[Code of Federal Regulations]
[Title 26, Volume 7]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.512(a)-1]

[Page 143-152]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.512(a)-1  Definition.

    (a) In general. Except as otherwise provided in Sec. 1.512(a)-3, 
Sec. 1.512(a)-4, or paragraph (f) of this section, section 512(a)(1) 
defines unrelated business taxable income as the gross income derived 
from any unrelated trade or business regularly carried on, less those 
deductions allowed by chapter 1 of the Code which are directly connected 
with the carrying on of such trade or business, subject to certain 
modifications referred to in Sec. 1.512(b)-1. To be deductible in 
computing unrelated business taxable income, therefore, expenses, 
depreciation, and similar items not

[[Page 144]]

only must qualify as deductions allowed by chapter 1 of the Code, but 
also must be directly connected with the carrying on of unrelated trade 
or business. Except as provided in paragraph (d)(2) of this section, to 
be directly connected with the conduct of unrelated business for 
purposes of section 512, an item of deduction must have proximate and 
primary relationship to the carrying on of that business. In the case of 
an organization which derives gross income from the regular conduct of 
two or more unrelated business activities, unrelated business taxable 
income is the aggregate of gross income from all such unrelated business 
activities less the aggregate of the deductions allowed with respect to 
all such unrelated business activities. For the treatment of amounts of 
income or loss of common trust funds, see Sec. 1.584-2(c)(3).
    (b) Expenses attributable solely to unrelated business activities. 
Expenses, depreciation, and similar items attributable solely to the 
conduct of unrelated business activities are proximately and primarily 
related to that business activity, and therefore qualify for deduction 
to the extent that they meet the requirements of section 162, section 
167, or other relevant provisions of the Code, connected with the 
conduct of that activity and are deductible in computing unrelated 
business activities are directly connected with the conduct of that 
activity and are deductible in computing unrelated business taxable 
income if they otherwise qualify for deduction under the requirements of 
section 162. Similarly, depreciation of a building used entirely in the 
conduct of unrelated business activities would be an allowable deduction 
to the extent otherwise permitted by section 167.
    (c) Dual use of facilities or personnel. Where facilities are used 
both to carry on exempt activities and to conduct unrelated trade or 
business activities, expenses, depreciation and similar items 
attributable to such facilities (as, for example, items of overhead), 
shall be allocated between the two uses on a reasonable basis. 
Similarly, where personnel are used both to carry on exempt activities 
and to conduct unrelated trade or business activities, expenses and 
similar items attributable to such personnel (as, for example, items of 
salary) shall be allocated between the two uses on a reasonable basis. 
The portion of any such item so allocated to the unrelated trade or 
business activity is proximately and primarily related to that business 
activity, and shall be allowable as a deduction in computing unrelated 
business taxable income in the manner and to the extent permitted by 
section 162, section 167, or other relevant provisions of the Code. 
Thus, for example, assume that X, an exempt organization subject to the 
provisions of section 511, pays its president a salary of $20,000 a 
year. X derives gross income from the conduct of unrelated trade or 
business activities. The president devotes approximately 10 percent of 
his time during the year to the unrelated business activity. For 
purposes of computing X's unrelated business taxable income, a deduction 
of $2,000 (10 percent of $20,000), would be allowable for the salary 
paid to its president.
    (d) Exploitation of exempt activities--(1) In general. In certain 
cases, gross income is derived from an unrelated trade or business 
activity 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. Since such items are incident to an 
activity which is carried on in furtherance of the exempt purpose of the 
organization, they do not possess the necessary proximate and primary 
relationship to the unrelated trade or business activity and are 
therefore not directly connected with that business activity.
    (2) Allowable deductions. Where an 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

[[Page 145]]

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 to the 
extent that:
    (i) The aggregate of such items exceeds the income (if any) derived 
from or attributable to the exempt activity; and
    (ii) The allocation of such excess to the unrelated trade or 
business activity does not result in a loss from such unrelated trade or 
business activity.

