Vorys, Sater, Seymour and Pease LLP MEMORANDUM TO: FROM: Ohio Library Council Vorys, Sater, Seymour and Pease LLP DATE: RE: Library Foundations, Friends Groups and the Library Ley Campaign; Rules and Restrictions Regarding Lobbying Actiities of Section 501(c)(3) Organizations All library foundations and most library friends groups hae been recognized as exempt from taxation under Section 501(c)(3) of the Internal Reenue Code of 1986, as amended. This status under the tax laws raises questions when those organizations want to lend their support to the library when the library has a tax ley or bond issue on the ballot. For tax purposes, supporting a library tax ley or bond issue whether through direct financial support (a grant or donation) or by actiities undertaken by the foundation or friends group directly implicates tax rules and restrictions regarding lobbying actiities. While the typical foundation or friends group would not self describe their actiities or donations in support of a ley or bond campaign as lobbying, that is how the Internal Reenue Serice iews such matters. The purpose of this memorandum is to proide a general oeriew of the rules and restrictions regarding lobbying actiities of Section 501(c)(3) 1 organizations classified as public charities under Sections 509(a)(1), (a)(2) or (a)(3) 2, and to thus proide guidance to library foundations and friends groups on what could constitute permissible support for library tax leies and bond issues. I. Lobbying Actiities Section 501(c)(3) proides an exemption from federal income tax for the following types of organizations: 1 All Section references hereafter are to the Internal Reenue Code of 1986, as amended, and the Treasury Regulations promulgated thereunder. 2 All further references to library foundations and friends groups in the memorandum refer only to those foundations and friends groups that hae been recognized as exempt from taxation under Section 501(c)(3).
Page 2 Corporations, and any community chest, fund, or foundation, organized and operated exclusiely for religious, charitable, scientific, testing for public safety, literary, or educational purposes,... no part of the net earnings of which inures to the benefit of any priate shareholder or indiidual, no substantial part of the actiities of which is carrying on propaganda, or otherwise attempting to influence legislation, (except as otherwise proided in subsection (h)), and which does not participate in, or interene in (including the publishing or distributing of statements), any political campaign on behalf of (or in opposition to) any candidate for public office. (Emphasis added.) Section 501(c)(3) organizations classified as public charities are not prohibited per se from engaging in lobbying actiities, but such actiities may constitute no more than an insubstantial part of the organization s oerall actiities. 3 Regs. 1.501(c)(3)-1(c)(3)(ii). There are two different standards for determining the substantiality of an organization s lobbying actiities: (1) the substantial part test and (2) the Section 501(h) election (a/k/a the expenditure test ). Any organization that does not make the Section 501(h) election to hae the substantiality of its lobbying actiities determined under the expenditure test is subject to the substantial part test. A. Substantial Part Test The Regulations address the lobbying actiities of Section 501(c)(3) organizations by referring to action organizations, stating that such organizations are not entitled to exemption. Regs. 1.501(c)(3)-1(c)(3)(i). A library foundation or friends group will be treated as an action organization if: (1) a substantial part of its actiities is attempting to influence legislation by propaganda or otherwise; or (2) its main or primary objecties may be attained only by legislation or a defeat of proposed legislation, and it adocates or campaigns for the attainment of such objecties as distinguished from engaging in nonpartisan 3 501(c)(3) organizations that are priate foundations generally may not engage in any lobbying actiities. It would be unusual, but not out of the question (especially if most of the support for the organization comes from a ery small group of donors), for a library foundation or friends group to be classified as a priate foundation.
