Comments on Budget Proposal to Tax the Investment Income of Section 501(c)(6) Organizations.

March 8, 2000

On March 8, 2000, Tax Executives Institute sent the following comments to Senator William V. Roth, Chairman of the Senate Finance Committee, and Representative Bill Archer, Chairman of the House Ways and Means Committee, concerning the Clinton Administration's proposal to tax the investment income of section 501(c)(6) organizations.

On February 7, 2000, President Clinton released his budget proposals for the fiscal year 2001. Included in those proposals was a provision to tax the investment income of organizations exempt from tax under section 501(c)(6) of the Internal Revenue Code. For the reasons set forth below, Tax Executives Institute strongly opposes the enactment of the proposal.

Background

Tax Executives Institute is the preeminent association of corporate tax professionals in North America. TEI has 5,000 individual members who represent more than 2,800 of the leading corporations in the United States, Canada, and Europe. As a professional association, TEI is dedicated to the development and implementation of sound tax policy, to promoting the uniform and equitable enforcement of the tax laws, and to reducing the cost and burden of administration and compliance to the benefit of both government and taxpayers. The companies represented by TEI members belong (either directly or through their employees) to numerous associations, including the Institute itself, that would be subject to the Administration's proposal.

The President's Proposal Should Be Rejected

Section 501(c)(6) of the Internal Revenue Code provides an exemption from income tax for nonprofit business leagues, chambers of commerce, and professional and trade associations. Such organizations are not taxed on the revenues derived from membership dues and exempt purpose activities. Income derived from unrelated business activities, however, is taxed under section 511 at the regular corporate rate, but an exclusion is provided for investment income derived from interest, dividends, rents, and royalties.

The Administration's fiscal year 2001 budget package exhumes a proposal to eliminate the current exclusion from unrelated business income tax (UBIT) in respect of investment income in excess of $10,000 earned by section 501(c)(6) organizations (such as TEI). The Administration explained the rationale for the proposal, as follows:

   The current-law exclusion from the UBIT for certain investment income of a
   trade association allows the organization's members to obtain an immediate
   deduction for dues or similar payments to the organization in excess of the
   amounts needed for current operations, while avoiding tax on a
   proportionate share of the earnings from investing such surplus amounts. If
   the trade association member instead had retained its proportionate share
   of the surplus and itself had invested that amount, the earnings thereon
   would have been taxed in the year received by the member. Although in some
   instances investment income earned tax-free by a trade association may be
   used to reduce member payments in later years, and hence reduce deductions
   claimed by members in such years, the member still has gained a benefit
   under current law through tax deferral. Thus, under current-law rules,
   trade association members may be able to claim current deductions for
   future expenses. Even assuming that dues and similar payments would be
   deductible by the member if made in a later year, to the extent that
   investment income is earned by the trade association in one year and spent
   in a later year, the current-law exclusion effectively provides the benefit
   of a deduction before the expenditure actually is made.

U.S. Department of Treasury, General Explanations of the Administration's Fiscal Year 2001 Revenue Proposals 177 (Feb. 2000). The Administration's proposal at once misapprehends and minimizes the basis of the tax exemption for organizations specified in section 501(c)(6) and the reasons for the UBIT provisions under which certain income of such organizations is currently subject to tax.

The Administration essentially ties the exemption from tax of investment income to whether an association's members deduct their dues and asserts that since members of a trade association can generally deduct dues payments, exempting investment income earned on "excess" dues payments would constitute an unwarranted double tax benefit.

