IRS revokes favorable royalty ruling.

• Author: Dillon, Randy

The IRS and exempt organizations have been engaged in a longrunning dispute over "royalty" income. The recent revocation of a favorable 1992 ruling suggests that tax-exempts should review all current royalty agreements, assess their exposure to the unrelated business income tax (UBIT) and, if possible, amend agreements to provide the strongest tax return position. Practitioners should also monitor a Tax Court case on this issue involving the Sierra Club.

Under Sec. 512(b)(2), exempt organizations may generally receive royalties without incurring a liability for UBIT. Exempt organizations have sought to apply the "royalty exception" to mailing list rentals, income from endorsed insurance programs, "affinity cards" and many other activities. In most "endorsement" arrangements, an exempt organization will license the use of its name and logo to a commercial entity for a royalty-generally a percentage of the licensee's gross revenues from the program; typically, the organization will also supply its mailing list to the licensee. The commercial licensee, in turn, solicits the organization's members for the insurance, credit card or other services.

The Service normally treats such arrangements as fully taxable for two reasons. First, the IRS views Sec. 513(h)(1)(B) as the sole UBIT exclusion for the rent or exchange of mailing lists; because the licensee is typically not a charitable organization, this exclusion does not apply. Second, because the organization's mailing list is an essential ingredient of most licensing arrangements, the Service contends that it is not possible to separate the income received for taxable mailing list rents from that received for a theoretically nontaxable name-and-logo royalty; see, e.g., GCM 39727.

However, in 1992 the IRS issued a favorable letter ruling that characterized an exempt organization's income from an insurance program as a tax-free royalty. In Letter Ruling 9220054, the organization had agreed to "endorse" insurance programs by permitting a commercial insurance broker to use the organization's name, letterhead and logo in promoting insurance products to the organization's members. The organization acknowledged that it had supplied the broker with its mailing list on one occasion, but agreed that it would not do so...