In order to qualify for exemption under Section 501(c)(8) or Section 501(c)(10), an organization must operate under the lodge system. This issue snapshot analyzes how to determine if an organization is operating under the lodge system. IRC Section and Treas. Regulation IRC Section 501(c)(8), Fraternal beneficiary societies, orders, or associations IRC Section 501(c)(10), Domestic fraternal societies, orders, or associations, operating under the lodge system Treas. Reg. Section 1.501(c)(8)-1(a), Fraternal beneficiary societies Treas. Reg Section 1.501(c)(10)-1, Certain fraternal beneficiary societies Resources (court cases, Chief Counsel Advice, Revenue Rulings, internal resources) Western Funeral Benefit Ass'n v. Hellmich, 2 F.2d 367 (E.D. Mo. 1924), stated that “the ‘lodge system’ is generally understood as an organization which holds regular meetings at a designated place, adopts a representative form of government, and performs its work according to ritual.” Fraternal Order of Civitans v. Commissioner, 19 T.C. 240 (1952), held that an organization, incorporated in 1937, whose members voted in 1946 to separate the “National Lodge” from the parent lodge and elect national officers, was not “operating under the lodge system” prior to 1946 “in that the petitioner was the only organization of its kind in existence and the record does not show that there was any ‘parent organization’ separate from the petitioner.” Hip Sing Asso. v. Commissioner, T.C. Memo 1982-203, held that existing local associations can band together formally to create a national (parent) organization. Each existing local association is a charter member "deemed to have been simultaneously `chartered by the parent they created. Rev. Rul. 55-495, 1955-2 C.B. 259 PDF, held that an organization which does not have a parent organization or subordinate branches does not qualify under Section 501(c)(8) because it does not operate under the lodge system. The organization considered was a local association of members of the same religious faith, created to assist its members in the case of sickness and other disaster and was deemed exempt under Section 501(c)(4). Rev. Rul. 75-199, 1975-1 C.B. 160 PDF, modifies Rev. Rul. 55–495 to remove the conclusion that the organization qualifies under Section 501(c)(4). Rev. Rul. 73-165, 1973-1 C.B. 224 PDF, held that a fraternal beneficiary society operating under the lodge system and providing member benefit payments may qualify for exemption under Section 501(c)(8) regardless of whether fraternal or insurance features predominate, as long as both features are present. Rev. Rul. 73-192, 1973-1 C.B. 224 PDF, held that an organization not operating under the lodge system, whose sole activity is to provide life, sick, and accident benefits exclusively for members of a fraternal beneficiary society operating under the lodge system, may qualify for exemption under Section 501(c)(8). Rev. Rul. 73-370, 1973-2 C.B. 184 PDF, held that a subordinate organization, formed and chartered by a local lodge exempt under Section 501(c)(10), to carry on fraternal and charitable activities in a particular geographical area, may qualify for exemption under Section 501(c)(10). Analysis Background IRC Section 501(c)(8) organizations: are fraternal beneficiary societies, orders, or associations operated under the lodge system or for the exclusive benefit of the members of a fraternity itself operating under the lodge system, and pay life, sick, accident, or other benefits to the members of such society, order, or association or their dependents. IRC Section 501(c)(10) organizations: are domestic fraternal societies, orders, or associations operating under the lodge system, do not offer life, sick, accident, or other benefits, and devote net earnings exclusively to religious, charitable, scientific, literary, educational, and fraternal purposes. Lodge system defined Treas. Reg. 1.501(c)(8)-1 provides that a fraternal beneficiary society is exempt from tax only if it is operated under the “lodge system” or for the exclusive benefit of the members. An organization is “operating under the lodge system” if it carries out its activities under a form of organization that comprises local branches called lodges, branches, chapters, and other similar designations. The local branches must be chartered by a parent organization and largely self-governing. The court in Western Funeral Benefit Ass’n v. Hellmich indicated the “lodge system” is generally understood to refer to an organization which holds regular meetings at a designated place, adopts a representative form of government, and performs its work according to ritual. Additionally, an organization that provides insurance to members of other lodges or organizations is not, for that reason, itself operated under the lodge system, although it may qualify for Section 501(c)(8) exemption as operated for the exclusive benefit of members of a lodge system, per Rev. Rul. 73-192. Parent and