Questions

In order to obtain tax-exempt status, charities cannot spend a substantial part of their activities attempting to influence legislation (aka lobbying). This means charities are allowed to lobby, but only an insubstantial amount. But what is or is not lobbying? Can an exempt organization escape the lobbying limitation if it opposes an Executive Order? What if the charity urges its supporters to call their senators to oppose a cabinet nominee? Can a charity support the organization of a march that supports its charitable mission?

The Rule

A charity can engage in advocacy around its core causes, but has to be cautious when its advocacy places the charity in the position of supporting or opposing legislation or nominees. The IRS prohibits organizations exempt under section 501(c)(3) from being organized or operated as “action” organizations. Generally this prohibition requires exempt organizations to spend an insubstantial amount of time and resources to lobbying. Unfortunately, there is no clear definition of “substantial” or “insubstantial” in the eyes of the IRS. So while a charity may lobby, the line between the safe amount of advocacy and too much lobbying can sometimes be hard to draw. The rules are stricter for private foundations – any time or resources spent on lobbying or political activity by a private foundation is considered a taxable expenditure.

Some types of lobbying are easy to identify. If a charity contacts their senator or representative to urge a vote in favor or against a particular bill, the charity is engaged in direct lobbying. If the charity encourages its supporters to take action in favor or against a particular piece of legislation, the charity is engaged in grass roots lobbying. Direct and grass roots lobbying are subject to the IRS’s rules on lobbying.

Cabinet and Judicial Nominations

At first glance, a cabinet or judicial nomination might not seem like “legislation.” Charities might think they are allowed to contact their legislators about nominees, or urge supporters to do so, without considering those activities as lobbying. But under long-standing guidance, the IRS considers a legislature’s advice and consent on the nomination process for cabinet appointees and federal judges to fall within the definition of “legislation.” Therefore, if a charity attempts to sway a legislator in favor or against a cabinet or judicial appointee (either directly or via public opinion), the charity is engaged in lobbying. In the case of a private foundation, such lobbying will trigger a tax liability.

Executive Orders

An Executive Order, on the other hand, is outside the legislative process. A charity can attempt to rally support for or opposition against an Executive Order without triggering the restriction on lobbying so long as it does not urge lawmakers to pass new legislation in response to the order. This applies equally to public charities and private foundations.

Marches & Rallies

In recent weeks numerous high-profile marches and rallies were organized around the country in support of or opposition to a number of causes. Some were in response to particular actions by the Executive Branch, while others were organized to support women’s rights, immigrants’ rights, or refugees’ rights. Where a march furthers a charity’s exempt purpose it is not lobbying. Consider a pro-environment march organized by a charity whose mission involves protecting the environment – the expenditures by the charity will further the charity’s mission, and are entirely appropriate. So long as a march or rally is not in support of or opposition to legislation, or a particular candidate for political office, the charity’s activities will not be subject to the lobbying or political action restrictions imposed by the IRS. As noted above, a march or rally in response to an Executive Order would not be considered lobbying, since an Executive Order is not legislation.

We Lobbied or We Want to Lobby– Now What?

If a 501(c)(3) already lobbied, or it wishes to lobby in the future, there are a few steps the organization should take. The first is to set up accounting and bookkeeping procedures that ensure all expenditures on lobbying activity are clearly accounted for. A public charity may choose to make a 501(h) election which will provide a fixed limit on what the charity can spend on lobbying. While the 501(h) election imposes a limit, it also acts as a safe harbor – the charity knows exactly how much it can spend on lobbying activity. Under 501(h), a charity may use up to 20% of the first $500,000 of its exempt-purpose expenditures to lobby – the limit increases depending on the size of the charity’s expenditures on charitable activities.

Charities should note that the 501(h) election only applies to the money spent on lobbying activities. If the charity has very cost effective methods of lobbying (such as rallying support on social media), it will be able to engage in a significant amount of lobbying activity.

A public charity also has the option to forego the 501(h) election. The charity would then be subject to the “insubstantial part test.” The test examines whether the charity’s lobbying activities are “substantial” or “insubstantial”, the vague standard set by the IRS.

