You may have heard about business leagues.
One very much in the news recently is the National Football
League, which has been considering giving up its tax-exempt status.
In the tax world, exempt entities obtain their exempt status
under Section 501(c). There is then a number, and that number is the “type” of
exempt under discussion. For example, a classic charity like the March of Dimes
would be a 501(c)(3). When we think of tax-exempts, we likely are thinking of
(c)(3)’s, for which contributions are deductible to the donor and nontaxable to
the recipient charity.
The (c)(3) is about as good as it gets.
A business league is a (c)(6). So is a trade association.
Right off the bat, payments to a (c)(6) are not deductible
as contributions. They are, however, deductible as a business expense- which
makes sense as they are business
leagues. You and I probably could not deduct them, but then again you and I are
not businesses.
There are some benefits. For example, a (c)(6) has virtually
no limit on its lobbying authority, other than having to pro-rate the member
dues between that portion which represents lobbying (and not deductible by
anybody) and the balance (deductible as a business expense).
There are requirements to a (c)(6):
(1) There
must be members.
a.
The members must share a common business
interest.
i. Members
can be individuals or businesses.
ii. If
membership is available to all, this requirement has not been met. This makes sense
when you consider that the intent of the (c)(6) is to promote shared interests.
(2) Activities
must be directed to improving business conditions in a line of business.
a.
Think of it as semi-civic: to advance the
general welfare by promoting a line of business rather than just the individual
companies.
b.
This pretty much means that membership must
include competitors.
c.
Sometimes it can be sketchy to judge. For
example, the IRS denied exemption to an organization whose principal activity
was publishing and distributing a directory of member names, addresses and
phone numbers to businesses likely to require their services. The IRS felt this
went too close to advertising and too far from the improvement of general
business conditions.
(3) The
primary activities must be geared to group and not individual interests.
a.
The American Automobile Association, for
example, had its application denied as it was primarily engaged in rendering
services to members and not improving a line of business.
(4) The
main purpose cannot be to run a for-profit business.
a.
This requirement is standard in the
not-for-profit world. You can run a coffee shop, but you cannot be Starbucks.
b.
For example, a Board of Realtors normally
segregates its MLS activities in another – and separate – company. The Board itself
would be a (c)(6), but the MLS is safely tucked away in a for-profit entity –
less it blow-up the (c)(6).
(5) Must
be not-for-profit.
a.
Meaning no dividends to shareholders or distributions
rights if the entity ever liquidates.
b.
BTW – and to clarify – a not-for-profit can show
a profit. Hypothetically it could show a profit every year, although it is
debatable whether it could rock the profit level of Apple or Facebook and keep
its exemption. The idea here is that profits – if any – do not “belong” to
shareholders or investors.
(6) There
must be no private inurement or private benefit to key players or a restricted
group of individuals.
a.
Again, this requirement is standard in the
not-for-profit world.
b.
This issue has been levelled against the NFL. Roger
Goodell (the NFL Commissioner) has been paid over $44 million a year for his
services. It does not require a PhD in linguistics to ask at what point this
compensation level becomes an “inurement” or “benefit” disallowed to a (c)(6).
There is litigation around (4) and (6). The courts have
allowed some business activity and some benefit to the members, as long as
it doesn’t get out of hand. The courts refer to this as “incidental benefit.”
Which can lead to interesting follow-up issues. Take a case
where the organization runs a business (within acceptable limits) and then uses
the profit to subsidize something for its members. Can this amount to private
inurement? The members are – after all - receiving something at a lower cost
than nonmembers.
Let’s take a look at a recent application. I think you know
enough now to anticipate how the IRS decided.
(1) The
(c)(6) members are convenience stores and franchisees of “X.”
(2) Revenues
will be exclusively from member fees.
(3) One-quarter
of member fees will be remitted annually to the national franchisee (that is, the
franchise above “X”)
(4) Member
franchisees will elect the Board.
(5) The
(c)(6) will educate and assist with franchise policies.
(6) The
(c)(6) will facilitate resolution between members and executives of “X.”
How did it go?
The IRS bounced the application.
Why?
We could have stopped at (1). There is no “line of business”
happening here. Members are limited to franchisees of “X.” Granted, “X”
participates in an industry but “X” does not comprise an industry.
The organization tried to clean-up its application after being
rejected but it was too little too late.
The organization was not promoting the industry as a whole.
It rather was promoting the interest of the franchisee-owners.
Nothing wrong with that. You just cannot get a tax exemption
for it.
