Applying for IRS Determination of Tax Exempt Status

Applying for IRS Determination of Tax Exempt Status For Your Chapter Henry A. Hart • SHRM General Counsel • January 25, 2011

Table of Contents 1. Important Differences between 501(c)(6) and 501(c)(3) 2. Most Chapters should apply for Exemption Under 501(c)(6), not 501(c)(3) 3. Applying for Income Tax Exemption Under 501(c)(6) – IRS Form 1024 and Instructions Thereto 4. Applying for Income Tax Exemption Under 501(c)(3) – IRS Form 1023 and Instructions Thereto (Not to be covered in detail in this webinar; major differences to be pointed out) ©SHRM 2007 2

Important Differences between 501(c)(6) and 501(c)(3) 1. 501(c)(6) Orgs Defined IRC Section 501(c)(6) exempts in pertinent part the following organizations: “Business leagues. . . not organized for profit and no part of the net earnings of which inures to the benefit of any private shareholder or individual. ” [The regulations under 501(c)(6) define “Business Leagues” as associations of persons having “some common business interest, ” the purpose of which is to promote such common business interest. ] The mission of SHRM chapters is generally to support the HR professional and advance the HR profession…. a classic purpose for a 501(c)(6) organization. ©SHRM 2007 3

Important Differences between 501(c)(6) and 501(c)(3) (cont. ) 501(c)(3) Orgs Defined IRC Section 501(c)(3) exempts in pertinent part the following organizations: “Corporations. . . organized and operated exclusively for religious, charitable, scientific. . . or educational purposes. . . no part of the net earnings of which inures to the benefit of any private shareholder or individual, no substantial part of the activities of which is carrying on propaganda, or otherwise attempting to influence legislation, [(except as otherwise provided in subsection (h)], and which does not participate in, or intervene in …, any political campaign on behalf of (or in opposition to) any candidate for public office. ” ©SHRM 2007 4

Important Differences between 501(c)(6) and 501(c)(3) (cont. ) IRS Regulation § 1. 501(c)(3)-1(c) states in pertinent part: “An organization will be regarded as “operated exclusively” for one or more exempt purposes only if it engages primarily in activities which accomplish one or more of such exempt purposes specified in § 501(c)(3). An organization will not be so regarded if more than an insubstantial part of its activities is not in furtherance of an exempt purpose. ” (Emphasis added). ©SHRM 2007 5

Important Differences between 501(c)(6) and 501(c)(3) (cont. ) IRS Regulation § 1. 501(c)(3)-1(d)(2) defines “charitable” purposes to include in pertinent part, “advancement of education or science. . . lessening the burdens of Government. ” IRS Regulation § 1. 501(c)(3)-1(d)(3) defines “educational” purposes to include in pertinent part those relating to, “the instruction or training of the individual for the purpose of improving or developing his capabilities; or the instruction of the public on subjects useful to the individual and beneficial to the community. ” ©SHRM 2007 6

Important Differences between 501(c)(6) and 501(c)(3) (cont. ) Permissible Activities of 501(c)(6) and 501(c)(3) Organizations A. Inurement of Benefit is Prohibited – Both 501(c)(6) and 501(c(3) organizations are prohibited from distributing any profits to their members or insiders. In addition, 501(c)(3) organizations, but not 501(c)(6) organizations, are covered organizations under the IRS Excess Benefit Transaction rules which impose excise tax penalties on those insiders who receive excess payments from 501(c)(3) organizations they are in a position to influence, and on those organizational managers who vote for such excess payments. ©SHRM 2007 7

Important Differences between 501(c)(6) and 501(c)(3) (cont. ) B). Lobbying and Political Activities – A 501(c)(6) organization may engage in any amount of lobbying or political activities without adversely affecting its 501(c)(6) status (although the portion of its member dues which are attributable to lobbying are not deductible by the members; and that amount which it spends on political activities attempting to influence elections is taxed at corporate income rates under IRC Section 527). A 501(c)(3) organization may not engage in any substantial lobbying ( but it may engage in an insubstantial amount of lobbying); and it may not engage in any amount of political activities attempting to influence an election. ©SHRM 2007 8

