Tax Exempt Charitable Organizations - Exempt Organizations' Use of the Internet

Originally published December 2003

I want to thank my partner Philip R. West for his assistance with international tax issues and thank Galina Kolomietz, an associate at Steptoe & Johnson LLP, for her general research assistance.

Non-Profits And The Internet: Tax And Other Legal Issues

TABLE OF CONTENTS

1. INTRODUCTION

2. FEDERAL INCOME TAX ISSUES

   1. ADVERTISING AND SPONSORSHIPS

      1. Use by Exempt Organizations

      2. Applicable Federal Tax Rules

      3. Application of Rules to Internet

   2. E-COMMERCE

      1. Direct Sales of Merchandise on an Exempt Organization's Website

      2. Relationships with Other Websites

   3. FUNDRAISING

      1. Section 501(c)(3) Organizations

      2. Non-section 501(c)(3) Organizations

      3. Charity Malls

      4. Online Auctions

   4. LOBBYING

      1. General Tax Rules

      2. Application of Rule to Internet

   5. POLITICAL ACTIVITIES

      1. General Tax Rules

      2. Application of Rules to Internet

   6. DISTANCE EDUCATION; ONLINE LEARNING

      1. Definition

      2. Education Offered Directly by University or Other Organization

      3. Education Offered by University or Other Exempt Organization in Conjunction with For-profit Entities

   7. DISCLOSURE REQUIREMENTS

      1. General Rule

      2. Widely Available Exception

   8. AUDITS AND CONTROVERSIES

1. EXEMPT STATUS FOR INTERNET SERVICE PROVIDERS

3. STATE AND LOCAL TAXES

   1. Overview

   2. Sales Tax Collection

      1. Current Law

      2. Current Legislative and Policy Issues

   3. Internet Tax Freedom Act: Taxes on Internet Access and Discriminatory Taxes

4. INTERNATIONAL TAX

5. STATE CHARITABLE SOLICITATION LAWS

6. COPYRIGHT LAW

7. LINKING AND FRAMING

8. PRIVACY LAWS

   I. INTRODUCTION

   Like for-profit businesses, government and individuals, tax-exempt organizations are turning to the Internet to conduct activities that were formerly conducted through different media. The use of the Internet raises many legal issues including federal, state, local and international income tax issues, state charitable solicitation law issues, copyright law issues, and privacy law issues. The first part of this outline focuses in some detail on federal tax issues raised by activities commonly conducted over the Internet by exempt organizations. The balance of the outline contains an overview of key state and local tax issues, international tax issues, state charitable solicitation laws, copyright issues, and privacy laws.1

   II. FEDERAL INCOME TAX ISSUES

   There is very little guidance on the federal income tax consequences of Internet use by exempt organizations. The Internal Revenue Service (the "Service") has stated that "the use of the Internet to accomplish a particular task does not change the way the law applies to that task."2 In many instances, however, it is difficult to apply laws and precedents written in a pre- Internet era to current Internet activities. There may be no clear counterpart to Internet activity in the non-Internet world, or the analogous activity in the Internet world may raise factors that call into question whether the pre-Internet rule should apply or how it should be applied.

   Recognizing that the Internet raises a number of novel tax issues for exempt organizations, the Service issued Announcement 2000-84, 2000-42 I.R.B. 385, setting forth a number of areas in which it is "considering the necessity of issuing guidance." This announcement is helpful in identifying issues for consideration, and particularly those issues that the Service views as important. To date, however, the Service's guidance has been limited and piecemeal, and that is not likely to change in the near term. Although guidance on the application of the Unrelated Business Income Tax ("UBIT") rules to Internet activities is in the Service's Priority Guidance Plan for FY 2003-2004, it was also in the plan for 2002-2003. Further, a year ago, Steve Miller, Director, Exempt Organizations Division, indicated that the Service is not likely to issue "massive guidance" on this issue.

