RESOURCES

501(c)(3) and (6) Organizations: A Comparative Analysis


I. INTRODUCTION

Q1: What is an IRC [Internal Revenue Code] § 501(c)(3) organization?

A1: This type of organization is one that is organized and operated primarily for religious, charitable, scientific, educational, and certain other purposes (that are not relevant to this analysis).

Q2: What is an IRC § 501(c)(6) organization?

A2: This type of organization, which is technically termed a business league but is often merely termed an association, is one that is organized and operated primarily to provide services to its members. Members may be human beings, organizations, or both.

Q3: What is the purpose of an IRC § 501(c)(3) organization?

A3: The purpose of this type of organization is to advance one or more of the purposes referenced above (see A1). Sometimes, the beneficiaries are members of a charitable class (such as the poor, the distressed, the aged, or students). Sometimes, the beneficiaries are members of the general public. Often, the purposes are inherently exempt ones, such as educational and scientific purposes.

Q4: What is the purpose of an IRC § 501(c)(6) organization?

A4: The purpose of this type of organization is to serve its members. This is the fundamental distinction between these two categories of tax-exempt organizations. This element turns on the primary purpose of the organization. Often, the organizations engage in the same activities (such as conferences and publications). For example, a bar association is almost always an IRC § 501(c)(6) organization, because its primary purpose is to provide services to its members, even though it may provide some benefits to society in general (such as community outreach and pro bono activities).

Q5: What are the functions of an IRC § 501(c)(3) organization?

A5: The functions of an IRC § 501(c)(3) organization can be multitudinous. There are endless types of programs that serve charitable, educational, and like ends. Some are charitable because they serve a charitable class (see A3), such as advancement of education. The definition of the term charitable also includes advancement of science, promotion of health, promotion of the arts, lessening the burdens of government, and promotion of social welfare. Some of these functions are inherently exempt, such as conferences, publications, and research. These organizations may make grants in furtherance of charitable and like ends.

Q6: What are the functions of an IRC § 501(c)(6) organization?

A6: The typical functions of an IRC § 501(c)(6) organization are those which serve its members. Thus, they include conferences and seminars; trade shows; publications, such as journals, newsletters, and books; award programs; scholarship and fellowship programs; maintenance of a conventional library and/or a Web site; certification programs; research; community outreach programs; public relations programs; attempts to influence legislation; operation of a political action committee; and limited social activities.

II. TAX LAW COMMONALITIES

Q7: Do IRC § 501(c)(3) organizations and IRC § 501(c)(6) organizations have any basic federal tax law commonalities?

A7: Yes. There are six of them.

Q8: What is the first of these commonalities?

A8: Both categories of organizations are exempt from the federal income tax (IRC § 501(a)), and perhaps state and/or local income tax.

Q9: What is the second of these commonalities?

A9: Both categories of organizations are subject to the private inurement doctrine. That doctrine, however, is far more developed in the context of IRC § 501(c)(3) organizations.

Q10: What is the third of these commonalities?

A10: Both categories of organizations are subject to the unrelated business rules (IRC §§ 511-514).

Q11: What is the fourth of these commonalities?

A11: Both categories of organizations are generally required to file annual information returns (IRC § 6033).

Q12: What is the fifth of these commonalities?

A12: Both categories of organizations may utilize one or more for-profit subsidiaries.

Q13: What is the sixth of these commonalities?

A13: Both categories of organizations are subject to the tax on political activities (IRC § 527(f)). This is the tax reason why an IRC § 501(c)(6) organization is likely to have a political action committee. By contrast, an IRC § 501(c)(3) organization is highly unlikely to have a political action committee (see A20).

III. TAX LAW DIFFERENCES

Q14: Do IRC § 501(c)(3) organizations and IRC § 501(c)(6) organizations have any basic federal tax law differences?

A14: Yes. There are eight of them.

Q15: What is the first of these differences?

A15: Nearly all IRC § 501(c)(3) organizations are eligible to receive deductible contributions (e.g., IRC § 170), while IRC § 501(c)(6) are not so eligible.

Q16: What is the second of these differences?

A16: IRC § 501(c)(3) organizations that are public charities are eligible to receive grants from private foundations (and comparable sources), while IRC § 501(c)(6) organizations are highly unlikely to receive grants from private foundation, because of the expenditure responsibility requirements (IRC § 4945(d)(4)(B), (h)).

