Prof'l Ins. Agents of Michigan v. Comm'r of Internal Revenue

• Decision Date: 17 February 1982
• Docket Number: Docket No. 11748-78.
• Citation: 78 T.C. 246
• Parties: PROFESSIONAL INSURANCE AGENTS of MICHIGAN, PETITIONER v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

78 T.C. 246

PROFESSIONAL INSURANCE AGENTS of MICHIGAN, PETITIONER

v.COMMISSIONER of INTERNAL REVENUE, RESPONDENT

Docket No. 11748-78.

United States Tax Court

Filed February 17, 1982.

Petitioner is a professional association of Michigan independent insurance agents and is exempt from tax as a business league under sec. 501(c)(6), I.R.C. 1954. During the taxable years in issue, petitioner performed various promotional and administrative services in connection with certain malpractice, health, disability, and life insurance programs underwritten by private insurance companies and made available to petitioner's members. For its efforts, petitioner received fees based on varying percentages of the premiums paid by participating members.

In March 1975, petitioner received an experience rating reserve refund from Time Insurance Co. in connection with a group health and life policy which petitioner had terminated on Jan. 1, 1974. It deposited the refund check in its general checking account and enjoyed unfettered dominion and control over the funds thereafter. Under an agreement with the insurance company, petitioner assumed a contingent liability, not to exceed the amount of the refund, for any claims which had not yet been filed under the canceled policy. No such claims were filed, however, and no portion of the refund was distributed to petitioner's members.

Held, the promotional and administrative fees were unrelated business income under sec. 512, I.R.C. 1954. Held, further: The experience rating reserve refund was not received by petitioner in trust for its members, but rather, was received under claim of right without restriction as to its use or disposition. Therefore, the refund constitutes unrelated business income under sec. 512 even though petitioner was under a contingent obligation to restore all or a part of the refund in the event additional claims were filed with Time Insurance. Bruce B. Hart, for the petitioner.

William F. Garrow, for the respondent.

DAWSON , Judge:

Respondent determined the following deficiencies in petitioner's Federal income taxes:

+-------------------------------+
                ¦TYE Sept. 30—   ¦Deficiency  ¦
                +------------------+------------¦
                ¦                  ¦            ¦
                +------------------+------------¦
                ¦1974              ¦$17,200.57  ¦
                +------------------+------------¦
                ¦1975              ¦41,692.72   ¦
                +------------------+------------¦
                ¦1976              ¦24,134.69   ¦
                +-------------------------------+
                

After concessions, the issues for decision are whether the following amounts received by petitioner, a business league of insurance agents exempt from taxation pursuant to section 501(c)(6),¹ constituted unrelated business taxable income under section 512:

(1) Fees received for performing various promotional and administrative services in connection with certain malpractice, health, disability, and life insurance programs which petitioner sponsored or helped make available to its members; and

(2) An experience rating reserve refund received from an insurance company upon termination of a group health and life policy which petitioner had contracted for and made available to its members.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found. The stipulation of facts and the attached exhibits are incorporated herein by reference.

Professional Insurance Agents of Michigan (hereinafter referred to as PIA or petitioner) was originally formed on April 20, 1937, as an unincorporated association under the laws of the State of Michigan and operated as such until May 27, 1956. The association was incorporated on May 28, 1956, under Michigan Act No. 372 of Public Acts of 1931, as amended, as a nonprofit corporation under the name of Michigan Association of Mutual Insurance Agents. On October 1, 1976, petitioner changed its name to Professional Insurance Agents of Michigan.

Petitioner's principal place of business at the time the petition in this case was filed was located in Lansing, Mich. Petitioner timely filed Forms 990 (Return of Organization Exempt from Income Tax) and 990-T (Exempt Organization Business Income Tax Return) for the taxable years ended September 30, 1974, 1975, and 1976, with the Internal Revenue Service Center in Philadelphia, Pa. Its income was computed according to the cash method of accounting.

On April 8, 1958, respondent ruled that petitioner was exempt from Federal income taxation as a business league under section 501(c)(6).

