501(c)(3) Charitable Organizations

Purposes
501(c)(3) organizations operate exclusively for charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, and preventing cruelty to children or animals.  For purposes of section 501(c)(3), the term charitable is used in its generally accepted legal sense and includes:

• Relief of the poor, the distressed, or the underprivileged
• Advancement of religion
• Advancement of education or science
• Erecting or maintaining public buildings, monuments, or works
• Lessening the burdens of government
• Lessening neighborhood tensions
• Eliminating prejudice and discrimination
• Defending human and civil rights secured by law
• Combating community deterioration and juvenile delinquency

Public Charity vs. Private Foundation
Every 501(c)(3) organization is classified as either a private foundation or a public charity. Private foundations and public charities are primarily distinguished by the level of public involvement in their activities. Public charities normally receive a significant portion of their financial support from the general public or governmental units and interact more with the public. 

A private foundation is typically funded by a single person, a family, or a company. Private foundations are subject to stricter operating restrictions because they are less open to public scrutiny than public charities. They are subject to certain excise taxes for failure to comply with those restrictions.  

Private foundations are further classified between private non-operating foundations and private operating foundations. The main difference is that private operating foundations actively “operate” or conduct their own charitable programs. Because of this major difference, private operating foundations are subject to the same regulations as public charities on a few key matters, which are generally more favorable than the rules applicable to non-operating foundations.

Lobbying
Lobbying is any attempt to influence legislation, including acts, bills, resolutions, or ballot initiatives by Congress, state legislatures, local councils, or similar governing bodies.

A public charity is not permitted to engage in substantial legislative activities. If lobbying activities are substantial, a 501(c)(3) organization may fail the operational test, risk losing its tax-exempt status, and, in certain cases, be liable for excise taxes.

Like public charities, private foundations will jeopardize their 501(c)(3) status if lobbying is a substantial part of their activities. However, private foundations are subject to a significant excise tax on their lobbying expenditures, such that the excise tax generally acts as a lobbying prohibition for private foundations.  A limited exception to this lobbying prohibition, known as the “self-defense” exception, applies if the communication addresses legislation that affects the foundation’s existence, powers and duties, tax-exempt status and/or deductibility of contributions.

Political Campaign Activities
All 501(c)(3) organizations are prohibited from directly or indirectly participating in or intervening in any political campaign on behalf of (or in opposition to) any candidate for elective public office.  Prohibited political campaign activities include any statements made by or on behalf of the organization in favor of or in opposition to any candidate for public office and contributions to political campaign funds.  Violating this prohibition may result in denial or revocation of tax-exempt status and the imposition of excise taxes on the organization.

Tax-Deductibility and other Characteristics 
Donations to 501(c)(3) organizations are tax-deductible, though the deductibility limits vary between public charities and private foundations (and generally are more generous for public charities). In addition, 501(c)(3) organizations are generally exempt from state income tax exemption and state sales tax exemption (although some states only grant sales tax exemption to a narrow subset of 501(c)(3) organizations).  501(c)(3) organizations are also generally eligible for the nonprofit mail rate, which provides a significant discount. 

Applying for Tax-Exempt Status
Organizations seeking 501(c)(3) tax-exempt status must file the Form 1023 or Form 1023-EZ.  Churches that meet the requirements of IRC Section 501(c)(3) are automatically considered tax-exempt and are not required to apply for and obtain recognition of tax-exempt status from the IRS, although many churches choose to apply for tax-exempt status to obtain the certainty of the IRS’s determination. A written IRS determination can also simplify applying for other benefits, like state tax exemptions.

501(c)(4) Social Welfare Organizations

Purposes
501(c)(4) organizations must be operated exclusively for the promotion of social welfare.  The tax regulations specify that an organization operates exclusively to promote social welfare if it is primarily engaged in promoting the common good and general welfare of the people of the community.

Lobbying
501(c)(4) organizations may engage in unlimited lobbying related to their exempt purposes without jeopardizing their tax-exempt status.  This ability to engage significantly in lobbying activities is a key reason many organizations choose the 501(c)(4) designation.