Q17: What is the third of these differences?

A17: Nearly all IRC § 501(c)(3) organizations are required to file applications for recognition of tax exemption (Form 1023) to be tax-exempt (IRC § 508(b)), while IRC § 501(c)(6) organizations can be tax-exempt without filing an application, although IRC § 501(c)(6) organizations can file an application (Form 1024) if they wish.

Q18: What is the fourth of these differences?

A18: The private benefit doctrine, applicable with respect to IRC § 501(c)(3) organizations, is not applicable with respect to IRC § 501(c)(6) organizations.

Q19: What is the fifth of these differences?

A19: IRC § 501(c)(3) organizations are limited, by the federal income tax law, as to the amount of lobbying they can engage in. By contrast, IRC § 501(c)(6) organizations do not have any restrictions imposed on them by the federal income tax law as to lobbying. (Lobbying activities by IRC § 501(c)(6) organizations can, however, have an impact as to the deductibility of membership dues (IRC §§ 162(e), 6033(e)).)

Q20: What is the sixth of these differences?

A20: IRC § 501(c)(3) organizations are prohibited, by the federal income tax law, from engaging in any political campaign activity. By contrast, IRC § 501(c)(6) organizations do not have any restrictions imposed on them by the federal income tax law as to political campaign activity. (Political campaign activities by IRC § 501(c)(6) organizations can, however, have an impact as to the deductibility of membership dues (IRC §§ 162(e), 6033(e)).)

Q21: What is the seventh of these differences?

A21: IRC § 501(c)(3) organizations are caught up in the intermediate sanctions rules (IRC § 4958). IRC § 501(c)(6) organizations are not subject to these rules (although they can be disqualified persons with respect to IRC § 501(c)(3) organizations).

Q22: What is the eighth of these differences?

A22: This difference pertains to funding. An IRC § 501(c)(6) organization is likely to be highly dependent, for its revenue, on membership dues. An IRC § 501(c)(3) organization is not likely to receive membership dues (although it can). An IRC § 501(c)(3) organization is more likely to be supported by gifts and grants (see A15). Both categories of organizations can receive related business income, investment income, and unrelated business income (see A10).

A23: Can an association be structured as an IRC § 501(c)(3) organization?

Q23: Yes. It is the primary purpose of the organization that determines whether it is an IRC § 501(c)(3) organization or an IRC § 501(c)(6) organization (see A4).

IV. IN-TANDEM OPERATIONS

Q24: Can an IRC § 501(c)(6) organization and an IRC § 501(c)(3) organization operate as related or affiliated organizations?

A24: Yes. As a matter of fact, this is a common practice. Usually, the IRC § 501(c)(6) organization is the parent entity and the IRC § 501(c)(3) organization is the subsidiary entity. Occasionally, nonetheless, the reverse will be the case.

Q25: How is this parent-subsidiary relationship manifested?

A25: The most common practice is by means of overlapping directorates. Another approach is to have the parent be the sole member of the subsidiary.

Q26: Apparently, this type of in-tandem relationship can exist without endangering the tax-exempt status of the IRC § 501(c)(3) organization.

A26: That is generally true, as long as all of the legal corporate niceties are satisfied, such as distinct boards, separate board meeting minutes, separate bank accounts, and the like.

Q27: Why is the previous answer conditioned?

A27: Because a most unfortunate court opinion has been issued in this setting (see A43).

Q28: Can the IRC § 501(c)(6) organization provide the IRC § 501(c)(3) organization with employees, office space, office equipment, and the like?

A28: Yes. This is a common practice. There is no need, by the way, for the IRC § 501(c)(6) organization to charge for these services (termed corporate services). If there is a charge, it should not exceed fair market value. If there is net revenue, it is not taxable as unrelated business income.

Q29: Can the IRC § 501(c)(3) organization provide the IRC § 501(c)(6) organization with employees, office space, office equipment, and the like?

A29: Yes, but this generally is inadvisable. An IRC § 501(c)(3) organization can lose its tax-exempt status if it engages in non-exempt activity to more than an insubstantial extent. If this type of arrangement cannot be avoided, the IRC § 501(c)(6) organization should pay fair market value for the services it receives.

Q30: Why would an IRC § 501(c)(6) organization want to have a related IRC § 501(c)(3) organization?

