Docket No. 6282-65.

54 T.C. 1325 (1970)


United States Tax Court.

Filed June 22, 1970.

Attorney(s) appearing for the Case

Samuel Brodsky and Anthony L. Tersigni, for the petitioner.

James Q. Smith and Marwin A. Batt, for the respondent.

SCOTT, Judge:

Respondent determined deficiencies and additions to taxes in petitioner's income taxes for the years and in the amounts as follows:

                                                                          Additions to tax under —
                      FYE June 30—                   Deficiency    Sec. 291,   Sec. 6651(a),
                                                                       I.R.C. 1939   I.R.C. 1954
1951 ---------------------------------------------------      $348.96        $87.24 ----------------
1952 ---------------------------------------------------       391.17         97.79 ----------------
1953 ---------------------------------------------------       404.54        101.14 ----------------
1954 ---------------------------------------------------       384.50         96.13 ----------------
1955 ------------------------------------------------------------------------------          $91.11
1956 ---------------------------------------------------     1,040.53   -----------        1,282.12
1958 ------------------------------------------------------------------------------          234.73
1960 ---------------------------------------------------    11,600.88   -----------        3,698.18
1962 ---------------------------------------------------     8,068.14   -----------        2,017.03
1963 ---------------------------------------------------     2,881.74   -----------          720.44
                                                            25,120.46        382.30        8,043.61

The issues for decision are:

(1) Whether petitioner is exempt from Federal income tax under the provisions of section 501(c)(4), I.R.C. 1954,1 and if not whether amounts received by petitioner from participants in the group insurance plan or from the insurance carrier as retroactive rate credits with respect to premiums paid constitute taxable income to petitioner.

(2) Whether petitioner had reasonable cause for failure to file income tax returns for the years here in issue.


Some of the facts have been stipulated and are found accordingly.

Petitioner is a trust created in 1951 by the New York State Association of Real Estate Boards for the purpose of providing group life insurance for individual and employer members of that association. The principal office of petitioner at the date of the filing of the petition in this case was New York, N.Y. Neither petitioner nor anyone on its behalf filed income tax returns or Forms 990-T for the years here in issue.

The trust was created by an agreement dated April 2, 1951, between the New York State Association of Real Estate Boards, Inc., and several individuals who were officers or otherwise connected with that association as trustees and such employer members of the association as accepted the agreement by signing a counterpart thereof. During the years here in issue, the New York State Association of Real Estate Boards, Inc. (hereinafter referred to as the association), was a statewide association of local real estate boards, real estate brokers, and other affiliated groups of persons such as builders, property owners, and salesmen. Real estate brokers might be individual members who became, as did groups of such brokers, members of the association by virtue of their membership in local real estate boards affiliated with the association. The association, which had its executive offices in Albany, N.Y., was exempt from Federal income tax by a ruling of the Commissioner of Internal Revenue dated January 14, 1943.

Petitioner was created to provide group life insurance for the members of the association. An employer member could through petitioner to whom the master policy of insurance was issued obtain insurance at a group rate for himself and his employees and a sole proprietorship individual member could obtain insurance for himself at a group rate. The members of the association who participated in the insurance program, whether actually employers or individuals, were referred to as employer members and this term will be so used herein. Originally, the administrative duties incident to petitioner's operations were handled by the association but after a year or two were turned over to a firm of insurance brokers who engaged an administrator to handle the work.

The executive director of the association billed the participant-employer members each month. The administrator of the fund collected the premium checks and sent a check to the insurance company for the total amount of the premium charged to the trust by the insurer. The administration of the plan was financed by the excess in the amount of premiums charged to the employer members over the premium charged by the insurance company to the trust. The cost of administration would be estimated every year and apportioned among employer members according to the dollar amount of insurance each had in effect. In certain years the excess over the premiums charged by the trustees was not sufficient to cover the administration expenses and in other years was in excess of such expenses. In 1951 the master policy was purchased from John Hancock Life Insurance Co. and in 1952 and subsequent years from United States Life Insurance Company.

