Tax aspects of lobbying by public charities.

In general, the majority of clients in a CPA practice are profit-oriented entities. However, many tax advisers do have a few tax-exempt organizations (e.g., public charities and churches) as clients, some taken on in response to requests of clients who are board members or contributors to the organizations. Since many public charities are governed by managers and part-time boards not attentive to tax consequences, it is important that tax advisers of such organizations be generally familiar with the unique rules governing public charities in order to protect their clients.

The ability of public charities to conduct lobbying activities has long been limited by Sec. 501(c)(3).(1) Under this section, "no substantial part" of the activities of an exempt organization can constitute "carrying on propaganda, or otherwise attempting, to influence legislation . . . ." Failure to comply with this restriction can result in the loss of tax-exempt status and the imposition of a tax. However, Sec. 501(h) provides safe harbors that permit an organization to engage in limited lobbying activities without losing its tax-exempt status. To avail itself of these safe harbors, an organization must file an election under Sec. 501(h).

This article will examine the election; provide an overview of the regulations governing how the lobbying safe harbors are applied; and outline the circumstances under which organizations should make the Sec. 501(h) election or forgo it.

Advantages of Making the Election

Organizations making the election under Sec. 501(h) have two distinct advantages. First, they know exactly how much they can spend without incurring a tax on their lobbying activities. Secondly, even if they exceed the safe harbor limit, and incur a tax on excess lobbying activities, they can pay the tax and still preserve their tax-exempt status. It is important to emphasize that nonelecting organizations are not governed by these rules and may not rely on the available safe harbors. Such organizations must instead test their fate in court while clinging to the vague requirement that "no substantial part" of their activities be lobbying, along with the knowledge that if they cross this vague line they face the loss of their tax-exempt status.(2)

Tax advisers should ensure that their clients are aware of this distinction in deciding whether to make the election and be subject to the potential increased cost of complying with the safe harbors. In this case, an ounce of prevention may be the only reasonable choice when there is no cure.

Direct Lobbying and Grass Roots Expenditures

Lobbying expenditures are defined as the sum of direct lobbying expenditures plus grass roots lobbying expenditures.(3) Direct lobbying involves an attempt to influence legislation through communication with a member of a legislative body or its employees.(4) The communication will be recognized as direct lobbying only if it refers to specific legislation and reflects a view on such legislation.(5) Legislation is defined to include any action by Congress, state legislatures or other similar local legislative body, or by the public in a referendum, ballot initiative, constitutional amendment or similar procedure.(6) Legislative bodies do not include executive, judicial or administrative bodies.(7)

Example 1: A public charity might attempt to influence a parks department to acquire a specific parcel of land for use as a public park. Such an action would not constitute lobbying. At the same time, attempting to influence the local legislative body to appropriate funds for this purpose would constitute lobbying.(8)

Attempts to influence legislation through an effort to sway the opinions of the general public or a segment of the general public constitute grass roots lobbying. In order to be recognized as grass roots lobbying, the communication must refer to specific legislation, reflect a view on such legislation and encourage the recipient to take action regarding the legislation.(9) By definition, encouraging a recipient to take action means that the communication states that the recipient should contact a legislator, gives the address or telephone number of the legislator, provides material such as a petition or tear-off postcard for communicating with the legislator, or identifies the legislator as opposing the communication's view or as being undecided regarding the legislation.(10)

Example 2: An organization places an article in its newsletter asserting that the lack of funding for education in the state is preventing the state from attracting new business. The article concludes that increased education funding is the key to the future success of the state.

Although the article is an attempt to influence public opinion with respect to education issues, the article would not be considered grass roots lobbying since it did not specifically cite pending legislation.(11) The same result would also be true if the article cited pending legislation, as long as it did not encourage readers to take action with respect to the legislation.

