Earlier this year, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2018-08, Clarifying the Scope and the Accounting Guidance for Contributions Received and Contributions Made. In issuing the guidance, the FASB noted that many not-for-profit organizations have trouble characterizing grants and similar agreements as either exchange contracts or as contributions for purposes of revenue recognition in their financial statements. Several aspects of the new guidance involve considerations that bear a striking similarity to those used when evaluating the taxability of grants and similar contracts for Washington business and occupation (“B&O”) tax purposes.
Grants and the B&O Tax
As noted in a previous article, there is no general nonprofit exemption from the State’s B&O tax. The B&O tax is a broad tax imposed for the privilege of engaging in business activities. For this purpose, “business activities” are broadly defined to include almost any activity, whether or not it is conducted for profit. That is not to say there are no exemptions or deductions that apply to nonprofit organizations, but oftentimes, strict requirements must be met to qualify. Grants are no exception.
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. Normally, some public benefit or social good resulting from the contribution is not sufficient to render it taxable. However, care should be taken when the grant agreement requires the grantee to discharge a specific statutory duty of a government agency. The Department of Revenue has determined that, in some cases, an agreement to fulfill a duty of a government agency is a taxable contract for services.
New FASB Guidance
The new FASB guidance clarifies how an organization determines whether a provider of funding and the organization are engaged in an exchange transaction. Funding providers can include government agencies, foundations, individuals, and others. The principal focus is on whether the funding provider is receiving direct commensurate value in return from the organization based on the following:
- The funding provider, even if it’s a governmental agency, is not synonymous with the general public. A benefit received by the public because of the arrangement is not the same as value received by the funding provider.
- Execution of a funding provider’s mission, or the positive sentiment from acting as a donor, does not constitute commensurate value for purposes of determining whether the transaction is a contribution or exchange.
Consistent with current GAAP, in a transaction where the funding provider is not itself receiving commensurate value, the organization must determine whether the transfer is a payment by a third-party payer on behalf of an existing exchange transaction between the organization and an identified customer. In this case, other guidance may apply.
This idea of commensurate value in exchange for funding found in the new guidance sounds very similar to the B&O tax idea of significant goods or services. While there may be meaningful differences between the two concepts, thinking about them in a similar fashion may be helpful in determining when funding might be subject to B&O tax.
For B&O tax purposes, 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. In making this determination, considering the GAAP treatment as a contribution or exchange transaction may be helpful. 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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