The agreement of April 2, 1951, provided in part:

3. The Trustees declare that they will receive, hold and expend the contributions of the Employer Members and the Employees of the Employer Members herein provided for and any other money or property which may come into their hands as Trustees hereunder (all such contributions, monies and property being herein sometimes called the "Trust Estate") with the powers and duties and for the uses, purposes and trusts herein defined and none other.

* * * * * * *

5. The Trustees shall make application to any reputable Insurance Company licensed in New York State and operating on the agency system, for such policies of group insurance providing for all or any Life, Accident, Health, Hospital or Surgical benefits or other insurance benefits which may be decided upon by the Trustees.

* * * * * * *

8. The Trustees shall use and apply the Trust Estate for the following purposes:

(a) To pay or provide for the payment of all the reasonable and necessary expense of collecting the Employer Member contributions and administering the affairs of the Trust.

(b) To pay or provide for the payment of the premiums under policies of Group or any other insurance provided for in "5" above.

(c) To establish and accumulate such reserve funds as the Trustees in their discretion, deem necessary or desirable for the proper execution of the trust herein created.

(d) To establish and accumulate dividends or experience rating refunds accruing from said policies. The Trustees may, in their discretion, hold or distribute such dividends or refunds. The Trustees may use any such funds specifically for any purpose relating to the administration of this trust. When, however, a distribution of dividends or refunds is authorized by the Trustees, the sum allocated for this purpose shall be divided in accordance with any equitable formula adopted by the Trustees, subject to the Trustees' duty to comply with Section 210, Article 9 of the Workmen's Compensation Law as amended.

At the suggestion of a representative of the insurance broker engaged to do administrative duties relating to petitioner's operations a new agreement was entered into on June 30, 1954, entitled, "Agreement and Declaration of Trust." This agreement was between individual trustees and employer members who became parties to the agreement by signing an application for group insurance. This agreement provided in part:


1. The Trustees shall have the power to demand, collect and receive premiums from the contributing employers for the purpose of paying their prescribed share of the cost of the insurance provided in Item III hereof, and shall hold the same as a Trust Fund until applied to the ultimate purposes herein provided. * * *

* * * * * * *

3. All funds received by the Trustees hereunder as part of the Trust Fund shall be used and applied in the following manner and for the following purposes.

(a) To pay or provide for the payment of all premiums on such insurance policies procured by the Trustees as and when the same shall fall due.

The Trustees are excused from investing funds coming into their hands, it being understood that such funds shall be paid in their entirety to the Company as premiums.

(b) To make refunds of unearned premiums to the Employers at such times as may be deemed by the Trustees to be proper.

4. Any and all experience rating refund shall be paid to the Trustees and shall be received by them as part of the Fund to be administered and distributed by them to the Employers in proportion to be premium payments by each Employer into such Fund for the year for which the refund is received as compared to the total premiums paid by all Employers participating in the Fund, except that the Trustees may use in their discretion any portion of such refunds for the administration of the Trust as provided in Item IV, Paragraph 4.

* * * * * * *


1. Any employer participating hereunder may withdraw from this Agreement and Declaration of Trust by giving written notice to the Trustees not less than thirty (30) days prior to the anniversary date of the group insurance policy or policies issued by the Company and as of such anniversary date such Employer's obligation to contribute to the Group Life Insurance Fund shall cease.

2. Upon termination of any Employer's participation hereunder, for any reason, the insurance on the Employees of such Employer will be cancelled as provided in the policy procured. Upon such termination such Employer will cease to have any rights whatsoever in or to the trust funds, unless and until such Employer is again restored as provided in the Insurance Plan.