   The Service did address Internet issues in its Continuing Professional Education Text for Fiscal Years 1999 and 2000 (hereafter referred to as "1999 CPE Text" and "2000 CPE Text").4 These texts are used by the Service for internal training purposes and have no precedential value. Moreover, in an area like the Internet where the Service is currently grappling with the issues, the Service's thinking may have changed after publication of these articles. Nevertheless, in the absence of more definitive guidance, the CPE texts can be quite useful as an indication of the Service's thinking.

   This part of the outline is organized by the types of activities in which exempt organizations typically engage on the Internet. With respect to each activity, the applicable federal tax issues are identified and the application of the law to those activities is discussed.

   A. ADVERTISING AND SPONSORSHIPS

   1. Use by Exempt Organizations.

      Many exempt organizations seek advertising and sponsorships as a source of funds for operating their websites. The federal tax issue raised by these arrangements is whether the payments received are includable in Unrelated Business Taxable Income ("UBTI").

      2. Applicable Federal Tax Rules.

      1. Advertising vs. Acknowledgement. UBTI generally includes income from advertising, see United States v. American College of Physicians, 475 U.S. 834 (1986), but acknowledgement of a gift or a sponsorship is not considered advertising. Because of the difficulty of drawing a line between an advertisement and an acknowledgement, Congress added section 513(i) to the Internal Revenue Code in 1997, providing a safe harbor for "qualified sponsorship payments."

         b. Qualified Sponsorship Payments. Section 513(i)5 provides that a qualified sponsorship payment (a "QSP") is not included in UBTI. A QSP is a payment made to an exempt organization by a person engaged in a trade or business with respect to which there is no arrangement or expectation that such person will receive any substantial return benefit other than the use or acknowledgment of the name or logo (or product lines) of the person's trade or business in connection with the exempt organization's activities. Section 513(i)(2)(A). As Section 513(i) is a safe harbor, a payment that is not a QSP may be excludable from UBTI under a different theory or provision. At the heart of the definition of a QSP is whether the payor has received a "substantial return benefit."

         (i) Use or Acknowledgement. Use or acknowledgement, as defined in the Code and regulations, is not a substantial return benefit. Use or acknowledgment may include (i) logos and slogans that do not contain qualitative or comparative descriptions of the payor's products, services, facilities or company, (ii) a list of the payor's locations, telephone numbers or Internet address, (iii) value-neutral descriptions, including displays or visual depictions, of the payor's product-line or services, and (iv) the payor's brand or trade names and product or service listings. Treas. Reg. Section 1.513-4(c)(2)(iii). A promotional logo or slogan that is an established part of the sponsor's identity does not, by itself, constitute advertising. Treas. Reg. Section 1.513-4(c)(2)(iv); see H.R. Conf. Rep. No. 220, 105th Cong., 1st Sess. 476 (1997).

         (ii) Advertising. In contrast, advertising for the payor is a substantial return benefit and generally will cause the payment to be taxable to the exempt organization. Advertising is any message or other programming material which is broadcast or otherwise transmitted, published, displayed or distributed, and which promotes or markets any trade or business, or any service, facility or product. Advertising includes messages containing qualitative or comparative language, price information or other indications of savings or value, an endorsement or other inducement to purchase, sell or use a sponsor's facility, products or services. Treas. Reg. Section 1.513-4(c)(2)(v).

         (iii) Contingent Payments. If a payment or the amount paid is contingent upon the level of attendance at an event, broadcast ratings, or other factors indicating the degree of public exposure to the sponsored activity, it is not a QSP and will be taxable income to the exempt organization receiving it, unless it is excludable from income under another theory or provision. Section 513(i)(2)(B)(I); Treas. Reg. Section 1.513-4(e)(2).

         (iv) Disregarded Benefits. Benefits received by a sponsor are disregarded and thus the sponsor has not received a substantial return benefit if the aggregate fair market value of all the benefits provided by the exempt organization do not exceed two percent of the amount of the payment. Treas. Reg. Section 1.513-4(c)(2)(ii). If the value of the benefits does exceed two percent of the payment, then the entire fair market value of the benefits is...