Page 3 analysis, study or research and making the results thereof aailable to the public. Regs. 1.501(c)(3)-1(c)(3)(ii), (i). 1. What is an attempt to influence legislation? The substantial part test is complicated by a lack of clarity regarding the definition of attempting to influence legislation. The Regulations simply state that for purposes of the substantial part test, an organization will be regarded as attempting to influence legislation if it: (1) contacts, or urges the public to contact, members of a legislatie body for the purpose of proposing, supporting or opposing legislation; or (2) adocates the adoption or rejection of legislation. Regs. 1.501(c)(3)-1(c)(3)(ii). The term legislation includes action by Congress, by any state legislature, by any local council or similar goerning body, or by the public in a referendum, initiatie, constitutional amendment or similar procedure. Id. For example, a local library operating ley or bond issue to be oted on by the public would be considered legislation under the substantial part test. Howeer, legislation does not include executie or administratie orders or rulings. See id. Whether a particular communication or action constitutes an attempt to influence legislation is determined from all of the facts and circumstances. See Internal Reenue Serice ( IRS ) Form 990, Schedule C, Part II-B, a copy of which is attached as Exhibit A, for examples of actiities that the IRS may consider to be attempts to influence legislation under the substantial part test. Notably, the definition of attempting to influence legislation under the substantial part test does not require any specific reference to legislation, either in communications with the legislature or with the public. At least two courts hae stated that an actiity can be lobbying een without an explicit legislatie reference. See, e.g., Christian Echoes National Ministry, Inc.. United States, 470 F.2d 849, 854 (C.A.10, 1972), cert. denied, 414 U.S. 864 (1973), and Fund For Study of Economic Growth and Tax Reform. I.R.S., 997 F. Supp. 15 (D.D.C. 1998), aff d, 161 F.3d 755 (D.C. Cir. 1998). Further, the Regulations state explicitly that the substantial part test will be applied without regard to the Section 501(h) rules
Page 4 discussed below, and the instructions to the newly reised Form 990 confirm the IRS iew that this applies to their definition of an attempt to influence legislation and the amount they allow. Regs. 1.501(h)-1(a)(4); Internal Reenue Serice, 2009 Instructions to Schedule C (Form 990 or 990-EZ), at 4, a copy of which is attached as Exhibit B. Hence, there is no basis for directly importing the highly faorable Section 501(h) definition of lobbying into the substantial part test. 4 The limited authority aailable under the substantial part test indicates that the IRS could treat a significant portion of the time and effort an organization spends considering policy issues and deeloping legislatie positions as lobbying. See League of Women Voters of U.S.. U.S., 180 F. Supp. 379 (Ct. Cl. 1960), cert. denied, 364 U.S. 822 (1960). In contrast, the Section 501(h) rules draw a fairly narrow and well-defined circle around the supporting actiities that will be attributed to an organization s lobbying by focusing only on work done to prepare specific lobbying communications. 2. How much lobbying is substantial? Attempts to influence legislation which comprise less than a substantial part of the organization s oerall actiities will not deprie it of exemption. Application of the substantial part test is a factual one. There is no simple rule as to what amount of lobbying actiities is substantial. Two of the leading cases in this area hae adopted the following standard for applying the substantial part test: The political efforts of an organization must be balanced in the context of the objecties and circumstances of the organization to determine whether a substantial part of its actiities is to influence, or is an attempt to influence, legislation. A percentage test to determine whether the actiities are substantial is not appropriate. Such a test obscures the complexity of balancing the organization s actiities in relation to its objecties and circumstances in the context of the totality of the organization. See Haswell. United States, 500 F. 2d 1133 (Ct. Cl. 1974); Christian Echoes National Ministry. United States, 470 F. 2d 849 (10th Cir. 1972). 4 Howeer, there is authority under Section 501(c)(3) indicating that some of the exceptions to lobbying codified under Section 501(h) also exist under the substantial part test, including the exceptions for (1) nonpartisan analysis and research, See Re. Rul. 64-195, 1964-2 C.B. 138; Re. Rul. 70-79, 1970-1 C.B. 127; (2) technical assistance to a goernmental body, See Re. Rul. 70-449, 1970-2 C.B. 111; and (3) self-defense lobbying, See Slee. Commissioner of Internal Reenue, 42 F.2d 184 (C.C.A. 2d Cir. 1930).