* * * * * * *



A majority of the Employers, may, by resolution duly signed, resolve to terminate this trust and insurance procured hereunder. In any such event the Trustees shall use the fund available in the trust fund to pay any and all obligations of the trust. Should the trust fund be insufficient to pay such obligations, the Employers will contribute an amount sufficient to cover any such deficiency, determined on the basis of the pro rata amount of the insurance in force on the lives of the Employees of the respective Employers immediately prior to such termination. Should there be a Surplus in the trust fund after payment of all obligations, such surplus shall be distributed by the Trustees to the Employers at the time of termination in proportion to the amount of premiums paid by each while an Employer hereunder. Upon termination of this trust the Trustees shall nevertheless continue as such for the purpose of dissolution and may take any action with regard to policies of insurance standing in their names which may be required by the Company.

From time to time petitioner would receive retroactive rate credits from the insurance company in varying amounts depending on the experience of the insurer in the prior year. A retroactive rate credit is an amount determined at the end of the policy year, representing the excess, if any, of the premiums earned for the policy year over the sum of the paid claims, increase in reserve expenses, and pooling charges. A reserve was set up in 1954 by petitioner at the suggestion of a representative of the insurance brokerage firm administering petitioner's operations to absorb any increases in the premium charged by the insurance company and that set by the trustees for the employer members and also possibly higher expenses. The purpose of establishing the reserve was to encourage sales by keeping a stable premium cost to the employer members insofar as possible. Such a reserve in the amount of approximately 1 year's premium is common in a group insurance trust. The reserve was funded by retention by petitioner in the reserve of a portion of the retroactive rate credit refunded to it. The balance of such refund was refunded to the employer member-participants.

When a retroactive rate credit was received, petitioner's administrator would meet with the chief underwriter of the insurance company and the chairman of petitioner's board of trustees to recommend how the credit should be divided between the reserve fund and refunds to participants. At the meeting the division would be determined. The amount determined to be refunded to the participants would be returned to the employer members on the basis of a percentage of premiums paid for the members in the current year. No dividend or refund was given to prior participants of the insurance trust who had dropped out by the time the retroactive rate credit was actually received by petitioner, even though the credit was based upon excess premiums of a prior year during which such person had participated.

Petitioner had an agreement with the association to pay it for certain services rendered. The association would cooperate with the insurance fund by having its traveling association secretary distribute to the local boards literature dealing with the insurance plan. In addition, four times a year the association would mail material prepared by petitioner's administrator to the entire association membership. In 1958 and 1959 petitioner agreed to pay the association for these services 20 percent of the retroactive rate credit it received. In 1960 the agreement was modified to provide for a payment of 20 percent of such retroactive rate credit to a maximum of $3,000. The $3,000 payment was a large factor in the income of the association exceeding its expenses during several of the association's fiscal years. No other funds of petitioner's were used by or passed on to the association during the years 1952 through 1963.2

Periodically membership drives were conducted to build up the membership participation in the insurance plan. If nonmembers of the association were successfully solicited, it was not necessary that they join a real estate board in order to be eligible for the insurance.

The following schedule shows petitioner's receipts and disbursements for its fiscal years ended June 30, 1956, through June 30, 1963:

                                                                                        Fiscal year ended June 30—
                                                                                1956         1957         1958         1959         1960         1961         1962         1963

Premiums received from participants --------------------------------------   $49,161.65   $51,815.10   $54,445.95   $58,637.72   $61,240.46   $62,894.53   $60,504.96   $60,580.81
Retroactive rate credits -------------------------------------------------    18,908.59   ----------     7,954.84     3,221.27    36,156.59       162.29    14,091.64    10,357.21
Interest -----------------------------------------------------------------       160.60       491.20       512.79       529.59       593.61     1,701.70     1,648.21     1,767.25
    Totals ---------------------------------------------------------------    68,230.84    52,306.30    62,913.58    62,388.58    97,990.66    64,758.52    76,244.81    72,705.27