A30: The answer lies in the concept of bifurcation. What would otherwise be one organization is, wholly for tax reasons, comprised of two entities. This is because then the educational, charitable, and like activities can be funded with contributions and/or grants. There are two basic models to use with this approach.

Q31: What is the first of these models?

A31: The first model has all of the educational, charitable, and like activities that otherwise would be conducted by the IRC § 501(c)(6) organization conducted by the IRC § 501(c)(3) organization. These activities are then, as noted (see A15, A16), funded with gifts and/or grants.

Q32: What is the second of these models?

A32: With the second approach, all of the educational, charitable, and like activities remain in and are conducted by the IRC § 501(c)(6) organization. The function of the IRC § 501(c)(3) organization is to raise money (gifts and/or grants) and make grants to the IRC § 501(c)(6) organization that are restricted to the funding of these activities.

Q33: Which model is the preferable one?

A33: From a law standpoint, there really is no preferable approach; either is quite proper. The first model (see A31) has somewhat of a preference, in that there is no potential issue, as there is with the second model (A32), as to whether charitable dollars are being devoted to noncharitable ends. The model that works best in a given situation will depend largely on personalities and politics.

Q34: Can there be a blend of these two models?

A34: Yes. The IRC § 501(c)(3) organization can conduct some educational and like activities itself and also make grants to the related IRC § 501(c)(6) organization.

Q35: What are some of the types of activities that can be conducted and funded, or just funded, by the IRC § 501(c)(3) organization?

A35: These activities usually are seminars, speakers’ series, publications (such as books and papers), research, maintenance of a library, scholarships, fellowships, and awards.

Q36: Can the recipients and/or beneficiaries of these activities be confined to members of the IRC § 501(c)(6) organization?

A36: Yes.

Q37: When would an IRC § 501(c)(3) organization want to establish a related IRC § 501(c)(6) organization?

A37: This is a far less likely occurrence. The most common use of this arrangement is placement of a program, by which individuals are certified, in a related IRC § 501(c)(6) organization. The IRS is of the view that this type of certification activity is inappropriate for an IRC § 501(c)(3) organization.

Q38: Could an IRC § 501(c)(3) organization utilize a related IRC § 501(c)(6) organization to conduct lobbying that is more extensive than the IRC § 501(c)(3) organization could conduct itself (see A19)?

A38: That can be done but it could be cumbersome if the lobbying organization had to have a membership (see A2). The better approach to this end would be to utilize a related IRC § 501(c)(4) organization.

Q39: In these in-tandem relationships, can the IRC § 501(c)(3) organization be a public charity?

A39: Absolutely. In fact, private foundation status is highly undesirable in this context. This is the case even though these related IRC § 501(c)(3) organizations are generically termed “foundations.”

Q40: What are the options as to public charity status in this context?

A40: The related IRC § 501(c)(3) organization can be publicly supported, either by reason of IRC §§ 170(b)(1)(A)(vi) and 509(a)(1) or by reason of IRC § 509(a)(2). It can be a supporting organization, pursuant to IRC § 509(a)(3). In rare circumstances, it could qualify as a school (IRC §§ 170(b)(1)(A)(ii) and 509(a)(1)).

Q41: Are you certain that it is possible for an IRC § 501(c)(3) organization to be a supporting organization for the benefit of an IRC § 501(c)(6) organization?

Q41: Yes (although there are some at the IRS who do not realize the fact). It is necessary, however, for the supported IRC § 501(c)(6) organization to meet the support requirements of IRC § 509(a)(2).

Q42: Are there any limitations, imposed by law, as to the number of IRC § 501(c)(3) organizations that an IRC § 501(c)(6) may control and use?

A42: No.

Q43: What is the unfortunate court opinion referenced earlier (see A27)?
A43: It is the opinion from the U.S. Tax Court styled Quality Auditing Company v. Commissioner. A summary of this opinion is in the Resource Library. The basic difficulty with this opinion is the court’s finding that the organization that was trying to qualify as an IRC § 501(c)(3) organization was conferring private benefit on the related IRC § 501(c)(6) organization and its members, and thus could not qualify for tax exemption.

For more information on this subject, see Hopkins, The Law of Tax-Exempt Organizations, Eighth Edition (John Wiley & Sons, 2003).

Additional information on this subject is available in Bruce R. Hopkins’ Nonprofit Counsel, a monthly newsletter published by Wiley.