Page 5 Although the courts hae refused to adopt a conclusie percentage test in applying the substantial part test, they hae recognized that one measure of the significance of an organization s lobbying actiities in relation to its objecties and circumstances is the amount of time and money deoted by the organization to those actiities. In Seasongood. Commissioner, 227 F. 2d 907 (6th Cir. 1955), the court concluded that an organization established to educate the public on political matters and to encourage citizens to ote did not iolate the substantial part test. In reaching its conclusion, the court relied on eidence demonstrating that the organization s lobbying actiities constituted less than 5% of its total actiities during the year. Howeer, in Haswell, supra, the court concluded that an organization established to encourage and promote the improement of passenger railway operations had iolated the substantial part test where the organization s lobbying expenditures ranged anywhere from 16.6% to 20.5% of its total expenditures per year. Oerall, the substantial part test offers little guidance or comfort to Section 501(c)(3) organizations that engage in lobbying actiities because of the uncertainty and subjectiity in determining whether lobbying is substantial. Howeer, a reiew of authorities discussing and applying this test generally indicates that in most situations an organization will not lose its exemption under Section 501(c)(3) where the percentage of time and money deoted by the organization to lobbying actiities does not exceed 5% of the total time and money expended by the organization in carrying out all of its actiities during a gien year. Of course, this percentage must be iewed in connection with the oerall facts and circumstances of each case, and factors unique to a particular situation may indicate that a higher or lower percentage is more appropriate. For example, the IRS reoked the Section 501(c)(3) status of the Sierra Club een though the Sierra Club only spent 2% of its total expenditures on lobbying because of the presence of a number of other factors that indicated that the Sierra Club s lobbying was a substantial part of its actiities. Note that the percentage of time and money is iewed in the context of the actiities of the friends group or foundation during the tax year in question. So, if a library foundation has no actiities or grants for exempt purposes during a tax year, then any expenditure at all in support of a library ley or bond issue could likely be problematic. 3. What is the penalty for iolating the substantial part test? As a technical matter, a iolation of the substantial part test in any year can result in reocation of an organization s Section 501(c)(3) status. As a practical matter, the IRS frequently settles cases that it beliees inole iolations of the substantial part test by imposing a sanction short of actual reocation; howeer, the IRS is under no legal obligation to forego pursuing reocation. If an organization loses its Section 501(c)(3) status because of excess
Page 6 lobbying expenditures, an excise tax of 5% of these expenditures is imposed on the organization and an additional 5% tax is imposed on any organization manager who willfully and without reasonable cause agreed to the expenditure, knowing that the loss of exemption would result. 4912(a) and (b). 4. How are lobbying actiities reported to the IRS under the substantial part test? If a Section 501(c)(3) organization does not make the Section 501(h) election, it reports its lobbying actiities on IRS Form 990, Schedule C, Part II-B, a copy of which is attached as Exhibit A. B. Section 501(h) Election Because of the uncertainty and subjectiity in applying the substantial part test, Congress enacted the safe harbor proisions of Section 501(h) in 1976. These proisions allow certain qualified public charities (generally public charities other than churches) to file an election under Section 501(h) to hae their lobbying actiities tested under safe harbor expenditure tests. A Section 501(c)(3) organization eligible to make the Section 501(h) election would do so by filing IRS Form 5768, a copy of which is attached as Exhibit C. 5 Under these tests, so long as the electing organization s lobbying expenditures remain within certain limits, the organization will not be subject to excise taxes for impermissible lobbying or, worse yet, reocation of its Section 501(c)(3) status. 1. What is lobbying? Under the Section 501(h) safe harbor, lobbying means expenditures to influence legislation. Legislation includes action by Congress, by any state legislature, by any local council or similar goerning body, or by the public in a referendum, initiatie, constitutional amendment or similar procedure. Regs. 56.4911-2(d)(1)(i). Thus, a local library tax ley or bond issue to be oted on by the public would be considered legislation under the 501(h) safe harbor. Howeer, legislation does not include executie or administratie orders or rulings. Regs. 56.4911-2(d)(3). 5 Organizations electing to use the expenditure test must file Form 5768 at any time during the tax year for which it is to be effectie. The election remains in effect for succeeding years unless it is reoked by the organization. Reocation of the election is effectie beginning with the year following the year in which the reocation is filed. 501(h)(6). So, a library foundation desiring to take adantage of the 501(h) election in the current year could file Form 5768 presently and take adantage of the election for the current tax year.