Important Differences between 501(c)(6) and 501(c)(3) (cont. ) Tax Treatment of 501(c)(3) Organizations and 501(c)(6) Organizations Income is Exempt From Federal Income Tax – The income of both 501(c)(3) and 501(c)(6) organizations is exempt from federal income tax, and from state income tax in most states (except to the extent that such income is from an unrelated trade or business in which case it is subject to federal income tax, and state income tax in most states, at corporate income tax rates, after deductions). ©SHRM 2007 9

Important Differences between 501(c)(6) and 501(c)(3) (cont. ) Charitable Contributions May be Made to a 501(c)(3) Organization - Charitable contributions may be made to a 501(c)(3) organization and deducted as such under IRC Section 170. Such voluntary contributions to a 501(c)(6) organization may not be deducted as a charitable contribution. This is the major difference in the tax treatment of 501(c)(3) and 501(c)(6) organizations. If an organization wants to fundraise and attract charitable contributions and grants, it will be very helpful for it to be a 501(c)(3) organization. But very few SHRM chapters actually do this. IRS Excess Benefit Transaction Rules – 501(c)(3) organizations, but not 501(c)(6) organizations, are covered organizations under the IRS Excess Benefit Transaction Rules. ©SHRM 2007 10

Important Differences between 501(c)(6) and 501(c)(3) (cont. ) Exemption from Some State and Local Taxes – whether an organization is exempt from state and local sales taxes, personal and real property taxes, gross receipts taxes, hotel taxes and similar taxes depends upon the statutory scheme of each particular state and locality. However, as a general rule, a 501(c)(3) organization is more likely to be exempt from some or all of such state and local taxes than is a 501(c)(6) organization. ©SHRM 2007 11

Important Differences between 501(c)(6) and 501(c)(3) (cont. ) Applicability of Miscellaneous Laws Non-Profit Postage Rates – 501(c)(3) organizations are likely to qualify for discounted Postal Service non-profit postage rates. It is very unusual for a 501(c)(6) organization to qualify for such non-profit postage rates; although SHRM is a 501(c)(6) organization and did obtain a permit from the Postal Service to mail at such non-profit rates. State and Local Gambling Laws – many states and localities have laws which require a license to conduct a raffle, and require an entity to be a 501(c)(3) organization to be eligible for a license. ©SHRM 2007 12

Most Chapters should apply for Exemption Under 501(c)(6), not 501(c)(3) Professional Societies as 501(c)(6) versus 501(3) Professional societies are often on the borderline between 501(c)(6) and 501(c)(3) status. If the activities of a professional society are primarily aimed at education or scientific study, and any promotion of the common business interests of its members is merely incidental to such educational or scientific purposes, it will qualify for 501(c)(3) status. On the other hand, if the activities of a professional society promote more than incidentally the common business interests of its members, it will be classified as a 501(c)(6) organization. ©SHRM 2007 13

Most Chapters should apply for Exemption Under 501(c)(6), not 501(c)(3) (cont. ) The IRS has acknowledged that a professional society may qualify for 501(c)(3) status; however, it has warned that it will revoke 501(c)(3) exemption if any “substantial” noncharitable or non-educational activities exist, regardless of the number of truly charitable or educational purposes the organization might otherwise have. IRS Exempt Organizations Handbook. Internal Revenue Manual. Section 6(11)(1). The IRS can be expected therefore, to closely scrutinize the 501(c)(3) status of any professional society which engages in numerous activities which appear to be devoted towards the promotion of the business interests of its professional members. ©SHRM 2007 14

Most Chapters should apply for Exemption Under 501(c)(6), not 501(c)(3) (cont. ) Conclusion on whether to apply for 501(c)(6) or 501(c)(3) …. Much easier, and safer for chapter to apply for 501(c)(6); very few chapters need the extra benefits of 501(c)(3) status which would make it worth the extra difficulty in obtaining the exemption, or worth the extra risk in maintaining the exemption, or worth the extra regulations on a 501(c)(3)’s activities. ©SHRM 2007 15

