(a) Revised Regulations

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:

1. Any communication expressing a view on, whether for or against, the selection, nomination, election, or appointment of one or more clearly identified candidates or of candidates of a political party that—
   1. Contains words that expressly advocate, such as “vote,” “oppose,” “support,” “elect,” “defeat,” or “reject;” or
   2. Is susceptible of no reasonable interpretation other than a call for or against the selection, nomination, election, or appointment of one or more candidates or of candidates of a political party;
2. Any public communication within 30 days of a primary election or 60 days of a general election that refers to one or more clearly identified candidates in that election or, in the case of a general election, refers to one or more political parties represented in that election;
3. Any communication the expenditures for which are reported to the Federal Election Commission, including independent expenditures and electioneering communications;
4. A contribution (including a gift, grant, subscription, loan, advance, or deposit) of money or anything of value to or the solicitation of contributions on behalf of—
   1. Any person, if the transfer is recognized under applicable federal, state, or local campaign finance law as a reportable contribution to a candidate for elective office;
   2. Any section 527 organization; or
   3. Any organization described in section 501(c) that engages in candidate-related political activity;
5. Conduct of a voter registration drive or “get-out-the-vote” drive;
6. Distribution of any material prepared by or on behalf of a candidate or by a section 527 organization including, without limitation, written materials, and audio and video recordings;
7. Preparation or distribution of a voter guide that refers to one or more clearly identified candidates or, in the case of a general election, to one or more political parties (including material accompanying the voter guide); or
8. Hosting or conducting an event within 30 days of a primary election or 60 days of a general election at which one or more candidates in such election appear as part of the program.¹⁷

(b) New Filing Requirements

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.

(c) Choosing to Apply Under (c)(4) Versus (c)(3)

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

• More than 30 percent of the net fair market value of the (c)(3)'s assets (other than those of a church) or 50 percent of the recipient organization's assets are transferred to a controlled non-(c)(3) entity, which then conducts excessive lobbying.
• The transfer is within two years of the discovery of excessive lobbying.
• Upon transfer or at any time within 10 years following such a transfer, the transferee is controlled by the same persons who control the transferor. Control for this purpose means that the persons in authority can, by using their voting power, require or prevent the transferee's spending of funds.²³

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

(d) Affiliated (c)(3) and (c)(4) Organizations

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.

(e) Conversion to (c)(3) Status

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:

• Private benefit and control Regardless of the size of the group benefited (there was no argument that Columbia resembles a city that would qualify), CRPA is owned and controlled by the homeowners and residents and serves their private interests. Every property owner possesses an ownership right in CPRA's facilities and services. The facilities open to the public represented less than 2 percent of the total, and out of 110,000 families, only 190 received reduced fees.
• Funding source Another factor distinguishing CPRA from a §501(c)(3) organization was its source of funds: No voluntary contributions were solicited from the public; the sole source of financing was property owner fees, which are nondeductible for §170 purposes.
• No charitable purpose The CPRA did not lessen the burdens of government. There was no proof that the State of Maryland or Howard County accepted such responsibilities and, based on documents regarding the public transportation system, Columbia was expected to bear the cost.
• Dissolution clause The CPRA's charter named three possible recipients of its assets upon dissolution: Howard County, an agency or instrumentality of the county, or one of the village associations. The first two qualify as §501(c)(3) recipients, but the last does not because village associations are (c)(4) organizations. Thus, the assets were not dedicated permanently to §501(c)(3) purposes.

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

• Contributions More than one-third of the organization's support was received from contributions from the general public (i.e., nonindustry members).
• Charitable services Gerontology, social services (legal and emotional counseling), job placement for the unemployed, and scholarships were considered charitable services.
• Charitable class Because of its size (more than 10,000 members), its dedication to members of a particular industry was ruled not to negate its charitable purposes.

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).

(a) Limitation on Involvement with Political Candidates

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.

(a) Membership Requirements

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.

(b) Permissible Activities

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.

(a) Characteristics of Homeowner's Associations

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:

• An annual election to be so taxed pursuant to the section is made and filed by the due date of the return, including extensions.⁹⁷
• The nonprofit must be organized and operated to acquire, construct, manage, maintain, and care for association property, whether held in common for the owners, held privately by the owners, or held by a governmental unit for use by the owners.⁹⁸
• Sixty percent or more of its gross income must be “exempt function income,” that is, membership dues, fees, or assessments from member owners of residential units. A settlement for past underassessments of dues paid by a real estate developer is exempt function income.⁹⁹
• Ninety percent or more of its expenditures in a tax year must be for “exempt function purposes.” These purposes include capital expenditures for property improvements or replacement costs, salaries of managers, clerical, maintenance, and security personnel, gardening, paving, street signs, property taxes, repairs to association property, and all other disbursements to acquire, construct, manage, and maintain the property.
• Eighty-five percent or more of the condominium, subdivision, development, or similar area related to the association must be used by individuals as residences. Vacant units are included if they were residences before they became unoccupied.¹⁰⁰
• No part of its net earnings can inure to the benefit of any private shareholder or individual.

