Tuesday, January 27, 2015

A Peek Inside Fraternal Societies - 501(c)(8) and 501(c)(10)s

From a federal tax perspective, what characteristic do the following organizations share:  The Elks Lodge, the Moose Lodge, the Knights of Columbus, the Order of the Eastern Star, the Freemasons, and the Shriners?  They are all “fraternal societies” under Internal Revenue Code (IRC) sections 501(c)(8) and 501(c)(10).  These organizations are therefore tax-exempt, although they are not qualified to receive tax-deductible contributions (unlike Section 501(c)(3) organizations).  Members of the societies are bound by common unifying objectives beyond purely social dimensions.  As additional features, 501(c)(8)s provide valuable insurance benefits, and 501(c)(10)s provide charitable benefits for millions of people.

Fraternal societies have long been a part of the fabric of American culture.  They reportedly have their “roots in the British friendly societies.  The friendly societies, in turn, were extensions of the medieval guilds, and ultimately of the burial societies of antiquity.”1 In 1868, John Upchurch founded the Ancient Order of United Workmen, the first fraternal benefit society.  Since that time fraternal societies have grown to become important contributors to the well-being of the communities they serve.  According to the National Center for Charitable Statistics, the largest fraternal benefit societies report revenues in excess of several billion dollars annually.2

501(c)(8) and 501(c)(10) Distinctions and Qualifications

Under the Internal Revenue Code, fraternal societies fall into one of two categories:  fraternal benefit societies under section 501(c)(8), which are those that provide benefits, such as life, sick, or accident benefits; and domestic fraternal societies under section 501(c)(10), which are those that do not provide benefits but donate their proceeds to charity.  Domestic fraternal societies are generally smaller, since they do not maintain substantive benefits programs.  Still, domestic fraternal societies often have extensive charitable operations, with operating budgets in excess of $10 million annually. 

To qualify as a 501(c)(8) fraternal benefit society, an organization must:

  1. Have a fraternal purpose.  This means membership must be based on a common tie or the pursuit of a common object.  The organization must have a substantial program of fraternal activities, which cannot be simply social activities.  Such purposes are deemed “fraternal” because of the feelings of commonality pursuing the joint purpose often creates.  As one court put it, “The term ‘fraternal’ can properly be applied to such an association for the reason that the pursuit of a common object…usually has a tendency to create a brotherly feeling among those who are thus engaged.3  While a 501(c)(8) may engage in political activities, such political activities are not considered fraternal and may not be the primary activity of the organization.  

  2. Operate under the lodge system.  The lodge system requires two entities:  a parent, and one or more subordinate organizations, each of which is largely self governing and called a “lodge.”  An organization operates under the lodge system if it is “carrying out its activities under a form of organization that comprises local branches called lodges, chapters, and the like."4
  3. Provide for the payment of life, sick, accident, or other benefits.  All members of the lodge system will ordinarily be eligible for benefits, though an association may establish reasonable criteria for excluding some members.  Notably, the fraternal activities of a 501(c)(8) need not predominate over the benefit-providing activities of the organization. 

Separately-organized insurance corporations that operate exclusively for the benefit of 501(c)(8) fraternal benefit societies also qualify for exemption under 501(c)(8), even if they do not operate under the lodge system.  Many of the largest 501(c)(8) exempt organizations are such separately-organized insurance corporations. 

To qualify as a 501(c)(10) domestic fraternal society, the first two criteria for 501(c)(8) organizations are exactly the same.  But whereas a c(8) must provide benefits for its members, a c(10) may not provide benefits for its members.  Instead, the c(10) must devote all its net earnings exclusively to religious, charitable, scientific, literary, educational, and fraternal purposes.  As a “domestic” fraternal society, a c(10) must also be organized in the United States. 

All of the above qualifications must be met for exemption.  For example, the IRS has denied exemption to an organization whose stated purposes were to “spread friendship and fraternity in the club; to aid the membership in the event of illness, personal injury, or accident; to pay benefits to sick members; in the event of death, to pay a death benefit to whomever the member shall have designated; and to develop patriotism among the membership.”  The IRS determined that because the organization was not operated under the lodge system, it did not qualify for exemption. 

For further information on 501(c)(8)s and 501(c)(10)s, as well as other nonprofit organizations, please contact one of our attorneys at 312.626.1600 or at info@wagenmakerlaw.com, or visit us on the web at www.wagenmakerlaw.com .

1See Leslie Siddeley, “The Rise and Fall of Fraternal Insurance Organizations,” Humane Studies Review, Volume 7, Number 2, Spring 1992.

2 http://nccsweb.urban.org/PubApps/subsectionPicker.php
3 National Union v. Marlow, 74 F. 775, 778-79 (8th Cir. 1896).  

