Dealing with Unrelated Business Income and Intermediate Sactions

A.  Taxation of Unrelated Business Income. 

By definition, tax-exempt organizations do not pay federal income tax on donations received and revenues generated by activities related to the performance of their exempt functions.  However, in an effort to increase revenues, tax-exempt organizations today are increasingly expanding their operations to include businesses and enterprises that may not be directly related to their original exempt purposes.  In the first half of the twentieth century, Congress recognized that exempt organizations operating similar businesses could gain an unfair advantage over their for-profit counterparts, and enacted legislation to address the situation.  IRC §511 imposes a tax on the unrelated business income of exempt organizations.  IRC §512(a)(1) defines “unrelated business taxable income” as the gross income derived from an unrelated trade or business that is regularly carried on by the organization.  IRC 512(b) contains certain modifications to the definition of unrelated business taxable income, and §513 provides certain statutory exclusions.


Prior to 1950, exempt organizations could engage in commercial business activities tax free, regardless of whether the particular business activity was related to the organization’s exempt purpose, as long as the profits from such activities were dedicated to and ultimately used for that exempt purpose.  In Trinidad v. Sagrada Orden de Predicadores, 263 U.S. 578 (1924), the United States Supreme Court declared that the destination of the income, rather than its source was the “ultimate test of [an organization’s] exemption.” 263 U.S. at 581.  Then in 1947, noodle manufacturer C.F. Mueller Company was granted tax exempt status based on the fact that it directed all its business profits to the tax-exempt New York University School of Law.  See C.F. Mueller Co. v. Commissioner, 190 F.2d 120 (3rd Cir. 1951).  The competitive advantage Mueller gained by operating free from income tax, along with a declining tax base, finally caused Treasury to urge Congress to pass legislation taxing such unrelated business income.

The Revenue Act of 1950 established the unrelated business income tax (UBIT) and effectively overturned the destination of income test.  Addressing the issue of unfair competition, the Act did not prohibit exempt organizations from engaging in unrelated businesses, but it imposed a tax on the profits of the unrelated activity in an effort to level the playing field between exempt organizations and for-profit businesses.  Today the provisions of the UBIT legislation are contained in IRC Sections 511 through 514.


IRC §511(a)(2) describes the organizations subject to tax on unrelated trade or business and include:

  • pensions, stock bonus plans and profit sharing plans described in §401(c);
  • exempt organizations described in §501(c); and
  • state colleges and universities.

The few exceptions include title holding companies, feeder organizations taxed under §502(a) and federal instrumentalities created pursuant to an act of Congress.


IRC §512(a)(1) states that UBIT is imposed on an organization’s gross income derived from an unrelated trade or business “less the deductions allowed by this chapter.”  IRC §512(a)(1). Business deductions must be directly connected to the carrying on of the trade or business to be deductible.  Id.  The Regulations further specify that deductions must have a “proximate and primary relationship” to the carrying on of the business activity.  Treas. Reg. 1.512(a)-1.  Salaries for personnel who work full-time for the unrelated business activity are fully deductible because they are clearly related and solely attributable to the activity.  However, where personnel or assets of an organization are used for a combination of unrelated business activity and activity related to the organization’s exempt purpose, the expenses must be allocated between the two types of uses, and the deductions applied accordingly.  Treas. Reg. 1.512(a)-1(d)(2). 

Tax on unrelated business income is imposed at the applicable corporate or trust rate, depending on whether the organization is a corporation or a trust.  IRC §511(a)(2)(A) and §511(b).  If an exempt organization has unrelated business income from several sources or activities, the tax is imposed on the aggregate gross income less the aggregate allowable deductions.  Treas. Reg. 1.512(a)-1(a).  This allows the excess deductions from one activity to offset the income from another.

Another rule that complicates UBIT calculations is set forth in the Regulations and provides that generally, if the unrelated business activity exploits the exempt function of the organization, the income derived from the unrelated activity cannot be offset by the associated expenses.  Treas. Reg. 1.512(a)-1(d).  An example of the type of unrelated business activity that exploits the exempt function of an organization is the sale of advertising in an organization’s periodical that contains editorial material related to the organization’s exempt purpose.  Id.  Subject to certain exceptions, the expenses associated with the sale of advertising could not be used to offset the income received therefrom.  The Regulations explain that because the items of deduction are “incident to an activity which is carried on in furtherance of the exempt purpose of the organization, they do not possess the necessary proximate and primary relationship to the unrelated trade or business activity and are therefore not directly connected with that business activity.”  Id.

