GKG Law Obtains Successful Ruling Overturning an Adverse IRS Determination for Association Client

On May 24, 2018, a GKG Law non-profit association client (the “Association”) received a no change letter from the Internal Revenue Service (“IRS”) Appeals Division.  The no change letter overturned a prior proposed determination of a substantial tax deficiency due to unreported unrelated business income (“UBI”) by the IRS Examinations Division.  During its examination of the Association’s operations, the IRS Examinations Division determined that the Association received more than $800,000 of UBI from the sale of journal advertising space during the tax years examined and that all such income should be reported as taxable UBI in future tax returns.  After the IRS Appeals Division indicated that it intended to uphold the proposed determination, the Association sought the expertise of GKG Law’s tax attorneys and hired the firm to assist the Association’s tax counsel in achieving a favorable resolution to the dispute.

Issue Background

At the time of the examination, the IRS was engaged in a project analyzing the income that multiple associations derived from the publication of journals.  Specifically, the IRS was concerned about whether associations that entered into publishing agreements with large publishing companies were mischaracterizing taxable advertising income as non-taxable royalty income.  Based on its examination of the Association, the IRS determined that under an agreement with an independent publisher, the Association had too much control over the substantive content of its journal to characterize any portion of the advertising income as a non-taxable royalty.  This determination was made even though the terms of the agreement gave the publisher the exclusive right to retain all income from the sale of advertising and near complete control over the sale of advertisements in the journal.  Nonetheless, the IRS attributed a portion of the publisher’s advertising income to the Association and proposed the assessment of tax on that amount.

It is notable that the IRS project from which the examination arose frequently reached different conclusions on this issue.  The IRS had a record of inconsistently applying the law to very similar factual scenarios, and, more significant, the final determination proposed by the IRS was primarily dependent on the location where an examination was conducted.  Examinations conducted in the IRS Mid-Atlantic Region (including the District of Columbia, Virginia, and Maryland) almost always resulted in a determination that the organization did not receive taxable advertising income; however, examinations conducted in the IRS Great Lakes Region (primarily consisting of the mid-west) almost always resulted in a determination that the organization was subject to tax on unreported UBI derived from the sale of advertising in its journal.

Recommendation and Resolution

Instead of seeking to resolve the matter though litigation against the IRS, GKG Law’s Association Practice Group immediately recognized the inconsistencies in the IRS determinations and recommended that the Association request a technical advice memorandum (“TAM”) from the IRS national office to determine whether the IRS could attribute taxable UBI to the Association in this situation.  Basically, a TAM is a memorandum published by the IRS national office that analyzes and provides the official IRS position regarding the application of the law with respect to an issue which the IRS field offices have decided inconsistently.  The position in the TAM is binding on the IRS with respect to the issue and the taxpayer for which the TAM was requested.

Upon consideration of the TAM, the IRS national office adopted the legal position presented by the Association and its tax counsel, ruling that advertising income earned by the publisher could not be attributed to the Association as UBI merely because the Association retained control over the substantive content of its journal.  Bound by the TAM, the IRS appeals office was required to overturn the IRS Examinations Division’s position taken in its examination and issued a no change letter indicating that the Association did not receive any UBI from the sale of journal advertisements.  Therefore, the organization was not required to pay tax on the proposed amount of UBI, approximately $800,000, or on the amount of such income received in future years, approximately $200,000 per year.

Larger Context of this Result

This successful result is a good reminder that organizations need to be aware of IRS enforcement efforts in their industry and should not merely accept the IRS position in an examination.  This is especially true in circumstances where the IRS is issuing uneven determinations to similar organizations.  It also demonstrates that organizations should be cognizant of potential administrative remedies to disputes with the IRS before accepting the inevitability of an IRS determination and seeking a judicial remedy through litigation. 

Due to its vast size and reach, it is inevitable that the IRS will occasionally reach incompatible conclusions that result in inconsistent interpretations of the law.  Being aware of such inconsistencies within an industry will help organizations determine whether they should challenge an IRS determination or re-evaluate their continued reliance on an older determination.

Read more on this issue and other successful outcomes for clients here.