Internal Revenue Code (IRC) §501(c)(6) provides exemption for business and professional associations not organized for profit and no part of the earnings of which inure to the benefit of private individuals or shareholders. It specifically names:
To qualify under §501(c)(6), a business league must have the following attributes:1
To qualify as a business league, the members of the association must have a “common business interest.” This essentially means that they form the league to advance a mutual goal of improving an industry or profession, not their individual interests. Promoting business referrals by encouraging members to do business with other members is thought by the IRS to provide personal service to individual members rather than promote the industry.2 The purpose for joining together must be to improve the overall economic condition of their field. Legislative lobbying germane to the interest of the league can be its sole purpose.3 Each member of the league typically conducts a profitable business operation in competition with the other members, some of whom can be involved in a variety of functions operating in the profession or line of business. Examples include the following:
Understanding what constitutes a “line of business” is the key to identifying groups that qualify as business leagues because they share a common business interest. A line of business is a trade or occupation, entry into which is not restricted by a patent, trademark, or similar device that would allow private parties to restrict the right to engage in the business.13 The term business is construed broadly to include almost any enterprise or activity conducted for remuneration. The term encompasses professions as well as mercantile and trading businesses.14 To qualify, a league's line of business must be broad; it must encompass the common business interest of an entire industry or one of its components, or an industry within a particular geographic area.
A nonprofit organized by businesspeople dedicated to the ideals of bettering their careers through the exchange of business leads was denied qualification as a business league.15 Each of the members represents a particular occupation with a goal of exchanging business leads among members. At weekly meetings, two members display their business information at exhibit tables and give presentations on their business products or services. The exhibit tables and presentations are designed to educate the membership about the exhibitors' businesses so members can provide business leads to each other. During the final 20 to 30 minutes of the meeting, each member passes leads to other members and presents a “commercial” for his or her business. Each quarter, a business mixer is held to which guests working in business categories not represented in the membership are invited. The goal is to gain new members and to promote the group to the community. Because the organization was found not to be structured along particular industry or business lines or an association of persons having some common business interest, it was denied exemption under §501(c)(6).
The computer industry provides good examples both of organizations deemed to serve a common business interest and of nonexempt private groups. In 1974, the IRS decided that an organization qualified as a business league because it was formed to stimulate the development of a free exchange of information about computer systems and programming. The membership was diverse, including businesses that owned, rented, or leased computers from a variety of manufacturers. It sponsored semiannual conferences, open to the public, to discuss technical and operational issues. Conversely, organizations formed for the same purposes by users of particular manufacturers' computers are denied business league status.16 Such user groups are deemed to promote the particular computer vendors, rather than to benefit the entire industry or all components of an industry within an area. The Guide International Corporation, limited in membership to IBM mainframe computer users, was denied exemption because it benefited IBM, a large but nonetheless particular segment of the computer business, not the computer business in general. A district court, in a tax refund suit, held that the association that develops and promotes Bluetooth wireless technology is not qualified for tax exemption under §501(c)(6). The activities were of a kind normally carried on by a for-profit and did not serve a particular “line of business,” citing the National Prime Users Group and Guide International cases.17
Unlike Prime and Guide, the Corporation for Open Systems International found another way to achieve exempt status for its newly created Open Systems Research and Educational Corporation.18 The entity was organized to conduct and disseminate the results of its research. It sought and achieved recognition as a charitable (c)(3) organization, not a business league. The Form 1023 stated that its research would benefit the general public and “the users of products or services of more than one industry or segment of an industry.” The application was initially denied exemption, presumably because the IRS thought there would be excessive private benefit from the research to the computer manufacturer. Upon appeal, the IRS National Office approved charitable status for the following reasons:
An organization established to develop an industry standard for low-level components of computer operating systems built on a software program was found not to qualify as a business league. League members were computer hardware manufacturers who joined to receive services “relieving them of necessity of developing or purchasing software similar to the platform to install on their hardware.”20 Another organization promoting a new technology standard for controlling and storing items on the Internet was also found to be performing services to provide its members with a “competitive edge.” It was said to be providing benefits only to its members and not to the entire industry.21 Negotiating bulk trade purchases and vendor rebates on behalf of members was a service to individual members and not work that advanced the conditions in a line of business.22
Associations of dealers and manufacturers of particular brands have been determined not to qualify for exemption as business leagues, because they failed to represent a “line of business.” An association of Midas Muffler dealers formed to represent the dealers in negotiations with the manufacturer failed to convince the Supreme Court that it constituted a “line of business.” It was deemed unfair to allow exemption to a group, the purpose of which is to compete with another group within an industry.23 Earlier, the Pepsi-Cola Bottlers' Association was allowed an exemption, a decision that the IRS promptly announced it would not follow.24
An association of licensed dealers of a patented product (held by the association) was deemed to engage in furthering the business interest of its member-dealers and failed to benefit competitors who manufactured the same product covered by the patent.25 Similarly, a shopping center merchants' association was found to benefit specific merchants. Its sole activity was to place advertisements to attract customers to the center and its membership was restricted to merchants in the one-owner shopping center.26 If, instead, membership were open to all merchants within the neighborhood and if the association were not concerned with landlord–tenant matters relating to the specific shopping center, exemption would be allowed.27
Dealers selling a particular type of car do not promote the automobile industry.28 Franchisees of a particular chain, such as McDonald's restaurants, would similarly be precluded from forming an exempt group, but a league of franchise holders open to all types of merchants or food establishments would qualify.
