It is well-established that an organization may be created to carry out its purposes through the development and implementation of programs designed to have an impact on community, state, or national policymaking.1 Environmental protection, housing, civil rights, aid to the poor, world peace, or other public issues may be involved. The pursuit of such subjects is the focus of both §§501(c)(3) and (c)(4) organizations. The term social welfare appears in the regulations defining charitable for (c)(3) purposes. This chapter focuses on the factors that distinguish a (c)(3) from a (c)(4) organization and the category of exemption most appropriate for organizations that pursue matters of public policy.
The regulations for Internal Revenue Code (IRC) §501(c)(4) were adopted in 1959 and cover only half a page. They list two basic types of organizations that fall into this category.
Type 1. The first type of (c)(4) is a civic organization that is organized for nonprofit purposes and operated exclusively for promotion of social welfare. To “promote social welfare means to promote in some way the common good and general welfare of the people of the community.”2 A community is traditionally a geographic unit bearing a reasonably recognizable relationship to an area identified as a governmental subdivision or a unit or district thereof. This concept includes bringing about civic betterment and social improvements. A civic league may focus on neighborhood protection, civil justice, improving mobility, and other issues of public concern. The regulations state that a social welfare organization may qualify for exemption as a charitable organization unless it is an action organization, or one the mission of which can only be accomplished with legislative changes.3
Because this type of nonprofit is often created to take action, meaning to change the laws, it cannot qualify under (c)(3). Promotion of social welfare does not include direct or indirect participation or intervention in political campaigns on behalf of or in opposition to any candidate for public office. However, lobbying can be its primary function, as long as the legislative activity promotes in some way the common good and general welfare of the people of a community. Election campaign involvement is also permitted, but cannot be a significant activity.4 The phrase “exclusively operated for civic welfare” does not prohibit an organization from earning some unrelated business income.5
Type 2. The second type of (c)(4) is a local association of employees whose membership is limited to the employees of a designated person or persons in a particular municipality and whose net earnings are devoted exclusively to charitable, educational, or recreational purposes.6
In 1996, §501(c)(4) was amended to prohibit a qualifying association from engaging in activities that allow net earnings to inure to the benefit of any private shareholder or individual.7 Prior to that time, the private inurement prohibition applied by statute only to §501(c)(3) entities.8 Intermediate sanctions can be applied to penalize associations that provide excess compensation or other monetary benefits to those that control the organization.9
In 1971, the IRS said, “The Service has used §501(c)(4), in many ways, as a convenient pigeonhole for organizations that, although worthy, fail to meet the particular requirements of other §501(c) organizations.”10
The term social welfare is included in the regulations defining charitable for (c)(3) purposes. Because promotion of social welfare can be the focus of both §§501(c)(3) and (c)(4) organizations, it is important to carefully choose which category is most appropriate for a particular organization.
IRC §501(c)(4) organizations have several elements in common with §501(c)(3) entities. They conduct similar social welfare activities, such as eliminating prejudice and discrimination, defending human and civil rights secured by law, and combating community deterioration and juvenile delinquency. Other parallels include the following:
The following characteristics of a §501(c)(4) organization are very different and serve to distinguish it from a §501(c)(3) organization:
Due to the lack of precise expense limit on (c)(4)s' electioneering, over the years many § 501(c)(4) entities (including, for example, the Swift Boat Veterans for Truth) conducted extensive endorsement activities in support of Bush in the 2004 election against his opponent John Kerry. Consequently, the expanded regulations were proposed in 2016.16
Proposed Definitions. The promotion of social welfare does not include direct or indirect candidate-related political activity. Candidate-related political activity means:
A new code provision was enacted at the end of 2015 in response to controversies in the IRS Determination Division in Cincinnati regarding the level of political activity of §501(c)(4) applicants. IRC §506 requires an organization to notify the IRS of its intent to operate as a §501(c)(4) organization. In 2018, the IRS released Form 8976, Notice of Intent to Operate under §501(c)(4), which must be filed electronically within 60 days after the entity is established or the entity will face a $20-per-day penalty, up to a maximum of $5,000.18
A newly formed §501(c)(4) entity may also submit Form 1024-A to obtain overt IRS approval for its tax-exempt qualification.19 This form was created in 2018 for §501(c)(4) entities with tax years ending on or after December 31, 2006.