Political Campaign Activities
501(c)(4) organizations can engage in political campaign activities if not the organization’s primary activity. 

Tax-Deductibility and other Characteristics
Donations to a 501(c)(4) organization are not tax-deductible. In addition, the names and addresses of donors do not need to be disclosed to the IRS in its annual Form 990 filing.  By contrast, all 501(c)(3) organizations must disclose their donors to the IRS in their Form 990 filings, and information about private foundation donors is made publicly available by the IRS.  Some organizations may also choose to seek 501(c)(4) status (especially as an alternative to 501(c)(3) private foundation status) if their donors do not need the benefit of tax-deductibility of their donations, and they would benefit from the more flexible rules applicable to 501(c)(4) organizations.

Applying for Tax-Exempt Status  
Organizations seeking 501(c)(4) tax-exempt status must file the Form 8976 Notice of Intent to Operate Under Section 501(c)(4), generally within 60 days of its formation. In addition to submitting Form 8976, organizations operating as 501(c)(4) organizations may also choose to file Form 1024-A to request recognition of tax-exempt status. Submitting Form 1024-A does not relieve an organization of the requirement to submit Form 8976.

501(c)(6) Business Leagues

Purposes
501(c)(6) organizations include business leagues, chambers of commerce, real-estate boards, and boards of trade.  A business league, which is perhaps the most common type of 501(c)(6) organization, is an association of persons having a common business interest, the purpose of which is to promote such common business interest and not to engage in a regular business of a kind ordinarily carried on for profit. Business leagues include trade associations and professional associations. To be considered exempt, a business league’s activities must be devoted to improving the business conditions of one or more lines of business as distinguished from performing particular services for individuals. 

Lobbying
501(c)(6) organizations may conduct unlimited lobbying to further their exempt purposes without jeopardizing their tax-exempt status.  An organization that engages in these activities must give its members notice of amounts of membership dues allocable to nondeductible lobbying expenditures; failure to provide such notice may subject the organization to a proxy tax on the amount of the expenditures.

Political Campaign Activities
501(c)(6) organizations are permitted to engage in political campaign activities if they are not the organization’s primary activity.

Tax-Deductibility and other Characteristics
Donations to a 501(c)(6) organization are not tax-deductible. 

Applying for Tax–Exempt Status
Organizations seeking 501(c)(6) tax-exempt status must file the Form 1024 with the IRS. 

Keep in mind that organizations engaging in lobbying and political campaign activities may also be subject to federal, state, and, in some cases, local lobbying registration and disclosure reports, depending on relevant factors, including the amount spent on the activities, whether lobbyists are retained, and the locations of such activities.  

Choosing the Classification of Your Organization

It is critical to correctly determine which tax-exempt status is most appropriate based on your organization’s key objectives.  Failure to apply for and obtain the correct tax-exempt status may subject an organization to unanticipated regulatory burdens and constraints and leave it unable to accomplish its essential goals.  While seeking reclassification of an organization’s tax-exempt status is possible, it can be a slow and complex process. As such, it is best to apply for the most strategically beneficial tax-exempt status from the outset.

The post Three Key Types of Federal Tax-Exempt Status[br] 501(c)(3), 501(c)(4), and 501(c)(6) appeared first on Perlman & Perlman.

I. Federal Tax Code Limitations on Public Charity Lobbying and Political Campaign Activities

Advocacy
A public charity can engage in an unlimited amount of advocacy in furtherance of its exempt purposes as long as that advocacy does not constitute lobbying or political campaign activity. This type of unrestricted advocacy may take many forms, including public education, nonpartisan research, and nonpartisan voter education, and can lay the groundwork for future lobbying activity.

Lobbying
What is Lobbying?
The Code recognizes two types of lobbying – direct lobbying and grassroots lobbying. In order for advocacy to be considered direct or grassroots lobbying, the communication must reflect the organization’s view on specific legislation.  “Legislation,” in this context, includes action by Congress, a state legislature, local council or similar governing body, and the general public in a referendum, initiative, constitutional amendment, or similar procedure. It generally does not include action by an executive branch of government or independent regulatory agencies.

