Tax exempt organizations must report and pay tax on their “unrelated business income.” Butler Snow recently represented The University of Mississippi (“UM”) in a federal income tax dispute in the United States Tax Court involving the proper amount UM should have reported as subject to the tax on unrelated business income. The most important issue in the case was whether any portion of payments that UM received from exclusive providers was taxable.
Like most major universities, UM enters into agreements with certain providers that pay UM for the right to be the “exclusive” provider of certain products used by UM. UM did not report the income that it received from these providers as part of its unrelated business income because of an Internal Revenue Code provision that exempts such “sponsor” income from taxation. The exemption does not apply, however, if the provider receives a “substantial return benefit” from UM in consideration for its payment to UM.
UM’s exclusive provider contracts with Coca Cola and Nike required UM’s athletic coaches to appear, upon the request of Coca Cola or Nike, at a specified number of events sponsored by the provider. UM included a provision in these contracts stating that when a coach does appear at an event sponsored by Coca Cola or Nike, the coach can only promote UM’s athletic teams – the coach cannot promote Coca Cola or Nike. During the tax years at issue, one exclusive provider failed to exercise any of its negotiated coach appearance rights. The other exclusive provider requested only one coach to appear at only one event that it sponsored.
The IRS asserted that Coca Cola and Nike received a substantial return benefit for their payments to UM in the form of the negotiated coach appearance rights. Therefore, the IRS considered the payments to UM from Coca Cola and Nike to be subject to the tax on unrelated business income.
UM successfully asserted that any portion of the payments received from Coca Cola and Nike attributable to the coach appearance rights was not subject to the tax on unrelated business income because that activity was related to UM’s exempt function of promoting athletics and the values of athletics participation. UM substantially prevailed on this issue in the negotiated settlement of the case.