Under the rule of the preceding sentence, expenses, depreciation and 
similar items paid or incurred in the performance of an exempt activity 
must be allocated first to the exempt activity to the extent of the 
income derived from or attributable to the performance of that activity. 
Furthermore, such items are in no event allocable to the unrelated trade 
or business activity exploiting such exempt activity to the extent that 
their deduction would result in a loss carryover or carryback with 
respect to that trade or business activity. Similarly, they may not be 
taken into account in computing unrelated business taxable income 
attributable to any unrelated trade or business activity not exploiting 
the same exempt activity. See paragraph (f) of this section for the 
application of these rules to periodicals published by exempt 
organizations.
    (e) Examples. This section is illustrated by the following examples:

    Example 1. W is an exempt business league with a large membership. 
Under an arrangement with an advertising agency W regularly mails 
brochures, pamphlets and other advertising materials to its members, 
charging the agency an agreed amount per enclosure. The distribution of 
the advertising materials does not contribute importantly to the 
accomplishment of the purpose for which W is granted exemption. 
Accordingly, the payments made to W by the advertising agency constitute 
gross income from an unrelated trade or business activity. In computing 
W's unrelated business taxable income, the expenses attributable solely 
to the conduct of the business, or allocable to such business under the 
rule of paragraph (c) of this section, are allowable as deductions in 
accordance with the provisions of section 162. Such deductions include 
the costs of handling and mailing, the salaries of personnel used full-
time in the unrelated business activity and an allocable portion of the 
salaries of personnel used both to carry on exempt activities and to 
conduct the unrelated business activity. However, costs of developing 
W's membership and carrying on its exempt activities are not deductible. 
Those costs are necessary to the maintenance of the intangible asset 
exploited in the unrelated business activity--W's membership--but are 
incurred primarily in connection with W's fundamental purpose as an 
exempt organization. As a consequence, they do not have proximate and 
primary relationship to the conduct of the unrelated business activity 
and do not qualify as directly connected with it.
    Example 2. (i) P, a manufacturer of photographic equipment, 
underwrites a photography exhibition organized by M, an art museum 
described in section 501(c)(3). In return for a payment of $100,000, M 
agrees that the exhibition catalog sold by M in connection with the 
exhibit will advertise P's product. The exhibition catalog will also 
include educational material, such as copies of photographs included in 
the exhibition, interviews with photographers, and an essay by the 
curator of M's department of photography. For purposes of this example, 
assume that none of the $100,000 is a qualified sponsorship payment 
within the meaning of section 513(i) and Sec. 1.513-4, that M's 
advertising activity is regularly carried on, and that the entire amount 
of the payment is unrelated business taxable income to M. Expenses 
directly connected with generating the unrelated business taxable income 
(i.e., direct advertising costs) total $25,000. Expenses directly 
connected with the preparation and publication of the exhibition catalog 
(other than direct advertising costs) total $110,000. M receives $60,000 
of gross revenue from sales of the exhibition catalog. Expenses directly 
connected with the conduct of the exhibition total $500,000.
    (ii) The computation of unrelated business taxable income is as 
follows:

(A) Unrelated trade or business (sale of
 advertising):
    Income.......................................   $100,000   .........
    Directly-connected expenses..................    (25,000)  .........
                                                  -------------
      Subtotal...................................     75,000    $75,000
                                                  =============
(B) Exempt function (publication of exhibition
 catalog):
    Income (from catalog sales)..................     60,000   .........
    Directly-connected expenses..................   (110,000)  .........
                                                  -------------
      Net exempt function income (loss)..........    (50,000)   (50,000)
                                                  =============

[[Page 146]]


      Unrelated business taxable income..........  ..........    25,000


    (iii) Expenses related to publication of the exhibition catalog 
exceed revenues by $50,000. Because the unrelated business activity (the 
sale of advertising) exploits an exempt activity (the publication of the 
exhibition catalog), and because the publication of editorial material 
is an activity normally conducted by taxable entities that sell 
advertising, the net loss from the exempt publication activity is 
allowed as a deduction from unrelated business income under paragraph 
(d)(2) of this section. In contrast, the presentation of an exhibition 
is not an activity normally conducted by taxable entities engaged in 
advertising and publication activity for purposes of paragraph (d)(2) of 
this section. Consequently, the $500,000 cost of presenting the 
exhibition is not directly connected with the conduct of the unrelated 
advertising activity and does not have a proximate and primary 
relationship to that activity. Accordingly, M has unrelated business 
taxable income of $25,000.

