Unpublished Disposition, 875 F.2d 870 (9th Cir. 1979)

MEMORANDUM^* 

Plaintiff-Appellant Professional Insurance Agents of Washington (PIAW) appeals from a final decision of the tax court entering deficiency judgments against PIAW of $2,983 for the taxable year ending September 30, 1978, and $2,250 for the taxable year ending September 30, 1979. We have jurisdiction pursuant to 26 U.S.C. § 7482 over PIAW's timely appeal, and we affirm.

* PIAW is a not-for-profit "business league" exempt from federal income taxation under 26 U.S.C. § 501(c) (6).¹  PIAW was incorporated in 1974 for the purpose of promoting the common interests of Washington state's independent insurance agents. PIAW's independent insurance agents sell insurance underwritten by a variety of companies, and the agents receive commissions on the policies they write. They do not earn a salary or benefits from the underwriters and are not employees.

PIAW's assessed tax deficiencies arise from its receipt of funds from the National Association of Professional Insurance Agents ("National Association") in connection with PIAW's promotion of an Errors and Omissions ("E & O") malpractice insurance plan sponsored by the National Association and underwritten by the Utica Mutual Insurance Group ("Utica").

E & O insurance provides independent insurance agents with protection against malpractice in writing and processing insurance policies. The Commissioner also determined deficiencies with respect to PIAW's receipts from group life, health and accident plans sponsored by the National Association, but PIAW only contested the assessed deficiencies in connection with the malpractice insurance in the tax court. This appeal only addresses the malpractice insurance plan.

Utica paid the National Association 13.5 percent of the premiums it received from agents purchasing its malpractice insurance in the State of Washington. PIAW promoted the malpractice insurance to all Washington independent agents, whether or not they were members of PIAW. In turn, the National Association paid PIAW 8/15ths of the amount it received from Utica for Washington agents subscribing to the malpractice insurance plan.

II

We review decisions of United States Tax Courts on the same basis as decisions in civil bench trials in United States District Courts. Sliwa v. Commissioner, 839 F.2d 602, 605 (9th Cir. 1988); Mayors v. Commissioner, 785 F.2d 757, 759 (9th Cir. 1986). Consequently, factual findings are reviewed under the clearly erroneous standard of Fed. R. Civ. P. 52(a), and mixed questions of law and fact that are not primarily factual are generally reviewed de novo. Mayors, 785 F.2d at 759. The ultimate question before us is whether PIAW's receipts from its malpractice insurance promotion are unrelated business income. While we analyze this ultimate issue de novo, it turns to a great extent of PIAW's motive, a finding we review for clear error. See Carter v. C.I.R., 645 F.2d 784, 786 (9th Cir. 1981) (determination of taxpayer's primary motivation is a question of fact); Illinois Ass'n of Professional Ins. Agents v. C.I.R., 801 F.2d 987, 992 (7th Cir. 1986) (reviewing under the clearly erroneous standard the tax court's finding that the Illinois independent insurance agents group had acted with a profit motive in promoting the National Association's malpractice insurance plan).

III

A tax-exempt organization such as PIAW is nonetheless subject to taxation on "unrelated business taxable income." 26 U.S.C. § 511(a) (1). This is defined as "the gross income derived by any organization from any unrelated trade or business ... regularly carried on by it, less the deductions allowed...." 26 U.S.C. § 512(a) (1). Congress defined "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 or function constituting the basis for its exemption...." 26 U.S.C. § 513(a). In sum, this determination "depends upon (1) whether [the activity] is a 'trade or business,' (2) whether it is regularly carried on, and (3) whether it is substantially related to [the organization's] tax-exempt purposes." United States v. American College of Physicians, 475 U.S. 834, 838-39 (1986).

Prior to Congress' passage of the Revenue Act of 1950, the law merely required that the profits earned by exempt organizations be used in furtherance of their tax-exempt purposes. The Act was designed to correct the unfairness of allowing exempt organizations to "carry on full-fledged commercial enterprises in competition with corporations whose profits were fully taxable." American College of Physicians, 475 U.S. at 838. To this end, the Act required a certain nexus between an organization's tax-exempt purposes and the source of its income. The tax court determined that PIAW's promotion of Utica malpractice insurance was unrelated business taxable income.

* As to the first prong of the unrelated business income test, Congress defined a "trade or business" as "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 Treasury Regulations state that a "trade or business" under section 162 is also a trade or business within the meaning of Secs. 511-513. 26 C.F.R. Sec. 1.513-1(b) (1979).

