Lobbying Expense Pitfalls for Exempt Organizations

In this election year, tax-exempt organizations may be involved in legislative activities that, if found to be substantial, could cause them to lose exempt status.

As in 1992 and 1996, on July 5, 2000, the IRS issued a news release (IR-2000-47), cautioning Sec. 501(c)(3) charitable organizations to stay within its guidelines for political campaign activities. These organizations cannot endorse candidates, make donations to campaigns, engage in fundraising or become involved in any way that may benefit a specific candidate. If an organization is found to have engaged in this prohibited activity, it can risk loss of its tax-exempt status or be subject to an excise tax on the money spent on that activity. Further, contributions to an organization that loses its exempt status due to political activities are not deductible by the donors for Federal income tax purposes.

The Service's warning should also be expanded to include lobbying activities. Charitable organizations exempt under Sec. 501(c)(3) are subject to limits on lobbying expenses and must be very cautious with respect to these activities.

Sec. 501(c)(3) states that "no substantial part of the activities" of an organization may be "carrying on propaganda, or otherwise attempting, to influence legislation." Payment of expenses for these activities is classified as direct or grass roots lobbying expenditures.

Direct lobbying, as defined by Regs. Sec. 56.4911-2(b)(1)(i), is any attempt to influence legislation through direct communication with a member of a legislative body or its employees who have direct participation in the formulation of the legislation. The communication is considered direct only if it refers to specific legislation and reflects a particular view on such legislation. Legislation, as defined by Regs. Sec. 56.4911-2(d)(1), includes any action by Congress, state or local legislatures, or by the public in a referendum, ballot initiative, constitutional amendment or similar procedure. An example of direct lobbying would be any attempt made to influence a Senate representative who is preparing legislation containing provisions that could directly affect an organization.

Grass roots lobbying communication, as defined in Regs. Sec. 56.4911-2(b)(2), is "any attempt to influence any legislation through an attempt to affect the opinions of the general public." Similar to direct lobbying, the communication must refer to specific legislation, give an opinion on such legislation and encourage the recipient to take action with respect to such legislation. Such encouragement can be any of the following: direct statements suggesting the recipient contact their legislator or government official; providing addresses and telephone numbers of the official; or distributing a petition on specific legislation. An example of grass roots lobbying would be the distribution of pamphlets on a specific referendum that is to be voted on in November by the public.

Exempt organizations qualifying under Sec. 501(c)(3) must operate exclusively for one or more exempt purposes (such as religious, charitable, scientific, testing for public safety, literary, educational or prevention of cruelty to children or animals). These organizations must also serve the public, rather than private, interests.

An organization that engages in a substantial amount of activities to influence legislation would be considered an "action" organization. "Action" organizations, per Regs. Sec. 1.501(c)(3)-1(c)(ii), do not operate exclusively for an exempt purpose and, therefore, are not eligible for exempt status; the lobbying is benefiting the organization or the initiatives of its directors and not the general public.

Substantial legislative activities are measured in two different ways: the substantial part test and the expenditure test. Unless the expenditure test is elected under Sec. 501(h)(10), each organization must follow the substantial part test.

The concept of substantiality under the substantial part test is not quantified in the Code or related statutes, but is based on facts and circumstances. The determination of what is considered "substantial" has been ruled to be much more than a percentage of time or money expended for legislative purposes. In Seasongood, 227 F2d 907 (1955), the Sixth Circuit held that less than five percent of an organization's "time and effort" devoted to legislative activities is insubstantial. However, in Christian Echoes Natl. Ministry, 470 F2d 849 (1972), the Tenth Circuit ruled that an organization's activities must be balanced in the context of its objectives and circumstances. The percentage tests referred to in these cases obscure the true balances of what is deemed legislative and charitable activities.

This causes great concern for small organizations, which could be spending a small amount of time and money on a legislative initiative (which it deems is insubstantial) and yet could be deemed to have a great impact on the organization once the new law is enacted. This could make the activity substantial and make the organization an "action" organization.

A tax-exempt organization bearing the risk of being considered an "action" organization can elect under Sec. 501(h)(10) to quantify its lobbying expenses under an expenditure test. This election allows Sec. 501(c)(3) organizations to make limited expenditures to influence legislation. However, the organization will be subject to an excise tax under Sec. 4911 if it spends more than the permitted amount. Sec. 501(h) provides a "lobbying ceiling amount" that can be used as a safe harbor for protecting the charity's exempt status. If an organization exceeds the lobbying ceiling amount defined under Sec. 501(h)(1) by more than 50% over a four-year period, the tax exemption would be denied, because a substantial part of the activities are deemed to be lobbying in nature. This four-year period begins only after the election has been made. After a couple of years, if an organization determines that lobbying ceiling amounts are being exceeded, in its third or fourth year, lobbying activities can be limited.

An electing organization must report the actual and permitted amounts of its lobbying expenditures on its annual Form 990, Return of Organization Exempt from Income Tax, Schedule A, Part VI-A. Organizations not electing should report their lobbying activities under Schedule A, Part VI-B, and attach a statement detailing their lobbying activities.

This election, and any subsequent revocation, is made by filing Form 5768, Election or Revocation of Election by an Eligible Section 501(c)(3) Organization to Make Expenditures to Influence Legislation, during the year in which the election is desired. The election is valid for all subsequent years, until the year in which Form 5768 is filed again to revoke the election. Thus, if an organization would like to elect or revoke for the year 2000, Form 5768 must be filed with the IRS by Dec. 31, 2000.

If a charitable organization is concerned that substantial lobbying activities exist, it may make sense to file the election under Sec. 501(h)(10) and report any of these possible expenditures under the expenditure test. The organization would no longer be subject to a facts-and-circumstances test as to the substantiality of its legislative activities. Organizations seeking government grants should be careful in their approach to legislators for funding, as the activity may be construed as lobbying if specific legislation is discussed.

After the November election, if an organization has performed some direct or grass roots lobbying activities, it may want to consider filing the election to be eligible to make expenditures to influence legislation. Fortunately, the organization will have almost two months to determine if an election is necessary before the December 31 required filing date.

Tax-exempt organizations constantly strive to preserve their exempt status. It would be unfortunate if that exemption is lost because certain lobbying expenses are deemed to be substantial under the facts-and-circumstances test.

From Joel E. Ackerman, CPA, Holtz Rubenstein & Co., LLP, Melville, NY