Fraternal organizations have been exempt from federal income tax since the enactment of the Revenue Act of 1913. Though the general exemption requirements have remained unchanged, over time additional guidance has established how to evaluate Section 501(c)(8) fraternal organizations’ benefits. This issue snapshot reviews what to consider when determining if benefits comply with Section 501(c)(8)(B). IRC Section and Treas. Regulation IRC Section 501(c)(8): Fraternal beneficiary societies, orders, or associations shall be exempt from federal taxation if they are: “(A) operating under the lodge system or for the exclusive benefit of the members of a fraternity itself operating under the lodge system, and (B) providing for the payment of life, sick, accident, or other benefits to the members of such society, order, or association or their dependents.” Treas. Reg. Section 1.501(c)(8)-1(a): Fraternal beneficiary societies are “exempt from tax only if operated under the lodge system or for the exclusive benefit of the members so operating. Operating under the lodge system means carrying on its activities under a form of organization that comprises local branches, chartered by a parent organization and largely self-governing, called lodges, chapters, or the like. In order to be exempt it is also necessary that the society have an established system for the payment to its members, or their dependents of life, sick, accident, or other benefits.” Resources (court cases, Chief Counsel Advice, Revenue Rulings, internal resources) Polish Army Veterans Post 147 v. Commissioner, 24 T.C. 891, 896 (1955), vacated and remanded, 236 F.2d 509, 512 (3rd Cir. 1956) (sustained that not a fraternal beneficiary society; reversed and remanded on deficiencies and penalties), held that an organization did not qualify as a Section 501(c)(8) organization when only ten percent of the membership were active members and entitled to benefits. The courts explained that the organization did not meet the benefits to members requirement under Section 501(c)(8)(B) because most of its members were not entitled to death, sick or disability benefits. Grange Ins. Ass’n v. Commissioner, 317 F.2d 222 (9th Cir.1963), rev’g 37 T.C. 582 (1961), held that "other benefits" referred to in § 501(c)(8)(B) were not limited to insuring members against injuries to the person (such as disability or death) but may also extend to insuring them against property loss. The appellate court pointed out that "other benefits” is characterized by the terms "life, sick, accident" and that “accident" relates to the cause of injury and not to the nature of the object of a loss. The Tax Court had held that the term “other benefits” did not include payments for loss or damage to a member’s property. Rev. Rul. 64-194, 1964-2 C.B. 149 PDF provided that a fraternal association having two classes of members (beneficial and social) qualified for exemption under Section 501(c)(8) even though its social members were not covered by its benefit program. Substantially all of the members were beneficial members. Benefits only were paid from a separate fund maintained solely by dues from beneficial members. Beneficial membership was available only to a member who joined prior to his/her 50th birthday, but social membership was available to older persons. The purpose of the restriction on beneficial membership was to discourage membership of persons principally interested in obtaining benefits rather than furthering the fraternal purposes of the organization. Thus, the organization utilized a nonbeneficial classification of membership to further the fraternal purposes of the organization. Rev. Rul. 73-165, 1973-1 C.B. 224 PDF provided that a fraternal beneficiary society that operated under the lodge system and provided for member benefit payments may qualify for exemption regardless of whether the fraternal or the insurance features predominate, as long as both features were present. Rev. Rul. 76-457, 1976-2 C.B. 155 PDF provided that an organization did not qualify for exemption under Section 501(c)(8) when it did not directly provide for the payment of life, sick, accident, or other benefits to its members, but rather arranged with insurance companies to provide optional insurance to its members. Rev. Rul. 84-48, 1984-1 C.B. 133 provided that a fraternal beneficiary society that provided legal expenses to defend members accused of criminal, civil, or administrative misconduct arising in the course of their employment, provided "other benefits" within the meaning of Section 501(c)(8). Rev. Rul. 84-49, 1984-1 C.B. 134 PDF provided that a fraternal beneficiary society that operated an orphanage for surviving children of deceased members provided "other benefits" within the meaning of Section 501(c)(8). Rev. Rul. 86-75, 1986-1 C.B. 245 PDF provided that whole life insurance constitutes a “life benefit” under Section 501(c)(8), even though the policy contains investment features, including that a member could borrow against the cash surrender value of the contract or withdraw the cash surrender value and terminate the contract. GCM 38192 (1979) discussed the historical development of Section 501(c)(8) benefits and concluded that in order for a benefit to be included within the term “other benefits,” it must be similar in nature to protection designed to compensate for expenses resulting from injury or loss of earning power. Therefore, payments from a legal defense fund maintained by a fraternal beneficiary society were “other benefits” if the payments protected against the risk of loss of earning power. However, payments for injury to property were not payments for “other benefits.” GCM 38312 (1980) concluded that the non-fraternal activities and non-fraternal benefits of a fraternal beneficiary society would result in the organization’s loss of Section 501(c)(8) exempt status unless the organization remained primarily engaged in fraternal activities and its benefits were primarily fraternal benefits. GCM 34607 (1971) concluded that an association whose fraternal features were so insubstantial as to make it indistinguishable from an ordinary life insurance company did not qualify for exemption under 501(c)(8). GCM 39575 (1986) concluded that the provision of annuities was considered “other benefits” because it protected against a “risk of loss of earning power” affecting the financial stability of its members. Analysis There are three general requirements needed for a fraternal beneficiary organization to qualify for exemption under Section 501(c)(8): to (1) be a fraternal organization, (2) operate under a lodge system, and (3) provide for the payment of life, sick, accident, or other benefits. This analysis focuses on the third requirement, the provision of benefits, and reviews two issues used to evaluate whether the benefits comply with exemption under Section 501(c)(8): Whether most of the fraternal members are provided benefits. Whether the type of benefit is permissible The issue of whether most of the fraternal members are provided benefits has two components. The first component focuses on the word “most” when considering whether most of the members are provided benefits. Polish Army Veterans Post 147 succinctly summarizes that requirement by concluding that an organization does not qualify as a fraternal organization where most of its members are not entitled to receive any benefits. In that case, 90% of the total membership was not entitled to receive benefits. However, “most” does not have to be “all” as explained in Rev. Rul. 64-194 PDF. In that ruling, the organization had two classes of membership (beneficial and social), and only the beneficial class, made up of most of the membership, was entitled to benefits. Nevertheless, substantially all of the members were eligible for benefits and benefits were payable from a separate fund maintained solely by dues from beneficial members. The second component focuses on the word “provided.” As explained in Rev. Rul. 76-457 PDF, the benefit must automatically accrue to the member as part of the dues paid. In that ruling, an organization did not qualify for exemption under Section 501(c)(8) because it did not provide an insurance benefit. Instead, members had the option to purchase insurance directly from an insurance company using their personal funds. Whether the type of benefit is permissible. The second issue focuses on whether the type of benefit provided is permissible under Section 501(c)(8). Life, sick, and accident benefits are specifically mentioned in the Code. Rev. Rul. 86-75 PDF held that life benefits include whole life insurance, which contain investment features. Sick benefits are designed to compensate for loss of income during a period of illness, and accident benefits are designed to compensate for a loss of earning power resulting from an injury. GCM 38192 (1979) discusses the historical development of Section 501(c)(8) benefits. The Code also lists “other benefits” as permissible benefits. Rev. Rul. 84-48 provides some guidance explaining what “other benefits” means. It concludes that “other benefits” must be similar in nature to life, sick, and accident benefits, and that they should be designed to compensate for expenses resulting from bodily injury or loss of earning power. In Rev. Rul. 84-48, the organization maintained a legal defense fund to defend members against criminal, civil, and administrative misconduct charges to protect against financial loss directly related the loss of earning power. As such, the legal defense fund benefit is considered “other benefits” within the meaning of Section 501(c)(8). Rev. Rul. 84-49 PDF illustrates another example of “other benefits” providing financial security after loss of earning power. In the ruling, an organization that operated an orphanage open to surviving dependent children of any deceased member was granted exemption under Section 501(c)(8). The expenses of the orphanages were paid from a separate fund supported by members’ dues. The ruling noted that although this was a noncash benefit like traditional life insurance, the orphanage provided its members’ children security against becoming wards of the state if their parents die. In GCM 39575 (1986) the provision of annuities was considered “other benefits” because it protected against a “risk of loss of earning power” affecting the financial stability of its members. However, an organization may not qualify under Section 501(c)(8) if it does not provide traditional types of insurance benefits enumerated in Section 501(c)(8) in addition to providing annuities. In Grange Insurance Ass’n of California, the 9th Circuit held that the statutory phrase “accident or other benefits” is sufficiently broad to include payments for injuries to property as well as to the person. However, in a footnote to GCM 38192, the Service disagreed with Grange Insurance Ass’n and instead provided that “accident and other benefits” does not include payments for injury to property. Issue indicators or audit tips When conducting an examination to determine whether benefits comply with Section 501(c)(8) exemption, consider the following items: Review the organizing documents, contracts, publications and disbursement records. Determine whether benefits automatically accrue as part of the dues paid. Determine whether most of the members are provided benefits. If there is a non-beneficial membership class, determine the purpose for which the organization established the distinction. Determine whether benefits are designed to compensate for a loss of earning power. If benefits are designed to compensate for a loss of property, consult with Division Council. Review the benefits features and determine if the organization is primarily engaged fraternal benefits. Review the activity features and determine if the organization is primarily engaged in fraternal purposes. Remember, with the passage of the PATH Act, there can be no modifications of exempt status. For further information see IRM 4.75.32.
