Each of the following organizations may apply for recognition of
exemption from federal income tax by filing Form 1024.
- Benevolent life insurance associations of a
purely local character and like organizations.
- Mutual ditch or irrigation companies and like
organizations.
- Mutual or cooperative telephone companies and
like organizations.
A like organization is an organization that performs
a service comparable to that performed by any one of the above
organizations.
The information to be provided upon application by each of these
organizations is described in this section. For information as to the
procedures to follow in applying for exemption, see chapter 1.
General requirements.
These organizations must use their income solely to cover losses
and expenses, with any excess being returned to members or retained
for future losses and expenses. They must collect at least 85% of
their income from members for the sole purpose of meeting losses and
expenses.
Mutual character.
These organizations, other than benevolent life insurance
associations, must be organized and operated on a mutual or
cooperative basis. They are associations of persons and organizations,
or both, banded together to provide themselves a mutually desirable
service approximately at cost and on a mutual basis. To maintain the
mutual characteristic of democratic ownership and control, they must
be so organized and operated that their members have the right to
choose the management, to receive services substantially at cost, to
receive a return of any excess of payments over losses and expenses,
and to share in any assets upon dissolution.
The rights and interests of members in the annual savings of the
organization must be determined in proportion to their business with
the organization. Upon dissolution, gains from the sale of appreciated
assets must be distributed to all persons who were members during the
period the assets were owned by the organization in proportion to the
amount of business done during that period. The bylaws must not
provide for forfeiture of a member's rights and interest upon
withdrawal or termination.
Membership.
Membership of a mutual organization consists of those who join the
organization to obtain its services, acquire an interest in its
assets, and have a voice in its management. In a stock company, the
stockholders are members. Membership may include distributors who
furnish service to individual consumers. However, it does not include
the individual consumers served by the distributor. A mutual service
organization may serve nonmembers as long as at least 85% of its gross
income is collected from members. However, a mutual life insurance
organization may have no policyholders other than its members.
Losses and expenses.
In furnishing services substantially at cost, an organization must
use its income solely for paying losses and expenses. Any excess
income not retained in reasonable reserves for future losses and
expenses belongs to members in proportion to their patronage or
business done with the organization. If such patronage refunds are
retained in reasonable amounts for purposes of expanding facilities,
retiring capital indebtedness, acquiring other assets, etc., the
organization must maintain records sufficient to reflect the equity of
each member in the assets acquired with the funds.
Dividends.
Dividends paid to stockholders on stock or the value of a capital
equity interest constitute a distribution of profits and are not
an expense within the term losses and expenses. Therefore, a
mutual or cooperative association whose shares carry the right to
dividends will not qualify for exemption. However, this prohibition
does not apply to the distribution of the unexpended balance of
collections or assessments remaining on hand at the end of the year to
members as patronage dividends or refunds prorated to each on the
basis of their patronage or business done with the organization. Such
distribution represents a reduction in the cost of services rendered
to the member.
The 85% requirement.
All of the organizations discussed in this section must submit
evidence with their application that they receive 85% or more of their
gross income from their members for the sole purpose of meeting losses
and expenses. Nevertheless, certain items of income are excluded from
the computation of the 85% requirement if the organization is a mutual
or cooperative telephone or electric company.
A mutual or cooperative telephone company will exclude from the
computation of the 85% requirement any income received or accrued
from:
- A nonmember telephone company for the performance of
communication services involving the completion of long distance calls
to, from, or between members of the mutual or cooperative telephone
company,
- Qualified pole rentals,
- The sale of display listings in a directory furnished to its
members, or
- The prepayment of a loan created in 1987, 1988, or 1989,
under section 306A, 306B, or 311 of the Rural Electrification Act of
1936.
A mutual or cooperative electric company will exclude from the
computation any income received or accrued from qualified pole rentals
and from the prepayment of loans described in (4) above. An electric
cooperative's sale of excess fuel at cost in the year of purchase is
not income for purposes of determining compliance with the 85%
requirement.
The term qualified pole rental means any rental of a
pole (or other structure used to support wires) if the pole (or other
structure) is used:
- By the telephone or electric company to support one or more
wires that are used by the company in providing telephone or electric
services to its members, and
- Pursuant to the rental to support one or more wires (in
addition to wires described in (1)) for use in connection with the
transmission by wire of electricity or of telephone or other
communications.
