## Facts

- The American Medical Association (AMA) was a tax-exempt membership organization under I.R.C. § 501(c)(6).
- AMA published two periodicals, *Journal of the American Medical Association* (JAMA) and *American Medical News* (AM News), containing medical articles that supported AMA’s exempt purposes and were provided to members as part of membership.
- Both periodicals also carried substantial paid advertising, which AMA conceded was an unrelated trade or business subject to the unrelated business income tax (UBIT) under 26 U.S.C. §§ 511–513.
- For tax years 1975–1978, AMA used “controlled circulation” by distributing complimentary copies to selected physicians (including nonmembers) to create an audience attractive to advertisers.
- The parties stipulated that AMA’s sole purpose for controlled circulation was to increase advertising revenue.
- The dispute concerned how to allocate journal-related income and expenses between exempt activities and the taxable advertising business, including the extent to which editorial and production costs could be deducted against advertising income.
- The district court largely accepted AMA’s allocation approach and ordered a full refund for the years at issue.
- The United States appealed, and AMA cross-appealed as to issues it lost.

## Issues

1. How should journal-related receipts be allocated between exempt membership-related circulation and the taxable advertising business when publications are distributed to members and also through controlled circulation?
2. How should dual-use expenses—particularly editorial and production costs—be allocated between exempt functions and unrelated advertising activity under the “directly connected” and “reasonable allocation” standards?
3. To what extent were the allocation methods accepted by the district court consistent with UBIT statutes and Treasury regulations, as opposed to improperly minimizing unrelated business taxable income (UBTI)?

## Decision

- The Seventh Circuit affirmed in part and reversed in part the district court’s judgment.
- The court agreed that advertising constituted unrelated business activity and that controlled circulation conducted solely to increase advertising revenue was part of that unrelated business activity.
- The court held that certain allocations adopted by the district court were overly favorable to AMA and not sufficiently supported by the statutory and regulatory requirement of reasonable allocation.
- The court rejected treating editorial costs as entirely exempt or entirely commercial; instead, it required a reasonable allocation reflecting the editorial content’s dual role.
- The case was remanded for recomputation of UBTI and any refund consistent with the appellate court’s allocation principles.

## Legal Principles

- UBIT applies to income from an unrelated trade or business regularly carried on by a tax-exempt organization, to limit competitive advantages from tax exemption.
- When income streams and activities serve both exempt and unrelated functions, gross receipts must be allocated in a manner consistent with the Code and Treasury regulations.
- Under Treas. Reg. § 1.512(a)-1, deductions against unrelated business income are allowed only for expenses “directly connected” with carrying on the unrelated trade or business.
- Dual-use expenses (such as editorial and production costs that further exempt purposes while also supporting advertising value) must be allocated on a reasonable basis; an organization may not use predominantly exempt-purpose costs to shelter unrelated advertising income without an adequate connection to the advertising business.
- Complimentary circulation undertaken solely to increase advertising revenue is treated as part of the unrelated advertising business for purposes of allocating relevant income and expenses.

## Conclusion

The Seventh Circuit required a fact-based, reasonable allocation of both receipts and dual-use expenses in computing UBTI from journal advertising, holding that controlled circulation aimed solely at boosting advertising revenue ties related income and costs to the unrelated business and can justify partial expense deductions, but not allocations that improperly minimize taxable income.


Am. Med. Ass’n v. United States, 887 F.2d 760 (7th Cir. 1989)