Here’s What You Should Know About Your 501(d)
The 501(d) model of tax exemption echoes all the way back to the use of home-brewed alcohol sales by monks to help keep their monastery running. The tradition of the monastically produced alcoholic beverage goes back over 1,000 years and has yielded the discovery of many a potent potable, from the Trappist style of beer to the sublimely sweet Frangelico and Benedictine from Belgium, and even the “medicinal” elixir Chartreuse, which is still made by monks today. Along similar lines, in the 17th century, a Benedictine monk perfected the method by which all sparkling wine that is made is legally allowed to be called “Champagne:” his name was Dom Perignon. You may be asking, “what does alcohol have to do with my 501(d) Organization?”
This tradition, along with many other communal religious makers of products or providers of services, came to my mind as I read the newly revised IRS Technical Guide on Religious and Apostolic Associations.[1] Although Religious Corporations, houses of worship, and other “Churches” generally don’t look at section 501(d) because doesn’t come with a built-in tax deduction like its famous cousin 501c3; however, it is a powerful tool for any organization looking for additional revenue to fuel their Blessings Model (i.e. when you’re in the business of blessings).
What is a 501(d) Organization?
To qualify for 501(d) tax exemption, an organization must fulfill four (4) elements:
- The organization must be a religious or apostolic association or corporation
- It must maintain a common or community treasury
- It engages in a business for the common benefit of its members; and
- Its members include in their gross income as dividends received their entire pro rata share of the organization’s taxable income for the year, whether such income is distributed to them.
The existence of a Religious Corporation easily fulfils the first element in the State of New York as the Religious Corporations Law requires every entity organized thereunder to be for a religious purpose.
The second element (i.e., common treasury) is a little more complicated. The IRS and the Tax Court use the following criteria to determine whether there’s a “common or community treasury: 1) All income is generated internally by community-operated businesses and from any income generated from property owned by the organization, 2) The income is placed into a common fund maintained by the organization, 3) the income is used for the maintenance and support of its members, 4) all members have equal, undivided interests in this common fund, and 5) no member has the right to claim title to the fund.
If the Grande Chartreuse monastery, where Carthusian monks still make Chartreuse liquor to this day, was a New York Religious Organization, it would easily qualify as a 501(d). It certainly has a “common treasury” and “engages in a business for the common benefit of its members. The funds collected from the sale of their liquor are used to upkeep the order’s facilities and keep the monks clothed and fed, while none of the monks can claim ownership of the monastery itself or its business.
It’s notable that, pursuant to a Tax Court ruling in 1986 that changed the IRS’s position on the subject,[2] members of a 501(d) are not required to take vows of poverty and dispose of all their property holdings outside of the organization to qualify for the exemption. Therefore, the 501(d) organization members can have their own lives, jobs, and income outside of the organization without jeopardizing the exemption.
The final element is somewhat straightforward: each member of the organization must declare their pro rata share of the net profit from the business as their gross income.
What is the advantage of 501(d) over 501c(3)?
An inherent advantage that a 501(d) organization has over its 501c3 counterpart is that a 501(d) organization can engage in, and obtain income from, any non-illicit business activity without paying taxes. 501c3 organizations must pay federal income tax for the net proceeds from “unrelated trade or business income” (i.e., a profitmaking activity that’s not directly related to the organization’s tax-exempt purpose). Here’s an example to put it in perspective. A 501c3 Church may make and sell sacramental wine to other churches purely for ritual purposes, however, that same church would have to pay income tax from any profits received from sale of their wine to the public. A 501(d) organization, on the other hand, is exempt from tax regardless of whom they sell their wine.
So, should my church be a 501(d)
No, but your church can leverage the 501(d) to your advantage by opening a separate Religious Corporation for that purpose. A group that qualifies under 501(d) can generate unlimited revenue for itself which, through tithing, can provide income to the church. This income is deducted against the tax liability for the members of the 501(d) and would not be considered unrelated trade income to the 501c3 Church due to the religious nature of the 501(d).
So, feel free to borrow from the time-honored spirit of Chartreuse monks and apply for a 501(d) tax exemption today. It may turn your water into wine!
For more information about religious corporations and the various tools available to them, please email Todd Kulkin (tk@warren.law).
[2] Twin Oaks Community, Inc. v. Commissioner, 87 T.C. 1233 (1986)