What is the Johnson Amendment?

Congress was in the process of modernizing the tax code in 1954 when then-Senator Lyndon Baines Johnson offered a provision clarifying reasonable boundaries between electoral politics and tax-exempt activities, including religious exercise. It was so noncontroversial at the time that Congress incorporated the Johnson Amendment without extended debate and Republican President Dwight D. Eisenhower signed it into law. The Johnson Amendment bars 501(c)(3) tax-exempt organizations, including churches and charities, from directly or indirectly participating in political campaigns for or against candidates. Violations can, in theory, lead to loss of tax-exempt status or excise taxes, though such penalties have historically been rare.

Current Legal Status

The Johnson Amendment remains part of the Internal Revenue Code and still technically applies to all 501(c)(3) organizations, including churches, charities, and educational institutions. It continues to prohibit these organizations from directly or indirectly intervening in political campaigns for or against candidates. While the Johnson Amendment remains federal law and has not been repealed by Congress or struck down by the courts, its scope and enforcement—especially for churches—has been actively contested and narrowed through administrative and legal actions.

The 2025 IRS Consent Decree Controversy

The National Religious Broadcasters Case

On July 7, 2025, the IRS entered into a proposed consent judgment in National Religious Broadcasters, et al. v. Bessent (formerly v. Long), filed in the U.S. District Court for the Eastern District of Texas (Case No. 6:24-cv-00311-JCB). In this case, two Texas churches (Sand Springs Church and First Baptist Church Waskom), along with National Religious Broadcasters and Intercessors for America, challenged the constitutionality of the Johnson Amendment, arguing it violated their First Amendment rights to free speech and free exercise of religion.

Rather than defending the Johnson Amendment in court, the IRS agreed to a proposed consent decree stating that the Johnson Amendment, “as properly interpreted,” does not prevent a “house of worship” from speaking “to its congregation, through customary channels of communication on matters of faith in connection with religious services, concerning electoral politics viewed through the lens of religious faith.”

Scope and Limitations of the Proposed Decree

The proposed consent decree is formally narrow: it directly binds only the named plaintiffs in the case. However, it has prompted significant concern among nonprofit and church-state advocates that the IRS is effectively creating a de facto carve-out for all houses of worship without issuing formal nationwide regulations or guidance. Critics argue that once the IRS accepts this interpretation for specific plaintiffs, it would be exceedingly difficult to enforce the Johnson Amendment against other similarly situated religious organizations.

The decree’s language about “customary channels of communication” has proven particularly controversial. During oral arguments on November 25, 2025, Judge J. Campbell Barker questioned what activities would qualify under this broad language. While plaintiffs argued it is limited to worship services, critics note that in the modern era, “customary channels” could include livestreamed sermons on YouTube, podcasts, and other digital platforms accessible to the general public—not just congregants.

Opposition and Intervention Attempts

Americans United for Separation of Church and State (AU) sought to intervene in the litigation to oppose the consent agreement. On December 12, 2025, Judge Barker denied AU’s motion to intervene as a party, ruling that AU lacked a direct, legally protectable interest in the potential enforcement of the Johnson Amendment against the plaintiffs. However, the court allowed AU to file amicus briefs and participate in oral arguments.

In a letter dated November 20, 2025, six Democratic Senators and nine Congressional Representatives, including Representatives Jamie Raskin, Jared Huffman, and James Clyburn, along with Senator Ron Wyden, urged Acting IRS Commissioner Scott Bessent to withdraw the proposed consent decree. The letter argued that the decree would violate the First Amendment’s Establishment Clause and the Fourteenth Amendment’s Equal Protection Clause by creating exemptions for religious entities that are unavailable to secular nonprofits.

Current Status of the Case

As of February 2026, the case remains pending before Judge Barker. Americans United for Separation of Church and State did not appeal the denial of its intervention motion within the 60-day window, and the court reopened the case in early February 2026. A final decision on the proposed consent decree is anticipated before spring 2026.

Enforcement Trends and Political Context

Enforcement of the Johnson Amendment against churches was already extremely rare before the 2025 consent decree. A 2017 Trump executive order had instructed the Treasury Department to be lenient in applying Johnson Amendment rules to religious entities, effectively softening enforcement in practice. The current Trump administration has renewed political efforts to severely limit or repeal the Johnson Amendment.

However, Congress has consistently rejected attempts to repeal or modify the Johnson Amendment. The Trump administration’s approach through the consent decree has been criticized as an “end run around Congress” that attempts to achieve through litigation and administrative settlement what could not be accomplished through the legislative process.

New York State’s Legislative Response: The Nonpartisan Pulpit Act

In direct response to the federal developments, legislation was introduced in the New York State Legislature on August 13, 2025. Senate Bill S8475 (sponsored by Senator James Skoufis) and its Assembly companion bill A9067 (sponsored by Assemblymember Tony Simone), collectively known as the “Nonpartisan Pulpit Act,” would amend both the New York State Tax Law §27-a and the Real Property Tax Law §§420-a and §420-b.

Key Provisions

The legislation would suspend tax-exempt status at the state level for any nonprofit organization that engages in political campaign activities as defined under the law. Organizations found to be in violation would lose eligibility for:

• Sales and use tax exemptions

• Real estate tax exemptions

• Corporate tax exemptions under 20 NYCRR 1-2.11(b)(6)

The bills build upon previous New York legislation. During the first Trump administration, in 2019, then-Governor Andrew Cuomo signed legislation (S.4347/A.623) that codified the Johnson Amendment into New York law by amending one section of the state tax law. The 2025 legislation goes significantly further by creating comprehensive enforcement mechanisms and expanding the scope of tax exemptions that could be lost.

Definition of Political Campaign Activity

The legislation defines “political campaign activity” as “any action, communication or expenditure which constitutes participation or intervention, directly or indirectly, in any political campaign on behalf of or in opposition to any candidate for office.” Specifically prohibited activities include:

(a) Making, soliciting, or facilitating, directly or indirectly, any contribution to or for the benefit of any candidate for public office’s authorized political committee or political party.

(b) Publishing or distributing, by any medium, including but not limited to written, electronic or oral statements, that expressly advocate for the election or defeat of a clearly identified candidate for public office.

(c) Using or permitting the use of the organization’s assets, facilities, staff, mailing lists, websites or other resources to support or oppose a candidate for public office, except as explicitly permitted under the safe harbor provisions.

Permissible Activities and Safe Harbors

The legislation carefully delineates permissible activities that would not be considered political campaign activity, including:

• Engaging in lobbying or advocating for the adoption or rejection of legislation

• Conducting non-partisan analysis, study or research and making the results available to the public

• Providing non-partisan voter education

• Encouraging participation in the electoral process through non-partisan voter registration

Safe harbor activities are also defined, including:

• Candidate appearances—only if all candidates are invited to participate equally; no communication about the event favors one candidate over another; and political fundraising does not occur

• Providing goods or services to candidates—so long as those goods and services are made available on the same terms to all candidates and the provision is part of the organization’s regularly conducted activities

• Website content or links—so long as the information is provided equally to all candidates and is unbiased or presented in a manner that does not indicate support or opposition to a particular candidate

Impact and Enforcement

The legislation is expansive and would impact not only nonprofits domiciled in New York State but also non-domiciled organizations operating or holding assets in the state. Section 5 of the bill directs the New York State Department of Taxation and Finance to establish rules and regulations to administer and enforce the provisions.

Senator Skoufis stated: “Most New Yorkers want politics to stay where it is—in political debates, newspaper op-eds, and the comment section on Facebook. Not in museums, soup kitchens, and certainly not in churches.” Assemblymember Simone added that “Community organizations succeed when they remain safe havens from partisanship.”

Current Legislative Status

As of February 2026, both S8475 and A9067 remain pending in committee. Senate Bill S8475 is assigned to the Senate Rules Committee, while Assembly Bill A9067 is in committee in the Assembly. Neither bill has advanced to the floor for a vote in either chamber.