The term rental, for this purpose, includes any sale of the
right to use the pole (or other structure).
The 85% requirement is applied on the basis of an annual
accounting period. Failure of an organization to meet the
requirement in a particular year precludes exemption for that year,
but has no effect upon exemption for years in which the 85%
requirement is met.
Gain from the sale or conversion of the organization's
property is not considered an amount received from members in
determining whether the organization's income consists of amounts
collected from members.
Because the 85% income test is based on gross income, capital
losses cannot be used to reduce capital gains for purposes of this
test.
Example.
The books of an organization reflect the following for the calendar
year.
| Collections from members |
$2,400 |
| Short-term capital gains |
600 |
| Short-term capital losses |
400 |
| Other income |
None |
| Gross income ($2,400 + $600 =$3000) |
100% |
| Collected from members ($2,400) |
80% |
Since amounts collected from members do not constitute at least 85%
of gross income, the organization is not entitled to exemption from
federal income tax for the year.
Voluntary contributions in the nature of gifts are not taken into
account for purposes of the 85% computation.
Other tax-exempt income besides gifts is considered as income
received from other than members in applying the 85% test.
If the 85% test is not met, your organization, if classifiable
under this section, will not qualify for exemption as any other type
of organization described in this publication.
Tax treatment of donations.
Donations to an organization described in this section are not
deductible as charitable contributions on the donor's federal income
tax return.
Local Life Insurance Associations
A benevolent life insurance association or an organization seeking
recognition of exemption on grounds of similarity to a benevolent life
insurance association must submit evidence upon applying for
recognition of exemption that it will be of a purely local character,
that its excess funds will be refunded to members or retained in
reasonable reserves to meet future losses and expenses, and that it
meets the 85% income requirement. If an organization issues policies
for stipulated cash premiums, or if it requires advance deposits to
cover the cost of the insurance and maintains investments from which
more than 15% of its income is derived, it will not be entitled to
exemption.
To establish that your organization is of a purely local
character, it should show that its activities will be confined
to a particular community, place, or district irrespective of
political subdivisions. If the activities of an organization are
limited only by the borders of a state, it cannot be purely local in
character. A benevolent life insurance association that does not
terminate membership when a member moves from the local area in which
the association operates will qualify for exemption if it meets the
other requirements.
A copy of each type of policy issued by your organization should be
included with the application for recognition of exemption.
Organizations similar to local benevolent life insurance
companies.
These organizations include those that in addition to paying death
benefits also provide for the payment of sick, accident, or health
benefits. However, an organization that pays only sick, accident, or
health benefits, but not life insurance benefits, is not an
organization similar to a benevolent life insurance association and
should not apply for recognition of exemption as described in this
section.
Burial and funeral benefit insurance organization.
This type of organization can apply for recognition of exemption as
an organization similar to a benevolent life insurance company if it
establishes that the benefits are paid in cash and if it is not
engaged directly in the manufacture of funeral supplies or the
performance of funeral services. An organization that provides its
benefits in the form of supplies and service is not a life insurance
company. Such an organization may seek recognition of exemption from
federal income tax, however, as a mutual insurance company other than
life.
Mutual or Cooperative Associations
Mutual ditch or irrigation companies, mutual or cooperative
telephone companies, and like organizations need not establish that
they are of a purely local character. They may serve noncontiguous
areas.
Like organization.
This is a term generally restricted to organizations that perform a
service comparable to mutual ditch, irrigation, and telephone
companies such as mutual water, communications, electric power, or gas
companies all of which satisfy the 85% test. Examples are an
organization structured for the protection of river banks against
erosion whose only income consists of assessments against the property
owners concerned, a nonprofit organization providing and maintaining a
two-way radio system for its members on a mutual or cooperative basis,
or a local light and water company organized to furnish light and
water to its members. A cooperative organization providing cable
television service to its members may qualify for exemption as a
like organization if the requirements discussed in this
section are met.
Associations operating a bus for their members' convenience,
providing and maintaining cooperative housing facilities for the
personal benefit of individuals, or furnishing a financing service for
purchases made by members of cooperative organizations are not like
organizations.
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