Section Library
Tax Exempt Status
Section 501(c) of the Internal Revenue Code classifies tax exempt organizations into 25 separate categories. Each category is treated differently, and classification in one category rather than another can make a significant difference to an organization's tax liabilities and responsibilities. The American Water Works Association and its sections are exempt under section 501(c)(3) of the code. All AWWA sections get their 501(c)(3) status through a group exemption. This is, in essence, an extension of the Association's 501(c)(3) status to all our sections.
Organizations, which are exempt under section 501(c)(3), are usually defined as "charitable" or "educational." These organizations are defined as being organized and operated exclusively for religious, charitable, scientific, testing for the public safety, literary or educational purposes. As a non-profit organization, no part of their net earnings may inure to the benefit of any private individual.
- Advantages to Classification as a 501(c)(3) Organization
- Exempt from tax on dues, interest, dividends, royalties, rents and any other income which is not derived from the conduct of an unrelated trade or business.
- In most states a 501(c)(3) organization is eligible for an exemption from most state taxes, including sales and real estate tax.
- May receive contributions deductible from the taxable income of the donor.
- May sponsor 403(b) retirement plans for their employees.
- Eligible for the third-class postal rate.
The requirements for obtaining and maintaining a section 501(c)(3) exemption may be summarized as follows: an organization carrying out educational, charitable, or religious activities, rather than an organization which serves the business interests of a particular profession/industry; if the organization does not exceed limitations imposed on lobbying and propaganda expenditures imposed by section 501(c)(3) and/or section 501(h), and if the organization engages in no activity intended to influence the election or defeat of any political candidate.
- Disadvantages
- A prohibition against all political activities (other than lobbying) for most exempt organizations.
- Some limitations on the amount of lobbying expenditures and activities of organizations exempt from taxation under 501(c)(3).
- Complex restrictions on certain transactions and complex compliance requirements on organizations deemed to be private foundations.
- Criticism from the for-profit sector for unfair competition.
- A growing Federal, state, and local compliance burden including income tax and informational filings and Federal, state, and local solicitation laws.
- Increased public scrutiny.
Maintaining Tax Exempt Status
In order to retain its tax exempt status, each section must meet two tests: the organizational test and the operational test. A section that fails to meet either the organizational or operational test cannot be exempt under Section 501(c)3. If a section engages in substantial non-exempt activities, it may impair its status as part of the exempt group, which includes the American Water Works Association and the other sections, or it may endanger the tax-exempt status of the entire group.
To satisfy the organizational test, a section's articles of incorporation, articles of association, or other written instrument by which it is created, must limit the purposes of the organization to one or more exempt purposes, and must not expressly authorize the organization to engage other than as an insubstantial part of its activities, in any activities which in themselves are not in furtherance of one or more exempt purposes. If a section does not have organizational documents, it will be governed by the organizational documents of the American Water Works Association.
The organizational documents must generally contain the same purposes of AWWA national.
Organizational documents may not empower the organization to conduct nonexempt activities unless they are insubstantial.
Assets in dissolution must be used for the organization's exempt purposes or must be transferred to another organization that is exempt under IRS Section 501(c)3. This provision must be stated in the organization's articles.
To satisfy the operational test, an organization must be deemed to operate "exclusively for" it's specified exempt purposes. A key element in the operational test is the requirement that the organization benefit the public at large. The IRS considers an organization that benefits private interest in anything more than an insignificant or incidental extent to have failed the test. While some form of private benefit is unavoidable, any benefit that accrues to a private individual, group, or organization must be merely incidental to the organization's serving the public.
AWWA sections may also be required to file annual information returns.