    (f) Determination of unrelated business taxable income derived from 
sale of advertising in exempt organization periodicals--(1) In general. 
Under section 513 (relating to the definition of unrelated trade or 
business) and Sec. 1.513-1, amounts realized by an exempt organization 
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. Paragraph (d) of this section 
provides for the allowance of deductions attributable to 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. Subparagraph (7) of this 
paragraph provides rules for determining when the unrelated business 
taxable income of two or more exempt organization periodicals may be 
determined on a consolidated basis.
    (2) Computation of unrelated business taxable income attributable to 
sale of advertising--(i) Excess advertising costs. If the direct 
advertising costs of an exempt organization periodical (determined under 
subparagraph (6)(ii) of this paragraph) exceed gross advertising income 
(determined under subparagraph (3)(ii) of this paragraph), such excess 
shall be allowable as a deduction in determining unrelated business 
taxable income from any unrelated trade or business activity carried on 
by the organization.
    (ii) Excess advertising income. If the gross advertising income of 
an exempt organization periodical exceeds direct advertising costs, 
paragraph (d)(2) of this section provides that items of deduction 
attributable to the production and distribution of the readership 
content of an exempt organization periodical shall qualify as items of 
deduction directly connected with unrelated advertising activity in 
computing the amount of unrelated business taxable income derived from 
the advertising activity to the extent that such items exceed the income 
derived from or attributable to such production and distribution, but 
only to the extent that such items do not result in a loss from such 
advertising activity. Furthermore, such items of deduction shall not 
qualify as directly connected with such advertising activity to the 
extent that their deduction would result in a loss carryback or 
carryover with respect to such advertising activity. Similarly, such 
items of deduction shall not be taken into account in computing 
unrelated business taxable income attributable to any unrelated trade or 
business activity other than such advertising activity. Thus:
    (a) If the circulation income of the periodical (determined under 
subparagraph (3)(iii) of this paragraph) equals or exceeds the 
readership costs of such

[[Page 147]]

periodical (determined under subparagraph (6)(iii) of this paragraph), 
the unrelated business taxable income attributable to the periodical is 
the excess of the gross advertising income of the periodical over direct 
advertising costs; but
    (b) If the readership costs of an exempt organization periodical 
exceed the circulation income of the periodical, the unrelated business 
taxable income is the excess, if any, of the total income attributable 
to the periodical (determined under subparagraph (3) of this paragraph) 
over the total periodical costs (as defined in subparagraph (6)(i) of 
this paragraph).

See subparagraph (7) of this paragraph for rules relating to the 
consolidation of two or more periodicals.
    (iii) Examples. The application of this paragraph may be illustrated 
by the following examples. For purposes of these examples it is assumed 
that the production and distribution of the readership content of the 
periodical is related to the organization's exempt purpose.

    Example 1. X, an exempt trade association, publishes a single 
periodical which carries advertising. During 1971, X realizes a total of 
$40,000 from the sale of advertising in the periodical (gross 
advertising income) and $60,000 from the sales of the periodical to 
members and nonmembers (circulation income). The total periodical costs 
are $90,000 of which $50,000 is directly connected with the sale and 
publication of advertising (direct advertising costs) and $40,000 is 
attributable to the production and distribution of the readership 
content (readership costs). Since the direct advertising costs of the 
periodical ($50,000) exceed gross advertising income ($40,000), pursuant 
to subdivision (i) of this subparagraph, the unrelated business taxable 
income attributable to advertising is determined solely on the basis of 
the income and deductions directly connected with the production and 
sale of the advertising:

Gross advertising revenue..................................      $40,000
Direct advertising costs...................................     (50,000)
                                                            ------------
Loss attributable to advertising...........................     (10,000)
                                                            ============



