Automobile dealer advertising association loses business-league exemption

Plain-English summary

An association coordinated and funded advertising for a limited group of automobile dealers in a designated market area. Member contributions paid for television, radio, newspaper, digital, and other campaigns designed to generate customer traffic for the participating dealerships. The IRS concluded that these campaigns performed particular advertising services for members rather than improving business conditions across the automotive industry. It therefore revoked the association's section 501(c)(6) business-league exemption. The IRS separately agreed that the association could use the cash method because another party controlled the advertising funds and disbursements, while requiring corporate income-tax returns for the revocation year and later years.

Ruling snapshot

• Question: Could the dealer advertising association retain section 501(c)(6) status, and could it continue cash-basis reporting?
• Outcome: revocation, with cash-basis accounting allowed for its taxable corporate returns
• Key authorities: IRC §§ 11, 448, 501(c)(6); Treas. Reg. § 1.501(c)(6)-1; Rev. Rul. 67-77

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
TEGE EO Examinations Mail Stop 4920 DAL
1100 Commerce St.
Dallas, Texas 75242

Date: December 27, 2016

Taxpayer Identification Number:
Person to Contact:
Employee Identification Number:

Number: 201717045
Release Date: 4/28/2017 Employee Telephone Number:

UIL: 501.06-00
CERTIFIED MAIL — RETURN RECEIPT
Dear

This is a final adverse determination regarding your exempt status under section 501(c)(6) of the
Internal Revenue Code. You are no longer exempt under section 501(a) of the Code for the year
ending December 31, 20XX.

The revocation of your exempt status was made for the following reason(s):

You fail to meet the requirements set forth in Section 1.501(c)(6)-1 of the Regulations to be exempt
under IRC 501(c)(6) because you provide advertising services to a limited number of

dealers. You are performing services for your members by advertising for automobiles sold by
your members. You are not engaging in activities to improve business conditions in the
automotive industry as a whole. Therefore, you are not entitled to exemption from Federal income
tax as a business league under IRC 501(c)(6).

You are required to file an income tax return on Form 1120. This return should be filed with the
appropriate Service Center for the tax year ending December 31, 20XX in accordance with the
instructions of the return.

Processing of income tax returns and assessments of any taxes due will not be delayed should a
petition for declaratory judgment be filed under section 7428 of the Internal Revenue Code.

If you decide to contest this determination under the declaratory judgment provisions of section
7428 of the Code, a petition to the United States Tax Court, the United States Claims Court, or the


district court of the United States for the District of Columbia must be filed before the 91st Day
after the date this determination was mailed to you. Please contact the clerk of the appropriate
court for rules regarding filing petitions for declaratory judgments by referring to the enclosed
Publication 892. You may write to the United States Tax Court at the following address:

United States Tax Court
400 Second Street, NW
Washington, DC 20217

You also have the right to contact the Office of the Taxpayer Advocate. The Taxpayer Advocate
Service (TAS) is an independent organization within the IRS that can help protect your taxpayer
rights. TAS can offer you help if your tax problem is causing a hardship, or you've tried but
haven't been able to resolve your problem with the IRS. If you qualify for TAS assistance, which is
always free, TAS will do everything possible to help you. Visit taxpayeradvocate.irs.gov or call 1-
877-777-4778. If you prefer, you may contact your local Taxpayer Advocate at:

Internal Revenue Service
Office of the Taxpayer Advocate

If you have any questions, please contact the person whose name and telephone number are
shown in the heading of this letter.

Sincerely,

Mary A. Epps
Acting Director, EO Examinations

Enclosures:
Publication 892


Department of the Treasury                         Date: July 22, 2016
Internal Revenue Service                           Taxpayer Identification Number:
Tax Exempt and Government Entities
Exempt Organizations Examinations
Form:

Tax Year(s) Ended:

Person to Contact/ID Number:
Contact Numbers:
Manager’s Name/ID Number:

Manager’s Contact Number:

UIL: 501.06-00 Response due date:

Certified Mail — Return Receipt Requested
Dear

Why you are receiving this letter

We propose to revoke your status as an organization described in section 501(c)(6) of the
Internal Revenue Code (Code). Enclosed is our report of examination explaining the proposed
action.

