which is being correlated with the plan seeking to satisfy the requirements of section 501 (c) (17) may be a plan which forms part of a voluntary employees' beneficiary association described in section 501 (c) (9), if such plan satisfies all the requirements of section 501 (c) (17) (A). Under this exception, for example, if an employer has established a plan providing for the payment of supplemental unemployment compensation benefits for his hourly wage employees and such plan satisfies the requirements of section 501(c) (17) (A) (even though the plan forms part of a voluntary employees' beneficiary association described in section 501(c) (9)), the salaried employees of such employee may establish a plan for themselves, and, if such plan provides for the same benefits as the plan covering hourly-wage employees, both plans may be considered as one plan in determining whether the plan covering the salaried employees satisfies the requirement that it be nondiscriminatory as to coverage. The foregoing example would also be applicable if the benefits provided for the salaried employees were funded solely or in part by employer contributions.

(d) Permanency of the plan. A plan providing for the payment of supplemental unemployment compensation benefits contemplates a permanent as distinguished from a temporary program. Thus, although there may be reserved the right to change or terminate the plan, and to discontinue contributions thereunder, the abandonment of the plan for any reason other than business necessity within a few years after it has taken effect will be evidence that the plan from its inception was not a bona fide program for the purpose of providing supplemental unemployment compensation benefits to employees. Whether or not a particular plan constitutes a permanent arrangement will be determined by all of the surrounding facts and circumstances. However, merely because a collective bargaining agreement provides that a plan may be modified at the termination of such agreement, or that particular provisions of the plan are subject to renegotiation during the duration of such agreement, does not necessarily imply that the plan is not a permanent arrangement. Moreover, the fact that the plan provides that the assets remaining in the trust after the satisfaction of all liabilities (including contingent liabilities) under the plan may be

99-151-69- 3

returned to the employer does not imply that the plan is not a permanent arrangement nor preclude the trust frum qualifying under section 501 (c) (17).

(e) Portions of years. A plan must satisfy the requirements of section 501 (c) (17) throughout the entire taxable year of the trust in order for the trust to be exempt for such year. However, section 501 (c) (17) (C) provides that a plan will satisfy the nondiscrimination as to classification requirements of section 501(c) (17) (A) if on at least one day in each quarter of the taxable year of the trust it satisfies such requirements. (f) Several trusts constituting one pian. Several trusts may be designated as constituting part of one plan which is intended to satisfy the requirements of section 501 (c) (17), in which case all of such trusts taken as a whole must meet the requirements of such section. The fact that a combination of trusts fails to satisfy the requirements of section 501 (c) (17) as one plan does not prevent such of the trusts as satisfy the requirements of section 501(c) (17) from qualifying for exemption under that section.

(g) Plan of several employers. A trust forming part of a plan of several employers, or the employees of several employers, will be a supplemental unemployment benefit trust described in section 501 (c) (17) if all the requirements of that section are otherwise satisfied.

(h) Investment of trust funds. No specific limitations are provided in section 501 (c) (17) with respect to investments which may be made by the trustees of a trust qualifying under that section. Generally, the contributions may be used by the trustees to purchase any investments permitted by the trust agreement to the extent allowed by local law. However, the tax-exempt status of the trust will be forfeited if the investments made by the trustees constitute "prohibited transactions" within the meaning of section 503. See section 503 and the regulations thereunder. In addition, such a trust will be subject to tax under section 511 with respect to any "unrelated business taxable income" (as defined in section 512) realized by it from its investments. See sections 511 to 515, inclusive, and the regulations thereunder.

(i) Allocations. If a plan which provides sick and accident benefits is financed solely by employer contributions to the trust, and such sick and accident benefits are funded by payment

of premiums on an accident or health insurance policy (whether on a group or individual basis) or by contributions to a separate fund which pays such sick and accident benefits, the plan must specify that portion of the contributions to be used to fund such benefits. If a plan which is financed in whole or in part by employee contributions provides sick and accident benefits, the plan must specify the portion, if any, of employee contributions allocated to the cost of funding such benefits, and must allocate the cost of funding such benefits between employer contributions and employee contributions.