An exception to the exploited activity rule is included in the Regulations and provides that if an unrelated trade or business is of the type normally carried on by a for-profit business, and the exploited exempt activity is also of a type normally carried on by a for-profit business in pursuance of such business, expenses attributable to the exempt activity will qualify as directly connected to the carrying on of the unrelated trade or business to the extent the aggregate expenses exceeds the income from the exempt activity and the allocation of excess expenses does not result in a loss from the unrelated trade or business.  Treas. Reg. 1.512(a)-1(d)(2).   The Regulations require that expenses “must be first allocated to the exempt activity to the extent of the income derived from or attributable to the performance of that activity.”  Treas. Reg. 1.512(a)-1(d)(2)(ii).   

B.  Defining Unrelated Business Income.

Subject to certain exceptions and modifications, IRC §512 defines “unrelated business taxable income” as gross income, less allowable deductions, derived by an organization, from any unrelated trade or business that is regularly carried on.  The basic elements of this definition are further defined in the Treasury Regulations as follows:


The Regulations state that the term “trade or business” has the same meaning it has in IRC §162, and “generally includes any activity carried on for the production of income from the sale of goods or performance of services.”  Treas. Reg. §1.513-1(b).  An income-producing activity will not lose its individual identity because it is carried on within the larger scope of activities of an exempt organization and must be evaluated on its own merits to determine whether the activity is unrelated to the organization’s exempt purpose.  Id.  The Regulations provide the example of commercial advertising sold in connection with the publication of an exempt organization’s periodical.  Although the periodical contains editorial material related to and furthering the organization’s exempt purpose, the sale of advertising may be considered a separate business activity, unrelated to that exempt purpose.


In determining whether a trade or business is “regularly carried on,” the Treasury Regulations require that the frequency and continuity of the specific business activity be compared to similar business activity conducted by nonexempt organizations.  Treas. Reg. §1.513-1(c)(1).  For instance, if the particular business activity is of a type normally carried on year-round by non-exempt businesses, the fact that an exempt organization engages in the activity for a limited two-week period will not rise to the level of “regularly carried on.”  The example given in the Regulations is a sandwich stand operated by a hospital auxiliary for two weeks at a state fair.  However, if the activity is carried on one day per week, throughout the entire year, as in the example of a commercial parking lot operated on Saturday of each week, the activity will be considered as regularly carried on.  Treas. Reg. §1.513-1(c)(2).  Seasonal activities are also viewed in light of the normal practice of for-profit businesses.  Regular, annual sales of holiday items would be an example.

The Regulations also contain rules for intermittent activities and state that “in general, exempt organization business activities which are engaged in only discontinuously or periodically will not be considered regularly carried on if they are conducted without the competitive and promotional efforts typical of commercial endeavors.”  Treas. Reg. §1.513-1(c)(2)(ii).  Particularly where the activity involves the casual sale of items in the course of the organization’s exempt purpose, such as the periodic sale of books to students by a college bookstore, the activity will not be treated as regularly carried on if the sales are not “systematically and consistently promoted.”  Id.

The Regulations also recognize that certain income producing activities occur “so infrequently that neither their recurrence nor the manner of their conduct will cause them to be regarded as trade or business regularly carried on.”  Treas. Reg. §1.513-1(c)(2)(iii).  This rule is often applied to short term or sporadic fund raising activities.  Even a recurring annual event such as an annual fund-raising dance will not be considered regularly carried on and therefore will not be considered an unrelated business activity subject to UBIT.


When determining whether the income from a business activity is subject to UBIT, most issues arise because the activity is not viewed as substantially related to the organization’s exempt purpose.  A business activity must be related to the organization’s exempt function in a way other than merely to produce income for the organization.  Treas. Reg. §1.513-1(d).  The Regulations state that a trade or business is only related to an organization’s exempt purpose “where the conduct of the business activities has causal relationship to the achievement of exempt purposes (other than through the production of income); and it is substantially related, for purposes of Section 513, only if the causal relationship is a substantial one.”  Treas. Reg. §1.513-1(d)(2).  In many cases, the production of goods or the provision of services obviously contributes significantly to an organization’s exempt purpose (for example, the provision of legal services by a non-profit legal aid organization).  However, in other cases, the line is not so clear and the Regulations provide that a determination will depend on the facts and circumstances of each case.  Id.

