Firm Raises Concerns About Deductibility of Goodwill Ad Payments

January 31, 2020

Mon L. Lam and Merrill D. Feldstein
Internal Revenue Service
1111 Constitution Avenue NW
Washington, DC 20224

Re: IRS REG-107431-19, Treatment of Payments to Charitable Entities in Return for Consideration

Dear Internal Revenue Service:

We welcome the IRS amending Treasury Regulation 1.162-15. However, the proposed amendments would increase confusion that already exists regarding which criteria govern deductibility under IRC 162 for goodwill advertising payments made to tax exempt entities under IRC 170 (“Section 170 Organizations”). This regulation was last amended 55 years ago. We urge the IRS to take this opportunity to resolve this confusion rather than increase it.

Discussion

Longstanding Confusion

Treasury Regulation 1.162-15(b) governs payments to 170 Organizations generally. These payments are deductible as business expenses under IRC 162 deduction if the payment (1) “bears a direct relationship to the taxpayer's business” and (2) is “made with a reasonable expectation of a financial return commensurate with the amount of the donation.” The specific subject of institutional and goodwill advertising payments to Section 170 Organizations is addressed by Treasury Regulation 1.162-20(a)(2). It allows deduction under IRC 168 if the expenditure is “related to the patronage the taxpayer might reasonably expect in the future.”

Under general principles of legal interpretation, if two laws govern the same factual situation, the law governing the specific subject matter takes precedence over the law governing general matters. Under this principle, goodwill advertising should be governed by the criteria of Section 1.162-20(a)(2), not the general criteria supplied under Section 1.162-15(b). Unfortunately, IRS authorities on this topic uniformly analyze goodwill advertising under the general criteria of Section 1.162-15(b). We have found only a single instance where the IRS analyzed the situation under the specific goodwill advertising criteria of Section 1.162-20(a)(2). See PLR 9309006 (1992).

A Growing Problem

Previously, this confusion created few problems. If the IRS rejected a goodwill advertising payment under IRC 162, the business could alternatively claim the payment as a charitable deduction under IRC 170. But the nature of business is changing with the rapid growth of social enterprise, where companies use business to advance both the public interest and their pecuniary interests. Many of these businesses already reach the 10% charitable deduction limit under IRC 170(b)(2)(A). Because their target customers are heavily engaged with Section 170 Organizations, these businesses frequently conduct goodwill advertising by making payments to Section 170 Organizations in exchange for their mutual publication of the taxpayer's financial support. But if the IRS rejects their deduction under IRC 162, the business cannot fall back on IRC 170 because they often have already reached the 10% limit.

States have responded to the explosive growth of social enterprise by adopting a new corporate form called the Benefit Corporation, which has now been adopted in 36 states. Unlike traditional corporations, whose state-sanctioned, codified purpose is to maximize the financial interests of shareholders, Benefit Corporations have the additional codified purpose of promoting the interests of society and the environment.

I led the effort to write and pass the 2011 legislation that created Benefit Corporations in California, and I am a founding director of the Benefit Company Bar Association. Our firm represents a large number of Benefit Corporations, and they (and their accounting professionals) frequently ask which criteria govern the deductibility of goodwill advertising under IRC 168. The IRS created considerable buzz throughout the Benefit Corporation community when it issued General Information Letter No. 2016-0063. That letter referenced the goodwill advertising criteria of Section 1.162-20(a)(2); however, it also referenced the general criteria that impose the conflicting, undefined, and amorphous requirements of a direct connection and commensurate financial return, thus generating more questions than it answered.

The Proposed Amendments Would Increase Confusion

The proposed amendments would add two illustrative examples to Section 1.162-15 at subsection (a)(2). Both involve instances of goodwill advertising and describe the taxpayers' expectations those expenses will attract customers and increase sales. The examples do not discuss or apply the general criteria of Section 1.162-15(a)(2) that require a direct connection and commensurate financial return. If adopted, these amendments will signal that the IRS disregards the goodwill advertising criteria of Section 1.162-20(a)(2). This is especially true because the proposed amendments also remove the cross reference currently found in 1.162-15(d) that states “For provisions dealing with expenditures for institutional or good will” advertising, see Section 1.162-20.”

Our Recommendations

To alleviate this confusion, we recommend the IRS instead:

If the IRS disagrees and instead wants goodwill advertising to be governed by the general criteria of Section 1.162-15, then we recommend it alleviate this confusion by:

We urge the IRS to adopt our primary recommendations because they provides the more sensible and workable solution. The requirement of a commensurate financial return makes sense for many business expenses because the cost and anticipated benefit can be reasonably projected. The same is arguably true for advertising expenses that promote a specific product or service. But it is unreasonable to impose this requirement on goodwill advertising because it promotes a company's name or brand which is inherently difficult to attribute to sales of the company's various products or services. We believe this is why the IRS created a separate regulation to govern goodwill advertising. (Historical note: The IRS adopted Section 1.162-15(a)(2) at the same time it last amended Section 1.162-15 in 1965.)

Conclusion

Clarity is always a goal of the regulatory development process. Unfortunately, over the past 55 years, the IRS has created confusion regarding which criteria govern the deductibility of goodwill advertising payments by ignoring the regulation it adopted in 1965 to address these specific expenditures. Instead of expanding that confusion, we urge the IRS to use this opportunity to explain that deductibility is governed by the criteria in Section 1.162-15(a)(2).

Society benefits from the continued growth of Benefit Corporations and social enterprise. The achievement of those benefits will be enhanced by the changes we request here.

Very truly yours,

WENDEL ROSEN LLP

Donald S. Simon
Oakland, CA