Publications

• 30 Second Ideas
• Accounting Updates
• Alerts
• Articles
• Business Surveys
• Construction Edge
• Healthcare Edge
• Insurance Edge
• Legal Talent
• Manufacturing Edge
• Not-for-Profit Edge
• Quick Links & Good Ideas
• SEC Edge
• Strategy Insights Blog
• Surviving the Upturn
• Tax Highlights

Article Author:

Certification — Same Activity, Different Result

Revenue from certification is typically considered UBTI when received by a Section 501(c)(3) organization but not a Section 501(c)(6) organization.

Certified products and services are ever-present. One can choose a meal based on certification marks such as the American Heart Association Heart-Check Mark,¹ select only toothpastes with the seal of the American Dental Association,² buy electronic products with the Underwriters Laboratory Seal of Approval,³ patronize only a certified mechanic to repair a car;⁴ a certified realtor to buy a home,⁵ and a certified financial planner to manage money.⁶ Exempt organizations—especially associations—often certify products, individuals, or processes for a fee. In some instances, certification may be a significant or even the principal activity and revenue source of an organization. 

Section 501(c)(3) membership associations provide certification programs for several reasons that extend beyond the desire for funds. Certification promotes an organization's industry or constituency, promotes the associations' brand, promotes order and discipline while discouraging trade abuses within an industry, and promotes consumer confidence in an industry's offerings. 

When certification is permitted for a Section 501(c)(3) organization

Section 513 provides that revenue of an exempt organization is unrelated business taxable income (UBTI) if the activity that generates such revenue is not substantially related to the organization's exempt purpose. In the case of certification by Section 501(c)(3) organizations, only accreditation of educational programs and institutions, programs that lessen the burdens of government, and testing for public safety are considered substantially related to a permissible exempt purpose.⁷ Otherwise, the law views these activities as taken on in the furtherance of private business interests. Revenue from other forms of certification undertaken by an Section 501(c)(3) organization will thus be considered to generate UBTI because such certification does not further an exempt purpose. 

The regulations provide that accreditation is an accepted charitable exempt purpose when it consists of the development and publication of standards for schools and colleges, regular inspection and evaluation, and the development of recommendations for institutional improvement.⁸ As such, fees that organizations receive for providing accreditation services are not UBTI. 

Section 501(c)(3) explicitly mentions “testing for public safety” as a permissible exempt purpose. Reg. 1.501(c)(3)-1(d)(4) elaborates that such testing includes the determination of whether consumer products are safe for use by the general public. The organization may not benefit private business interests in the context of this testing. One prominent ruling on this point relates to an organization that tests boating equipment for public safety in conjunction with the U.S. Coast Guard.⁹ Membership associations have trouble meeting these requirements, however. Their certification programs are not always designed for public safety. Moreover, these programs are designed to benefit the industry or profession they support as well as the individual or business receiving a credential or seal.¹⁰ 

Finally, lessening the burdens of government has evolved over the years into an acceptable exempt purpose for certification. Two cases decided around 1980 solidified this rational. In Professional Standards Review, 74 TC 240 (1980), the Tax Court held that an entity authorized to promote and manage Medicare and Medicaid records and services pursuant to federal law was performing a quasi-governmental function. Thus, the organization was formed in furtherance of a valid exempt purpose of lessening the burdens of government. In Indiana Crop Improvement Association, 76 TC 394 (1981), the Tax Court held that an organization that certified the quality and fitness of seeds lessened the burdens of government because it was serving an important governmental function and furthering public policy by implementing Indiana state law in lieu of and instead of a state agriculture department, which Indiana did not have. The IRS acquiesced in this case.¹¹ 

Lessening the burdens of government requires that a Section 501(c)(3) organization demonstrate a very close connection to a governmental body. This is a difficult standard to prove, as many cases and rulings relating to certification demonstrate. In Quality Auditing Co., Inc., 114 TC 498 (2000), a Section 501(c)(6) association developed standards to certify the fitness of structural steel fabrication. The association funded the startup of a separate Section 501(c)(3) organization to carry out the certification program. The (c)(3) argued that it had two legitimate exempt purposes—lessening the burdens of government and testing for public safety. The (c)(6) association had originally developed its certification program at the behest of governmental agencies. The Tax Court held that while government agencies had originally asked the association to develop a certification program, there was no evidence that the government viewed auditing of steel fabrication as a governmental responsibility, nor was there any evidence that, but for the association and subsequently the would-be charity, the government would have developed a similar program. As such, the (c)(3)'s activities were deemed to be operated on behalf of private business interests. 

