Differences between 501(c)(3) and 501(c)(6) Organizations

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Are you thinking of creating a tax-exempt organization under federal income tax law? Tax-exempt organizations can provide extraordinary benefits to their members and society, but forming such organizations may entail significant knowledge of the law, as well as the ability to pay expensive application fees.

In this article I will briefly explain the basic differences between two common types of tax-exempt organizations, 501(c)(3) and 501(c)(6).

General Rules of Tax-Exempt Organizations

In general, net earnings may not inure to the benefit of individuals or private shareholders under either a 501(c)(3) or a 501(c)(6). Form 990 (Return of Organization Exempt From Income Tax) is the standard annual return required to be filed (and other forms, such as Form 990-EZ may be filed, depending upon size or characteristics of the organization).

In order to be granted tax-exempt federal income status, organizations must demonstrate when applying to the IRS that they meet various applicable tests. The rest of this article will explore some of the basic differences between 501(c)(3)’s and 501(c)(6)’s when it comes to these rules, such as the general purpose, and common interest requirements, as well as the advantages and disadvantages such organizations may have when it comes to tax deductions and influencing legislation through lobbying.

General Purpose – 501(c)(6)

Typically, a 501(c)(6) organization must demonstrate that improvement of business
conditions is the general purpose of the organization (this information should be included with the application form). The improvement of business conditions should relate to one or more “lines of business”, rather than the performance of “particular services” for individual persons. A line of business commonly refers to either a certain geographic area’s entire industr, or to all of its components of an industry, but would not include a group comprised of businesses that market a particular brand within an industry. Performance of particular services such as advertising that carries the name of members, interest-free loans, assigning exclusive franchise areas, operation of a real estate multiple listing system, or operation of a credit reporting agency, are examples of what would not be sufficient to show an improvement in business conditions.

General Purpose – 501(c)(3)

In contrast, 501(c)(3)’s include entities organized for charitable, educational, religious, literary, scientific, or other limited (such as amateur athletic organizations, or prevention of cruelty to children or animals) purposes.

Common Interest – 501(c)(6)

A 501(c)(6) organization must be able to show in the application documents that a common business interest of the community, or the conditions of a particular trade, will be advanced. Some examples as noted by the IRS of a common business interest would be: promotion of higher business standards and better business methods and encouragement of uniformity and cooperation by a retail merchants association; education of the public in the use of credit; establishment and maintenance of the integrity of a local commercial market; and encouragement of the use of goods and services of an entire industry. Some examples of membership associations include chambers of commerce, real estate boards, boards of trade, or professional sports leagues. Form 1024 is filed to apply for tax-exempt status for such organizations.

Common Interest – 501(c)(3)

Unlike a 501(c)(6), owners of a 501(c)(3) generally do not need to share a common interest. Form 1023 is filed to apply for tax-exempt status for such 501(c)(3) organizations.

Tax Deductions for Donations – 501(c)(6)

Contributions to 501(c)(6) organizations are not deductible as charitable contributions on a donor’s federal income tax return. However, donations may be deductible provided that they are ordinary and necessary trade or business expenses in the conduct of the taxpayer’s business.

Tax Deductions for Donations – 501(c)(3)

In contrast to 501(c)(6) organizations, taxpayers may deduct gifts, cash, or other items as charitable deductions to 501(c)(3) organizations on their federal income tax returns.

Lobbying – 501(c)(6)

501(c)(6) organizations are allowed to engage in substantial lobbying activities in order to attempt to influence legislation. However, 501(c)(6) organizations may need to disclose to their members the percentage of annual dues paid related to lobbying.

Lobbying – 501(c)(3)

In contrast, lobbying activities are significantly limited for 501(c)(3) organizations. If it is determined that an organization engages in a substantial part of its activities in lobbying, it may risk the loss of its tax-exempt status. An organization will be considered to be attempting to influence legislation, “[I]f it contacts, or urges the public to contact, members or employees of a legislative body for the purpose of proposing, supporting, or opposing legislation, or if the organization advocates the adoption or rejection of legislation.”

Depending upon the facts, it may be possible for a tax-exempt organization to have a separate components (such as entity having separate 501(c)(3) and 501(c)(6) components) in order maximize allowable lobbying, or other, activities. But both components would need to go through separate application processes in order for this to occur.

In future articles, we will cover the possibility of converting a tax-exempt organization into a different type of tax-exempt entity. However, this process, like the application process can be complex, and an experienced attorney is often necessary.

Contact Sherayzen Law Office for Tax and Business Questions About 501(c) Organizations

Due to the complexity of the topic, this article only provides a very general background to the differences about these two common types of 501(c) organizations, and it should not be relied upon to make a decision in your particular situation. If you have any further questions with respect to 501(c) organizations, please contact Sherayzen Law Office for legal and tax help.

IRS Tax Gaps Estimates Show Taxpayers owe $385 Billion in 2006 Taxes

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The Internal Revenue Service recently released new “tax gap” estimates for tax year 2006, showing that taxpayers owe $385 Billion (an increase of about 1/3 over the tax gap from tax year 2001).  The tax gap is defined as the amount of tax liability owed by taxpayers that is not timely paid.

The tax gap is divided into three components: non-filing, underreporting and underpayment.  Most of the increase in the tax gap from tax years 2001-2006 occurred in underreporting and underpayment; in the non-filing segment, the numbers were largely unchanged.

