Are You Smarter Than A Lawyer?Why the Exemption Exists & What Every Society Should Consider in Meeting IRS Rules

March 12, 2010Paul Johnston

Vice President & Managing Counsel, Corporate LawThrivent Financial for Lutherans

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Law of Rock History

“If our history can challenge the next wave of musicians to keep moving and changing, to keep spiritually hungry, that's what it's all about.”

– Carlos Santana

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Law of Fraternal Benefit Societies

• Relatively few statutory requirements

• Significant regulatory and case law requirements

• All of which are impacted by political environment

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Get ready to play …

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Are You Smarter Than A Lawyer?

Bar exam

Grade School

Increasing Education Levels

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Cheats

Peak

Copy

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Are You Smarter Than A Lawyer?

Bar exam

Grade School - Anniversaries

Q: Other than the 40th Anniversary of Woodstock, 2009 marked what other significant anniversary?

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100 Years of Fraternal Tax Exemption

1909 Excise Tax Exemption• Fraternals were first exempted from federal taxation in

1909, when an excise tax was imposed on for-profit corporations, and “every insurance company”, whether they were non-profit or for profit.

• Congressional Record confirmed fraternals were not “insurance companies”.

• Senator Flint: “The insurance is a mere incident to the purpose of the organization..”

1913 Income Tax Exemption• Exemption from 1909 excise tax exemption carried over

into the federal income tax that started in 1913.

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Junior High – Fraternal RequirementsGrade School

Q: Name one of the four basic requirements of being a fraternal benefit society?

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Four Basic Requirements of Fraternals

1. Have a fraternal and benevolent purpose;

2. Have a common bond among members;

3. Operate under the lodge system; and

4. Provide for the payment of life, sick, accident, or other benefits.

Internal Revenue Code 501(c)(8), requires fraternals to:

Not just an insurance company.

Not a charity.

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Requirement #1 – Fraternal PurposeConduct Fraternal Activities

“Even if the members of an organization enjoy a common tie or goal, the organization does not serve a fraternal purpose unless its members engage in fraternal activities.”

Substantial Fraternal Activities Required

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High School – Fraternal Activities

Q: Name two of the five types of fraternal activity

Junior High

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Requirement #1 – Fraternal PurposeConduct Fraternal Activities

• Charitable -- providing relief to the poor, the distressed, lessening the burdens of government

• Social -- interaction for strengthening personal relationships among fraternal’s members

• Educational – instruction for improving capabilities of persons or providing knowledge of useful subjects

• Religious -- advancement of religion, fellowship taking place in a religious setting

• Patriotic – inspiring devotion to country and supporting military personnel and their families

Five Types of Activities the IRS Considers to be Fraternal

NOT with a substantial purpose of promoting sales of products or services.

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Bachelor’s Degree – Common BondHigh School

Q: Members of fraternal benefit societies must share a common bond. Name two types of common bonds for fraternals.

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Requirement #2Common Bond

• “The members of a fraternal society must have a common fraternal bond … adopted the same or very similar calling, avocation, profession, or working in unison to accomplish some worthy objective or common cause.”

• Membership in an organization itself not sufficient as a common bond.

• Social activity alone does not establish a common bond.

“Common” Common Bonds: Occupational, Ethnic, Gender and Religion

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Are You Smarter Than A Lawyer?Bar exam

Bachelor’s DegreeFraternal Secretary

Q: Which two of these bands performed at Woodstock?

The Who The Rolling Stones The Grateful Dead

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Rolling Stones Not Invited

•$$$

•“Street Fighting Man” not equal to “Peace & Love”

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Fraternal Secretary Fraternal President: Lodge System

Q: Lodges or chapters are a historical custom of fraternal benefit societies. (True or False)

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Requirement #3 Operate Under the Lodge System

Treasury Regulation Requirements:

“A fraternal beneficiary society is exempt from tax only if operated under the “lodge system” or for the exclusive benefit of the members so operating”.

To qualify for tax exemption, fraternal activities need to be conducted under a specific type of organizational structure – the lodge system

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Requirement #3 Operate Under the Lodge System

1. Chartered by the Parent

2. Subordinate Units of the Parent

3. Largely Self Governing

4. Local

Key Requirements of Lodges

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Requirement #3 Operate Under the Lodge System

1. Admit Members

2. Hold Meetings

3. Separate Legal Entities from Parent

4. Conduct Substantial Fraternal Activities

5. Representative Form of Government

6. Ritual

Additional Requirements of Lodges

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Fraternal President

Law Degree: Benefits

Q: Fraternals can provide insurance, mutual funds and banking services to their members. (True or False)

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Requirement #4Provide Life, Sick, Accident, or Other Benefits to Members or their Dependents

General IRS View• Insure a person against bodily injury, sickness, or death, or loss

of earning power.

Sick and Accident Benefits

Insurance Benefits• Life Insurance• Annuities

“Other” Benefits• Rulings focus on protection – do not stray far from insurance

Types of Benefits that Qualify as “Life, Sick, Accident or Other Benefits” under 501(c)(8)

To Members and Their Dependents• Beneficiary Restriction - IRS position that providing benefits to persons who are not members or their

dependents is outside the parameters of section 501(c)(8).

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Are You Smarter Than A Lawyer?

Bar exam – real world application

Grade School Junior High

Bachelor’s Degree

Fraternal Secretary Fraternal President

Law Degree

High School

Q: Does anyone still pay attention to these requirements?

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Real world application

IRS still pays attention•Annual 990 reporting•IRS Audits

Policymakers & Regulators still pay attention•2009 proposed repeal of state tax exemption (Hawaii, Washington) •2005 Congressional review•Financial services reform 2010, “Pay-go” budget challenges•Annual state reporting of use of tax exempt funds

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Knowledge of History & Rules = Ready

Ready for challenges•Knowledge base is platform for effective advocacy

Ready for change•Where we’ve been challenges us to bring about informed change and growth