Article II of petitioner's articles of incorporation (non-profit) described the objectives of the business league as follows:

The object of this Association shall be to maintain and extend the American Agency System, which system is defined to be the production of insurance premiums and service of insurance contracts by insurance agents operating solely on a commission basis on their own account as independent contractors, owning their own expirations and who maintain their own offices separate from any insurance company; to promote the equitable rights of its members; to provide its members with increased knowledge thru education in insurance underwriting and selling, loss prevention and agency management; to promote a high standard of ethics, friendship and cooperation among its members, to better serve the public, themselves, their companies and to professionalize the industry; to oppose bad practices of insurance and to cooperate with the Department of Insurance of the State of Michigan.

About 1,000 of the nearly 2,400 eligible insurance agents in Michigan belonged to petitioner during the years in issue. Many of the other agents belonged to a rival trade organization similar to petitioner operating under the name of Independent Insurance Agents of Michigan. The average member of petitioner was a relatively small insurance agency with an average of three to five employees, writing primarily personal lines of coverage such as automobile and homeowners' insurance and generating an average annual premium volume of around $400,000.

Upon becoming a member of petitioner, an insurance agent (agency) automatically became a member of the National Association of Professional Insurance Agents (National Association). This was a nationwide organization of insurance agents whose membership consisted of the members of the various State and regional affiliates. Despite their shared membership, petitioner and the National Association were separate, autonomous organizations, operated independently of one another. The governing body of the National Association was a board of directors comprised of two or three directors elected by each local organization.

Memberships in petitioner were made available in the following categories:

(a) A-Agency, a partnership or corporation. This was a voting membership. Only one vote was given to a member under this category, even though the member may have consisted of more than one person as a partner or employee in a partnership or corporation.

(b) B-Agency, sole proprietorship not incorporated. This was a voting membership with one vote per sole proprietorship.

(c) C-Associate Member. This was a nonvoting membership open to those whose businesses were related to the insurance industry; for example, underwriters and insurance carriers.

(d) D-Subscription Member. This was a nonvoting membership that was available to employees of A or B Agency members and entitled them to receive publications and mailings of the National Association.

New and prospective PIA members were mailed a membership packet containing explanatory material concerning the various programs made available to the membership by petitioner and the National Association. This included information on educational seminars, educational programs leading to certification as qualified insurance counselors, copies of the various newsletters and magazines which members were entitled to receive, and brochures on various group insurance programs.

Membership benefits offered by petitioner during the years in issue included the following:

(a) Members were provided the opportunity to attend various conventions, seminars, and educational programs conducted or sponsored by petitioner relating to the insurance industry.

(b) Members were given a subscription to The Promoter, a bimonthly periodical published by petitioner, which included articles of interest to the membership and news items selected to keep members informed of matters pertaining to the insurance industry.

(c) Members were given a subscription to the Mich-A-Gram, a newsletter published by petitioner, informing them of matters of interest such as seminars, educational opportunities, and legislative developments affecting the insurance industry.

(d) Members were provided representation before the State of Michigan legislative and regulatory bodies.

(e) Members were provided the opportunity to apply for coverage (for themselves and their employees) under (1) a group life and health insurance policy underwritten by the Independent Liberty Life Insurance Co., (2) an “Errors and Omissions” liability policy sponsored by the National Association and underwritten by the Utica Mutual Insurance Co., and (3) certain other group insurance policies sponsored by the National Association.

Additional Facts Pertaining to Insurance Programs

Errors and Omissions (E & O) insurance is a type of professional malpractice insurance which protects the insurance agent from liability in the event his client suffers a loss as a result of errors made in writing a policy. The insurance is expensive and difficult to underwrite and the insurance carriers who offer it prefer to spread their risk by selling to a national market on a group, rather than an individual, basis. As a result, the market for coverage on an individual basis was both limited and volatile, with insurance companies occasionally finding it necessary to discontinue the coverage soon after entering the market.

In order to increase the...