There are limitations on activities organizations can conduct based on their specific tax exempt status under Section 501(c)(3) or Section 501(c)(6) of the Internal Revenue Code, respectively. Section 501(c)(3) organizations must be organized and operated primarily for charitable, educational, religious, or scientific purposes. Section 501(c)(6) organizations must be organized and operated to advance a type of business or profession as a whole. It is important to determine whether development and implementation of standards, assessments, and certification programs are consistent with Section 501(c)(3) purposes or Section 501(c)(6) purposes.
Under the Internal Revenue Code and IRS regulations, educational purposes relate either 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.” Treas. Reg. 1.501(c)(3)-1(d)(3). Examples of educational organizations include schools with regularly scheduled curriculums, museums, and organizations that present public discussion groups, forums, panels, lectures or similar programs. In a series of revenue rulings, the IRS has provided further guidance on what types of activities are considered “educational” for these purposes.
Pure instructional programs that provide training directly to individuals are of course considered educational in nature (see, e.g., Rev. Rul. 77-272, 1977-2 C.B. 191, providing apprenticeship training programs to Native Americans furthers educational purposes), as are organizations that publish and disseminate informational material which confers a benefit on the public as a whole (see, e.g., G.C.M. 38459, July 31, 1980, publication of weekly periodical and scholarly articles furthers educational purposes). In addition, the IRS has found that an engineering society qualified for exemption under Section 501(c)(3), because its research was conducted for the benefit of, and distributed freely to, the general public. Rev. Rul. 71-506, 1971-2 C.B. 232.
However, activities that primarily benefit the members of a given profession rather than the community at large will generally not be considered educational within the meaning of Section 501(c)(3). For example, in Rev. Rul. 76-366, 1976-2 C.B. 144, an association of investment clubs did not further educational and charitable purposes, because “many of the activities [of the organization were] directed in whole or in part to the support and promotion of the economic interests of the investment clubs that comprise its membership.” Also, in Rev. Rul. 74-553, 1974-2 C.B. 168, a nonprofit organization that administered peer review boards was not operated exclusively for charitable and educational purposes, because “its primary objective is to maintain the professional standards, prestige, and independence of the organized medical profession and thereby furthers the common business interest of the organization’s members.” Likewise, in Rev. Rul. 73-567, 1973-2 C.B. 178, a medical specialty board that devised and administered examinations to physicians did not qualify as a Section 501(c)(3) exempt organization, because the organization’s activities were directed primarily to serving the interests of the profession.
In Rev. Rul. 71-505, 1971-2 C.B. 232, a city bar association conducted many bona fide educational activities, such as sponsoring educational seminars, publishing articles, maintaining speaker panels, and providing legal assistance to indigent individuals. However, the association also conducted activities that were “directed at the promotion and protection of the practice of law” and furthered the common business purposes of the members, and the IRS found that the existence of these non-educational purposes precluded designation of the association as a Section 501(c)(3) organization. Similarly, the IRS held in Rev. Rul. 71-504, 1971-2 C.B. 231, that a medical society that engaged in a variety of educational activities, but also provided a patient referral service and conducted public relations activities for the profession, was not operated exclusively for educational and charitable purposes.
Specifically, IRS officials have often interpreted standard setting and certification activities (even when conducted in conjunction with legitimate educational and training activities) as primarily advancing the business interests of a particular industry or of the individuals credentialed more consistent with a Section 501(c)(6) organization rather than one dedicated to the public interest under Section 501(c)(3). For example, in Rev. Rul. 70-187, 1970-1 C.B. 131, product testing and certification activities were considered self-regulatory measures to prevent trade abuses in an industry and consistent with Section 501(c)(6) status. In P.L.R. 8315046, a testing, inspection, and certification program for products was considered an activity in furtherance of improvement of business conditions and found to be consistent with Section 501(c)(6) status. Further, the IRS has challenged certification programs as inconsistent with Section 501(c)(3) status, whether or not the certification activities are substantial in relation to the organization’s budget. Thus, any formal testing and certification program traditionally could provide grounds for the IRS to revoke or deny Section 501(c)(3) status, or require that certification activities be “spun off” to a Section 501(c)(6) organization.