The size and extent of the business activity will also be considered when determining whether the activity contributes “importantly to the accomplishment of the exempt purpose.”  Treas. Reg. §1.513-1(d)(3).  For instance, where an activity is conducted on a larger scale than is reasonably necessary to achieve the exempt function of the organization, the excess gross income from the activity may be subject to UBIT.  Id.  Other issues that arise in this area include the sale or disposition of products resulting from the exempt function of the organization, dual use of facilities of the organization and exploitation of the exempt function.

a.   Disposition of Products Resulting from the Exempt Function.  A simple example involves an organization that trains and rehabilitates disabled persons and sells products made by these persons.  The income from the product sales would not be subject to UBIT because the production and subsequent sale of the items contributes importantly to the organization’s exempt function.  The Regulations provide guidance in this area and state that “if the product is sold in substantially the same state it is in on completion of the exempt functions,” the income will not be subject to UBIT.  Treas. Reg. §1.513-1(d)(4)(ii).  However, in the example of an experimental dairy herd maintained by a research organization that sells milk and cream, but also uses the milk in the further manufacture of ice cream, the income from the ice cream sales may be subject to UBIT because the sale of ice cream is not substantially related to the organization’s exempt purpose.

b.   Dual Use of Facilities.  Exempt organizations often rent buildings or employ their assets in other commercial endeavors.  The test to determine whether the income derived from such activity is subject to UBIT is whether the rental activity or commercial endeavor contributes importantly to the organization’s exempt purpose.  Treas. Reg. §1.513-1(d)(4)(iii).  The example from the Regulations is a museum that rents its theater auditorium.  If educational films are shown during the museum’s operating hours for the purpose of public education, the rental income should not be subject to UBIT (the educational nature of the activity is sufficiently related to the museum’s exempt purpose).  However, if the theater is rented periodically to show commercial films for ordinary public entertainment, after the museum’s operating hours, the income will likely be considered unrelated business income.

Income received as a result of the dual-use of an organization’s property should not be confused with rental income received by the organization.  Whether an item is rent is determined based on “the facts and circumstances of each case.”  Treas. Reg. §1.512(b)-1.  Periodic, fixed rental payments will likely be viewed as true rent, and therefore excluded from UBIT pursuant to one of the UBIT modifications set forth in IRC §512(b), while one-time use payments will not.  Additionally, payments for services that are not customarily rendered in connection with the provision of rental property, such as dry cleaning and concierge services furnished by rental apartment buildings, will not qualify as rent excluded from UBIT.

c.   Exploitation of Exempt Functions.  Capitalizing on an exempt organization’s good name or exploiting its reputation in connection with a commercial enterprise will be viewed as an unrelated activity and any income generated therefrom will be subject to UBIT unless the commercial activity itself contributes importantly to the exempt purpose of the organization.  Treas. Reg. §1.513-1(d)(4)(iv).  A fee received for product endorsements is a common example.  Unless the sale of the particular product contributes significantly to the exempt purpose of the organization, endorsement fees will be unrelated taxable business income.

C.  Exceptions to Unrelated Business Income.


The IRC lists eleven specific activities that are excluded from the definition of “unrelated trade or business.”  These activities will not be subject to UBIT if carried on by an exempt organization.  IRC §513.  These exceptions include:

a.   Work Performed by VolunteersIRC §513(a)(1).  Any trade or business in which substantially all of the work is performed for the exempt organization by volunteers is not included in the definition of unrelated trade or business.  As an example, the regulations describe a retail store operated by an orphanage and run completely by uncompensated volunteers.  Treas. Reg. 1.513-1(e).  In this example, the income generated by the retail store is not subject to UBIT.

b.   Activities for Member ConvenienceIRC §513(a)(2).  501(c)(3) organizations and colleges and universities described in IRC §511(a)(2)(B) may operate a trade or business primarily for the convenience of its members, students, patients, officers or employees, and such trade or business will not be considered an unrelated trade or business for purposes of UBIT.  Bookstores and food service operations often fall within this exception.  The regulations also provide an example of a college laundry operated for laundering dormitory linens and student clothing.  Treas. Reg. 1.513-1(e)(2).

c.   Sale of Donated MerchandiseIRC §513(a)(3).  The sale of merchandise by an exempt organization will not be considered an unrelated trade or business if substantially all of the merchandise was received by the organization as gifts or contributions.  This exception is commonly applied to thrift shops selling donated books, clothing and other merchandise.

