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Executive Summary: Certification — Same Activity, Different Result

Certification of products and processes is ever present in US business. Certifications are typically carried out by tax-exempt Section 501(c)(3) and Section 501(c)(6) organizations. When Section 501(c)(3) organizations carry out certifications, the income is often subject to unrelated business income. The law permits certification by Section 501(c)(3) organizations as a tax-exempt activity in certain limited circumstances. There are also instances in which Section 501(c)(3) organizations with certification as their primary activity have lost exemption. Section 501(c)(3) organizations with taxable certification activities can restructure their activities through the use of a separate Section 501(c)(6)  organizations to mitigate their income tax problem. This is because when Section 501(c)(6) organizations carry out certifications, the income is typically not subject to unrelated business income. 

In the case of certification by Section 501(c)(3) organizations, only accreditation of educational programs and instruction, lessening the burdens of government, and testing for public safety are considered substantially related to a permissible exempt purpose and thus exempt from income tax.  As the full article explains in more detail, the aforementioned exempt purposes are narrowly defined. Consequently, Section 501(c)(3) organizations often have unrelated business income on revenue from certification activities. Moreover, Section 501(c)(3) organizations that focus exclusively or predominantly on certification activities may not qualify as tax-exempt organizations.

Interestingly, organizations carrying out certification activities that would be taxable in a Section 501(c)(3) organization will not be subject to tax if the activity is carried out in a Section 501(c)(6) organization. The law views activities with commercial purposes such as certification less suspiciously in the section 501(c)(6) context. Consequently, certification is typically tax exempt in a Section 501(c)(6) organization provided it benefits an industry or business line as a whole. Certification activities that give preferential treatment to an individual business over an industry as a whole will be considered taxable unrelated activities even in a Section 501(c)(6) organization. Thus, it is important that certification activities are structured in a manner that complies with the tax law.

Section 501(c)(3) organizations with certification activities can restructure their organizations in a manner that converts the certification revenue from taxable to tax exempt. Organizations can use a new or existing Section 501(c)(6) to operate the certification activity while still retaining much of the underlying intellectual property in the Section 501(c)(3) organization. It is also possible to retain the educational component of a certification activity in a 501(c)(3) organization.

For a more comprehensive discussion of these matters, please read the complete article: "Certification — Same Activity, Different Result."

For further information please contact David Lowenthal, Tax Senior Manager, dlowenthal@BlackmanKallick.com or 312-980-2954 or your Blackman Kallick representative.

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.