Appeal from the United States District Court for the Southern District of Illinois, Springfield Division. No. S 75 C 121 -- J. Waldo Ackerman, Judge .
Before Fairchild, Chief Circuit Judge, and Swygert and Sprecher, Circuit Judges.
The issue raised in this appeal is whether a tax-exempt organization's solicitation of contributions through the mailing of greeting cards to potential contributors constitutes an unrelated trade or business within the meaning of sections 511-13 of the Internal Revenue Code. We hold that it does not and reverse the judgment below.
The Hope School is a non-profit charitable and educational organization exempt from federal income tax under 26 U.S.C. § 501(c)(3). For the tax years 1968 through 1970, the Commissioner assessed against the School an unrelated business income tax deficiency because of funds it received as the result of a contributions solicitation campaign. Taxpayer paid the $238,465.91 assessed and instituted a refund action in the United States District Court for the Southern District of Illinois, arguing that proceeds from the campaign were not unrelated business income as defined in 26 U.S.C. §§ 511-13. A jury entered a verdict for the Government and Taxpayer appealed.
Dr. Charles E. Jordan founded the Hope School in 1957 after unsuccessful attempts to find a suitable school for his daughter who was born blind and severely brain damaged. Although the School was originally located in one room in a residential dwelling, it gradually grew into a 25 acre facility which, during the tax years in question, cared for 76 children with severe, multiple handicaps.*fn1 In the first years, Dr. Jordan was the primary source of financing for the School, investing between $350,000 and $400,000 of his personal money to pay medical expenses and the salaries of the personnel. Tr. 86.*fn2 In the early 1960's, after he had tried unsuccessfully to solicit contributions from several foundations and organizations, Dr. Jordan was contacted by Mr. Bernard Gerchen, the President of American Mailing Consultants, with a plan for soliciting contributions from the public at large.
Pursuant to that original plan worked out by Mr. Gerchen and the Board of Directors of the Hope School, American Mailing sent out packages of greeting cards to prospective donors, with information about the School and a request for contributions. The recipients of the cards were under no obligation to give any money to the School and were free to keep the cards at no charge. American Mailing bore the entire economic risk of the operation: when the recipients of the cards kept the package without making a contribution, American Mailing suffered the loss. When contributions were received, however, American Mailing kept the first $1.10 per package, with all the surplus going to the Hope School.*fn3
The cards were mailed out twice a year and included a form to be used if a recipient wished to order additional packages. American Mailing managed the entire operation. It printed, packaged and mailed the greeting cards and the accompanying solicitation letter. No Hope School employees were involved in any way with the production or mailing of the cards.
Each package of cards distributed during the tax years in question contained a remittance envelope for contributions. The envelope was addressed to the Hope School, at a box maintained by it at the Illinois National Bank in Springfield, Illinois. Bank personnel opened the envelopes and deposited a portion of each contribution into the respective accounts of American Mailing and the Hope School.
In assessing the unrelated business tax against the School, the Service classified as income the amount received from the mailing of a single box of cards that was less than or equal to $2.00. Any money received in excess of $2.00 per box was considered a donation.
The Government contends that the proceeds from these solicitations constitute income from an unrelated business and are therefore taxable under sections 511-13 of the Internal Revenue Code. The School, on the other hand, relies on sections 512-13 and the accompanying Treasury Regulations to support its contention that it was not engaged in the operation of a trade or business at all.
Sections 511-12 set forth the basic premise that some otherwise tax-exempt organizations shall be taxed on income derived from the regular operation of any unrelated trade or business. In defining "unrelated trade or business," section 513 refers to any trade or business the conduct of which is not substantially related to the tax-exempt purpose of the organization. Neither party disputes that the proceeds in question are the product of a regularly conducted activity which is Not substantially related to the purpose of the Hope School;*fn4 rather, the controversy stems from whether the proceeds were the product of a regularly conducted trade or business.
The Internal Revenue Code nowhere gives a precise definition of "trade or business," but some guidelines can be gleaned from the Treasury Regulations and case law. In regulation § 1.513-1(b), the Service states that the same standard applies for determining whether an activity constitutes a trade or business for purposes of section 513 as for purposes of section 162.*fn5 Moreover, the regulation states that "an activity Does not possess the characteristics of a trade or business within the meaning of section 162 . . . when an organization sends out low cost articles incidental to the solicitation of charitable contributions." 26 C.F.R. § 1.513-1(b) (emphasis added). In McDowell v. Ribicoff, 292 F.2d 174, 178 (3d Cir.), Cert. denied, 368 U.S. 919, 82 S. Ct. 240, 7 L. Ed. 2d 135 (1961), a case discussing the requirements for a trade or business under section 162, the court elaborated further:
The phrase "trade or business" connotes something more than an act or course of activity engaged in for profit. Indeed, the Internal Revenue Code itself . . . distinguishes between a "trade or business" on the one hand ...