Recent Successes in Challenging IRS UBI Determinations Showcase the Importance of Scrutinizing Adverse IRS Determinations
Recently, GKG Law successfully assisted two clients with navigating challenges to adverse Unrelated Business Income (“UBI”) determinations made by the Internal Revenue Service (“IRS”). Combined, these saved our clients’ almost $2.4 million in taxes in 2018 alone. The first resulted in a nearly $2 million tax refund and future tax savings of hundreds of thousands of dollars in each future tax year, and the second resulted in the IRS overruling a proposed tax deficiency of approximately $400,000.
Successfully Challenging Outdated UBI Determinations
The first successful result occurred in May 2018 when GKG Law’s non-profit organization client (the “Organization”) received notification from the IRS that it would receive a refund of nearly $2 million in taxes paid on income that the IRS improperly deemed to be UBI. This result came after the Organization initially questioned whether its UBI was substantial enough to jeopardize its exempt status and sought counsel from GKG Law’s tax law experts who immediately recognized the Organization’s income was incorrectly characterized as UBI and that it was entitled to a refund.
The initial IRS determination was made more than 30 years ago, after an examination determined that the Organization’s income derived from administering certain purchasing programs for its members was UBI subject to federal income tax. In each year since, the Organization paid tax on all its net revenue derived from the purchasing programs, regularly exceeding $1 million. Under the guidance of members of GKG Law’s Association Practice Group, the Organization filed amended returns seeking refunds for taxes paid in all open years. Subsequently, the IRS opened an examination which resulted in the approval of the full amount of the refund request for each tax year. The IRS now recognizes these programs as related to the Organization’s tax exempt mission, solidifying its status and saving hundreds of thousands of dollars in taxes each year going forward.
Successfully Challenging Inconsistent UBI Determinations
The second successful result also occurred in May 2018, when a GKG Law non-profit association client (the “Association”) received a no change letter from the IRS Appeals Division, overturning a prior proposed determination of a substantial tax deficiency issued by the IRS Examinations Division. During an examination of the Association’s operations, the IRS 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. Following word that the IRS Appeals Division 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.
The IRS determined that under an agreement with an independent publisher, which gave the publisher exclusive control of and right to retain all income from advertising sales, 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. As such, the IRS attributed a portion of the publisher’s advertising income to the Association as UBI and proposed the assessment of tax on that amount.
Instead of seeking to resolve the matter though litigation against the IRS, GKG Law recognized regional inconsistencies in IRS rulings on this issue 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. This TAM would provide an official and binding IRS position regarding the application of the law in respect to this issue and the Association. Upon consideration of the TAM, the IRS national office ruled that advertising income earned by the publisher could not be attributed to the Association as UBI. Subsequently the IRS appeals office was required to overturn the position taken in its examination and, as a result, the Association 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.
What Could These Results Mean for You?
GKG’s recent successes are good reminders that organizations should occasionally reevaluate their programs and activities previously deemed to be unrelated, even activities which the IRS has determined to be unrelated. Circumstances and IRS positions change, and those activities may no longer be characterized as unrelated trades or business activities. These outcomes also highlight 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. As a rule, organizations should be cognizant of potential administrative remedies to disputes with the IRS before accepting the inevitability of an IRS determination or seeking a judicial remedy through litigation.