By Bob Heller, JD, LLM
For those in the nonprofit community with activities in Washington, it often bears repeating that there is no general nonprofit exemption from the State’s business and occupation (“B&O”) tax. The B&O tax is a tax imposed on gross revenue for the privilege of doing business. The State’s definition of “business” is very broad, such that it is hard to imagine any human endeavor that isn’t captured by the definition. Therefore, it is prudent for a nonprofit organization to consider all amounts it receives as taxable and then look for a specific exemption or deduction that may apply.
It may come as a surprise to many that there is no general B&O tax exemption for grants. A deduction is allowed, however, for donations or contributions received. Therefore, to be deductible, a grant must be considered a donation or contribution. According to the Department of Revenue, an amount will qualify as a donation or contribution if it is received with no strings attached. This means that the payment must not be received in exchange for any significant goods, services or benefits. But what does this mean in the context of a grant?
The Department recognizes that it is common for a person who is making a contribution to impose restrictions on how funds are used – usually requiring some form of accountability as a condition of their contribution. Guidance from the Department explains that, if the contribution conditions don’t result in a direct benefit to the donor, the contribution will be deductible. Public acknowledgement of a contribution is not considered to confer a significant direct benefit on the donor.
The Department will generally presume that a grant is a deductible donation or contribution when three conditions exist. First, as discussed above, the grantor cannot receive significant goods, services or benefits in return for making the grant. Second, the grantee must be a nonprofit or governmental entity. Although this condition is not stated in the deduction statute, the Department is skeptical that anyone would make a grant to a for profit business without expecting something substantial in return. Finally, the grant funds must be used to promote, advance, or fulfill “charitable purposes” (as such term is construed under Internal Revenue Code section 501(c)(3) and relevant treasury regulations), which may include offsetting an organization’s administrative expenses related to its charitable purpose.
Grants that involve studies, such as medical or sociological research, are not deductible if the grantor has any rights to the findings or intellectual property resulting from the studies. Published reports that are available to the general public by the grantee organization, and not specifically for the benefit of the grantor, are generally not considered to be a significant good or service unless the findings are only of practical value to the grantor. For example, a study of alternative uses for a patented drug commissioned by the patent holder would be taxable even if the findings of the study were made widely available at no charge to the medical community.
In addition to considering whether contribution conditions result in a direct benefit to the grantor, it is important to distinguish between a grant and a contract for services. While the label given to a document is not determinative, because many grant awards have contractual obligations, care should be exercised in evaluating any document bearing the title “agreement” or “contract.” At the very least, these titles can mislead a tax auditor into concluding that the arrangement doesn’t meet the requirements for deductibility. Sub awards can also be problematic because they often call for performing services for the benefit of the primary grant recipient to assist in carrying out its grant objectives. Such an arrangement would likely be treated as taxable fees for services and not a deductible donation or contribution.
The bottom line is that a grant that is also a donation or contribution will be deductible. It is not always clear, however, whether a significant good, service or benefit is involved. Given the complexity of making this determination, nonprofit grant recipients are encouraged to contact a tax advisor for assistance in evaluating grants when there is a question about the tax implications.
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