However, the lack of movement thus far suggests that the legislation may face significant political obstacles, particularly given concerns about enforcement against houses of worship and potential constitutional challenges.

The fate of the legislation may also be influenced by the outcome of the federal National Religious Broadcasters case. If Judge Barker approves the consent decree, it could strengthen arguments for state-level protections. Conversely, if the consent decree is rejected and the Johnson Amendment is upheld at the federal level, the urgency for state legislation may diminish.

Outstanding Questions and Concerns

Numerous concerns have been raised about New York’s effort to reinforce the Johnson Amendment at the state level:

Will Other States Follow?

A critical question is whether other states will enact similar legislation or whether New York will remain an outlier. If New York stands alone, the impact of the legislation may be limited, as organizations could simply avoid operating in New York or relocate their activities to other states.

Constitutional Challenges

If the U.S. Supreme Court takes up a Johnson Amendment case and determines—following reasoning similar to Citizens United v. FEC—that the Johnson Amendment violates nonprofit corporations’ right to free speech, state-level enforcement could be deemed unconstitutional as well. The proposed federal consent decree, if approved, could serve as a stepping stone toward such a Supreme Court challenge.

Practical Implementation Challenges

The safe harbors, while well-intentioned, may prove impractical when multiple candidates are running for the same position. For example, if ten candidates are running for a single office, must a nonprofit invite all ten to speak at an event to maintain safe harbor protection? What happens if some candidates decline to participate?

Enforcement Against Houses of Worship

The most sensitive question involves enforcement against religious organizations. Who will enforce the prohibitions if clergy endorse candidates from the pulpit? Will houses of worship actually lose their tax exemptions, potentially forcing churches, temples, and mosques to close their buildings as they lose valuable real estate tax exemptions? This scenario could create significant First Amendment concerns and political backlash.

De Minimis Standard

Is there a de minimis test that accounts for an isolated, errant comment by clergy or nonprofit leaders? The legislation does not explicitly address whether a single inadvertent statement would trigger loss of tax-exempt status or whether there is a threshold of activity required before enforcement action is taken.

Financial Impact

Democratic lawmakers have raised concerns about the fiscal impact of weakening the Johnson Amendment. The Congressional Joint Committee on Taxation estimated in 2017 that repealing the Johnson Amendment would cost taxpayers $900 million over 10 years. If the federal consent decree or state legislation leads to increased political activity by tax-exempt organizations, contributions could be redirected from taxable sources to tax-deductible donations, reducing tax revenue while subsidizing political speech.

Equal Protection Issues

If the federal consent decree is approved and applies only to the named plaintiffs, it could create equal protection violations by treating similarly situated organizations differently. Conversely, if other organizations successfully petition for the same exemption, it could lead to a cascade of litigation that effectively nullifies the Johnson Amendment without Congressional action.

Looking Ahead

As of February 2026, the fate of both the federal consent decree and New York’s Nonpartisan Pulpit Act remains uncertain. Judge Barker’s decision on the National Religious Broadcasters case is expected soon and will have significant implications for the future of the Johnson Amendment nationwide.

The New York legislation remains pending in committee. If enacted, it would create the first comprehensive state-level enforcement mechanism for Johnson Amendment principles, potentially serving as a model for other states—or standing as an isolated effort in a changing landscape of church-state relations and campaign finance law.

What is clear is that after 70 years of relative stability, the Johnson Amendment faces its most serious challenge yet. The outcome of this controversy will shape the intersection of tax policy, campaign finance, religious freedom, and the separation of church and state for years to come.

Sources

National Religious Broadcasters v. Bessent, No. 6:24-cv-00311-JCB (E.D. Tex.)

New York State Senate Bill S8475 (2025-2026)

New York State Assembly Bill A9067 (2025-2026)

Letter from Representatives Raskin, Huffman, Clyburn, and Senator Wyden to Acting Commissioner Scott Bessent (November 20, 2025)

National Council of Nonprofits, “Protecting the Johnson Amendment and Nonprofit Nonpartisanship”

Interfaith Alliance, “What is Happening with the Johnson Amendment?”

Tax Notes, “Parties Square Off in Johnson Amendment Oral Arguments” (November 26, 2025)

Tax Notes, “Organization Not Allowed to Intervene in Johnson Amendment Case” (December 12, 2025)

The National Law Review, “IRS Enters into Consent Decree Limiting Application of Johnson Amendment” (September 12, 2025)

Religious News Service, “Democrats urge Trump administration to keep ban on letting churches endorse” (November 20, 2025)

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Unsurprisingly, the IRS has not been immune to the recent churn within the federal government workforce. Over the past year, wait times for processing Form 1023 have been anywhere from 7.5 to 9 months. The IRS’s website states that applicants who submitted their applications after September 25, 2024, have not yet been assigned reviewers. This wait may increase in the coming months. Thus, you might wonder—are there faster options available?  

The IRS offers an option for organizations with a compelling reason to request faster, expedited processing. The IRS guidelines include the following examples of compelling reasons to approve expedited processing. 

• If the organization has a pending grant, not receiving it could adversely impact its ability to operate.
• If the organization is newly established and offers disaster relief to victims of emergencies. 
• If delays in issuing a determination letter are caused by errors made by the IRS. 

If your organization qualifies under one of those reasons, consider applying for expedited processing. To achieve this, we suggest closely following the IRS’s requirements.  Your organization must submit a letter to the IRS outlining the compelling reason(s) for the expedited processing request. As you prepare your request, we recommend considering and framing it with the following in mind.    What reasons justify your organization receiving its determination letter sooner than other organizations waiting in the processing queue for months? The IRS must understand why your organization must receive its determination letter quickly.    

Suppose your organization has a donor willing to give a vital grant. Still, the grant depends on the organization’s formal confirmation of its tax-exempt status by a specific deadline.  In that case, you can ask the donor if they are willing to send a letter to the IRS on behalf of the organization. If the donor agrees to write a letter, they should include the following information:  

• The committed donor’s name (the person or the organization)
• The amount of the donation (or value of the asset being donated)
• The date the donation will be forfeited or permanently redirected to another organization. 

In your organization’s letter to the IRS, it is important to explain the potential harm to the organization and/or its charitable class if there is a delay in receiving the IRS determination letter. For example, consider the following.   

Your organization is submitting an application to the IRS for tax exemption and plans to operate a drug and alcohol treatment center for teens. The previous center closed years ago, and no other similar center exists in the area. A donor has pledged a specific amount that will cover the center’s construction costs if your organization can provide proof of its tax-exempt status by a specific date. Your organization cannot open the treatment center without funding for the building.  

In this scenario, if your organization submitted an expedited request to the IRS, your letter should emphasize the impact of the donation on the organization. For example, without donations, your organization could not open a center. You might consider highlighting how long your organization would take to raise the same amount the donor is pledging and how many people your organization could assist if the center opened sooner with the donor’s contribution. Then, ask the donor to write a letter to the IRS on the organization’s behalf, providing the information listed above, which would accompany the expedited request.  

Even if your facts may not be as urgent or compelling as this example, conveying how a long delay will significantly hinder your ability to execute critical programming with real-world consequences might still make submitting an expedited review request worthwhile.

Given the staffing uncertainty at the IRS and throughout all federal agencies, predicting what will happen in the coming months is nearly impossible. If your situation fits the IRS’s stated criteria for expedited processing, it may be worth submitting an expedited review request, especially if you provide essential services to your community. And remember, if you have questions or need assistance, be sure to consult with legal counsel.  

The views expressed in this article reflect Perlman & Perlman’s experience with expedited processing.  While we have not heard of specific changes, it is uncertain if staffing reductions and changes in the administration’s priorities will impact on the IRS’s review of expedited processing requests. 