d.   Qualified Public Entertainment ActivitiesIRC §513(d)(2).  Exempt organizations described in IRC §501(c)(3), (4) or (5) (considered qualifying organizations), may conduct qualified public entertainment activities such as educational or agricultural fairs or expositions for the purpose of attracting the general public without implicating UBIT, provided certain conditions are met.  These conditions include 1) the entertainment activity must be in connection with an international, national, state, regional or local fair or exposition; 2) the activity must be conducted in accordance with applicable state law governing such activities; 3) the activity must be conducted under a state law providing for a limited license (not more than 20 days) for such activity; and 4) the organization regularly conducts an agricultural or educational fair or exposition as one of its substantial exempt purpose.

e.   Qualified Convention and Trade Show ActivitiesIRC §513(d)(3).  Certain convention and trade show activities intended to attract persons in a particular industry and the general public will be excluded from the definition of unrelated trade or business if conducted by a qualified organization for the purpose of promoting and stimulating an interest in the products and services of the particular industry.  A qualified organization is an organization described in IRC §501(c)(3), (4), (5) or (6) which regularly conducts a trade show or convention as one of its substantial exempt purposes.  Similar to the §513(d)(2) exception above, the trade show or convention activity must be conducted in connection with an international, national, state, regional or local convention, meeting or show.

f.   Certain Hospital ServicesIRC §513(e).  An exempt hospital may provide services to other exempt hospitals, and the income generated will not be subject to UBIT if the activity or service satisfies certain conditions including 1) the recipient hospital serves no more than 100 inpatients; 2) the service would normally be performed as part of the recipient hospital\’s exempt purpose if the recipient hospital were to perform the service itself; and 3) the service is provided at a cost which does not exceed the actual cost of providing the service.

g.   Bingo GamesIRC §513(f).  Bingo games conducted by exempt organizations on a non-commercial basis will not be considered unrelated trade or business if the activity does not violate state or local law, and meets the definition of “bingo game” contained in §513(f)(2).  For purposes of this exception, a “bingo game” is “any game of bingo of a type in which usually the wagers are placed, the winners are determined, and the distribution of prizes or other property is made, in the presence of all persons placing wagers in such a game.”  IRC §513(f)(2).  This definition is meant to distinguish traditional bingo from scratch-off or other predetermined games.

h.   Certain Pole RentalsIRC §513(g).  This section contains an exception specifically for mutual or cooperative telephone or electric companies, and provides that such a business engaging in qualified pole rentals is not conducting an unrelated trade or business for purposes of UBIT.

i.   Low-Cost Articles Incidental to SolicitationsIRC §513(h)(1)(A).  Exempt organizations to which contributions are deductible under paragraphs (2) or (3) of §170(c) may distribute low-cost articles incidental to the solicitation of charitable contributions without implicating UBIT if the articles distributed do not exceed a cost per item to the organization of $5.00 (adjusted for cost of living increases).  The distribution cannot be made at the request of the recipient, or with the express consent of the recipient, and the distribution must be accompanied by a request for a charitable contribution.  The recipient must also be informed that he/she can keep the article with no obligation.  A common example of this exception is the practice of mailing personalized address labels with a solicitation for a charitable contribution.

j.   Exchange or Rental of Member ListsIRC §513(h)(1)(B).  Exempt organizations to which contributions are deductible under paragraphs (2) or (3) of §170(c) may also engage in the business of renting or exchanging donor or member names and addresses with other exempt organizations without implicating UBIT.

k.   Qualified Sponsorship PaymentsIRC §513(i).  The activity of soliciting and receiving qualified sponsorship payments by an exempt organization will not be considered engaging in unrelated trade or business if there is no expectation or arrangement that the person or business making the payment will receive any substantial return benefit other than the use or acknowledgment of a name or logo in connection with the particular activity of the exempt organization.  Advertising messages that contain qualitative or comparative language, price information, indications of savings or value, endorsements, or inducements to purchase, sell or use the particular product may not be used.  Additionally, the qualified sponsorship payment may not be contingent upon the level of attendance at an event, broadcast ratings or any indication of exposure to the public.  This exception does not apply to payments for the placement of a name or logo in a regularly scheduled and printed publication of an exempt organization unless the publication is primarily distributed in connection with a specific event conducted by the exempt organization.  This exception is meant to distinguish the sponsorship of a specific event by placing a business’ name in the event’s program brochure from the type of activity that would be considered more traditional advertising such as name placement in a regularly published periodical.