X has realized a loss of $10,000 from its advertising activity. This 
loss is an allowable deduction in computing X's unrelated business 
taxable income derived from any other unrelated trade or business 
activity.
    Example 2. Assume the facts as stated in example 1, except that the 
circulation income of X periodical is $100,000 instead of $60,000, and 
that of the total periodical costs, $25,000 are direct advertising 
costs, and $65,000 are readership costs. Since the circulation income 
($100,000) exceeds the total readership costs ($65,000), pursuant to 
subdivision (ii)(a) of this subparagraph the unrelated business taxable 
income attributable to the advertising activity is $15,000, the excess 
of gross advertising income ($40,000) over direct advertising costs 
($25,000).
    Example 3. Assume the facts as stated in example 1, except that of 
the total periodical costs, $20,000 are direct advertising costs and 
$70,000 are readership costs. Since the readership costs of the 
periodical ($70,000), exceed the circulation income ($60,000), pursuant 
to subdivision (ii) (b) of this subparagraph the unrelated business 
taxable income attributable to advertising is the excess of the total 
income attributable to the periodical over the total periodical costs. 
Thus, X has unrelated business taxable income attributable to the 
advertising activity of $10,000 ($100,000 total income attributable to 
the periodical less $90,000 total periodical costs).
    Example 4. Assume the facts as stated in example 1, except that the 
total periodical costs are $120,000 of which $30,000 are direct 
advertising costs and $90,000 are readership costs. Since the readership 
costs of the periodical ($90,000), exceed the circulation income 
($60,000), pursuant to subdivision (ii) (b) of this subparagraph the 
unrelated business taxable income attributable to advertising is the 
excess, if any, of the total income attributable to the periodical over 
the total periodical costs. Since the total income of the periodical 
($100,000) does not exceed the total periodical costs ($120,000), X has 
not derived any unrelated business taxable income from the advertising 
activity. Further, only $70,000 of the $90,000 of readership costs may 
be deducted in computing unrelated business taxable income since as 
provided in subdivision (ii) of this subparagraph, such costs may be 
deducted, to the extent they exceed circulation income, only to the 
extent they do not result in a loss from the advertising activity. Thus, 
there is no loss from such activity, and no amount may be deducted on 
this account in computing X's unrelated trade or business income derived 
from any other unrelated trade or business activity.

    (3) Income attributable to exempt organization periodicals--(i) In 
general. For purposes of this paragraph the total income attributable to 
an exempt organization periodical is the sum of its gross advertising 
income and its circulation income.
    (ii) Gross advertising income. The term gross advertising income 
means all amounts derived from the unrelated advertising activities of 
an exempt organization periodical (or for purposes

[[Page 148]]

of this paragraph in the case of a taxable organization, all amounts 
derived from the advertising activities of the taxable organization).
    (iii) Circulation income. The term circulation income means the 
income attributable to the production, distribution or circulation of a 
periodical (other than gross advertising income) including all amounts 
realized from or attributable to the sale or distribution of the 
readership content of the periodical, such as amounts realized from 
charges made for reprinting or republishing articles and special items 
in the periodical and amounts realized from sales of back issues. Where 
the right to receive an exempt organization periodical is associated 
with membership or similar status in such organization for which dues, 
fees or other charges are received (hereinafter referred to as 
membership receipts), circulation income includes the portion of such 
membership receipts allocable to the periodical (hereinafter referred to 
as allocable membership receipts). Allocable membership receipts is the 
amount which would have been charged and paid if:
    (a) The periodical was that of a taxable organization.
    (b) The periodical was published for profit, and
    (c) The member was an unrelated party dealing with the taxable 
organization at arm's length.

See subparagraph (4) of this paragraph for a discussion of the factors 
to be considered in determining allocable membership receipts of an 
exempt organization periodical under the standard described in the 
preceding sentence.
    (4) Allocable membership receipts. The allocable membership receipts 
of an exempt organization periodical shall be determined in accordance 
with the following rules:
    (i) Subscription price charged to nonmembers. If 20 percent or more 
of the total circulation of a periodical consist of sales to nonmembers, 
the subscription price charged to such nonmembers shall determine the 
price of the periodical for purposes of allocating membership receipts 
to the periodical.
    (ii) Subscription price to nonmembers. If paragraph (f)(4)(i) of 
this section does not apply and if the membership dues from 20 percent 
or more of the members of an exempt organization are less than those 
received from the other members because the former members do not 
receive the periodical, the amount of the reduction in membership dues 
for a member not receiving the periodical shall determine the price of 
the periodical for purposes of allocating membership receipts to the 
periodical.
    (iii) Pro rata allocation of membership receipts. Since it may 
generally be assumed that membership receipts and gross advertising 
income are equally available for all the exempt activities (including 
the periodical) of the organization, the share of membership receipts 
allocated to the periodical, where paragraphs (f)(4) (i) and (ii) of 
this section do not apply, shall be an amount equal to the 
organization's membership receipts multiplied by a fraction the 
numerator of which is the total periodical costs and the denominator of 
which is such costs plus the cost of other exempt activities of the 
organization. For example, assume that an exempt organization has total 
periodical costs of $30,000 and other exempt costs of $70,000. Further 
assume that the membership receipts of the organization are $60,000 and 
that paragraphs (f)(4) (i) and (ii) of this section do not apply. Under 
these circumstances $18,000 ($60,000 times $30,000/$100,000) is 
allocated to the periodical's circulation income.
    (5) Examples. The rules set forth in paragraph (f)(4) of this 
section may be illustrated by the following examples. For purposes of 
these examples it is assumed that the exempt organization periodical 
contains advertising, and that the production and distribution of the 
readership content of the periodical is related to the organization's 
exempt purpose.