It is possible for an organization to qualify for exemption under both §§501(c)(3) and (c)(4), but that important choice must be made when a project promoting social welfare applies for exempt status. Those that plan to conduct action activities and expect to engage in extensive lobbying beyond the limits permitted under (c)(3) must seek (c)(4) status.20 There are very few circumstances under which (c)(4) would be chosen in preference to (c)(3), particularly when tax-deductible contributions can be sought.
An existing (c)(3) organization that expects its future lobbying efforts will cause it to lose its charitable status should apply to convert its category of exemption before the excessive lobbying activity occurs. A (c)(3) organization that loses its exemption because it engages in excessive lobbying cannot then convert to the (c)(4) class, but instead loses its exempt status and becomes a taxable entity.21 Intentional avoidance of this rule was anticipated by Congress. A transfer of assets by a (c)(3) to create a separate (c)(4) organization may result in loss of the (c)(3)'s exempt status. The excessive activity is attributed to a (c)(3) spinning off assets to carry on the lobbying in the following circumstances:22
The Christian Coalition's application for qualification as a §501(c)(4) civic welfare organization failed to receive IRS approval after 10 years of discussions. The coalition says it withdrew Form 1024 and chose to operate as a business corporation with freedom to endorse political candidates and make financial contributions to support candidates of its choice. Although the facts are not known, it is presumed that the coalition's voter guides and other election-related activities represented too high a portion of its overall activities.24 Some commentators question why the organization had sought (c)(4) status in the first place rather than classification as a political organization.25
It is common for (c)(4) organizations to operate in affiliation with charitable organizations. Social welfare programs often encompass issues that are the subject of legislative proposals and also entail research, public education, and other activities that qualify as charitable. When it is anticipated that the advocacy efforts will make charitable status difficult to obtain or maintain, two organizations can be formed from the inception: (1) a (c)(4) to carry out lobbying activities and (2) a (c)(3) for strictly charitable activities.
Affiliated (c)(3) and (c)(4) organizations can operate side by side; can share resources, such as office space, equipment, and personnel; and often have similar names—the Sierra Club and the Sierra Club Legal Defense Fund, for example. However, the financial affairs of each organization must be kept separate.26 Essentially, policies creating a protective firewall to keep them separate is in order. Documentation evidencing the fashion in which common costs are shared and allocated must be maintained. Form 990, Schedule C, requires that very detailed information be reported about such sharing.27
Although overlapping board members are permissible, common control can suggest a lack of independence. The safest relationship is for each organization to have independent control. Staff overlap must be carefully documented with time records and evidence of staff activity. Shared facilities, memberships, funding campaigns, publications, and other overt products of activity deserve careful expense allocations based on time spent, space occupied, or another suitable indicator of respective use.28 Alliance for Justice has publications that aid in establishing policies for affiliated organizations to “ensure accurate and legally permissible resource allocations between a related (c)(3) and (c)(4).”29
A grant from the (c)(3) to the (c)(4) can be made if the grant is restricted to charitable purposes, such as research not associated with particular legislative proposals. If allocated to lobbying, the grant should not be for an amount that would violate the (c)(3)'s limitations. Clearly, the (c)(3) organization should not raise general support funds to be transmitted to the (c)(4), but the reverse would be allowable.
Circumstances of an organization qualified under (c)(4) may change. If legislative activity declines or for other reasons, an organization may consider converting its tax-exempt status to (c)(3). To explore the issues involved in such a conversion, consider two examples.