Direct lobbying refers to attempts to influence specific legislation through communication with a member or employee of a legislative body or a government official who participates in the formulation of legislation.  A “member of a legislative body” generally includes members of Congress, state legislators, county supervisors and commissioners, city council members, members of international bodies with legislative power, legislative staffers, and the general public when voting on a ballot measure. Communication with other government employees, such as executive or administrative officials and staff, will be considered lobbying if those officials participate in the formulation of legislation and the purpose of the communication is to influence legislation. However, in general, communication with judges, executive branch officials, school board members, members of other similar local special purpose bodies, and members of the public when not voting on ballot measures do not qualify as communication with a member of a legislative body, and are therefore excluded from  the definition of “direct lobbying.”

Grassroots lobbying refers to attempts to influence specific legislation by urging the public to take action with respect to the legislation. Common actions that constitute grassroots lobbying include: (1) directing the public to contact a legislator for the purpose of influencing legislation, (2) providing the contact information for a legislator, (3) providing a means to contact the legislator (e.g., a petition or postcard), or (4) publicly identifying a legislator as being opposed to or undecided about the organization’s view on the legislation.

Public Charity Lobbying Limits
A section 501(c)(3) public charity may engage in direct or grassroots lobbying as long as it does not devote a substantial part of its overall activities to lobbying activities (the “substantial part test”). There is no bright line rule stating what constitutes a “substantial” amount of lobbying activity. Whether an organization has devoted a substantial part of its activities to lobbying depends on all facts and circumstances, including the time of both compensated and volunteer workers devoted to lobbying activity and lobbying expenditures. If a public charity engages in a substantial amount of lobbying activity in any one year, the Internal Revenue Service (IRS) can revoke its tax-exempt status causing all of the organization’s income to be subject to tax. In addition, the IRS may impose a tax equal to 5% of lobbying expenditures on the organization and, separately, on any manager who agreed to make the expenditures knowing the organization would likely lose its tax-exempt status.

There is little guidance about what constitutes “substantial” lobbying activity and the consequences resulting from a violation of the substantial part test are severe. As a result, many organizations desire a more definite set of rules. Fortunately, Congress responded in 1976 when it enacted Code Sections 501(h) and 4911 setting forth the “expenditure test” as an alternative to the substantial part test. Charities seeking clearer limitations for their lobbying activities may elect to be subject to the “expenditure test” instead of the substantial part test by filing Form 5768 with the IRS (also known as making “a 501(h) election”).

While the substantial part test takes into consideration all facts and circumstances, including time spent by volunteers on lobbying activity, the expenditure test is concerned only with an organization’s lobbying expenditures. Under the expenditure test, lobbying will not jeopardize a charity’s tax-exempt status unless the organization’s lobbying expenditures exceed 150% of the lobbying expenditure allowance set by the Code taking into account the current year and the previous three years. For the first three years of its first election an organization need only take into consideration the years in which the election has been in effect as long as its lobbying expenditures do not exceed 150% of the lobbying expenditure allowance for those years . A public charity that has made a 501(h) election can spend up to twenty-five percent (25%) of its lobbying expenditure allowance on grassroots lobbying or up to the entire amount on direct lobbying. Lobbying expenditures in excess of this allowance will be subject to a 25% tax. Also, for electing charities, the Code exempts certain activities from the definition of lobbying including nonpartisan analysis or research, discussions of broad social, economic, and similar problems, requests for technical advice, and certain “self-defense” communications made by the organization to a legislative body or its representatives.