What you need to do if you agree

If you agree with our proposal, please sign the enclosed Form 6018, Consent to Proposed
Action — Section 7428, and return it to the contact person at the address listed above (unless
you have already provided us a signed Form 6018). We'll issue a final revocation letter
determining that you aren’t an organization described in section 501(c)(6).

If we don't hear from you

If you don’t respond to this proposal within 30 calendar days from the date of this letter, we'll
issue a final revocation letter. Failing to respond to this proposal will adversely impact your legal
standing to seek a declaratory judgment because you failed to exhaust your administrative
remedies.

Effect of revocation status
If you receive a final revocation letter, you'll be required to file federal income tax returns for the
tax year(s) shown above as well as for subsequent tax years.

What you need to do if you disagree with the proposed revocation
If you disagree with our proposed revocation, you may request a meeting or telephone
conference with the supervisor of the IRS contact identified in the heading of this letter. You also

Letter 3618 (Rev. 6-2012)
Catalog Number 34809F


may file a protest with the IRS Appeals office by submitting a written request to the contact
person at the address listed above within 30 calendar days from the date of this letter.

The Appeals office is independent of the Exempt Organizations division and resolves most
disputes informally.

For your protest to be valid, it must contain certain specific information including a statement of
the facts, the applicable law, and arguments in support of your position. For specific information
needed for a valid protest, please refer to page one of the enclosed Publication 892, How to
Appeal an IRS Decision on Tax-Exempt Status, and page six of the enclosed Publication 3498,
The Examination Process. Publication 3498 also includes information on your rights as a
taxpayer and the IRS collection process. Please note that Fast Track Mediation referred to in
Publication 3498 generally doesn’t apply after we issue this letter.

You also may request that we refer this matter for technical advice as explained in Publication

892. Please contact the individual identified on the first page of this letter if you are considering
requesting technical advice. If we issue a determination letter to you based on a technical
advice memorandum issued by the Exempt Organizations Rulings and Agreements office, no
further IRS administrative appeal will be available to you.

Contacting the Taxpayer Advocate Office is a taxpayer right

You have the right to contact the office of the Taxpayer Advocate. Their assistance isn't a
substitute for established IRS procedures, such as the formal appeals process. The Taxpayer
Advocate can't reverse a legally correct tax determination or extend the time you have (fixed by
law) to file a petition in a United States court. They can, however, see that a tax matter that
hasn't been resolved through normal channels gets prompt and proper handling. You may call
toll-free 1-877-777-4778 and ask for Taxpayer Advocate assistance. If you prefer, you may
contact your local Taxpayer Advocate at:

Internal Revenue Service
Office of the Taxpayer Advocate

Letter 3618 (Rev. 6-2012)
Catalog Number 34809F


For additional information

If you have any questions, please call the contact person at the telephone number shown in the
heading of this letter. If you write, please provide a telephone number and the most convenient
time to call if we need to contact you.

Thank you for your cooperation.

Sincerely,

Margaret Von Lienen
Director, EO Examinations

Enclosures:

Report of Examination
Form 6018
Publication 892
Publication 3498

Letter 3618 (Rev. 6-2012)
Catalog Number 34809F


Schedule number or exhibit

Form 886-A EXPLANATIONS OF ITEMS

(in lieu of)
Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
ISSUES:

1. Can (the “Association’),

providing advertising services to its members, claim to be a business league under Section
501(c)(6) of Internal Revenue Code (the “Code”)?

2. Can the Association continue to report its financial information on a cash basis for 20XX and
after?

FACTS:
Background

The Association incorporated on March 10, 20XX, and stated its purpose as “to engage in any
lawful act or activity, other than credit union business.”

The Association completed a Form 1024, Application for Recognition of Exemption Under Section
501(a), on June 15, 20XX, applying for exempt status under Section 501(c)(6) of the Code. The
Association described its activities on its Form 1024 as follows:

The Organization’s activities are to promote and advertise products and services
retailed by each member. The venues for promotion will be television XX%, radio
XX% and newspaper X%. Television advertising agency will be retailed [sic] to
produce and market comercials [sic] relating to the organization's members products
and services. The same will be done for the two other venues (radio and
newspaper). The promoters and advertising agencies will be evaluated as to their
effectiveness and the public awareness of the member's product and services.

