Self-Declared Exempt Organizations – A Guide to Ensure IRS Compliance

Self-Declared Exempt Organizations

In its 2012 workplan, the IRS announced it will be paying closer attention to self-declared exempt 501(c)(4), (c)(5), and (c)(6) organizations. These groups include social welfare organizations; labor, agricultural and horticultural groups, business leagues, and chambers of commerce.

Such organizations consider themselves to be tax-exempt because of the nature of their activities, but they have not filed for nor received a formal determination letter from the IRS. These groups are allowed to operate without an official IRS determination because, unlike the 27 month filing deadline for 501(c)(3) charities, they are not subject to a deadline for filing an application for exemption.

The IRS has stated that it will send a comprehensive questionnaire to such organizations in 2013 to ensure that they have classified themselves correctly and that they are complying with applicable rules. Because of the increased scrutiny, now is a good time for such organizations to review their activities to ensure compliance with the law.

Self-declared organizations may also wish to file Form 1024 to obtain formal IRS recognition of their tax-exempt status. The basic requirements for these groups are as follows:

501(c)(4) Social Welfare Organizations

In order to be a 501(c)(4) Social Welfare Organization, an organization must meet certain operational criteria. An organization is organized and operated to promote social welfare if it is primarily engaged in promoting the common good and general welfare of the community or is committed to civic betterment and social improvements. Further, the earnings of a Section 501(c)(4) organization may not inure to the benefit of any private shareholder or individual. If the organization engages in an excess benefit transaction with a person having substantial influence over the organization, an excise tax may be imposed on the person and any managers agreeing to the transaction.

Update: New legislation enacted at the end of 2015 added Section 506 to the Internal Revenue Code. Section 506 requires an organization to notify the IRS of its intent to operate as a Section 501(c)(4) organization. The IRS has developed a new form – Form 8976 – that organizations should use to provide this notification.

501(c)(5) Labor, Agricultural, or Horticultural Organizations

Section 501(c)(5) provides for the exemption of laboragricultural or horticultural organizations. To be exempt, an organization must meet the following requirements:

  • The net earnings of the organization may not inure to the benefit of any member; and
  • The objects of the organization must be the betterment of conditions of those engaged in the pursuits of labor, agriculture, or horticulture, the improvement of the grade of their products, and the development of a higher degree of efficiency in their respective occupations.

Generally, an organization is not described in section 501(c)(5) if its principal activity is to receive, hold, invest, disburse, or otherwise manage funds associated with savings or investment plans.

501(c)(6) Business Leagues and Chambers of Commerce

A business league is an association of persons having some common business interest, the purpose of which is to promote such common interest and not to engage in a regular business of a kind ordinarily carried on for profit. For example, trade associations and professional associations are business leagues. To be exempt, a business league’s activities must be devoted to improving business conditions of one or more lines of business as distinguished from performing particular services for individuals. No part of a business league’s net earnings may inure to the benefit of any private shareholder or individual and a business league may not be organized for profit or to engage in an activity ordinarily carried on for profit (even if the business is operated on a cooperative basis or produces only enough income to be self-sustaining).  The term line of business generally refers either to an entire industry or to all components of an industry within a geographic area.  It does not include a group composed of businesses that market a particular brand within an industry.

To qualify as a 501(c)(6) business league, the organization must be organized to promote its members’ common business interests. Similar to a 501(c)(4) organization, a 501(c)(6) organization cannot engage in unrelated business activity to more than an incidental degree and is prohibited from performing services for individual members. Rather, the organization must promote the industry it was formed to support as a whole, even if it benefits persons who are not members of the league.

A 501(c)(6) chamber of commerce is an organization of the same general class as a business league, except that where a business league serves only the common business interests of a single industry,  a chamber of commerce serves the economic interests of a community. It is an organization where the common business interest is generally the economic welfare of an entire community. Membership in a chamber of commerce is voluntary and open generally to all business and professional men in the community.

Additional Traits Common to 501(c)(4), 501(c)(5), and 501(c)(6) Organizations

Certain characteristics are common to both 501(c)(4), 501(c)5), and 501(c)(6) organizations. Specifically, such organizations must:

  • not be organized for profit;
  • ensure that no part of its net earnings inure to the benefit of any private shareholder or individual; and
  • ensure that unrelated business activities are conducted on an insubstantial basis if at all.

In addition, such organizations may devote a substantial part of their activities to lobbying purposes so long as it is related to their exempt purpose. For tax purposes, lobbying essentially means attempting to influence legislation by urging members of the legislature to propose, support, or oppose the legislation. Lobbying also includes asking members of the public to take action expressing their support or opposition to the legislation.

Such organizations are also permitted to participate in political campaigns so long as such activities are related to their exempt purpose and are insubstantial in relation to their overall activities. However, the amounts expended for such activities may be treated as political organization taxable income.

Also, the organizations must notify dues-paying members of the portion of dues that the organization reasonably estimates will be allocable to the organization’s political campaign expenditures during the year, as that portion of dues is not deductible as a business expense. Alternatively, such organizations may elect to pay a proxy tax on the amount of membership dues that were used for political campaigns or lobbying activities.

Charitable Tax Deduction

Section (c)(4), (c)(5), and (c)(6) organizations should be aware that unless the organization is a public entity that uses the donation for public services (e.g., state or local government or volunteer fire department), charitable deductions to the organization are not tax deductible.

Update: As of January 7, 2013, applications for exemption that are filed after the 27 months following the entity’s formation will not receive a letter dating back to the postmark date of the application. The IRS will no longer issue retroactive recognition of exemption for organizations that have not filed within 27 months of formation. See, Rev. Proc. 2013-9.

Ellis Carter is a nonprofit lawyer with Caritas Law Group, P.C. licensed to practice in Washington and Arizona. Ellis advises nonprofit and socially responsible businesses on corporate, tax, and fundraising regulations nationwide. Ellis also advises donors with regard to major gifts. To schedule a consultation with Ellis, call 602-456-0071 or email us through our contact form

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