with affinity credit card programs
By Anna Marie Kukec
An affinity credit card program sponsored by a national nonprofit organization generates tax-free royalty income, according to a U.S. Tax Court decision in March.The Sierra Club’s win over the Internal Revenue Service also affects other nonprofits, including bar associations. Thirty-eight state and 29 local bars offer credit card programs as a member benefit, according to the 1998 Bar Activities Inventory, compiled by the American Bar Association Division for Bar Services.
The lengthy Sierra Club case began in the mid-1980s when the IRS targeted both the credit card and mailing list rental income. In a general audit, the IRS discovered an average of $250,000 in annual royalty income from mail list rentals in 1985, 1986 and 1987. The club argued that the rental was related to its tax-exempt purpose and only provided to nonprofits or organizations with similar philosophies and demographics. The mailing list case was then settled out of court in December 1997. (Also see "While some nonprofits battle IRS, bars use caution when selling or renting mailing lists," Bar Leader, May 1998, p. 13.)
Stemming from that same audit, the IRS charged the club in 1991 with actively engaging in a joint business venture with American Bankcard Services and Chase Lincoln Bank. The club’s affinity credit card program began in 1986 and generated $7,000. In 1987, it generated $300,000. Only those two tax years from the audit were included in the case.
The club’s name and logo appeared on the credit card, and a small percentage of what was charged by participating members was remitted to the club. Also, American Bankcard Services marketed the program’s services and benefits to club members and advertised in the club’s magazine.
The club remained passive in the joint venture and did not get involved with the business activities, according to B. Holly Schadler, the Washington, D.C., lawyer who represented the Sierra Club. However, the IRS argued that the club was active and performed services by taking complaints and inquiries regarding ABS and Chase Lincoln. Also, the club’s director signed a solicitation letter on club stationary.
"It (the club) only wanted quality control," says Schadler, adding that the letter was prepared and mailed by the bank. While the case was pending, Sierra Club members continued to use their cards.
An IRS spokesman and the lawyer who worked on the Sierra Club case both declined to comment about the Tax Court decision or whether an appeal will be filed.
While the Tax Court has sided with the nonprofit on credit card royalty income, the IRS continues to take the position that this revenue is taxable, states George Constantine of Washington, D.C., staff liaison for the American Society of Association Executives Legal Section Council and ASAE staff counsel.
"This particular decision is significant because it applied a new test for determining whether such income is taxable, set forth by the 9th Circuit. Still, we have heard nothing to lead us to believe that the IRS will back down from its aggressive stand. So enforcement may very well not change at all until there are more appellate level decisions," he says.
Constantine refers to a 1996 decision by the 9th Circuit Court that "royalties are payments for the right to use intangible property." It also defined royalty as passive income, which cannot be included as compensation for services rendered by the owner of the property.
Bars monitor case
Bar associations have been watching the Sierra Club case because its outcome could affect their own programs.
"The IRS has coveted associations’ royalty relationships for many years even though these affinity relationships are textbook examples of how the IRS defines royalty in other contexts," says Dennis Rendleman of Springfield, counsel of the Illinois State Bar Association.
These nondues sources of income are important, especially for voluntary bars, because they help to control dues and to avoid complete reliance on dues income, Rendleman adds.
"We hail the Tax Court decision as a guide to apply to similar programs we use to generate non-dues revenue," says Marc Meadow, associate executive director of the Beverly Hills Bar Association.
A bar foundation director also watched the Sierra Club case. "I have not read the Sierra case, but I heard about it and was mainly relieved that the Tax Court confirmed what our accountants had advised on the treatment of the income," says Elizabeth "Libby" Turley of Frankfort, director of the Kentucky Bar Foundation, which has a credit card affinity program.
A similar tax case against the Oregon State University Alumni Association is pending in the 9th Circuit. The University of Oregon and its alumni association filed a joint suit challenging the IRS’s taxation of their affinity card program about 12 years ago. Mona Buckley, executive director of the Multnomah Bar Association, is a former staff and board member of the alumni association who was involved in the case.
"We won challenges, in-state, though the IRS fought every step of the way. It’s overdue time the IRS put this issue to bed," says Buckley about the alumni association case.
After expanding their affinity program this year, Multnomah bar leaders decided to have a lawyer and an accountant review those relationships. A percentage or portion of that royalty money might be taxable, explains Buckley.
"You aren’t doing an affinity program without some revenue attached (sponsorship, royalties), and if the program doesn’t bring value and revenue to the business, they won’t want to be in it," Buckley says.
The Oregon and Sierra Club cases should provide guidance for bar associations and other nonprofit organizations on how to structure their programs for royalty income. Agreements between the nonprofit and the credit card bank or service company must clearly outline the permissible activities and the role each party fulfills, notes Schadler.
"A nonprofit should not get involved with the administration, solicitation or promotion of the card. That should be done by the bank. On the other hand, the nonprofit should license its name and logo and review any materials sent to members," advises Schadler.
The author is the reporter for Bar Leader.
