Nat'l Educ. Ass'n of the United States v. Comm'r of Internal Revenue, 22838–09.

• Decision Date: 28 September 2011
• Docket Number: No. 22838–09.,22838–09.
• Citation: 137 T.C. 100,137 T.C. No. 8
• Parties: NATIONAL EDUCATION ASSOCIATION of The United States, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Tax Court

137 T.C. 100
137 T.C. No. 8

NATIONAL EDUCATION ASSOCIATION of The United States, Petitioner
v.
COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 22838–09.

United States Tax Court.

Sept. 28, 2011.

[137 T.C. 100]

P is a tax-exempt labor organization described in I.R.C. sec. 501(c)(5). In its FYE Aug. 31, 2001, 2002, and 2003, P published two magazines at an expense of about $7 million, and it distributed those magazines to dues-paying members and to a very few non-member paying subscribers. P's literature and that of its State and local affiliates stated that members received the magazines as a benefit of membership and stated an amount of dues that paid for the magazines. Members who declined the magazines did not pay a smaller amount of dues. P made most but not all of the content of the magazines available

[137 T.C. 101]

for free over the Internet to the general public. P published paid advertising in the magazines, by which it earned approximately $1 million in net profit each year. On its returns P reported negligible circulation income, resulting in a substantial claimed loss on its circulation activity. P used that loss to fully offset its taxable advertising profit. Therefore, P reported that it owed no unrelated business income tax (UBIT).

Held: Under 26 C.F.R. sec. 1.512(a) –1(f)(3)(iii), Income Tax Regs., which requires an allocation of membership dues to circulation income “[w]here the right to receive an exempt organization periodical is associated with membership or similar status in the organization”, the “right to receive” must be a legal right. Under this regulation, P was required to allocate a portion of members' dues to circulation income.

Miriam L. Fisher and Theodore J. Wu, for petitioner.

Robin W. Denick and Catherine R. Chastanet, for respondent.

GUSTAFSON, Judge:

Petitioner National Education Association of the United States (“NEA”) is a labor organization described in section 501(c)(5).¹ It is therefore generally exempt from Federal income tax under section 501(a); but to the extent it engages in income-generating activity unrelated to its tax-exempt purposes, it is potentially liable under sections 511 through 513 for unrelated business income tax (“UBIT”). NEA publishes magazines mainly for its members (an activity “related” to its exempt purposes and not subject to UBIT) and sells advertising in those magazines (an “unrelated” activity that is subject to UBIT). By a notice of deficiency dated June 25, 2009, the Internal Revenue Service (IRS) determined deficiencies in NEA's UBIT in the following amounts:

+------------------------------------------+
                ¦Tax year ended Aug. 31 ¦UBIT deficiency ¦
                +------------------------+-----------------¦
                ¦2001 ¦$319,094 ¦
                +------------------------+-----------------¦
                ¦2002 ¦444,554 ¦
                +------------------------+-----------------¦
                ¦2003 ¦342,371 ¦
                +------------------------------------------+
                

NEA brought this case pursuant to section 6213(a), asking this Court to redetermine those deficiencies.

[137 T.C. 102]

The issue for decision is whether NEA must allocate a portion of its members' dues to the circulation income of those magazines. The parties agree that the outcome of this dispute depends on whether, for purposes of 26 C.F.R. section 1.512(a)1(f)(3)(iii), Income Tax Regs., membership in NEA gave members “the right to receive” NEA periodicals. If the members had a “ right to receive” the magazines, then: (a) a portion of the members' dues was circulation income; (b) as a result of that income, NEA did not have a loss from circulation activity; (c) NEA's income from advertising (an “unrelated” activity subject to UBIT) was therefore not offset by any circulation losses; and (d) NEA owes tax on the advertising income. NEA concedes that if the IRS prevails on this issue, then the IRS's computations are correct with respect to the amounts of membership dues allocable to circulation income for the years at issue.

For the reasons explained below, we find that membership in NEA did give members “the right to receive” the NEA magazines. Consequently, NEA must allocate a portion of its members' dues to circulation income.

FINDINGS OF FACT

The parties submitted this case fully stipulated pursuant to Rule 122. The stipulation of facts filed November 26, 2010, and the attached exhibits are incorporated herein by this reference. At the time that NEA filed its petition, NEA maintained its principal place of business in Washington, D.C.