Premiums paid out for participants' insurance ----------------------------    44,976.81    48,254.98    50,684.03    54,012.01    56,547.99    57,301.98    46,505.71    44,036.81
Distributions of refunds to participants ----------------------------------------------     6,467.00        59.68     4,145.92       (10.18)    5,461.50    ---------    10,060.96
Administrative fee -------------------------------------------------------     3,412.21     3,329.67     4,661.46     4,843.14     4,915.59     4,224.84     4,428.39     4,089.01
Advertising and promotion paid to the Association ------------------------     3,500.00     3,000.00     1,590.97       788.07     3,000.00     3,000.00     3,000.00     3,000.00
                                                                                        |   1,033.52       796.36       631.07       150.00        49.44  |
Miscellaneous expenses ----------------------------------------------------------------<       25.75                                            3,550.00   >----------------------
                                                                                        |                                                                 |
Audit fee ----------------------------------------------------------------       400.00       400.00       600.00       600.00       612.84       612.00       605.05       619.99
Fidelity insurance premiums ------------------------------------------------------------------------        40.65       162.55       162.55       162.55       162.55       162.55
     Totals --------------------------------------------------------------    52,289.02    62,510.92    58,433.15    65,182.76    65,378.79    74,362.31    54,791.70    61,969.32
Accumulated reserve ------------------------------------------------------      (1)          (1)          (1)      17,940.24    50,552.11    40,948.32    62,401.13    73,227.78

1 This amount is computable from the record but has not been actually computed by either party.

Respondent in his notice of deficiency dated August 31, 1965, computed the deficiencies as heretofore set forth on the basis of considering receipts by petitioner as "income" and disbursements as "expenses" which resulted in losses for certain years which were considered as net operating loss carrybacks. The tax was computed by allowing the credits and deductions provided for "Trusts" under section 642, I.R.C. 1954, or section 163, I.R.C. 1939. On March 24, 1966, petitioner delivered to the district director of internal revenue, Manhattan District, a check in the amount of $25,120.46, together with a letter stating that the check was in payment of the deficiencies asserted in the notice of deficiency dated August 31, 1965, and should be applied against the asserted deficiencies only. In this letter petitioner called attention to the fact that it had filed a petition for redetermination of these deficiencies with this Court.


Petitioner contends that it is exempt from taxation under section 501(c)(4)3 dealing with civic leagues or organizations not organized for profit but operated exclusively for the promotion of social welfare or local associations of employees, the membership of which is limited to employees of a designated person or persons in a particular municipality and the net earnings of which are devoted exclusively to charitable, educational, or recreational purposes.

Section 1.501(c)(4)-1, Income Tax Regs.,4 states that a civic league or organization may be exempt as a 501(c)(4) organization if it is a nonprofit organization and is operated exclusively for promotion of social welfare, defined as "the common good and general welfare of the people of the community." The cases indicate that the promotion of social welfare is a limitation on civic leagues as well as "organizations," thereby approving of the regulations. People's Educational Camp Society, Inc. v. Commissioner, 331 F.2d 923 (C.A. 2, 1964), affirming 39 T.C. 756 (1963). It has been held that where the primary economic benefit from an organization is limited to that organization's members, the organization is not operated exclusively for the social welfare within the meaning of the statute. Consumer-Farmer Milk Coop. v. Commissioner, 186 F.2d 68 (C.A. 2, 1950), affirming 13 T.C. 150 (1949).

In order for an organization to be exempt from tax under section 501(c)(4), the statute requires that it be one which promotes the common good and general welfare of people in a community as a whole. United States v. Pickwick Electric Membership Corp., 158 F.2d 272 (C.A. 6, 1946). Petitioner in the instant case was organized for the benefit of its members only. These members were a small group interested in obtaining group insurance. Petitioner offered its benefits to only the limited class of its members and their employees. There is not in such an organization the requisite civic concern to constitute "social welfare," and therefore petitioner does not qualify for tax exemption under section 501(c)(4). Petitioner does not claim exemption under any other section of the Code.5

Petitioner in its brief concedes that if it is not exempt from Federal income tax under section 501(c)(4), the interest it received constitutes taxable income to it.6 Petitioner contends that the premiums received from its members and the retroactive rate credits received from the insurance company are not income but that the premiums are contributions to the "trust estate" by its members and the rate credits are merely a part of such contributions returned to petitioner and held in trust by petitioner for its members.

