In Uncategorized on 09/28/2011 at 18:23

Or, Your Dues Include the Magazine

The National Education Association (NEA) publishes two magazines, both of which contain paid-for advertising. The costs of the magazines are included in the annual dues paid by members, and members can opt out of receiving the magazines (but with no reduction in their annual dues). NEA deducted the magazine costs from the advertising revenue, attributed no part of the members’ dues as income to offset the magazine costs (circulation income), and claimed to owe no Unrelated Business Income Tax (UBIT).

Wrong, says Judge Gustafson, in National Education Association, 137 T.C. 8, filed 9/28/11. The key regulation is section 1.512(a)-1(f)(3)(iii).

Judge Gustafson: “The issue for decision is whether NEA must allocate a portion of its members’ dues to the circulation income of those magazines. The parties agree that the outcome of this dispute depends on whether, for purposes of 26 C.F.R. section 1.512(a)-1(f)(3)(iii), Income Tax Regs., membership in NEA gave members ‘the right to receive’ NEA periodicals. If the members had a ‘right to receive’ the magazines, then: (a) a portion of the members’ dues was circulation income; (b) as a result of that income, NEA did not have a loss from circulation activity; (c) NEA’s income from advertising (an ‘unrelated’ activity subject to UBIT) was therefore not offset by any circulation losses; and (d) NEA owes tax on the advertising income. NEA concedes that if the IRS prevails on this issue, then the IRS’s computations are correct with respect to the amounts of membership dues allocable to circulation income for the years at issue.” 137 T.C. 8, at p. 3

Of course, the aim is to prevent otherwise exempt organizations (as NEA would be pursuant to Section 501(c)(5)) from making a profit on selling advertising in their publications to offset their non-publishing operating expenses, giving them an unfair advantage over taxpaying periodical publishers. The Regulations “fragment” taxable advertising income from exempt-function income.

NEA’s key claim was that their members had no “right to receive” the periodicals in exchange for their dues payments. First, NEA could stop publishing at any time, and the members had no legally enforceable right to receive the magazines. Second, NEA put the magazines on-line and not restricted to “members only”.

After much fencing between NEA and IRS, and after parsing of the term “right to receive”; with Judge Gustafson wading through law dictionaries, a U. S. Supreme Court First Amendment decision, Treasury Regulations, IRS Announcements, PLRs and unpublished Technical Advice Memoranda, Judge Gustafson concludes that the member did have the requisite “right to receive” the magazines, and NEA owes the UBIT.

NEA told its members what part of their dues was allocated to the magazines. The magazines were the vehicle by which NEA conveyed essential information mandated by NEA’s constitution and by-laws. Although NEA argued they could have stopped publishing at any time, they didn’t during the years at issue. Moreover, NEA stated in writing that their publication schedule was fixed a year in advance, and NEA had contracts with its advertisers. Result: NEA couldn’t establish that it could stop publication at any time. Thus, the members had enough of a “right to receive” the magazines to satisfy the Regulation at issue.

Finally, the on-line argument falls. NEA argued that anyone can read the magazines on-line, members and non-members alike, at no charge, so it cannot be fairly said that the members received the magazines in exchange for the payment of their dues, and thus had the right to receive them.

Judge Gustafson again, a jurist of great patience: “This contention is contradicted, however, by two facts:

“First, the Internet versions of the periodicals do not include all of the content of the paper editions. The paid advertising and the letters to the editor are available only in the print edition. The record includes no evidence that these features are of no value to members.

“Second, that NEA goes to significant expense and trouble to produce the paper editions shows that paper copies of the periodicals have value even in the Internet era. We take judicial notice of the fact that many periodicals have both online editions that one may access without cost and paper editions for which subscriptions must be paid. Evidently, a market still exists for paper publications. A user who has on-line access to a publication may still value receiving a paper copy. NEA put on no evidence that its members do not value the paper periodicals.” 137 T.C. 8, at p.35.

I can’t write a takeaway any better than Judge Gustafson did: “26 C.F.R. section 1.512(a)-1(f)(3)(iii), Income Tax Regs., requires an allocation of membership dues to circulation income if the exempt organization’s members have a legal right to receive the publications. For the years at issue, NEA members had such a legal right to receive the periodicals. The fact that NEA also made most of the content of the periodicals available on the Internet does not change this conclusion. Consequently, the IRS was correct in requiring NEA to allocate a portion of its membership dues to circulation income.” 137 T.C. 8, at p. 39.

501(c)s and your tax advisers, read and heed. And stand by for the inevitable appeal, as every 501(c) in the country with a magazine will be filing amicus briefs.

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