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While there is no actual codified definition, MRIs are generally understood to be risk-adjusted or “prudent” market-rate investments.  It is a financial vehicle made out of the organization’s investment assets (e.g., its endowment) rather than its program assets.  Unlike its counterpart, the Program Related Investment (PRI), which has the primary goal of accomplishing a charitable purpose, an MRI seeks to generate a market rate of return on capital while also furthering a social purpose.  Put another way, PRIs offer solutions where the markets do not have a solution, while MRIs use the power of the market to create impact. 

It’s important for foundations seeking to establish their investment strategy to understand the key legal and structural differences between PRIs and MRIs.  Since the requirements to qualify as a PRI are more stringent than an MRI, a PRI avoids being classified as a jeopardizing investment, and can be counted towards a foundation’s annual distribution requirement.  

An MRI, on the other hand, is a commercial investment that also has a goal to create social impact but is not subject to the stringent standards of the PRI.  Consequently, an MRI does not count towards a foundation’s annual requirement and is not excluded from the rules governing jeopardizing investments.  In addition, in calculating the amount of a foundation’s five percent annual distribution requirement, MRIs are not excluded from the foundation’s assets, as is the case with PRIs. (For an in-depth discussion of PRIs, please read Are You Looking to Make an Impact? Consider a Program Related Investment).  

While the rules governing the MRI are not as rigid as those governing PRIs, there are a few key ones that MRIs must comply with. The “Jeopardizing Investments” rule, found in Section 4944 of the Internal Revenue Code (“Code”), imposes an excise tax on private foundations that invest “any amount in such a manner as to jeopardize the carrying out of its exempt purposes.” A private foundation and its management may be subject to excise taxes for making a jeopardizing or imprudent investment.  Because the Jeopardizing Investments rule applies to MRIs, MRIs must be comprised of prudent investments.

MRIs must also comply with the “Excess Business Holdings Rule.” Section 4943 of the Code states that a foundation, together with its disqualified persons, may own no more than twenty percent of the voting stock of a business enterprise (some exceptions may apply). 

Since MRIs are not treated as a charitable activity but rather as commercial investments, they must meet the prudent investor standards under state and federal law.  The applicable State-enacted version of The Uniform Prudent Management of Institutional Funds Act (UPMIFA) applies a standard for prudent investments whereby “each person responsible for managing and investing an institutional fund shall manage and invest the fund in good faith and with the care an ordinarily prudent person in a like position would exercise under similar circumstances.”  In addition, UPMIFA lists a number of factors that must be considered, if relevant, when making an investment.  Most states have adopted a form of UPMIFA. 

Developing an MRI Strategy

The board of an organization that is considering embarking on an MRI strategy should, as a matter of good governance, consider its rationale. Whether as a stand-alone policy or a policy that is incorporated into the organization’s investment policy, drafting a written MRI Policy should be the board’s first step.  The discipline of drafting an MRI policy will ensure that everyone is in agreement when it comes to incorporating MRIs into the overall investment strategy. 

The substance of the MRI Policy will depend in part on the organizational view of MRIs and their purpose.  Some may view MRIs from a programmatic standpoint, wherein the MRI serves as a tool available to the organization in implementing its philanthropic strategy.   Other organizations may view MRIs from an investment perspective and consider it as an opportunity to make a market rate investment that also happens to foster social impact.    

The following is a list of important questions that should be asked when drafting an MRI Policy. 

• Why Does the Organization Want to Make an MRI? 

It’s helpful for an organization to consider what it believes is the key objective for entering into an MRI strategy.  The organization should consider what it hopes to accomplish by making an MRI.  If the full board is in agreement regarding the rationale or objectives for entering into MRIs, it will help support the development of a uniform set of metrics used by the organization when assessing the success of MRIs in achieving those goals.

• Does the organization have the skills and staffing within the organization to carry out an MRI Strategy?  

In order to implement an MRI, organizations will need to rely on individuals with various expertise including investment, programmatic and legal experience.  Executives and the board should determine whether they can utilize in-house staff or board members, or whether they should consider engaging consultants.

The board should take into consideration if it will require a legal opinion that the potential MRI does not qualify as a jeopardizing investment. The size of the MRI relative to the organization’s investment portfolio may be a factor for consideration when determining whether a legal opinion is warranted.  

• Who will be responsible for oversight?  

Prior to entering into an MRI strategy, the board should consider who will be responsible for oversight of the strategy.  If the organization is considering the MRI as a key tool in accomplishing its philanthropic objectives, it may make sense to have both an advisor with programmatic experience as well as one with investment experience onboard. 

On the other hand, if the foundation views the MRI primarily as a market rate investment that also has social impact, a person or committee with investment experience, guided by a board-approved statement of social impact objectives, may suffice.  The investment committee of the board may be an appropriate oversight body for this responsibility when aligned with the foundation’s MRI objectives.  

• What will the balance be between investment risk and social return?

In advance of embarking on an MRI strategy, the board should determine whether it is willing to take a greater financial risk (while still complying with UPMIFA) to the extent the social returns of the investment have the potential to be great.  It may be that, regardless of the potential for social impact results, the board’s appetite for investment risk will remain the same.   Making a riskier investment may require altering existing investments within the organization’s portfolio in order to comply with UPMIFA’s requirement that each individual investment be reviewed in the context of the entire portfolio, in accordance with prudent investor standards.   

Consider the scenario in which the financial rewards are substantial, but the social impact is not as significant.  The answer to these questions will largely depend on how the Board views mission-related investing and why it has decided to enter this arena.  A board would be well-advised to determine in advance of entering into an MRI how it feels about risk and what the appropriate balance is in guiding its MRI strategy.  

• How will the organization measure the success of a Mission Related Investment? 

In reviewing the performance of an MRI, members of the board and management of the foundation should discuss how they intend to measure success.  The foundation could establish that success is based on the investment generating a minimum level of return, while achieving a loosely defined social impact.  For example, investing in a clothing manufacturer that uses environmentally friendly dyes for its fabrics could result in generous returns to its investors but only modest results in terms of reducing harmful environmental impact.  

With a benchmark focusing significantly on market rate returns, an investment that generates modest financial returns but generates substantial social impact may be considered unsuccessful because the return on investment was too low.  The members of the board should consider how much of a social impact they are looking to make through any MRI.   

In Conclusion

The philanthropic sector has come to understand that aligning investments with mission and values can be financially rewarding.  A greater number of foundations have decided to take a portion of their endowment and invest it in ways that align with their mission. Some have decided to invest their entire investment portfolio or endowment in line with their mission.

I predict that in the next few years we are going to see a dynamic shift in the way funders and their boards view their fiduciary obligations. Foundations contemplating entering into MRIs would be well advised to create a policy that articulates how MRIs can be thoughtfully carried out to achieve the desired investment and social objectives.

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Under the Internal Revenue Code, all 501(c)(3) organizations are prohibited from participating in any political campaign on behalf of or in opposition to any candidate for elective public office.  This includes contributions to political campaigns or public statements of position made on behalf of the organization in favor of or in opposition to any candidate for public office.  The IRS explains on its website that non-partisan voter registration and get-out-the-vote drives may be permissible as long as they do not bias, favor or oppose one candidate over another, or have the effect of favoring a candidate or group of candidates.   For private foundations, there are more specific rules restricting their grantmaking for voter registration activities.  

Although public charities are prohibited from engaging in political campaign activities on behalf of or in opposition to candidates, the IRS states that “The political campaign intervention prohibition is not intended to restrict free expression on political matters by leaders of organizations speaking for themselves, as individuals. Nor are leaders prohibited from speaking about important issues of public policy. However, for their organizations to remain tax exempt under section 501(c)(3), leaders cannot make partisan comments in official organization publications or at official functions of the organization.” (IRS Rev. Rul. 2007-41).

If you lead or work for a public charity and plan to get involved in political activities in a personal capacity, you should keep the following guidelines and best practices in mind.    

