“Got milk?” This phrase may instantly bring to mind a famous campaign to promote milk consumption. This PR campaign was promoted by a trade association dedicated to—what else—selling milk! How could tax-exempt status belong to a group of businesses? The answer is through Section 501(c)(6) of the Internal Revenue Code, which provides exemption for “business leagues”—commonly known as trade associations—as well as chambers of commerce, real estate boards, boards of trade, and sports leagues. Here are some basics about trade associations.
Key Attribute – Advancing a “Line of Business”
What are a trade association’s key attributes? Like Section 501(c)(3) public charities, trade associations enjoy tax-exempt status for federal income tax purposes and are usually formed as nonprofit corporations under state law. But trade associations are different when it comes to membership involvement, benefits involved, and permitted political activity. The primary distinction is that trade associations must advance a “line of business,” through the members’ common business interests. They may not be organized for profit, nor for improper private benefit.
Consider another business example: plumbers. Many plumbers’ trade associations exist to promote professionalism, quality work for customers, educational opportunities, networking, legislative advocacy, problem solving, and business growth. (See here, for example.)
What is the basis of Section 501(c)(6) exemption for plumbers, milk sellers, and many other businesses? Why should they be entitled to form a tax-exempt organization whose operations are focused on improving their own line of business?
The underlying public policy concept is that society benefits from efficient and cost-effective lines of business, like plumbing, milk, and many other industries. For example, plumbers can collaborate to develop better ways to perform their craft. The association orchestrates educational conferences and awards 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.
Primarily for Common Industry Interests
But take note: If the entity’s operations primarily advance the interests of its members, rather than 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, Section 501(c)(6) entities may not direct their particular services for the benefit of individual persons.
In one tax case (among many), 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 within the industry, not boost the interests of the industry as a whole. 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.
Organizations exempt under Section 501(c)(6) must have members, though the legal rights of the members may vary greatly. As a result, such organizations’ bylaws will necessarily be more complex than an organization without members, as the rights of members must be considered and provided for alongside the fiduciary duties and governance responsibilities of the board of directors.
A trade association will typically need to determine the number and types of classes of membership. For example, will there be regular members along with student, associate, or honorary members? If so, how may classes should be allowed to vote? On what matters?
As with every membership organization, the matters available for member vote should be carefully considered and set forth, both to enable the directors to continue governing the organization and to enable the members to have a voice in the organization. If too many matters require member votes, then an organization could be hamstrung without sufficient participation—which could occur if members feel burdened by notice, quorum, voting, and other meeting requirements. However, if the directors retain most of the control in the organization, as with most tax-exempt nonprofits, a check should be set in place to ensure that the organization’s activities continue to further the exempt purpose of primarily advancing the interests of their members’ industry.
Generally, organizations tax-exempt under Section 501(c)(3) may engage in some lobbying—activities attempting to influence legislation—as long as such activities do not constitute a “substantial” part of its activities. Such organizations may not engage in any political campaign activity. For more information concerning Section 501(c)(3), lobbying, and political campaign activities, see our prior article.
On the other hand, trade associations and other organizations exempt under Section 501(c)(6) may engage in an unlimited amount of lobbying, provided that the lobbying is related to its exempt purpose. Such an organization may also engage in political campaign activity, provided that this activity does not constitute its primary activity.
Lobbying and some political campaign activity are thus permissible for trade associations. Significantly, however, any expenditures for such activities are not deductible as business expenses. In other words, membership dues to a trade association are deductible as a business expense, except to the extent attributable to a trade association’s lobbying or political campaign activity. Only the portion of membership dues or other payments that are not used for such activities may be deducted as business expenses.
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, Section 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 tax-exempt status.