Nonprofit profits in treating payments as royalty income

The IRS challenged whether a publisher’s payments to a nonprofit for publishing the nonprofit’s magazine are subject to unrelated business taxable income (UBTI). While nonprofits are generally exempt from income taxes, nonprofits must pay taxes at the normal corporate rates on their UBTI. UBTI is income from the conduct of any trade or business not substantially related to the exercise or performance by such organization of its charitable purpose. UBTI rules were enacted to prevent tax exempt organizations from competing unfairly with businesses whose earnings are taxed.

Advertising income received for publishing a nonprofit’s magazine would generally be considered subject to UBTI. However, under the Internal Revenue Code, royalty payments are exempt from UBTI.

Here, the nonprofit licensed its name, logo and magazine to a publisher in exchange for a royalty payment equal to a percentage of the net income the publisher earned for publishing the magazine. The publisher’s net income derived primarily from the revenue generated from the magazine’s print advertising sales.

Case law provides that the less involvement the nonprofit has in the activities of advertising, the more likely the payments will be treated as royalty income and exempt from UBTI. Bad facts would include having advertising checks payable to the nonprofit, officers of the nonprofit reviewing sale presentations, telemarketers being considered joint employees of the publisher and the nonprofit and the publisher acting as agent for the nonprofit. However, where the publisher acts only as an independent contractor, the publisher is solely responsible for the advertising content, the publisher exclusively handles the commercial advertising, and advertising checks are payable to the publisher, the payments to the nonprofit from the publisher should be considered royalty income exempt from UBTI.

When the IRS challenges a reporting position, proper planning and strategic direction from a tax attorney are essential for success. 

This Chuhak & Tecson, P.C. communication is intended only to provide information regarding developments in the law and information of general interest. It is not intended to constitute advice regarding legal problems and should not be relied upon as such.

Client alert authored by: David B. Shiner, Principal