Editor: Mark G. Cook, CPA, CGMA
In Letter Ruling 201918016, the IRS addressed a question posed by a professional sports franchise that is selling "memberships" to some of its fans in order to raise money to build a new arena. The sports franchise sought assurance that it does not have to include in gross income certain payments it receives for the memberships. The IRS agreed with the team's position that the amounts received for the memberships do not constitute income because the team is obligated to repay the money to the "members."
The taxpayer is a partnership for federal tax purposes. It owns three LLCs: LLC1, LLC2, and LLC3. All three LLCs are single-member LLCs and are disregarded as separate entities from the taxpayer for federal tax purposes.
LLC1 owns and operates a professional sports franchise. LLC2 is building a new arena where the team will play its home games. LLC3 is responsible for financing the construction of the arena. To obtain funds needed to build the arena, LLC3 will issue nonequity memberships to the team's fans (members) in return for a fee (the membership amount), which can be paid by installments under a deferred payment plan (either in annual payments or monthly payments plus interest). Under the agreements between the members and LLC3 (the membership agreements), the memberships will last from the date the membership agreements are entered into until a repayment date, on which LLC3 must repay the membership amount paid by the member. The repayment date is a date after the substantial completion of the stadium.
The membership agreements between the members and LLC3 set out the rights, privileges, duties, and obligations of the membership. Under the membership agreement, members are (1) granted exclusive privileges, such as access to presales to purchase tickets for the events at the arena; (2) obligated to purchase team season tickets from the taxpayer for a specific designated seat; and (3) provided opportunities to purchase playoff tickets and tickets to other events at the arena.
The IRS's ruling
Endorsing the taxpayer's view, the IRS ruled that the membership amounts are not includible in gross income at the time of receipt because they are subject to LLC3's unconditional obligation to repay these amounts to the members. In short, because of this obligation, the taxpayer lacked the requisite complete control over the membership amounts for them to be gross income. "A taxpayer does not have an accession to wealth, nor complete dominion over an item, if received subject to an unconditional obligation to repay the item," the letter ruling explained. If there is an unconditional obligation to make repayment, "the taxpayer is not enriched by the transaction and, therefore, does not realize gross income within the meaning of section 61 of the Code."
In support of this conclusion, the IRS referred to Glenshaw Glass Co., 349 U.S. 925 (1955), in which the Court described gross income as "undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion." In addition, the Service cited two other Supreme Court cases, James, 366 U.S. 213 (1961) (involving embezzled funds), and Tufts, 461 U.S. 300 (1983) (involving a loan), in which the Court held that if a taxpayer receives money with an unconditional obligation to return or repay, the money received is not gross income to the taxpayer.
While it ruled that membership amounts the taxpayer received were not includible in gross income, it emphasized that interest payments made by members who elected to pay the membership amount in installments would be includible in the taxpayer's income.
Unlike the sale of a personal seat license, which is a paid license that gives the holder the right to buy season tickets for a certain seat in a stadium, the membership amount received by the taxpayer here is subject to LLC3's unconditional obligation to repay the members; the taxpayer has neither complete control of the money nor an accession to wealth. In the case of a personal seat license, the proceeds from the license's sale are identified as gross income under Sec. 61, and the money received must be reported as income when each installment becomes due and payable, or each installment is received, whichever happens first, according to Chief Counsel Advice 200247035. In contrast, in the membership contract situation, rather than being enriched by the transaction, the taxpayer is unconditionally obligated to refund the money to the members.
Similar to the present case, in Letter Ruling 201722004 (involving a sports team), the IRS held that the proceeds a corporation received from members were not gross income to the corporation for federal income tax purposes because the proceeds were received subject to the corporation's legally enforceable and binding obligation to repay the proceeds to members. Because the proceeds were refundable under certain terms and conditions, just like the membership amount in Letter Ruling 201918016, they were not includible in the corporation's gross income under Sec. 61.
Since that earlier letter ruling was limited to only the specific case and taxpayer that requested the ruling, the taxpayer in the present case could not fully rely on it as precedent, even though the facts were quite similar. Likewise, Letter Ruling 201918016 may not be relied on or cited as precedent by other taxpayers.
Mark G. Cook, CPA, CGMA, MBA, is the lead tax partner with SingerLewak LLP in Irvine, Calif.
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