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No. 95-2791WM

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American Academy of Family *

Physicians, a not-for-profit *

corporation, *

*

Appellee, * Appeal from the United States

* District Court for the Western

v. * District of Missouri.

*

United States of America, *

*

Appellant. *

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Submitted: April 8, 1996

 Filed: August 6, 1996

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Before FAGG, WOLLMAN, and MURPHY, Circuit Judges.

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FAGG, Circuit Judge.

The Internal Revenue Service (IRS) appeals the district court's grant

of a tax refund to the American Academy of Family Physicians (Academy).

The IRS contends the Academy, a tax-exempt organization, is required to pay

federal income tax on certain payments it received through its sponsorship

of group insurance plans. We conclude the payments are not taxable, and

affirm.

The Academy is a national association of family physicians that was

organized to represent the interests of family physicians and to promote

quality health care. The Academy is exempt from federal income tax as a

business league under 26 U.S.C. § 501(a), (c)(6). The Academy created the

American Academy of Family Physicians Foundation (Foundation) to serve as

the Academy's charitable arm. The Foundation is exempt from federal income

tax as a scientific and educational foundation. See id. § 501(a),
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(c)(3).

The Academy owns and sponsors group disability, medical, and life

insurance plans that are available to Academy members and their employees.

The Principal Mutual Life Insurance Company (Principal) underwrites the

policies. The policies were initially administered by an individual, and

when he died, he bequeathed the business of administering the policies to

the Foundation. The Foundation then created AAFP Insurance Services, Inc.

(ISI), a separate corporation, and turned over the administration of the

insurance plans to ISI. ISI is a for-profit corporation that pays federal

income tax on its profits from administering the insurance plans and

distributes dividends to the Foundation, which owns all ISI's stock. The

Academy provides its membership lists to ISI for fair market value. ISI

reports twice a year to an Academy committee, and must obtain the

committee's approval before making any changes to the policies. 

The Academy members who elect coverage under the group policies pay

premiums to Principal. Principal sets aside part of the premium payments

as reserves to pay future claims, and Principal controls the investment of

the reserves. The group policies require Principal to turn over to the

Academy any reserve funds remaining after the policies have been terminated

and all the claims have been paid, whenever that might occur. In the

meantime, whether the insurance plans are profitable for Principal or not,

the policies require Principal to make annual payments to the Academy for

Principal's use of the reserves, based on a fixed percentage of the

insurance reserves. Principal paid the Academy over $600,000 a year during

the Academy's 1984 to 1987 fiscal years. The issue on appeal is whether

these annual payments are taxable.

 

The IRS contends the payments are taxable under 26 U.S.C. § 511,

which provides that an organization entitled to a tax
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exemption under § 501(a), like the Academy, still must pay income tax on

its "unrelated business taxable income." See id. § 511(a)(1)-(2)(A).

Unrelated business taxable income is income the organization earns by

regularly carrying on a trade or business that is not substantially related

to the purposes or functions entitling the organization to its § 501(a) tax

exemption. Id. §§ 512(a)(1), 513(a). Here, the IRS concluded Principal's

payments to the Academy were compensation for the Academy's sponsorship of

the group insurance plans, and the payments qualified as unrelated business

taxable income. The IRS determined the Academy had improperly failed to

pay tax on the payments received from 1984 to 1987. The Academy paid the

back taxes and interest assessed by the IRS and then brought this refund

action, contending the Academy's participation in the insurance plans did

not constitute a trade or business under § 513 and the payments from

Principal were interest, a type of income specifically excluded from

unrelated business taxable income, id. § 512 (b)(1). Relying on the

parties' extensive factual stipulations, the district court decided the

Academy's insurance activities were not a trade or business, granted the

Academy summary judgment, and ordered a tax refund. The district court did

not reach the interest issue.

