What’s the Difference Between a 501(c)(3) and a 501(c)(6)?

If you’re reading this article, you’re probably familiar with the basic concept of a 501(c)(3) tax-exempt organization (even if you didn’t know it was officially called that). As a refresher, 501(c)(3)s are those organizations that have formed themselves as a nonprofit organization at the state level, and then gone on to obtain that coveted tax-exempt status from the IRS based on their charitable purpose. But what many don’t realize is that 501(c)(3) status is only one of a number of different types of tax-exempt statuses the IRS can bestow. The 501(c)(6) status, the more “business-like” brother of the 501(c)(6), is one such status.

SO, WHAT’S A 501(C)(6)?

The IRS commonly refers to 501(c)(6) organizations “business leagues” or “associations,” which is an apt general descriptor for these types of organizations. They are set up with the primary (and permissible) purpose of promoting their members’ common business interests without the intention of making a profit from these activities. This is unlike 501(c)(3)s, which must pursue a charitable mission that benefits the public at large, or a specific charitable class (e.g. the poor, students, the disabled, immigrants, etc.). For this reason, 501(c)(6)s are typically the organization of choice for those individuals or businesses who want to pool resources in order to advance the interests of the specific profession in which they work.

Examples – Chambers of Commerce, Business Improvement Districts, the State Bar Association, an association of craft breweries, etc.

Tax TreatmentSimilar to 501(c)(3) organizations, 501(c)(6)s are exempt from federal income taxes (after submitting a 1024 application, or self-declaring their status), and may be exempt from state and local taxes, depending on their activities. However, unlike 501(c)(3)s, donors to 501(c)(6)s cannot take a charitable deduction on their tax returns for their donations. Businesses who are members of the 501(c)(6), on the other hand, may be able to write off their donations as a business-related expense, provided the business member operates in the same industry as the 501(c)(6).

For this reason, 501(c)(6)s rarely, if ever, receive donations from the general public who aren’t involved in the organization’s industry (after all, who would want to donate to a business organization if they didn’t get some sort of benefit in return? Is true philanthropy even a thing? That’s a discussion for a different time).

Membership – Due to the fact that a 501(c)(6) can’t usually sustain itself on donations from the general public, the overwhelming majority opt to form as “membership” organizations. This results in a setup where the organization receives all, or the majority, of its operating budget from membership dues. In return, members receive the benefits the organization strives to achieve or provide, for example improved conditions in their industry through lobbying elected officials or government agencies, promotional and advertising activities, free or low-cost educational materials and seminars, etc.

Activities – 501(c)(6) organizations must operate to improve the conditions of their chosen industry or region as a whole, and cannot engage in activities designed to drive customers to just one or a few of its members. Additionally, unlike 501(c)(3) organizations, 501(c)(6)s cannot engage in any profit-generating activities (other than, obviously, seeking to add dues-paying members), and are explicitly prohibited from offering the same type of services or products as are sold by its members.

OK, GOTCHA (I THINK). NOW, WHAT ARE THE MAIN DIFFERENCES BETWEEN 501(C)(3) AND 501(C)(6) ORGANIZATIONS?

As we mentioned above, the major difference that many social entrepreneurs care about when deciding between the two types of organization is the inability for donors to take a deduction for their donations to a 501(c)(6) organization. The other significant difference to consider lies in the IRS’ so-called organizational test.

A 501(c)(3) must be organized and operated exclusively for charitable purposes. This requirement encompasses the obligation to include in its organizing document (i.e. Articles of Incorporation, etc.) an explicit statement of its exempt purpose, and this purpose must fit within the IRS’s definition of exempt purpose – either charitable, religious, educational, scientific, literary, and three others that rarely apply. If an organization applies for tax-exempt status under 501(c)(3), and does not meet this requirement, the IRS will likely reject the application. Following the winding path, if a 501(c)(3) does not abide by its stated charitable purpose after it has been granted tax-exempt status, the IRS (or a state’s Attorney General) can seek revocation of the organization’s tax-exempt status (which can be retroactive, leading to a massive headache for all involved).

Besides the two main differences above, there are a significant number of nuanced, but nevertheless important differences between the two types. In the interest of not boring the pants off you with another 5 or 6 walls of text, we have summarized all of the major differences in the table below:

 

  501(c)(3) 501(c)(6)
Donations: Deductible as charitable contributions by donors on their tax returns Not deductible by donors, but businesses may be able to deduct donations as a business expense.
Organizational Test: Must state and abide by a specific exempt purpose. Failure to do so can and will result in a loss of tax-exempt status. Does not necessarily need to have a stated exempt purpose (simply needs to have the purpose of improving the conditions of workers/businesses in their chosen industry)
Assets: Assets must be dedicated to a charitable purpose. In practice this means that any assets donated to the nonprofit cannot be pulled out again, even if the nonprofit shuts down. Upon closing down, its assets must be distributed to other nonprofits with the same or similar mission. No requirement to dedicate assets.
Political Activities: Absolutely and expressly prohibited – organization cannot support or oppose candidates for public office. Political activities permitted, but organization will have to pay taxes on this activity.
Lobbying / Legislative Activities: Permitted, but must be “insubstantial,” which is a vague test (test is set at <20% if organization makes 501(h) election). No limit on legislative activity provided its purpose is to further the stated purpose of the organization.
Funding: Organization must ensure that it generates enough revenue through public donations to meet the IRS’ public support test (1/3 of its operating budget each year). Failure to do so will result in reclassification as a Private Foundation, which has less tax advantages and more stringent distribution requirements. Public support test not a requirement. Most, if not all, of organization’s revenue comes from membership dues.
Filing Requirements: Must file form 1023 (or 1023EZ, for organizations that will make less than $50k each year for 3 years) in order to obtain tax-exempt status. Is not required to file anything with IRS in order to be tax-exempt (can self-declare), but most do file form 1024 as it provides more certainty and familiarity when seeking state and local tax exemption.

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By: Kieran de Terra, Esq. – 02/28/17

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