Page 7 There are two types of lobbying actiities for purposes of the Section 501(h) safe harbor: (1) direct lobbying, and (2) grass roots lobbying. Unless a foundation or friends group has engaged in an actiity that meets the definition of direct lobbying or grass roots lobbying, it has not engaged in lobbying for purposes of the Section 501(h) safe harbor. a. What is direct lobbying? Direct lobbying inoles communications with (1)(a) any member or employee of a legislatie body, or (b) any goernment official or employee (other than a member or employee of a legislatie body) who may participate in the formulation of the legislation, but only if the principal purpose of the communication is to influence legislation, which (2) refer to specific legislation, and (3) reflect a iew on such legislation. Regs. 56.4911-2(b)(1)(i) and (ii). Specific legislation includes both legislation that has already been introduced in a legislatie body and a specific legislatie proposal that the organization either supports or opposes. Regs. 56.4911-2(d)(1)(ii). In the case of a referendum, ballot initiatie, constitutional amendment, or other measure that is placed on the ballot by petitions signed by a required number or percentage of oters, an item becomes specific legislation when the petition is first circulated among oters for signature. Id. Consider the following examples pertaining to direct lobbying: Example (1). Organization P s employee, X, is assigned to approach members of the Ohio General Assembly to gain their support for a pending bill which affects Ohio s libraries. X drafts and P prints a position letter on the bill. P distributes the letter to members of the General Assembly. Additionally, X personally contacts seeral members of the General Assembly or their staffs to seek support for P s position on the bill. The letter and the personal contacts are direct lobbying communications. Example (2). Organization M s president writes a letter to the State Representatie representing the district in which M is headquartered, requesting that the Representatie write the State Library of Ohio regarding proposed regulations recently published by that agency. M s president also requests that the Representatie s letter to the State Library state the Representatie s support of M s application for a library district
Page 8 boundary change under consideration by the agency. The letter written by M s president is not a direct lobbying communication. Example (3). Organization Z prepares a paper on funding problems of Ohio s libraries. The paper does not reflect a iew on any specific pending legislation or on any specific legislatie proposal that Z either supports or opposes. Z s representaties gie the paper to a state legislator. Z s paper is not a direct lobbying communication. See Regs. 56.4911-2(b)(4)(i), Examples 1, 2 and 3. (1) Special Rule public treated as a legislatie body There is a special rule where a communication refers to and reflects a iew on specific legislation that is the subject of a referendum, ballot initiatie or similar procedure. Regs. 56.4911-2(b)(1)(iii). In such a case, the general public in the state or locality where the ote will take place constitutes a legislatie body, and indiidual members of the general public are deemed to be legislators. Id. Accordingly, if such a communication is made to one or more members of the general public in that state or locality, the communication is a direct lobbying communication. For example, if a communication to one or more members of the public refers to and reflects a iew on a local library operating ley or bond issue to be oted on by the public, such communication would be treated as direct lobbying under this special rule. b. What is grass roots lobbying? Grass roots lobbying inoles communications with members of the general public which (1) refer to specific legislation, (2) reflect a iew on such legislation, and (3) encourage the recipients of the communications to contact legislators or otherwise take action with respect to such legislation. Regs. 56.4911-2(b)(2)(iii). Specific legislation includes both legislation that has already been introduced in a legislatie body and a specific legislatie proposal that the organization either supports or opposes. Regs. 56.4911-2(d)(1)(ii). In the case of a referendum, ballot initiatie, constitutional amendment, or other measure that is placed on the ballot by petitions signed by a required number or percentage of oters, an item becomes specific legislation when the petition is first circulated among oters for signature. Id. The following types of communications are examples of encouraging a recipient to take action with respect to specific legislation:
Page 9 (1) stating that the recipient should contact a legislator, goernment official or goernment employee; (2) stating the address, telephone number or similar information of a legislator, goernment official or goernment employee; (3) proiding a petition, tear-off postcard or similar material for the recipient to communicate with a legislator, goernment official or goernment employee; or (4) specifically identifying one or more legislators who will ote on the legislation as: (a) opposing the communication s iew with respect to the legislation; (b) being undecided with respect to the legislation; (c) being the recipient s representatie in the legislature; or (d) being a member of the legislatie committee or subcommittee that will consider the legislation. See Regs. 56.4911-2(b)(2)(iii). Encouraging a recipient to take action does not include naming the main sponsor(s) of the legislation for purposes of identifying the legislation. Id. The Regulations offer the following specific examples of grass roots lobbying: Example (1). A pamphlet distributed by organization Y states that the President s plan for a drug-free America, which will establish a drug control program, should be passed. The pamphlet encourages readers to write or call your senators and representaties and tell them to ote for the President s plan. No legislatie proposal formally bears the name President s plan for a drug-free America, but that and similar terms hae been widely used in connection with specific legislation pending in Congress that was initially proposed by the President. Thus, the pamphlet refers to specific legislation, reflects a iew on the legislation, and encourages readers to take action with respect to the legislation. The pamphlet is a grass roots lobbying communication. Example (2). Assume the same facts as in Example (1), except that the pamphlet does not encourage the public to write or call
