Nat'l Water Well Ass'n, Inc. v. Comm'r of Internal Revenue

• Citation: 92 T.C. 75,92 T.C. No. 7
• Decision Date: 24 January 1989
• Docket Number: Docket No. 22420-83.
• Parties: NATIONAL WATER WELL ASSOCIATION, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: United States Tax Court

92 T.C. 75

92 T.C. No. 7

NATIONAL WATER WELL ASSOCIATION, INC., Petitioner

v.COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 22420-83.

United States Tax Court

Filed January 24, 1989.

P, a trade association for the water well industry, is exempt from taxation as a business league under sec. 501(c)(6), I.R.C. 1954. As the group policyholder of an industry casualty insurance policy, P actively sponsors and promotes that insurance program. Under an agreement with the insurance company, P performs a variety of services for the insurance company and for the insurance brokerage company that manages that insurance program. During the year in issue, P received a dividend from the insurance company in connection with that insurance program, part of which P distributed to those insured under the group policy and part of which P retained. R determined that the retained dividend (less related expenses) constituted unrelated business taxable income (UBTI) under sec. 512, I.R.C. 1954.

HELD: The test as to whether an activity constitutes a trade or business for purposes of UBTI is the profit motive test, determined by objective factors. United States v. American Bar Endowment, 477 U.S. 105 (1986), and Professional Insurance Agents of Michigan v. Commissioner, 726 F.2d 1097 (6th Cir. 1984), affg. 78 T.C. 246 (1982), applied and activity found to be a trade or business.

HELD FURTHER: The test under sec. 513(a), I.R.C. 1954, as to whether the conduct of such a trade or business is substantially related to the business league's exempt purpose is whether the activity is conducted to provide benefits to the business league or industry as a whole as opposed to benefits to members in their individual capacity in proportion to fees paid. United States v. American College of Physicians, 475 U.S. 834 (1986), and Illinois Association of Professional Insurance Agents v. Commissioner, 801 F.2d 987 (7th Cir. 1986), affg. a Memorandum Opinion of this Court, applied and conduct of activity found not substantially related to business league's exempt purpose.

HELD FURTHER: The dividend from the unrelated business activity did not constitute a royalty payment under sec. 512(b)(2), I.R.C. 1954, since the dividend was not passive income in payment for the use of a valuable property right, but more akin to compensation for P's active role in the insurance program. Fraternal Order of Police Illinois State Troopers Lodge No. 41 v. Commissioner, 833 F.2d 717 (7th Cir. 1987), affg. 87 T.C. 747 (1986), applied. Robert D. Marotta and Michael A. Mess, for the petitioner.

Genevieve K. Murtaugh, for the respondent.

OPINION

PARKER, JUDGE:

Respondent determined a deficiency in petitioner's Federal income tax for its fiscal year ended October 31, 1980 in the amount of $21,082. The issues for decision are:

(1) Whether insurance dividends received by petitioner, a business league exempt from taxation under section 501(c)(6), ¹ as the group policyholder of an insurance program that the business league endorsed constitute unrelated business taxable income under section 512; and (2) If so, whether the income is excludable from the unrelated business tax as royalties under section 512(b)(2).

This case was submitted fully stipulated under Rule 122. The stipulation of facts and the exhibits attached thereto are incorporated herein by this reference.

Petitioner, National Water Well Association, Inc., is a corporation with its principal place of business in Worthington, Ohio at the time the petition was filed in this case. Petitioner is a corporation organized under the laws of the State of Ohio. ²

After incorporating in the State of Ohio, petitioner filed an Application for Recognition of Exemption, Form 1024, with the office of the Internal Revenue Service in Cincinnati, Ohio on June 7, 1979. This exemption was granted and petitioner is now a business league exempt from Federal income tax under section 501(c)(6). Petitioner filed a Return of Organization Exempt from Income Tax, Form 990, for the taxable year ending October 31, 1980 with the Internal Revenue Service Center in Cincinnati, Ohio.