In defining what constitutes grass roots lobbying, the regulations differentiate between "encouraging" and "directly encouraging" the recipient to take action. If a communication identifies members in the legislature who will vote on the legislation, and states whether they oppose or are undecided regarding the legislation, without directly encouraging the recipient to contact the legislator, it would fall within the exception for nonpartisan analysis, study or research and, therefore, not be considered a grass roots lobbying expenditure.(12)

Example 3: A newsletter is circulated to individuals who are not members of the organization. An article in the newsletter reports on the prospects of passage of an education bill and notes that the organization supports the bill. The story provides a full and fair explanation of the issues along with names of undecided legislators. However, the article does not ask readers to contact the legislators.

This example would also not be considered grass roots lobbying because the full and fair presentation of the issues brings it within the exception for nonpartisan analysis, study or research. However, a failure to present a full and fair presentation of the issue would have resulted in the newsletter being considered grass roots lobbying. The same would be true if the presentation were fair but the article encouraged individuals to contact undecided legislators.

As a final word of caution, it is necessary to recognize that organizations that have as a main or primary objective the passage or defeat of legislation may still lose their tax-exempt status. Such organizations are deemed to be "action organizations" under the regulations and are generally characterized as advocating or campaigning for legislative objectives. Organizations engaged in nonpartisan analysis, study or research that make their results available to the general public are not deemed "action organizations."(13)

Computing the Excise Tax Under Sec. 4911

Sec. 4911 limits the amount that may be spent on lobbying without the imposition of a tax and places a separate limit on the total that may be spent on grass roots lobbying. The amount of lobbying expenses an electing organization can incur before triggering the excise tax is limited to the lesser of $1 million or the amount computed using the table above.(14) This amount is referred to as an organization's lobbying nontaxable amount (LNTA). The greater the expenditures of the tax-exempt organization, the smaller the percentage of tax-free lobbying expenditures allowed. Once an organization exceeds these limits, it is subject to a tax of 25% of the excess of lobbying expenses over LNTA.(15)

Within these limits, Congress placed more restrictive limitations on what might be spent on grass roots lobbying (i.e., influencing the public) than on what may be spent on direct lobbying (i.e., influencing Congress). Accordingly, an electing charity's "grass roots nontaxable amount" is limited to 25% of its LNTA, with an overall limit on grass roots lobbying of $250,000.(16)

The Code provides ceiling amounts as safe harbors in protecting a charity's tax-exempt status.(17) By exceeding the "lobbying ceiling amounts" over a four-year period, the charity can lose its tax-exempt status.(18) The "lobbying ceiling amount" limits total expenditures on lobbying to 150% of the LNTA. Similarly, a "grass roots ceiling" amount limits expenditures on grass roots lobbying to 150% of its grass roots nontaxable amount. Exceeding either of these limits over a four-year period will cause an organization to forfeit its tax-exempt status. Example 4, on page 40, adapted from the regulations, demonstrates the steps an electing charity should use in computing the maximum allowable lobbying and grass roots expenditures.

While the loss of tax-exempt status is certainly a harsh penalty, the severity is tempered somewhat by the requirement that the determination be made over a four-year period. Consequently, a charity like W in Example 4, finding itself exceeding the ceiling amounts in a given year, can limit its lobbying expenditures in subsequent years and hence work its way back into compliance with the law. The four-year period begins only after the election is made.

How to Make the Election and Who May Make It?

The election to be governed by Sec. 501 (h) is made by having the organization file Form 5768, Election/Revocation of Election by an Eligible Section 501(c)(3) Organization To Make Expenditures To influence Legislation, before the end of the first year for which the organization wants the election to apply. Once made, the election remains in effect indefinitely without the filing of additional election forms.(19) The election can be terminated by the organization's voluntary revocation or involuntary revocation, i.e., the election is automatically revoked when the organization ceases to he an eligible organization.(20)

Organizations that may make the election include publicly supported organizations listed in See. 501 (c)(3). Churches and members of an affiliated group of organizations with members that are churches are disqualified from making the election. This means that, in all cases, churches and church organizations will be subject to the "no substantial part" test. However, once again, the safe harbor provisions may not be used by nonelecting organizations to define or interpret whether "no substantial part" of an organization's activities is considered the carrying on of propaganda, or otherwise attempting to influence legislation.

