In Texas, property owners associations (“Associations”) are typically non-profit corporations created under Chapter 22 of the Texas Business Organizations Code. As a result, many Associations want to know if they qualify for certain tax exemptions reserved for non-profit entities, which can be significant over the life of the Association. Texas tax law provides an exemption from sales tax on goods and services purchased for use by organizations exempt under Section 5.01(c)(3), (4), (8), (10) or (19) of the Internal Revenue Code (the “Code”). This article will focus on the qualifications required for an Association to pursue 501(c)(3) or 501(c)(4) designation from the IRS, as well as some helpful guidance from IRS Revenue Rulings, in which the IRS has provided an official interpretation of the Code as it related to a specific set of facts.
Code § 501(c)(3)
Code §501(c)(3) provides for the exemption from Federal income taxes of an organization organized and operated EXCLUSIVELY FOR CHARITABLE PURPOSES. The Treasury Regulations provide that an organization is not organized or operated exclusively for one or more exempt purposes unless it serves a public rather than a private interest. The Treasury Regulations provide that the term “charitable” is used in Code §501(c)(3) in its generally accepted legal sense and includes, among other things, the lessening of the burdens of government. Lessening the burdens of government overlaps social welfare and may include providing services usually provided by a governmental agency, such as services provided at the expense of the taxpayers.
Establishing lessening the burdens of government can be a high hurdle to clear. Proving that an organization is lessening the burdens of government requires that (i) its activities are activities that a governmental unit considers to be its burdens; and (ii) the activities actually lessen such governmental burden. The organization must demonstrate that a governmental unit considers the organization to be acting on the government's behalf, thereby actually freeing up government assets — human, material, and fiscal — that would otherwise have to be devoted to the particular activity.
This determination is based on facts and circumstances. An activity is a burden of government only if there is an objective manifestation by a governmental unit that it considers the activities of the organization to be its burden. Such consideration may be evidenced by the interrelationship between the governmental unit and the organization. A favorable working relationship between a government and an organization is strong evidence that the organization is actually lessening the burdens of the government. [1] Examples of varying projects qualifying as charitable under this category include: (i) combating drug traffic [2] and (ii) maintaining volunteer fire departments [3] and police performance programs. [4]
Even if an organization's activities lessen the burdens of government, it must otherwise satisfy the requirements under Code § 501(c)(3). Thus, an organization must demonstrate that its activities serve a public rather than a private interest within the meaning of the Treasury Regulations. This means that an organization which claims to lessen the burdens of government must demonstrate that any private benefit received by individuals or businesses is both qualitatively and quantitatively incidental to its exempt purposes. To be qualitatively incidental, the private benefit must be a necessary accompaniment of activities which benefits the public at large. To be quantitatively incidental, the private benefit must be insubstantial in the context of the overall public benefit.
In sum, even if an Association demonstrates that (i) its activities are activities that a governmental unit considers to be its burdens; and (ii) the activities actually lessen such governmental burden, given the Association would not be primarily providing services to, or benefiting, any person other than members of the Association, it will likely be difficult to demonstrate that the Associations serves a public rather than a private interest.
Code § 501(c)(4)
Code § 501(c)(4) provides for the exemption from Federal income tax of civic leagues or organizations not organized for profit but operated exclusively for the promotion of social welfare. The concept of social welfare implies a service or program directed at benefitting the community rather than a private group of individuals. Per the Treasury Regulations, an organization is operated exclusively for the promotion of social welfare if it is primarily engaged in promoting, in some way, the common good and general welfare of individuals within a community. Per the Treasury Regulations, an organization described in Code § 501(c)(4) is one which is operated primarily for the purpose of bringing about civic betterments and social improvements.
The IRS has generally found that homeowners’ associations in a gated development do not meet the requirements for exemption under Code § 501(c)(4) due to the fact that the general public is restricted from access to property owned by the Association. [5] However, the fact that there is a security gate does not automatically mean that the property owned by the Association is not accessible to the general public. In most cases, the gate does restrict access to the general public, but there are two generally recognized exceptions: (1) if the association is able to establish that it serves the community at-large, i.e., the Association provides benefits to a community which extends beyond the gates; or (2) if the Association occupies essentially the same geographic area as a recognized governmental entity.
It should be noted that Revenue Ruling 80-63 generally holds that the term “community” is determined on a case-by-case basis including by analyzing whether the activities of the organization have sufficient community-wide benefit which promotes social welfare as required by Code § 501(c)(4).
Although an area represented by an Association may not be a community for the purpose of the exemption, if the Association's activities benefit a community, it may still qualify for an exemption. For instance, if the Association owns and maintains common areas and facilities for the use and enjoyment of the general public as distinguished from areas and facilities whose use and enjoyment is restricted to members of the Association, then it may satisfy the requirement of serving a community. If the Association represents an area that is not a community, it generally will not qualify for exemption under Code § 501(c)(4) if it restricts the use of its recreational facilities to its members, i.e., the use and enjoyment of the common areas owned and maintained by an Association must be available and extended to members of the general public, as distinguished from controlled use or access restricted to the members of the Association.[6] Organizations promoting the interests of residents of a specific residential development generally do not qualify.
In conclusion, Associations may qualify for exemption as Code § 501(c)(4) social welfare organizations, but such organizations often have difficulty satisfying the requirement that they serve the interests of a community and not simply the interests of the association's members.
We suggest the Association retain and work with a certified public accountant to advise the Association as to matters of taxation and completing the appropriate tax forms.
Disclaimer: Content contained within this publication provides information on general legal issues and is not intended to provide advice on any specific legal matter or factual situation. This information is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. Readers should not act upon this information without seeking professional counsel.
[1] Rev. Rul. 85-2, 1985-1 C.B. 178.
[2] Rev. Rul. 85-1, 1985-1 C.B. 177.
[3] Rev. Rul. 74-361, 1974-1 C.B. 130.
[4] Rev. Rul. 74-246, 1974-2 C.B. 159.
[5] Revenue Ruling 74-99, 1974-1 CB 131 as modified by Revenue Ruling 80-63, 1980-1 CB 116; PLR 200706014.
[6] Revenue Ruling 80-63, 1980-1 CB 116.