T.C. Memo. 2001-38
UNITED STATES TAX COURT
ARKANSAS STATE POLICE ASSOCIATION, INC., Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 13425-98. Filed February 20, 2001.
Gregory B. Graham, for petitioner.
William I. Miller, for respondent.
MEMORANDUM OPINION
SWIFT, Judge: Respondent determined deficiencies in
petitioner's Federal income taxes and additions to tax as
follows:
Addition to Tax
Year Deficiency Sec. 6651(a)
1993 $60,004 $15,001
1994 63,730 15,933
1995 71,158 –-
1996 80,289 20,072
- 2 -
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years in issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
After settlement of some issues, the issue for decision
involves whether payments petitioner received in connection with
advertising in a law-enforcement trade publication should be
treated under section 512(b)(2) as royalty payments and excluded
from petitioner's unrelated business taxable income.
Background
This case was submitted fully stipulated under Rule 122, and
the facts are not in dispute.
Petitioner constitutes a not-for-profit corporation,
organized under the laws of Arkansas and recognized under section
501(c)(5) as generally exempt from Federal income tax.
Petitioner was formed for the purpose of, among other
things, promoting impartial enforcement of law and order,
increasing efficiency in the police profession, and cultivating a
spirit of fraternity and mutual helpfulness among and between the
Arkansas law enforcement community and the people of Arkansas.
During the years 1993 through 1996, under an agreement
entitled “Royalties and Licensing Agreement” (the Agreement)
between petitioner and Brent-Wyatt West (BWW), an Arizona
- 3 -
publishing company, three editions of The Arkansas Trooper (TAT),
petitioner's official magazine, were produced each year. In
preparation for publication of each edition of TAT, articles,
photographs, letters, and publicity regarding Arkansas law
enforcement activities were collected through an officer of
petitioner, reviewed by the officer of petitioner, and submitted
by the officer of petitioner to BWW.
Each edition of TAT also contained numerous advertisements
from a wide variety of Arkansas businesses, all directed at
petitioner’s members. The advertisements were solicited from
Arkansas businesses over the telephone by employees of BWW. The
advertisements generally promoted Arkansas businesses and/or
commended Arkansas law enforcement activities. BWW employees
developed the presentations to be used in soliciting the
advertisements, but the advertising presentations and the
advertising copy were subject to review and approval by
petitioner.
BWW designed the layout of each edition of TAT, printed
copies of TAT, and distributed the copies free of charge to each
member of petitioner, to advertisers who purchased advertisements
in TAT at a cost of at least $100, and to each Arkansas State
Legislator.
Each edition of TAT expressly stated that all “editorial
contributions” (namely, articles, photographs, letters, and
- 4 -
publicity) from petitioner's members, from readers of TAT, and
from others should be submitted to petitioner for review and
submission to BWW, that no part of TAT could be reproduced
without written permission from petitioner and from BWW, and that
any problems with regard to the solicitation of advertisements
should be directed to petitioner.
Under the Agreement, BWW was authorized to use petitioner's
name and logo in connection with the publication of TAT and the
solicitation of advertisements in TAT. The substantial proceeds
received during the years in issue relating to the paid
advertisements appearing in each edition of TAT were divided
between petitioner and BWW as follows:
Percentage
Petitioner 27
BWW 73
In addition, under the Agreement between petitioner and BWW, BWW
was required to pay petitioner an annual fee of $25,200.
Each edition of TAT generally contained a message from
petitioner's president, articles regarding law enforcement
activities and conferences, and anecdotal stories involving
individual law enforcement officers. The text of a typical
letter published in the Fall-1995 edition of TAT is set forth
below:
- 5 -
Dear Association Members: Thank you for the
contribution to the Pine Bluff Youth Council (PBYC)
Awards Program. The $400 check will enable us to
acknowledge area high school students who would not
ordinarily receive recognition.