Page 10 representaties, but does list the members of the committee that will consider the bill. The pamphlet is a grass roots lobbying communication. * * * Example (4). Organization B, a non-membership organization, includes in one of three sections of its newsletter an endorsement of two pending bills and opposition to another pending bill and also identifies seeral legislators as undecided on the three bills. The section of the newsletter deoted to the three pending bills is a grass roots lobbying communication. * * * Example (7). Organization F mails letters requesting that each recipient contribute money to or join F. In addition, the letters express F s opposition to a pending bill that is to be oted upon by the U.S. House of Representaties. Although the letters are form letters sent as a mass mailing, each letter is indiidualized to report to the recipient the name of the recipient s congressional representatie. The letters are grass roots lobbying communications. Regs. 56.4911-2(b)(4)(ii)(B), Examples 1, 2, 4 and 7. lobbying: In contrast, the following are examples of communications that are not grass roots Example (1). Organization L places in its newsletter an article that asserts that lack of new capital is hurting State W s economy. The article recommends that State W residents either inest more in local businesses or increase their saings so that funds will be aailable to others interested in making inestments. The article is an attempt to influence opinions with respect to a general problem that might receie legislatie attention and is distributed in a manner so as to reach and influence many indiiduals. Howeer, the article does not refer to specific legislation that is pending in a legislatie body, nor does the article refer to a specific legislatie
Page 11 proposal the organization either supports or opposes. The article is not a grass roots lobbying communication. Example (2). Assume the same facts as Example (1), except that the article refers to a bill pending in State W s legislature that is intended to proide tax incenties for priate saings. The article praises the pending bill and recommends that it be enacted. Howeer, the article does not encourage readers to take action with respect to the legislation. The article is not a grass roots lobbying communication. Example (3). Organization B sends a letter to all persons on its mailing list. The letter includes an update on numerous enironmental issues with a discussion of general concerns regarding pollution, proposed federal regulations affecting the area, and seeral pending legislatie proposals. The letter endorses two pending bills and opposes another pending bill, but does not name any legislator inoled (other than the sponsor of one bill, for purposes of identifying the bill), nor does it otherwise encourage the reader to take action with respect to the legislation. The letter is not a grass roots lobbying communication. * * * Example (6). Organization E, an enironmental organization, routinely summarizes in each edition of its newsletter the new enironment-related bills that hae been introduced in Congress since the last edition of the newsletter. The newsletter identifies each bill by a bill number and the name of the legislation s sponsor. The newsletter also reports on the status of preiously introduced enironment-related bills. The summaries and status reports do not encourage recipients of the newsletter to take action with respect to legislation. Although the summaries and status reports refer to specific legislation and often reflect a iew on such legislation, they do not encourage the newsletter recipients to take action with respect to such legislation. The summaries and status reports are not grass roots lobbying communications. Regs. 56.4911-2(b)(4)(ii)(A), Examples 1, 2, 3 and 6.
Page 12 2. Exceptions to the definition of lobbying There are fie exceptions under Section 4911(d)(2) that are not considered direct or grass roots lobbying for purposes of the Section 501(h) safe harbor: a. Making aailable the results of nonpartisan analysis, study and research. This is not typically something a library foundation or friends group would do. b. Proiding technical adice or assistance on the written request of a goernmental body. Again, this is not typically a foundation or friends group actiity. c. Communicating on matters affecting the existence of the organization, its exempt status or the deduction of contributions to it; i.e. self defense lobbying. So, if the foundation or friends group needed to defend its tax status, such expenditures would not be lobbying. d. Communications with goernment officials that are not intended to influence legislation. e. Communications between the organization and its bona fide members with respect to legislation of direct interest to the organization and such members proided that the communication does not directly encourage the member to engage in direct or grass roots lobbying. So, correspondence to members telling them that a ley campaign will be on the ballot would, by itself, not be lobbying. 4911(d)(2). 3. Grants treated as lobbying a. Grants to Section 501(c)(3) public charities In general, if a Section 501(c)(3) organization that has made a Section 501(h) election makes a grant to another Section 501(c)(3) public charity and the grant is made for the general support of the grantee, the grantor will not hae to count any of the grant against its lobbying limit, regardless of the grantee s lobbying actiities. See PLR 200943042 (July 29, 2009). So, if a foundation makes a general grant to a friends group for general support of the friends group, there are no lobbying implications. Similarly, if the grant is earmarked for specific actiities or programs of a grantee that do not include any lobbying, none of the grant