Example 1. Representing the population of a planned community of 100,000 residents qualifies for §501(c)(4) status, not (c)(3), in the opinion of the Tax Court.30 Columbia Park and Recreation Association (CPRA) was a nonprofit organization formed to build and operate “facilities and services for the common good and social welfare of the people” of Columbia, Maryland; to represent property owners and residents with respect to owner assessment and collection of fees for such services; and to enforce property covenants.
The CPRA built the public utility and transportation systems, parks, pools, neighborhood and community centers, and recreational facilities such as tennis courts, golf courses, a zoo, an ice rink, boat docks, and athletic clubs for the community. CPRA essentially functions like a municipality, but is not a political subdivision of the county in which it is located. CPRA was formed by the private developers of Columbia. Columbia has “villages” that have formed separate civic associations.
For the first 12 years of CPRA's existence, it was classified as a §501(c)(4) organization. To qualify for tax-favored bond financing, CPRA sought reclassification as a §501(c)(3) organization in 1982. The IRS denied the (c)(3) exemption based on failure of both the operational and the organizational test, as follows:
Example 2 . A civic welfare organization operated to meet the financial and emotional needs of individuals employed in an industry worldwide was allowed to merge itself into its subsidiary §501(c)(3) organization, because it possessed the requisite charitable characteristics, as follows:31
In both examples, note that the organizational activities benefit a limited class of individuals. What distinguishes the two is (1) the character of the activities and (2) the sources of support. Relieving suffering in distress situations is generally considered charitable, as is promotion of health and education. Recreation, preservation of property values, and commuting to work are not generally classified as charitable activities.32
The IRS essentially found that a volunteer fire company could merge its §501(c)(4) entity into its §509(a)(3) supporting organization to form a single §501(c)(3) organization.33 The organizational documents of both organizations dedicated the assets to charitable purposes so that, as a practical matter, either organization could have survived. For tax purposes, however, the assets of the (c)(3) organization could not have been transferred to the (c)(4).
The primary characteristic of a qualifying civic league is that it operates to benefit the members of a community as a whole, be it the world or a small town, as opposed to operating a social club for the benefit, pleasure, or recreation of particular individuals. The IRS has taken the position that a community is traditionally a “geographic unit bearing a reasonably recognizable relationship to an area ordinarily identified as a govenunental subdivision or a unit or district thereof.”34
Social events sponsored by civic leagues are permitted, if they are incidental to the group's primary function.35 One court stated that “the organization must be a community movement designed to accomplish community ends.”36 Another said, “In short, social welfare is the well-being of persons as a community.”37 The following projects have been determined to be qualifying activities for civic leagues:
A civic organization that benefits private individuals or operates for profit cannot qualify as a (c)(4) organization. The following groups have failed to receive exemption:
Civic leagues must operate exclusively for the promotion of social welfare65 and are often referred to as social welfare organizations. Such organizations must operate exclusively for the promotion of social welfare by primarily engaging in promoting in some way the common good and general welfare of the people of the community.66 Social welfare is specifically listed as a charitable purpose67 so that such an organization may qualify for exemption as a charitable organization if it is not an “action” organization.68
Take note of the words exclusively and primarily in the preceding paragraph. The words are not defined numerically in the tax code or regulations applicable to social welfare organizations. In 1981, the IRS ruled that supporting a candidate cannot be a primary purpose, but can be a secondary one.69 This ruling also said there was no complete ban, but did not provide a quantifiable measure of the amount of campaign spending or activity that was allowed. Discussions in Chief Counsel Memos during 1979 and 1980 and annual IRS Exempt Organizations Continuing Education Texts for many years made no mention of specific limits. This lack of guidance was much of the cause for IRS decision delays in 2010–2013 regarding many applications for exemption, due to the applicants' campaign involvement.70