(j) Required records and returns. Every trust described in section 501(c) (17) must maintain records indicating the amount of separation benefits and sick and accident benefits which have been provided to each employee. If a plan is financed, in whole or in part, by employee contributions to the trust, the trust must maintain records indicating the amount of each employee's total contributions allocable to separation benefits. In addition, every trust described in section 501 (c) (17) makes one or more payments totaling $600 or more in 1 year to an individual must file an annual information return in the manner described in paragraph (b) (1) of § 1.6041-2.

which

[T.D. 6972, 33 F.R. 12901, Sept. 12, 1968]

§ 1.501 (c) (17)-3

Relation to other sec

tions of the Code. (a) Taxability of benefit distributions-(1) Separation benefits. If the separation benefits described in section 501(c) (17) (D) (i) are funded entirely by employer contributions, then the full amount of any separation benefit payment received by an employee is includible in his gross income under section 61(a). If any such separation benefit is funded by both employer and employee contributions, or solely by employee contributions, the amount of any separation benefit payment which is includible in the gross income of the employee is the amount by which such distribution and any prior distributions of such separation payments exceeds the employee's total contributions to fund such separation benefits.

(2) Sick and accident benefits. Any benefit payment received from the trust under the part of the plan, if any, which provides for the payment of sick and accident benefits must be included in

gross income under section 61(a), unless specifically excluded under section 104 or 105 and the regulations thereunder. See section 105(b) and § 1.105-2 for benefit payments expended for medical care, benefit payments in excess of actual medical expenses, and benefit payments which an employee is entitled to receive irrespective of whether or not he incurs expenses for medical care. See section 213 and § 1.213-1(g) for benefit payments representing reimbursement for medical expenses paid in prior years. See 1.501(c) (17)-2(i) for the requirement that a trust described in section 501(c) (17) which receives employee contributions must be part of a written plan which provides for the allocation of the cost of funding sick and accident benefits.

(b) Exemption as a voluntary employees' beneficiary association. Section 501 (c) (17) (E) contemplates that a trust forming part of a plan providing for the payment of supplemental unemployment compensation benefits may, if it qualifies, apply for exemption from income tax under section 501(a) either as a voluntary employees' beneficiary association described in section 501 (c) (9) or as a trust described in section 501(c) (17).

(c) Returns. A trust which is described in section 501(c) (17) and which is exempt from tax under section 501 (a) must file a return in accordance with section 6033 and the regulations thereunder. If such a trust realizes any unrelated business taxable income, as defined in section 512, the trust is also required to file a return with respect to such income.

(d) Effective date. Section 501 (c) (17) shall apply to taxable years beginning after December 31, 1959, and shall apply to supplemental unemployment benefit trusts regardless of when created or organized.

[T.D. 6972, 33 F.R. 12902, Sept. 12, 1968] § 1.501 (d) Statutory provisions;

ex

emption from tax on corporations, certain trusts, etc.; religious and apostolic organizations.

SEC. 501. Exemption from tax on corporations, certain trusts, etc. * * *

(d) Religious and apostolic organizations. The following organizations are referred to in subsection (a): Religious or apostolic associations or corporations, if such associations or corporations have a common treasury or community treasury, even if such associations or corporations engage in business for the common benefit of the members, but only if the members thereof include (at the time of

filing their returns) in their gross income their entire pro rata shares, whether distributed or not, of the taxable income of the association or corporation for such year. Any amount so included in the gross income of a member shall be treated as a dividend received.

§ 1.501(d)-1 Religious and apostolic associations or corporations.

(a) Religious or apostolic associations or corporations are described in section 501(d) and are exempt from taxation under section 501(a) if they have a common treasury or community treasury, even though they engage in business for the common benefit of the members, provided each of the members inIcludes (at the time of filing his return) in his gross income his entire pro rata share, whether distributed or not, of the net income of the association or corporation for the taxable year of the association or corporation ending with or during his taxable year. Any amount so included in the gross income of a member shall be treated as a dividend received.

(b) For annual return requirements of organizations described in section 501 (d), see section 6033 and paragraph (a) (5) of § 1.6033-1.

Under section 11(b) of the Internal Security Act of 1950 (50 U.S.C. 790(b)), as amended, which is made applicable to the Code by section 7852 (b) of that Code, no organization is entitled to exemption under sections 501(a) or 521 (a) for any taxable year if at any time during such year such organization is registered under section 7 of such Act or if there is in effect a final order of the Subversive Activities Control Board established by section 12 of such Act requiring such organization to register under section 7 of such Act, or determining that it is a Communist-infiltrated organization.

§ 1.502 Statutory provisions; feeder organizations.

SEC. 502. Feeder organizations. An organization operated for the primary purpose of carrying on a trade or business for profit shall not be exempt under section 501 on the ground that all of its profits are payable to one or more organizations exempt under section 501 from taxation. For purposes of this section, the term "trade or business" shall not include the rental by an organization of its real property (including personal property leased with the real property). § 1.502-1 Feeder organizations.