4 2004 IRS EO CPE Text, Barnett and Thomas, “IRC 501(c)(8) Fraternal Beneficiary Societies and IRC 501(c)(10) Domestic Fraternal Societies”

Friday, January 16, 2015

Supreme Court to Hear Same-Sex Marriage Cases

Today (January 16, 2015) the United States Supreme Court granted certiorari to four cases appealed from the federal Sixth Circuit Court of Appeals on the issue of same-sex marriage.  The Court’s decision to hear the cases addresses the recent split between the federal circuits on the issue.  At issue are the following: (1) whether the Fourteenth Amendment requires states to license marriage between two people of the same sex, and (2) whether states must recognize marriages between same-sex couples performed in other states. 

Background:  DOMA and the Sixth Circuit split

In 2013, the Supreme Court struck down the Defense of Marriage of Act (DOMA), which had restricted certain federal benefits to heterosexual unions.  The Court held that Section 3 of DOMA was an unconstitutional violation of the Due Process Clause of the Fifth Amendment.  As reported last month in the Wagenmaker & Oberly blog, following the Supreme Court’s decision, many federal district courts have rapidly overturned state laws prohibiting same-sex marriage as being invalid under the U.S. Constitution’s due process and equal protection protections.  To date, the Fourth, Seventh, Ninth, and Tenth Circuits have decided cases that have effectively legitimized same-sex marriage in the 30 states within those circuits.

Bucking that trend, in November 2014 the Sixth Circuit Court of Appeals reversed decisions of four federal district courts that struck down such state laws.  See DeBoer v. Snyder, No. 14-1341, 2014 WL 5748990.  In validating state laws proscribing same-sex marriage, the Sixth Circuit decision has created a split among the federal courts.  That split concerns the key question of states’ rights to be self-determining with respect to this crucial question on marriage.  According to the two-judge majority in DeBoer, the Fourteenth Amendment does not prohibit a state from defining the nature of marriage.  In particular, the Sixth Circuit court noted that, in each of the states in question, laws proscribing same-sex marriage had been established through extensive legislative and voter activity.  The Court reasoned that the strength of each state’s views on the same-sex marriage issue deserved great deference.  As expected, the Sixth Circuit cases were appealed to the Supreme Court.

The question before the court:  states’ rights and the Fourteenth Amendment

            In the Supreme Court’s granting of cert, the Court consolidated all four cases from the Sixth Circuit.  The Court is limiting its consideration to the two legal issues listed in the above opening paragraph.  Initial briefs are expected to be filed by February 27, 2015, with reply briefs to be filed by April 17, 2015.  It is expected that the Court will also likely receive numerous amicus curiae (“friend of the court”) briefs in support of each side.  A final decision should be forthcoming by the end of June, before the Court recesses for the summer. 


Commentators are already noting the historic significance of this case, whatever its outcome.  The result of the Court’s deliberations may have special importance for religious nonprofits.  Many worshipping bodies and faith-based organizations have strong doctrinal statements and belief systems concerning the nature of marriage, sexual orientation, and same-sex marriage.  The First Amendment generally protects churches, mosques, and other worshipping groups with regard to their beliefs and practices pertaining to sexual orientation and gender identity issues.  On the other hand, non-church religious organizations and faith-based businesses have more limited protections.  Whatever the Supreme Court’s decision, it is likely to significantly impact such groups’ operations and activities.  Our law firm will continue to monitor the progress of briefs related to the case, and provide updates as we have them.

            For further legal information on same-sex marriage, sexual orientation, and gender identity, and the relevance of such issues in the nonprofit setting, please contact one of our attorneys at info@wagenmakerlaw.com or 312.626.1600, or visit us on the web at www.wagemakerlaw.com .

Tuesday, January 13, 2015

Restricted Gifts: Clarity is the Best Policy

When it comes to large donations for special philanthropic projects or goals, clarity is essential for both satisfied donors and responsible nonprofit organizations.  The recent case of Register v. The Nature Conservancy (Dec. 9, 2014), which was decided by a Kentucky federal trial court, amply demonstrates this principle.

The problem began in 2002, when nature-lover and long-time supporter Layton Register made a $1,000,000 gift to The Nature Conservancy (TNC), a nationally respected public charity.  According to court documents, Register and TNC communicated at length about their mutual goal of purchasing Kentucky land known as Griffith Woods.  The purchase was completed later that year, with TNC using Register’s gift plus an internal loan to buy the land for $2,000,000. 

