Appeal from the United States Tax Court, Washington, D.C. No. 28717-81--William A. Goffee, Judge.
Before COFFEY and RIPPLE, Circuit Judges, and WILL, Senior District Judge.*fn*
WILL, Senior District Judge.
The tax court found*fn1 that the Illinois Association of Professional Insurance Agents, Inc. (IAPIA or Association), a tax-exempt business league, was subject to the tax on unrelated business income on the fees it received in 1976 and 1977 for performing promotional and administrative services in connection with the sale of errors and omissions insurance to its members. We affirm for the reasons stated in this opinion.
The Association is exempt from federal taxation under section 501(c)(6) of the Internal Revenue Code which provides an exemption for "business leagues . . . not organized for profit and no part of the net earnings of which inures to the benefit of any private shareholder or individual." 26 U.S.C. § 501(c)(6). However, "[a] tax-exempt organization must pay tax on income that it earns by [regularly] carrying on a [trade or] business not 'substantially related' to the purposes for which the organization has received its exemption from federal taxation." United States v. American College of Physicians, 475 U.S. 834, 106 S. Ct. 1591, 1600, 89 L. Ed. 2d 841 (1986); United States v. American Bar Endowment, 477 U.S. 105, 106 S. Ct. 2426, 2430, 91 L. Ed. 2d 89 (1986); 26 U.S.C. § 511(a).
Amounts received by a tax-exempt organization from its insurance programs constitute "unrelated business taxable income," if the activity "(1) constitutes a trade or business; (2) is regularly carried on; and (3) is not substantially related to [the organization's] tax-exempt purposes" (other than through the production of funds). American Bar Endowment, 106 S. Ct. at 2430; 26 C.F.R. 1.513-1(a); 26 U.S.C. §§ 512(a) & 513(a). The Association contends that the fees it received in connection with the sale of errors and omissions insurance do not constitute unrelated business income and are not taxable, first, because its activities do not constitute a "trade or business". Second, if its activities do constitute a trade or business, though the Association admits the activities were carried on regularly, it claims that the errors and omissions insurance business is substantially related to its exempt purposes.
We must determine whether the tax court erred in deciding that the Association's errors and omissions insurance activities constituted a trade or business and that those activities were not substantially related to its exempt purpose.
The evidence before the tax court consisted of the stipulations of the parties and the testimony of Harold S. Price, the executive director of the IAPIA during 1976 and 1977. During those years, IAPIA had about 900 members, all independent insurance agents, most of whom ran one or two person insurance agencies in small communities.
The objectives of the Association, as stated in its by-laws are
to maintain and extend the American Agency System; to promote the equitable rights of its members; to provide its members with an increased knowledge of insurance underwriting and selling, loss prevention, and agency operation; to foster a high standard of insurance ethics and promote friendship in the insurance business; and to do all things to the end that its members may better serve the public, their companies and themselves.
IAPIA made a number of insurance programs available to its members through the National Association of Professional Insurance Agents (National Association) with which IAPIA is affiliated as a state association. "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 error made in writing a policy." Professional Insurance Agents of Michigan v. C.I.R., 726 F.2d 1097, 1099 (6th Cir. 1984) (PIA of Michigan). Harold Price, IAPIA's executive director, testified that in the early 1960s, errors and omissions insurance was not widely available and was not consistently offered to independent insurance agents. In order to increase the availability and to maintain continuity of such coverage, the National Association sponsored an errors and omissions insurance program underwritten by a group of underwriters, but issuing individual policies to insurance agents. According to Price, in later years, including the years in question here, errors and omissions insurance was available from other sources. The National Association received a percentage of the premiums as a service fee from the insurance companies offering the various plans. A portion of those fees was distributed to the state association, including IAPIA, for services rendered by them on behalf of the National Association. Only the fees earned by IAPIA for its activities in support of the errors and omissions insurance program are at issue in this case,*fn2 the Association having agreed that fees derived from the performance of services on other insurance programs are unrelated business taxable income not substantially related to its exempt purposes.
The tax court found that IAPIA performed the following services in connection with the errors and ...