In addition to the statutory exclusions set forth in IRC §513, modifications to the definition of unrelated trade or business can be found in §512(b) and include exceptions for rents, royalties, dividends and interest income, and noninventory-type property sales.

a.   RentsIRC §512(b)(3).  Rental income received by an exempt organization from real property, and incidental rents attributed to personal property leased in connection with real property, is excluded from unrelated business income and therefore not subject to UBIT.  To qualify for this exception, the rental amount cannot depend on the income or profits derived from the leased property, except that a rental amount based on a fixed percentage of sales is acceptable.   With respect to the rent exception, neither the IRC nor the Regulations specify that the exempt organization must own the property in order to exclude rental payments from unrelated business taxable income.  This means that rent received under a sub-lease arrangement can be excluded from unrelated business taxable income, provided all other conditions are met.  Finally, the exception for rental income does not apply if the property is rented to a controlled organization.  Control is defined as an 80% ownership interest or a situation where 80% of the directors or trustees also represent, directly or indirectly, the parent organization.

b.   RoyaltiesIRC §512(b)(2).  Production royalties and other royalties measured by gross or taxable income of property are generally excluded from unrelated trade or business and not subject to UBIT.  As discussed in the affinity card example below, royalty payments received by exempt organizations often create UBIT issues as the exempt organizations seek to expand the definition of royalty.

c.   Interest and DividendsIRC §512(b)(1).  An exempt organization’s income from interest and dividends is generally not considered income from an unrelated trade or business and will therefore not be subject to UBIT, however the interest and dividend payments must be correctly characterized as such, based on the facts and circumstances of the situation.  This exception recognizes that such passive investment income is not likely to create competition with commercial businesses.

d.   Property Sales (Noninventory)IRC §512(b)(5).  Gain or loss from the sale, exchange or other disposition of property is excluded from the definition of unrelated business taxable income unless the property sold consists of inventory, stock-in-trade or property held primarily for sale to customers in the ordinary course of the trade or business.  This exception allows an organization to sell or exchange real estate, equipment, and other noninventory property without incurring UBIT on the proceeds.


IRC §514 contains an important caveat with respect to the statutory exclusions and modifications to unrelated trade or business.  This section provides that a percentage of the gross income derived by an exempt organization from debt-financed property must be reported as income from an unrelated trade or business.  The percentage of income reported is determined by dividing the average acquisition indebtedness by the adjusted basis of the property.  IRC §514(a)(1).  With respect to the UBIT exceptions for rent and for property sale proceeds, the Regulations at §1.512(b)-1 state specifically that neither exception is available if the property in question is “debt-financed property” as defined in IRC §514(b).  “Debt-financed property” is any property held to produce income and with respect to which there is acquisition debt, however the definition excludes property, the use of which is substantially related to the organization’s exempt purpose.  Acquisition debt includes indebtedness incurred by the exempt organization for the purchase or improvement of the property, and also includes any mortgage indebtedness assumed by the exempt organization in connection with the property acquisition.  IRC §514(c).



Exempt organizations utilize the Internet for many of the same purposes that for-profit businesses do.  The Internet is a fast and efficient way to get an organization’s message out to a broad audience, and an attractive and informative website can significantly increase donor awareness.  Exempt organizations are also finding that the sale of Internet advertising can generate significant revenue, resulting in new UBIT issues.  Many of the issues have yet to be decided and little guidance is provided from the IRS.  However, based on the current UBIT provisions, we can anticipate that income received from regular paid advertising on an exempt organization’s website will be treated as unrelated business income, similar to advertising in a periodical.  In contrast, a one-time reference to a for-profit business in connection with a public service announcement on a website may be treated as a corporate sponsorship payment and not subject to UBIT.

In comparing for-profit Internet advertising and corporate sponsorships, the IRS has indicated that a static link can qualify as a corporate sponsorship while a moving banner will be considered advertising.  IRS Exempt Organizations Continuing Professional Education Technical Instruction Program FY 2000, 2000 WL 34402221 (I.R.S.) at Part 2, Para. 1(D).  However, if the website links and banners belong to other nonprofits, should the income escape UBIT under the rule that revenue received from an exchange of member lists between exempt organizations is not subject to UBIT?

Product sales via the Internet may also present new issues in the future, but for now, we can compare Internet sales to catalog sales and evaluate the UBIT implications based on the whether the activity is regularly carried on and substantially related to the organization’s exempt purpose.


In response to the increasing volume of travel tour activities conducted by exempt organizations and the associated UBIT issues, Treasury issued new regulations in 2000 to provide guidance in this area.  The Regulations provide that travel tour activities that are not substantially related to the exempt purpose of the exempt organization will be considered an unrelated trade or business with respect to that organization.  Treas. Reg. §1.513-7.  Whether the activity is substantially related to the organization’s exempt purpose is a facts and circumstances test, and the factors to be considered include how the tour is developed, promoted and operated.  Id.  The Regulations recognize that application of the rules may result in different UBIT treatment for different tours conducted by the same organization.  Id.

