IRS Rules that Most Certification and Accreditation Revenue of 501(c)(3) Associations Is Subject to UBIT
September 13, 2021
In a 2004 ruling, the IRS determined that a Section 501(c)(3) membership association’s certification program generates taxable unrelated business income (“UBI”) to the association. The ruling – a Private Letter Ruling (PLR 200439043, June 28, 2004) issued by the IRS addressing the particular facts of one organization, with the organization’s identifying information redacted – provided valuable insight into the IRS’ approach regarding certification program revenue received by 501(c)(3) organizations and ended up having a significant impact on a large number of 501(c)(3) professional membership associations across the United States.
The result was much more far-reaching than the potential imposition of unrelated business income tax (“UBIT”). Both to avoid having to pay UBIT on certification-related income and to avoid putting the 501(c)(3) organization’s tax-exempt status at risk – which can happen when a tax-exempt organization earns too much UBI as compared to its total income (usually, more than 20 percent of its total income) – since 2004, most 501(c)(3) organizations with certification or accreditation programs ended up creating affiliated 501(c)(6) associations and “spinning off” their certification and accreditation programs into the 501(c)(6) entities.
The 2004 ruling made clear that most certification program revenue is not substantially related to the purposes of a 501(c)(3) organization – which has to primarily benefit the public – because such programs primarily benefit the certified professionals, with usually only incidental benefits to the public. For 501(c)(3) organizations, such public benefits have to outweigh the private benefits, both quantitively and qualitatively. Such income is thus subject to UBIT, with the tax-exempt status of the organization at great risk of revocation if too much UBI is earned compared to total income. Moreover, the 2004 ruling indicated clearly that the IRS will include in its calculation of certification program revenue the income that an organization receives from the sale of study guides and from educational programs that are “designed primarily to assist candidates in passing” a certification examination.
That is not the case for 501(c)(6) associations, where the income will generally be deemed to be substantially related to its tax-exempt purposes and thus tax-free, as the principal purpose of the association is to promote and further the profession or industry represented by the association.
As a result of the 2004 IRS ruling, as stated above, most 501(c)(3) entities with certification or accreditation programs ended up “spinning off” such programs into affiliated 501(c)(6) associations.
For more information, contact Mr. Tenenbaum at jtenenbaum@TenenbaumLegal.com.