Taxing Lessons Case Summaries

Case — Unrelated Business Taxable Income

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TL Case Summ


Does a nonprofit organization have to allocate a portion of member dues to offset losses from a taxable activity?


Taxpayer Says: Members did not have a right to receive magazines published by the organization. Therefore, no allocation of dues is necessary to offset the losses generated by the publication of the magazines.

Internal Revenue Service Says: Membership did give members the right to receive the magazine and part of the dues received from members should be allocated to offset the loss.


From Internal Revenue Code Section 511(a)(1): Provides for taxing the unrelated business taxable income (UBTI) of an exempt organization as a trade or business activity that is not substantially related to the organization’s exempt purpose.

From Internal Revenue Code Section 512(a)(1): Generally defines UBTI as gross income from an unrelated trade or business less allowable deductions connected directly with the carrying on of such trade or business.

From Federal Tax Regulation 1.512(a)–1(f)(3)(i): With respect to periodicals published by tax-exempt organizations, this section “fragments” the organization’s taxable trade or business of selling advertising space (i.e., advertising income) from the organization’s nontaxable activity of publishing readership content related to the organization’s exempt purpose (i.e., circulation income).

From Federal Tax Regulation 1.512(a)–1(f)(3)(iii) (in part): Where the right to receive an exempt organization periodical is associated with membership or similar status in such organization for which dues, fees or other charges are received (hereinafter referred to as “membership receipts”), circulation income includes the portion of such membership receipts allocable to the periodical (hereinafter referred to as “allocable membership receipts”). * * *

From National Association of Life Underwriters, Inc. v. Commissioner: The following formula conceptualizes these rules: (1) Gross advertising income, minus (2) direct advertising costs, minus (3) excess readership costs (the amount by which readership costs exceed circulation income), equals (4) net UBTI from the sale of advertising.


Tax-exempt organizations are generally required to pay income tax on activities that are unrelated to the main purpose of the organization. For instance, if the organization’s main exempt purpose is education, an activity not substantially related to education is considered unrelated business taxable income and is taxable, even if the proceeds from the unrelated activity are used to fund the education.

When a tax-exempt organization publishes a magazine for its members and sells advertising space in the magazine, income from the publishing activity is related to the exempt purpose, while the advertising is a distinct, unrelated, and taxable activity. When members have a “right to receive” the publication, part of the dues the members pay is allocated to the taxable advertising activity (which increases the taxable income).

The dispute in this case arises from the meaning of “right to receive.”

The National Education Association of the US (NEA), a teacher’s union, published two magazines that were distributed to members and others via postal mail and the Internet. NEA sold advertising in the magazines and reported the income and related expenses from the advertising as unrelated business taxable income.

NEA members paid dues that included a cost for the magazines. That portion of the dues was not included in the unrelated business taxable income on NEA’s tax return, with the result that the organization showed a loss for each of the years in question (2001-2003).

The IRS disagreed with the losses reported on the tax returns, and allocated a portion of the dues to the taxable activity, resulting in $3.16 million of income over the three years. The change led to an assessment of approximately $1.1 million in tax.

NEA says no portion of the dues needs to be included in the unrelated business taxable income, because members did not have an enforceable legal “right to receive” the magazines. NEA was under no obligation to continue publishing the magazines and publication could stop at any time. In addition, nonmembers could access the magazine, for free, on the Internet. While the Internet version did not contain all the content that was in the hard copy, since most of the magazine could be read without paying dues, it follows that paying dues was not a requirement for receiving the magazine, and members therefore did not have a right to receive them.

The IRS says NEA members did have a right to receive the magazines because NEA enrollment forms made it clear part of the dues was paid for the subscription. In addition, the press schedule was set a year in advance, NEA had contracts with advertisers that contained circulation volume commitments, and postal regulations require a certain number of subscribers in order for a publication to receive favorable rates, all of which is at odds with being able to stop publication at any time.


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HL Carpenter, an experienced investor and a CPA, specializes in reader friendly articles on taxes and investing for individuals and small businesses, and publishes two newsletters: Taxing Lessons and Top Drawer Ink. Visit and

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Right answer!
For the IRS. For the years at issue, NEA members had 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.