    Example 1. U is an exempt scientific organization with 10,000 
members who pay annual dues of $15 per year. One of U's activities is 
the publication of a monthly periodical which is distributed to all of 
its members. U also distributes 5,000 additional copies of its 
periodical to nonmember subscribers at a cost of $10 per year. Pursuant 
to paragraph (f)(4)(i) of this section, since the nonmember circulation 
of U's periodical represents 33\1/3\ percent of its total circulation 
the subscription price charged to nonmembers will be

[[Page 149]]

used to determine the portion of U's membership receipts allocable to 
the periodical. Thus, U's allocable membership receipts will be $100,000 
($10 times 10,000 members), and U's total circulation income for the 
periodical will be $150,000 ($100,000 from members plus $50,000 from 
sales to nonmembers).
    Example 2. Assume the facts as stated in example 1, except that U 
sells only 500 copies of its periodical to nonmembers, at a price of $10 
per year. Assume further that U's members may elect not to receive the 
periodical, in which case their annual dues are reduced from $15 per 
year to $6 per year, and that only 3,000 members elect to receive the 
periodical and pay the full dues of $15 per year. U's stated 
subscription price to members of $9 consistently results in an excess of 
total income (including gross advertising income) attributable to the 
periodical over total costs of the periodical. Since the 500 copies of 
the periodical distributed to nonmembers represents only 14 percent of 
the 3,500 copies distributed, pursuant to paragraph (f)(4)(i) of this 
section, the $10 subscription price charged to nonmembers will not be 
used in determining the portion of membership receipts allocable to the 
periodical. On the other hand, since 70 percent of the members elect not 
to receive the periodical and pay $9 less per year in dues, pursuant to 
paragraph (f)(4)(ii) of this section, such $9 price will be used in 
determining the subscription price charged to members. Thus, the 
allocable membership receipts will be $9 per member, or $27,000 ($9 
times 3,000 copies) and U's total circulation income will be $32,000 
($27,000 plus $5,000).
    Example 3. (a) W, an exempt trade association, has 800 members who 
pay annual dues of $50 per year. W publishes a monthly journal the 
editorial content and advertising of which are directed to the business 
interests of its own members. The journal is distributed to all of W's 
members and no receipts are derived from nonmembers.
    (b) W has total receipts of $100,000 of which $40,000 ($50x800) are 
membership receipts and $60,000 are gross advertising income. W's total 
costs for the journal and other exempt activities is $100,000. W has 
total periodical costs of $76,000 of which $41,000 are direct 
advertising costs and $35,000 are readership costs.
    (c) Paragraph (f)(4)(i) of this section will not apply since no 
copies are available to nonmembers. Therefore, the allocation of 
membership receipts shall be made in accordance with paragraph 
(f)(4)(iii) of this section. Based upon pro rata allocation of 
membership receipts (40,000) by a fraction the numerator of which is 
total periodical costs ($76,000) and the denominator of which is the 
total costs of the journal and the other exempt activities ($100,000), 
$30,400 ($76,000/$100,000 times $40,000) of membership receipts is 
circulation income.