An activity is better in a (c)(6) than a (c)(3)

Quality Auditing represents an activity that was in fact carried out in a Section 501(c)(6) organization previously. It is clear that had the would-be Section 501(c)(3) organization applied to be a (c)(6) organization, it would have been granted such exemption. Quality Auditing is one of several examples of would-be certifiers that failed to establish an exempt purpose under Section 501(c)(3) but could have established such a purpose under Section 501(c)(6) .¹² 

Since the underlying exempt purpose of a Section 501(c)(6) organization differs from that of a Section 501(c)(3) organization, a (c)(6) and a (c)(3) may be able to do the exact same activity yet receive different tax treatment because the activity may fit an exempt purpose of one type of entity but not the other. Whether the revenue of either type of organization is UBTI under Section 513 will depend on its own appropriate exempt purposes. 

Under the Section 501(c)(6) regulations, a business league is an association of persons having some common business interest, the purpose of which is to promote such common interest and not to engage in business of a kind ordinarily carried on for profit.¹³ In contrast, the law for Section 501(c)(3) organizations treats any benefit of private interests as adverse to a charitable purpose.¹⁴ This means that when a Section 501(c)(6) business league earns revenue from the certification activities, and those activities are structured in such a way as to benefit the common business interests of an industry, the revenue should not be UBTI. 

In Rev. Rul. 70-187, 1970-1 CB 131 , several manufacturers in the same industry formed a Section 501(c)(6) organization to establish acceptable standards for the type of product they sold. The manufacturers wanted to assure that this type of product was accurately promoted using standardized criteria in marketing materials. Certification was open to anyone manufacturing the product and the standards for certification were made available to any applicant. Products meeting the certification criteria were awarded a seal of approval. Nothing in the certification program replaced routine testing or quality control. As such, there was no concern that a particular service was being provided for one business to the exclusion of others.¹⁵ The Service ruled that the certification program was an activity related to the common business interests of the manufacturers' industry. Therefore, the program was in furtherance of the organization's exempt purpose under Reg. 1.501(c)(6)-1 . 

Certification of individuals typically involves qualifying people to participate in an occupational field or designate a specific skill set within that field. In Rev. Rul. 67-296, 1967-2 CB 212 , a Section 501(c)(6) association composed of members of a particular profession designed a program to raise educational standards within the profession. Professionals could attain a specific status by passing an examination designed to test professional qualifications. The association conducted classes for anyone desiring to take the examination, and charged tuition for the classes. The Service held that the tuition would not be UBTI for the association. The ruling did not address whether any fees were charged to take the examination. Subsequent rulings have clarified that fees paid to take certification exams or administer certification programs for individuals are also considered related to a (c)(6)'s exempt purpose.¹⁶ 

A certification program requires the certifying organization to develop or use a standard. Standards are often pre-existing criteria based on government laws and regulations or industry standards. In some instances associations develop their own standards, sometimes contracting with a third party for the purpose. All of these activities are permissible for a Section 501(c)(6) organization. However, standards need not be owned or developed by a certifying (c)(6) organization. This can be beneficial in several planning contexts discussed further below. 

Education and training is another part of many certification programs. This includes general offerings on topics relating to certification standards or criteria. Education also might include courses in preparation for a certification examination. Prior rulings make it clear that education related to a certification process may be provided by a (c)(6) as an activity substantially related to its exempt purpose. Often, organizations charge significant fees for classes pertaining to a certification while assessing minimal charges for the certification exam or ongoing certification registration. Education in some instances can be offered outside of the (c)(6) offering the certification. 

When evaluating a certification program in a Section 501(c)(6) organization for UBTI exposure, the starting point is Louisiana Credit Union League, 51 AFTR 2d 83-451 , 693 F2d 525 , 82-2 USTC ¶9717 (CA-5, 1982), aff'g 46 AFTR 2d 80-6065 , 501 F Supp 934 , 80-2 USTC ¶9805 (DC La., 1980). This case set forth the follow two-part test under which an income producing activity will be considered substantially related to the exempt function of an exempt organization: 

1. The activity is unique to the organization's tax-exempt purpose. Consideration will be given to both the uniqueness of the relationship and the manner in which the organization carries on the endeavor. 
2.  Direct benefits flowing from the activities inure to its members in their capacities as members of the organization. This requires a determination of whether the activities benefit its members as members, rather than in their individual capacities.

Based on the Louisiana Credit Union standard and the other applicable case law and rulings, the author can suggest a framework for structuring a Section 501(c)(6) certification program to avoid receiving UBTI: 

• The program must be related to a standard that is material and significant to the sponsoring association. Absent a standard that matters to the industry, there cannot be relatedness.
• Whether the certification process is an optional self-regulatory process or a mandatory industry requirement, it must be open to any qualifying applicant and thereby not limited to members of the association.¹⁷ Under the second part of the above test, organizations want to avoid activities with benefits that inure to members. Opening activities to applicants other than members alleviates this concern.
• The certification program may not serve as a replacement for routine quality testing of products or individuals in the normal course of business. Certification programs should not serve as a substitute for the regular manufacturing or personnel review process. This would also raise an inurement problem.