In reviewing the district court's decision, we first must determine

the meaning of the phrase "trade or business" in § 513. Section 513(c)

defines a trade or business as "any activity which is carried on for the

production of income from the sale of goods or the performance of

services." Treasury Regulation § 1.513-1(b) clarifies this statutory

definition by providing that "trade or business" has the same meaning in

§ 513 as it does in 26 U.S.C. § 162, the Internal Revenue Code section

permitting business expense deductions. United States v. American Bar

Endowment, 477 U.S. 105, 110 (1986). The standard test for whether an

activity is a trade or business under § 162 is whether the activity "`was

entered into with the dominant hope and intent of realizing a profit.'"

Id. at 110 n.1 (quoting Brannen v. Commissioner, 722 F.2d 695, 704 (11th
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Cir. 1984)). In other words, "the taxpayer's primary purpose for engaging

in the activity must be for income or profit." Commissioner v.

Groetzinger, 480 U.S. 23, 35 (1987). In keeping with these interpretations

of § 162, several courts of appeals have adopted a profit motive test to

determine whether an activity is a trade or business for purposes of the

unrelated business income tax. American Bar Endowment, 477 U.S. at 110 n.1

(citing Professional Ins. Agents v. Commissioner, 726 F.2d 1097 (6th Cir.

1984); Carolinas Farm & Power Equip. Dealers Ass'n v. United States, 699

F.2d 167 (4th Cir. 1983); Louisiana Credit Union League v. United States,

693 F.2d 525 (5th Cir. 1982)). "`[T]he existence of a genuine profit

motive is the most important criterion for . . . a trade or business.'"

Professional Ins. Agents, 726 F.2d at 1102 (quoted case omitted); see

Louisiana Credit Union League, 693 F.2d at 532.

In addition to the profit motive requirement, the income-producing

activity of a tax-exempt organization must have the general characteristics

of a trade or business. American Bar Endowment, 477 U.S. at 110-11.

Specifically, some courts of appeals have recognized that an exempt

organization must carry out extensive business activities over a

substantial period of time to be engaged in a trade or business, and we

agree with the reasoning of these cases. See Zell v. Commissioner, 763

F.2d 1139, 1142 n.2 (10th Cir. 1985) (interpreting "trade or business" in

§ 162); Professional Ins. Agents, 726 F.2d at 1102 (interpreting §§ 162

and 513); McDowell v. Ribicoff, 292 F.2d 174, 178 (3rd Cir.) (interpreting

§ 162), cert. denied, 368 U.S. 919 (1961). Contrary to the IRS's position,

requiring extensive commercial activities is consistent with American Bar

Endowment, in which the Supreme Court held the American Bar Endowment's

(ABE's) group insurance program was a trade or business for purposes of §

513(c) and triggered the unrelated business income tax, see 477 U.S. at

119. The ABE's insurance activities were clearly extensive. The ABE

assembled a group of better-than-average insurance risks and negotiated on
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their behalf with insurance companies, id. at 111, compiled lists of ABE

members and solicited them, collected premiums for the insurer, maintained

files on each policyholder, answered members' questions about the policies,

and screened claims for benefits, id. at 107. 

Moreover, the ABE's significant business activity was important to

the Supreme Court's analysis. The Supreme Court decided the ABE's

insurance activities met the definition of a trade or business because they

involved both the sale of goods and the performance of services, and

"possesse[d] the general characteristics of a trade or business." Id. at

110-11. Indeed, the ABE was engaging in the same kind of commercial

activities that taxable organizations perform to earn a profit. Id. at

111. Recognizing that "[t]he undisputed purpose of the unrelated business

income tax was to prevent tax-exempt organizations from competing unfairly

with businesses whose earnings were taxed," the Supreme Court described the

ABE's insurance program as a classic example of "the sort of unfair

competition that Congress intended to prevent." Id. at 114. Having

examined Supreme Court and court of appeals precedents, we conclude we must

consider both the Academy's motive for participating in the insurance plans

and the nature and extent of the Academy's participation during the

relevant tax years.

In our view, the Academy did not have the profit motive required for

a trade or business. Id. at 110 n.1. The IRS contends the Academy was

earning a profit because the payments from Principal to the Academy were

essentially "a brokerage fee for [the Academy's] delivering its members to

the insurance company as premium-paying customers." Appellant's Br. at 24.

This contention is unsupported by the record and goes against the grain of

the parties' stipulations. 