However, a recent ruling by the IRS signaled a change in its position. P.L.R. 200439043 involved a large Section 501(c)(3) organization that conducted numerous activities, including operation of a professional certification program. Consistent with prior holdings, the IRS found that the certification activities were not “substantially related” to exempt purposes under Section 501(c)(3). The IRS took the position that an activity might be consistent with, appropriate for, and related to Section 501(c)(6) activities, but nonetheless would not be “substantially related” to Section 501(c)(3) exempt purposes.
The IRS also found, however, that the certification program was “insubstantial” in comparison with the extensive activities of the organization and would not jeopardize its Section 501(c)(3) status. This appears to be a significant departure from previous IRS positions, in which any sort of a substantial or significant certification program would be held inconsistent with 501(c)(3) status and, thus, not appropriate to be conducted by such an organization. As a result, many Section 501(c)(3) organizations had spun off certification programs into Section 501(c)(6) entities as a reasonable way to protect the tax exempt status of the main organization.
Because the program was also considered a “regularly carried on” trade or business, the IRS further held that revenues from the certification program would be considered unrelated business income subject to tax (“UBIT”)1 to a Section 501(c)(3) organization. It is likely that many Section 501(c)(3) organizations have not been treating revenues from such exclusively-(c)(6) activities as UBIT, but rather considering them simply insubstantial although not taxable. In addition, the ruling is noteworthy because it concludes that an insubstantial professional certification program will not jeopardize the main organization’s Section 501(c)(3) status. The ruling does not discuss what specific factors led the IRS to conclude that the program was insubstantial, i.e., whether revenues, budget amounts, size of staff, etc. were determinative. The IRS does not, however, direct that such a program be carved out and separated from the Section 501(c)(3) organization.
This position has important implications for any Section 501(c)(3) organizations conducting activities that might be characterized as predominantly in furtherance of (c)(6) but not (c)(3) purposes, including not only certification, but also other peer review activities, professional referral programs, industry advocacy efforts, etc. It should be emphasized, too, that a Private Letter Ruling such as this one is explicitly not considered to be “precedent” binding upon other exempt organizations beyond the one for which the ruling was issued.
Another important yet unique aspect of the legal analysis involves certification programs that have been developed pursuant to a direct or indirect governmental mandate. Where the activity arguably “lessens the burdens of government,” the IRS has traditionally granted Section 501(c)(3) status. An important case in this regard is Indiana Crop Improvement Assn. v. Commissioner of Internal Revenue, 76 T.C. 394 (1981), in which an Indiana university, which previously had performed agricultural regulatory functions on behalf of the state, delegated to a private nonprofit association the responsibility of seed certification in accordance with Indiana and federal law. The association also conducted research and educational activities.
The court found that the association’s certification activities were in furtherance of an exempt charitable purpose under Section 501(c)(3), because the association lessened the burdens of government. See also G.C.M. 37222 , August 19, 1977 (preparation of test format to be used by state registration boards does not involve the instruction or training of individuals and is not “educational” within the meaning of Section 501(c)(3), but constitutes “lessening the burdens of government” provided the organization’s governing documents reflected such purposes and the organization was not formed to support another non-Section 501(c)(3) organization). So, where a certification program is developed and conducted pursuant to requirements of federal or state law, it will be reasonable to take the position that such program lessens the burdens of government and should be consistent with Section 501(c)(3). It should be noted, however, that lessening the burdens of government as a ground for supporting Section 501(c)(3) status has not, as a general matter, been recently favored by the IRS.
It is important for professional certification organizations to be cognizant of the IRS position on these issues. While many organizations with Section 501(c)(3) status may conduct professional certification programs, either as a significant or insignificant portion of their overall activities, proactively considering these issues would be advisable to avoid controversy with the IRS at some point in the future.
Footnotes
Tax exempt organizations are subject to tax on net revenues considered to be unrelated to their exempt purpose and function, i.e., UBIT. To determine whether an organization has UBIT, three factors must be present. The income must be (i) from a trade or business, (ii) that is regularly carried on, and (iii) that is unrelated to the organization's exempt purpose. While a comprehensive analysis of UBIT is beyond the scope of this article, excessive amounts of UBIT (for example, over perhaps forty percent of the organization’s budget) will jeopardize tax exempt status.