Certification can be UBTI even for a (c)(6)

Reg. 1.501(c)(6)-1 provides that an exempt trade associations' “activities should be directed to the improvement of business conditions of one or more lines of business as distinguished from the performance of particular services for individual persons.” Those "particular services" can turn revenue into UBTI. In Rev. Rul. 68-294, 1968-1 CB 264 , an organization's exemption application under Section 501(c)(6) was rejected because its primary activity—a traffic bureau for members and nonmembers as a service in the shipment of their goods and products—was deemed to be particular service for individual persons. 

In Ltr. Rul. 8503103 , a Section 501(c)(6) organization focused on the construction industry proposed a training program for construction workers as well as a registration program to help hourly workers find jobs. The IRS ruled that the training program was related to the organization's exempt purpose, but the registration program was considered a particular service for members and nonmembers. Thus, it was not substantially related to the organization's exempt purpose. The Service relied on Rev. Rul. 61-170, 1961-2 CB 112 , which ruled that a job placement service for nurses was considered an unrelated business activity because it was very similar to a type of business ordinarily carried on for profit. This ruling illustrates that while certification and training may improve an individual's job opportunities, the organization will be subject to UBTI to the extent it earns revenue facilitating those job opportunities. 

In Ltr. Rul. 200536026 , a would-be Section 501(c)(6) organization offered a forum for individuals trying to raise revenue to start businesses. The Service rejected the application and in so doing cited Rev. Rul. 67-296 , above, in ruling that the applicant was not raising education standards within its industry, but merely providing a business forum. This ruling raises the important point that education must consist of some form of study related to the standard or industry. It cannot be limited to an opportunity to network with people interested in a standard or a certification test. 

Structuring certification programs

Structuring a certification program can involve a variety of components including the use of outside for-profit entities, other Section 501(c)(6) associations, and Section 501(c)(3) organizations. The (c)(6) organization carrying out the certification program need not design the standard, provide the education, or even carry out the testing. This means that a Section 501(c)(6) association may provide a certification program by contracting with other parties to carry out all parts of the program. As long as the standard is significant to the industry and the design of the program is not a particular service to members, the revenue received by the association will not be considered UBTI. 

In Ltr. Rul. 9428035 , a Section 501(c)(6) organization promoted the use of hot mix asphalt pavement. The organization provided information to the public about hot mix asphalt and acted as a liaison between governments and certain users of the asphalt. The association also designed a certification program for individuals who work with hot mix asphalt. The organization entered into a contract with a company that uses the asphalt. The organization conducted classes and provided the facilities and instructors. The company trained the instructors, developed the course materials and examinations, and carried out all testing. The organization did not provide any job referral services to the company or any other member. The Service ruled that the revenue received by the organization under the certification program was not UBTI. 

The implication of this ruling is that an organization can contract with a for-profit enterprise for almost any role in a certification program. As long as the for-profit receives compensation only for the services it provides under the program, the association's revenue will not otherwise be tainted by its relationship with the for-profit entity. This would appear to be true even if the for-profit contractor was a member of the certifying organization, as was the case in Ltr. Rul. 9428035 . Members often possess the most expertise about a particular product, process, or profession. Consequently, many associations rely on members to conduct portions of their certification program. 

Moreover, it would also stand to reason that a Section 501(c)(3) organization could be similarly utilized on a contractual basis, with the attendant limitations related to fair value and inurement. The (c)(3) would have to be able to document that its work was related to its exempt purpose to avoid UBTI. This may be easier than having the (c)(3) operate the entire certification program, since the (c)(3) is merely providing a component of the certification process, such as developing and maintaining the standard or providing instructors for related training. 

The Section 501(c)(6) association must be careful to avoid providing employment referrals or other business services to its contractor or contractors, lest its certification revenue stream be deemed as resulting from a particular service and consequentially considered UBTI. 

If an organization creates and maintains its own standard, the research and development of the standard can be done by a Section 501(c)(3) organization. The (c)(3) will need to qualify to do research as a scientific research organization under Reg. 1.501(c)(3)-1(d)(5) . Such an organization must be scientific and conduct research in the public interest. While discussion of scientific research is beyond the scope of this article, the public interest requirement means that the research must be made widely available. Some Section 501(c)(6) organizations may not wish to have important industry standards made public, however, especially if there are competing associations in the same industry. 

Because a Section 501(c)(3) organization may develop and/or own intellectual property, such as a standard that is suitable for certification, an organization family consisting of a (c)(3) and a (c)(6) may structure an arrangement whereby the (c)(3) licenses use of its standard in a certification program administered by its related (c)(6). The (c)(6) must pay the (c)(3) a reasonable royalty commensurate with the rules for fair value and arm's-length transactions under Section 482 . Assuming the (c)(6) is not controlled by the (c)(3) (for purposes of Section 512(b)(13) ), the (c)(3)'s royalty revenue will be excluded from UBTI under Section 512(b)(2) . 

