Tax-Exemption For Your Chapter
By Patti Arthur
One of the most common questions we hear is how to operate or form an EAA Chapter so that it is tax exempt. There are two provisions of the Internal Revenue Code that allow tax-exempt status. Examining these allows one to develop a general framework on how to acquire it and keep it.
First, a simple description (if it can ever be called that) of Section 501 of the Internal Revenue Code is in order. This is the fairly complex section of the federal tax law that exempts certain types of business organizations from federal income taxation. However, this law also says an organization will be taxed on any income it earns that is “not substantially related” to its exempt purpose. This “unrelated income” will be taxed at the normal corporate rates.
Excessive unrelated income can lead to revocation of tax-exempt status, although this rarely happens. Additionally, to acquire and keep tax-exempt status, no part of an organization’s net earnings may “inure” to the benefit of any individual or private shareholder.
It is this “private inurement” that sets non-profits apart from for-profit companies. You see, tax-exempt organizations may certainly earn a profit. They just cannot let that profit benefit private shareholders or individuals in a way that is outside of the tax-exempt purpose. That profit must be put back into the organization to further its tax-exempt purpose for the existence, and can include things such as upkeep of facilities and compensation for employees.
Now, let’s get to the heart of the matter and see how we can become a tax-exempt Chapter. There are essentially two sections of the Internal Revenue Code that fit EAA Chapters: Sections 501(c)(3) and (c)(7). Section 501(c)(3) describes “charitable organizations” and (c)(7) covers recreational and social clubs. Depending on the nature and purpose of the individual chapter and its regular activities, it should fit into one of these sections.
Section (c)(7) is a little easier to describe, so let’s cover that first. This section allows federal tax-exempt status for clubs and social organizations established primarily for pleasure, recreation, and other non-profit purposes. This would adequately describe an EAA Chapter whose main purpose is to gather members together for social activities, Saturday afternoon hangar get-togethers, fly-ins, cookouts, an annual Christmas party, and so on.
The organization can also be involved in certain other “non-profit” activities like safety seminars, educational programs on aircraft maintenance for members, “Kids Day” events to introduce children to flying, Young Eagles flights, and flights by members donated to take sick children to medical treatment, as long as the primary purpose of the chapter is for social and recreational purposes.
Tax-exempt status under the more coveted Section 501(c)(3) is a little more difficult to describe. This section provides tax-exempt status for organizations engaged in “charitable purposes.” These purposes may be many or few, but essentially they are those activities that benefit the public in some manner. They may be educational, religious, scientific, literary, or any number of other activities that help citizens. Once again, no net profit can inure to the benefit of private shareholders or individuals.
In addition to the earnings of the organization being exempt from tax, Section 501(c)(3) allows donations to be tax deductible to the giver, which is why many chapters desire (c)(3) status. Along with that benefit, however, come many burdens.
Upon application for this status, the chapter must demonstrate to the IRS that its primary purpose is indeed “charitable,” and that it exists to benefit the public in some manner. It must show an abundance of activities that, for example, educate its members and the public on safety, aeromedical factors, or aircraft maintenance and compliance with the FARs.
The chapter can also have a focus on bringing the delights of flying to children by conducting school visits or Young Eagles programs, or have science and education days for field trips at its facilities. It can provide free flights to citizens requiring a medical treatment or conduct “Make-A-Wish” type programs. You might even have a chapter whose sole purpose is to run an aviation history library.
Essentially, that main purpose has to pass the “sniff test” to be awarded (c)(3) status. This doesn’t mean a chapter can’t have cookouts and holiday parties for its members. The primary purpose, however, must be charitable, educational, or scientific, to convince the IRS that (c)(3) should be granted.
To acquire tax-exempt status, a chapter would complete IRS Form 1024 to go under Section (c)(7), and Form 1023 for the more elusive (c)(3) status. Let me assure you, both forms are long and difficult to complete and should always be tackled under the guidance of an attorney or CPA familiar with tax-exempt organizations. The IRS examines these forms carefully and they must be completed with precision and proper advocacy.
A good place to start understanding what the IRS wants is Publication 557: Tax-Exempt Status for Your Organization. Any chapter considering tax-exempt status should get this publication and read it cover to cover with thought and consideration. Publication 557 and Forms 1023 and 1024 (along with a voluminous amount of other helpful guidance) can be found at www.irs.gov.
After reading Publication 557, try downloading Form 1024 or 1023, as appropriate, and go over the form carefully. At the end of those forms is a long checklist of documents the IRS also requires. That checklist includes things an organization must do prior to filing for tax-exemption. For example, the organization must elect directors and file Articles of Incorporation or Organization, adopt by-laws (EAA has by-law guidelines available), receive a tax ID number from the IRS, disclose detailed (actual or proposed) financial data, and enclose the application fee.
After the form is complete and the required documents enclosed, the Exempt Plans/Exempt Organizations Division (EP/EO) of the IRS will review the package and issue a Determination Letter either granting tax-exempt status or denying it, and explaining the reason for denial. Denial usually results from incomplete answers on the form, generalities in describing the chapter’s activities, lack of financial data (or proposed data for new chapters), or just plain not meeting a tax-exempt purpose. A chapter may appeal a denial and can be successful if the original denial was based on incomplete information.
GOT IT? KEEP IT
Once a letter is issued granting tax-exempt status, one important detail required to keep it is to keep excellent records. If your gross receipts are more than $25,000, make sure you file an annual tax return for the chapter on Form 990 or 990-EZ. File Form 990-T if your chapter conducts activities that earn income not related to its tax-exempt purpose. Simply having this income is usually not enough to cause revocation, but it has been known to happen. Failure to file any return can result in steep fines.
The best way to keep your tax-exempt status is to stay true to your purpose. It’s a good idea to go over the original application on Form 1023 or 1024 once a year and do a little self-examination on the chapter’s activities. Keep a record of that as well.
Federal tax-exempt status can provide many benefits for EAA Chapters. This article discussed only the basics and there is much more to the story. If this is a path your chapter would like to explore, contact EAA or get in touch with a local attorney or CPA for more details specific to your particular group.
Patti Arthur is a member of the EAA Legal Advisory Council. Her law practice is based in Colorado and is limited to aviation tax matters and advising tax-exempt organizations.
Reprint – Sport Aviation March 2006