EO IRS Update:
- UBTI From Labor Organization Magazine
- Corporate Sponsorship Regulations
- Incentive Payments to Physicians
By Harry J. Friedman, Greenberg Traurig, Phoenix Office
View or download the PDF version of this Alert
UBTI From Labor Organization Magazine
In a recent case, the Eighth Circuit Court of Appeals affirmed the Tax
Court decision that the Arkansas State Police Association (“ASPA”) received
unrelated business taxable income (“UBTI”) as a result of revenues earned
in connection with the publication of its magazine. The Eight Circuit distinguished
a number of recent judicial decisions dealing with affinity credit cards.
|"the payments were not
royalty income from the publisher since it was not acting to
ASPA is an organization exempt from tax under Section 501(c)(5) of the
Code, a labor organization. A for-profit business published the Arkansas
Trooper, ASPA’s official magazine, under an agreement with ASPA. The
publisher designed the layout and printed and distributed the magazine.
ASPA provided its membership list to the publisher. Income that ASPA received
in connection with the magazine was treated as royalty income on its tax
In a number of recent cases, the courts have rejected the IRS contention
that payments made to tax-exempt organizations by credit card companies
to utilize the name of the organization and its mailing list to distribute
credit cards was not UBTI (GT Alert, December 1999,
Likely to Stop Litigation of Affinity Credit Card Case”). These cases generally
held that a tax organization’s de minimis participation
in the credit card distribution, limited to supervising or controlling the
manner in which its name was used, did not prevent the payment received
from the credit card company from constituting non-taxable royalties. The
IRS has announced it would no longer litigate cases involving affinity credit
ASPA argued that the receipt of payments from the publisher of its magazine
was no different than the receipt of royalty payments from credit card companies.
The Court of Appeals disagreed, concluding that the advertising revenues
received by ASPA were different than payments from credit card companies
for the use of an exempt organization’s name. The court noted that the affinity
credit card cases involved the payment of royalties because the credit card
company merely paid the tax-exempt organizations named to promote the credit
card company’s product. In contrast, the publisher used ASPA’s name to promote
ASPA, not the publisher. Instead, the Court relied on National Collegiate
Athletic Assoc. vs. Commissioner, a 1991 case involving the publication
of programs for the NCAA Division 1 Basketball Tournament. The advertisement
income received by the NCAA was treated as UBTI because the publisher was
deemed to be acting on the behalf of the NCAA to promote the NCAA, not the
promotion of the publisher’s products. Likewise, here the payments were
not royalty income from the publisher since it was not acting to promote
The ASPA case indicates that revenues paid to an exempt organization
that arose from advertising in the organization’s journal or magazine may
constitute UBTI. The label on the agreement, “royalties and licensing agreement,”
was given no effect by the court. Instead, the court found an agency relationship
between ASPA and the publisher where the publisher merely acted as an agent
for ASPA to sell advertising and to publish the magazine.
The Court of Appeal’s decision highlights the definition of “royalty.”
A royalty is a payment for the use of the exempt organization’s intangible
property by another person where the use of the intangible property is for
that person’s benefit. Publications of an exempt organization will not generate
revenues that exploit an organizations intangible property for the benefit
of the publisher. Under this decision, advertising revenues from the magazine
or journals sent to members cannot constitute “royalties” for UBTI purposes.
Corporate Sponsorship Regulations
The IRS has issued final Treasury Regulations dealing with corporate
sponsor payments to tax-exempt organizations. The IRS had issued Proposed
Regulations dealing with corporate sponsorship payments in 2000 (GT Alert, March 2000, “IRS Issues Corporate Sponsorship Regs.”) These
issues first arose in 1991, when the IRS concluded that payments to the
Cotton Bowl from its corporate sponsor, Mobil Corporation, were UBTI because
the Cotton Bowl provided advertising services. The outcry from exempt organizations
resulted in legislation that allowed exempt organizations to receive payments
from corporate sponsors in exchange for naming the event or other acknowledgements
of the payments. The Proposed Regulations provided a means to distinguish
between acknowledgements of sponsorship payments and advertising.
The Final Regulations generally follow the Proposed Regulations in defining
non-UBTI sponsorship payments as payments made by a party engaged in a business
that did not result in a “return benefit” to the person operating business.
The Proposed Regulations permitted an acknowledgement of the payor’s name
or logo in connection with the exempt organization activities, but prohibit
comparison advertising and price information. The Final Regulations contain
the same rules.