Applying for Income Tax Exemption Under 501(c)(6) – IRS Form 1024 and Instructions Thereto 501(c)(6) organizations, are not required to have an IRS Determination Letter in order to be tax-exempt under such sections; they merely need to be able to demonstrate that they have in fact been organized and operated as such an organization. However, it is typically advisable to obtain a determination letter to remove any doubt on the issue, particularly if the organization files a Form 990 or Form 990 N. The IRS can be expected to check the names of those Form 990 and Form 990 N filers to see if they have IRS determination letters; and if they have no determination letter, the IRS is likely to make them apply for one or will audit the organization. ©SHRM 2007 16

Applying for Income Tax Exemption Under 501(c)(6) – IRS Form 1024 and Instructions Thereto (cont. ) To apply for IRS determination letter of 501(c)(6) status a chapter must File: • Form 1024 Application • Form 8718 (one page; very simple) must be accompanied by a one-time user fee ($400 if annual gross receipts past 4 years averaged $10, 000 per year or less; otherwise $850). Form 8718 has address where to send application. • And if legal counsel wants to communicate with the IRS concerning the application, a power of attorney on Form 2848 must also be provided with the application. ©SHRM 2007 17

Applying for Income Tax Exemption Under 501(c)(6) – IRS Form 1024 and Instructions Thereto (cont. ) Let’s Look at the Form 1024 Application: Part 1 – Pretty innocuous – name, address, and other background information on chapter Part II – Activities and Operational Information – #1 This is the opportunity to make your case for exemption. For each activity listed, explain how it furthers in substantial part your tax exempt mission. #5 – List SHRM –Say that you are a chapter of the Society for Human Resource Management, a separate legal entity and itself a 501(c)(6) ©SHRM 2007 18

Applying for Income Tax Exemption Under 501(c)(6) – IRS Form 1024 and Instructions Thereto (cont. ) Part III – Financial Information Statement of Rev and Ex – current year (no later than 60 days old) and past three years (if in existence less than a year, provide proposed budgets for 2 years. ) Balance Sheet Part IV – Notices (Not applicable to 501(c)(6)…ignore this section) ©SHRM 2007 19

Applying for Income Tax Exemption Under 501(c)(6) – IRS Form 1024 and Instructions Thereto (cont. ) Schedules – the only Schedule applicable to 501(c)(6) organizations is Schedule C -(ignore the rest). On Schedule C, you only need to answer # 1 which requires you to describe services performed for members. Add a sentence at the end to explain how these services help support and advance the HR profession as a whole. ©SHRM 2007 20

Applying for Income Tax Exemption Under 501(c)(6) – IRS Form 1024 and Instructions Thereto (cont. ) • Checklist on last page of Form 1024 > Attach signed Form 8718 and user fee > Mail to address on Form 8718 > Show Employer ID Number (“EIN”) - if do not have EIN, can get by phone – See Form 1024 Instructions at Part 1, # 2, page 2 > Attach conformed copy of organizing instrument ©SHRM 2007 21

Applying for Income Tax Exemption Under 501(c)(3) – IRS Form 1023 and Instructions Thereto Form 1023 is similar to Form 1024, but more onerous Asks additional questions. 501(c)(3) is like Caesar’s wife. So there are more questions on lobbying (cannot be more than insubstantial) , political activities [absolute bar on any political activities of a 501(c)(3)], compensation of Directors, officers, key employees, and independent contractors, and scholarships. But perhaps the most important difference between the Form 1024 and 1023 is that in addition to establishing exemption from tax, the 501(c)(3) applicant must establish in the Form 1023 the basis for its exemption from private foundation status, which concerns sources and amounts of public support and may require assistance from a tax advisor. ©SHRM 2007 22

Source for pertinent IRS forms • Form 1023 http: //www. irs. gov/pub/irs-pdf/f 1023. pdf • Instructions for Form 1023 http: //www. irs. gov/pub/irspdf/i 1023. pdf • Form 1024 http: //www. irs. gov/pub/irs-pdf/f 1024. pdf • Instructions for Form 1024 http: //www. irs. gov/pub/irspdf/i 1024. pdf • User fee Form 8718 http: //www. irs. gov/pub/irspdf/f 8718. pdf • IRS Website http: //www. irs. gov/index. html ©SHRM 2007 23

QUESTIONS? ©SHRM 2007 24