rather than focusing on promoting a brand or product, a campaign can instead drive mission awareness and engagement. One of my favorite examples of how to do this well is Share Our Strength/No Kid Hungry’s #Hangry Campaign, which won a 2018 Halo Award for Best Experiential Marketing Campaign from my favorite social impact convener, Engage for Good.
3. Offer exclusive or unique opportunities to engage with your organization’s mission (e.g., small group conversations with grantee scientists to learn about the groundbreaking research they are supporting; program site visits; employee volunteer opportunities), or to collaborate with like-minded fellow corporate partners to further enhance their support of the cause. DonorsChoose came up with a really creative corporate partnership opportunity to do “flash funding” of all projects that meet certain criteria. This video showcasing Google’s participation in flash funding showcases the creativity of this corporate partnership opportunity.
4. As discussed earlier, charities may provide marketing communications on behalf of corporate partners if they are infrequent or occasional in nature only. Consider associating any such communications with short-term tentpole events (e.g., the organization’s annual gala, or a weeklong celebration of an event uniquely tied to the organization’s mission, such as Earth Day, World AIDS Day, International Women’s Day). As noted above, organizations should work with their legal counsel to determine how to safely structure these limited marketing communications to avoid incurring UBIT.
Options That Involve Paying Some UBIT
There may be select opportunities where an organization decides that the amount of revenue that will be generated if the organization undertakes marketing and advertising in connection with a corporate partnership (vs. not doing so) is worth paying the associated tax. Before embarking on such a decision or strategy, keep in mind that the decision should not be made in isolation, but should be reviewed at three different levels: (1) overall organizational impact; (2) impact on overall corporate partnership strategy; and (3) impact on the specific corporate partnership.
Overall organizational impact: Consider the organization’s collective unrelated business activities (not just those associated with corporate partnerships), including the amount of the organization’s time, effort, and monetary resources put towards those activities altogether, to determine if there will be any broader impact on the organization’s tax-exempt status.
Impact on overall corporate partnership strategy: Consider the reality that corporate partners do look at what a charity has done or publicly communicated on behalf of its other corporate partners. If your organization makes an exception to its general “no marketing policy” for one corporate partner, other corporate partners may start asking for a similar exception.
Impact on the specific corporate partnership: The actual UBIT calculation is determined within a specific contractual relationship. The tax is assessed on the fair market value of the marketing services provided. It may be the case that only a portion of the revenue generated will be considered taxable, while the remaining portion of the payments remain nontaxable. In addition, to the extent that a payment is being treated as a tax-deductible donation by the company, the amount of the charitable contribution that is deductible for federal income tax purposes is limited to the excess of the total contribution over the value of the goods and services provided by the charity in exchange for that contribution. The value of the marketing services should be documented in communications with the corporate partner to create an audit trail, should a question ever arise.
Subject to all of the above considerations, here are a couple of ways organizations can work with their corporate partner where some UBIT will be assessed.
1. Select a specific corporate partnership opportunity to engage in co-promotion with, and clearly document how you determined that the opportunity merits taking on an active marketing role. To avoid a flood of “what about our company?” requests, be prepared to articulate internally as well as externally to your other corporate partners (if necessary) why that opportunity was an exceptional case, and substantively different in nature from your typical corporate partnerships.
2. Clearly document the marketing services to be provided, and their fair market value, and ensure that the company’s payments will exceed that fair market value. The organization can consider entering into two separate agreements, one that documents a traditional cause marketing or sponsorship relationship that does not require any active marketing or promotional efforts by the charity, and a separate marketing services agreement that sets forth specific marketing activities to be conducted by the charity, and a commensurate marketing services fee. While this could be accomplished within a single agreement with careful documentation, separation may help ensure that none of the nontaxable payments under the cause marketing or sponsorship agreement are considered to be a payment for any part of the marketing activities.
Footnotes
[1] Organizations that are recognized as tax-exempt are still subject to tax on their unrelated business income. A tax-exempt organization that has $1,000 or more of gross income from an unrelated business must file Form 990-T with the IRS.
[2] The amount of the unrelated business income that will be taxed is reduced by the amount of expenses directly connected with the conduct of the unrelated trade or business activity.
[3] The potential risk of loss of exemption derives from the general principle that a tax-exempt organization must be organized and operated exclusively (which has been interpreted as primarily) for exempt purposes. In determining whether an organization’s unrelated business activities could put its exemption at risk, it must consider the amount of time, resources and effort it is expending on those non-exempt activities compared with its tax-exempt activities.
[4] The term trade or business generally includes any activity carried on for the production of income from selling goods or performing service. The sale of advertising or provision of marketing services constitutes a “trade or business.”
[5] Treas. Reg. § 1.513-1(c).
[6] Treas. Reg. § 1.513-1(c).
[7] Id.
[8] Treas. Reg. § 1.513-1(d)(2).
[9] Id.
[10] Internal Revenue Code § 513(i).
[11] For those of you paying close attention, I used a brand that happens to have a seemingly “qualitative” trademarked tagline to highlight a special exception within the UBIT rules – “Logos or slogans that are an established part of a payor’s identity are not considered to contain qualitative or comparative descriptions.” See Treas. Reg. § 1.513–4(c)(iv).
[12] The Treasury Regulations include this Music Shop example, and note that if this statement is made in exchange for a so-called sponsorship payment, it would constitute advertising, even though a portion of the statement is an acknowledgment. See Treas. Reg. § 1.513–4(f).
[13] The Treasury Regulations include this example of an “endorsement,” and state that, where the charity has reviewed and approved this statement to be placed on the pharmaceutical company’s website in exchange for a sponsorship payment used to fund the charity’s educational program, the statement is considered an endorsement, and is advertising. See Treas. Reg. § 1.513–4(f).
The information provided in this post does not constitute legal advice to any individual or entity, and is not intended to substitute for legal counsel.
