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Monday, March 14, 2011

The IRS, Private Inurement and Non-Profit Association Management

Few subjects in an association leader’s life are as misunderstood and nebulous as private inurement.  The mere reference to private inurement inspires puzzled looks on volunteer faces, and worry on the faces of association executives.  Indeed, even the IRS admits that it is unable to assign it a precise definition.  This posting is aimed at recapping private inurement principles, and provide some examples of it in association settings.  This is, of course, a summary, not an exhaustive review of the subject.


Section 501(c)(6) of the Internal Revenue Code provides for the exemption of business leagues, chambers of commerce, real estate boards, boards of trade, and professional football leagues, which are not organized for profit and “no part of the net earnings of which inures to the benefit of any private shareholder or individual.”  Because determination of whether inurement exists is largely based on facts, the definition of inurement is not precise.  An outline of inurement principles is available in the IRS publication “Exempt Organizations – Technical Instructions Program for FY 2003.”

The inurement prohibition does not completely preclude members of a 501(c)(6) organization from receiving benefits such as newsletters and informative materials, and of course there is no rule against an association member being more successful as a result of being a member of an organization.  However, inurement results from “an expenditure of organizational funds resulting in a benefit which is beyond the scope of benefits which logically flow from the organization’s performance of its exempt functions.  G.C.M. 38599 (11/1980).

Payments to Insiders.  Payments to association insiders, including officers, directors and other leaders, should be made only on an arm’s length, reasonable basis.  Circumstances in which a director or officer is compensated for their time beyond that which primarily benefits the association, is a potential inurement.  For example, an association may pay a stipend for officers in order to enable the association to recruit high quality leaders, provided the stipend is paid primarily for the benefit of the association.  Also for example, an association paying its CEO more than a reasonable salary could be found to have paid an excess benefit, a form of private inurement, and be severely penalized for having done so.  The moral of the story: always scrutinize payments to insiders to ensure the payment is absolutely defensible in terms of the reason for the payment, and in terms of the amount.

Payments to Members.  Historically, the IRS and courts have found inurement when the exempt organization’s payments directly benefit members.  Examples include:

  • Providing financial assistance and welfare benefits for members (See Rev. Rul. 67-251, 1967-2 C.B. 196).
  • Paying members for expenses incurred in defending, and judgments rendered in, malpractice suits (See National Chiropractic Association, Inc. v. Birmingham, 96 F. Supp. 874 (N.D. Iowa 1951).
  • Owning a copyright on a product sold, and distributing the royalties to members.
  • Distribution of non-member income to members in the form of rebates or reduced dues.
  • Rebates to members of amounts paid by both members and nonmembers for space at a trade show.

Performance of Particular Services for Members.  Further, an organization's performance of particular services for its members or others is not an exempt activity under Code section 501(c)(6).  Although such activities alone do not preclude exemption, an organization engaged primarily in performing particular services is not exempt under section 501(c)(6).   Examples are as follows:

  • Advertising that carries the names of members may be performing particular services; but promoting the business of an industry by encouraging the use of its products is not.
  • Furnishing particular information and specialized individual services to members through publishing and other means to effect economies in business operations may be performing particular services; but educating members on how to improve their business results is not.
  • Operating a multiple listing service for members of a real estate involves performing particular services.
  • Operating parking lots for members' customers may be performing particular services, but providing parking as part of a plan to promote patronage of businesses in an area may not be.
  • Providing insurance coverage often involves performing particular services.  Similarly, negotiating discounted healthcare or similar services for members and/or nonmembers and providing related services may be performing particular services.

Assessing Your Risk.  Presumably, every association has exempt purposes, such as improvement of business conditions, education, and the general advancement and growth of its members and industry.  From there, it is essential to determine whether any of the benefits members receive exceed the scope of benefits that would logically flow from its performance of the associations exempt functions.  Are the association’s general funds subsidizing or offsetting members costs of doing business?   Is the association providing “particular services” that would otherwise be provided by a business ordinarily carried on for a profit?  Are nonmember dues or other profits being used to provide benefits at little or no cost to members?  If the answer to these kinds of questions is arguably “yes,” then it is time to carefully review the question with your lawyer or accountant.

The penalties for private inurement are substantial.  Depending on the depth of the inurement, the nonprofit could suffer financial penalties and lose its tax exempt status.  If the persons receiving the benefit are “insiders” (generally officers, directors, senior employees), the IRS may declare an excess benefit transaction, and impose severe fines and penalties.  Interestingly, the most common form of private inurement comes in the form of these “excess benefit” transactions, usually overcompensation paid to “volunteer” leader, a staff member or consultant (who is an insider).


As noted above, private inurement is a difficult but important subject.  It is important for association professionals to understand enough about it to recognize when it becomes a potential problem.  At that point, or whenever there is doubt, the association should seek expert input and opinions concerning the risk.  In so doing, the association gains a significant level of protection in the form of lessened risk, and proof of good faith (that is, that the association was concerned about private inurement, obtained an opinion of a CPA or legal counsel that the practice was probably not an inurement, and acted in good faith on reliance on that advice).