• Employees who endorse or support candidates, make public comments in person, express themselves in writing or online, or engage in other electioneering activities, should refrain from using organizational titles or the organization’s name while making such endorsements or expressing such support.  
• If an employee is identified by name or title in public communications, the employee should include this statement: Titles and affiliations of each individual are provided for identification purposes only and do not reflect the views of the organization or imply an endorsement by the organization. 
• Organization leadership and employees who use personal email communications, personal social media platforms, and any online platforms not affiliated with the organization to communicate about or engage in political campaign activities should include the following disclaimer in the ‘About/Bio’ section and where possible, at the end of such communications:  All personal views and opinions expressed are my own and do not represent or reflect the views of any organization.  Although this disclaimer will not provide absolute cover, its inclusion helps to draw a clearer line between the individual’s affiliation with an organization and their rights as a private citizen.
• Organization representatives cannot support or oppose candidates at organization-sponsored events.  For example, an employee should not, while attending a charity-sponsored event, wear any political t-shirts, buttons, hats, etc. 
• Employees should not use organizational resources, including phones, copiers, computers, office space, email addresses, office addresses, organization name, organization online and social media platforms, donor or mailing lists, for supporting or opposing candidates.  

If you lead or work for a public charity, consider the following tips to help keep your organization in compliance during election season.   

• Organization leaders should provide written notice to members of the Board, staff, and volunteers of its policy against using organizational resources for political campaign activity.  In addition to developing a policy on political activities, leaders should regularly update the policy and train the Board, staff, and volunteers.

• Charities should not report or comment on staff and volunteer personal campaign intervention activities in the charity’s newsletter, on its websites, or any social media accounts.  
• When dealing with the public on issues relating to an election, charity spokespersons should regularly include disclaimers that the charity cannot and does not endorse political candidates (The organization can post a disclaimer on the charity’s website to this effect). While such disclaimers will not excuse partisan activity, they can help explain that a charity’s public communications are not intended to support or oppose candidates, particularly where members of the public might construe certain communications to involve political campaign intervention. 

When it comes to political campaign activities, public charities have different restrictions than the individuals who lead and work for them have in their personal capacities.  That said, to help keep your organization out of trouble, the best thing you can do is to understand the rules and make sure there is a clear line between what you do in your personal capacity from that of the organization you work for.

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So how is advocacy different from lobbying, and exactly where is the line between the two? As I wrote in my previous article, advocacy is a broad term which  describes various facets of the work nonprofit organizations undertake.  Although it isn’t a statutorily defined term, advocacy refers to many types of activities, which include educating about and raising awareness of an issue; advancing the organization’s charitable mission; raising funds; communicating with members and the public; and influencing behaviors, attitudes, and policies related to the organization’s mission.

By contrast, lobbying is a statutorily defined term.  The Lobbying Disclosure Act regulates federal lobbying, and each state and many cities have their own  laws that define and regulate lobbying.  For public charities, the IRC defines lobbying as “any attempt to influence any legislation through an attempt to affect the opinions of the general public or any segment thereof, and any attempt to influence any legislation through communication with any member or employee of a legislative body, or with any government official or employee who may participate in the formulation of the legislation.” This federal tax code definition covers both grassroots and direct lobbying. 

The IRC defines certain activities as exceptions, and, therefore, does not count them towards the organization’s lobbying limits.  These include: making available the results of nonpartisan analysis, study, or research; providing technical advice or assistance to a governmental body; appearances before, or communications to, any legislative body about decisions that might affect the existence of the organization, its powers and duties, and tax-exempt status; communications between the organization and its members on legislation or proposed legislation of direct interest to the organization and its members; and any communications with a government official other than communications that would be considered lobbying. 

The term advocacy generally encompasses a broad range of exceptions to lobbying.  If your organization is conducting and publishing research and disseminating it in a nonpartisan manner, it is not considered to be lobbying.  What about activities that don’t easily fall into one of these exceptions?  For example, perhaps your organization has a meeting with legislators and their staff about important policy issues without discussing specific legislation.   What if, during the meeting, your organization identifies legislative priorities and its position on various topics, some of which are addressed in currently pending legislation?  Most often, the answer to the question “is this lobbying” is going to be “it depends.”  It depends on who is present, what is said, and other factors. 

With this clear-as-mud guidance, it can be both confusing and onerous for a public charity to assess and determine whether the multitude of advocacy activities it engages in count as lobbying.   When clarity is called for, there are two recommended steps: 1) confer with legal counsel, and 2) establish written guidelines for organizational lobbying. 

Consulting with legal counsel serves a few purposes.  First and foremost, your legal counsel can analyze how the unique facts apply to the law – something an online search can’t do.  Next, talking to your lawyers about your current and planned lobbying activities gives the organization an opportunity to educate and train staff and Board members on the rules and limitations. Once the organization’s leadership is trained, they should draft guidelines based on the types of activities the organization typically engages in.  By developing guidelines for the organization, leadership can craft a strategy with respect to advocacy and lobbying activities with a better understanding of what is, and what is not, lobbying. This will ensure compliance while fostering the confidence to effectively advocate in furtherance of its charitable objectives. 

Because the rules can be confusing, many organizations shy away from engaging in certain activities for fear they may breach the regulations on lobbying.  It’s good to remember, however, that public charities are allowed to lobby up to a certain limit if they track their expenditures and report them.  Once understood and exercised with confidence, lobbying can be a powerful tool in assisting a charity to fulfill its mission. 

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While “pay-for-play” is still prohibited by the NCAA,² these new rules have opened the door for college athletes to explore a new world of sponsorships, endorsements and compensation.  For example, college athletes can now earn money for commercials, appearances, speeches, social media posts, hosting sports camps, giving lessons, writing books and more — all without violating NCAA rules.

“NIL collectives” have emerged as the chief brokers of these opportunities.  This article discusses what NIL collectives are, their legal forms of organization, and the regulatory framework that governs them.

How are NIL Collectives Structured?
NIL collectives are entities that are structurally independent of a school, yet fund NIL opportunities for the school’s student-athletes. They are typically founded by well-known alumni and supporters of the school.  Collectives generate and pool revenue raised through contributions from a wide variety of sources, including boosters, businesses, fans and more.  They use these funds to create opportunities for student-athletes to leverage their NIL in exchange for compensation.

While a number of NIL collectives have been formed as for-profit entities,³ in a growing number of cases, they have been formed as nonprofits. Numerous nonprofit collectives have, in turn, sought and obtained 501(c)(3) public charity status from the IRS, which potentially allows donors to receive a tax-deduction for their contribution to the collective.⁴

Tax-exempt collectives typically use student-athletes as independent contractors to help further their charitable mission.  For example, some provide in-kind contributions of a student-athlete’s services to other charities, including speaking, appearances and other public relations services that help expand the charities’ reach and visibility in their communities.  The student-athlete is paid by the tax-exempt collective to provide the services, while the other charities receive these services on a pro bono basis.

Special Rules Governing Tax-Exempt NIL Collectives
Collectives that obtain tax-exemption should be mindful of special rules that apply to tax-exempt entities.  These rules are enforced not only by the IRS, but also by State Attorneys General, whose responsibility is to ensure that charitable funds are used for charitable purposes. These rules require that tax-exempt cooperatives operate differently from the typical NIL collective.

For example, NIL collectives commonly facilitate endorsement, merchandising and marketing deals that allow for-profit companies to promote their products and services using a student-athlete’s NIL, which helps these for-profit companies increase business and revenues.  Many NIL collectives have the flexibility to promote such commercial interests due to their structure as for-profit (and therefore, taxable) entities.

However, facilitating commercial deals does not constitute a permissible purpose for a charitable, tax-exempt organization.  Therefore, if a tax-exempt NIL collective engages in such activity, revenues from this activity could be taxed by the IRS as unrelated business income – i.e., income from a trade or business, regularly carried on, that is not substantially related to the collective’s charitable mission.

