Calculating "in-house" lobbying expenses under IRS safe harbors.

The provision of the Revenue Reconciliation Act of 1993 disallowing deductions for lobbying expenses under Sec. 162(e) does not provide clear rules on how taxpayers are to calculate total nondeductible expenditures. While computation of lobbying expenses paid to professional lobbyists and other "third parties" should be relatively straightforward, it is unclear how expenses attributable to lobbying performed "in-house" should be calculated. For example, Sec. 162(e) does not specify what portion of an office's overhead or travel and entertainment expenses might be nondeductible as a result of lobbying activities. Similarly, often it will not be clear whether an activity is sufficiently related to lobbying to be subject to the disallowance provisions.

The IRS has attempted to help. Proposed regulations issued late last year would allow business and tax-exempt organizations to avoid having to track these "inhouse" expenses. instead, the optional safe harbors rules generally would require only that taxpayers capture the total hours that employees spent lobbying.

Under the "ratio" method safe harbor, in-house lobbying expenses generally would be the total cost of operations multiplied by a fraction, the numerator of which is total lobbying labor hours and the denominator of which is total taxpayer labor hours. Hours spent by secretarial, maintenance and similar personnel could be excluded from both the numerator and the denominator.

Under a second proposed safe harbor (the "gross-up" method), a taxpayer first would determine, for each employee, hours spent lobbying divided by total hours worked for the year. This fraction would be multiplied by wages or salary, excluding pension or other qualified benefit costs. This amount would then be multiplied by 175%, which would produce total in-house lobbying expenses.

Not all of an employee's time spent lobbying would have to be taken into account under these safe harbors. Taxpayers could disregard lobbying by employees who spend less than 5% of their time lobbying. This de minimis rule, however, would not apply to "direct contact" lobbying, defined as meetings, telephone conversations, letters, or other similar communications with legislators and certain high-ranking Federal officials - but not their staffs. All employee time spent on direct contact lobbying would have to be counted as time spent lobbying.

To take advantage of either safe harbor, a taxpayer must establish some type of recordkeeping that would capture the time its employees spend lobbying. Several options are available. Some firms, for example, are asking employees involved in lobbying to submit one-page monthly lobbying summaries. These forms normally include a listing of lobbying projects and the corresponding hours spent on each project.

The Service also has provided a third alternative. Under this approach, taxpayers could allocate costs to lobbying activities by applying the approaches of the uniform capitalization (UNICAP) regulations under Sec. 263A. This approach could entail a major modification of the taxpayer's UNICAP system of cost accounting in order to make the appropriate calculation.

Most taxpayers, trade associations and other exempt organizations subject to the deduction disallowance at this point appear to be considering using either the ratio method or gross-up method. Since the calculations are relatively simple, and would require essentially the same data, some taxpayers may postpone any final decision until they have a chance to "run the numbers" under both approaches at year-end.

A second set of regulations, proposed in May 1994, contains additional rules and definitions to be applied in determining whether an activity is "lobbying." Some activities will never be considered to be lobbying: (1) 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, and (2) preparing routine brief summaries of the provisions of specific legislation.

The preamble to the May regulations states that the IRS has decided not to adopt a so-called "monitoring lookback" rule. In its place, however, the Service has proposed a series of activities that support lobbying but also may have been engaged in for nonlobbying purposes. Generally, if an activity was engaged in for nonlobbying purposes beginning prior to the first tax year preceding the year in which lobbying commences, it is presumed not to be lobbying support for any and all years. Conversely, except to the extent that the taxpayer can rebut it, it is presumed that supporting activities commenced in the year that lobbying begins, or the preceding year, is solely for lobbying purposes.

The second set of proposed regulations also contains a rule that would attribute to a taxpayer the activity of another taxpayer (for example, a trade association) if the taxpayer is not fully compensated for the cost of services of facilities provided to the other taxpayer, and such services or facilities are used by the other taxpayer to make or support lobbying. Thus, if a taxpayer provides an employee to help a trade association in its lobbying, the activities of the trade association will be attributed to the taxpayer.

Proposed definitions for key concepts, including "communication", legislation," "specific legislation" and "action," have also been included.

It should be noted that the IRS may revise the safe harbors, the presumptions and the definitions of key concepts when it finalizes the proposed Sec. 1621e) regulations. Other rules affecting calculation of nondeductible lobbying expenses - including the 5% de minimis rule - also are subject to change.