In the spring of 2013, the news broke that Forms 1024, Application for Recognition of Exemption under IRC § 501(c)(4), for social welfare organizations with names indicating a connection to a political campaign, such as “Tea Party” or “Patriot,” were targeted for enhanced scrutiny. A “be on the lookout” (BOLO) list was used to guide the process. Complaints from those targeted led to an uproar that received significant press coverage and resulted in many IRS EO personnel resignations, congressional investigations, and an audit of the process by the Treasury Inspector General for Tax Administration (TIGTA).71
In June 2013, the IRS announced an expedited processing plan for §501(c)(4) applications that had been pending for more than 120 days. Representatives of such organizations, under penalties of perjury, were asked to sign a declaration with respect to the level of their organization's social welfare activities and political campaign intervention activities. The organization was asked to express its expectation to spend 60 percent or more of both its total expenditures and its total time (measured by employee and volunteer hours) on activities that promote social welfare. Additionally, an assurance was requested that during each past, current, and future years the entity has and will spend less than 40 percent of its expense and time on direct or indirect participation or intervention in any political campaign on behalf of (or in opposition to) any candidate for public office. The IRS said, “These percentage representations are not an interpretation of law but are a safe harbor for those organizations that choose to participate in the optional process.”72
Another aspect of the issue at that time was the fact that the tax code did not require a §501(c)(4) organization to seek recognition of exemption. It formerly could be self-declared, but is required to file Form 990.
The Protecting Americans from Tax Hikes Act of 2015 (PATH Act) added new IRC §506 to impose a requirement for the filing of an initial notification, including a user fee, on new and certain existing §501(c)(4) organizations. Self-declaring as a path for (c)(4) exempt status was removed. The IRS 2015–2016 Priority Guidance Plan intention to provide rules pertaining to political activities never occurred and was dropped in 2016–2017.
Under §506, a new organization that wishes to be classified as a §501(c)(4) organization without filing Form 1024 (called a self-declarer) must submit an initial notification together with a user fee.73 Under §506, effective July 8, 2016, Form 8976, plus a $50 fee, must be submitted electronically within 60 days of formation. Submission past the due date can bring a $20 penalty. The information required is the name, address, employer identification number, date organized, state in which organized, a statement of purpose of the organization, and the annual accounting period. The IRS noted that it may require additional data in future published guidance and that filers can expect to be required to provide supporting information with the first Form 990-series return filed after submitting the initial notification.
An association of employees of a particular company working in a local area to serve charitable, educational, or recreational purposes without allowing its assets to benefit the employees as individuals can qualify for tax exemption under §501(c)(4).
The statute describes a local association as one limited to employees of a designated person or persons in a particular municipality. The word local means the organization has a purely local character confined to a particular community, place, or district, irrespective of political subdivisions.74 A limit circumscribed by the borders of a state is too broad. An association limited to specified counties in two states, however, did qualify.75 Employees of a business with locations in different cities and states would need to form separate associations in the various locations.76
The words person or persons allow an association to be comprised of employees of more than one employer in a local area.77 Retired employees can be members78 even if they were not members while they were actively employed.79 The association may limit its membership to certain classes of employees. In one example, the IRS thought it was acceptable for an employee health club to admit only salaried employees and exclude hourly workers.80 The 200 employees were deemed not to represent an “excessively exclusive” arrangement, but an association limited to employees paid more than $100,000 annually might not qualify.
Associations must conduct activities of a charitable, educational,81 or recreational nature. The association might sponsor the company softball team or conduct safety programs or continuing education classes. An association that promotes cultural activities for employees by securing blocks of tickets for symphony or ballet performances could qualify.
The association that exists primarily to provide insurance, pension, or other retirement benefits to its members is not considered charitable and cannot qualify.82 It was unsuccessfully argued that such an association formed by government employees should qualify as charitable because it relieves the burdens of government.83 The IRS holds the same opinion.84 Similarly, an association formed to provide cooperative buying services85 cannot qualify.
