Is your 501(c)(6) generating taxable income?
By Cecily Jackson and Jenny Kassan
In a recent Technical Advice Memorandum (TAM), the IRS determined that a major source of revenue for a 501(c)(6) trade association was unrelated business income and therefore taxable.
The trade association’s purpose was to promote a particular sport within a region. Individuals can only play the sport at sports facilities that charge a fee to play. The trade association sold discount coupons for use of such facilities.
In the TAM, the IRS listed the requirements for a Section 501(c)(6) organization:
(1) It must be an association of persons having a common business interest,
(2) Its purpose must be to promote that common business interest,
(3) It must not be organized for profit,
(4) It should not be engaged in a regular business of a kind ordinarily conducted for a profit,
(5) Its activities should be directed toward the improvement of business conditions of one or more lines of business as opposed to the performance of particular services for individual persons, and
(6) Its net earnings, if any, must not inure to the benefit of any private shareholder or individual.
The Internal Revenue Code imposes a tax on income to a nonprofit organization derived from any unrelated trade or business regularly carried on. An unrelated trade or business is any trade or business which is not substantially related to the organization’s exempt purposes.
The trade association argued that the discount coupon program is substantially related to its exempt purposes because it encourages more people to engage in the sport.
The IRS disagreed. The question turned on whether the sale of coupons promotes general interest and involvement in the sport or if it constitutes the performance of particular services for individual persons or businesses. The IRS concluded that the sale of coupons only benefited those facilities that chose to participate and not the sport as a whole and therefore the sale of coupons was basically an advertising service for individual businesses.
The IRS states, “Advertising campaigns . . . that name and promote specific businesses rather than the industry as a whole constitute the performance of particular services for individual persons” which is an unrelated trade or business.
We know of many 501(c)(6) organizations that promote their members by maintaining business directories, spotlighting their members on their web sites, etc. These organizations need to be careful that their activities don’t start to look like the sale of advertising (or else pay tax on the revenue associated with those activities). (Note that occasional highlighting of members such as for a special event is not a problem because the tax on unrelated business income only applies to a trade or business that is regularly carried on.)
The following are some examples of activities that have been found to be taxable as unrelated business income to a 501(c)(6):
- Advertising of products and services in an association journal, even if those products and services are related to the purpose of the organizations
- Promotions that mention particular businesses
- Promotion of members to the exclusion of non-members in the same industry when members and non-members meet similar standards
- Fee-based services for members and/or non-members that are similar to what might be provided by a commercial business
- Providing discounted parking for patrons of only certain businesses in a downtown area.
The following are some examples of activities that have been found to be substantially related and therefore not taxable as unrelated business income:
- Publication of educational information that incidentally promotes specific businesses
- Providing discounted parking for all visitors to a downtown area
- Sponsorship of tournaments to promote interest in a sport and sale of broadcasting rights to those tournaments
- Promotion of an entire industry or line of business such as Washington apples or the use of plywood as a building material.
Note that a nonprofit can lose its exempt status if a significant amount of its revenue is derived from and/or a significant amount of its resources is devoted to an unrelated activity.
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