Get Help

In today’s political climate, many charities find themselves confronting challenging questions regarding lobbying and political activity. While some of these questions have straightforward answers, others require careful consideration. A charity’s decisions around lobbying and political activity have potentially significant consequences, ranging from possible taxes to loss of exemption.  If you have any questions regarding lobbying or political activity, consultation with a legal professional may be a good idea.

The post Charities Can Lobby – But What Activities are Lobbying? appeared first on Perlman & Perlman.

Clients new to the world of private foundations (including clients who suddenly find themselves at the helm of family foundations) are often unsure of how to compensate directors, and if it is even legally permissible.  This is not surprising, since, at first glance, the law in this area is puzzling, and several different pieces of the law must be fit together to reveal the full picture.

Among the many peculiar and non-intuitive features of the tax rules for private foundations is that, in the first instance, compensation by a foundation to a “disqualified person” is categorized as an impermissible act of “self-dealing.”  (Foundation directors, their spouses, and their family members – among others – all fall within the law’s definition of a “disqualified person.”)  However, as with many areas of tax-exempt organizations law, this blanket prohibition is followed by a list of exceptions.  The key exception regarding compensation provides that payment of compensation by a private foundation to a disqualified person will not be considered impermissible self-dealing as long as the compensation is not excessive and the compensation is for “personal services which are reasonable and necessary to carrying out the exempt purpose of the private foundation.”

“Personal services” is not a defined term in the statute, but the Treasury Regulations include as examples of personal services: legal services, investment management services, and general banking services.  Further, the term is generally understood to include professional and managerial services rendered by a disqualified person in her capacity as an officer, director, trustee, or executive director of the private foundation.   Much ink has been spilled by others attempting to define “personal services,” and there is a hefty pile of private letter rulings devoted to the topic.  This is understandable since all self-dealing transactions, including impermissible compensation to a director, can result in excise taxes imposed on the self-dealer (e.g. an improperly compensated director), and in certain circumstances, on the other foundation managers and on the foundation itself.  One reason for this onoing uncertainty is that, in the leading case on this issue, Madden v. Commissioner of Internal Revenue, T.C. Memo 1997-395, 74 T.C.M. 440 (1997), the tax court held that the term “personal services” should be construed narrowly and that personal services are “essentially professional and managerial in nature.”  This of course begs the question:  what counts as “professional and managerial?”   That is a question for another day.  For current purposes, however, it is clear that non-excessive compensation to a director for her duties as a director falls squarely within the exception, and is therefore not “self-dealing.”

This background helps illuminate the odd way in which Form 990-PF is structured with respect to reporting on director compensation.  If a private foundation does compensate, or reimburse expenses of, a director or other disqualified person, the organization must answer “Yes” to question 1a(4) of Part VII-B on its Form 990-PF.  That question is straight-forward enough.  It simply asks:  did the foundation “pay compensation to, or pay or reimburse the expenses of, a disqualified person?”

Unfortunately, the crucial follow-up question “1b” is not nearly as straight-forward.  In my practice, I have seen that even experienced preparers will sometimes answer it incorrectly or simply leave it blank.   The awkwardly worded question, which cries out for an English teacher’s red pen, asks:  “If any answer is “Yes” to 1a(1)-(6), did any of the acts fail to qualify under the exceptions described in Regulations…?”  Unless a foundation is intentionally disclosing impermissible activity and including a check to the IRS for excise taxes, the correct answer to this question should be “no”.   By answering “no,” a foundation informs the IRS that “yes” – the compensation (or other transaction) is within the exceptions to self-dealing described in the Treasury Regulations, and therefore is permissible and not subject to excise taxes.

Perhaps what trips up preparers and foundation officials is the section heading for Part VII-B:  “Statements Regarding Activities for Which Form 4720 May Be Required.”   As most informed foundation managers know, Form 4720 is not a form you want to file.  Form 4720 is used to calculate and pay excise taxes for activities that are disallowed under the Internal Revenue Code, and private foundations almost never have a reason to file them voluntarily.  Since Part VII-B, Question 1b refers to the “exceptions” to “self-dealing,” preparers and managers may be eager to answer this question “yes” with the hope that doing so signals “yes, these activities were exceptions to self-dealing.”  However, because of the clunky wording of the question, the answer should almost always be “no.”   A private foundation intending to answer this question “yes” likely has bigger problems than bad grammar.

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