The tax laws in the United States provide for several types of tax-exempt organizations, including charities, social welfare organizations, and business leagues.
In Private Letter Ruling 200709070 the IRS has brought attention to the requirements for organizations to qualify as a tax-exempt “business league.” The ruling denied tax-exempt status to a referral/leads group on the grounds that its activities did not improve the business conditions of one or more businesses, its primary activities consisted of providing services for particular persons, and it was engaged in a regular business of a kind ordinarily carried on for profit.
This ruling presents an opportunity to review the specific requirements for a business league to qualify for tax-exempt status, including the common business interest, membership organization, and not-for-profit requirements.
What is a Private Letter Ruling?
Before getting into the IRS’s decision, we first have to have a basic understanding of what an IRS private letter ruling is.
An IRS private letter ruling is a written statement issued by the IRS in response to a taxpayer’s request for guidance on a particular tax matter. It applies only to the specific taxpayer who requested it and the particular situation described in the ruling.
Private letter rulings are intended to provide clarity on how the tax laws and regulations apply to a specific set of facts or circumstances. They are not binding on the IRS or the courts, but they can be helpful in providing guidance to taxpayers who are unsure about how to apply the tax laws to their particular situation.
Private letter rulings are generally not made public, although redacted versions may be released to protect taxpayer confidentiality while providing guidance to other taxpayers facing similar issues. To obtain a private letter ruling, a taxpayer must submit a detailed request that includes a description of the relevant facts and circumstances, as well as a legal analysis of the tax issues involved. The IRS charges a fee for issuing a private letter ruling, and the process can take several months.
What is a Tax Exempt Business League?
We also need to have an understanding of what a business league is.
A “business league” is an association of persons having a common business interest, whose purpose is to promote the common business interest and not to engage in a regular business of a kind ordinarily carried on for profit. Its activities are directed to the improvement of business conditions of one or more lines of business rather than the performance of particular services for individual persons.
The Treasury Regulations set out the following specific requirements for business leagues:
- It must be an association of persons having some common business interest and its purpose must be to promote this common business interest;
- It must be a membership organization and have a meaningful extent of membership support;
- It must not be organized for profit;
- No part of its net earnings may inure to the benefit of any private shareholder or individual;
- Its activities must be directed to the improvement of business conditions of one or more lines of business as distinguished from the performance of particular services for individual persons;
- Its primary activity does not consist of performing particular services for individual persons; and
- Its purpose must not be to engage in a regular business of a kind ordinarily carried on for profit, even if the business is operated on a cooperative basis or produces only sufficient income to be self-sustaining.
Each factor has to be considered.
Referral Group is not a Business League
According to the IRS, this referral group did not qualify as a “business league” because its activities did not improve the business conditions of one or more businesses, its primary activities consisted of providing services for particular persons, and it was engaged in a regular business of a kind ordinarily carried on for profit.
The IRS focused on the following facets of this referral/leads group: it restricted its membership to individuals or firms in a different trade, businesses, or occupations who do not compete with each other; its primary purpose was to provide exclusive listings (or referrals/leads) to its members, and the group did not do anything to help business conditions outside of helping their own businesses.
Other Options Might Work
So what could the referral/leads group have done differently that might have qualified it for not-for-profit status?
Perhaps it could have segregated its activities into for-profit and not-for-profit activities and operated two separate business enterprises for each activity. Perhaps it could have promoted business ethics to members or required its members to promote business ethics outside of the group in an effort to help business conditions outside of helping individual member businesses. Perhaps it could open multiple chapters so that members from competing trades or businesses could participate while still maintaining the integrity of the referral/leads group.
This is an example of why advanced tax planning can come in handy.