Recordkeeping

The regulations provide that an organization that elects to be covered under Sec. 501(h) must keep detailed records of its direct and grass roots lobbying expenditures, including:

* The amounts paid directly or indirectly for lobbying, including the mailing, printing and distribution costs paid to individuals or organizations.

* The amount of current or deferred compensation of employees who engage in direct lobbying.

* Out-of-pocket expenses paid on behalf of the organization for direct lobbying.

* The portion of general overhead and administrative expenses of an organization allocable to direct lobbying.

* Expenses for member newsletters or publications that are considered to be direct lobbying expenses. (See the discussion following Example 2, supra.)(21)

Records must also be kept for all grass roots expenses. Thus, an organization must keep separate records in the detail listed above for both direct lobbying and grass roots expenses.

Affiliated Groups

In order to prevent the creation of multiple organizations to obtain multiple million dollar caps and circumvent the sliding-scale percentage limitations imposed by the regulations, special rules have been created to treat members of "affiliated groups" as a single organization in computing the various limits on what they might spend on lobbying activities. Affiliated groups exist if one organization is able to control the action on legislative issues of the other organization either by interlocking governing boards or by written provisions in the governing instrument of the controlled organization. In determining if the groups are affiliated, it is necessary only that one be able to control the others; it is not necessary that the control be exercised.(22)

There is a presumption under the regulations that control exists whenever the controlling organization's members have sufficient votes to either constitute or deny a quorum, or if they constitute a majority of incumbent members of the governing board. However, no affiliated group exists by interlocking governing boards if the number of representatives of one organization constitutes less than 15% of the incumbents on the governing board of a second organization.(23)

There is also a possibility of three or more affiliates. If a single organization controls two or more organizations, all are affiliated. A chain rule links multiple organizations. Thus, if organization A controls organization B and organization B controls organization C, A is affiliated with C.(24)

Under Regs. See. 56.4911-8, an affiliated group's tax-exempt purpose expenditures, lobbying expenditures and grass roots expenditures are combined in determining whether the group has excess expenditures subject to tax. if the group has made excess lobbying expenditures, and if at least one electing charity has made any lobbying expenditures, the tax owed by the group is shared by the electing charities in proportion to their share of total lobbying expenditures. If only one member of the group is an electing charity, that organization is responsible for all of the tax resulting from the group's excess lobbying expenditures. If the group has made excess grass roots lobbying expenditures, and if at least one electing charity has made any grass roots lobbying expenditures, the tax owed by the group is shared by the electing charities in proportion to their share of total grass roots lobbying expenditures.

If an affiliated group is subject to the tax, but none of the electing charities have made direct or grass roots lobbying expenditures, the electing charities share the tax in proportion to their exempt purpose expenditures. Nonelecting charities cannot be held liable for the excise tax imposed under Sec. 4911. Determining the LNTA

                            Percentage of organization's exempt
Level of exempt             purpose expenditures that represent
purpose expenditures        the LNTA
Not over $500,000           20% of expenditures
$500,001-$1,000,000         $100,000 plus 15% of expenditures
                            over $500,000
$1,000,001-$1,500,000       $175,000 plus 10% of expenditures
                            over $1,000,000
Over $1,500,000             $225,000 plus 5% of expenditures
                            over $1,500,000

Limited Affiliated Groups

A separate set of rules is provided for organizations that are members of a "limited affiliated group," defined as a group of two or more organizations that are members of an affiliated group solely because provisions of their governing instrument bind them with respect to national legislative issues.(25) The regulations define national legislative issues as limited to action by the U.S. Congress or by the public in any national procedure.(26) The rules governing this type of affiliated group make a distinction between the controlling organization and the controlled organization.

