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.