Thursday, November 20, 2008
Reports from the tech world (see here, here and here) are that the IRS is investigating the tax status of the nonprofit Mozilla Foundation. Apparently, the issue is whether the foundation qualifies as a public charity or private foundation, and central to the dispute is the fact that last year the Foundation received 88% of its revenues from Google as part of an agreement that causes the Firefox browser to default to a Google search page. The Mozilla Foundation apparently is taking the position that these revenues are "royalties" and thus are excluded from the public support test for public charity status under Code Section 509(a)(1) via 170(b)(1)(A)(vi). Though the IRS has not yet taken a position, apparently the Foundation is worried that the Service will view these payments as unrelated business income (from advertising); the Foundation has sufficient doubt about this issue that they have set aside $100,000 to cover taxes that would be applicable if the IRS finds that these are advertising revenues and switches the Foundation's status to that of a private foundation.
The issue regarding whether certain payments are "royalties" or unrelated business income has come up in a major way before. The key case in this area is Sierra Club v. Commissioner, 86 F.3d 1526 (9th Cir. 1996) in which the 9th Circuit held that "royalties" in § 512(b) "are defined as payments received for the right to use intangible property rights and that such definition does not include payments for services." The IRS had maintained that Sierra Club's income from renting mailing lists and from its "affinity card" arrangements with credit card companies were unrelated business income; the IRS ended up losing on both counts (the 9th Circuit held for Sierra Club on the mailing list issue; the IRS lost on the credit card issue on remand).
From 1994-1998, the IRS tussled with AARP over whether AARP's receipts from insurance companies for AARP "approved" insurance polices were royalties; eventually AARP and the IRS settled the case with AARP agreeing to restructure and move business services into a for-profit subsidiary, but the IRS agreeing that AARP's insurance-company payments qualified as royalty income.
My guess is that the IRS is going to classify this income as UBI, not royalties, but there's certainly enough doubt about the definition of royalties that I wouldn't bet much on it.