Tax-Exempt Organizations and Internet Commerce: The Application of the Royalty and Volunteer Exceptions to Unrelated Business Taxable Income

The Internet has created new opportunities for both large and small tax-exempt organizations (EOs) to raise funds through relationships with online vendors and “charity malls.” EOs provide hyperlinks to online vendors\u27 websites through affiliate arrangements. In return, EOs receive payments based on a percentage of sales made at the vendor websites attributable to the EOs\u27 hyperlinks. EOs also enter into payment arrangements with charity malls. Charity malls are commercial websites that provide hyperlinks to online vendors and attract consumers by pledging to donate a percentage of any purchases made through the malls to charity. There is no express authority stating how such payments should be characterized for unrelated business taxable income (UBTI) purposes when affiliate and charity mall arrangements are regularly carried on and not substantially related to an EO\u27s exempt purpose. This article proposes two Internal Revenue Service (IRS) Revenue Rulings. The Rulings establish that, in certain instances, the payments to an EO attributable to relationships with online vendors and charity malls should be treated as royalty income exempt from unrelated business income tax (UBIT) under § 512(b)(2) of the Internal Revenue Code (the Code). The proposed Revenue Rulings would recognize the circumstances under which payments from online vendors and charity malls to EOs constitute nontaxable royalty income, rather than UBTI