Fraternal Order of Police, Illinois State Troopers, Lodge No. 41 v. C.I.R.

• Decision Date: 15 December 1987
• Docket Number: No. 87-1358,87-1358
• Citation: 833 F.2d 717
• Parties: -6050, 87-2 USTC P 9624 FRATERNAL ORDER OF POLICE, ILLINOIS STATE TROOPERS, LODGE NO. 41, Petitioner- Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 717

833 F.2d 717

60 A.F.T.R.2d 87-6050, 87-2 USTC P 9624

FRATERNAL ORDER OF POLICE, ILLINOIS STATE TROOPERS, LODGE NO. 41, Petitioner- Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

No. 87-1358.

United States Court of Appeals Seventh Circuit.

Argued Sept. 24, 1987.

Decided Nov. 17, 1987.

Rehearing Denied Dec. 15, 1987.

Richard L. Meives, Vassen, Vetter & Meives, P.C., Belleville, Ill., for petitioner-appellant.

Jane S. Kimball, Asst. Atty. Gen., Tax Div. Dept. of Justice, Washington, D.C., for respondent-appellee.

Before BAUER, Chief Judge, KANNE, Circuit Judge, and ESCHBACH, Senior Circuit Judge.

BAUER, Chief Judge.

The Fraternal Order of Police ("FOP") appeals from a decision of the United States Tax Court that found FOP deficient in income tax payments for the taxable years September 30, 1976 through September 30, 1980. ¹

The issues on appeal are whether income received from certain listings printed in The Trooper, a magazine published by FOP, constitute taxable income derived from an unrelated trade or business under section 511 of the Internal Revenue Code of 1954 (26 U.S.C.) ("the Code"), and if so, whether such receipts are excludable as royalties from the unrelated business tax income under section 512(b)(2) of the Code. The Tax Court concluded that such income is taxable. We affirm.

I. TAX COURT FINDINGS OF FACT

The relevant facts found by the Tax Court are as follows: FOP is a not-for-profit corporation organized under Illinois law and has its principal place of business in Springfield, Illinois. FOP is an exempt organization under section 501(c)(8) of the Code. Its active members are regularly appointed and commissioned police officers in the Illinois Department of Law Enforcement or troopers in the Illinois State Police. FOP's constitution and bylaws state that its purpose is to assist worthy members, their families, widows, and orphans.

In August, 1975, FOP formed the Troopers Alliance ("Alliance"). Alliance had basically the same membership as FOP and was formed to carry out the specific goal of providing money for hospitalization and dental programs for members and their families.

In September, 1975, Alliance entered into a Solicitation and Publishing Agreement ("Agreement I") with Organization Services Corporation ("OSC") for the publication of a magazine known as The Trooper. Under Agreement I, Alliance was to receive 20 percent of the "gross advertising revenue actually collected" by OSC. Agreement I referred to persons who place "listings" in the magazine as "advertisers" and to "listings" as "advertising." The solicitation program was referred to as the "ad solicitation program," the "advertising marketing program," and the "marketing of advertising." Agreement I also provided that OSC was to determine the "advertising rates ... for local and national advertisers" and referred to the receipts to be derived from the contracts as "advertising revenue."

On December 20, 1975, Alliance assigned all of its rights, title, and interest in Agreement I to FOP. On December 23, 1975, FOP and OSC cancelled Agreement I and entered into a Second Solicitation and Publishing Agreement ("Agreement II"). Agreement II was identical in all material respects to Agreement I, except that under Agreement II FOP was given greater control over the bank account into which the revenues were deposited. FOP's executive committee was then informed that Alliance had been disbanded and that its "ad solicitation program" would thereafter be conducted by FOP. The committee also was advised that future proceeds from the program would be used to provide death benefits, legal assistance, scholarships, hardship assistance, and possibly dental insurance for FOP members and their families.

On December 24, 1978, FOP and OSC entered into another publishing agreement ("Agreement III"). Agreement III provided that OSC was to publish each issue of The Trooper within ten weeks after having collected $150,000 in "advertising revenue." Agreement III also increased FOP's share of "gross advertising revenue actually collected" from 20 percent to 23 percent.

The Trooper is comparable in quality to most nationally published commercial magazines and in content is almost identical to Law and Order, an independent magazine published for policemen. Its editorials and articles are of particular interest to police officers and cover a wide range of professional, commercial, consumer, and leisure topics. The Trooper's circulation during the years in issue was approximately 2,000. Copies were distributed to FOP members and associate members, businesses and individuals having listings in The Trooper, Illinois legislators and other public officials, as well as other persons designated by FOP from time to time. ² One of FOP's officers served as executive editor of the magazine and FOP had the right to censor text, editorials, and business listings, as well as to control any reprints.

