AARP Settles IRS Dispute for $135 Million : Nonprofits: The two still disagree about whether royalty revenues are taxable.

The American Assn. of Retired Persons, in what may be the first of a number of government levies on nonprofit groups, revealed it paid $135 million to settle a dispute with the Internal Revenue Service over income it earned from royalties on various products and services sold to its members.

AARP, the nation’s second-largest nonprofit organization after the Roman Catholic Church, does not directly sell products and services. However, it contracts with companies such as Hartford Insurance, Prudential, American Express and Scudder Investments, that market an array of insurance, prescription drugs and other products and services under the AARP banner. These companies pay royalties to AARP, which has 33 million members, ages 50 and older.

The Washington-based retirees’ group had operating revenue of $369 million last year, more than half of it from fees earned selling and promoting products and services.

However, the IRS settlement leaves open the question of whether AARP’s future income will be taxed, said the group’s spokesman, Peter Ashkenaz.

The $135 million was a “settlement”--not a payment of back taxes--agreed to in an effort to avoid a costly court battle with the IRS, Ashkenaz said Tuesday. AARP and the IRS still disagree about whether royalty revenues are taxable, he added.

The IRS, citing tax privacy laws, refused to comment.

However, the AARP settlement appears to be one of the first and most noteworthy results of a two-year effort to closely scrutinize the tax returns of nonprofit organizations through a so-called “coordinated examination program.”

The IRS program involves sending out teams of tax specialists, who conduct an exhaustive line-by-line exam of the company’s financial records, pension plans and computer systems.

Early examinations of hospitals found a variety of technical violations that spurred the IRS to expand the program, IRS officials have said. While the agency would not comment about specific groups under scrutiny, nonprofit officials maintain that fines and taxes are likely to be levied against other nonprofit organizations, particularly colleges and health care concerns.

Part of the reason for the newfound IRS scrutiny is that many nonprofits now derive a portion of their incomes from unconventional sources, such as the royalties paid to AARP. And these new sources of income are becoming increasingly important in the $700-billion-a-year nonprofit sector.

“There’s a need to be able to diversify income,” said Ann Mitchell, executive director of the National Council of Nonprofit Assns. “For some organizations that has meant . . . looking at more fee-for-service types of things.”

Additionally, nonprofit health care facilities are increasingly starting for-profit subsidiaries and affiliates. The tax implications of these arrangements are complex and, because they’ve yet to be tested in the courts, still subject to interpretation.

The AARP settlement, paid in April for the tax years 1985 through 1993, was in lieu of taxes and was not an admission by the AARP that it either owed taxes or will owe taxes in future years, Ashkenaz said.

AARP Executive Director Horace B. Deets said the AARP had $19.6 million in financial reserves even after covering the settlement. The payment would not cause the AARP to reduce its services or staff, Ashkenaz added.

Associated Press contributed to this report.