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GT Alert

EO IRS Update:

  • UBTI From Labor Organization Magazine
  • Corporate Sponsorship Regulations
  • Incentive Payments to Physicians

May 2002
By Harry J. Friedman, Greenberg Traurig, Phoenix Office

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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.

Harry J. Friedman
"the payments were not royalty income from the publisher since it was not acting to promote itself."

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 return.

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, “IRS 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 cards.

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 itself.

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 services;

(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


Additional Information:

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This GT ALERT is issued for general purposes only and is not intended to be construed or used as legal advice. Greenberg Traurig attorneys provide practical, result-oriented strategies and solutions tailored to meet our clients’ individual legal needs. The Firm’s responsive approach to client service often cuts across legal subject matter, applying the right experience and resources to provide cost-effective solutions.