During the past few years several associations have offered dues rebates to assist members who are struggling financially.
But for REALTOR® associations that are tax exempt under Section 501(c)(6) of the Internal Revenue Code, rebating a portion of paid dues to members can come with tax risks. Here, NAR General Counsel Laurie Janik explains the right way and the wrong way to organize your rebate program:
One of the key differences between for-profit organizations—whether they be corporations, partnerships, or LLCs—and tax-exempt, not-for-profit associations is that for-profit entities routinely distribute their net earnings to their investors. Tax-exempt, not-for-profit associations, however, are prohibited from making such distributions. The language in the tax code that addresses this topic speaks in terms of “inurement” and says that no part of the net earnings of the tax-exempt entity can inure to the benefit of any individual.
Would a dues rebate constitute inurement? According to prior tax rulings, only if properly structured can a dues rebate avoid being considered a distribution of net earnings that confers individual benefits. The price for not properly structuring your rebate or refund could be the loss of your tax-exempt status.
Rebate or Refund Structure
To avoid being considered inurement, the refund must satisfy two tests. First, the money to be refunded may come only from dues and other amounts contributed by the class of members receiving the refund. Second, the amount refunded must be repaid in the same proportion as the funds were paid. The following examples are helpful to understand how to structure a proper rebate.
Source of the Funds
One association conducted a successful trade show in which income paid by exhibitors exceeded expectations. Some of the exhibitors were members, but most were not. The association decided to rebate a portion of booth fees to those members who exhibited. No rebate was provided to the nonmembers who exhibited.
In this case—Michigan Mobile Home and Recreational Vehicle Institute v. Commissioner—the Internal Revenue Service determined that the association was not entitled to its tax-exempt status because the funds rebated to members were paid by both members and nonmembers. The money was being refunded only to a small group of those who paid, not all. Consequently, the earnings from the trade show inured to the benefit of this select group of recipients.
Here’s another example. After looking at the year-end financial statements showing a surplus, an association decided to issue a rebate of $100 to all its members. Rebate recipients included affiliate members, whose annual dues are only $75. Active members’ dues are paid based on a size formula, with larger firms paying more than smaller firms.
This rebate is problematic on multiple fronts. First, the affiliate members should not receive a rebate that exceeds the amount they pay in dues. Nor should the amount rebated to the affiliate members be the same as the amount rebated to active members, whose dues are greater. Moreover, the active members should not all receive the same amount, because they pay differing amounts of dues based on the size of their firm. The proper way to calculate the rebate is as a percentage of dues, with each member receiving a rebate of the same percentage paid to the association.
The IRS treats a refund as a reduction in dues. Therefore, if a member deducts a portion of the dues paid to the association as an ordinary and necessary business expense, that total amount deducted would be reduced by the amount of the refund.
Reserves Should Be Preserved
There is less guidance from the IRS for associations wishing to “refund” to members amounts that have been accumulated over the years and placed into the association’s reserve account. Such a distribution could be considered a payment of net earnings-—derived from the dues payments (as well as other sources of income) from years past—to current members. Adopting this view would lead to the conclusion that it is not possible to make a distribution of accumulated reserves that satisfies the need for the refunded funds to have been paid by the recipients. However, it is also possible for an association to claim that the funds being refunded were paid by the recipients, provided the amount of the refund does not exceed the payments the member paid. Associations wishing to refund from reserves should be sure to consult with their tax adviser before proceeding.
In sum, associations may refund to their members unused dues at year end, provided the money being refunded was paid by the class of members receiving the refund, and provided further that the amount paid is in proportion to the dues payment each recipient made. Use of reserves for a refund should be done with the advice of a tax expert.
Is Dues Payment Bartering Legal?
When an East Coast REALTOR® association CEO offered a financially struggling member the opportunity to teach classes at the association in lieu of paying dues, she knew there would be some paperwork involved to properly record this exchange.
All barter agreements are subject to federal taxation and must be properly recorded. Associations must mark the member’s dues invoice as paid by barter. Not-for-profit associations must record as income the fair market value of this member’s teaching services.
Likewise, the member reports as income the amount of dues covered. Of course, if the barter was in lieu of dues, no taxes are owed by the not-for-profit association since it does not pay taxes on its dues income. However, if the barter was for a product or service that is subject to unrelated business income tax, then the income would be taxable. For example, since multiple listing services are considered to be a for-profit activity and associations pay tax on net MLS income, if the barter for services is in lieu of the member paying MLS fees, then the income goes in the column for MLS income and any net income is subject to taxation.
Always consult a tax adviser to make sure that barter transactions are properly recorded and reported.
Laurie Janik is General Counsel of the NATIONAL ASSOCIATION OF REALTORS®. Contact her at 312-329-8371, or firstname.lastname@example.org.