To qualify under §501(c)(4), an organization must serve a constituency that constitutes a community rather than a limited group of individuals. The homeowner's association exemplifies the type of group not qualified for (c)(4) tax-exempt status, but the distinction between those that qualify and those that do not is often vague. One IRS definition of community says that the term “has traditionally been construed as having reference to a geographic unit bearing a reasonably recognizable relationship to an area ordinarily identified as a governmental subdivision or a unit or district thereof.”86 A community is sometimes hard to define, and the facts and circumstances of each case are determinative.87 Taken as a whole, the rulings indicate that to prove that an organization operates for the benefit of the community as opposed to individual residents, the following factors must be present:88
Although it may undertake some activities that benefit the community, the typical homeowner's association will not qualify for §501(c)(4) exemption if its primary focus is to benefit individual owners—the first four items in the previous list. To stop some of the controversy, clarify the rules, and allow tax relief for such associations, in 1976 Congress enacted §528, which provides a special exemption section for homeowner's associations. Two types of associations qualify: condominium management associations and residential real estate management associations.96 The basic requirements for qualifying include the following:
The tax relief is only partial. Although all of a qualifying civic league's income is exempt from income tax, a homeowner's association pays tax. It can elect to pay either a flat 30 percent tax on its nonexempt function income (basically, income from charges for common-area facilities, passive investment income, and any unrelated business income less deductions) or the normal corporate tax payable on all of its income. Exempt function revenues are those received from the member property owners as dues or assessments, unless such fees or assessments represent payments for services rendered to the members. Taxable revenues101 for §528 purposes include the following:
Deductions from the listed taxable income items include expenses directly connected with producing the nonexempt function income. There is a specific $100 deduction. No deduction for net operating loss or dividends received is allowed.
A homeowner's association has an annual choice of electing to pay income tax as a normal corporation rather than to pay the flat 30 percent tax on its investment income. For taxable income of up to $50,000 the normal corporate tax rate for 2010 was 15 percent, and 25 percent for the next $25,000. For an association with modest taxable income, the election to pay the 30 percent tax may not be suitable. The decision turns on factors that should be quantified in each case to make the correct choice. The tax rate is one factor and is influenced by both the amount of the income and the kind of income that is taxable. The part of an association's net income that is considered exempt function income is not taxed if the election is made, but it is taxed if the association elects to be taxed as a normal corporation.
A nonelecting homeowner's association is subject to a deduction limitation rule,102 which allows deduction of expenses attributable to owner activities only to the extent of owner income. It is extremely important, therefore, to understand the interplay of the deduction limit in §277 and the flat tax of §528, which contains the exclusions from income. In other words, even though the association's financial statements show no net profit, it may have taxable income.
Once the election is made or not made, the association may seek permission from the IRS to revoke or elect pursuant to the relief provision of §9001. When the wrong decision was made based on the recommendation of a professional advisor, revocation has been allowed.103 Form 1120H filers need not pay quarterly estimated tax. The balance of tax is due by the fifteenth day of the third month following the end of the taxable year. For further details, see IRS Publication 588, Tax Information for Homeowners Associations.
Many non-(c)(3) organizations are required to make two different disclosures of the deductibility of payments they solicit. Organizations can be penalized for failure to properly make the disclosures.
Social welfare organizations, agricultural organizations, business leagues, and many other tax-exempt organizations not eligible to receive gifts deductible as charitable contributions must say so on fund-raising solicitations.104 Exempt organizations subject to the disclosure requirement include the following:
An express statement that payments (whether called dues, gifts, contributions, or something else) are not tax deductible as a charitable donation must be printed on written requests for payments and announced in solicitations made by phone, radio, television, and the Internet (though the latter was not mentioned in the 1988 legislation). Certain types of exempt function payment requests are excluded, such as a fee for a newsletter ad, registration for an educational conference, premiums for an insurance program, community association fees for police and fire protection, and other payments for specific services rendered by the nonprofit.