An organization qualifies for exemption under section 501(c)(6) of the Code only if its activities are "directed to the improvement of business conditions of one or more lines of business as distinguished from the performance of particular services for individual purposes." Treas. Reg. [sections] 1.501(c)(6)-1 (1958). Where the revenues to fund those activities derive from is not the key issue. Hence, while dues and other exempt purpose revenues (e.g., fees from educational programs) may be used to fund an organization's exempt purposes, investment income is also an important source of revenue. The use of passive investments promotes economic stability and permits organizations to maintain operating funds in accordance with legitimate cash management policies. Without alternative forms of revenues, membership organizations may be forced to raise their dues -- an action that would generate a currently deductible business expense and certainly vitiate any revenue-raising purpose behind the proposal.(1)

The Administration errs in linking the exemption from tax to whether and when the members of the exempt organization may deduct their dues. Indeed, the UBIT provisions currently in the Code were enacted primarily to eliminate a source of unfair competition by placing the unrelated business activities of a tax-exempt organization on the same tax basis as for-profit activities. Hence, when the tax was enacted as part of the Revenue Act of 1950, Congress explained its narrow intent, as follows:

   The problem at which the tax on unrelated business income is directed here
   is primarily that of unfair competition. The tax-flee status of [section
   501] organizations enables them to use their profits tax-free to expand
   operations, while their competitors expand only with the profits remaining
   after taxes.

H.R. Rep. No. 81-2319, 81st Cong., 2d Sess. 36-37 (1950); S. Rep. No. 81-2375, 81st Cong., 2d Sess. 28-29 (1950).(2) Congress recognized, however, that, in the absence of unfair competition, investment income was an important source of revenue for tax-exempt organizations; it therefore excluded interest, dividends, rents, and royalties from the UBIT "because they are `passive' in character and are not likely to result in serious competition for taxable businesses having similar income." H.R. Rep. No. 81-2139 at 36-38; S. Rep. No. 81-2375 at 30-31. Hence, the UBIT provisions were not motivated by the connection between an exempt organization's investment income and its members' dues payments.

Contrary to the Administration's assumption, not everyone paying dues to section 501(c)(6) organizations necessarily realizes a tax benefit from those payments. For example, many (though concededly not most) TEI members pay their dues personally (rather than have their dues paid or reimbursed by their corporate employer). Because of the limitations on deducting employee business expenses, those members may not enjoy a tax benefit associated with their dues.

Finally, members of organizations exempt under other provisions of the Internal Revenue Code -- associations the Administration does not propose to subject to the tax on investment income -- may enjoy comparable tax benefit for their dues or other payments to the association. Members of labor unions (which are exempt under section 501(c)(5)), for example, are entitled to deduct their dues as employee business expenses. The Administration, however, does not propose to tax the investment earnings of those organizations, presumably because the availability or nonavailability of a deduction for dues is irrelevant to the purpose of which the exemption from tax was granted: Such organizations advance socially laudable ends. The same is true of organizations exempt under section 501(c)(6).

Conclusion

In an organization such as TEI, revenues are used to fund educational programs, cooperate in joint projects with the Internal Revenue Service and other government taxing authorities, comment on specific tax issues, and facilitate better communication between tax officials and its own members -- all of which further the Institute's exempt purposes and its ongoing commitment to maintaining a tax system that works. Passive investment income permits the organization to provide public service on tax administrative matters to the benefit of both corporate taxpayers and the government. Other section 501(c)(6) organizations serve similarly salutary purposes. The reason for exempting such investment income from UBIT is just as valid today as it was half a century ago. The Administration's proposal to tax such income should be rejected.

Tax Executives Institute appreciates this opportunity to present our views on the Clinton Administration's Budget Proposal to tax the investment income of section 501(c)(6) organizations. If you have any questions, please do not hesitate to contact me at [phone], or Timothy J. McCormally of the Institute's professional staff at [phone].

(1) The Administration acknowledges this but contends its proposal is nevertheless meritorious because current law "effectively provides the benefit of a [dues] deduction before the expenditure actually is made." We suggest that such a "matching" rationale betrays a compulsion toward theoretical purity that is neither achievable in practice, uniform in application, nor justified in terms of the administrative burden and complexity it would spawn.

(2) This position was reaffirmed in 1976 when the Senate Finance Committee noted that one of the major purposes of the UBIT is "to make certain that an exempt organization does not commercially exploit its exempt status for the purpose of unfairly competing with taxpaying organizations." S. Rep. No. 94-938, 94th Cong., 2d Sess. 601 (1976).