Political Campaign Activity
In addition to placing limits on lobbying activity, the Code prohibits a public charity from engaging in political campaign activity. An organization engages in political campaign activity when it participates or intervenes, directly or indirectly, in any political campaign on behalf of or in opposition to any candidate for public office. Whether an organization is participating or intervening in a political campaign depends on all of the facts and circumstances of each case. The IRS often looks for whether the communication, in content, structure, or distribution, evidences a bias or preference with respect to the views of any candidate or group of candidates. A “candidate for public office” is anyone who offers himself or herself, or is proposed by others, as a contestant for an elective office at the federal, state or local level. Participation in a political campaign might include actions such as endorsing or supporting financially a candidate for public office, a political party or a political action group or making statements in favor of or in opposition to a candidate. Certain voter education activities, such as releasing voter guides or legislative scorecards can, if structured appropriately, be conducted in a non-partisan manner and not constitute political campaign activity. A public charity that engages in any political campaign activity will lose its tax-exempt status.

II. Creating an Affiliated 501(c)(4) Organization

The limitations placed on public charity lobbying and political campaign activity may not allow a charity to engage in the level of advocacy necessary to achieve a desired policy outcome.  One option in this instance is to establish a 501(c)(4) social welfare organization. Contributions to a 501(c)(4) are not deductible as charitable contributions, but 501(c)(4)s may engage in an unlimited amount of lobbying as long as the issues relate to the exempt purpose of the organization. In addition, 501(c)(4) organizations may engage in limited political campaign activities, subject to campaign finance laws, as long as these activities are not its primary activity. Charities should consider the operational and strategic implications of this decision, including:

• if there is a sufficient donor base to support a new 501(c)(4) organization;
• if additional advocacy tools will complement the 501(c)(3)’s advocacy efforts;
• whether the organization’s policy issue has been politicized in a way that makes it difficult to discuss in a non-partisan manner; and
• the effect of establishing an affiliated 501(c)(4) on the organization’s reputation.

Below are a few more considerations for public charities that plan to establish an affiliated 501(c)(4) organization.

Legal Separation
The 501(c)(4) must be a separate legal entity from the 501(c)(3). Usually, 501(c)(4) organizations are established as corporations under state law and, as such, are required to observe corporate formalities. The two organizations should maintain their own books and records, bank accounts, mailing addresses, and file their own tax returns and applications for tax-exempt status.

The board of directors of the 501(c)(4) organization must operate independently from the 501(c)(3), including holding distinct meetings. The 501(c)(3) and 501(c)(4) may have board members in common. If the boards completely overlap, careful attention must be paid to keep meetings and decisions separate so that it is clear which board is acting at a given moment. Even with careful recordkeeping, there are reasons to keep board overlap to a minority of the board. Minority overlap will allow the disinterested majority of the board of each entity to approve financial transactions (e.g., grants or loans) between the entities and protect the interests and separate existence of both entities. Further, if the 501(c)(4) will engage in any political campaign activity, it is often advisable to increase the separation between the two entities to reduce the risk that any political activity of the (c)(4) may be attributed to the 501(c)(3).

Financial Separation
A 501(c)(3) must not subsidize the day-to-day operations of an affiliated 501(c)(4). If the two entities will share office space, equipment, and/or staff, the (c)(4) must pay its share of the cost. Typically, this arrangement is memorialized in a written cost-sharing agreement.

Shared employees should keep written time records in order to support allocation of salary between the two organizations. This is critical if the (c)(4) will engage in political campaign activity since the (c)(3) may not directly or indirectly support the political activity of the (c)(4).

As in the case with employee time, the (c)(4) should pay its fair share for any office space or equipment used so that the (c)(3) is not subsidizing the (c)(4)’s activities. The (c)(4) might sublease office space from the (c)(3) at fair market value, pay its share of the rent to the landlord directly, or even pay the full amount of rent and allow the (c)(3) to occupy the space free of charge.

Operational Separation
The charity may not control or give the appearance that it controls the everyday activities of the (c)(4). The (c)(3)’s and (c)(4)’s purposes may align, but each organization should maintain and document its own levels of authority and responsibility in day-to-day operations. Set up good legal compliance systems from the beginning and train staff so they know these systems and can make sure they function effectively.