The disclosure must be “conspicuous and easily recognizable.” The statement of nondeductibility must be clearly legible in type of the same size as the primary message of the written piece. It cannot be obscured by placement, color, shape, or other means and cannot be buried in some part of the solicitation materials that ordinarily would not be noticed and read by the recipient. The script of telephone, radio, television, and Internet solicitations must contain a statement that the payments are not tax deductible.105 In 2002, the IRS announced that the disclosures are not “difficult to adapt to computer-based communications” and found “no reason to treat e-mail solicitation any differently from direct mail solicitations. Web-based fund-raising is similar to print media, since unlike telephone, television, and radio, the viewer generally controls what he or she looks at and for how long.”106
The following four conditions should exist for the website solicitation to meet the disclosure requirements:
The penalty for failure to disclose is $1,000 a day, up to $10,000 each year. The IRS imposed the maximum penalty for nondisclosure on a §527 political organization in the first ruling issued on the subject. No notice was included in its telemarketing script. It argued that it had relied on the “inadequate compliance information supplied to it by its national umbrella organization” so that the penalty should be excused for “reasonable causes.” The IRS found that the organization was “not run by inexperienced individuals ignorant of the tax laws, but by experienced, knowledgeable individuals with paid staff having access to information concerning the rules.”107
Congress listened to President Bill Clinton's suggestion that almost all lobbying expenses be made nondeductible for income tax purposes. Before 1994, a business expense deduction was not allowed for political campaign activity and grassroots lobbying attempts to influence the public at large, but expenses of direct efforts to influence lawmakers were deductible. IRC §162(e) was revised108 to add two new types of nondeductible lobbying and political activity—for both for-profit and nonprofit entities—bringing the total to four, as follows:
Influencing legislation is defined by §162(e)(4) to mean “any attempt to influence any legislation through communicating (oral or written) with any member or employee of a legislative body or with any government official or employee who may participate in the formulation of legislation.” Influencing legislation is additionally defined by the regulations to include “[a]ll activities, such as research, preparation, planning, and coordination, including deciding whether to make a lobbying communication, engaged in for a purpose of making or supporting a lobbying communication, even if not yet made.”109 The term legislation includes actions with respect to acts, bills, resolutions, or similar items by Congress; any state legislature, local council, or similar governing body; or the public in a referendum, initiative, constitutional amendment, or similar procedure.110
Action is limited to the introduction, amendment, enactment, defeat, or repeal of acts, bills, resolutions, or similar items. The IRS has deemed confirmation of a judicial nominee to be “similar to” legislation.111 Actions of federal or state administrative or special-purpose bodies, such as auditing or issuing rulings, are not included.112 Attempting to influence regulations proposed by the Treasury Department would not be considered legislative activity. These rules contain no exceptions for nonpartisan research and study of issues germane to legislative actions, as found in §4911 applicable to (c)(3) organizations. Some guidance as to when an issue becomes a legislative proposal is provided in the regulations under a “look-back rule.”113 The congressional conferees did say that any “communication compelled by subpoena, or otherwise compelled by federal or state law, does not constitute an attempt to influence legislation or an official's actions, and therefore is not subject to the general disallowance rules.”114
Local Councils. A special exception was carved out to permit the deduction of expenses of attempting to influence legislation of “any local council or similar governing body.”115 Any legislative body of a political subdivision of a state, such as a county or city council, comes within the exception for local lobbying.116 State-level lobbying expenses associated with legislative actions of a state legislature are treated on a par with federal lobbying. Note, however, that communications with state officials are not subject to the disallowance provisions for federal officials.