In the bylaws, the Association stated its purposes as follows:

_.. Primary Purpose. ... to advertise and promote the products and services of
dealers who are members of this corporation.

... General Purposes ...

(a) To foster and promote retail trade and commerce in connection with the
products and services of the members, and to protect the same from unjust and
unlawful exactions and impositions.

(b) To foster and promote the interest of those persons, firms and corporations
engaged in the retailing of in the DMA
(Designated Market Area-a television advertising market as defined by Nielsen

Form 886-A (1-1994) Catalog Number 20810W Page 1 publish.no.irs.gov | Department of the Treasury-Internal Revenue Service


Schedule number or exhibit

Form 886-A EXPLANATIONS OF ITEMS

(in lieu of)

Name of taxpayer Tax Identification Number Year/Period ended

12/31/20XX

Media Research, Inc.), and such other areas as may be designated by the Board of
Directors and

(c) To conduct and operate means and places of disseminating information
relative to the use of motor vehicles and to promote the sale of motor vehicles, and
for such purposes to establish, conduct and manage advertising and promotional
campaigns, exhibitions, display tests, trials, and demonstrations.

(d) To promote the establishment and maintenance of a high standard of
business ethics by members of the corporation and by all other automobile dealers,
and to discourage the use of false or misleading advertising or any other business
practice, which may be detrimental to the public and the retail automobile industry.

The bylaws limited its membership as follows:

_.. those persons and legal entities who (1) are actively engaged in the retailing of
motor vehicles as duly authorized holders of Dealer Sales and
Service Agreements for vehicles (“Dealers”), (2) are doing
business in or about that geographical area as delineated by

as the DMA, and such other areas as may be designated by the Board of
Directors and , and (3) are participating in a

under the term of the program and
contributing funds to that program at the rate established by the Board of Directors.
Applications for membership shall be submitted to the Board of Directors, and an
affirmative vote of a majority of the Directors shall be required for election to
membership.

On October 1, 20XX, we asked for clarification on some items stated in the Form 1024, and
informed the Association that “Currently, it does not appear that your organization will meet the
standards of section 501(c)(6). Please submit any and all information that you would like us to
consider ...” We did not receive a response.

On November 20, 20XX, we notified the Association that we could not review the application
because we didn’t receive the requested information. We allowed the Association to provide the
requested information within 90 days, to re-activate the application process. We have no records
of the Association providing any of the requested information.

Activities

We audited the Form 990, Return of Organization Exempt From Income Tax, for the year ended
December 31, 20XX. The Association provided the following statement in regards to its activities:

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Schedule number or exhibit
Form 886-A EXPLANATIONS OF ITEMS
Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
The is formed with 1 or more dealers within a DMA
(designated market area). The dealer(s) agree to contribute a certain percentage of
each vehicle sale that goes into the budget. The budget is then invested for

marketing & advertising purposes to generate qualified customer traffic to the
contributing dealerships. By combining forces, it allows the dealers to afford
expensive advertising costs such as TV, digital and experiential executions. The
advertising agency handles all this for the dealer group and reports back on a
regular basis (in-person meetings, conference calls, etc).

For the , all X dealers in the DMA contribute to this budget
at X.X% of each new vehicle sale. At the beginning of each year, an estimated
budget is established and an advertising plan is put together for the calendar year.
The agency develops a recommendation and presents this to the group, upon
approval the agency executes the plan (media, production, experiential, etc.). As
each month passes by, actual sales and expenditure information gets updated and
tracked (i.e. Jan gets actualized in early Feb). It’s the agency’s responsibility to
keep accurate records of this in order to gage if the earlier estimates are holding
true. The agency will then make appropriate changes to the overall advertising plan
based on the actual information if necessary. This process continues through the
entire year.

Members of the Association held regular meetings and communicated with each other throughout
the year to discuss and decide when and how to advertise their products. However, the
Association did not provide minutes of these meetings to us.

