Carolina Farm & Power Equip. Dealers Ass'n v. US

• Decision Date: 20 January 1982
• Docket Number: No. 80-07-CIV-5.,80-07-CIV-5.
• Citation: 541 F. Supp. 86
• Court: U.S. District Court — Eastern District of North Carolina
• Parties: CAROLINA FARM & POWER EQUIPMENT DEALERS ASSOCIATION, INC., Plaintiff, v. UNITED STATES of America, Defendant.

541 F. Supp. 86

CAROLINA FARM & POWER EQUIPMENT DEALERS ASSOCIATION, INC., Plaintiff, v. UNITED STATES of America, Defendant.

No. 80-07-CIV-5.

United States District Court, E. D. North Carolina, Raleigh Division.

January 20, 1982.

Thomas L. Norris, Jr., Curtis A. Twiddy, Poyner, Geraghty, Hartsfield & Townsend, Raleigh, N. C., for plaintiff.

William Woodward Webb, Asst. U. S. Atty., Raleigh, N. C., Victoria V. Brown, Atty., Tax Div., U. S. Dept. of Justice, Washington, D. C., for defendant.

MEMORANDUM OPINION

BRITT, District Judge.

Pursuant to order of referral, Magistrate Charles K. McCotter, Jr., on 12 June 1981 filed his memorandum and recommendation with regard to the cross motions for summary judgment in which he recommended that the defendant's motion be granted and the plaintiff's motion be denied. The matter is now before the Court on objections filed by the plaintiff on 2 July 1981.

The Court has considered each of the plaintiff's objections, supplemented by the reasoning and authorities cited in support thereof. An independent review of the record by the Court and a consideration of the authorities cited by the parties lead the Court to decline to adopt the recommendations of the Magistrate. This memorandum opinion explains fully the reasons for the Court's decision.

FACTS

Carolina Farm & Power Equipment Dealers Association hereinafter referred to as the Association is a nonprofit corporation, organized under the laws of North Carolina and exempt from federal income taxes. See 26 U.S.C. § 501(c)(6) (1976). Primarily, it promotes and improves the business conditions and general welfare of independent retail distributors of farm and power equipment in North and South Carolina. Corporations, partnerships, and sole proprietorships comprise the Association's membership. Among its activities, the Association monitors state and federal legislation, conducts workshops relevant to the trade, publishes a newsletter and offers opportunities for group health insurance.

On 9 February 1955, the Association entered into a trust agreement, creating an insurance trust fund hereinafter referred to as the Trust, with members of the Association's Board of Trustees serving as trustees. The Trust operates and funds an economical group insurance program available to the Association's members and their employees. Federated Mutual Implement and Hardware Insurance Company of Owatonna, Minnesota hereinafter referred to as Federated, issued a master group insurance policy to the Trust, with participants in this program receiving a certificate of coverage from the Trust. The program includes life, accident and health, and hospital and surgical policies. While enrollment in an insurance program is not a prerequisite to membership in the Association, only members and their employees may participate. Approximately forty-one percent (41%) of the membership participated during the years at issue here.

The Association employs four (4) people, all of whom operate, to some extent, the insurance program. One devotes full time, one two-thirds time, one one-third time, and one one-fourth time to this activity. The Association pays salaries to and provides office space for these employees, who render the following services:

1. Distribute information pamphlets to current and prospective members (although a representative of Federated handles initial enrollment);

2. Prepare and distribute monthly premium notices to members;

3. Forward to Federated the monthly premiums remitted to the Trust by its members;

4. Communicate with Federated any member's requested change in insurance coverage; and,

5. Provide information for members with questions concerning the insurance program.

Federated rebated to the Association as an administrative allowance an amount equal to seven percent (7%) of the gross accident and health insurance premiums, paying the sum in two installments during 1973, 1974, 1975 and 1976. Approximately two-thirds of this allowance was paid to the Association and was reflected on its financial statements as income to the Association. The remaining one-third was paid to the Trust and recorded as an income item to the Trust. For 1977, the entire administrative allowance was recorded as income to the Trust. Net receipts of the Trust were used to pay the Trust's operating expenses and maintain a reserve fund. Net receipts of the Association were used for its operating and general expenses.

In addition to these rebates, Federated paid to the Trust experience refunds, which consisted of amounts by which the annual premiums paid by the members exceeded the aggregate claims of those members under group coverage. The experience refunds were prorated to the members, however, rather than going into either the Trust funds or the Association's account.

