IRS treats an educational website as a periodical for advertising cost allocation

Plain-English summary

An educational private operating foundation replaced its print magazine with a free website containing archived and regularly updated editorial content. The foundation also received advertising revenue and wanted to allocate readership-related costs against that income under the unrelated business income tax rules. The IRS ruled that the website met the definition of a periodical because it functioned like a traditional publication and published material regularly in electronic form. The ruling applied the periodical cost allocation rules under Treas. Reg. § 1.512(a)-1(f).

Ruling snapshot

• Question: Does the foundation's educational website qualify as a periodical for unrelated business income tax cost allocation?
• Outcome: Approved.
• Key authorities: IRC §§ 501(c)(3), 4942(j)(3), 511, 512, and 513; Treas. Reg. §§ 1.512(a)-1(f) and 1.513-4.

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
WASHINGTON, D.C. 20224

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

Release Number:201405029 Contact Person:
Release Date: 1/31/2013
Date: November 8, 2013 Identification Number:

Contact Number:

FAX Number:
Uniform Issue List: Employer Identification Number:
511.00-00
512.05-00
Dear

This is in response to the ruling request dated November 21, 2011, submitted by your
authorized representative regarding whether your website constitutes a “periodical” for purposes
of the unrelated business income tax costs allocation rules of section 1.512(a)-1(f) of the
Income Tax Regulations.

FACTS:

You are an organization described in section 501(c)(3) of the Code. You are classified as a
private operating foundation described in section 4942(j)(3), operated for educational purposes.

For several years your primary activity has been publishing an educational magazine.

Originally, you published a print version every other month. More recently, to reduce costs and
increase readership, you discontinued the print version and now publish the content exclusively
on your website, free of charge. The website includes essentially the same kind of content,
addressing the same or similar subjects that appeared in the print version of the magazine. The
website contains all of the material available in the former print version, plus new features such
as documentary videos that can only exist in an online form. All past articles are archived and
searchable on your website. You represent that the website is updated regularly, at least
weekly. It appears from recent posts on the website that it is updated ordinarily every business
day. Each article shows its publication date.

Although you receive grants and contributions, you are supported, in part, by advertising
revenues. You employ and/or contract with writers, researchers, a creative director and an
editorial director to produce the editorial content of the website (as you did for the print
magazine). You also incur expenses for website maintenance and overall administration.

LAW:

Section 511 of the Code imposes a tax on the unrelated business taxable income of exempt
organizations described in section 501(c).

Section 512(a)(1) of the Code defines the term “unrelated business taxable income” as the
gross income derived by any organization from any unrelated trade or business regularly carried
on by it, less the allowable deductions which are directly connected with the carrying on of such
trade or business, both computed with the modifications provided in section 512(b).

Section 513(a) of the Code defines the term “unrelated trade or business” as any trade or
business the conduct of which is not substantially related (aside from the need of such
organization for income or funds or the use it makes of the profits derived) to the exercise or
performance by such organization of its exempt purpose or function.

Section 513(c) of the Code provides that the term “trade or business” includes any activity,
which is carried on for the production of income from the sale of goods or the performance of
services.

Section 1.512(a)-1(d)(1) of the regulations provides, in pertinent part, that in certain cases,
gross income is derived from an unrelated trade or business which exploits an exempt activity.
One example of such exploitation is the sale of advertising in a periodical of an exempt
organization which contains editorial material related to the accomplishment of the
organization's exempt purpose. Except as specified in subparagraph (2) of this paragraph and
paragraph (f) of this section, in such cases, expenses, depreciation and similar items
attributable to the conduct of the exempt activities are not deductible in computing unrelated
business taxable income.

Section 1.512(a)-1(d)(2) of the regulations provides, in pertinent part, that where unrelated trade
or business activity is of a kind carried on for profit by taxable organizations and where the
exempt activity exploited by the business is a type of activity normally conducted by taxable
organizations in pursuance of such business, expenses, depreciation and similar items which
are attributable to the exempt activity qualify as directly connected with the carrying on of the
unrelated trade or business activity.

