Opinion ID: 411167
Heading Depth: 1
Heading Rank: 4

Heading: the first inquiry: trade or business income?

Text: 33 In determining whether LCUL is to be charged with the unrelated business income tax, we must first ascertain whether the League has income from a trade or business. For these purposes the term trade or business includes any activity that is carried on for the production of income from the sale of goods or the performance of services, I.R.C. Sec. 513(c), and generally conveys the same meaning it does in section 162. Treas.Reg. Sec. 1.513-1(b). LCUL first contends that its insurance revenue is not income at all, but rather a nontaxable rebate of premiums. LCUL also asserts that neither its insurance promotions nor its debt collection activities rise to the level of a trade or business. 15 Finally, the League argues that its insurance and debt collection work does not constitute a trade or business because it is passive in nature and therefore insufficient to attract the unrelated business income tax. 34
35 In characterizing the fees received from its insurance promotions as nontaxable rebates, the League invokes the established principle that mutual insurance premium rebates are not income to the policyholder. See Penn Mutual Life Insurance Co. v. Lederer, 252 U.S. 523, 40 S.Ct. 397, 64 L.Ed. 698 (1920); G.C.M. 10798, XI-2 C.B. 58 (1932). In support of this contention, the League cites New York State Association of Real Estate Boards Group Insurance Fund v. Commissioner, 54 T.C. 1325 (1970), and Rev.Rul. 64-258, 1964-2 C.B. 134. Each of these authorities involved an association that served as a mere conduit for the transfer of funds from an insurance company to the association's members. Rebates representing excess premium payments were transferred by the insurer to the association and ultimately distributed to the individual members of the association, in whose hands the rebates were nontaxable. Under these circumstances, the funds retained only temporarily by the conduit association were held not taxable to the association. 36 We find these authorities inapposite to the case at bar. An insurance rebate consists of money returned to a policyholder from the premiums he has paid. The League's contracts with CUNA/CUMIS indicate that this insurance revenue was earned by virtue of LCUL's endorsement and marketing activities on the carrier's behalf; therefore, it cannot be characterized as a rebate. Nor does LCUL act as a conduit between insured and insurer. Here, as in the authorities cited, the League receives payments from the insurance company, but, unlike the authorities cited, the League makes no corresponding distribution to the individual credit union policyholders. Thus the insurance-related payments received by the League must be considered income in its hands. 37
38 Having concluded that the League's insurance payments are in fact income, we must now determine whether that income was generated by trade or business activity. In order to develop a cogent standard for determining when an activity rises to the level of a trade or business, we follow the roadmap provided by the Code and regulations. 39 The plain language of the statute directs that any activity which is carried on for the production of income is to be deemed a trade or business. I.R.C. Sec. 513(c). The phrase carried on for the production of income limits the types of activities covered and requires an examination of the exempt organization's underlying reasons for engaging in the questioned activity. If the organization has as its motive the production of income, the challenged activity constitutes a trade or business under section 513(c). Thus, the unembroidered language of the Code prescribes the application of a motive test. Accord, Carolina Farm & Power Equipment Dealers Association v. United States, 541 F.Supp. 86 (E.D.N.C.1982) (distinguishing between activities designed to produce income and those that generate income incidental to another primary purpose). 40 The regulations under section 513 strengthen this interpretation of the statute by incorporating the section 162 meaning of the term trade or business. Treas.Reg. Sec. 1.513-1(b). The familiar jurisprudence of section 162, which allows a deduction for trade or business expenses, provides a touchstone for evaluating the status of an activity. It is well established [for purposes of section 162] that the existence of a profit motive is the most important criterion for the finding that a given course of activity constitutes a trade or business. Lamont v. Commissioner, 339 F.2d 377, 380 (2d Cir.1964) (emphasis added). See also Hirsch v. Commissioner, 315 F.2d 731 (9th Cir.1963); International Trading Co. v. Commissioner, 275 F.2d 578 (7th Cir.1960). In addition to the intent to earn a profit, the section 162 usage of trade or business connotes extensive activity over a substantial period of time during which the taxpayer holds itself out as a provider of goods and services. McDowell v. Ribicoff, 292 F.2d 174 (3d Cir.1961). See also Stanton v. Commissioner, 399 F.2d 326 (5th Cir.1968). 41 We believe that the profit motive standard is the proper one to be applied in this case, for it is consistent with the plain language of section 513 as well as the accompanying regulations. The statute, which clearly encompasses within its parameters any activity carried on for the production of income, first raises the issue of motive. The regulations, which invoke section 162 and its profit motive gloss, confirm that motive is the key inquiry. Thus, to determine whether a tax-exempt organization is carrying on a trade or business, the court must look to see whether that institution is engaged in extensive activity over a substantial period of time with the intent to earn a profit. Accord, Professional Insurance Agents v. Commissioner, 78 T.C. 246 (1982). 16 42 The district court found that the League engaged in the activities challenged here primarily because these enterprises produced revenue necessary to finance the League's operations. Our examination of the record convinces us that this was a finding of profit motive and that such a finding was not clearly erroneous. The League's extensive involvement in insurance and debt collection activities has been detailed above. LCUL did everything short of actually selling the insurance and collecting the debts itself: it selected the companies whose products and services would be endorsed, actively marketed and promoted those products and services to member credit unions, and performed the day-to-day administrative tasks essential to the insurance and debt collection operations. More comprehensive involvement would be difficult to imagine. As reflected by the League's receipts for the years in issue, LCUL was amply rewarded for its efforts--its activities were highly profitable, and those profits were increasing. We agree with the district court that the League had the profit motive for its insurance and debt collection activities necessary to a finding of a trade or business for purposes of the unrelated business income tax. 43 LCUL argues that its involvement in the insurance and debt collection activities was primarily passive in nature and therefore did not amount to a trade or business. Citing Oklahoma Cattlemen's Association v. United States, 310 F.Supp. 320 (W.D.Okla.1969), and San Antonio District Dental Society v. United States, 340 F.Supp. 11 (W.D.Tex.1972), the League asserts that no trade or business is present where an exempt organization has no control over the possible financial result of an endeavor. 17 Thus, the League reasons, it is not engaged in trade or business activity because it exercises no control over the financial outcome of the insurance and debt collection enterprises. We do not agree. 44 We find these cases unpersuasive for several reasons. We note that both cases involved taxable years preceding the 1969 amendments to section 513, 18 which included the first statutory definition of the term trade or business, now codified at section 513(c). Both Oklahoma Cattlemen's and San Antonio District Dental Society characterized the definition of trade or business as a problem, and noted that at that time the Code provided no helpful explanation. Oklahoma Cattlemen's, 310 F.Supp. at 322; San Antonio District Dental Society, 340 F.Supp. at 14. Thus, both courts were forced to construct a meaning for the term from whole cloth. With the enactment of section 513(c), this sort of interpretation is no longer necessary. Section 513(c) now clearly states that any activity carried on for the production of income constitutes a trade or business. Section 513(c) does not draw a distinction between different types of services, and thus effectively overrules the active/passive dichotomy employed in the above cases. Professional Insurance Agents v. Commissioner, 78 T.C. 246, 263 (1982). 19 45 To summarize, we reject the League's contention that only active participation in an enterprise warrants its treatment as a trade or business for purposes of the unrelated business income tax. Instead, we adopt a profit motive test for making the trade or business determination, for we believe such a standard to be consonant with the language of the Code and its amplifying regulations. The district court found that the League had a profit motive for its activities and was engaged in a trade or business under section 513(c). We affirm that finding. 46