Hobby groups do not qualify as business leagues because a hobby is not a business.29 To be characterized as a business, the activity must be entered into with the intention of producing a profit. For income tax purposes, an activity is presumed to be a hobby if it loses money for more than two years in a five-year period.30
Gardeners, pet owners, card players, and collectors of antiques, baseball cards, fine art, and so on, form groups for purposes somewhat similar to those of typical business leagues. However, unless the members are pursuing their hobby interests for personal profit, and therefore for individual business purposes, exemption is not available for the group under §501(c)(6). Such a group may, however, qualify in other categories of exemption, such as social club, civic welfare organization, or (rarely) charitable, depending on its purposes.
A qualifying business league must devote its efforts primarily to promoting the industry. A (c)(6) association may not, as a significant activity, engage in a regular business of a kind ordinarily carried on for profit.31 Services rendered for members aimed at improving the industry or maintaining its standards are treated as related to the exempt purposes. Activities that benefit members as individuals are unrelated. Excessive unrelated activity can preclude exemption32 and is subject to the unrelated business income tax (UBIT).33 Examples of the types of services that have been held to be “related” or to serve the industry as a whole, rather than the individual members, follow.
Services giving benefit to the members as individuals rather than to the industry as a whole may disqualify a business league as exempt if such services constitute a substantial and major activity of the organization. Individual benefit services are also subject to the unrelated business income tax.45
The distinction is often vague, but several factors evidence the difference. Of primary importance is the way that persons are charged for receiving the services, and whether the services are available to the general public. When the services are rendered in return for a specific charge or the services are available only to members, individual benefit is generally found. Activities for which individual members are not expected to pay are evidence of intangible industry-wide benefit. Making services available to all also reflects cooperative effort. By contrast, when members buy and the association sells services for member convenience or cost savings, individual benefit results. Examples of services that have been considered as providing individual benefit follow:
The details of a few cases and rulings help to identify the types of facts and circumstances applied to determine the character of a program as accomplishing an exempt function. In one such instance the American Academy of Family Physicians' information clearinghouse for physician placement fostered the “appropriate distribution of physicians to provide health care for the nation.” The court found that this stated objective advanced the organization's exempt purposes, so that the fees charged to access the information were related income. Additionally, the court found that payments to the business league by an insurance company did not stem from profit-motivated business activity, but instead represented passive interest income not taxable as unrelated business income.71 Member insurance services were handled by an independent company that was required by the association to maintain reserves to pay claims and pay a fixed percentage of the reserves annually to the league without regard to the profitability of the insurance program. The court noted that the association's involvement did not possess the general characteristics of a trade or business: it furnished a list of its members, allowed the use of its name, and monitored the insurance products to ensure that the needs of its members were met. The league did not underwrite or administer the policies or have any other activities the court could equate to operating a business.72
Another physician recruitment program, called Medical Opportunities in Michigan, was found not to jeopardize the tax-exempt status of the Michigan Health Council, a (c)(3) organization.73 The program was established to bring physicians, physician assistants, nurse practitioners, nurse midwives, and certified registered nurse anesthetists to the underserved and growing communities in Michigan. A priority-neutral computerized database of available positions, with no advertisements or logos of health-care entities, was made available free of charge to prospective medical workers. The facts indicated that about 72 percent of Michigan's counties had primary care physician shortages and that 62 percent of the physicians trained in Michigan left the state to begin their medical practices. These facts, plus a finding that the registry was “clearly distinguishable from commercial placement services,” allowed the IRS to find that the database promoted health and consequently served a charitable purpose. The IRS also found that no private benefit existed because there was a broad cross-section of potential subscribers and most of the job postings were for nonprofit hospitals, clinics, and community health centers. The IRS noted that the Tax Court had found that organizations that further exempt purposes through sponsoring legal or medical referral services do not confer private benefits so long as the service is open to a broad representation of professionals and no select group of professionals is the primary beneficiary of the service.74
In another case, the IRS concluded that a business league operated its recycling facility as a trade or business unrelated to its exempt activities.75 After the municipal dump in their area was closed, the league became a state-certified site in order to serve its members. However, other for-profit facilities operated in the area and performed a similar service, and several league members, including one of the larger manufacturers, used other facilities for waste disposal. Because the facility was not unique to the industry, the facility was treated as an unrelated business. Although the league argued that it was irregularly operated, the facility accepts material for recycling for seven months out of the year and pumps surface water 12 months of the year. Those factors indicated that the league operated the facility on a fairly continuous basis and met the requirement that the business be regularly carried on.