Communications with Executive Branch. Making a direct communication with high officials in the executive branch of the federal government in an attempt to influence their official actions is lobbying and expenses paid are not deductible. The disallowance applies when the communiqué concerns administrative action as well as pending or proposed legislation. The covered executive branch officials include the following:
A communication regarding proposed Treasury Department regulations may or may not be a direct communication. Comments about regulations submitted through normal channels to lower-level employees are not generally regarded as a communication with a cabinet member. Direct contact with the Secretary of the Treasury and his or her deputy, however, would be. The cost of research and analysis conducted to gather information intended to be communicated to a covered official is also nondeductible.
A communiqué addressed to a noncovered official can be treated as a direct communication if the covered official is the intended recipient.117 The fact that a cabinet-level official must ultimately approve or sign off on a regulation does not make the lower-level contact a nondeductible activity.118 It is important to distinguish regulation and procedural communications from those involving legislation. Communication with a member of the executive branch on any level concerning legislation being formulated will be treated as an attempt to influence legislation. Concerning the charitable lobbying rules, the IRS has stated that a treaty required to be submitted by the president to the Senate is considered “legislation” from the moment a U.S. representative begins negotiations with the other country's delegates.119
Dues paid to membership organizations, including a civic league, labor union, or business league, are not deductible to the extent the money is spent on nondeductible lobbying or political expenses.120 The disallowance applies to dues paid to organizations that spend more than $2,000 annually on “in-house” expenses, or what the IRC calls a de minimis amount.121 An allocation of overhead costs, third-party payments, dues to other organizations, grassroots lobbying, political campaign intervention, and foreign lobbying are not considered in-house expenses. Also, certain organizations whose members ordinarily do not deduct their dues are excluded from this nondeductibility provision.122
Exempt organizations, other than (c)(3)s, that spend money for lobbying expenses associated with legislative and executive-branch communications have a choice under these rules. The first choice Congress gives an organization that lobbies is to disclose the nondeductible amount to its members. Under this choice, members are informed of the portion of nondeductible lobbying expenses paid with or allocable to the dues payments. With the proper notice to members, the organization can essentially pass through its nondeductible lobbying. Choice 2 allows the organization itself to instead pay unrelated business income tax on its lobbying expenditures, called a proxy tax.
Documents seeking payment of dues from members of organizations making the first choice must contain the estimated amount of the portion of dues that are nondeductible. If such notice is not given, the organization pays the proxy tax on its lobbying expenditures.123 Form 990 Schedule C requires the organization to report the total amount of dues allocable to lobbying. The calculation of the nondeductible dues portion is made on a first-in, first-out basis. Disallowed expenses are considered as paid out of member dues rather than other funds or revenues of the organization. If the portion of member dues actually collected totals less than the amount of nondeductible lobbying in any one year, the excess expense is carried over to the succeeding year. This rule prevents an organization from using savings or other resources every other year or so to reduce bad member relations that might result from nondeductibility of dues.
The league or union that chooses not to, or fails to, notify its members of the nondeductible amount pays a proxy tax. The tax is payable at the highest corporate tax rate, currently 21%.124 The choice can be made (or imposed because of a mistake) annually. The tax is due on the portion of member dues allocable to expenditures for nondeductible lobbying activities, but cannot exceed the amount of dues received during a year.125
Organizations that establish to the satisfaction of the secretary that substantially all of the dues or other similar amounts paid by persons to such organizations are not deductible without regard to §162(e) are excluded from this disclosure and disallowance provisions. The IRS explains the application of this exception by category of organization.
Automatically Excluded. The notification and/or proxy tax provisions do not apply to organizations recognized by the IRS as exempt from taxation under §501(a) other than those exempt under §501(c)(4), (5), or (6).
Excluded by Nondeductibility. An exempt organization that cannot satisfy the automatic exclusions may still be excluded if it
The procedure defines the significant terms as follows:
The definition of annual dues is straightforward and clear. However, the meanings of similar amounts and member are vague and broad. Assume that a group of individuals creates an organization to lobby the state legislature for more school funding. A self-perpetuating board creates a nonmembership not-for-profit corporation and seeks (c)(4) status. Using a direct mail campaign, the organization seeks support from citizens statewide. There is no mention of membership or dues nor of assessment. Under a strict reading of the IRS definition, such voluntary payments could be construed as similar amounts. A cautious organization in this situation might notify supporters of the nondeductibility of their payments.
