Structuring licensing agreements.

Q: My association wants to license its name and logo to a magazine publisher for a fee. Can an agreement be structured to ensure that the association's revenue will be tax exempt?

A: Yes, but the agreement must be structured carefully. There are two big traps to beware of: 1) agency and 2) performance of significant services. The Internal Revenue Service (IRS) will be watching to see whether your association falls into either one. Here are the basic rules for royalty agreements:

* A true royalty is a payment for the use of valuable intangible property rights, such as a trademark, trade name, or copyright. The owner of the intangible property rights (licensor) grants the license passively to the user (licensee).

* The Internal Revenue Code excludes true royalties from taxation as unrelated business income (IRC section 512(b)(2)).

* As long as the relationship between the two parties remains a simple, passive relationship of licensor to licensee, payments for licensee's use of the property will be tax-free royalty payments to the licensor.

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Keep in mind, however, that trade associations that have licensed their intangible property rights to magazine publishers have gotten into trouble with the IRS because of the two traps mentioned earlier.

1. Agency. If the association participates in or maintains too much control over significant aspects of the publication of the magazine, the IRS will assert that the magazine publisher is merely the agent for the association. Then the IRS will attribute the magazine's advertising revenues to the association, resulting in unrelated business income tax for the association. This has happened in cases where the association has done one or more of the following:

* solicited magazine articles and editorials from its members;

* maintained final editorial control over the magazine content;

* directed the activity of the magazine's ad salespeople;

* allowed the ad salespeople to solicit ads in the name of the association;

* directed that advertiser's checks be made payable to the association;

* asserted that the magazine is "The Official Magazine of the ABC Association."

The question for the IRS is this, Did the association maintain such control over the magazine that the publisher was in truth merely the agent of the association?

2. Performance of significant services. The association may also face taxation if it provides significant services to the magazine publisher. For example, in addition to passively licensing its name and logo to the publisher, the association may agree to solicit articles and editorials from its members; provide photographs from its photo library upon the publisher's request; provide booth space at the association convention for the publisher to promote its magazine; or assist with the distribution of the magazine. If the association substantially participates in and maintains control over significant aspects of the publication, the association may face taxation.

An association that wants to confidently receive tax-exempt royalty payments from a magazine publisher in exchange for use of its name and logo, must therefore tread carefully.

--Mark Truesdell, Beving, Swanson, and Forest PC, Des Moines; [e-mail]. The "Legal" item is not intended as legal advice but rather as an educational overview.