United States v. American College of Physicians
1986 U.S. LEXIS 102, 106 S. Ct. 1591, 475 US 834 (1986)
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Rule of Law:
A tax-exempt organization must pay tax on income from a trade or business that is not “substantially related” to its exempt purposes, with “substantially related” depending on whether the conduct of the business activity contributes importantly to the organization's exempt purpose, not merely on the incidental informational content of the product or service.
Facts:
- The American College of Physicians (ACP) is an organization exempt from taxation under § 501(c)(3) due to its educational and public health purposes.
- ACP publishes The Annals of Internal Medicine (Annals), a monthly medical journal containing scholarly articles relevant to the practice of internal medicine.
- Annals accepts commercial advertisements for pharmaceuticals, medical supplies, and equipment useful in internal medicine, as well as job notices.
- ACP had a longstanding policy of accepting only advertisements containing information about the use of medical products and screened them for accuracy and relevance.
- In 1975, Annals produced a net advertising income of $153,388, on which ACP paid $55,965 in taxes.
- ACP did not use the advertising to provide a comprehensive or systematic presentation of any aspect of the publicized goods or services; companies willing to pay for advertising space got it, and some advertisements were for established drugs or repeated, undermining a suggestion that they were principally designed to alert readers of recent developments.
Procedural Posture:
- The American College of Physicians (ACP) reported its 1975 net advertising income as taxable and paid $55,965 in taxes to the Internal Revenue Service (IRS).
- ACP filed a timely claim with the IRS for a refund of these taxes.
- When the Government demurred (refused the refund), ACP filed suit in the United States Claims Court.
- The Claims Court held a trial and concluded that the advertisements were not substantially related to ACP's tax-exempt purposes and that the advertising proceeds were taxable.
- ACP appealed the Claims Court's decision to the Court of Appeals for the Federal Circuit.
- The Court of Appeals reversed, holding that the trial court's finding was clearly erroneous and that the advertising was substantially related to ACP's tax-exempt purpose.
- The Government filed a petition for certiorari, which the Supreme Court granted.
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Issue:
Does a tax-exempt organization's income from selling commercial advertising space in its professional journal constitute taxable "unrelated business income" when the advertising is not actively managed by the organization to contribute importantly to its educational purpose?
Opinions:
Majority - Justice Marshall
Yes, the American College of Physicians' income from selling commercial advertising space in its professional journal constitutes taxable "unrelated business income" because the organization's conduct of the advertising business did not importantly contribute to its educational purposes. The Court affirmed that under 26 U.S.C. § 513(c), the publication of paid advertising is considered a separate "trade or business" distinct from the editorial content. The central question was whether this advertising business was "substantially related" to ACP's exempt purposes under § 513(a) and Treas. Reg. § 1.513-1(d)(2), meaning it must "contribute importantly" to those purposes. The Court rejected the Government's argument that Treasury regulations or legislative history established a per se rule for taxing all journal advertising income, emphasizing that substantial relation depends "in each case upon the facts and circumstances involved." The proper focus for determining substantial relation is on the conduct of the tax-exempt organization itself, not merely on the informational content that readers might incidentally glean. The Claims Court correctly found that ACP did not manage its advertising business to provide a comprehensive or systematic presentation of information. Instead, ads were placed by paying companies, often for established products, and some even lacked a conceivable relation to the College's exempt purposes. Therefore, the advertising did not contribute importantly to ACP's educational functions.
Concurring - Chief Justice Burger
Yes, the income from selling advertising space is taxable under the current Treasury regulations as interpreted by the majority. Chief Justice Burger, joined by Justice Powell, concurred, acknowledging the public value of medical journals in disseminating information and the role advertising plays in reducing publication costs and enhancing circulation. He noted that such journals provide continuing education, a non-profit endeavor. However, he stated that while a regulation recognizing these realities would be appropriate, creating such regulations is the responsibility of the Executive Branch and Congress, not the courts. He therefore joined the majority opinion because it offered a permissible reading of the existing Treasury regulations.
Analysis:
This case significantly clarifies the application of the "substantially related" test for unrelated business taxable income (UBIT) under § 513(a) to commercial activities like advertising. It firmly rejects a per se rule of taxability for journal advertising, maintaining a fact-specific inquiry, but critically shifts the analytical focus from the inherent informational value of the advertisements to the conduct of the tax-exempt organization in operating the business. The ruling imposes a higher burden on organizations to demonstrate that they actively manage commercial endeavors in a manner that "contributes importantly" to their exempt mission, forcing a deliberate, rather than incidental, link between the business's operation and the organization's core purpose. This ensures that non-profits do not gain an unfair competitive advantage by merely offering a commercial platform under the guise of an exempt activity.