There are a number of other considerations when establishing an affiliated 501(c)(4) organization, including issues related to applying for tax-exempt status, startup costs, joint fundraising, grants or loans between the organizations, and whether the two entities can share other resources, such as donor lists or a website.  To navigate these issues, it is helpful to seek qualified counsel.

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On July 16, 2018, the IRS issued Revenue Procedure 2018-38. Under the pending rule modification, many nonprofits, including 501(c)(4), (5), and (6) organizations, that  must include the donor information  on Schedule B  will no longer be required to do so. (Other organizations formed under Section 501(c)(3) or Section 527 will still need to provide it on Schedule B.) The change takes effect for tax years ending on or after December 31, 2018. The move by IRS to limit its collection of contributor information has been met with both cheers and jeers, which I summarize below.

Cheers

In the eyes of those supporting the change to the reporting requirements, the collection of contributor information represents a chilling of free speech and a donor’s right of association and privacy. The supporters also point to the IRS’ occasional inadvertent disclosure of donor information, making the case that removing the requirement to submit it will further insure protection of the contributors’ speech and privacy rights. The argument is also made that the IRS has no need for the information except in the case of an audit. For its part, the IRS reasons that the reporting and redacting of donor information is a waste of time and resources for both the agency and nonprofits.

Jeers

Critics of the move argue that the IRS is inviting additional improper funding into so called “dark money” groups (such as 501(c)(4) organizations) which have become increasingly active in American elections since the Citizens United Supreme Court decision in 2010. Since donors to these groups already avoid much of the public disclosure required of traditional political organizations, the fear is that the new rule invites abuse of existing campaign finance laws, including foreign contributions. Critics are also quick to point out that the IRS’ change came on the same day news outlets reported an arrest of a Russian national accused of attempting to improperly influence American politics through, among other things, the influence of U.S. nonprofit organizations.

Further, the adversaries note that inadvertent disclosures made by the IRS of protected information have been rare and do not appear to have chilled the free speech activity of those organizations. As to the IRS’ rationale that its rule change protects limited resources, they counter that the Schedule B change will increase initial investigatory costs as the request for donor information will have to be assessed and handled on a case-by-case basis. When the IRS needs to audit an organization’s financials, it will create even more work for IRS agents and nonprofits and could result in more frequent and invasive audits.

States Seek to Shine a Light on Dark Money

The new rules by the IRS may be made less relevant by state legislatures. New York, as an example, recently enacted a statute requiring both 501(c)(3) organizations (public charities and private foundations) who provide support to 501(c)(4) organizations (advocacy organizations) in excess of $2,500 in any six  month period, regardless of the purpose and the form of that support, to reveal its major donors on a public website established by the Attorney General’s office. In addition,  the new law requires that 501(c)(4)s that expend more than $10,000 in any one year on broadly communicated lobbying type activities also report their donors on the Attorney General’s  public website. (For a more in-depth discussion see:  Shining a Light on Dark Money: Floodlight or Flashlight ).  Although they are unlikely bedfellows, Citizen’s United and the ACLU have each challenged the new statute, resulting in a stay of its implementation.

Practical Effect

One thing the supporters and critics agree on is that IRS rarely uses the contributor information it currently collects, and nonprofits will still be required to keep records of their donations. The rules regulating the nonprofit sector are under-enforced at the federal level.  State charities regulators tend to be on the front lines of enforcement. The IRS’s change may have the effect of encouraging proactive states, as New York has done, to begin requiring contributor information as part of state filing and disclosure requirements. Regardless of how the states react to the decreased disclosure and transparency, the clear message to the nonprofit sector is that the current administration places less of an emphasis on transparency than its predecessors.

Just In

In late breaking news, the Governor of Montana, Steve Bullock (D), sued the Trump administration to void the new rules stating that it would  undermine the state’s ability to regulate nonprofits and make it harder to police illegal spending in political campaigns. It should be noted that Montana has some of the least rigorous oversight of charitable activities of any state in the country and as a result they depend heavily on the information filed with the IRS.  Undoubtedly, other states are likely to follow Montana’s lead as well.

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