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Common sense for royalty income.

Common Sense for Royalty Income

Protect passive activity.

What happens when an exempt organization licenses its name and/or logo to a taxable entity to market commercial products and services? As long as the association is not actively involved in or providing substantial services for the commercial marketing, income derived from such arrangements is royalty income. It is not subject to unrelated business income tax (UBIT).

The Internal Revenue Code (IRC) provides the royalty exclusion. While the legislative history isn't clear on why this exemption was created, royalty income is typically passive and therefore within the ambit of traditionally recognized sources of nontaxable income for exempt organizations.

The Internal Revenue Service describes a royalty as a payment relating to the use of a valuable right. Payments for the use of trademarks, trade names, service marks, or copyrights ordinarily are classified as royalties whether they are set at a flat fee or based on usage. IRS consistently concludes that royalty income is exempt from UBIT, even if an organization retains the right to approve the quality or style of products or services sold.

IRS has ruled that providing certain personal services that benefit the licensee, rather than protect the intangible property right being licensed, disqualifies payments as royalties. Such services include personal appearances and interviews required in connection with licensing agreements.

When an association's role in facilitating the business use of its licensed property is too active, courts have concluded that the income does not constitute a royalty because the association itself engaged in a business activity. For example, in the 1989 National Water Well Association case, the tax court examined the association's endorsement and sponsorship of an insurance program that used the association's membership list. The court held that dividends received for the association's sponsorship did not fall within the UBIT royalty exemption. The association played an active role in the program, the court found, by providing exhibit space and answering inquiries from current and potential policyholders under contract to the insurance company.

IRS likely will consider money paid for services such as providing membership lists, endorsements, promotions, advertisements, or administrative activities as compensation for services rendered and not royalty income. Write a separate and distinct contract for related services.

In March 1988, IRS ruled that payments to a 501(c)(3) exempt organization under a licensing agreement for the use of the organization's name and logo were royalties. In 1990 IRS revoked the ruling, generating much attention and concern. If you read the private letter ruling closely, however, the basis for the change was that payments made under the licensing agreement for the use of the name and logo were inseparable from and essentially for the use of the mailing list. Therefore, a separate license agreement for the use of a name and logo without any related services should still meet the royalty exception.

Another area that has received IRS attention recently is income from affinity credit card programs and other affinity merchandising activities. The current IRS position holds such income subject to UBIT and not excludable royalty if an association provides its mailing list to a third party as part of an affinity arrangement. The IRC provides a limited exception for the rental or exchange of donor mailing lists among exempt organizations that are eligible to receive charitable contributions.

George D. Webster is general counsel to ASAE and a partner in Webster, Chamberlain & Bean, a Washington, D.C., law firm.
COPYRIGHT 1991 American Society of Association Executives
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Title Annotation:Legal; taxation of royalty income
Author:Webster, George D.
Publication:Association Management
Date:Sep 1, 1991
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