Also, if the IRS finds that these commercial activities constitute a primary or substantial non-exempt purpose of the organization, the IRS could revoke its tax-exempt status.⁵ State Attorneys General could bring enforcement actions for similar reasons.  Therefore, if a tax-exempt collective facilitates marketing or similar NIL arrangements, it should generally avoid arrangements promoting goods and services of for-profit companies.  However, it could use the NIL of student-athletes to help promote and amplify the charitable missions of nonprofits serving communities.⁶

NIL collectives are also becoming well-known for offering lucrative compensation to student-athletes in connection with promotional deals.  For many collectives, their status as for-profit entities give them the flexibility to do so.

But, in the context of a tax-exempt collective, these payments must be reviewed carefully to ensure they do not constitute “excessive compensation” for federal tax law purposes.  NIL collectives should therefore carefully structure athletes’ compensation in accordance with IRS rules to ensure it does not exceed fair market value.  Failure to do so could put the collective at risk of losing its tax-exemption, and lead to potential enforcement actions by State Attorneys General.

However, it should be noted that even if such compensation is determined to be reasonable, a tax-exempt NIL collective could nevertheless lose its exemption if the IRS determines that its primary or substantial purpose is to pay or recruit student-athletes.  For this reason, it’s important that tax-exempt collectives work closely with legal counsel to ensure they have well-constructed charitable programs.

Given the risks outlined above, an NIL collective seeking tax-exempt status should carefully consider whether any of its time and resources will be spent on pursuing commercial (non-exempt) activities.  Collectives considering such activities should consult with counsel to reconsider its structural options, and discuss whether it would be advisable to create a for-profit subsidiary to house any commercial activity.

NCAA Interim Rules
Aside from understanding the regulatory framework discussed above, NIL collectives (no matter their legal form) should have an understanding of the NCAA rules which, as of the time of this writing, consist of interim rules adopted in July 2021.  These interim rules will remain in effect until federal legislation creates a national standard (which is what the NCAA is calling for), or until new NCAA rules are adopted.  While the purpose of the interim rules is to suspend NCAA restrictions on athletes’ profiting off their NIL, the rules maintain certain guardrails to prevent “pay-for-play” and similar arrangements.  Subject to state law, the following is prohibited under the interim rules:

• NIL opportunities cannot be used as a recruiting tool for prospective student athletes.  Such an action is considered an “improper recruiting inducement.”  Therefore, NIL collectives should refrain from making offers of NIL opportunities contingent upon a student-athlete’s enrollment at a particular school.
• As discussed above, NIL arrangements that constitute “pay-for-play” are also prohibited.   This rule prohibits any kind of arrangement that constitutes compensation in exchange for a student-athlete’s participation or performance in college athletics.
• NIL agreements should be specific about the NIL work being performed by the athlete in exchange for compensation, and such compensation should be paid only for work performed.  Such compensation must be determined through an independent analysis, based upon the facts of each specific case and the value each athlete offers to an NIL arrangement.
• The NCAA interim rules prohibit compensation from any school in exchange for the use of a student athlete’s name, image or likeness.  In addition, schools may not direct how student-athletes use NIL compensation.  (For example, schools may not require a student-athlete to use NIL compensation for financial aid.) Athletic department staff are not allowed to represent student-athletes in marketing their athletic ability or reputation.  They also may not communicate with a recruit on behalf of an NIL collective.  In addition, such staff may not facilitate a meeting between an NIL collective and a student-athlete, including, for example, by sharing a recruiting list or watch list.

State Laws and School Policies
As noted above, the NCAA’s interim rules are subject to state law, which varies depending on the state.⁷  Therefore, NIL collectives should take steps to ensure compliance under any applicable state law, including any state law that applies to the collective, the school where the student-athlete is enrolled, as well as the state where the NIL activity will take place.

The collective should also look at any specific NIL policies established by the college.

Both state laws and school policies may include reporting requirements that NIL collectives should be aware of, and some state laws prohibit athletes from entering into a contract that conflicts with the student-athlete’s team contract.

Understanding the regulatory framework governing NIL collectives will help avoid missteps that can lead to punitive actions by the IRS, NCAA or State Attorneys General, or scrutiny from Congress, which has also taken an interest in these entities.  As the NIL’s regulatory environment continues to evolve, it is incumbent on both collectives and student-athletes to take affirmative steps, including consulting with legal counsel, to ensure compliance.

1 This dramatic shift by the NCAA also came on the heels of its loss before the U.S. Supreme Court in NCAA v. Alston 141 S. Ct. 2141 (2021). Though NIL compensation was not the subject of this case, Justice Kavanaugh wrote a concurring opinion which suggested that the NCAA’s NIL compensation rules could be in violation of antitrust laws, and stated that “the NCAA is not above the law.”  The NCAA’s change also follows action by numerous states that, since 2019, had led the way in creating NIL rights for student athletes.

2 As discussed later in this article, “pay-for-play” refers to any kind of arrangement that constitutes compensation in exchange for a student-athlete’s participation or performance in college athletics.

3 Other legal forms taken by NIL collectives have included formation as for-profit limited liability companies (“LLCs”), which provides more flexibility in a number of ways.  For example, unlike tax-exempt nonprofits, for-profit LLCs are not subject to a cap on what’s considered reasonable compensation.  They may therefore offer student-athletes NIL work at any compensation structure.  For-profit LLCs are also not subject to limitations on the type of activities they can facilitate.  Therefore, unlike tax-exempt entities, for-profit LLCs may facilitate NIL arrangements for student-athletes such as merchandising or endorsement deals which promote commercial activities.  NIL collectives should consult with counsel to discuss the various pros and cons of these options.

4 On September 29, 2022, Senators John Thune (R-S.D.) and Ben Cardin (D-Md.) introduced the Athlete Opportunity and Taxpayer Integrity Act which, if passed, would “prohibit individuals and organizations from using the charitable tax deduction for specific contributions that compensate college or incoming college athletes for the use of their (NIL).”   They argue that “(s)uch activity is inconsistent with the intended purpose of the charitable tax deduction, and it forces taxpayers to subsidize the potential recruitment of – or payment to – college athletes based on their NIL status.”  As of the time of this writing, this federal legislation is the latest of more than a handful of NIL proposals introduced, but not yet passed, in Congress.  Congress’ appetite for eventually passing NIL legislation is unclear, though these proposals do indicate that NIL collectives are facing increased scrutiny from Congress.

5 Regs. Sec. 1.501(c)(3)-1(e)(1) and Sec. 1.501(c) (3)-1(c)(1).

6 One example of this approach is discussed in the previous section – i.e.,  tax-exempt collectives that provide in-kind contributions of a student-athlete’s services to other charities to help them promote their charitable missions.

7 As discussed above, the NCAA is lobbying Congress for legislation that would create a national standard, and thereby pre-empt differing state laws.

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Current Trends and Issues in Charitable Regulation

Regulators
Conference panels presented by various state regulators covered ongoing trends and issues. Public trust of the charitable sector was a topic of general concern, based on surveys indicating a decrease in the trust in the nonprofit sector.  The regulators noted that they play an important role in enhancing trust by providing meaningful oversight of the sector.

Noteworthy topics included the importance of Board governance and oversight, particularly in monitoring the organization’s finances. The panelists noted a rise in for-profit entities soliciting in-kind disaster relief, particularly those that do not have a nonprofit partner. This trend has been largely observed in connection with the rise of natural disasters and the war in Ukraine.   Regulators are also troubled by the balloon and bust of opioid-crisis relief organizations. This is threatening given the importance these organizations play in their local communities. Such failures have been attributed to their overly rapid growth.

Several state regulators noted an increase in mergers and acquisitions filings of hospitals. Approval of these transactions generally turns on the question of whether the transaction is in the best interest of the community. As for charity care, regulators noted that nonprofit hospitals have a duty to provide subsidized care to patients in need, something they say they have seen too little of.

A notable increase of fraud, committed in the name of charities or directed at charities, is also of concern. It is reported that there has been a rise of bad actors using the name and information of known and respected charities to commit fraud.  One typical scheme is the impersonation of regulators claiming that registration fees are past due. Charities that receive such calls are admonished to use best efforts to confirm the identity of caller.

NASCO puts out an annual report detailing trends on state regulation and enforcement.