NEA and its affiliates

NEA originated in 1857 as the National Teacher's Association. In 1906 a special act of Congress incorporated the entity under its current name. NEA operates under a charter, a constitution, bylaws, and standing rules; and its stated goals include serving as a national voice for education, promoting the health and welfare of children and/or students, and protecting the rights of educational employees and advancing their interests and welfare.

NEA charters State and local affiliates that meet standards set in NEA's bylaws. The IRS recognizes both NEA and the affiliates as exempt from tax under section 501(a) as section 501(c)(5) labor organizations. Individuals become members of

[137 T.C. 103]

NEA only by becoming members of one of the State or local affiliates. The affiliates are responsible for enrolling members, collecting and remitting dues, and a variety of other activities.

In the years at issue NEA had 54 main affiliates and more than 2–1/2 million members (of whom more than 160,000 were retired members). Each NEA member paid dues of $123 for the 2000–2001 school year and slightly more in subsequent years. NEA therefore received well over $300 million in dues in each of the years at issue.

NEA's magazines

NEA produced numerous books, pamphlets, booklets, and other publications. Only two of NEA's publications are pertinent here—NEA Today for active members and This Active Life for retired members. (We refer to these two publications collectively as the “magazines”.) NEA began publishing NEA Today in 1982 and This Active Life in 1999.

Since 1982 NEA has published NEA Today. In the years at issue NEA published eight monthly issues of NEA Today over the course of a school year. As the magazine explained to its readers, its “press schedule * * * is set a year in advance”. Each issue consisted of 52 pages in a 10–inch by 14–inch newspaper tabloid format. NEA distributed more than 2.4 million printed copies per issue to dues-paying members by mail. About 40,000 NEA members (i.e., less than two percent) declined the subscription, but they did not receive a reduction in their dues for doing so. NEA did not actively promote outside subscriptions and sold fewer than 200 hard copy subscriptions to nonmembers. NEA distributed complimentary copies to NEA employees, employees of NEA affiliates, attendees at NEA hosted meetings, school officials, media representatives, government officials, and members of the public who requested individual issues.

The masthead on the inside of the cover of each NEA Today issue included the following statements:

NEA Today is published eight times a year, monthly, in September, October, November, January, February, March, April, and May by the National Education Association * * *.

* * *

[137 T.C. 104]

NEA Today is mailed to all NEA members as a benefit of membership. Nonmember subscription price: $45 institutional, $80 domestic and foreign. For members, subscriptions represent $4 of annual dues.²

In the years at issue and thereafter, NEA also made articles from NEA Today available free on the Internet to the general public. The Internet version did not contain letters to the editor and excluded the advertising. Despite the availability of articles on the Internet, NEA continued to mail hard copies of NEA Today to members, even to two members in the same household.

Since 1999 NEA has published This Active Life. In the years at issue NEA annually published six bi-monthly issues of This Active Life in standard 8.5–inch by 11–inch magazine format. NEA individually addressed and mailed This Active Life to retired dues-paying members, with per-issue circulations of 175,400, 195,516, and 215,633 for its fiscal years ending August 31, 2001, 2002, and 2003. As with NEA Today, recipients could decline the subscription to This Active Life, though only a small percentage chose to do so. Members who declined delivery did not receive a reduction in their membership dues. NEA did not make available hard copies of This Active Life for purchase or as courtesy copies. As it did with NEA Today, NEA made This Active Life available free on the Internet to the general public.

The masthead on page three of each This Active Life issue included the following statement:

This Active Life * * * is published bimonthly by the National Education Association * * *. * * * Annual subscription price: $2.30 (included in membership dues and available only as a part of membership).³

Advertising

NEA sells advertising space to help defray the expenses of creating, producing, and mailing the magazines. As a result of the advertising revenue, the net cost per member for a year's delivery of NEA Today was $4.10 in the years at issue.

One of the reasons that NEA sent separate issues of the magazines to NEA members in the same household was to

[137 T.C. 105]

fulfill circulation volume commitments that NEA made in its advertising contracts.

References in NEA documents to members' receipt of magazines

NEA's governing documents contained statements related to NEA publications, as follows:

Article IX, sections 2(b) and 3(b), of NEA's constitution provided that, with respect to amending the NEA constitution and bylaws, “The text of the proposed amendment shall be printed in an official publication sent to all members at least sixty (60) days prior to its consideration.”

Section 2–3(c)of NEA's bylaws provided that “[a]ll members shall be eligible to receive * * * reports and publications of the Association in accordance with the...