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.taxmap/pubs/p557-030.htm#TXMP417581ba
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. taxmap/pubs/p557-030.htm#TXMP48e9070btaxmap/pubs/p557-030.htm#TXMP3e0ec9f1
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. taxmap/pubs/p557-030.htm#TXMP598a8434
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.taxmap/pubs/p557-030.htm#TXMP29886c23
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.taxmap/pubs/p557-030.htm#TXMP6c3f2c3e
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.taxmap/pubs/p557-030.htm#TXMP23c72a0a
All of the organizations listed above 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.taxmap/pubs/p557-030.htm#TXMP1b192ee3
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 of the 85% requirement any income received or accrued from:
- Qualified pole rentals,
- Any provision or sale of electric energy transmission services or ancillary service if the services are provided on a nondiscriminatory open access basis under an open access transmission tariff approved or accepted by the Federal Energy Regulatory Commission (FERC) or under an independent transmission provider agreement approved or accepted by FERC (other than income received or accrued directly or indirectly from a member),
- The provision or sale of electric energy distribution services or ancillary services if the services are provided on a nondiscriminatory open-access basis to distribute electric energy not owned by the mutual or electric cooperative company:
- To end-users who are served by distribution facilities not owned by the company or any of its members (other than income received or accrued directly or indirectly from a member), or
- Generated by a generation facility not owned or leased by the company or any of its members and which is directly connected to distribution facilities owned by the company or any of its members (other than income received or accrued directly or indirectly from a member),
- Any nuclear decommissioning transaction, or
- Any asset exchange or conversion transaction.
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.taxmap/pubs/p557-030.htm#TXMP65eb548f
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.taxmap/pubs/p557-030.htm#TXMP5809b825
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|
|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.taxmap/pubs/p557-030.htm#TXMP7900f6d1
Donations to an organization described in this section are not deductible as charitable contributions on the donor's federal income tax return.taxmap/pubs/p557-030.htm#TXMP3ac4d316
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.taxmap/pubs/p557-030.htm#TXMP3c08beb9
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.taxmap/pubs/p557-030.htm#TXMP163c74d1
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.taxmap/pubs/p557-030.htm#TXMP05cef34a
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.taxmap/pubs/p557-030.htm#TXMP70989c27
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.