In making his gift, Register expressed an additional goal of continued stewardship and management of Griffith Woods by TNC.  Register’s goal apparently did not pan out.  TNC sold part of the land in 2004 to the University of Kentucky (UK).  TNC sold the rest of the land in 2011 to the Kentucky Department of Fish and Wildlife Resources (KDFWR).   A proposed management partnership between TNC and UK never worked out for UK’s purchased land.  TNC’s additional sale to KDFWR contained few restrictions.  As a result, no portion of Register’s donation ultimately was used to benefit Griffith Woods.  Rather, from TNC’s total $2,000,000 purchase, TNC later received  $2,500,760 in sales proceeds that it used for another land project and for its general operating fund.

The grass clearly was not greener for Register, who by now was a very dissatisfied donor.  He sued TNC for breach of contract, fraud, and other claims, all related to his $1,000,000 gift.  

On a pretrial “summary judgment” motion filed by TNC, the court carefully evaluated the extensive exchange of letters, witness notes, and other evidence relevant to Register’s intentions for his donation and the parties’ understanding about any restrictions thereon.  At the outset, the court recognized that Register may have made a conditional gift to TNC, with legally enforceable restrictions.  TNC did not dispute the legal principle that Register could impose contractual terms for his donation.  Rather, TNC argued that it had met all such terms, by purchasing Griffith Woods.  The question thus was whether TNC had any further obligations, particularly to retain ownership of Griffith Woods or to maintain it as Register originally intended, such as through a conservation easement imposed on a subsequent owner. 

The court determined that Register had indeed intended to make a restricted gift.  Its parameters, however, were unclear.  The court noted the following evidence as highly relevant:  (a) Register’s own words, as reflected in his communications, and the consistency therein; and (b) TNC’s actions in treating his gift as restricted for quite some time.  The court further recognized the legal principle that, although circumstances may change over time (e.g., with new people responsible for leading a nonprofit), “the recipient of a conditional gift is not at liberty to ignore or materially modify the expressed purpose underlying the donor’s decision to give.”  And this is true even if the changed conditions make the agreed-upon obligations burdensome or unwise.

With these legal principles applied to the unclear facts at hand, the court denied TNC’s motion to dismiss the case on such summary basis.  The case thus will proceed to trial (unless the parties can settle), with a jury to decide the factual issues of what restrictions exist and whether TNC has complied with them.  Notably, the court further ruled that if a jury decides in Register’s favor, then he will be entitled to return of his $1,000,000 gift.

What lessons can be learned by responsible nonprofit leaders who wish to cultivate their large donors well and without fear of later controversy? 

First, define all terms of a restricted gift, in a clear and detailed writing. While parties within a charitable context may operate in considerable good faith and with the best of intentions, they nevertheless should treat such significant transactions with all the seriousness due a significant contract.  A good contract reflects a clear “meeting of the minds.”  The written agreement thus should address the following standard contract questions: 
·      What is intended to be given/received? 
·      On what terms? 
·      Within what specified time frames? 
·      By whom?
·      With what/any restrictions?
·      What are the “what if’s” to be addressed, in case of changed circumstances or later problems? 

Second, show consideration for donors by taking these extra steps to document the gift well, both for the present and the future.  TNC lost a dedicated supporter through its own lack of attentiveness to detail.  Other nonprofits take note:  there is no excuse for sloppiness when it comes to sizeable donations.  In addition, one should not assume that a donor will supply the necessary specificity through its own correspondence.  Nor should a nonprofit leader expect that the donor would acquiesce to a gift’s changed use in the event of changed circumstances.

Third, and on a related note, keep in touch with valued donors!  Circumstances may change, making what seemed appropriate at the time no longer so.  Perhaps TNC’s entire philanthropic fiasco could have been avoided if TNC simply had maintained better donor relations with Register.  Even when specific parameters may be ambiguous, as TNC alleged in its case, it may be extremely helpful to ask permission for changing the use of a donor’s original gift.  Such a pragmatic, legally compliant approach is an optimal solution for nonprofits handling restricted donations, thereby showing respect for a donor’s wishes and allowing for mutually agreed gift restriction updates.

For further guidance on charitable contributions and other legal areas affecting nonprofit organizations, please contact one of our attorneys at info@wagenmakerlaw.com, or 312.626.1600, or visit us at www.wagenmakerlaw.com.

Monday, January 5, 2015

When is a “religious” organization religious enough for unemployment insurance tax exemption?

Is your religious organization liable for unemployment insurance tax?  Certain religious nonprofits are indeed exempt from state unemployment insurance tax.  It is important, however, that such nonprofits understand their specific state requirements for exemption, which may be very different from IRS exemption..  Depending on your state’s requirements, even being determined to be a “church” by the IRS may not be enough for state unemployment exemption.

Intro: Exemption for religious groups?