The stipulations show the payments were not compensation for
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services rendered and were not profit in a commercial sense. As we have

already explained, the parties stipulated the group policies entitled the

Academy to receive the excess reserves after the policies' termination.

Thus, the Academy had a recognizable interest in the reserves Principal was

holding. The parties also stipulated Principal was required to make the

annual payments to the Academy as "interest on [the] insurance reserves for

Principal's use of the reserves." Appellant's App. at 148. These annual

payments were based on a specified, annual, fixed percentage of the

insurance reserves, and were generated by Principal's investment of the

reserves. Further, the parties stipulated the interest on the insurance

reserves was payable without regard to the profitability of the group

insurance plans. Based on these stipulations, the annual payments were

neither brokerage fees nor other compensation for commercial services, but

were the way the parties decided to acknowledge the Academy's eventual

claim to the excess reserves while Principal was still holding and using

the reserves. We need not decide whether the payments were interest within

the meaning of § 512(b)(1) as the Academy asserts, because the stipulated

record persuades us the payments were not compensation for commercial

services performed by the Academy and were not profit for purposes of the

unrelated business income tax.

Besides finding no profit motive, we also conclude the Academy's

involvement in the insurance plans was not extensive and did not "possess[]

the general characteristics of a trade or business." American Bar

Endowment, 477 U.S. at 110-11. At most, the Academy purchased the group

policies offering coverage to its members, sold its membership lists to ISI

for fair market value, allowed Principal and ISI to use the Academy's

endorsement, and kept track of the policy provisions to make certain the

insurance products the Academy sponsored would meet the needs of its

members. The IRS stipulated that ISI handled the promotion, marketing, and

administration, and Principal processed the insurance applications and made

decisions about coverage. The Academy had no
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administrative or underwriting responsibilities, unlike the ABE and the

taxpayers in all the other cases the IRS cites on appeal. See id. at 107,

111; Texas Farm Bureau v. United States, 53 F.3d 120, 124-25 (5th Cir.

1995); Illinois Ass'n of Professional Ins. Agents v. Commissioner, 801 F.2d

987, 989-90 (7th Cir. 1986); Professional Ins. Agents, 726 F.2d at 1099,

1100, 1102; Carolinas Farm & Power Equip. Dealers Ass'n, 699 F.2d at 168;

Louisiana Credit Union League, 693 F.2d at 533. The parties' stipulations

make clear the Academy was not engaged in the kind of activities that

concerned the Supreme Court in American Bar Endowment. While the ABE

negotiated with an insurance company and performed numerous administrative

tasks, 477 U.S. at 107, 111, the Academy neither carried on a tax-free

business nor sought a competitive edge for the group insurance program

based on the Academy's tax-exempt status. Instead, it was ISI that

operated the group insurance program for a profit and passed its after-tax

profits on to the Foundation (in the form of dividends) to support the

Foundation's charitable work. ISI paid income tax like all other competing

commercial entities. Although the Academy made group coverage available

by assembling its members into a group and purchasing the policies, the

Academy consistently acted like an insurance customer, not an insurance

company, and ISI took the active, profit-making role. We conclude the

Academy's involvement in the group policies was not significant enough to

constitute a trade or business and expose the Academy to income tax.

Contrary to the IRS's view, "not every income-producing and profitmaking endeavor constitutes a trade or business." Groetzinger, 480 U.S.

at 35. The Academy's sponsorship of a group insurance program administered

in its entirety by an unrelated, non-exempt corporation with no competitive

advantage over other taxable organizations does not translate into taxable

business activity for the Academy. Even if Principal made the payments to

the Academy for the Academy's sponsorship -- and the parties' stipulations

show otherwise -- the payments would not be taxable. 
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For purposes of this case, it does not matter whether the payments were

brokerage fees, gratuities to promote goodwill, or interest, because the

Academy was not engaged in business activity for a profit and the unrelated

business income tax does not apply. We affirm the judgment of the district

court. 

A true copy.

Attest:

CLERK, U.S. COURT OF APPEALS, EIGHTH CIRCUIT.