SCOTUS Reports

Tag: civic league

  • Kentucky Municipal League v. Commissioner, 81 T.C. 88 (1983): When Income from Services is Substantially Related to Exempt Purposes

    Kentucky Municipal League v. Commissioner, 81 T. C. 88 (1983)

    Income from services provided by a tax-exempt organization is not unrelated business taxable income if it is substantially related to the organization’s exempt purposes.

    Summary

    The Kentucky Municipal League (KML), a non-profit civic league, assisted its member cities in collecting unpaid taxes from insurance companies. The IRS determined that KML’s share of the collected taxes constituted unrelated business taxable income. The Tax Court held that KML’s collection activities were substantially related to its exempt purpose of promoting practical and effective local government, thus the income was not taxable. The court emphasized that KML’s services directly contributed to the cities’ essential functions, distinguishing it from commercial collection activities.

    Facts

    The Kentucky Municipal League (KML) is a non-profit organization exempt under section 501(c)(4) as a civic league promoting social welfare. KML’s primary function is to assist Kentucky cities in practical, effective, and economical local government. Since 1954, KML has helped approximately 70 of its 150 member cities collect unpaid license taxes from insurance companies. KML entered into contracts with these cities, assuming all collection expenses in exchange for 50% of the collected taxes. In 1977, KML received $219,325. 73 from these collections, retaining $29,799 after payments to the cities and to Glenn Lovern & Associates (GLA), who performed the actual collection work under KML’s supervision.

    Procedural History

    The IRS determined a deficiency of $4,373 in KML’s federal income tax for the fiscal year ending June 30, 1977, asserting that KML’s share of the collected taxes was unrelated business taxable income. KML petitioned the Tax Court for a redetermination of this deficiency. The Tax Court, after reviewing the stipulated facts, held that KML’s collection activities were substantially related to its exempt purposes and thus not subject to tax.

    Issue(s)

    1. Whether the income derived by KML from its tax collection activities constitutes unrelated business taxable income under section 512(a)(1) of the Internal Revenue Code.

    Holding

    1. No, because the court found that KML’s tax collection activities were substantially related to its exempt purposes of promoting practical and effective local government.

    Court’s Reasoning

    The court applied the three-part test from section 1. 513-1(a) of the Income Tax Regulations to determine if income is unrelated business taxable income: (1) whether the activity is a trade or business, (2) whether it is regularly carried on, and (3) whether it is substantially related to the organization’s exempt purposes. The court focused on the third element, finding that KML’s collection activities were substantially related to its exempt function of promoting effective local government. The court reasoned that KML’s assistance in collecting taxes was an essential service that directly contributed to the cities’ ability to perform their governmental functions, as stated in the opinion: “The collection of the taxes is certainly an essential function of the city, and when the league performed that function for the city, it was carrying out the very purpose for its organization and operation. ” The court distinguished KML’s activities from those of commercial collection agencies, noting that KML’s oversight and authority over the collection process were services that the cities might not have been willing to delegate to a commercial entity. The court rejected the IRS’s reliance on cases involving business leagues, emphasizing that KML, as a civic league, was assisting governmental entities in their exempt activities.

    Practical Implications

    This decision clarifies that income from services provided by a tax-exempt organization can be exempt from unrelated business income tax if those services are substantially related to the organization’s exempt purposes. Legal practitioners advising non-profit organizations should carefully analyze the relationship between the organization’s income-generating activities and its exempt functions. This case suggests that services directly supporting the essential functions of member organizations, especially governmental entities, are likely to be considered substantially related. The ruling may encourage non-profits to engage in activities that directly support their members’ core functions without fear of incurring unrelated business income tax. Subsequent cases, such as Hi-Plains Hospital v. United States, have applied similar reasoning to determine the tax-exempt status of income from services provided by non-profit organizations.

  • Kentucky Municipal League v. Commissioner, 81 T.C. 156 (1983): Income from Tax Collection by Exempt Civic League

    81 T.C. 156 (1983)

    Income derived by an exempt civic league from collecting unpaid taxes for its member municipalities, where such activity is substantially related to the league’s exempt purpose of promoting effective local government, does not constitute unrelated business taxable income.