(a) In the case of an organization operated for the primary purpose of carrying on a trade or business for profit, exemption is not allowed under section 501 on the ground that all the profits of such organization are payable to one or more organizations exempt from taxation under section 501. For the purpose of this rule, the term "trade or business" does not include the rental by an organization of its real property (including personal property leased with the real property). In determining the primary purpose of an organization, all the circumstances must be considered, including the size and extent of the trade or business and the size and extent of those activities of such organization which are specified in the applicable paragraph of section 501.

(b) If a subsidiary organization of a tax-exempt organization would itself be exempt on the ground that its activities are an integral part of the exempt activities of the parent organization, its exemption will not be lost because, as a matter of accounting between the two organizations, the subsidiary derives a profit from its dealings with its parent organization, for example, a subsidiary organization which is operated for the sole purpose of furnishing electric power used by its parent organization, a taxexempt educational organization, in carrying on its educational activities. However, the subsidiary organization is not exempt from tax if it is operated for the primary purpose of carrying on a trade or business which would be an unrelated trade or business (that is, unrelated to exempt activities) if regularly carried on by the parent organization. For example, if a subsidiary organization is operated primarily for the purpose of furnishing electric power to consumers other than its parent organization (and the parent's tax-exempt subsidiary organizations), it is not exempt since such

business would be an unrelated trade or business if regularly carried on by the parent organization. Similarly, if the organization is owned by several unrelated exempt organizations, and is operated for the purpose of furnishing electric power to each of them, it is not exempt since such business would be an unrelated trade or business if regularly carried on by any one of the tax-exempt organizations. For purposes of this paragraph, organizations are related only if they consist of

(1) A parent organization and one or more of its subsidiary organizations; or (2) Subsidiary organizations having a common parent organization.

An exempt organization is not related to another exempt organization merely because they both engage in the same type of exempt activities.

(c) In certain cases an organization which carries on a trade or business for profit but is not operated for the primary purpose of carrying on such trade or business is subject to the tax imposed under section 511 on its unrelated business taxable income.

[T.D. 6500, 25 F.R. 11737, Nov. 26, 1960, as amended by T.D. 6662, 28 F.R. 6973, July 29, 1963]

§ 1.503 (a) Statutory provisions; requirements for exemption; denial of exemption to organizations engaged in prohibited transactions.

SEC. 503. Requirements for exemption— (a) Denial of exemption to organizations engaged in prohibited transactions—(1) General rule.

(A) An organization described in section 501(c)(3) which is subject to the provisions of this section shall not be exempt from taxation under section 501(a) if it has engaged in a prohibited transaction after July 1, 1950. (B) An organization described in section 501 (c) (17) which is subject to the provisions of this section shall not be exempt from taxation under section 501 (a) if it has engaged in a prohibited transaction after December 31, 1959.

(C) An organization described in section 401(a) which is subject to the provisions of this section shall not be exempt from taxation under section 501(a) if it has engaged in a prohibited transaction after March 1. 1954.

(2) Taxable years affected. An organization described in section 501 (c) (3) or (17) or section 401(a) shall be denied exemption from taxation under section 501 (a) by reason of paragraph (1) only for taxable years after the taxable year during which it is notified by the Secretary or his delegate that it has engaged in a prohibited transaction,

unless such organization entered into such prohibited transaction with the purpose of diverting corpus or income of the organization from its exempt purposes, and such transaction involved a substantial part of the corpus or income of such organization. [Sec. 503 (a) as amended by sec. 2, Act of July 14, 1960 (P.L. 86-667, 74 Stat. 535)] [T.D. 6972, 33 F.R. 12903, Sept. 12, 1968] § 1.503 (a)-1 Denial of exemption to organizations engaged in prohibited transactions.

(a) The prohibited transactions enumerated in section 503 (c) are in addition to and not in limitation of the restrictions contained in section 501(c) (3) or (17), or section 401(a). Even though an organization has not engaged in any of the prohibited transactions referred to in section 503 (c), it still may not qualify for tax exemption in view of the general provisions of section 501(c) (3) or (17), or section 401(a). Thus, if a trustee or other fiduciary of the organization (whether or not he is also a creator of such organization) enters into a transaction with the organization, such transactior. will be closely scrutinized in the light of the fiduciary principle requiring undivided loyalty to ascertain whether the organization is in fact being operated for the stated exempt purposes. (b) An organization—

(1) Described in section 501(c) (3) which after July 1, 1950, nas engaged in any prohibited transaction as defined in section 503 (c), unless it is excepted by the provisions of section 503(b), or