The text of one of the many brief advertisements appearing
in the Fall-1995 edition of TAT is set forth below:
Standing behind the ASPA from... Pine Bluff Radiologists
Under the Agreement, BWW, as publisher, bore all costs
associated with production of each edition of TAT. Checks in
payment of advertising in TAT were made to the order of
petitioner and were deposited into a bank account controlled by
BWW. BWW was required to allow petitioner to review the records
relating to the bank account into which the advertising proceeds
were deposited.
As indicated, the written materials relating to TAT were
subject to the approval of petitioner. Prior to publication, an
officer of petitioner reviewed draft copies of each edition of
TAT.
An officer of petitioner also reviewed the language of
promotional and advertising sales materials relating to
petitioner. Petitioner's officer, however, did not otherwise
monitor BWW's employees in the solicitation of advertisements for
TAT.
- 6 -
Petitioner maintained a membership list and made it
available to BWW in connection with the distribution of TAT.
Under the Agreement, BWW was identified as an independent
contractor, not as an employee of petitioner. If petitioner
believed that either BWW or its employees “damaged, infringed,
tarnished, or otherwise degraded” petitioner's name, petitioner
could, at its discretion, terminate the Agreement and its
relationship with BWW.
BWW was required to and did publish at least 2,250 copies of
each edition of TAT. For the 4 years in issue, in connection
with the publication of TAT, petitioner received from BWW a total
of $876,697, consisting of the 4 annual $25,200 payments due from
BWW and petitioner's share of the advertising proceeds relating
to TAT.
For 1993 through 1996, petitioner timely filed Form 990,
Return of Organization Exempt From Income Tax. Petitioner
treated the above $876,697 as royalty income and excluded it from
its unrelated business taxable income. For 1993, 1994, and 1996,
petitioner did not file Form 990-T, Exempt Organization Business
Income Tax Return.
Discussion
Section 511(a) provides for the imposition of tax on a tax-
exempt organization's unrelated business income. Section
512(b)(2), however, provides that “royalties” received from an
- 7 -
unrelated business are to be excluded from unrelated business
taxable income. The text of section 512(b)(2) provides as
follows:
There shall be excluded [from unrelated business taxable
income] all royalties (including overriding royalties)
whether measured by production or by gross or taxable income
from the property, and all deductions directly connected
with such income.
Royalties reflect payment for the use of valuable intangible
property rights, such as trademarks, trade names, and copyrights.
See, e.g., Fraternal Order of Police v. Commissioner, 833 F.2d
717, 723 (7th Cir. 1987), affg. 87 T.C. 747 (1986); Rev. Rul. 81-
178, 1981-2 C.B. 135, 136.
Royalties, however, do not include payment for personal
services. See Sierra Club, Inc. v. Commissioner, 86 F.3d 1526,
1532 (9th Cir. 1996), affg. T.C. Memo. 1993-199, and revg. in
part on other grounds and remanding 103 T.C. 307 (1994); see also
Mississippi State Univ. Alumni, Inc. v. Commissioner, T.C. Memo.
1997-397; Rev. Rul. 81-178, 1981-2 C.B. 135, 136.
De minimis personal participation in an unrelated business
will not necessarily disqualify royalty treatment for payments
received by a tax-exempt organization. See Oregon State Univ.
Alumni Association, Inc. v. Commissioner, T.C. Memo. 1996-34,
affd. 193 F.3d 1098 (9th Cir. 1999).
- 8 -
The parties herein agree that the publication of TAT was not
substantially related to petitioner's tax-exempt purpose, and
(absent qualification of the payments petitioner received as
royalties) petitioner concedes that the $876,697 received from
BWW during the years in issue is to be treated as unrelated
business taxable income.
Whether payments are to be treated as royalties is to be
determined from all of the facts and circumstances of each case.
See sec. 1.512(b)-1, Income Tax Regs.
In Fraternal Order of Police v. Commissioner, supra, a
fraternal police organization contracted with a publishing
company to publish its official magazine. The police
organization could prepare editorials and articles for the
magazine, and the police organization could control and had final
authority over the editorial content, the sale of advertising,
the reprinting of the magazine, and the bank account into which
advertising sales proceeds were deposited, a percentage of which
the organization received. The police organization also could
appoint the magazine's executive editor.