Following an audit of the Association's tax returns, the Commissioner of Internal Revenue determined that the seven percent (7%) administrative allowance constituted unrelated business income. Experience refunds, on the other hand, were not considered unrelated business income. The Association paid this tax liability for 1973-77 and initiated an administrative claim for a refund. More than six months have elapsed since the filing of the claim, but the IRS has failed to notify the Association as to its status. Accordingly, on 3 January 1980 the Association initiated this civil action for a refund of the taxes paid.

DISCUSSION

The central issue is whether the Association's involvement in making health insurance available to its members constitutes an unrelated trade or business. In some cases a tax is imposed on certain income of otherwise exempt organizations. 26 U.S.C. § 511 (1976). The Internal Revenue Code defines an unrelated trade or business as

Any trade or business the conduct of which is not substantially related (aside from the need of such organization for income or funds or the use it makes of the profits derived) to the exercise or performance by such organization of its ... purpose or function constituting the basis for its exemption ....

26 U.S.C. § 513(a). Resolution of this question, based upon the preceding statute, involves two areas of analysis. First, the activity must be a trade or business regularly conducted by the exempt organization. Second, the trade or business must not be substantially related to the exempt purpose of the organization. 26 C.F.R. § 1.5131(a)(2) (1980). If either element is determined in favor of the exempt organization, then no tax is imposed on the income.

I. TRADE OR BUSINESS OF THE ORGANIZATION

In making a determination regarding the income which the Association receives as a result of its members purchasing insurance, examination must first be made of the phrase "trade or business." If the Association's activities are not embraced by this concept, further inquiry is unnecessary, as the statute (section 511) would not apply.

A. Plain Meaning of the Statute

Statutory interpretation begins with ascertaining, if possible, the plain meaning of the statute. Touche Ross v. Redington, 442 U.S. 560, 568, 99 S.Ct. 2479, 2485, 61 L.Ed.2d 82 (1979). Although engaging in this canon of construction risks both oversimplification and belaboring the obvious, it nevertheless undergirds a more comprehensive focus on the legislation under consideration. When the language of the statute is sufficiently clear in its context, it controls. Ernst & Ernst v. Hochfelder, 425 U.S. 185, 201, 96 S.Ct. 1375, 1384, 47 L.Ed.2d 668 (1976) (and cases cited therein).

The term "trade or business" contemplates "any activity which is carried on for the production of income from the sale of goods or the performance of services." 26 U.S.C. § 513(c). The language limits the types of activities covered to those "carried on for the production of income." Distinctions exist between activities which are designed to produce income and those which generate income merely incidental to another primary purpose. The plain meaning of trade or business dictates examining the underlying reason behind the Association engaging in the insurance-related activity. Inasmuch as the Association's explicit purposes include providing opportunities for its members to obtain group health insurance, the logical rationale for this activity is to develop group insurance options rather than to produce income. The receipt of a small percentage of insurance premiums hardly seems the motivation for the Association's activity. The language of the statute suggests that when, as here, the activity is purposed primarily for reasons other than the production of income, it does not constitute a trade or business.

A plain meaning analysis was performed by another court, which reached a contrary conclusion. Louisiana Credit Union League v. United States, 501 F.Supp. 934, 939 (E.D. La.1980). The court focused on the phrase "any activity" to give expansive treatment to the statute. Id. This court declines to read the language of section 513 so broadly. To do so ignores the qualifying language in the statute, particularly "carried on for the production of income." Congress did not word the statute "any activity which produces income." Rather, it used the language "which is carried on for the production of income" to legislate the importance of considering an exempt organization's motivation for engaging in the questioned activity. This specific language, although subtle, cannot be ignored.

B. Legislative History and Judicial Interpretation

Courts have not agreed on the meaning of section 513. Some courts focus on whether the activity is a trade or a business. See, e.g., Hope School v. United States, 612 F.2d 298 (7th Cir. 1980); Clarence LaBelle Post No. 217, Veterans of Foreign Wars of United States v. United States, 580 F.2d 270, 279 (8th Cir. 1978), cert. dismissed, 439 U.S. 1040, 99 S.Ct. 712, 58 L.Ed.2d 716 (1979); Disabled American Veterans v. United States, 650 F.2d 1178 (Ct.Cl.1981); Louisiana...