Petitioner is an association composed of persons engaged in the water well industry. In 1980 petitioner had approximately 8,000 members grouped into five divisions, which included 1) the Contractors Division composed of individuals and companies engaged in the business of water well drilling, 2) the Manufacturers Division composed of individuals and companies engaged in manufacturing equipment, materials or supplies used in the water well industry, 3) the Suppliers Division composed of individuals and companies that supply equipment (on a wholesale or retail basis) to the water well industry, 4) the Ground Water Technology Division composed of colleges and universities studying or teaching subjects related to the water well industry, and geologists and other professionals involved in the evaluation, development or investigation of ground water, and 5) the Pump Installation Contractors Division composed of individuals and companies engaged in the business of water systems or pump installation, maintenance or repair. The governing document of petitioner is its bylaws. The bylaws specify:

The objectives of this association shall be: to assist, promote, encourage, and support the interests and welfare of the water well industry in all of its phases; to foster, aid and promote scientific education, standards, redevelopment, and to advance the science of ground water hydrology; to promote harmony and cooperation between well contractors and scientific agencies relative to the proper development and protection of underground water supplies; to encourage cooperation of all interested groups relative to the improvement of drilling and pumping equipment; to encourage, serve, assist and promote closer cooperation among the existing state water well contractors' associations and to foster the development of such associations in states where they do not exist; to collect, analyze, and disseminate to the public facts about the role of the water well industry in the economy of the nation; and to advance generally the mutual interests of all those engaged in the water well industry, in their own and the public interest.

The management and control of petitioner is vested in its board of directors, which consists of nine members of the Contractors Division, the immediate past president, and two members of each of the other four divisions. Petitioner maintains a staff that manages and operates the organization. This staff's duties include membership administration and relations, production of related publications, presentation of educational programs for the water well industry, research in the water well and ground water fields, and promotion of safety programs.

Petitioner sponsors various insurance programs for its members. During the year in issue, the programs petitioner sponsored included life insurance, accident and disability insurance, industry casualty insurance, errors and omissions insurance, and health insurance.

At one time, water well drillers were classified, for insurance purposes, in the same category as oil well drillers. Several years before the year in issue, petitioner conducted a study that showed that the safety experience record for water well drillers was better than the safety record of oil well drillers and justified a separate classification for water well drillers. As a result of petitioner's study, Maryland Casualty Insurance Company (hereinafter referred to as Maryland Casualty) agreed to classify water well drillers as a less risk-prone industry than previously classified. Based on this classification, Maryland Casualty developed a comprehensive industry casualty insurance program for the water well industry, which included coverage for workers' compensation, general liability, business equipment liability, and automobile liability insurance. This insurance program will be referred to hereinafter as either the ‘industry casualty insurance program‘ or the ‘Safety Dividend Casualty Program.‘ Maryland Casualty was the insurer, and the insurance brokerage company that managed and monitored the program was the ‘Planning Corporation,‘ located in Vienna, Virginia.

Petitioner agreed to endorse and sponsor Maryland Casualty's comprehensive industry casualty program, known as the Safety Dividend Casualty Program. Petitioner became the group policyholder of this insurance policy. Petitioner entered into a written agreement with Maryland Casualty in which petitioner agreed to: (1) provide assistance to Maryland Casualty in endorsing, promoting, and sponsoring the insurance program, (2) give Maryland Casualty cooperation and advice in presenting the insurance program to potential participants, (3) make known the availability of the insurance program to its members, (4) not sponsor or endorse any other property or casualty insurance program nor allow its list of property or casualty insured risks to be disseminated to other parties for purposes of direct or indirect solicitation for any other property or casualty insurance program, (5) cooperate with and assist Maryland Casualty, upon its request, in the collection of any premiums that are payable to Maryland Casualty under the insurance program by providing it with available pertinent information that may facilitate collection of the premiums, and (6) obtain the written approval of Maryland Casualty for any promotional literature referring to the insurance program before distributing it to its members.

In fulfilling these contractual obligations, petitioner provided Maryland Casualty and/or the Planning Corporation with its membership lists, wrote articles on safety and its effects on insurance, provided exhibit space for Maryland Casualty at its conventions and meetings, and answered inquiries from present and potential policyholders regarding the insurance. Petitioner also placed advertisements...