The business listings in The Trooper were of two types, both of which covered a wide range of professional, commercial, consumer, and leisure goods or services. The first type of listing was the Business Directory, which classified and arranged the listers in the same manner as the "yellow pages" of a telephone directory. This statement from the editors preceded the Business Directory:

ON THE FOLLOWING PAGES, listed by category of service or product, are advertisers who support The Trooper magazine. Consider these fine companies when making purchases for yourself or your family.

The second type of listings were referred to as "large listings" and included such well known companies or products as American Airlines, Michelob Beer, Johnny Carson Clothes, Midas Mufflers, and Ryder Trucks. The Trooper had an "Advertisers' Index" which contained the name of the sponsor of each large listing and the page upon which its listing was located. Large listings contained the usual elements associated with advertisement such as blocking, illustrations, signatures, trademarks and emblems. Many of the large listings contained well-known slogans used by the sponsors in their national advertising campaigns.

OSC employed an independent contractor to solicit listings from individuals and corporations. The contractor or one of his employees would contact a potential lister and, after a brief introduction, would inform the potential lister that FOP was putting together the next issue of The Trooper and that the proceeds from the published listing would add to FOP's death fund to aid the families of policemen and troopers killed or injured in the line of duty. The solicitor would then ask the potential lister to sponsor a "nice listing" in the magazine. All solicitations were monitored by FOP members. Businesses listing in The Trooper often noted on their checks that the payments were for "advertising." Moreover, the bank account for the "advertising marketing program" was in FOP's name and was controlled by FOP.

During the years 1976-1980, FOP received a total of $4,625,106.07 from the business listings in The Trooper. In its unrelated business taxable income for the taxable years ended September 30, 1976 through September 30, 1979, FOP included as "gross advertising income" receipts from the large listings but not the receipts from the Business Directory. For the taxable years ended September 30, 1980, none of the listing receipts were included in unrelated business taxable income.

II.

As noted above, FOP is a tax-exempt organization under section 501(c)(6) of the Internal Revenue Code, which provides an exemption for organizations "not organized for profit and no part of the net earnings of which inures to the benefit of any private shareholder or individual." 26 U.S.C. Sec. 501(c)(6). The Code, however, does impose a tax, at ordinary corporate rates, on the income that a tax-exempt organization receives from an "unrelated trade or business ... regularly carried on by it." 26 U.S.C. Secs. 512(a)(1), 511(a)(1). The Code defines an "unrelated trade or business" as "any trade or business the conduct of which is not substantially related ... to the exercise or performance by such organization of its charitable, educational, or other purpose," Sec. 513(a). ³ See United States v. American College of Physicians, 475 U.S. 834, 106 S.Ct. 1591, 1594, 89 L.Ed.2d 841 (1986); United States v. American Bar Endowment, 477 U.S. 105, 106 S.Ct. 2426, 2430, 91 L.Ed.2d 89 (1986); Illinois Ass'n of Professional Ins. Agents v. Commissioner of Internal Revenue, 801 F.2d 987, 988 (7th Cir.1986). Under the Code's three-part test, a tax-exempt organization, like FOP, must pay taxes on income earned from the listings in The Trooper if this activity "(1) constitutes a trade or business; (2) is regularly carried on; and (3) is not substantially related to [FOP's] tax-exempt purposes." American Bar Endowment, 106 S.Ct. at 2430; Illinois Ass'n of Professional Ins. Agents, 801 F.2d at 988; 26 C.F.R. 1.513-1(a); 26 U.S.C. Secs. 512(a), 513(a).

FOP concedes that the publication of the paid business listings in The Trooper is "regularly carried on" and is "not substantially related" to the organization's tax-exempt purposes. Nevertheless, FOP contends that income earned from the paid listings are not taxable because their publication does not constitute a "trade or business" under section 513(c). On appeal, FOP also asserts that the coverage of section 513(c) does not extend to noncommercial advertising.

A. ADVERTISING

Because of the findings of the Tax Court, we need not decide whether section 513(c) makes a distinction between commercial and noncommercial advertising. Although the Tax Court did not explicitly label the paid business listings as "commercial," its conclusion that the listings constitute advertising rested on the commercial nature of the published listings. The Tax Court found that the "vast majority" of the listings found in The Trooper were similar, if...