To Preserve Their Tax Status, Associations Must Observe Limits
Nonprofit trade associations, or 501(c)(6) organizations, exist to promote their members’ common interests and improve business conditions or “one or more lines of interest.” Whether the association is a local chamber of commerce, a real estate board or a large professional group such as the American Bar Association or American Medical Association, associations’ tax-exempt status is contingent on their sponsoring certain types of activities. When they fail to do so, the IRS may take action.
Typically, associations get into trouble when they interpret terms such as “promote common interests” and “improve business conditions” too broadly. For example, they might provide customized sales training or technology consulting for one or only some of its members. But associations don’t qualify for tax-exempt status if they exist only to perform services for individual members.
The Internal Revenue Code also warns associations against engaging in business that’s normally carried out on a for-profit basis. And groups that are primarily social or that exist to promote a hobby (instead of a profession or for-profit industry) generally don’t qualify for the 501(c)(6) status. Courts have, in fact, denied the exemption to such groups as the American Kennel Club and American Automobile Association.
Differentiating between activities
To avoid IRS scrutiny, your association needs to be able to differentiate between activities that are considered qualified and those that are nonqualified. For example, it’s perfectly acceptable for your association to attempt to influence legislation relating to the common business interests of your organization’s members. You can also test and certify products and establish industry standards; publish statistics on industry conditions to promote your members’ line of business; and research effective business practices and share that information with your members. These and similar activities fulfill the purpose of promoting common interests and improving business conditions.
But you should limit certain activities, particularly if they benefit specific association members rather than the industry or profession as a whole. These might include:
- Selling advertising in member publications,
- Facilitating the purchase of supplies and equipment for members,
- Offering estimating services to builders and conducting listing services for real estate board members,
- Providing workers’ compensation insurance to members.
Note that your association’s “primary purpose” matters when assessing activities. Most associations perform some activities that don’t primarily serve common business interests. But in general, you can avoid harming your exempt status if these activities are limited in scope and number.
Another critical point is that, even when certain activities don’t threaten your exempt status, performing services for members can trigger unrelated business income tax (UBIT). Typically members pay for such services directly, instead of through dues or other common assessments. Depending on the services your association provides and the revenues raised, additional reporting may be required and you may owe UBIT.
If you find that your association is performing more and more or substantial services for individual members, take steps to protect your association’s tax-exempt status. You might, for example, form a separate, related for-profit organization to offer those services.
Keeping your focus
The IRS is on the lookout for 501(c)(6) associations that don’t promote common business interests. Your group should primarily focus on exchanging information for business development and promoting the interests of your members and the industry. If it doesn’t, it may be time to review and revise your offerings.