Under the specific terms of the trust agreement all moneys taken in by the petitioner from its members are specifically set aside for the purpose of procuring insurance for the participant employers or of being returned to the members. Respondent does not deny that under the terms of the "trust agreements" it is a fact that all moneys taken in by petitioner (except interest income) are held in trust for specific uses for the members' benefit or to be returned to the members. Respondent states that he would never have determined the deficiency if petitioner had operated in accordance with its trust agreement. Respondent argues that under the agreement of June 30, 1954, the trustees had no right to set up a reserve of a portion of the retroactive rate credits and in so doing appropriated the amounts to petitioner's own purposes or in substance made a "claim of right" to the amounts.

We do not agree with this contention of respondent. The trust agreement specifically provided that the trustees were empowered to "make refunds of unearned premiums to the employers at such times as may be deemed" by them "to be proper." It likewise specifically provided that all such amounts were to be returned to employer members, even though such employer members might not be the identical persons or groups as the employer members who had paid in the funds, because of members being added and members dropping out.

In several cases, the first being Seven-Up Co., 14 T.C. 965 (1950), we have considered the question of whether amounts paid into a fund by various persons was income to the recipient or was held as a "trust fund." The taxpayer in the Seven-Up case sold an extract to franchise bottling companies. The bottlers had exclusive franchises and controlled sales and promotions in their own territories with the petitioner furnishing advertising materials to them at cost. The bottlers in order to tie in advertising on a national basis came together and set up an informal fund to handle national advertising, paying into the fund $17.50 per gallon of extract purchased. The moneys were paid to the Seven-Up Co. which commingled the funds in its own accounts but kept them separated on its books and records and dispersed them for the intended purposes. In that case we held that moneys received were subject to a trust obligation and that any diversion of that money could be enjoined in equity and was not therefore income to a taxpayer which had no claim of right to the funds.

In the recent case of Angelus Funeral Home, 47 T.C. 391 (1967), we held that certain predeath funeral payments received by the tax-payer were not taxable income when received. The taxpayer in that case entered into contracts for predeath funeral payments to be applied against the cost of the taxpayer's services at the customer's death or forwarded at that time to another funeral home to apply against such cost if the customer's death occurred outside the reasonable range of the taxpayer's service. Our holding was on the basis that under the holding in the Seven-Up case the payments were held as a trust fund. We specifically limited our holding in Angelus Funeral Home to those contracts which stated that the sum would be held by the taxpayer in an irrevocable trust for funeral purposes and would accrue to the funeral home only upon performance of its services. In the recent case of Dri-Power Distributors Association Trust, 54 T.C. 460 (1970), we reaffirmed our holdings in Seven-Up and Angelus Funeral Home. In that case we held that amounts were not includable in the gross income of the trust which served as a mere conduit for the expenditure of the contributions for advertising, freight, and promotional purposes. In that case the distributors of the Dri-Power Co. had been paying all advertising, freight, and promotional costs of the product themselves. They came together and formed an association which set up the fund to handle advertising, freight, and promotional costs and contributed a stipulated amount to the fund.

The instant case is indistinguishable in principle from Dri-Power Distributors Association Trust, supra. In this case the agreement between the trustees and the employer members specifically provided that the funds were to be used to pay premiums on insurance policies and to make refunds of unearned premiums to the employers at times deemed proper to the trustees. The trustees never had unrestrained use of the funds in their possession and were a mere conduit between the member participants and the insurance company.

Although the respondent seems to raise the issue of the legality of the first trust instrument under New York law, we find that to be irrelevant under the doctrine of Seven-Up Co., supra, where the trust arrangement was very informal, but recognized by all the parties involved.

Under the rationale of Broadcast Measurement Bureau, Inc., 16 T.C. 988 (1951), we do not consider the method of petitioner's computation of refunds on the basis of insurance in force by current member participants, thereby excluding participants insured during the year the retroactive rate credits were earned who had subsequently dropped out of the trust, to cause the funds not to be held in trust for the employer members. Even if certain member participants will be benefited by the moneys contributed to the trust by other member participants who subsequently drop out, the rate credits are not income to the trust but amounts it is required to distribute to the beneficiaries.