(2) Described in section 401 (a) which after March 1, 1954, has engaged in any prohibited transaction as defined in section 503 (c) or which after December 31, 1962, has engaged in any prohibited transaction as defined in section 503 (j);

or

(3) Described in section 501(c) (17) which after December 31, 1959, has engaged in any prohibited transaction as defined in section 503 (c),

shall not be exempt from taxation under section 501 (a) for any taxable year subsequent to the taxable year in which there is mailed to it a notice in writing by the Commissioner that it has engaged in such prohibited transaction. Such notification by the Commissioner shall be by registered or certified mail to the last known address of the organization. However, notwithstanding the requirement of notification by the Commissioner, exemption shall be denied with respect to

any taxable year if such organization during or prior to such taxable year commenced the prohibited transaction with the purpose of diverting income or corpus from its exempt purposes and such transaction involved a substantial part of the income or corpus of such organization. For the purpose of this section, the term "taxable year" means the established annual accounting period of the organization; or, if the organization has no such established annual accounting period, the "taxable year" of the organization means the calendar year.

(c) The application of section 503 (c) may be illustrated by the following examples:

Example (1). A creates a foundation in 1954 ostensibly for educational purposes. B, a trustee, accumulates the foundation's income from 1957 until 1959 and then uses a substantial part of this accumulated income to send A's children to college. The foundation would lose its exemption for the taxable years 1957 through 1959 and for subsequent taxable years until it regains its exempt status.

Example (2). If under the facts in example (1) such private benefit was the purpose of the foundation from its inception, such foundation is not exempt by reason of the general provisions of section 501 (c) (3), without regard to the provisions of section 503, for all years since its inception, that is, for the taxable years 1954 through 1959 and subsequent taxable years, since under section 501 (c) (3) the organization must be organized and operated exclusively for exempt purposes. See § 1.501 (c) (3)-1. See also § 1.504-1 for loss of exemption in the case of certain organizations accumulating income.

IT.D. 6500, 25 F.R. 11737, Nov. 26, 1960, as amended by T.D. 6972, 33 F.R. 12903, Sept. 12, 1968]

§ 1.503(b) Statutory provisions; requirements for exemption; organizations to which section 503 applies.

SEC. 503. Requirements for exemption. *** (b) Organizations to which section applies. This section shall apply to any organization described in section 501(c) (3) or (17) or section 401 (a) except

(1) A religious organization (other than a trust);

(2) An educational organization which normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly carried on;

(3) An organization which normally receives a substantial part of its support (exclusive of income received in the exercise or performance by such organization of its charitable, educational, or other purpose or

function constituting the basis for its exemption under section 501 (a)) from the United States or any State or political subdivision thereof or from direct or indirect contributions from the general public;

(4) An organization which is operated, supervised, controlled, or principally supported by a religious organization (other than a trust) which is itself not subject to the provisions of this section; and

(5) An organization the principal purposes or functions of which are the providing of medical or hospital care or medical education or medical research or agricultural research.

[Sec. 503 (b) as amended by sec. 2(b), Act of July 14, 1960 (Pub. Law 86-667, 74 Stat. 535)] [T.D. 6972, 33 F.R. 12903, Sept. 12, 1968]

§ 1.503 (c) Statutory provisions; requirefor exemption; prohibited transactions.

ments

SEC. 503. Requirements for exemption. *

(c) Prohibited transactions. For purposes of this section, the term "prohibited transaction" means any transaction in which an organization subject to the provisions of this section

(1) Lends any part of its income or corpus, without the receipt of adequate security and a reasonable rate of interest, to;

(2) Pays any compensation, in excess of a reasonable allowance for salaries or other compensation for personal services actually rendered, to;

(3) Makes any part of its services available on a preferential basis to;

(4) Makes any substantial purchase of securities or any other property, for more than adequate consideration in money or money's worth, from;

(5) Sells any substantial part of its securities or other property, for less than an adequate consideration in money or money's worth, to; or

(6) Engages in any other transaction which results in a substantial diversion of its income or corpus to;

the creator of such organization (if a trust); a person who has made a substantial contribution to such organization; a member of the family (as defined in section 267 (c) (4)) of an individual who is the creator of such trust or who has made a substantial contribution to such organization; or a corporation controlled by such creator or person through the ownership, directly or indirectly, of 50 percent or more of the total combined voting power of all classes of stock entitled to vote or 50 percent or more of the total value of shares of all classes of stock of the corporation.