A league operating to provide a telephone answering service to distribute calls for towing service on a rotational basis to its tow truck operating members did not qualify for exemption.76 The activity provided members with an economical and convenient way to conduct their individual businesses and represented particular services for its members, as distinguished from the improvement of business conditions of its industry.
Administrative services to maintain vacation pay and guaranteed annual income accounts required by a collective bargaining agreement, as opposed to negotiating the contract, also provided individual service to members. The organization's role as a record keeper and collection and disbursement agent was an unrelated business activity.77
A business league that partly finances its activities by earning unrelated business income faces limitations on deductions that can offset such income. In calculating the tax on unrelated business income, the exploitation rule disallows the deduction of expenses attributable to the league's member or exempt function activities.78 Losses incurred in membership activities cannot be deducted against business income. Despite the economic fact that the league has a loss overall, it may have to pay tax.79
To avoid this situation, a league might consider abandoning its exempt status and filing as a normal corporation showing no profit. IRC §277 is designed to prevent this tactic. Membership expenses are deductible only to the extent of membership income and cannot be deducted against business income for a nonexempt taxpayer.
The portion of total support received from members is a factor in determining qualification. The IRS expects “meaningful membership support,” although the code and regulations contain no specific numerical support requirement. Revenue received in rendering services to individuals that do not benefit the industry as a whole cannot provide a major portion of the league's budget. As is true for other categories of exempt organizations, there is no prohibition against a league earning such income as long as the amounts are insubstantial, but there is no exact numerical test.80 When a league's income from providing such services is excessive, its exempt status is jeopardized and the income is taxable. A safe rule of thumb is that more than 50 percent of the league's support should come from member dues and exempt function charges. Decisions that illustrate the IRS's view on revenue sources follow:
An exempt business league may have different classes of members, as long as the purpose is to advance the interests of the profession and all members share the same common business interest. Junior, senior, retired, associate, student, supporters, and other types of categories are common, in recognition of age, stature, or active versus peripheral involvement in the business. Varying levels of dues can also be charged to different types of members, presumably based on their ability to pay or their involvement in league activities. Those members required to have continuing education might pay more than inactive or student members who are not required to participate in classes, for example. Member dues and assessments are deductible as business expenses for members who are actively engaged in a trade or business, except for the amount of the dues allocable to political activity or grassroots lobbying.83
The charging of substantially greater dues to associate members has been said to evidence private inurement benefiting the active members, although higher associate dues were permissible when the revenues benefited the entire industry by allowing more extensive programs.84 Dues paid by associate or other subclass members who joined to market their products or obtain association benefits, such as group insurance, may be taxable as unrelated business income.85 In one instance, industry suppliers could promote their products in the association publications and obtain the mailing list by becoming associate (nonvoting) members. Because the motivation of association members was to sell products to members rather than to advance the industry, their dues represented advertising revenue.86
Prior to 1997, the IRS asserted that membership assumes some right to participate in the organization's direction as well as an obligation to help support the organization through regular financial contributions. “Most importantly, members have voting rights and have a voice in the administration and direction of the organization.” Labor unions and the IRS battled about the character of associate members for some years. The IRS eventually eased its stance and issued formal guidance on the character of member dues, originally only for labor unions87 but later extended to (c)(6) organizations.88 A primary-purpose test is used to ask, “Was the associate member category created and used to further the organization's exempt purposes or simply to produce unrelated income?” Where members serve only to buy unrelated goods and services (insurance or advertising, for example), their dues will be treated as unrelated income. The procedure gives no specific criteria for applying the test except to say the IRS will look to the purposes and activities of the organization rather than its members. Subsequently, the IRS was asked to consider the status of “allied members” of a professional association. Although their rights were not as extensive as those accorded regular members, the associates could vote and serve as officers at a chapter level, and their dues were similar to those of regular members. The IRS thought, therefore, that the dichotomy between regular and allied members did not evidence an organizational purpose to generate unrelated income.89
Tax-exempt organizations may also be members of a qualifying league, despite the fact that the regulations define a business league as an association of persons. A labor union and a business league have been permitted to form a qualifying league.90