Underreporting in 2006, as in 2001, was the largest contributing factor to the tax gap, increasing to $376 billion (and $67 billion on corporate income taxes) from $285 billion five years earlier.  Underpayment of tax in 2006 increased to $46 billion, up from $33 billion in 2001.  Non-filing accounted for $28 billion in 2006, up a billion from five years before.

Despite the increase in the tax gap over the five years, the voluntary compliance rate (the percentage of total tax revenues paid on a timely basis) stayed almost statistically unchanged, at around 83%.

The 2006 gross tax gap (the amount that was not timely paid), was estimated at $450 billion, an increase from $345 billion in 2001.  The 2006 net tax gap, (the amount of tax that was never paid), was $385 billion, up from $290 billion from five years earlier.

IRS Declares New 2012 Offshore Voluntary Disclosure Program

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On January 9, 2012, the Internal Revenue Service announced that it opens another offshore voluntary disclosure program – 2012 Offshore Voluntary Disclosure Program or 2012 OVDP – to help people hiding offshore accounts get current with their taxes and announced the collection of more than $4.4 billion so far from the two previous international programs.

The IRS opened the 2012 OVDP following continued strong interest from taxpayers and tax practitioners after the closure of the 2011 and 2009 programs. The third offshore program comes as the IRS continues working on a wide range of international tax issues and follows ongoing efforts with the Justice Department to pursue criminal prosecution of international tax evasion. This program will be open for an indefinite period until otherwise announced. Program was closed in 2018.

“Our focus on offshore tax evasion continues to produce strong, substantial results for the nation’s taxpayers,” said IRS Commissioner Doug Shulman. “We have billions of dollars in hand from our previous efforts, and we have more people wanting to come in and get right with the government. This new program makes good sense for taxpayers still hiding assets overseas and for the nation’s tax system.”

The 2012 OVDP is similar to the 2011 OVDI program in many ways, but with a few key differences. First, unlike the last year, there is no set deadline for people to apply. Second, while the 2012 OVDP penalty structure is mostly similar to the OVDI program, the taxpayers in the highest penalty category will suffer from a hike in the penalty rate – the new penalty framework requires individuals to pay a penalty of 27.5 percent of the highest aggregate balance in foreign bank accounts/entities or value of foreign assets during the eight full tax years prior to the disclosure. That is up from 25 percent in the 2011 program. Some taxpayers will be eligible for 5 or 12.5 percent penalties; these remain the same in the new program as in 2011. Third, participants must file all original and amended tax returns and include payment for back-taxes and interest for up to eight years as well as paying accuracy-related and/or delinquency penalties. Fourth, as under the prior programs, taxpayers who feel that the penalty is disproportionate may opt instead to be examined.

The important details of the 2012 OVDP are still going to be announced by the IRS later.  It is important to emphasize, however, that the terms of the 2012 OVDP could change at any time going forward. For example, the IRS may increase penalties in the 2012 OVDP for all or some taxpayers or defined classes of taxpayers – or decide to end the program entirely at any point.

The IRS also stated that it is currently developing procedures by which dual citizen taxpayers, who may be delinquent in filing but owe no U.S. tax, may come into compliance with U.S. tax law.

“As we’ve said all along, people need to come in and get right with us before we find you,” Shulman said. “We are following more leads and the risk for people who do not come in continues to increase.”

This offshore effort comes as Shulman also announced today the IRS has collected $3.4 billion so far from people who participated in the 2009 offshore program, reflecting closures of about 95 percent of the cases from the 2009 program. On top of that, the IRS has collected an additional $1 billion from up front payments required under the 2011 program. That number will grow as the IRS processes the 2011 cases.

In all, the IRS has seen 33,000 voluntary disclosures from the 2009 and 2011 offshore initiatives. Since the 2011 program closed last September, hundreds of taxpayers have come forward to make voluntary disclosures. Those who have come in since the 2011 program closed last year will be able to be treated under the provisions of the new 2012 OVDP program.

Contact Sherayzen Law Office for Legal Help With Your Voluntary Disclosure

If you are currently not in compliance with U.S. tax laws, contact Sherayzen Law Office for legal help. Our experienced international tax firm will explore all of the available options, advise you on the best course of action, draft all of the required documentation, provide IRS representation, and conduct the necessary disclosure to bring your affairs tax affairs into full compliance with U.S. tax system.

Social Security Wage Base Increase in Tax Year 2012

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In November of 2011, the Social Security Administration announced that the wage base (also known as “contribution and benefit base”) used for computing the social security tax is increased to $110,100 in the tax year 2012.  The wage base is used to compute the maximum amount of income subject to the Social Security taxes.

This is the first increase since 2009.  From 2009 through 2011, the wage base was $106,800.

Similarly, the earnings needed to earn one Social Security credit also slightly increased to $1,130 in 2012 (in 2011, it was $1,120).

IRS Extends the 2011 Tax Return Filing Deadline to April 17, 2012

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On January 4, 2012, the Internal Revenue Service announced that the taxpayers will have until  April 17, 2012 (Tuesday) to file their 2011 tax returns and pay any tax due.  This is because April 15, 2012, falls on a Sunday, and Emancipation Day, a holiday observed in the District of Columbia, falls this year on Monday, April 16, 2012.  Since, according to federal law, District of Columbia holidays impact tax deadlines in the same way that federal holidays do, all taxpayers will have two extra days this year to file their 2011 tax returns.  Note, however, that taxpayers requesting an extension will have until October 15, 2012, to file their 2011 tax returns; there is no change in the filing date here.

The IRS will begin accepting e-file and Free File returns on January 17, 2012. Additional details about e-file and Free File will be announced later this month.