The Proposed Regulations addressed “exclusive provider arrangements.”
An exclusive provider arrangement is when an exempt organization agrees
not to sell products or services that compete with those of the sponsor.
These Regulations were in response to reported transactions between several
universities and soft drink manufacturers to limit competing products on
their campuses. Under the Proposed Regulations, payments in connection with
an exclusive provider arrangement would be treated as UBTI. Several commentators
objected to these provisions. The Final Regulations contain the same treatment
for exclusive provider arrangements. However, under the Final Regulations,
the right to simply be the sole sponsor of an activity or the only sponsor
representing a particular business will not be treated as UBTI.
The Final Regulations address hyperlinks from an exempt organization’s
Web site to the Web site of the corporate sponsor. The mere existence of
the hyperlink to the sponsor’s Web site from the organization’s Web site
in one example in the Final Regulations, is deemed to be a mere acknowledgement
of the sponsor’s payment to the organization. A second example involves
an endorsement of a product on the sponsor’s web site by the exempt organization;
the endorsement converts the acknowledgement into advertising.
The IRS is actively looking at UBTI issues in connection with hyperlinks
from exempt organization Web sites. The Final Corporate Sponsorship Regulations
provide that the guidance on hyperlinks contained in these rules may not
necessarily apply outside the context of corporate sponsorship payments.
Nevertheless, as the only existing guidance, it would be anticipated that
practitioner’s will use these examples when formulating links between exempt
organization Web sites and for-profit entity Web sites.
Incentive Payments to Physicians
In a recent IRS informal pronouncement, an IRS representative concluded
that there is no prohibition or per se rule preventing health
care organizations from making incentive payments to physicians.
The information letter, which is not binding on the IRS, concerned a
participating hospital receiving a global payment for hospital and physician
services provided on an in-patient basis for some fee for service Medicare
beneficiaries. The financial risk to an individual physician or group of
physicians would be neither 25% more than nor 25% less than the amount the
physician or group of physicians would have been paid under traditional
Medicare programs. In addition, it was represented that the incentive payments
were not focused solely on lowering the volume or cost of services provided
to the beneficiaries. Evidence of high quality outcomes and the ability
to support continuous quality improvement efforts were required to be demonstrated
by participating hospitals. The quality standards were to be monitored by
an independent organization.
The information letter indicates that, in the past, the IRS has considered
various factors to determine whether an arrangement violates the prescriptions
against private inurement and impermissible private benefits. The factors
listed in the letter include:
(i) independent board of directors or independent compensation committee
making determinations of compensation;
(ii) the existence of a conflicts of interest policy for the hospital
pursuant to which the independent board of directors was acting;
(iii) whether the compensation arrangement with the physician results
in total compensation that is reasonable;
(iv) whether there is an arm’s length relationship between the healthcare
organization and the physician, or does the physician participate impermissibly
in the management or control of the organization;
(v) does the compensation arrangement include a ceiling or reasonable
maximum on the amount that a physician may earn, does the compensation
arrangement have the potential for reducing charitable services or benefits;
(vi) does the compensation arrangement take into account data that
measures quality of care or patient satisfaction;
(vii) does the amount a physician earns under the compensation arrangement
depend on net revenues;
(viii) does the arrangement accomplish the organization’s charitable
purposes, such as keeping actual expenses within budgeted amounts where
expenses determine the amount the organization charges for charitable
(ix) is the compensation arrangement merely a device to distribute
all or a portion of the healthcare organizations profits to persons who
are in control; and
(x) does the compensation arrangement reward the physician based on
services the physician actually performs or is it based on performance
in an area where the physician performs no significant functions.
The letter notes that in summary, “there is no prohibition or per
se rule that prevents healthcare organizations from making incentive
payments to physicians.” All of the relevant factors discussed above will
be considered by the IRS in examining an incentive program.
While this letter is not binding on the IRS, it once again confirms that
Section 501(c)(3) organizations may provide various forms of incentive compensation
to employees. While this letter directly addressed the incentives paid to
hospital physicians, the same consideration should equally apply in the
case of other types of Section 501(c)(3) organizations.
These factors should be taken into account and their consideration documented
by Section 501(c)(3) organizations entering into incentive compensation
arrangements with executives.
© 2002 Greenberg Traurig
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