Page 13 will count as a lobbying expense by the grantor. See id. In the preceding two situations, it is recommended that the grants be subject to a grant agreement that proides that none of the grant will be used for lobbying to aoid any argument from the IRS that any part of the grant was for lobbying. If and to the extent a Section 501(c)(3) organization that has made a Section 501(h) election makes a grant to another Section 501(c)(3) public charity and the grant is earmarked for grantee actiities that are lobbying, it will count as a lobbying expense of the grantor, and the nature of the grantee s lobbying (direct or grass roots) will similarly pass through to the grantor. Regs. 53.4911-3(c)(1) and (2). In this case, rather than haing to wait and see how the grantee spends the grant, the grantor can choose to control the expense contractually in adance by entering into a grant agreement that (1) earmarks specific amounts of the grant for direct lobbying or for grass roots lobbying, up to specific dollar caps, and (2) proides that any amounts expended by the grantee in iolation of the stated limits must be returned to the grantor. So, in the unusual case where a foundation would gie a grant to a friends group for the friends group to use in support of a ley or bond issue campaign as well as for non-lobbying actiities, this argues for a specific grant agreement, to protect the foundation. b. Grants to noncharities If a Section 501(c)(3) organization that has made a Section 501(h) election makes a transfer without full consideration to a noncharity (a nonexempt entity or an organization exempt under a proision other than Section 501(c)(3)), lobbying expenditures of the noncharity are attributed, at least in part, to the Section 501(c)(3) organization. Regs. 56.4911-3(c)(3)(i)(A). The amount so attributed is the lesser of (1) the noncharity s lobbying expenditures or (2) the excess of the amount transferred by the Section 501(c)(3) organization to the noncharity oer the consideration receied in exchange. Regs. 56.4911-3(c)(3)(i)(E). The amount transferred is the money paid, the fair market alue of property transferred to the noncharity, or, if greater, the Section 501(c)(3) organization s cost for the property. If the noncharity makes both grass roots and direct lobbying expenditures, the grass roots expenditures are attributed first to the Section 501(c)(3) organization. Regs. 56.4911-3(c)(3)(ii). Howeer, these rules do not apply to controlled grants. A controlled grant is a grant to a noncharity that meets the following requirements: (i) the grantor limits the grant to a specific project of the grantee that is in furtherance of the grantor s (nonlobbying) exempt purposes; and (ii) the grantor maintains records to establish that the grant is used in furtherance of the grantor s (nonlobbying) exempt purposes. Regs. 56.4911-3(c)(3)(i)(B) and 56.4911-4(f)(3).
Page 14 Most library foundation and friends group grants to a library ley or bond PAC will be without strings, thus the entire amount of the grant will be considered a lobbying expense. 4. Allocating lobbying expenditures to actiities The general rule is that all costs of preparing a direct or grass roots lobbying communication are included as expenses for direct or grass roots lobbying including compensation for an employee s serices attributable to the direct or grass roots lobbying communication, and the allocable portion of administratie, oerhead, and other general expenditures attributable to the direct or grass roots lobbying communication. For example, all expenditures for researching, drafting, reiewing, copying, publishing and mailing a direct or grass roots lobbying communication, as well as an allocable share of oerhead expenses, are included as expenditures for direct or grass roots lobbying. 5. The Safe Harbor An organization which has filed a safe-harbor election under Section 501(h) essentially has two different leels of percentages to consider. 1. The first leel ( Leel 1 ) references the percentages the organization must stay within to aoid a 25% excise tax. The Leel 1 percentages are applied annually and the 25% excise tax is imposed on lobbying expenditures in excess of the allowable lobbying expenditures. 2. The second leel ( Leel 2 ) references the percentages the organization must stay within to aoid losing its tax-exempt Section 501(c)(3) status altogether. The Leel 2 percentages are applied oer a floating four-year aerage. The Leel 1 and Leel 2 percentages are calculated with reference to an organization s exempt purpose expenditures. The Regulations proide a detailed definition of exempt purpose expenditures. Exempt purpose expenditures generally include any amounts paid to adance a charitable purpose, plus lobbying expenditures and some fundraising expenditures. On the other hand, exempt purpose expenditures generally do not include capital expenditures such as the purchase of land or the costs of constructing a building (een if such building is used for exempt purposes), inestment management expenses, expenses related to the conduct of any unrelated trade or business, amounts paid for outside fundraising serices, or expenses related to a separate fund-raising unit within the organization.