    (6) Deductions attributable to exempt organization periodicals--(i) 
In general. For purposes of this paragraph the term total periodical 
costs means the total deductions attributable to the periodical. For 
purposes of this paragraph the total periodical costs of an exempt 
organization periodical are the sum of the direct advertising costs of 
the periodical (determined under subdivision (ii) of this subparagraph) 
and the readership costs of the periodical (determined under subdivision 
(iii) of this subparagraph). Items of deduction properly attributable to 
exempt activities other than the publication of an exempt organization 
periodical may not be allocated to such periodical. Where items are 
attributable both to an exempt organization periodical and to other 
activities of an exempt organization, the allocation of such items must 
be made on a reasonable basis which fairly reflects the portion of such 
item properly attributable to each such activity. The method of 
allocation will vary with the nature of the item, but once adopted, a 
reasonable method of allocation with respect to an item must be used 
consistently. Thus, for example, salaries may generally be allocated 
among various activities on the basis of the time devoted to each 
activity; occupancy costs such as rent, heat and electricity may be 
allocated on the basis of the portion of space devoted to each activity; 
and depreciation may be allocated on the basis of space occupied and the 
portion of the particular asset utilized in each activity. Allocations 
based on dollar receipts from various exempt activities will generally 
not be reasonable since such receipts are usually not an accurate 
reflection of the costs associated with activities carried on by exempt 
organizations.
    (ii) Direct advertising costs. (a) The direct advertising costs of 
an exempt organization periodical include all expenses, depreciation, 
and similar items of deduction which are directly connected with the 
sale and publication of advertising as determined in accordance with 
paragraphs (a), (b), and (c) of this section. These items are allowable 
as deductions in the computation of unrelated business income of the 
organization for the taxable year to the extent they meet the 
requirements of

[[Page 150]]

section 162, section 167, or other relevant provisions of the Code. The 
items allowable as deductions under this subdivision do not include any 
items of deduction attributable to the production or distribution of the 
readership content of the periodical.
    (b) The items allowable as deductions under this subdivision would 
include agency commissions and other direct selling costs, such as 
transportation and travel expenses, office salaries, promotion and 
research expenses, and direct office overhead directly connected with 
the sale of advertising lineage in the periodical. Also included would 
be other items of deduction commonly classified as advertising costs 
under standard account classification, such as art work and copy 
preparation, telephone, telegraph, postage, and similar costs directly 
connected with advertising.
    (c) In addition to the items of deduction normally included in 
standard account classifications relating to advertising costs, it is 
also necessary to ascertain the portion of mechanical and distribution 
costs attributable to advertising lineage. For this purpose, the general 
account classifications of items includible in mechanical and 
distribution costs ordinarily employed in business-paper and consumer 
publication accounting provide a guide for the computation. Thus, the 
mechanical and distribution costs in such cases would include the 
portion of the costs and other expenses of composition, presswork, 
binding, mailing (including paper and wrappers used for mailing), and 
the bulk postage attributable to the advertising lineage of the 
publication. The portion of mechanical and distribution costs 
attributable to advertising lineage of the periodical will be determined 
on the basis of the ratio of advertising lineage to total lineage of the 
periodical, and the application of that ratio to the total mechanical 
and distribution costs of the periodical, where records are not kept in 
such a manner as to reflect more accurately the allocation of mechanical 
and distributions costs to advertising lineage of the periodical, and 
where there is no factor in the character of the periodical to indicate 
that such an allocation would be unreasonable.
    (iii) Readership costs. The readership costs of an exempt 
organization periodical include expenses, depreciation or similar items 
which are directly connected with the production and distribution of the 
readership content of the periodical and which would otherwise be 
allowable as deductions in determining unrelated business taxable income 
under section 512 and the regulations thereunder if such production and 
distribution constituted an unrelated trade or business activity. Thus, 
readership costs include all the items of deduction attributable to an 
exempt organization periodical which are not allocated to direct 
advertising costs under subdivision (ii) of this subparagraph, including 
the portion of such items attributable to the readership content of the 
periodical, as opposed to the advertising content, and the portion of 
mechanical and distribution costs which is not attributable to 
advertising lineage in the periodical.
    (7) Consolidation--(i) In general. Where an exempt organization 
subject to unrelated business income tax under section 511 publishes two 
or more periodicals for the production of income, it may treat the gross 
income from all (but not less than all) of such periodicals and the 
items of deduction directly connected with such periodicals (including 
readership costs of such periodicals), on a consolidated basis as if 
such periodicals were one periodical in determining the amount of 
unrelated business taxable income derived from the sale of advertising 
in such periodical. Such treatment must, however, be followed 
consistently and once adopted shall be binding unless the consent of the 
Commissioner is obtained as provided in sections 446(e) and Sec. 1.446-
1(e).
    (ii) Production of income. For purposes of this subparagraph, an 
exempt organization periodical is published for the production of income 
if:
    (a) The organization generally receives gross advertising income 
from the periodical equal to at least 25 percent of the readership costs 
of such periodical, and
    (b) The publication of such periodical is an activity engaged in for 
profit.