Nonprofit Sector and Practitioner Panelists
In the afternoon, other stakeholders in the charitable sector spoke on the trends they have observed during the past year. Jan Masaoka, CEO of the California Association of Nonprofits, discussed the Association’s concerns with donor-advised funds (DAFs) arising from the delay in time between donor benefit (i.e., the donor’s tax-deduction) and the donation reaching its target community. Erin Bradrick, Principal of NEO Law Group, spoke on the growth of fiscal sponsorships and the lack of sector education and oversight that exists. She observed that Decentralized Autonomous Organizations (DAOs) have the theoretical ability to seek 501(c)(3) status without having a governing body (the core distinguishing characteristic of DAOs).  Ms. Bradrick also noted an upward trend in the politicization of issues directly tied to key nonprofit areas, which have created a tension between state and federal law., naming the recent cannabis and abortion access laws as prime examples.

NFT and Cryptocurrency
Sara Hall, Chief Legal Officer and General Counsel of ALSAC, Andrea Kramer, Partner of McDermott, Will & Emory, Ruth Madrigal, Principal of the Exempt Organizations Group at KPMG, and Beth Short, Director of Outreach and Education, Charitable Law Section of the Ohio Attorney General’s Office, discussed cryptocurrencies, NFTs, and other emerging forms of donation.  The panel noted that these forms are not suitable for all organizations, as there is significant risk and several complex issues to consider in accepting donations of cryptocurrency.

It was noted that organizations that decide to accept NFT or cryptocurrency donations should ensure they have a detailed donation acceptance policy and procedure in place.  The policy should include how the organization will protect the security of the crypto wallets through which they accept the donation, how to appraise the cryptocurrency or NFT, and whether to use an intermediary service like a Donor Advised Fund (DAF). Including the development department on any decision on acceptance of these donations is critical.

Now and Next in Charitable Giving
In her keynote address, Dr. Una Osili, Associate Dean for Research and International Programs at the Indiana University Lilly Family School of Philanthropy, made a deep dive into the data to identify donor trends. Among those Dr. Osili highlighted are that giving is at an all-time high, that individuals remain the largest group of donors, and that fewer households are donating. She also pointed to a downturn in religious donations, historically the largest generator of donations, and an upturn in donations to racial identity and environmental groups. Donors are moving from a trend of making passive donations to getting more involved in the causes they support through active engagement and education.

Dr. Osili ended by sharing some of her key findings, notably that giving is the great equalizer. Adjusted for gross income, charitable giving is the same across all groups. Technology, specifically crowdfunding websites and social media, has become one of the strongest vehicles for attracting donations, making up 40% of all giving. Finally, charities should start thinking of the value of donating one’s testimonial and network of connection, not just time and gifts. For more information, visit the Indiana University website at Generosity for Life.

Establishing a Healthy Board
Dr. Gerri King, President of Human Dynamics Associates, taught board mediation and communication techniques. Her talk centered on the five states of group development: Forming, Storming, Norming, Performing and Adjourning. Dr. King explained that at each stage, there are unique challenges affecting Board dynamics, and that any change to the make-up of the Board can be a setback.

Dr. King emphasized the importance of creating a no blame, no gossip environment among the team and the organization, noting that although it sounds simple, it can be intensely difficult to achieve. The benefits, as she noted, are indispensable., creating higher accountability, cohesion, trust and efficiency.

Update on the California Charitable Fundraising Platform Law
Brian Armstrong, Deputy Attorney General of the California Attorney General’s Office, discussed Assembly Bill 488, which is set to take effect on January 1, 2023. This is the first law in the U.S. specifically designed to regulate online charitable fundraising platforms, including through a new registration and reporting requirement, specific required public disclosures, and other provisions designed to safeguard charitable donations received through these platforms.

The proposed regulation is currently in the “review of public comments” stage. Armstrong indicated that a second, 15-day period for public comments will open up again once the review is complete, but did not specify when that would be.  During the follow-up Q&A, our team learned that the registration portion of the law is not likely to go into effect on January 1, 2023. Still pending would be final regulations and the development of the new registration forms. However, the AG’s office intends to begin enforcement of those portions of the law which are not dependent upon the passage of final regulations (e.g., the disclosure requirements).

Charitable fundraising platforms and platform charities should take time to carefully review their current platform disclosures (including disclosures made throughout the user/donor flow, as well as the platform Terms of Use) and ensure they are in compliance with these new requirements.  For more details on the legislation, please read California Enacts New Law to Regulate Charitable Fundraising Platforms by firm partner Karen Wu.

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Navigating the types of activities that tax-exempt nonprofits are allowed to engage in (and how much) without jeopardizing their tax-exempt status can be tricky.  Many charities engage in types of activities that are important to the organization’s mission, donors, and people they serve.  Two activities that charities may use to influence public policy include “advocacy” and “lobbying.”  While advocacy and lobbying are terms that are sometimes used synonymously, the two are distinct in important ways, most notably because federal tax law limits the amount of lobbying that charities may engage in.

How Does Advocacy Differ from Lobbying?

Advocacy can take many forms that do not constitute lobbying, including: leading, directing, conducting, and publishing research; and disseminating educational information.  Charities may engage in many different types of advocacy, and so long as that activity does not constitute lobbying, 501(c)(3) organizations are generally not limited in the amount of time or money they can spend on advocacy.

Lobbying, on the other hand, is subject to specific, restrictive rules.  Charities may engage in only an insubstantial amount of lobbying, and must take care not to jeopardize their tax-exempt status or run afoul of other lobbying restrictions.  Lobbying is any attempt to influence legislation, which can include acts, bills, resolutions, or ballot initiatives by Congress, state legislatures, local councils, or similar governing bodies.  An organization whose employees contact or urge others to contact members or employees of one of these bodies for the purpose of influencing (by encouraging them to adopt, reject, support, or oppose) legislation, is engaging in lobbying.

State and Local Lobbying Registration, Reporting, and Disclosure Requirements

In addition to following the strict federal tax rules governing the type of lobbying and amount of lobbying an organization can engage in,  charities should also be aware of any state and local requirements to register (including registration of certain employees as lobbyists, or registration of the organization itself, which retains and pays lobbyists) and to report lobbying expenditures and activities on a regular basis.¹ Federal and state lobbying rules can be confusing and complicated, and often depend on several factors, including: (1) whether the organization employs an in-house lobbyist or an outside lobbyist; (2) whether any of the organization’s employees are lobbying; (3) the total amount of expenses the organization spends on lobbying activities; and (4) the timing of any contacts or communications made with federal or state officials.

After the organization makes a determination about which federal and state registration requirements apply to its lobbying activities, the organization and its lobbyists must file regular reports (often quarterly or semi-annually) until the registration terminates (the method by which registrations are terminated also varies from state to state), or otherwise expires.

If an organization decides to engage in lobbying activities, it is critical to ensure that executive staff are aware of the applicable requirements for registration, reporting, and disclosure.  Failure to comply can result in fines, censure from the regulatory agency, and possible negative press exposure for the organization.

1 While this article is focused on the lobbying rules as they pertain to 501(c)(3) public charities, it is worth noting that 501(c)(4) organizations, which may engage in unlimited lobbying in furtherance of their tax-exempt missions, are more likely to trigger lobbying registration and disclosure requirements.

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Within a week, the group created the ConstitutionDAO, organized its followers on Discord (a messaging and community platform), and raised roughly $47 million in virtual currency.⁴ Armed with their new war chest, the group bid on, but ultimately failed to win, the Sotheby’s auction, losing out to a hedge fund billionaire who purchased the copy of the Constitution for $43.2 million (the Constitution DAO had withheld some funds to cover costs associated with winning the auction).⁵

Following their loss, the creators of the group were faced with what to do with the virtual currency sitting in the DAO’s treasury. Many of the community members sought refunds, only to learn that the transaction costs (also known as gas fees) would eat up much of their original contribution.⁶ Ultimately, the ConstitutionDAO’s founders decided to shut it down.⁷ The token issued in connection with the project, originally intended to be used to allow holders to vote on what the DAO would do in the future, lives on, with some holders still hoping to profit.⁸

What if the ConstitutionDAO had succeeded? Who would have “owned” the copy of the Constitution the group would have purchased? In a later interview one of the founders of ConstitutionDAO, Jonah Erlich, disclosed that the group had partnered with a traditional nonprofit organization that would have had legal custody of the Constitution.⁹ The fact that this new type of organization would be reliant on a traditional nonprofit provides excellent insight into the emerging world of DAOs. It also gives us an entry point to examine this new structure.