Section 1.512(a)-1(f) of the regulations provides that under section 513 and 1.513-1, amounts
realized from the sale of advertising in a periodical constitute gross income from an unrelated
trade or business activity involving the exploitation of an exempt activity, namely the circulation
and readership of the periodical developed through the production and distribution of the
readership content of the periodical. Thus, subject to the limitations of paragraph (d)(2) of this
section, where the circulation and readership of an exempt organization periodical are utilized in
connection with the sale of advertising in the periodical, expenses, depreciation, and similar
items of deductions attributable to the production and distribution of the editorial or readership
content of the periodical shall qualify as items of deductions directly connected with the
unrelated advertising activity. Subparagraphs (2) through (6) of this paragraph provide rules for
determining the amount of unrelated business taxable income attributable to the sale of
advertising in exempt organization periodicals.

Section 1.513-4 of the regulations provides rules for qualified sponsorship payments, and
excepts from such rules the income from the sale of advertising or acknowledgements in
exempt organization periodicals. A “periodical” is defined as regularly scheduled and printed
material published by or on behalf of an exempt organization that is not related to and primarily
distributed in connection with a specific event conducted by the organization. For this purpose,

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printed material includes material that is published electronically.

In section 1.513-4(f) of the regulations, Example 11, W, a symphony orchestra, maintains a Web
site containing pertinent information and its performance schedule. The Music Shop makes a
payment to W to fund a concert series, and W posts a list of its sponsors on its Web site,
including the Music Shop's name and Internet address. W's Web site does not promote the
Music Shop or advertise its merchandise. The Music Shop's Internet address appears as a
hyperlink from W's Web site to the Music Shop's Web site. W's posting of the Music Shop's
name and Internet address on its Web site constitutes acknowledgment of the sponsorship. The
entire payment is a qualified sponsorship payment, which is not income from an unrelated trade
or business.

In section 1.513-4(f) of the regulations, Example 12, X, a health-based charity, sponsors a year-
long initiative to educate the public about a particular medical condition. A large pharmaceutical
company manufactures a drug that is used in treating the medical condition, and provides
funding for the initiative that helps X produce educational materials for distribution and post
information on X's Web site. X's Web site contains a hyperlink to the pharmaceutical company's
Web site. On the pharmaceutical company's Web site, the statement appears, "X endorses the
use of our drug, and suggests that you ask your doctor for a prescription if you have this
medical condition." X reviewed the endorsement before it was posted on the pharmaceutical
company's Web site and gave permission for the endorsement to appear. The endorsement is
advertising. The fair market value of the advertising exceeds 2% of the total payment received
from the pharmaceutical company. Therefore, only the portion of the payment, if any, that X can
demonstrate exceeds the fair market value of the advertising on the pharmaceutical company's
Web site is a qualified sponsorship payment.

ANALYSIS:

Advertising income derived by exempt organizations in connection their periodicals is subject to
the tax on unrelated business income. As noted above, rules for the determination of unrelated
business taxable income derived from the sale of advertising in exempt organization periodicals
are contained in section 1.512(a)-1(f) of the regulations.

Section 1.513-4 of the regulations holds that the term periodical means regularly scheduled and
printed material published by or on behalf of an exempt organization that is not related to and
primarily distributed in connection with a specific event conducted by the exempt organization,
and for this purpose, printed material includes material that is published electronically. In
section 1.513-4(f), Examples 11 and 12, the rules for qualified sponsorship payments rather
than periodical advertising were applied to the exempt organization’s website, indicating that a
website is ordinarily not regarded as a periodical. In your case, however, you argue for
treatment of your website as a periodical so that you may use your excess readership costs to
offset your advertising income like commercial publications do.

We agree. Your primary purpose and function is to publish educational information, which you
do on the website. Your prior print periodical has in effect moved onto the website. The website
is operated similarly to that of many newspapers and magazines with an online presence, with
new material published regularly and old content also readily available. Under the

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circumstances, the website serves the function of a traditional periodical and should be treated
as such.

RULING:

Based on your representations, we rule that your website meets the definition of the term
“periodical” which appears at section 1.513-4 of the regulations. Thus, the website constitutes a
periodical for purposes of the unrelated business income tax cost allocation rules of section
1.512(a)-1(f).

This ruling is based on the understanding that there will be no material changes in the facts
upon which it is based.

Except as specifically ruled upon above, no opinion is expressed concerning the federal income
tax consequences of the transactions described above under any other provision of the Code.

Pursuant to a Power of Attorney on file in this office, a copy of this letter is being sent to your
authorized representative. A copy of this letter should be kept in your permanent records.

If there are any questions about this ruling, please contact the person whose name and
telephone number are shown in the heading of this letter.

Sincerely,

Theodore R. Lieber
Manager, EO Technical Group 3