United States v. American Bar Endowment
1986 U.S. LEXIS 110, 91 L. Ed. 2d 89, 477 U.S. 105 (1986)
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Rule of Law:
A tax-exempt organization's income-generating activity constitutes a taxable "trade or business" if it involves the sale of goods or services in a commercial manner, regardless of the organization's ultimate charitable motive or fundraising purpose. For a taxpayer to deduct a portion of a payment made to a charity in exchange for a benefit, the taxpayer must demonstrate they purposefully contributed an amount in excess of the fair market value of the benefit received.
Facts:
- The American Bar Endowment (ABE), a tax-exempt charitable organization, raises funds by providing group insurance policies to its members, who are all part of the American Bar Association (ABA).
- ABE negotiates favorable insurance rates due to its size and the low-risk profile of its members, which results in the insurance company paying annual refunds, known as "dividends," back to ABE.
- As a mandatory condition of participating in the insurance program, ABE members must agree to assign their share of any dividends to ABE.
- ABE uses the substantial funds generated from these retained dividends to finance its charitable and educational activities.
- The insurance policies offered by ABE are priced competitively with other similar insurance products available on the open market.
- ABE advises its members that their assigned share of the dividends constitutes a tax-deductible charitable contribution.
Procedural Posture:
- The Internal Revenue Service (IRS) audited the American Bar Endowment (ABE) and assessed a tax deficiency, classifying its insurance program income as unrelated business income.
- ABE paid the tax and subsequently sued the United States for a refund in the U.S. Claims Court (a trial court).
- At the same time, several individual members of ABE who participated in the insurance program also sued for tax refunds in the Claims Court, arguing they were entitled to charitable deductions.
- The two lawsuits were consolidated for trial in the Claims Court.
- The Claims Court ruled in favor of ABE, finding its program was not a 'trade or business,' but ruled against the individual members, finding they had not proven donative intent.
- Both the government (regarding the ABE ruling) and the individual members appealed to the U.S. Court of Appeals for the Federal Circuit (an intermediate appellate court).
- The Court of Appeals affirmed the judgment in favor of ABE but reversed the judgment against the individual members, remanding their case for further proceedings.
- The United States petitioned the U.S. Supreme Court for a writ of certiorari on both the 'trade or business' issue and the charitable deduction issue, which the Court granted.
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Issue:
Does a tax-exempt organization's group insurance program, which generates income through member-assigned dividends, constitute an "unrelated trade or business" subject to federal income tax, and are the members' premium payments partially deductible as charitable contributions?
Opinions:
Majority - Justice Marshall
Yes, the program constitutes an unrelated trade or business, and no, the premium payments are not deductible as charitable contributions. An activity is a "trade or business" if it is carried on for the production of income from the sale of goods or services. ABE's insurance program fits this definition because it sells insurance policies to its members and earns considerable income, possessing the general characteristics of a commercial enterprise. The argument that the dividends are "donations" fails because members are required to assign them as a condition of participation; it is not a voluntary choice. Furthermore, because ABE prices its insurance competitively, members are not making a payment in excess of the fair market value of the benefit they receive. Therefore, ABE's profits are taxable as unrelated business income, and the members cannot claim a charitable deduction because they did not prove they intentionally paid more than the value of the insurance they received in return.
Dissenting - Justice Stevens
No, the program does not constitute an unrelated trade or business, and the payments should be deductible. The primary purpose of the unrelated business income tax is to prevent unfair competition, and the trial court found no evidence that ABE's program had any negative competitive impact. The program has always been operated and understood by its members as a charitable fundraising endeavor, not a commercial enterprise. The members' assignment of dividends is a clear expression of their charitable intent, not a coerced commercial transaction. Given the lack of unfair competition and the clear fundraising nature of the activity, the income should not be taxed, and the members' contributions should be recognized as deductible.
Analysis:
This decision significantly clarifies the definition of a "trade or business" for tax-exempt organizations, emphasizing the nature of the activity over the organization's motive. It establishes that if a fundraising activity is structured like a commercial enterprise (e.g., selling a product at market rates), it will likely be subject to the unrelated business income tax. The ruling also reinforces the quid pro quo principle for charitable deductions, setting a high bar for taxpayers to prove they intentionally paid more than the value of a benefit received. This precedent forces charities to be more careful in structuring fundraising programs that involve the sale of goods or services.
