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March 28, 1985


The opinion of the court was delivered by: Getzendanner, District Judge:


This action for a refund of federal taxes, brought pursuant to 28 U.S.C. § 1346(a), is before the court on the cross-motions for summary judgment of plaintiff Water Quality Association Employees' Benefit Corporation ("the Corporation") and defendant United States of America. In this action, the Corporation claims entitlement to a tax refund for taxes paid in 1981 by it and its predecessor, the Water Quality Employees' Benefit Trust ("the Trust"). At issue on these motions is the validity of Treas. Reg. § 1.501(c)(9)-2(a)(1). Should the regulation be found valid, full summary judgment in favor of the government will be warranted. If the regulation is found invalid, however, the Corporation will need to show other facts before prevailing. Hence, the Corporation's motion for summary judgment is in the nature of a motion for partial summary judgment.


The parties agree to the following facts: The Water Quality Association ("WQA") was founded nearly thirty years ago and is composed of retailers, distributors, suppliers, and manufacturers of point-of-use water conditioning equipment, such as water softeners. WQA's members are scattered throughout the United States. WQA is a trade association exempt from federal income taxation under 26 U.S.C. § 501(c)(6).

Since each WQA member has on the average of five employees, it was expensive for each member to obtain insurance for its employees. Consequently, WQA established the Trust so that its members could pool their limited insurance premiums and thereby decrease the cost of insurance while increasing the insurance protection for the member employees. An insurance company was appointed to underwrite the joint purchase of group life and health insurance as well as disability income insurance for WQA member employees and their dependents. The Trust itself has never underwritten the insurance coverage for trust participants, but rather has acted as a conduit, collecting contributions from WQA member participants and paying those contributions to the insurance company as insurance premiums. Only WQA members and their employees were allowed to participate in the Trust.

Over the years, the members benefitted from the underwriting of such a large and homogeneous group. By 1981, over 3,000 individuals were insured through the program. The Trust paid dividends to participants when the insurance company's claims and expenses were less than anticipated. Additionally, a portion of the insurance refunds were retained by the Trust and were used to establish a reserve to pay off deficits when they occurred.

Since the trust agreement was drafted to provide for payments only to trust beneficiaries and for necessary administrative expenses, the Trust applied for a federal income tax exemption under 26 U.S.C. § 501(c)(9).*fn1 Section 501(c)(9) allows an exemption for a "voluntary employees' beneficiary association" ("VEBA") established to provide certain insurance benefits. In 1977, the Internal Revenue Service granted the exemption. At that time, the exemption for the Trust was well within the proposed Treasury Regulation defining the scope of VEBAs.*fn2 On August 1, 1981, the Trust transferred the insurance plan and its assets to the Corporation, which operates the insurance program in exactly the same manner as did the Trust.

The Corporation claims that it, like the Trust, is entitled to the tax exemption provided by § 501(c)(9) since, like the Trust, it is a "voluntary employees' beneficiary association." However, on July 17, 1980, the proposed regulation discussed above was withdrawn and on January 8, 1981, a final regulation defining VEBAs was published containing a "same geographic locale" limitation that the parties agree renders the Corporation ineligible for the exemption.*fn3

The principal difference between the 1969 proposed regulation (in effect for 12 years) and the 1981 final regulation is the requirement that when employees from employers in the same line of business desire to form a VEBA, the employers must be located in the "same geographic locale." The Corporation admits that its member employers are not located in the same geographic locale. Hence, if the final regulation is found valid, full summary judgment in the government's favor would be warranted.


The question before the court, one of first impression, is whether Treas. Reg. § 1.501(c)(9)-2(a)(1) effectuates the congressional intent of 26 U.S.C. § 501(c)(9). The Internal Revenue Commissioner's power to prescribe regulations

  is not the power to make law — for no such power
  can be delegated by Congress — but the power to
  adopt regulations to carry into effect the will of
  Congress as expressed by the statute. A regulation
  which does not do this but operates to create a
  rule out of harmony with a statute is a mere

In determining the validity of a Treasury Regulation, courts have relied on the criteria set forth in National Muffler Dealers Association v. United States, 440 U.S. 472, 99 S.Ct. 1304, 59 L.Ed.2d 519 (1979). See e.g., Strick Corp. v. United States, 714 F.2d 1194, 1197 (3d Cir. 1983), cert. denied, ___ U.S. ___, 104 S.Ct. 2345, 80 L.Ed.2d 819 ...

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