The league may not allow its assets to inure to the benefit of individual members or otherwise operate primarily to benefit its members. The league may not, as its primary activity, provide direct services of benefit to individual members, but it can provide a whole host of services designed to benefit their common interests. The IRS Internal Revenue Manual91 and the courts have provided some additional guidance as to when inurement results, as follows:
A chamber of commerce or board of trade is distinguishable from a business league because it serves the general economic welfare of a community. Membership is typically open to all lines of business within a geographic area. Its activities must be directed at the promotion of the area's business and usually include the promotion of tourism, publishing directories of resources available in the area, developing programs to promote the business climate, conducting studies, and similar projects. The following activities have been ruled to be suitable for a chamber of commerce:
The basic difference between §501(c)(5) and §501(c)(6) is sometimes gray, due both to industry type and to congressional logic. While (c)(5) is narrow and applies only to agricultural groups and labor unions, (c)(6) is broad and includes almost any business enterprise or activity.105
To contrast the two categories of §501(c) classification, consider a rose growers' association. Such an association could qualify as a business league under §501(c)(6). As well, the organization can also be classified under §501(c)(5) as horticultural if its members are all directly involved in the cultivation of roses with the purpose of bettering the conditions of persons growing roses, improving the grade of roses, and developing growing systems. However, if group membership includes nongrowers such as shippers, pesticide suppliers, and florists, it will not qualify under §501(c)(5) and will instead have to meet the tests for §501(c)(6).
In many ways, the two categories are identical. For both, unrelated business income is taxed and must not be a substantial revenue source or activity. For both categories, economic benefits and services cannot generally be rendered to individual members. However, labor unions can provide mutually funded benefits for life, health, and accident insurance.
Neither political activity nor lobbying is prohibited under either §501(c)(5) or §501(c)(6). Advocacy of legislation beneficial to the common business interest can conceivably be the group's primary purpose, if the activity is undertaken to improve working conditions, production, or efficiencies.106 Whether an activity is “primary” is generally measured by dollars expended on that function in relation to the league's total budget. For both, the portion of member dues spent on lobbying and electioneering efforts are nondeductible and specific disclosures must be made to members.107
Form 1024 is filed to achieve recognition of exemption. Statutorily, a league essentially qualifies if it meets the §501(c)(6) definitions, and need not seek IRS approval to qualify. As a practical matter, however, the IRS requires filing of Form 1024 to avoid subjecting the league's income to tax. The process of seeking exemption is discussed in §18.1. The information return, Form 990 or 990-EZ, that is filed annually to report activity and allow the IRS to review continued qualification is discussed in §18.2.
The non-(c)(3) categories of tax-exempt organizations are not subject to a specific organizational requirement, as discussed in §7.1(a) concerning labor unions. The instructions to Form 1024, however, say that exemption will not be approved unless organizing documents are attached. They go on to say that bylaws are internal rules and are not, by themselves, organizational documents—but Form 1024 requests that bylaws be attached.
A business league may qualify for state and local tax exemptions. In Texas, for example, an automatic exemption from the corporate franchise tax is granted for organizations furnishing their IRS determination letter evidencing their qualification as a §501(c)(6) organization. The sales tax exemption is only granted to a chamber of commerce or a convention and tourist promotional agency representing a Texas city or county, and then only if the entity is not organized for profit and no part of its earnings inure to a private shareholder or other individual. Most Texas business leagues are subject to the sales tax on items they buy, lease, or consume. The rules of the particular state(s) in which a league operates must be investigated.
Business, trade, and professional associations described in §501(c)(6) can create a separate organization to pursue their educational, cultural, scientific, or other charitable interests. The motivation is usually financial: to form an entity able to seek funding from those who desire a charitable deduction for their support or those (such as another foundation) whose grants can be paid only for charitable purposes. Say, for example, an association wishes to create a library of educational materials. Rather than increasing overall dues, members capable of paying more can be asked to voluntarily contribute to the library. Gifts to the league itself for its use in establishing the library would not be deductible as contributions (though they could be a business expense), but a gift to the league's separate charity for the purpose of maintaining a library would be, so long as the library is open to the general public.108 Grants from foundations, corporations, and testamentary bequests from members can also be sought. See discussion of sponsorships in §21.8(e) for circumstances under which such payments may be treated as advertising taxable as unrelated business income to the league.