WHAT ARE DAOS?

In a traditional corporation or limited liability company, the organization is formed by filing paperwork with a government office, typically a state’s Department of State. By creating a legal entity, the people behind the organization are protected from liability. When someone sues a corporation over a contract dispute or other liability, the directors, officers, employees, members, and volunteers are not liable individually. Rather, it’s the corporation that must answer for its liabilities.

In a DAO, however, there is no formal legal entity. Built using the same blockchain technologies that underly the virtual currency ecosystem, DAOs are organizations that are never incorporated in any state (with limited exceptions). The founders create the DAO, and it simply exists.

While DAOs actual structures vary, most DAOs issue a token that gives members of the DAO voting rights. Once tokens are issued, in order to make decisions, all token holders are allowed to vote. The idea, touted by DAO supporters, is that this new structure democratizes organizational decision-making, placing it in the hands of the members. An oversimplified comparison would be a for-profit company that has no paid executives or board of directors, making every decision by allowing all shareholders to vote.

Although the ConstitutionDAO is a well-known example, DAOs are proliferating in the nonprofit community. Here are a few interesting examples: DiatomDAO is raising support to protect the oceans;¹⁰ KlimaDAO hopes to speed up solutions for climate change by increasing the price of carbon assets;¹¹ Bloomeria is using NFTs to increase biodiversity; ¹² and The Regen Network is issuing a token as part of a group of entities to realign the agricultural economy with ecological health.¹³

While each of the foregoing organizations uses the language of the DAO and decentralization, they also demonstrate how the DAO community encompasses many different structures. For instance, the Regen Network is comprised of a traditional C-Corporation, a traditional 501(c)(3) public charity, and a decentralized DAO program.¹⁴ The DiatomDAO is purely a decentralized entity, “owned and directed” by its token holders (see more on this below). The ConstitutionDAO, while operated as a decentralized DAO, would have relied on a traditional 501(c)(3) public charity (one named EnDAOment¹⁵) had it won the Sotheby’s auction and needed a legal entity with which to hold the copy of the Constitution. As you can see, while many groups use the mantle of “DAO”, the term encompasses many different structures.

WHAT ARE THE BENEFITS OF DAOS?

Now that we’ve discussed what DAOs are, and seen some examples, let’s step back to consider what DAO proponents like about the structure. In theory, a pure DAO offers each supporter the opportunity to participate in the group’s decision-making. If a member of a charitable DAO wants to make a grant, they would propose it to the rest of the DAO community. The members then hold a vote. Using this structure, a DAO represents a more direct form of organizational decision-making and, for donors, more direct-action philanthropy.

Further, by avoiding any legal structure, some DAO proponents believe this new structure will give DAOs greater flexibility. Without a state’s laws dictating how decisions have to be made or how boards have to be structured, a DAO might be nimbler. Some libertarians believe that DAOs, who have no real jurisdictional nexus to any state, might even be able to avoid generally applicable laws.¹⁶

WHAT ARE THE DRAWBACKS OF DAOS?

While there is a lot to be excited about by DAOs, they use an organizational structure in its infancy, with many more questions than answers. One critique is that the voting structure adopted by most DAOs (1 token = 1 vote) replicates existing problems with shareholder structures, namely, that the larger shareholders control organizational decision-making, alienating smaller shareholders. If one person holds 60% of the DAO’s tokens and the DAO implements a 50+1% vote threshold decision-making could be even more centralized than it would be in a traditional organization with a board and executives who can counterbalance a large shareholder’s interests. The DAO community has proposed some possible solutions to this problem, such as limiting votes to one per token holder, or creating non-transferable tokens to limit token holder hoarding. Each of these solutions have drawbacks, but they could drive decision-making closer to the idealized notion of the DAO.

Another issue is the legal uncertainty of DAOs. Assume that the libertarian notion that DAOs are legally unaccountable as organizations, since they are not organized in any state nor do they have any other jurisdictional nexus with any local, state, or federal government. That might put the DAO beyond the reach of regulators and law enforcement, but it would not exempt the individuals participating in or working for the DAO, all of whom are real people subject to normal laws. Actually, the idea of a group of people running an unincorporated organization isn’t new. In New York, for instance, such an entity would be deemed an “unincorporated association.” Under longstanding common law, an unincorporated association is not legally separate from the members who comprise it.¹⁷ That means that members of a DAO could be taking on direct legal risk from their participation in the DAO. If the DAO were to breach a contract, discriminate against an employee, or cause other real-world harm, the DAO’s members might be jointly and severally liable.

It’s also an open question whether regulators will share the libertarian view that DAOs are not subject to local, state, or federal laws. It wouldn’t be surprising to see the Securities and Exchange Commission (SEC) bring an enforcement action against a DAO, given that it has already notified the Decentralized Finance (DeFi) community that it considers many DeFI products analogous to products regulated by the Commission.¹⁸ The SEC has already brought an enforcement action against a Wyoming organization operating under the guise of a DAO, albeit only after the entity sought SEC approval to register two tokens as securities.¹⁹

Finally, DAOs in the philanthropic sector face the additional hurdle of providing tax-deductibility to donors. In general, a contribution to a non-charitable intermediary doesn’t allow a donor to take a tax-deduction. The answer to that question isn’t clear²⁰ as it depends on how the entity is treated for tax-purposes, whether its distributions would otherwise qualify for a tax-deductions, and whether it is considered an agent for the donors or beneficiary charities. A person hoping for a tax-deduction should contact a tax professional to examine the particular DAO’s structure and the taxpayer’s circumstances. To date, I’m unaware of any DAO specifically advertising the deductibility of contributions to its treasury, nor having considered tax-deductibility as part of their DAO structure (except, of course, for DAOs like Endaoment and Regen Network that operate using a traditional 501(c)(3) corporate structure).

WHAT’S NEXT FOR DAOS?

Despite the novelty of and the uncertainty surrounding DAOs, their popularity is undeniable. This was exemplified by the incredible enthusiasm around ConstitutionDAO. Taking advantage of the late 2021 surge in the value of many cryptocurrencies, DAOs provide an opportunity for the crypto community to put its assets to work in novel ways, including philanthropy. While they are evolving, DAOs will likely persevere, barring regulator intervention to shut them down.  Donors and charities looking to participate in the DAO community should do so carefully, and with the benefits of advisors familiar with the DeFi and DAO space.

1 https://www.sothebys.com/en/digital-catalogues/the-constitution-of-the-united-states

2 Id.

3 https://www.theverge.com/22820563/constitution-meme-47-million-crypto-crowdfunding-blockchain-ethereum-constitution

4 https://www.constitutiondao.com/

5 https://www.vice.com/en/article/qjb8xv/hedge-fund-ceo-who-bailed-out-gamestop-short-seller-bought-the-constitution

6 https://www.theverge.com/2021/11/24/22800995/constitutiondao-refund-progress-steep-gas-fees-cryptocurrency

7 https://www.theverge.com/2021/11/23/22799192/constitutiondao-shutting-down-lost-auction-refunds

8 The latest price quote for the PEOPLE token can be found at  https://coinmarketcap.com/currencies/constitutiondao/.

9 https://www.theverge.com/22820563/constitution-meme-47-million-crypto-crowdfunding-blockchain-ethereum-constitution.