This Court and the Court of Appeals for the Seventh Circuit
concluded that the organization took an active role in the
publication of the magazine and that the payments received from
the publishing company did not qualify as excludable royalties
under section 512(b)(2).
- 9 -
In State Police Association of Massachusetts v.
Commissioner, 125 F.3d 1 (1st Cir. 1997), affg. T.C. Memo. 1996-
407, a police organization contracted with various publishing
companies for publication of a magazine in return for a share of
advertising proceeds from the magazine. Largely because of the
police organization’s close supervision over and involvement in
the content of the magazine and in the sale of advertising for
the magazine, this Court and the Court of Appeals for the First
Circuit concluded that the publishing companies acted as agent
for the police organization and that the payments the police
organization received from the publishing companies constituted
unrelated business taxable income. See id. at 7.
Petitioner relies on Rev. Rul. 81-178, 1981-2 C.B. 135, in
which a tax-exempt organization licensed other businesses to use
the organization's trademarks, trade names, and other intangible
property in the promotion and sale of the other businesses'
products and services. The tax-exempt organization retained the
right to approve the quality or style of the products or services
sold by the businesses using its name. In the ruling, respondent
concluded that the payments the tax-exempt organization received
from the businesses would constitute royalty payments and that
“the mere retention of quality control rights by a licensor in a
licensing agreement situation does not cause payments to the
licensor under the agreements to lose their characterization as
- 10 -
royalties.” Id. at 136. In the ruling, however, respondent also
stated that if members of a tax-exempt organization provide
personal services in connection with the endorsement of the other
businesses' products, the payments received by the tax-exempt
organization would no longer qualify as royalties. See id.
Like the tax-exempt organizations in Fraternal Order of
Police v. Commissioner, supra, and State Police Association of
Massachusetts v. Commissioner, supra, petitioner herein
significantly participated in and maintained control over
significant aspects of the publication of TAT. Petitioner
possessed authority over the editorial content of TAT, and
petitioner received and reviewed the articles, photographs,
letters, and publicity for each edition of TAT.
This case is dissimilar from the so-called affinity credit
card cases and mailing list cases in which tax-exempt
organizations license their names to be used in the sale or
promotion of another business' unrelated products (e.g., a credit
card company's credit) and in which it has been held that the
fees received by the tax-exempt organization qualified as exempt
royalty income. See Sierra Club, Inc. v. Commissioner, supra;
Common Cause v. Commissioner, 112 T.C. 332 (1999); Mississippi
State Univ. Alumni, Inc. v. Commissioner, supra; Oregon State
Univ. Alumni Association, Inc. v. Commissioner, supra.
- 11 -
Petitioner's participation in the publication of its own
official magazine was not passive or de minimis. TAT represented
not the magazine of BWW but the magazine of petitioner through
which petitioner promoted and actively sought not just to
capitalize on the value of its name but to carry out its
organizational purposes and objectives, which were stated in the
Fall-1995 edition of TAT as follows:
to more effectively communicate between members of this
department so as to encourage collective input and
participation in short-term and long range goals of the
Arkansas State Police.
The $876,697 petitioner received from BWW as petitioner's
share of TAT advertising proceeds does not reflect royalty
income. The payments are to be treated as unrelated business
taxable income.
When tax-exempt organizations such as petitioner receive
income from an unrelated trade or business of $1,000 or more,
they are required to file Form 990-T, Exempt Organization
Business Income Tax Return. See sec. 1.6012-2(e), Income Tax
Regs.
Section 6651(a)(1) provides for an addition to tax unless
the failure to file required tax returns is due to reasonable
cause and not due to willful neglect. The present case involves
close questions of fact and law that have been extensively
litigated. We do not sustain respondent's additions to tax.
- 12 -
To reflect the foregoing,
Decision will be entered
for respondent as to the
deficiency amounts and for
petitioner as to the additions
to tax.