(b) Calculating the Tax

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:

• Interest earned on deposits and investments held in a sinking fund for improvements or repairs, including tax-exempt interest.
• Member assessments for mortgage principal, interest, and real estate taxes on association property.
• Amounts received for work performed on privately owned property.
• Assessments for maintenance, trash collection, or snow removal.
• Nonmember usage fees, as well as member fees for special services.

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.

(c) Annual Election

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.

(a) Notice of Noncharity Status

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:

• Organizations not described in §170(c) that are exempt from tax under §501(c) or §501(d) and political organizations defined in §527(e), including political campaign committees and political action committees.
• Organizations listed above whose gross annual receipts exceed $100,000 (multiple organizations created to circumvent this limit can be combined by the IRS).

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:

1. The solicitation includes an express statement that payments are not tax deductible as charitable contributions.
2. The statement is at least the same type size as the primary message and is readily visible against the background of the page.
3. The statement appears on the same [web] page as, and in close proximity to, the actual request for funds.
4. The statement is either the first sentence in a paragraph or itself constitutes a paragraph.

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

(b) Dues Not Deductible as Business Expense

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:

1. Influencing legislation
2. Contacts with certain senior executive branch officials in attempts to influence official actions or positions of such officials
3. Political campaign activities
4. Grassroots lobbying

(c) Definition of Legislation

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:

• The president and the vice president.
• Cabinet members, others having cabinet-level status, and their immediate deputies.
• The two most senior officers of each agency within the Executive Office of the President, such as the National Security Agency.
• An employee of the Executive Office of the President.

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

(d) Nondeductible Membership Dues

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.

(e) Proxy Tax

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

(f) Excepted Organizations

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).

• (c)(4) organizations are excluded if the following applies:
  • More than 90 percent of all annual dues are received from members who each pay annual dues of $105 for 2012, $103 for 2011, and $101 for 2010.¹²⁶
  • More than 90 percent of all annual dues are received from organizations described in §501(c)(3), state or local governments, or entities whose income is exempt under §115.
• (c)(5) organizations follow the same rule as (c)(4)s.
• (c)(6) If more than 90% of all annual dues are received from members who each pay annual dues of $166, the organization is not subject to the lobbying disclosure rule.

Excluded by Nondeductibility. An exempt organization that cannot satisfy the automatic exclusions may still be excluded if it

• Maintains records establishing that 90 percent or more of the annual dues (or similar amounts) paid to it are not deductible without regard to §162(e).
• Notifies the IRS that it is excluded by §6033(e)(3) when it files its annual Form 990.

The procedure defines the significant terms as follows:

• Annual dues are the amount an organization requires a person, family, or entity to pay to be recognized by the organization as a member for an annual period.
• Similar amounts include, but are not limited to, voluntary payments made by persons, families, or entities; assessments made by the organization to cover basic operating costs; and special assessments imposed by the organization to conduct lobbying activities.
• Member is used in its broadest sense and is not limited to persons with voting rights in the organization.

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

(g) Cost of Lobbying

To tally up its lobbying costs, an organization includes the following:

• Third-party costs, or amounts spent specifically on lobbying—daily fees paid to professional lobbyists, expenses of travel to Washington, or cost of an opinion poll.
• An allocable portion of the organization's overall operating expenses.
• Expenses of preparing, planning, or coordinating lobbying activities.
• Research and monitoring costs which, upon “looking back,” are shown to lead up to lobbying.

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

(h) Look-Back Rule

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

• Whether the activity and the lobbying communication are proximate in time.
• Whether the activity and the lobbying communication relate to similar subject matter.
• Whether the activity is performed at the request of, under the direction of, or on behalf of a person making the lobbying communication.
• Whether the results of the activity are also used for a nonlobbying purpose.
• Whether, at the time the taxpayer engages in the activity, there is specific legislation to which the activity is related.

The final regulations helpfully list the activities that will be treated as having no purpose to influence legislation:

• Determining the existence or procedural status of specific legislation, or the time, place, and subject of any hearing to be held by a legislative body with respect to specific legislation.
• Preparing routine, brief summaries of the provisions of specific legislation.
• Performing an activity to comply with any law, such as satisfying state or federal securities law filings.
• Reading any publications available to the general public or viewing or listening to other mass-media communications.
• Merely attending a widely attended speech.

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.