10 https://diatom.fund/

11 https://www.klimadao.finance/

12 https://bloomeria.org/

13 https://www.regen.network/

14 https://www.regen.network/faq/organization

15 https://endaoment.org/

16 For instance, in his conversation on the Deep Background podcast, Erik Voorhees argued that a DAO could avoid the difficulties of employment law because no states employment laws would apply. https://www.pushkin.fm/episode/whats-the-deal-with-decentralized-autonomous-organizations/

17 See, generally, New York Elec. C. Assn. v. Local Union No. 3, (NY Sup. Ct. 1941), available at https://casetext.com/case/new-york-elec-c-assn-v-local-union-no-3

18 https://www.sec.gov/news/statement/crenshaw-defi-20211109

19 https://www.sec.gov/news/press-release/2021-231; https://www.coindesk.com/policy/2021/11/11/sec-stops-wyoming-based-dao-from-registering-2-digital-tokens/.

20 For an excellent discussion, see Prof. Samuel Brunson’s blog post https://lawprofessors.typepad.com/nonprofit/2021/11/charitable-daos-revisited.html.

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Nonprofits and for-profits (in this article, “Brands” for easy reference) can collaborate in a number of ways to benefit both organizations. Nonprofits benefit by receiving financial support and access to a wider audience. Brands benefit from the goodwill generated by supporting a charitable cause, while simultaneously furthering their own purposes. These collaborations may take a number of forms. (For further reading, see  articles on our website , Selfish Giving, and Engage for Good’s online resource Cause Marketing and the Law).

We’ve recently seen a number of nonprofits expand their efforts to more consciously address online collaboration. In this article, I provide a refresher to clarify where the IRS draws the line on these types of partnerships. Understanding this line can help Brands to maximize their benefits and charities to avoid unwanted tax consequences.

What are Qualified Sponsorship Payments?

A typical strategy for Brands and nonprofits to collaborate is through sponsored events. While the pandemic has thrown traditional fundraising events for a loop, many nonprofits have pivoted to digital engagements or are now beginning to plan live events again as vaccination rates rise. Whether an event is digital or live, many nonprofits underwrite their events with support from Brand sponsors. In exchange for this support, Brands typically receive certain benefits. Those benefits may include a page in the event program, placement of their logo on the step-and-repeat, or a booth at the event. In the virtual context, Brands may get a shout-out or other acknowledgment during the event, in thank-you emails to attendees, or in press releases issued by the nonprofit.

If a nonprofit wants to avoid tax on the sponsorship payments that are received in exchange for certain benefits to the Brand, one strategy is to ensure that the payments qualify as “Qualified Sponsorship Payments”, the term used in Section 513(i) of the Internal Revenue Code. In order to be categorized as a Qualified Sponsorship Payment, the payment must be made without any arrangement or expectation of a “substantial return benefit.” Payments made in return for advertising or marketing services may constitute a substantial return benefit, and cause the payment to be subject to tax under the IRS’s Unrelated Business Income Tax (“UBIT”) rules.

So when does including a Brand’s logo in the nonprofit’s event, or allowing the Brand to have a booth or table at the event, constitute a “substantial return benefit”? Fortunately, the IRS has provided guidance on this question. According to the IRS, one way to avoid providing the Brand a “substantial return benefit” is for the Brand and nonprofit to avoid language that “promotes or markets any trade or business”. The IRS goes on to provide several examples of activities that are allowable under the qualified sponsorship rules, including:

• Distributing a Brand’s products to the general public at the event, either for free or purchase
• Including a Brand’s logo, slogan, address(es), telephone number, descriptions of a Brand’s product line or services, PROVIDED that all the foregoing do not include any comparative or qualitive descriptions of the Brand’s goods and services.
• Exclusive sponsorship arrangements (i.e., having a Brand be the only bakery sponsoring the event. NOTE – this is different than an exclusive provider arrangement, described below)

The IRS, in its guidance, also describes what types of messaging and activities are considered “substantial” return benefits for Brands and therefore NOT qualified sponsorship activities, including:

• Advertising for the Brand (messaging that promotes or markets a Brand, including messaging that contains comparative or qualitative descriptions of the Brand’s goods/services)
• Exclusive provider arrangements that limit the sale, distribution, availability, or use of competing products/services in connection with the nonprofit’s event/activities (i.e., having a Brand be the sole provider of cookies for an event. NOTE – this is different from the exclusive sponsorship arrangements, described above)

Social Media Considerations

Many Brands and nonprofits have begun to include social media posts as part of their messaging around events and partnerships. In addition to concerns about UBIT and qualified sponsorships, Brands and nonprofits have to be wary of rules implemented by the social media platforms (Instagram, Twitter, and TikTok, for instance) and guidelines issued by the Federal Trade Commission.

Nonprofits often thank their Brand sponsors for their support. It’s important that the language included in those posts is agreed upon by the Brand and nonprofit, and is vetted to make sure it doesn’t amount to an advertisement or endorsement of the Brand’s products or services. Similarly, when a Brand posts to highlights its support of the nonprofit, the parties should ensure that the post doesn’t create the implication that the nonprofit is endorsing the Brand’s products.

Brands and nonprofits also have to make sure their posts include appropriate disclosures to put their respective followers on notice that the content they are posting is part of a partnership. How those disclosures should be structured depends on the platform and the nature of the post, but has to be clear enough so that the posts comply with the platforms’ rules and the FTC’s guidelines.

If the Brand and nonprofit have brought a celebrity or influencer into the event to help raise its profile, the same general principles apply to the influencer’s posts. The Brand and nonprofit should make sure there are contractual provisions as well as practical guidelines provided that clarify what the influencer can and cannot post, how those posts should be timed and structured, and what material disclosures must be included.

Advice for Brands and Nonprofits

Brands and Nonprofits need to carefully review their contracts and social media posts to ensure they are not violating the rules regarding Qualified Sponsorships or social media platform disclosures. All posts made by the nonprofit thanking the Brand should avoid any qualitative language. Here are two sample statements to differentiate between comments that could be considered advertising vs. those that are just acknowledgments:

• Acknowledgment – NONPROFIT thanks BRAND for their steadfast support of our event. With BRAND’s support, we raised $100,000 in furtherance of our mission to end childhood hunger.
• Advertising – NONPROFIT thanks BRAND, purveyor of the best chocolate chip cookies in the NYC-area, for their support of our event. BRAND is one of the best companies and we thank them for their continued support. Find their cookies available for delivery at [WEBSITE].

In the second statement, the nonprofit used qualitative language around the Brand and its products. It also made a general comparative characterization of the Brand and linked to the Brand’s website, not for general informational purposes but to encourage viewers to order the Brand’s products. The second statement would be considered advertising, and could trigger UBIT for the nonprofit. The first statement merely identifies the Brand as a supporter of the nonprofit and its mission, and would be considered an acknowledgment.

In the contract governing the sponsorship or collaboration, the nonprofit should include restrictions on the Brand’s ability to use the nonprofit’s name and trademarks. For instance, the nonprofit should include a clause that prohibits the Brand from using pictures and videos from a nonprofit’s event in the Brand’s television, print, or social media advertising to promote its products or services. If a Brand seeks to incorporate the nonprofit’s photos and videos into content that highlights the Brand’s social mission and corporate responsibility, the nonprofit should carefully define the limits of that right to avoid an inadvertent endorsement.

The Brand and nonprofit should also consider how to enforce their contractual rights with regard to one another and any social media personalities that are part of the event. Payments can be delayed until after certain deliverables, to ensure all parties remain in sync in the run-up to the event. The parties should also consider the duration of their contractual rights –event contracts often terminate immediately upon the completion of the event, but if the parties are allowed to use each other’s names and logos even after the event is over, the contract should cover that ongoing use.

In order to manage the logistics of the event and the many deliverables that are included in sponsorship agreements, Brands and nonprofits can designate point people to review and approve deliverables. Specifying in the contract who the points-of-contact will be, as well as the required turnaround times, will help ensure the parties remain on good terms and maximize the event’s potential.

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