April 3, 2012
Corporate and tax law attorneys frequently are asked to assist clients who have formed or want to create an organization that will serve the public good. Section 501 of the Internal Revenue Code recognizes the desirability of such organizations by according tax-exempt status to "[c]orporations, and any community chest, fund, or foundation" that is "organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition . . . , or for the prevention of cruelty to children or animals." I.R.C. § 501(c)(3) (emphasis added). The Treasury Regulations further indicate that in order to be exempt from taxation under § 501(c)(3), an organization must be both "organized and operated exclusively for one or more of the purposes specified in such section." Treas. Reg. § 1.501(c)(3)-1(a)(1). According to the Regulations, "[i]f an organization fails to meet either the organizational test or the operational test, it is not exempt [from taxation]." Id.
A. Organizational Test
The Treasury Regulations provide that an organization is organized exclusively for one or more exempt purposes only if its articles of organization (1) limit the purposes of the organization to one or more exempt purposes, and (2) do not expressly empower the organization to engage, other than as an insubstantial part of its activities, in activities which in themselves are not in furtherance of one or more exempt purposes. Treas. Reg. § 1.501(c)(3)-1(b)(1)(i). The Regulations go on to caution that
An organization is not organized exclusively for one or more exempt purposes if its articles expressly empower it to carry on, otherwise than as an insubstantial part of its activities, activities which are not in furtherance of one or more exempt purposes, even though such organization is, by the terms of such articles, created for a purpose that is no broader than the purposes specified in section 501(c)(3).
Id. § 1.501(c)(3)-1(b)(1)(iii). As part of an organization's application to the IRS for tax-exempt status, it must submit a detailed statement of its proposed activities. Id. § 1.501(c)(3)-1(b)(1)(v).
B. Operational Test
The Regulations state that "[a]n organization will be regarded as operated exclusively for one or more exempt purposes only if it engages primarily in activities which accomplish one or more of such exempt purposes specified in section 501(c)(3)." Treas. Reg. § 1.501(c)(3)-1(c)(1). In addition, the Regulations say that "[a]n organization will not be so regarded if more than an insubstantial part of its activities is not in furtherance of an exempt purpose." Id. The Regulations warn that "[a]n organization is not operated exclusively for one or more exempt purposes if its net earnings inure in whole or in part to the benefit of private shareholders or individuals." Id. § 1.501(c)(3)-1(c)(2). Furthermore, "[a]n organization is not operated exclusively for one or more exempt purposes if it is an action organization." Id. § 1.501(c)(3)-1(c)(3)(i) (emphasis added). An organization is an "action organization" if (1) a substantial part of its activities is attempting to influence legislation by propaganda or otherwise; or (2) it participates or intervenes, directly or indirectly, in any political campaign on behalf of or in opposition to any candidate for public office; or (3) it has the following two characteristics: (a) its main or primary objective or objectives may be attained only by legislation or a defeat of proposed legislation; and (b) it advocates, or campaigns for, the attainment of such main or primary objective or objectives as distinguished from engaging in nonpartisan analysis, study, or research and making the results thereof available to the public. Id. § 1.501(c)(3)-1(c)(3)(ii)–(iv).
C. Political Activities By § 501(c)(3) Organizations
Since we are in the middle of an election year in which the U.S. presidency, all seats in the U.S. House of Representatives, numerous U.S. Senate seats, and many key state and local political offices are being contested, special attention is being paid to the above-described Regulations that prohibit certain political activities on the part of aspiring or existing organizations that hold or hope to acquire tax-exempt status under § 501(c)(3). It has been held that an exemption from taxation under § 501(c)(3) is lost by virtue of participation by an otherwise tax-exempt organization in any political campaign on behalf of any candidate for public office, regardless of whether or not such campaigning constitutes a substantial part of the organization's activities. United States v. Dykema, 666 F.2d 1096 (7th Cir. 1981), cert. denied, 456 U.S. 983, reh'g denied, 458 U.S. 1132 (1982). However, a tax-exempt organization is not engaged in prohibited legislative activity if, at the request of a legislative committee, a representative of the organization testifies as an expert witness as to pending legislation that might affect the entity. Rev. Rul. 70‑449, 1970‑2 C.B. 111.