subordinate The term “operating under the lodge system” implies, at a minimum, two active entities: a parent and a subordinate (referred to as a “lodge”). The intention to operate in this manner is insufficient. An organization is operating under the lodge system only when the parent and local organizations exist and are active; mere provision in the constitution and by-laws for such bodies is not enough. There are no clear rules setting forth any minimum requirements regarding the regularity or frequency of membership meetings at the local level as long as the lodge system is effectively used as a means of maintaining a representative form of government. In addition, there are no specifications as to the kinds of activities an organization must engage in to be operated under the lodge system. Rev. Rul. 73-165 discusses the necessary ratio of fraternal activity to beneficial activity required of a Section 501(c)(8) organization, and states that there is no requirement that either feature predominate so long as both are present. The court in Fraternal Order of Civitans of America v. Comm’r. held that an organization, incorporated in 1937, whose members voted in 1946 to separate the “National Lodge” from the parent lodge and elect national officers, was not “operating under the lodge system” prior to 1946 “in that the petitioner was the only organization of its kind in existence and the record does not show that there was any ‘parent organization’ separate from the petitioner.” Similarly, Rev. Rul. 55-495 held that an organization which does not have a parent organization or subordinate branches does not qualify under Section 501(c)(8) because it does not operate under the lodge system. However, an organization may be exempt under Section 501(c)(8) even if it is not operated under the lodge system itself as long as it is operated for the exclusive benefit of the members of an Section 501(c)(8) organization that is so operated. A separately organized insurance branch need not benefit all the members of a lodge system. For instance, it may serve the members of a single lodge. Rev. Rul. 73-192 concerns an organization composed of members of a lodge operating under the lodge system. The organization’s sole purpose is to provide for the payment of life, sick, and accident benefits exclusively for members of the lodge. Thus, even though the organization itself does not operate under the lodge system, it operates exclusively for the benefit of the members of a fraternal beneficiary society itself operating under the lodge system, and it provides life, sick, and accident benefits to the members of that society. Each lodge operating under the lodge system must be recognized as a subordinate by a parent. But that does not mean that a new lodge must be created by the parent. Indeed, Hip Sing Association, Inc. v. Comm’r illustrates that existing autonomous organizations can choose to operate under the lodge system by banding together and creating their own parent. It is also possible for existing lodges to create additional lodges. In Rev. Rul. 73-370, an organization was formed by a lodge of a fraternal beneficiary society to carry out the activities of the society within a particular geographic area. The parent authorized the local lodges to create subordinate organizations to carry its fraternal and charitable activities into additional geographical areas. The new organization operated under a charter from the local lodge, and its members had to adhere to the rules and regulations of the local lodge and the laws and edicts of the parent. This ruling held that the new organization functioned as part of the lodge system of a fraternal society and, since its net earnings were devoted exclusively to charitable and fraternal purposes and it did not provide for the payment of life, sick, accident, or other benefits to its members, it was exempt under Section 501(c)(10). Issue indicators or audit tips The following should be considered in order to determine whether an organization is operating under the lodge system: Review the parent organization’s organizing documents to determine if it has rules governing subordinate lodges. Inspect the subordinate lodge’s charter to verify if it is a parent organization’s subordinate lodge. Review the minutes, correspondence files, and reports subordinate lodges submit to the parent organization or, for an examination of a parent organization, reports it received from the subordinate lodges to verify that active parent and subordinate lodges exist. Note: If the subordinate lodges aren’t required to submit activity and financial reports to the parent organization, this may indicate the parent organization and subordinate lodges aren’t operating under the lodge system. If the parent organization and the subordinate lodges aren’t operated under the lodge system, neither the parent organization nor the subordinate lodges qualify for exemption under Section 501(c)(8) or Section 501(c)(10).