, the Association’s representative, stated that the Association did not have a bank
account. withholds X.X percent of funds for advertising allowance. Dealers put out
advertisements in their local area and pays advertising expenses directly to the vendors.
pool their resources to do group advertisements. Although these dealers conducted their
advertising activities through the Association, it has no monetary transactions.

keeps track of funds it withholds, and expenses it pays. sends monthly reports to the
Association, showing available funds and expenses paid. monthly reports for 20XX indicate
that held $X,XXX,XXX.XX; paid $X,XXX,XXX.XX in expenses; and returned $XXX,XXX.XX to
dealer-members. returned funds to dealer-members throughout the year, averaging $XX,XXX
a month. indicated the Association’s account balances as $XX,XXX.XX at the beginning, and
$XXX,XXX.XX at the end of 20XX.

Returns Filed

Our records indicate that the Association filed Forms 990, and Forms 990-T, Exempt Organization
Business Income Tax Return, since 20XX. The Association reported zero revenue and expense
on all Forms 990-T.

Form 886-A (1-1994) Catalog Number 20810W Page 3 publish.no.irs.gov | Department of the Treasury-Internal Revenue Service


Form 886-A

(in lieu of)

EXPLANATIONS OF ITEMS

Schedule number or exhibit

Name of taxpayer

Tax Identification Number

Year/Period ended

12/31/20XX

The Association filed Forms 990 based on

changed its reporting style, even though it continues to check the box for cash accounting method.
The Association reported the total amount withheld as revenue, resulting in net gain or loss for the

year, as shown in the table below:

monthly reports, using cash method. Prior to
20XX, the Association only reported the total amount of expenses paid as both revenue and
expenses, and zero amounts for balance sheet items. Beginning in 20XX, the Association

Description 20XX 20XX 20XX 20XX
Membership dues (n1) X,XXX,XXX | X,XXX,XXX | X,XXX,XXX | X,XXX,XXX
Expenses

Accounting X, XXX

Advertising & promotion X,XXX,XXX | X,XXX,XXX | X,XXX,XXX X,XXX,XXX

Administration fees XX,XXX XXX, XXX XXX,XXX XXX, XXX

Conference, conventions & meetings X, XXX

Insurance X,XXX

Travel X,XXX
Total Expenses X,XXX,XXX | X,XXX,XXX | X,XXX,XXX | XX,XXX,XXX
Net Income x (Xx,XXX) XXX, XXX XX, XXX
Accounts Receivable (n2) X XX,XXX XXX, XXX XXX, XXX
n1. Total less

n2 This amount was $xxx,xxx on 20xx return.

In retrospect, indicated the change in reporting since 20XX was incorrect, because
“There has never been nor there ever will be any profits relating to the above mention advertising
expenditures. controls the funds (bank accounts) and the disbursements
(checks).”

LAW:

Issue 1: Exemption status

Section 501(c)(6) of the 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 inure to the benefit of any private shareholder
or individual.

Section 1.501(c)(6)-1 of Treasury Regulations (the “Regulations”) describes a business league as
an association of persons having some common business interest, the purpose of which is to
promote such common interest and not to engage in a regular business of a kind ordinarily carried
on for profit. It is an organization of the same general class as a chamber of commerce or board

Form 886-A (1-1994) Catalog Number 20810W Page 4 publish.no.irs.gov | Department of the Treasury-Internal Revenue Service


Schedule number or exhibit

Form 886-A EXPLANATIONS OF ITEMS

(in lieu of)

Name of taxpayer Tax Identification Number Year/Period ended

12/31/20XX

of trade. Thus, its activities should be directed to the improvement of business conditions of one
or more lines of business as distinguished from the performance of particular services for
individual persons. An organization, whose purpose is to engage in a regular business of a kind
ordinarily carried on for profit, even though the business is conducted on a cooperative basis or
produces only sufficient income to be self-sustaining, is not a business league.

Revenue Ruling 67-77, describe a situation similar to the Association. It states, “An organization
composed of dealers in a certain make of automobile in a designated area is organized and
operated for the primary purpose of financing general advertising campaigns to promote, with
funds contributed by dealer members, the sale of that make of automobile. Held, the organization
is performing particular services for its members and is not entitled to exemption from Federal
income tax as a business league under section 501(c)(6) of the Code of 1954.”

