Academic journal article Journal of Accountancy

Clarifying Unrelated Business Income

Academic journal article Journal of Accountancy

Clarifying Unrelated Business Income

Article excerpt

Although tax-exempt organizations are exempt from federal taxation on their principal activity, they must pay tax on any unrelated business income. Numerous court cases have considered what constitutes unrelated business income. Recently the Eighth Circuit Court of Appeals clarified the taxation of royalty income.

The Arkansas State Police Association signed an agreement with Brent-Wyatt West (BWW) to publish a magazine called the Arkansas Trooper. Labeled a royalty agreement, the document required BWW to pay the police association $25,200 per year plus between 26% and 27% of the magazine's advertising revenue. BWW had total responsibility for marketing the magazine and paying all publication costs. The association's vice-president of public relations spent only 15 to 20 hours a year on magazine-related activities including reviewing content for suitability and encouraging members to submit articles and photographs.

The Tax Court agreed with the IRS that the association's receipts of about $877,000 in the years at issue were taxable unrelated business income and not nontaxable royalty income. The association appealed.

Result. For the IRS. The taxpayer argued that the proceeds were passive royalty income exempt from tax under IRC section 512(b). It equated its case to the affinity-card cases in which the courts held that the payments an exempt organization had received for the right to use its name were nontaxable royalty income. They also relied on two examples from revenue ruling 81-178, 1981-2 CB 135.

In both instances the tax-exempt entity licensed its name to a taxable organization, which used the name to sell a product. …

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