Apr 1, 2011

AARP is in trouble again

AARP is under the fire again over whether is a legitimate tax-exempt organization or just a disguised for-profit company.

Specifically, AARP is under attack for receiving $657 million in royalty revenue from insurance contracts in 2009.

There is a history here. In the last decade, AARP and the IRS disputed the taxability of some of the same proceeds, i.e. was the royalty income received by AARP for such contracts actually related to their "exempt purpose" - i.e. advocating for senior citizens. The IRS settled the case with AARP, who agreed to restructure and move business services to a for-profit subsidiary. In the deal, the IRS agreed that the insurance services were royalty income, which was exempt from "unrelated business income tax" - i.e. the tax paid by tax-exempts for running for-profit businesses.

Tax-exempts can have unrelated business activities. However, it cannot be substantial. If the activity is substantial, the tax-exempt loses its status.

On April 1, 2011, the CEO of AARP, Barry Rand, provided his defense of AARP's extensive insurance business operations. At a highly contentious joint hearing by the House Ways and Means Health Care and Oversight subcommittees, he stated in defense of AARP that all of the funds used by the royalties go back into the mission and purpose of AARP. While that is true, it is not a very good defense. Mr. Rand is essentially stating that the "destination of the funds" determines whether the activities are tax-exempt. Prior to the Revenue Act of 1950, Mr. Rand would have had a position. Tax exempt organizations could raise income in a for-profit manner as long as it was used for a charitable purpose- i.e. the "destination of funds" test.

However, one can see the absurdity in this rule and eventually Congress changed the rule in 1950. What was born was the concept of "unrelated business income" - i.e. income whose source was not tax-exempt but rather in the form of a for-profit business. However, specifically exempted from the tax was several passive activity income sources such as certain rents and royalties. Removing the "destination of funds" test makes perfect common sense - if not, for-profit businesses would be put at a significant disadvantage to their tax exempt counterparts performing the same for profit activity but have no resulting taxes.

AARP may be exempted from paying taxes on the income, but they still have to explain their primary activities- which is still the test for tax exemption. As my friends at the IRS would say - "just follow the money and it will tell you their purpose."

That leads us back to Mr. Rand's testimony today. What is AARP's primary purpose??? Mr. Rand should be answering that question. When your membership dues increase 32% in 7 years but your royalty income triples, you have some explaining to do about your true activities.

Surely, there are many companies out there who are put at a disadvantage from AARP's activities. Maybe the two Republicans who started this inquiry got an ear full from them. Today they did not get a good explanation from Mr. Rand. The "ends justify the means" argument will not bear well for your organization's tax exempt status.

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