A review of the examples described in §1.513-7 is helpful to understand the factors that qualify one tour as substantially related and another tour as unrelated:

A travel program operated by a university alumni association for its members will not be substantially related to the association’s mission where the association contracts with a third party travel agent to make the travel arrangements and does not include any scheduled instruction or curriculum related to the destinations.  Treas. Reg. §1.513-7(b).  However, an exempt organization formed to educate the public about the geography and culture of the United States may receive tax-free income from an organized study tour of a national park or other location in the United States, where the tour is conducted by certified teachers, includes five to six hours per day of instruction related to the destination, offers examinations and course credit, and is directed at students enrolled in a degree program at a particular educational institution.  Id.

A travel tour can even be viewed as partially related and partially unrelated, as in the example of the exempt organization that offers an educational and cultural tour with two different participation options.  Treas. Reg. §1.513-7(b).  Option One includes a substantial amount of instruction designed to immerse the participants in the culture, history and language of the destination.  Option Two includes no instruction and offers participants primarily recreational activities.  In this case, the income received by the exempt organization in connection with Option Two would be considered unrelated taxable business income subject to UBIT while the income attributed to Option One would be considered sufficiently related to the organization’s exempt purpose.  Id.


Affinity card arrangements involve the use of an exempt organization’s name and/or logo on a credit card.  The credit card company usually pays the exempt organization a fee based on the amount of sales generated in exchange for the use of the name or logo.  The exempt organization may also supply the credit card company with a mailing list of its members for marketing purposes, and this may or may not be an exclusive use arrangement.  Exempt organizations have argued that the payments received from such arrangements constitute royalties and are therefore not subject to UBIT.  However, the IRS has taken the position that such payments are not royalties where an exchange of mailing lists is involved, and that unless the exchange is with another exempt organization, the payments received are subject to UBIT.  Tech. Adv. Mem. 93-24-002 (Feb. 11, 1993).

In Sierra Club v. Commissioner (Sierra II), the IRS argued that payments received by the Sierra Club from an affinity card arrangement were subject to UBIT because the Sierra Club was engaging in the unrelated trade or business of promoting the acquisition and use of the particular credit card.  Sierra Club v. Commissioner, 103 T.C. No. 13 (CCH) 5050 (1994), as corrected, 103 T.C. No. 17 (1994).  The Tax Court rejected the IRS’s argument and found that no joint venture existed between the Sierra Club and the credit card company, American Bank Services, Inc.  Id.  The court found that the Sierra Club did not have the required proprietary interest in the net profits from the activity and did not have an obligation to share in the losses, two important requirements for a joint venture.  Id.  The court also found that the Sierra Club was not acting as a sole proprietor in the business of promoting the credit cards through an agent because the Sierra Club did not have sufficient control over American Bank Services, Inc. to create an agency relationship, and the Sierra Club did not sufficiently share in the net profits or losses of the business activity.  Id. 

In deciding the question of whether the payments were royalties, the court found that the agreement between American Bank Services, Inc. and the Sierra Club was strictly for the use of the Sierra Club’s name, marks, and mailing list, and that these items were intangible property.  The court further held that the consideration received by the Sierra Club under the agreement was consideration for such use and not consideration for services performed or property other than valuable intangible property. The court concluded that “such consideration thus constitutes royalties within the meaning of section 512(b)(2).”  Id.

On appeal, the Ninth Circuit agreed that “royalties” as used in §512(b) are defined as “payment received for the right to use intangible property rights,” but that royalties do not include payment for services.  Sierra Club Inc. v. Commissioner, 86 F.3d 1526, 1535 (Ninth Cir. 1996).  The court remanded the case to the Tax Court for a redetermination of whether the agreement between the Sierra Club and American Bank Services, Inc. was strictly for intangible property rights (and the payments were therefore royalties) or whether the agreement included services to be performed by the Sierra Club.  Id. At 1536.

On remand, the Tax Court held that “none of the receipts were in consideration for services provided by [Sierra Club] as part of the credit card program.”  Sierra Club, Inc. v. Commissioner, T.C. Memo 1999-86.  The court stated that “the receipts were in consideration for the use of [Sierra Club’s] valuable intangible property, and as such, constituted “royalties” within the meaning of section 512(b)(2).”  Id.

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