In the National Muffler Dealers Association, Inc., v. United States (99 S.Ct. 1304, 1310+,
U.S.N.Y.), a trade organization for muffler dealers sued for an income tax refund, claiming the
“business league” exemption. The District Court rendered judgment for the Government and the
United States Court of Appeals for the Second Circuit, 565 F.2d 845, affirmed. On certiorari, the
Supreme Court, Mr. Justice Blackmun, held that, because the association had confined its
membership to dealers franchised by one company and its activities to the muffler business, it was
not a “business league.”

Issue 2: Accounting Method and Tax on Net Income

Section 11 of the Code imposes income tax on net earnings of corporations.
Section 448(a) of the Code allows a corporation to use cash basis of account, if it meets one of

the exceptions. The applicable exception here is Section 448(b)(3): Entities with gross receipts of
not more than $5,000,000.

TAXPAYER’S POSITION:

states that the Association will agree with our proposal to deny its exempt status.
However, the Association should not be paying taxes on funds it never received, and had no
control over.

GOVERNMENT’S POSITION

Issue 1: Exemption status

Form 886-A (1-1994) Catalog Number 20810W Page 5 publish.no.irs.gov | Department of the Treasury-Internal Revenue Service


Schedule number or exhibit

Form 886-A EXPLANATIONS OF ITEMS

(in lieu of)

Name of taxpayer Tax Identification Number Year/Period ended

12/31/20XX

The Association fails to meet the requirements set forth in Section 1.501(c)(6)-1 of the Regulations
to be exempt under Section 501(c)(6) of the Code, because it provides advertising services to a

limited number of dealers. The following facts support this statement:
• The Association's membership is limited to dealers in the geographical
area outlined by as the DMA.
• Members participate in a under the term of the

program and contribute funds at rates established by

• The Association's activities directly benefit its members when it promotes and advertises
members’ products and services.

The Association’s activity is similar to situations stated in Revenue Ruling 67-77, and the court
case, National Muffler Dealers Association, Inc., v. United States. In the Revenue Ruling, the
organization was not exempt under Section 501(c)(6) of the Code because it was providing
specific services to its members. In the court case, the organization was providing its services to
muffler dealers of specific manufacturer. Three different courts supported our position that the
organization should not be a exempt under Section 501(c)(6) of the Code.

The Association can’t claim that it qualifies as a business league under Section 501(c)(6) of the
Code, and we should deny its exempt status effective January 1, 20XX.

Issue 2: Accounting Method and Tax on Net Income

The Association meets an exception to use cash accounting method. The Association used cash
method since its formation until 20XX.

We agree that reporting financial activities on cash basis is proper because the Association has no
fiscal control of funds. According to the records we reviewed, has control of the following
financial matters:

• How much to withhold in advance, based upon agreements with dealer-members
• Adjustments to make, based upon actual delivery of automobiles makes to dealers
• Funds to return to dealer-members and which dealer-member to return funds to
• Expense disbursements

Although the Association has excess funds, the Association can only use them in manners agreed
upon between and dealer-members.

CONCLUSION

Form 886-A (1-1994) Catalog Number 20810W Page 6 publish.no.irs.gov | Department of the Treasury-Internal Revenue Service


Schedule number or exhibit

Form 886-A EXPLANATIONS OF ITEMS

(in lieu of)

Name of taxpayer Tax Identification Number Year/Period ended

12/31/20XX

Issue 1: Exemption status

The Association is performing services for its members by advertising for automobiles sold by its
members. The Association isn’t engaging in activities to improve business conditions in the
automotive industry as a whole. Therefore, it is not entitled to exemption from Federal income tax
as a business league under Section 501(c)(6) of the Code. We deny the exempt status of the
Association effective as of January 1, 20XX.

Issue 2: Accounting Method and Tax on Net Income

The Association is required to file Forms 1120, U.S. Corporation Income Tax Return, for 20XX and
all subsequent tax years.

The Association may use cash accounting method to report its financial information for these
years.

Form 886-A (1-1994) Catalog Number 20810W Page 7 publish.no.irs.gov Department of the Treasury-Internal Revenue Service