The vague definition of the term member for this purpose is quite contrary to the definition suggested by the IRS in trying to tax associate member dues of labor unions and business leagues. For that purpose, the IRS says a member is a person who has a formal relationship with and specific rights and obligations in relation to the organization.127
To tally up its lobbying costs, an organization includes the following:
The preamble to the regulations says that costs properly allocable to lobbying activities are to be calculated using any reasonable method consistently applied.128 The method must, however, follow specific rules for the exclusion or inclusion of labor. The labor hours (and presumably the cost of the labor, dependent on the method used) of persons spending less than 5 percent of their time on lobbying may be ignored as de minimis, unless the time is spent in direct-contact lobbying.
Two distinct categories of costs are allocable: labor costs and general and administrative (G&A) costs. G&A is said to include depreciation, rent, utilities, insurance, maintenance costs, security costs, and other administrative department costs (for example, payroll, personnel, and accounting). The regulations suggest, but do not limit the organization to, use of one of the following three allocation methods.
Type 1: Ratio Method. A percentage of the organization's overall operating costs, not including third-party lobbying expense, is allocated to lobbying. The ratio compares the total number of hours the organization's personnel spend directly engaged in lobbying to the total number of hours personnel work. Any reasonable method may be used to determine labor hours. The opening explanation suggests, as examples of records to be maintained, daily time reports or daily logs. Absent exact records, it may be assumed that full-time personnel spend 1,800 hours a year on the “taxpayer's trade or business.” Support personnel labor—“persons engaged in secretarial, maintenance, and similar activities”—may be excluded from both the numerator and the denominator of the ratio calculation.
Type 2: Gross-Up Method. Under this method, the total lobbying cost is
“Basic labor costs” means salary or other payment for services plus payroll taxes. Pension, profit sharing, employee benefits, and supplemental unemployment benefit plan costs, as well as other similar costs, are not included. The lobbying activities of many nonprofits are conducted by volunteers. This method cannot be used by organizations that do not incur reasonable labor costs for persons engaged in lobbying (efforts conducted by volunteers).129
Type 3: §263A Cost System. The cost system provided for manufacturing businesses can be used. Lobbying activity is treated as a service department or function to which costs are allocated, using a step methodology. The regulations contain a detailed example that can be studied to consider the viability of this choice. Under normal tax accounting rules, the choice of method is binding and alterable only with IRS permission.130
Internal Revenue Code §162(e)(5)(c) broadens the definition of what constitutes amounts spent to influence legislation to include “any amount paid or incurred for research, or preparation, planning, or coordination of any such activity.” Merely monitoring legislative activity is not an attempt to influence it. An organization, however, must look back and reclassify monitoring expenses as nondeductible131 in cases where it monitors legislation and subsequently attempts to influence the formulation or enactment of the same (or similar) legislation. The costs of the monitoring activities generally will be treated as incurred in connection with nondeductible lobbying activity. Likewise, if the organization conducts research and prepares presentations, meetings, and communications with underlings of a covered executive branch official “with a view toward directly communicating with the top official,” all of the costs are nondeductible.132
The regulations recognize that an organization might be involved in matters of legislative import for multiple reasons and suggest that all of the facts and circumstances surrounding an activity be considered to identify the “purpose of an expenditure.” The organization may treat an activity partially as related to a legislative initiative and partially for a nonlobbying purpose. The IRS suggests that the following facts would determine the purpose of engaging in such an activity:133
The final regulations helpfully list the activities that will be treated as having no purpose to influence legislation:
Six detailed examples in the regulations can be studied by an organization wishing to distinguish between activities that have lobbying import and those that have no purpose to influence legislation.
18.117.148.177