Tax break for industry developers? Yes. Section 501(c)(6) of the Internal Revenue Code provides income tax exemption for organizations that advance a “Line of Business.” Trade associations are one type of 501(c)(6). But the category is much more broadly defined. The statutory definition includes, “Business leagues, chambers of commerce, real-estate boards, boards of trade, or professional football leagues (whether or not administering a pension fund for football players), not organized for profit and no part of the net earnings of which inures to the benefit of any private shareholder or individual.
In recent months, the media has scrutinized professional sports leagues’ tax-exempt status. Legislators are taking a closer look at these multi-billion dollar enterprises that enjoy tax exemption. Critics question the fairness and applicability of tax exemption to such exceedingly profitable businesses. Such scrutiny invites the more fundamental question: What is the basis of the 501(c)(6) exemption? Why should plumbers, for example, be entitled to form an organization whose operations are focused on improving the plumbing line of business?
The underlying idea is that the nation benefits from efficient and cost-effective lines of business, like plumbing. In our example, member plumbers collaborate to develop better ways to perform their craft. The association puts on educational conferences and develops certifications to that end. Tax exemption relieves the association of a substantial burden so that it might better focus on improvement within the industry. In the interest of such improvement, the government eliminates the income tax burden. The result is, arguably, better plumbing (or other services) for the nation.
But take note: If the entity’s operations primarily advance the interests of its members, but not the members’ industry more broadly, the IRS may refuse or revoke exemption. Business leagues must be directed to the improvement of business conditions of one or more lines of business. Moreover, 501(c)(6) entities may not direct their particular services for the benefit of individual persons.
Recently, the IRS denied exemption to an organization that claimed it was organized to advance a particular industry. The organization’s bylaws appeared to state a qualified purpose: “to further define standards for, and promote market acceptance of, next generation technology with security methods that prevent unauthorized use or copying and its applications.” So far, so good. The “promotion of next generation technology” has the ring of industry advancement. Had that been the end of the story, the organization may have received its exemption.
However, upon closer inspection, the IRS decided that the organization’s activities were not directed to the improvement of business conditions of the industry as a whole, but to the performance of particular services for members. In particular, the IRS noted:
- The above-mentioned “next generation technology” was proprietary and trademarked;
- Only members of the organization were permitted to use the technology;
- The organization promoted members’ products under a registered logo;
- The minimum quality standards established by the organization were for members' products; and
- Members’ products were then sold under registered trademark names.
The IRS determined the organization’s activities were intended to give the members a competitive advantage. Further, the IRS determined that the association promoted a particular brand on behalf of its members, who were owners/developers of that particular brand. The IRS thus concluded that the organization did not operate as a “business league” under section 501(c)(6) and denied its exemption application.
Section 501(c)(6) of the Internal Revenue code provides trade associations a valuable exemption to advance certain lines of business. In many cases, industries benefit from the collaborations by same-industry professionals. Such industry collaboration may be greater than the sum of the parts. And tax exemption helps. Of course, 501(c)(6) organizations must be careful. When members take the place of the industry as the central focus, the organization can run afoul of the IRS, and jeopardize its exemption. Consultation with qualified legal counsel can help the organization identify such trouble spots.