In United States v. American Bar Endowment, 477 U.S. 105 (1986), the Court held that income earned by the American Bar Endowment ("ABE") from the promotion of group life, health, accident and disability insurance was unrelated business taxable income. The ABE conceded that its promotion was regularly carried on and that it was not substantially related to the ABE's tax-exempt purposes. Id. at 110. Consequently, the only question before the Court was whether the income earned from the promotion of this insurance was a "trade or business." In noting that the Treasury regulations incorporated section 162's definition of "trade or business," the Court stated that " [t]he standard test for the existence of a trade or business for purposes of Sec. 162 is whether the activity 'was entered into with the dominant hope and intent of realizing a profit.' " Id. at 110 n. 1 (citations omitted). The Court noted that several circuit courts had adopted this "profit motive" test.² 

The American Bar Endowment decision sent a clear message to professional groups that they could no longer promote insurance to their members with the expectation that their receipts from underwriters would be tax-exempt. Indeed, PIAW has recognized this lesson by not contesting the Commissioner's determination that earnings from its promotion of group life, health and accident plans were unrelated business taxable income. But PIAW contends that it did not promote Utica's malpractice insurance with the intent of making a profit.

* PIAW's primary evidence that it did not have the requisite profit motive in promoting the National Association's malpractice insurance is the testimony of Arline B. Baker, PIAW's executive director and director of education. She testified that PIAW's activities in connection with the National Association's plan were limited to informing independent agents about the plan and to making applications available to all interested agents. She said that PIAW would not have altered its conduct with respect to its promotion of the plan in the event the National Association ceased remitting a portion of the premiums to PIAW.

PIAW argues that Baker's "uncontradicted testimony on an issue of fact must be credited unless the witness is impeached or the testimony is inherently implausible." This court has soundly rejected this cardboard approach to trial testimony. In Hunsaker v. Commissioner, 615 F.2d 1253, 1257-58 (9th Cir. 1980), the tax court refused to credit the taxpayer's unimpeached testimony as to his motive in making a loan to his father's corporation. The Hunsaker court rejected the taxpayer's argument that "the Tax Court, as a matter of law, must credit his uncontroverted and self-serving trial testimony as establishing ... his dominant motivation...." Id. at 1257. Instead, the court stated that the tax court was entitled to "consider the contemporaneous objective circumstances" providing clues to the taxpayer's motive. Id.

PIAW admits that it recommended the Utica plan as the "best and most stable coverage available on the market." But it argues that it did this only with the intent of promoting the general use of E & O insurance by independent agents. PIAW argues that its general promotion of E & O insurance advances the cause of independent agents by (1) providing them with malpractice coverage comparable to what company agents receive by virtue of their employment, (2) promoting public confidence in the stability and integrity of independent agents, (3) providing consumers with increased protection in the event an error is made, and (4) protecting independent agents as a profession against the instability of uninsured litigation.

2

PIAW focuses on Baker's testimony as to PIAW's actual intent in promoting the malpractice insurance plan in order to distinguish two cases which found that PIAW's sister organizations in Illinois and Michigan had profit motives in promoting the National Association's malpractice plan. In the Illinois Ass'n case, the court upheld the tax court's finding that the Illinois Association of Professional Insurance Agents ("IAPIA") had "the intent to make a profit from its activities in support of the National Association's errors and omissions insurance program...." 801 F.2d at 992. The court cited IAPIA's executive director's testimony that if the National Association reduced its premium percentage, he "might have suggested to the National that maybe they weren't doing a good job." Id. In Professional Ins. Agents of Michigan v. Commissioner, 726 F.2d 1097, 1102 (6th Cir. 1984), the court held that the Professional Insurance Agents of Michigan ("PIA") had a profit motive in promoting several different insurance plans, including the National Association's malpractice plan. The court especially noted PIA's president's testimony that "absent a proper split of the insurance premiums a different company would have been selected." Id.

PIAW performed much the same services for the National Association as did its sister organizations in Illinois and Michigan. PIAW enclosed descriptive brochures of the plan, rate schedules and applications in its standard membership package to new and prospective members. A sample brochure puffed the National Association's Utica insurance plan as being the "star" among E & O coverage. PIAW also published a monthly newsletter called "Evergreen Events." In the September 1978 edition, an article "suggest [ed] that if you do not have your professional liability exposure properly covered, you should apply for coverage through the PIA-Utica Program." In the March 1980 newsletter (six months after the last relevant taxable year) PIAW asked its members to "Stick With Us" for malpractice coverage, and noted that " [c]ompetition is more severe today than ever before."

The tax court also found that PIAW attempted to answer questions about the Utica insurance plan, and would give the inquiring individual a toll free telephone number to call if a question could not be answered. PIAW does not challenge these findings as clearly erroneous.