A charitable organization established by a business league must meet the same standards for qualification as a §501(c)(3) organization that require it to operate exclusively to benefit the general public, rather than to benefit the league and its members. In the IRS view, the foundation cannot serve to improve the reputation and business interest of the association's members and the profession of which they form a part. For this reason, an organization that administers a national certification exam, presents seminars, and seeks to serve the public interest by maintaining high standards in the accounting profession cannot qualify as an educational organization.109 A foundation can present educational programs, such as classes leading to certification in a particular line of business or continuing education. A foundation should not be responsible for certification, enforcement of a code of ethics for those who are certified, or other activities germane to an association of persons having a common business interest (definition of (c)(6) organization).110 The foundation can conduct research on subjects pertaining to the business of the association members, but the results of the research must be available to the general public and conducted under the standards for charitable research organizations.111 An engineering society conducting research that is made available to universities on a cost basis was allowed to convert to a (c)(3) because it did not police its profession or undertake a public relations program (so that it did not qualify as a business league).112 The foundation can make scholarship grants to persons aspiring to enter the business, but should not sponsor an essay contest designed to increase public interest in its members and the line of business they represent.113
A business league and the foundation it creates can share common or overlapping board members or trustees; the league can, and for management reasons often does, absolutely control its affiliated foundation. Facilities, personnel, and other costs can be shared. When such a sharing arrangement exists, documentation must be maintained to evidence that the foundation's funds are not used for association purposes.114 Furnishing of administrative services to the foundation for free is a charitable activity on the league's part that should not jeopardize its (c)(6) status if it is inconsequential to the league's overall operations.115
A controlled charitable subsidiary of a business league (or a (c)(4) or (c)(5) organization) may qualify as a public charity for one of three reasons. If its annual support is received from a broad range of contributors, it may qualify under §509(a)(1). If its primary source of support comes from sales of educational programs and materials, it may qualify under §509(a)(2). Lastly, it may be entirely funded and controlled by its affiliated (c)(6) organization and eligible under §509(a)(3). The charity's charter and organizational rules must be carefully drawn to meet the specific requirements for the last category, referred to as a supporting organization.116 The third type may be desirable for a foundation that is receiving funding from a variety of sources because it avoids the need to maintain detailed public support information to prove that the affiliate is not a private foundation.
Lastly, rather than forming a new, separate charitable organization, it is conceivable that a (c)(6) organization might be able to requalify as a (c)(3) if its resources are devoted primarily to educational and charitable activities. The determinative factors include whether the organization promotes and protects the profession or business of its members and/or engages in extensive legislative activity.117 Sponsoring semiannual law institutes and moot court proceedings and providing legal assistance to indigents were agreed to be charitable and educational activities for a city bar association. Establishing minimum fee schedules, enforcing standards of conduct, and studying ways to make the practice of law more profitable instead promote the common business purpose of the bar's members. Thus, a bar association conducting both educational and professional standard-type activities was not allowed to be reclassified as a (c)(3).118
The Revenue Act of 1993 revised §162(e) and added direct lobbying expenses to the list of expenses that are nondeductible for income tax purposes. Leagues that finance their lobbying efforts with member dues payments must allocate their resources between those spent on lobbying and those spent on other programs. “Conspicuous and easily recognizable” notice of the nondeductible amount must be provided to members on dues notices soliciting payment, providing a reasonable estimate of the lobbying expenses to be paid out of the dues.119 A report of compliance with the rules, including the amount of lobbying expenses and dues allocable thereto, must be provided on Form 990, filed annually.
A league that is able to show that 90 percent or more of its members do not benefit from the deduction of their dues, because they claim the minimum standard deduction, is excluded from these rules. Additionally, a league substantially all of whose members are §501(3) organizations is also excluded from the notice requirement. A league can choose to pay a proxy tax (at highest corporate rate) on its lobbying expenditures itself, rather than disclosing the nondeductible amount to its members. The limitation on deductibility of dues attributable to an organization's lobbying activity and associated reported requirements is outlined in §6.5.
Amounts expended in connection with political campaigns are also not deductible, and federal election laws generally prevent a business league from itself expending funds for electioneering. The association that wants to afford its members the opportunity to influence elections must, therefore, create a separate fund generally known as a political action committee (PAC). Chapter 23 outlines the definitions and limitations on activities of PACs and tax imposed on political expenditures if paid with organizational funds.
(9th Cir. 2010); see also Priv. Ltr. Rul. 200837035 for the CO-7 brand group's failure to qualify.
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