When may a nonprofit promote a donor's or board member’s business through its website or other communications? If the nonprofit allows the promotion as a sponsorship, through a fundraising program in which the business is donating money to the nonprofit, the promotion is likely permissible. If the business is paying fair market value for advertising, provided the amount of the organization’s overall advertising is within appropriate limits and subject to possible tax liabilities, the promotion should be fine too. But serious legal problems can arise when and if the business does not pay the nonprofit (or pays less than it should) for marketing benefits. Here’s why, as well as how to guard against such problems.
The Basics – No Inurement or Impermissible Private Benefit
Every Section 501(c)(3) nonprofit must continually ensure that its organizational resources (funds, personnel, and even website) are directed toward the advancement of the nonprofit’s tax-exempt purposes. Indeed, this responsibility forms part of each director and officer’s fiduciary “duty of obedience” to the corporate purpose.[1] Stated oppositely, the nonprofit must guard against inurement and impermissible private benefits.
The term “inurement” refers the improper use of charitable resources or assets to benefit directors and officers or any other nonprofit “insider.” Improper use is rarely as obvious as direct theft. It more often occurs through the form of benefits, such as casual compensation for a hard-working volunteer, favorable business contracts at more than fair market value, other financially significant “perks” for leaders, or personal use of nonprofit resources like a vehicle, some or all of a facility, or equipment.
Impermissible private benefit is similar in concept to inurement, but it covers individuals who are not nonprofit insiders. The exchange of services or resources between a nonprofit and private interests is not prohibited, but the exchange must:
- Be at fair market value (FMV) or better in favor of the nonprofit;
- Necessarily advance the mission of the nonprofit; and
- Further the nonprofit’s mission at a level proportionate to the nonprofit’s resources utilized.[2]
With respect to (3) above, nonprofit leaders should exercise caution when forging relationships with private interests, as any private benefit must correlate to the public benefit created by the exempt activity. For example, a donor could provide funds for a school’s music program that benefits the donor’s children, but the music program funding should not be limited to only the donor’s children and a few others. Ideally, the music program would benefit several grades or even the whole school, and therefore only incidentally benefit the donor’s children (i.e., in relation to the entire benefit). As another example, a nonprofit should not allow a business to receive free advertising. Correspondingly, the nonprofit should not provide free “sponsorships” if others must provide a donation for such marketing opportunity.
By failing to charge money for a business’s advertising or sponsorship, the nonprofit will be facilitating impermissible private benefit (if the business is an outsider to the organization) or inurement (if the business’s owner is on the board or otherwise a key leader of the nonprofit). Please note too that “sponsorships” in tax parlance generally means a payment for which a business does not expect any substantial return other than mere acknowledgment of the business’s name, logo, or product lines. By contrast, “advertising” typically involves an invitation to purchase goods, such through sales price information, recommendations from the nonprofit, qualitative language, or other inducement to purchase.
At the Carwash
To illustrate these legal principles, let’s look at hypothetical Midwest Food Pantry and Bob’s Carwash, a 501(c)(3) nonprofit and a for-profit entity, respectively.
Imagine that Nancy is a director of the nonprofit Midwest Food Pantry and also a business owner of a for-profit store, Chicago Floral. If she were to add a link to Chicago Floral’s business page to the Midwest Food Pantry website, such links might constitute inurement, because the charity’s resources are arguably being used to advance personal business interests of an insider – that is, Nancy, who in a position to exercise substantial control over the organization. Depending on the facts and circumstances, such links could be grounds for revocation of Midwest Food Pantry’s tax-exempt status under IRC 501(c)(3), plus the possibility of hefty excise taxes against Nancy and the nonprofit. Where the Internal Revenue Service finds more than an insubstantial amount of these types of activities (or any inurement at all), the Service may revoke the tax-exempt status of an organization under IRC 501(c)(3).
Now let’s suppose that Midwest Food Pantry’s website presence and impact grows over time. A local Chicago businessperson, Bob, who is a friend of Nancy’s but not otherwise involved in Midwest Food Pantry, approaches her and asks her to advertise his carwash with the nonprofit’s resources. Bob is a good friend, and generally supports the cause of Midwest Food Pantry, even making a donation from time to time, so Nancy agrees. Without any payment for the use of the space on the website or the links, such arrangement likely constitutes impermissible private benefit. Charitable resources - the website and Midwest Food Pantry’s goodwill in the community - are being used to advance Bob’s private interests, without any fair exchange to Midwest Food Pantry.
Getting Commercial – But Not Too Much!
Changing the scenario, Bob promises to provide a royalty to Midwest Food Pantry for every car his business washes, if Nancy posts a link to his business on the nonprofit’s website. Suppose the royalty is fair to the organization. Under federal law, the advertising is not strictly prohibited, but it is not generally regarded as an “exempt activity.” Midwest Food Pantry may only engage in an insubstantial amount of advertising (as compared to its overall activities), in order to protect its tax-exempt status.[3]
As one solution in this case, Bob may “sponsor” the organization. For example, Midwest Food Pantry may post a statement that says “Bob’s Carwash Proudly Sponsors Midwest Food Pantry,” with a link Bob’s Carwash website, in exchange for some payment (i.e., the “sponsorship”). But in order to implement this solution without jeopardizing Midwest Food Pantry’s charitable status, the charity must be careful not to recommend or endorse Bob’s Carwash. Another solution may be to develop a commercial “co-venturing” arrangement, but Nancy and Bob will need to be attentive to accompanying state-specific regulations [4] and keep such activity to a relative minimum.
Working Together for Good
Many nonprofits have close ties with for-profit businesses, as part of their leaders’ many-layered professional and personal relationships. That’s wonderful and should be encouraged! But to the extent such relationships result in economic benefits to any insider, or involving more than incidental private benefit to others, such benefits should be conscientiously monitored and defined. A key safeguard is through annual conflicts of interest disclosure statements, an accompanying conflict of interest policy, and careful evaluation of any identified conflicts.[5] By taking such precautions, the nonprofit can remain true to its charitable purpose, protect its tax-exempt status, and otherwise get along well with its stakeholders.
[1] For guidance about the fiduciary duty of obedience, see our blog on Staying True to Your Mission.
[2] For further discussion of what may constitute too much private benefit, please see our blog on Public Charities and Private Benefit.
[3] For a case study on too much commerciality, see our blog on Structuring Tax-Exempt Business Activities Under Section 501(c)(3).
[4] See our blog on Cause-Related Marketing and Commercial Co-Ventures.
[5] For further guidance on nonprofit conflicts of interests implicated by these inurement and private benefit considerations, see our blog on The Duty of Loyalty.