State unemployment insurance laws generally provide an exemption for certain religious organizations.  Illinois is typical, providing exemption for churches, other religious institutions, denominations or similar associations and church-controlled schools

820 ILCS 405/211.3.  But the statutory qualifications, and the courts' interpretations thereof, may vary from state to state.  Religious employers thus should be careful to understand their particular state’s requirements. In addition, they should  be aware that an IRS determination of “church” status or other religious exemption might not, in itself, be enough to qualify an organization for exemption under state unemployment law.   

Consider the following recent example, where a nonprofit organization that served and was closely affiliated with a church was deemed not to qualify for the state “church” exemption from unemployment tax liability, despite the IRS’s recognition of “church” status.

Case: Close but no cigar

In Beverly Hall Corp. v. Unemployment Comp. Bd. of Review, the Pennsylvania court held that an organization, which was purported to be organized for religious purposes, did not qualify for the unemployment tax exemption.  2014 WL 7014088 (Pa. Commw. Ct. Dec. 15, 2014). In that case, an employee who had been terminated was held eligible for unemployment benefits, and his former employer liable for the cost of such coverage.

The employer in question, BHC, is a Pennsylvania corporation associated with the Church of Illumination (Church), a Pennsylvania nonprofit, at which members of the Rosicrucian Fraternity worship.  Id. at *1.  BHC’s activities are intended to advance the Church’s religious beliefs.  In the words of the Church’s spiritual leader,

“[T]he Church of Illumination ha[s], since [its] beginnings, emphasized the importance of the purity of the body as it relates to the growth and advancement of the soul. As that was alluded to earlier in the — one of the meanings of the size of the pyramid. We are taught in Corinthians, in the New Testament, that we are the temples of the living God, and we are not to defile that temple, and the Church takes that quite seriously and to heart . . . Due to the increasing complexity of the ability to find what we consider to be organic, non-chemical, pesticide-free, spiritual food, for our temple, in 2009, Beverly Hall Corporation Board agreed to start a biodynamic -Beatrice Franklin Biodynamic Farm.”

Id. at *2.  With the foregoing as the organization’s spiritual framework, BHC, which operates the farm where the employee worked, grew produce for the Church.  In its argument, BHC relied on this spiritual framework, and the following additional support for its claim that the organization qualified for the exemption:   

·               The Church controlled BHC.  The Church members elected each of the nine voting members and three nonvoting members of BHC.
·               BHC produced testimony that the Farm is not profitable and that since its start, the organization has provided approximately $200,000.00 in subsidies. 
·               The Internal Revenue Service (IRS) determined in 1971 that BHC constituted a “church,” and that since that time, the Commonwealth of Pennsylvania re-approved and recertified its non-profit status. 

For these reasons, among others, BHC argued it was a religious organization, and thus qualified for the exemption. 

The court disagreed.  The court noted that, according to the Church’s own spiritual leaders, BHC is “the entity that runs the logistics of the [C]hurch” by “maintaining the grounds, the buildings, [and] hiring the personnel needed to perform the [C]hurch functions.”  Id.  The court reasoned, “The only testimony regarding the purpose of BHC clearly establishes that it was created not for religious purposes, but to perform the administrative, non-theological work of the Church, such as ground and building maintenance and hiring.”  Id. at *5.  That the IRS had recognized the BHC as a “church” was not a determinative fact in this case.  Indeed, “[a] nonprofit corporation responsible solely for managing the administration and finances of a religious organization is not ‘operated primarily for religious purposes.’”  Id. (internal citations omitted).

Lessons learned

The above case provides insight useful to nonprofit leaders in at least two important ways.  First, all nonprofit organizations should be mindful of applicable state laws concerning unemployment insurance tax liability.  In Illinois, under the Illinois Unemployment Insurance Act (“Act”) and subject to certain qualifications, if a nonprofit employer does not have, or has not had, four or more employees for at least twenty calendar weeks in a given year, the entity is considered exempt from the payment of contributions to the Illinois Department of Employment Security.  Under the Act, employees of such an organization will not eligible to receive unemployment insurance benefits and must be notified of such ineligibility under the Act.  Similar requirements may apply to nonprofits in other states. Nonprofits that conduct their operations in multiple states should further be aware of the complex requirements governing unemployment taxation in such scenarios.  Please see our firm’s December 2014 blog article on multi-state unemployment insurance requirements.

Second, religious organizations seeking further exemption from unemployment insurance tax should be careful to understand the distinctions between exemption standards under federal and state law. Standards under many state-level taxation regimes, like unemployment insurance, are often very different than the base standard for federal income tax exemption under Section 501(c)(3).  Religious organizations should therefore seek qualified legal counsel to determine whether state-level exemptions apply.

For further information concerning employment-related  considerations affecting nonprofit organizations, please contact one of our attorneys at info@wagenmakerlaw.com, or 312.626.1600, or visit us on the web at www.wagenmakerlaw.com