While a (c)(3) may certainly own the intellectual property related to a certifiable standard, it is less clear to what extent it may avoid UBTI while participating in the educational component of a certification program carried out by a (c)(6). Under Rev. Rul. 67-296 , above, a curriculum of training may constitute a certification regime. A (c)(3) may provide education as part of its exempt purpose, but a (c)(3) should be careful that its educational offerings are not part and parcel of the certification process. For example, it would be wise for the (c)(3) to avoid providing classes that specifically prepare an applicant for a certification exam. 

Example 1. Organization A is a Section 501(c)(3) public charity with an exempt purpose of scientific research and education related to motor vehicles. One of Organization A's projects is to develop a standard for measuring the environmental fitness of motor vehicles. (Assume that there is no government regulation of this matter and that this activity is otherwise legal.) Organization B is a Section 501(c)(6) association representing motor vehicle manufacturers. Organization B is developing a certification program that measures the environmental fitness of motor vehicles. Organization A may license its standard to Organization B in return for a royalty equal to a percentage of the gross revenue Organization B earns through its certification program. Organization A also enters into a contract with Organization B to provide educational content and instructors to explain its standard. Organization A's gross receipts under this arrangement would not be UBTI. 

Example 2. Same as Example 1, except Organization B contracts with Organization A to provide an on-line test guide and lecture series describing how to design motor vehicles that will attain favorable ratings under the certification program administered by Organization B. Assume that the revenues Organization A receives under this contract are insubstantial to its overall operation. The revenues that Organization A receives will be considered to be received as part of a certification program and consequently should be treated as UBTI. 

Conclusion

Certification is one of the few activities that will be treated as generating UBTI for a Section 501(c)(3) charity, but treated as in furtherance of the exempt purpose—and so not treated as UBTI—for a 501(c)(6) business league. A Section 501(c)(6) organization must be careful to limit its certification program to avoid providing particular services to member or nonmember participants in the certification process, however, or its revenue will be considered UBTI. A Section 501(c)(3) organization may participate in a certification program by providing the underlying standard that is certified, or education about the standard, to a Section 501(c)(6) organization, including a related organization. 

This aritcle was originally published in Taxation of Exempts. For further information please contact David Lowenthal, Tax Senior Manager, dlowenthal@BlackmanKallick.com or 312-980-2954 or your Blackman Kallick representative.

 

---

 

1: See heartcheck.org for more information about the Heart-Check Mark for Food Manufacturers. 

2: See ada.org for more information about the ADA Seal of Acceptance Program and Products. 

3: See UL.com for more information about the many public safety certifications given by Underwriters Laboratory. It is the author's understanding that Underwriters Laboratory is no longer operating its core business as a tax-exempt organization. 

4: See ase.com for more information about the certification of automotive professionals by the National Institute for Automotive Service Excellence. 

5: See nar.org for information about the certification of real estate professionals. 

6: See cfp.net for more information about certified financial planners. 

7: Along the same lines, Section 501(c)(3) explicitly mentions “testing for public safety” as a permissible exempt purpose. This includes the determination of whether consumer products are safe for use by the general public. See also Rev. Rul. 65-61, 1965-1 CB 234 . 

8: Rev. Rul. 74-146 interpreting Reg. 1.501(c)(3)-1(d)(2) . Accreditation is not necessarily the same activity as certification, but it is certainly a similar activity. The author has included accreditation to be complete in this analysis. 

9: Rev. Rul. 65-61 , supra note 7. 

10: For one exception, see Rev. Rul. 65-61 , supra note 7. 

11: AOD 1981-95. 

12: See also Rev. Rul. 78-426, 1978-2 CB 175 ; GCM 39721 , 4/11/88; Ltr. Rul. 200439043 . 

13: Reg. 1.501(c)(6)-1 . 

14: Reg. 1.501(c)(3)-1(d)(1)(iii) . 

15: See Rev. Rul. 68-294, 1968-1 CB 46 . 

16: Ltr. Rul. 9428035 , Ltr. Rul. 8503103 . 

17: It is not inconceivable that a certification process could be limited to members. In most instances, however, this limitation will imply that the services are particular to the individual business interests of the members to the exclusion of benefiting the industry as a whole. 

 

This publication is part of Blackman Kallick’s marketing of professional services, and is not written tax advice directed at the specific facts and circumstances of any person and/or entity. Contents of this publication are of a general nature, and you should not act on this information without obtaining professional advice from your business advisor that is appropriately tailored to your individual needs and circumstances. This written advice is not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.