3

PIAW nonetheless attempts to distinguish what it labels the "vastly different factual records in the Michigan and Illinois cases" on the basis that there is "no record evidence to show that PIAW engaged in these activities for the purpose of realizing a profit." While Baker did not make the admissions made by the Illinois and Michigan directors, the tax court clearly understood that the critical issue was whether "the activity was engaged in with the intent to make a profit." Opinion at 9. "We think this requirement is clearly satisfied in the instant case." Id. at 10.

The tax court dismissed Baker's testimony as "self-serving"³  and noted that PIAW had failed to produce any other evidence that "the monies [it] received ... were other than in exchange for the services rendered by petitioner in connection with the marketing of the National Association's E & O plan." Id. The tax court also cited the "highly profitable" nature of PIAW's promotion and its belief that PIAW would have terminated its efforts absent the "commission remittance arrangement." Id. The tax court properly took these objective circumstances into account in assessing PIAW's motive.⁴ 

Credibility judgments are the peculiar province of fact-finders. The tax court's finding that PIAW acted with a profit motive in promoting Utica's insurance is reviewable only for clear error. Our review of the record fails to impress us with the firm and definite conviction that the tax court erred.

B

PIAW concedes that the second prong of the unrelated business income test is satisfied; the activities in question were "regularly carried on." The third prong of the test is whether PIAW's promotion of Utica's malpractice insurance is substantially related to PIAW's tax exempt purposes. The central inquiry is whether PIAW's promotion "contribute [d] importantly to the accomplishment of [its exempt] purposes." 26 C.F.R. Sec. 1.513-1(d) (2) (1979). "In determining whether activities contribute importantly to the accomplishment of an exempt purpose, the size and extent of the activities involved must be considered in relation to the nature and extent of the exempt function which they purport to serve." 26 C.F.R. Sec. 1.513(d) (3) (1979).

The other relevant inquiry focuses on the nature of an exempt business league, which is "not to engage in a regular business of a kind ordinarily carried on for profit." 26 C.F.R. Sec. 1.501(c) (6)-1 (1979). The exempt activities of a business league "should be directed to the improvement of business conditions of one or more lines of business as distinguished from the performance of particular services for individual persons." Id.

* In the American College of Physicians decision, the Court held that advertising profits received by the journal The Annals of Internal Medicine were not substantially related to the journal's tax exempt purposes, and thus were unrelated business taxable income. The Court focused upon the statutory language of 26 U.S.C. § 513(a), which provides for the taxation of " 'any trade or business the conduct of which is not substantially related,' [thereby] directing our focus to the manner in which the tax-exempt organization operates its business." 475 U.S. at 849 (emphasis in original). In rejecting the journal's argument that its advertisements performed an educational function supplemental to the journal's editorial content, the Court agreed with the Claims Court that the advertisements were not published with such a systematic editorial goal. Instead, " [t]hose companies willing to pay for advertising space got it; others did not." Id.

In the Illinois Ass'n case, the court interpreted the American College of Physicians decision to present this critical question: "Did the Association conduct its errors and omissions insurance business in a manner which was intended to further its exempt purposes, or did it conduct its business in a manner which indicates that raising revenue was the primary concern?" 801 F.2d at 994. By framing the question in this manner, however, the court can be said to have merged the "trade or business" prong with the "substantially related" prong, as the court makes an organization's intent central to both inquiries.

2

The American College of Physician decision did not indicate that an organization's intent is relevant to whether its activities are substantially related to its exempt purposes. The Court stated, for example, that " [w]e believe that the Claims Court was correct to concentrate its scrutiny upon the conduct of the College...." 475 U.S. at 848. The Court meant to distinguish between the first prong which necessarily hinges on the organization's subjective intent, and the third prong which turns on the objective circumstances surrounding the manner of operation of the fund-raising enterprise.⁵ 

The Professional Ins. court concluded that " [o]nly those activities that benefit the independent insurance agents in their capacities as regular members of PIA can be substantially related to PIA's exempt function." 726 F.2d at 1104. The test the court adopted for determining whether a benefit accrued in an individual or a membership capacity was whether the benefits received were directly proportional to the fee paid. "A product or service that seeks to accomplish a truly tax exempt purpose does not assure the member that he will receive benefits directly proportional to the fees he pays." Id. General educational programs and lobbying efforts clearly meet the membership capacity test, as the received benefits could be "negligible or far more valuable than the amount of their dues." Id.

The test adopted by the Professional Ins. court is well-suited to analyze the manner in which a fund-raising enterprise is conducted. We agree that the promotion of a particular E & O insurance plan by a group representing independent insurance brokers is not substantially related to the organization's tax-exempt purposes. Accordingly, the tax court properly entered deficiency judgments against PIAW.

AFFIRMED