IRS Ruling on Naming Rights Could Remove Tax-Exempt Status of Some Construction Bonds

IRS Ruling on Naming Rights Could Remove Tax-Exempt Status of Some Construction Bonds

(In a time when all colleges need more money, this just seems ridiculous to me)

By MICHAEL ARNONE

Colleges that sell tax-exempt bonds to pay for construction and then make lucrative deals to sell the naming rights to the new facilities might soon have a difficult choice to make: lower the value of the naming-rights contracts or lose the tax-free status of their bonds.

The U.S. Internal Revenue Service issued a ruling last November, which was made public only recently, that stated that the privileges that individual donors and corporations enjoy by purchasing naming rights to facilities such as stadiums and arenas count as a "personal-business use" of that property. Tax law states that if the value of personal-business use exceeds a certain proportion of the value of the property and the costs of debt service on it, the IRS will revoke the bonds' tax-exempt status.

Public institutions can make deals worth up to 10 percent of the values of property and the amount of debt, while most private nonprofit organizations have a threshold of only 5 percent. The law does not apply to for-profit entities because they are not allowed to issue tax-exempt bonds.

How applicable the ruling is to colleges is still unclear. Higher-education institutions do fall under the categories of public and private institutions covered by the decision. But the decision was made in a private-letter ruling, which settles how existing law applies to one particular case involving a city's convention center. The ruling is not a full-fledged regulation and cannot be used as precedent in other cases, said Anthony Burke, an IRS spokesman, but tax experts will see it as guidance on how the IRS views this particular issue.

Some of those experts are skeptical, though, of the IRS's intrepretation of the law and say that the ruling could have a big effect on colleges. "It's a bit of a stretch to say that because a facility is named after you, you have control over it," said Linda B. Schakel, an expert on tax-exempt bonds and president-elect of the National Association of Bond Lawyers. She said that when she worked for the U.S. Department of Treasury from 1995 to 1997, she helped write the law on which the IRS based the private-letter ruling. "It's a little bit different than controlling how your name appears on concessionaires' cups and janitors' uniforms," she said.

Joseph R. Irvine, a tax lawyer for Ohio State University, said that any institution that has sold tax-exempt bonds to pay for new construction should be concerned. Most issuers, including colleges, he said, "will see that this is the position the IRS would take on an audit."

Colleges often pay for new construction with tax-exempt bonds through their local or state governments. The tax-free nature of the bonds make them attractive to potential buyers, who would be understandably upset if they found out later that they owed taxes on them.

And selling naming rights can mean big bucks for cash-strapped institutions. The University of Maryland at College Park is getting $20-million over the next 25 years from Comcast, the country's largest cable company, for its new arena, the Comcast Center. In one of the biggest deals, California State University at Fresno is getting $40-million over 20 years from Save Mart, a regional supermarket chain, for its new stadium, the Save Mart Center.

But naming rights carry with them their effects on any tax-exempt bonds used to finance construction, said Gregory V. Johnson, a tax lawyer and national chairman of public finance at the Denver office of Patton Boggs, a law firm. "It's not just putting your name on a building, it's putting your name on a building for a business purpose."

For example, if a Mr. Jones personally donates $20-million to his alma mater and in gratitude it names a stadium after him, the bonds would be tax-exempt. If Mr. Jones's company pays the institution $20-million to put its name on a stadium for advertising purposes, though, the bonds might be taxable. That would depend on whether the institution was public or private, and whether the payments met either the 10- or 5-percent thresholds, respectively, of private use.

The ruling will affect colleges and universities more than cities and municipalities because higher-education institutions tend to build smaller facilities, Mr. Johnson said. The proportional value of naming rights increases as the size and cost of facilities decrease, he said.

Mr. Irvine said he doesn't think a naming-rights gift for OSU's new arena exceeded the 10-percent threshold, but he will check to make sure. Ohio State used tax-exempt bonds to build the new arena where its basketball and hockey teams play and the university sponsors other events. The university also received $12.5-million in 1998 from the Schottenstein family, which owns Value City, a national furniture chain, to name the facility the Value City Arena at the Jerome Schottenstein Center.

Deborah Adishian-Astone, executive director of auxiliary services at Fresno State, said in an e-mail message that the university used tax-exempt bonds to finance the Save Mart Center. But she said the ruling does not apply to Fresno because Save Mart's money doesn't reach the 10-percent limit.

Another important concern colleges have is whether the ruling could be applied retroactively to outstanding bond issues. Because the ruling is based on existing law, it could affect projects that are already under way, Ms. Schakel said. But Mr. Johnson said that the ruling only applies to its particular case and that the IRS almost never applies laws retroactively.

Answering that question is crucial to colleges, said Mr. Irvine, because they might have to pay "very substantial penalties" if their bonds became taxable.

When the IRS removes the tax-free status from bonds, colleges normally enter agreements in which they, and not the bond buyers, pay the taxes that are due, Ms. Schakel said. "Universities want to keep in the good graces of bondholders," she said.

Mr. Irvine, Mr. Johnson, and Ms. Schakel all said there is a big push among tax lawyers for the IRS to issue an official regulation to clarify the issue of naming rights.

Background article from The Chronicle:

• Novel Corporate Deal Will Finance New Basketball Arena for U. of Maryland(1/14/2000