We hold that petitioner's only receipts of "taxable income" are from interest. Its other receipts were merely trust funds to be disbursed for insurance premiums or operation expenses or at a proper time returned to the "trust beneficiaries."

Petitioner filed no Federal income tax returns for the years here in issue and did not file Forms 990-T returns required by organizations exempt from Federal income tax as petitioner claims to be. Seeking to excuse its failure, petitioner argues that its trustees were not informed by counsel or by their accountants that returns of any nature should have been filed.

Erroneous advice or a taxpayer's belief that no return is required is not reasonable cause for failure to file returns where the regulations clearly state that a return should be filed. See Knollwood Memorial Gardens, 46 T.C. 764, 795 (1966), and cases there cited. Petitioner here seeks to be excused because of the failure of its advisers to advise it to file such returns. There is no showing that petitioner ever sought direct advice whether to file. A taxpayer is not relieved from the legal obligation to file, and the additions to tax for failing to fulfill that obligation merely because it was not offered unsolicited advice. Knollwood Memorial Gardens, supra.

We sustain respondent in his determination of additions to tax for failure of petitioner to file returns.

Decision will be entered under Rule 50.


1. All references are to the Internal Revenue Code of 1954 unless otherwise indicated.
2. Apparently some amount was paid to the association for administrative services in 1951 but the record is not clear in this respect.

(a) EXEMPTION FROM TAXATION. — An organization described in subsection (c) or (d) or section 401(a) shall be exempt from taxation under this subtitle unless such exemption is denied under section 502, 503 or 504.

* * * * * * *

(c) LIST OF EXEMPT ORGANIZATIONS. — The following organizations are referred to in subsection (a):

* * * * * * *

(4) Civic leagues or organizations not organized for profit but operated exclusively for the promotion of social welfare, or local associations of employees, the membership of which is limited to the employees of a designated person or persons in a particular municipality, and the net earnings of which are devoted exclusively to charitable, educational, or recreational purposes.
4. Sec. 1.501(c)(4)-1 Civic organizations and local associations of employees.

(a) Civic organizations — (1) In general. A civic league or organization may be exempt as an organization described in section 501(c)(4) if —

(i) It is not organized or operated for profit; and (ii) It is operated exclusively for the promotion of social welfare.

(2) Promotion of social welfare — (i) In general. An organization is operated exclusively for the promotion of social welfare if it is primarily engaged in promoting in some way the common good and general welfare of the people of the community. An organization embraced within this section is one which is operated primarily for the purpose of bringing about civic betterments and social improvements. A "social welfare" organization will qualify for exemption as a charitable organization if it falls within the definition of "charitable" set forth in paragraph (d)(2) of section 1.501(c)(3)-1 and is not an "action" organization as set forth in paragraph (c)(3) of section 1.501(c)(3)-1.

5. Petitioner in its brief specifically states that it is not claiming exemption under sec. 501(c)(6) dealing with, among other organizations, "real-estate boards." At the trial petitioner's counsel had indicated that because of its close connection with the association which was exempt under this section, it might likewise be so exempt. Since petitioner now specifically disavows such a contention, we need not consider the question. Petitioner does not contend that it is exempt under sec. 501(c)(9) and from the facts we have set forth it would appear that petitioner does not claim exemption under this section since its membership is not limited to "employees."
6. As we understand this concession it embraces offsetting all expenses of petitioner's operation against its receipts from its employer members, so that the interest is taxable in full except for the exemption of $100 allowed by sec. 163(a), I.R.C. 1939, and sec. 642(b), I.R.C. 1954. In any event any argument that amounts charged to employer members for expenses of petitioner's operation were not to be used specifically for such purpose and if in excess of the amount needed in a particular year for such purpose applied to such purpose for a subsequent year, would be completely inconsistent with petitioner's argument that these payments constituted the "trust estate" contributed by the "trust beneficiaries" and were therefore not "income" of the trust.


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