    Summary

    The Kentucky Municipal League (KML), an exempt civic league, contracted with member municipalities to collect their unpaid insurance taxes. KML retained 50% of the collected taxes to cover expenses and as revenue. The IRS determined that KML’s share of these taxes was unrelated business taxable income (UBTI). The Tax Court held that KML’s tax collection activities were substantially related to its exempt purpose of promoting effective and economical local government, as it provided a valuable service to its members that contributed to their essential governmental functions. Therefore, the income was not UBTI.

    Facts

    The Kentucky Municipal League is a non-profit organization exempt under section 501(c)(4) as a civic league, promoting effective local government in Kentucky.

    Member municipalities authorized KML to collect unpaid insurance taxes, a service some cities found more practical and economical to outsource than to handle internally.

    KML contracted with Glenn Lovern & Associates (GLA) for the actual collection work, under KML’s supervision.

    KML received 50% of the collected taxes, GLA received 37.5%, and the municipalities received the remaining 12.5%.

    KML’s staff handled administrative tasks related to collections, such as mail, deposits, and inquiries.

    The Commissioner determined that KML’s share of the collected taxes constituted unrelated business taxable income.

    Procedural History

    The Commissioner of Internal Revenue issued a notice of deficiency to the Kentucky Municipal League for federal income tax.

    The Kentucky Municipal League petitioned the Tax Court for review.

    The Tax Court ruled in favor of the Kentucky Municipal League.

    Issue(s)

    1. Whether the income received by an exempt civic league from collecting unpaid taxes for its member municipalities constitutes income from an unrelated trade or business under Section 512(a)(1) of the Internal Revenue Code.

    2. Whether the tax collection activity is substantially related to the Kentucky Municipal League’s exempt purpose of promoting social welfare and effective local government.

    Holding

    1. No, because the income is derived from an activity substantially related to the organization’s exempt purpose.

    2. Yes, because the tax collection service directly contributes to the essential governmental functions of the member municipalities and promotes effective and economical local government.

    Court’s Reasoning

    The court applied the three-part test for unrelated business taxable income: (1) trade or business, (2) regularly carried on, and (3) not substantially related to the organization’s exempt purpose. The court focused on the third prong, substantial relatedness.

    The court stated, “Trade or business is ‘related’ to exempt purposes, in the relevant sense, only where the conduct of the business activities has causal relationship to the achievement of exempt purposes (other than through the production of income); and it is ‘substantially related,’ for purposes of section 513, only if the causal relationship is a substantial one. Thus, for the conduct of trade or business from which a particular amount of gross income is derived to be substantially related to purposes for which exemption is granted, the production or distribution of the goods or the performance of the services from which the gross income is derived must contribute importantly to the accomplishment of those purposes.”

    The court found that KML’s exempt purpose was to promote practical, effective, and economical local government. Collecting taxes is an essential function of municipal government. By providing this service, KML relieved municipalities of the burden and expense of tax collection, thus promoting more effective and economical local government.

    The court distinguished this case from cases involving business leagues, noting that KML is a civic league assisting exempt organizations (municipalities), whereas business league cases often involve activities that primarily benefit individual members’ businesses, not the broader exempt purpose.

    The court also addressed the Commissioner’s argument that KML’s activities were similar to a commercial collection agency. While acknowledging commercial agencies exist, the court found KML provided a unique service by coordinating collections for multiple cities and maintaining oversight and control in a way that individual cities might not entrust to a commercial agency. This unique aspect further supported the substantial relatedness to KML’s exempt purpose.

    Practical Implications

    This case clarifies that services provided by exempt organizations to their members can be considered substantially related to their exempt purpose, even if those services generate income.

    It emphasizes that the critical factor is whether the service contributes importantly to the organization’s exempt purpose, not merely whether it generates funds or resembles a commercial activity.

    For civic leagues and similar exempt organizations, this case provides support for offering services to member entities that directly aid in their governmental or charitable functions without necessarily creating unrelated business income.

    Later cases would likely distinguish this ruling based on the specific nature of the exempt organization, the services provided, and the directness of the contribution to the exempt purpose. Organizations need to demonstrate a clear and substantial causal link between their income-generating activities and their exempt functions to rely on this precedent.