Page 15 Leel 1 Percentages The 25% excise tax will be aoided if an organization meets both of the following tests on an annual basis: 1. Direct and grassroots lobbying test. The organization s combined direct and grassroots lobbying expenditures must stay within the following parameters: if exempt purposes expenditures are: then allowable lobbying expenditures are: $500,000 or less: 20% of that amount $500,000 to $1,000,000: $100,000, plus 15% of the excess expenditures oer $500,000 $1,000,000 to $1,500,000: $175,000, plus 10% of the excess expenditures oer $1,000,000 oer $1,500,000: $225,000, plus 5% of the excess expenditures oer $1,500,000 (up to a maximum of $1,000,000) 2. Grassroots lobbying test. The organization s grass roots lobbying expenditures, standing on their own, must stay within 25% of the allowable lobbying expenditures calculated under the first test aboe. Thus, for example, if an organization s exempt purpose expenditures are $50,000, then the total allowable lobbying expenditures for the organization would be $10,000 and, of this $10,000, grass roots lobbying expenditures could not exceed $2,500. Leel 2 Percentages If an electing organization s lobbying expenditures normally (on aerage oer a four-year period) exceed 150% of the allowable lobbying expenditures calculated under either of the Leel 1 tests described aboe, it will lose its Section 501(c)(3) status. What do these tests under the safe harbor mean for most library foundations and friends groups? Assume that a library foundation s exempt purposes expenditures during a four year period hae been $10,000 per year. During the current year (with $10,000 exempt purpose expenditures), the Leel 1 test would allow $2000 of expenditures for direct and grassroots
Page 16 lobbying (of which $500 could be grassroots lobbying). If the library foundation did not engage in any direct or grassroots lobbying for the three years immediately prior to the current year and was willing to pay the 25% excise tax, then the leel 2 test would allow up to a total of $12,000 of expenditures for direct and grassroots lobbying (of which $3,000 could be grassroots lobbying) during the current year (at the cost of up to a $2500 tax). 6. How are lobbying actiities reported to the IRS for purposes of the Section 501(h) election? If a Section 501(c)(3) organization makes the Section 501(h) election, it reports its lobbying actiities on IRS Form 990, Schedule C, Part II-A, a copy of which is attached as Exhibit A. C. Adantages of the Section 501(h) election 1. Expenditure Limits The Section 501(h) safe harbor proides specific limits on an organization s lobbying expenditures. Actiities that do not require expenditures of funds, such as work performed by olunteers, are not taken into account. The substantial part test has no clear limits and is based not only on expenditures but on many other factors. 2. Penalty Under the Section 501(h) safe harbor, if an organization exceeds the lobbying ceiling during any tax year, it is subject to a penalty tax of 25% of the excess. Howeer, it will not be subject to reocation of its tax exempt status unless it exceeds the lobbying ceiling by more than 150% oer a 4 year period. A iolation of the substantial part test in any single year can result in reocation of an organization s tax exempt status. 3. Definition of Lobbying Section 501(h) proides a fairly precise and narrow definition of lobbying. The Regulations applying the substantial part test explicitly state that it will be applied without regard to the Section 501(h) rules. This creates great uncertainty regarding what constitutes lobbying for purposes of this test. D. Disadantage of the Section 501(h) election
Page 17 1. Total Lobbying Permitted Section 501(h) limits lobbying expenditures to $1 million for oerall lobbying and $250,000 for grass roots lobbying. Very large organizations may be able to spend more on lobbying, and particularly on grass roots lobbying, under the substantial part test. II. Conclusion Section 501(c)(3) organizations such as library foundations and friends groups may engage in a limited amount of lobbying so long as lobbying does not constitute a substantial part of the organization s actiities. Qualified Section 501(c)(3) organizations seeking more certainty than that offered by the substantial part test may elect to be goerned by the safe harbor proisions of Section 501(h). Such electing organizations may spend up to a calculable percentage of their total annual expenditures for lobbying without jeopardizing their Section 501(c)(3) status. IRS CIRCULAR 230 DISCLOSURE: In order to ensure compliance with requirements imposed by the U.S. Internal Reenue Serice, we inform you that any federal tax adice contained in this communication (including any attachments) is not intended or written to be used, and it cannot be used, by any taxpayer for the purpose of (i) aoiding penalties that may be imposed under the U.S. Internal Reenue Code or (ii) promoting, marketing, or recommending to another person, any transaction or other matter addressed herein.