[[Page 151]]


For purposes of the preceding sentence, the determination whether the 
publication of a periodical is an activity engaged in for profit is to 
be made by reference to objective standards taking into account all the 
facts and circumstances involved in each case. The facts and 
circumstances must indicate that the organization carries on the 
activity with the objective that the publication of the periodical will 
result in economic profit (without regard to tax consequences), although 
not necessarily in a particular year. Thus, an exempt organization 
periodical may be treated as having been published with such an 
objective even though in a particular year its total periodical costs 
exceed its total income. Similarly, if an exempt organization begins 
publishing a new periodical, the fact that the total periodical costs 
exceed the total income for the startup years because of a lack of 
advertising sales does not mean that the periodical was published 
without an objective of economic profit. The organization may establish 
that the activity was carried on with such an objective. This might be 
established by showing, for example, that there is a reasonable 
expectation that the total income, by reason of an increase in 
advertising sales, will exceed costs within a reasonable time. See Sec. 
1.183-2 for additional factors bearing on this determination.
    (iii) Example. This subparagraph may be illustrated by the following 
example:

    Example. Y, an exempt trade association, publishes three periodicals 
which it distributes to its members: a weekly newsletter, a monthly 
magazine, and quarterly journal. Both the monthly magazine and the 
quarterly journal contain advertising which accounts for gross 
advertising income equal to more than 25 percent of their respective 
readership costs. Similarly, the total income attributable to each such 
periodical has exceeded the total deductions attributable to each such 
periodical for substantially all the years they have been published. The 
newsletter carries no advertising and its annual subscription price is 
not intended to cover the cost of publication. The newsletter is a 
service of Y distributed to all of its members in an effort to keep them 
informed of changes occurring in the business world and is not engaged 
in for profit. Under these circumstances, Y may consolidate the income 
and deductions from the monthly and quarterly journals in computing its 
unrelated business taxable income, but may not consolidate the income 
and deductions attributable to the publication of the newsletter with 
the income and deductions of its other periodicals since the newsletter 
is not published for the production of income.

    (g) Foreign organizations--(1) In general. The unrelated business 
taxable income of a foreign organization exempt from taxation under 
section 501(a) consists of:
    (i) The organization's unrelated business taxable income which is 
derived from sources within the United States but which is not 
effectively connected with the conduct of a trade or business within the 
United States, plus
    (ii) The organization's unrelated business taxable income 
effectively connected with the conduct of a trade or business within the 
United States (whether or not such income is derived from sources within 
the United States).

To determine whether income realized by a foreign organization is 
derived from sources within the United States or is effectively 
connected with the conduct of a trade or business within the United 
States, see part 1, subchapter N, chapter 1 of the Code (section 861 and 
following) and the regulations thereunder.
    (2) Effective dates. Subparagraph (1) of this paragraph applies to 
taxable years beginning after December 31, 1969. For taxable years 
beginning on or before December 31, 1969, the unrelated business taxable 
income of a foreign organization exempt from taxation under section 
501(a) consists of the organization's unrelated business taxable income 
which:
    (i) For taxable years beginning after December 31, 1966, is 
effectively connected with the conduct of a trade or business within the 
United States, whether or not such income is derived from sources within 
the United States;
    (ii) For taxable years beginning on or before December 31, 1966, is 
derived from sources within the United States.
    (h) Effective date. Paragraphs (a) through (f) of this section are 
applicable with respect to taxable years beginning after December 12, 
1967. However, if a taxpayer wishes to rely on the rules stated therein 
for taxable years

[[Page 152]]

beginning before December 13, 1967, he may do so.

[T.D. 7392, 40 FR 58638, Dec. 18, 1975, as amended by T.D. 7438, 41 FR 
44392, Oct. 8, 1976; T.D. 7935, 49 FR 1694, Jan. 13, 1984; T.D. 8991, 67 
FR 20437, Apr. 25, 2002]