Generally, the penalty tax provisions of Sec. 4911 are applied individually to an electing charity member of a limited affiliated group. An electing controlling organization must include in its direct or grass roots lobbying expenditures the direct or grass roots expenditures of the controlled organization related to national legislative issues. At the same time, the controlling organization may not include the exempt purpose expenditures of the controlled organization. Since controlled organizations are not required to include the lobbying or tax-exempt purpose expenditures of controlling organizations, they are not subject to the penalty tax or loss of tax-exempt status as often as controlling organizations.

New Legislation

The Revenue Reconciliation Act of 1993 (RRA) excludes charitable organizations as described in Sec. 501(c)(3) from the reporting requirements for lobbying and political expenditures required of other tax-exempt organizations. The Act does deal with charitable organizations indirectly, however, by providing an anti-avoidance rule designed to prevent other organizations from using a charity as a conduit to conduct lobbying activities. Specifically, no deduction will be permitted either as a charitable contribution or as a business expense if an organization uses a charity to conduct lobbying activities of direct financial interest to the donor's organization and a principal purpose of the contribution is to avoid the general disallowance rules that would apply if the donor had directly conducted the lobbying activity itself.(27) It is important to note that a charitable organization that is used to violate the anti-avoidance rules does not jeopardize its tax-exempt status.

Choosing to Make the Election

At one extreme, an organization that makes no lobbying expenditures, and does not see itself making any such expenditures in the future, will no doubt find the election unnecessary. At the other extreme, an organization that consistently makes lobbying expenditures that exceed the permitted limits will not be able to preserve its Federal tax exemption by making the election and, therefore, may also decide to forgo making the election. Between these extremes, there seems to be quite a variety of organizations that should find the safe harbors very attractive.

The costs of recordkeeping and monitoring the level of direct and grass roots lobbying expenditures is probably minimal since all public charities are required to disclose their lobbying expenditures on their annual Form 990, Return of Organization Exempt From Income Tax.28 Therefore, a public charity that makes lobbying expenditures on a regular basis may find the costs of compliance with the safe harbors an acceptable price for preserving its tax-exempt status. Tax advisers of such organizations should be familiar with these basic provisions to help their public charity clients make the election wisely and reconsider it on an annual basis. (1) See Mancino, "Lobbying by public charities," 11 The Tax Adviser 452 (Aug. 1980). (2) See Murray Seasongood, 227 F2d 907 (6th Cir. 1955)(48 AFTR 711, 56-1 USTC [paragraph]9135), and Anthony Haswell, 500 F2d 1133 (Ct. Cl. 1974)(34 AFTR2D 74-5559, 74-2 USTC [paragraph] 9591). (3) Regs. Sec. 56.4911-2(a)(1). (4) Regs. Sec. 56.4911-2(b)(1)(i). (5) Regs. Sec. 56.4911-2(b)(1)(ii). (6) Regs. Sec. 56.4911-2(d)(1). (7) Regs. Sec. 56.4911-2(d)(3). (8) Regs. Sec. 56.4911-2(d)(4). (9) Regs. Sec. 56.4911-2(b)(2)(i) and (ii). (10) Regs. Sec. 56.4911-2(b)(2)(iii). (11) Regs. Sec. 56.4911-2(b)(4)(ii)(A). (12) Regs. Sec. 56.4911-2(b)(2)(iv) and (c)(1). (13) Regs. Sec. 1.501(c)(3)-1(c)(3). (14) Sec. 4911(c)(2). (15) Sec. 4911(a)(1). (16) Sec. 4911(c)(4). (17) Sec. 501(h)(1). (18) Regs. Sec. 1.501(h)-3(b)(1). (19) Regs. Sec. 1.501(h)-2(a). (20) Regs. Sec. 1.501(h)-2(d) and (c). (21) Regs. Sec. 16.4911-6. (22) Regs. Sec. 56.4911-7(a)(1). (23) Regs. Sec. 56.4911-7(b). (24) Regs. Sec. 56.4911-7(d)(2). (25) Regs. Sec. 56.4911-10(a). (26) Regs. Sec. 56.4911-10(g). (27) Sec. 170(f)(9), added by RRA Section 13222(b). (28) See Form 990, Schedule A, Organization Exempt Under Section 501(c)(3).