In a case involving a charitable organization's involvement in political activities, the IRS ruled that the organization's fund-raising letters, which purportedly sought support for its voter education and registration program, actually violated the statutory prohibition against intervention in a political campaign. I.R.S. Tech. Adv. Mem. ("TAM") 96-09-007 (Mar. 1, 1996). According to the IRS in TAM 96-09-007, the charity's letters coincided with election periods, and certain catchwords and commentary used therein revealed bias for and against certain candidates, notwithstanding a statement to the effect that the charity's efforts were nonpartisan. In reaching its decision, the IRS noted that the charity's goal of attracting the interest and financial support of the recipients of the letters was irrelevant. Furthermore, the IRS pointed out that even though the charity's intervention into the political arena may have been an insubstantial part of its overall activities, its actions were prohibited under § 501(c)(3).
In a case involving an organization that supported the adoption of a flat tax, a federal appellate court held that the entity was a prohibited "action organization" under Treasury Regulation § 1.501(c)(3)-1(c)(3) because, during an election year, the entity tried to sell its view on the flat-tax issue to Congress, the President, and the public. Fund for the Study of Econ. Growth & Tax Reform v. IRS, 161 F.3d 755 (D.C. Cir. 1998).
On the other hand, there are creative ways in which an organization can preserve its tax-exempt status under § 501(c)(3) and still, at least indirectly, engage in otherwise prohibited political activities. For example, a federal appellate court once ruled that a church can carry on political campaigning without losing its tax-exempt status by separately incorporating a nonprofit entity that, in turn, forms a political action committee ("PAC"). Branch Ministries v. Rossotti, 211 F.3d 137 (D.C. Cir. 2000). However, according to the Branch Ministries court, the catch is that a tax-exempt church that forms a PAC cannot use its tax‑free dollars to fund the PAC. Id. at 143. Furthermore, the tax-exempt church must maintain records that demonstrate that tax‑deductible contributions to the church are not being used for political activities. Id. at 144.
In a very recent administrative decision, the IRS ruled that a nonprofit health-care organization would not jeopardize its tax-exempt status under § 501(c)(3) by creating and operating a PAC that qualifies as a ' 501(c)(4) "social welfare organization." I.R.S. Priv. Ltr. Rul. ("PLR") 2011-27-013 (July 8, 2011). In rendering its decision in PLR 2011-27-013, the IRS ruled that the health-care organization would not be violating the prohibition under § 1.1501(c)(3)‑1(3)(c) against participating or intervening in a political campaign. The IRS noted that the PAC, which was to be created merely as an incidental part of the activities of the § 501(c)(4) social welfare organization, would be operated independently of the § 501(c)(3) health-care organization and that it would administer its own affairs separately.
In another twist to its ruling in PLR 2011-27-013, the IRS determined that the prohibition against political activity by a § 501(c)(3) organization would not prevent the health-care organization from establishing and maintaining a voluntary payroll deduction plan that would enable its individual employees to make contributions to any I.R.C. § 527 political organization. The IRS reasoned that the prohibition against political activity applies only to § 501(c)(3) organizations and not to individuals who act independently in deciding whether to make contributions to § 527 political organizations.
It is also important to note that the prohibition against political activity by a § 501(c)(3) organization is a two-way street. Should political influences be found to have played a role in the IRS's consideration of an application to be exempted from federal income tax as a charitable or educational organization, the Service's ruling on the application will be deemed to be null and void. Ctr. on Corp. Responsibility, Inc. v. Shultz, 368 F. Supp. 863 (D.D.C. 1973).
For further guidance in this area, it should be pointed out that in 2007, the IRS published 21 hypothetical scenarios in order to provide guidance as to what constitutes permissible versus impermissible involvement in a political activity by an organization that is or wants to be exempt from taxation under § 501(c)(3). See Rev. Rul. 2007‑41, 2007‑1 C.B. 1421.