[PROGRAM TITLE]

I. iNTRODUCTION AND OVERVIEW

Other chapters of this book discuss the various campaign finance and lobbying laws applicable to politically involved organizations. However, separate and different tax and IRS disclosure requirements affect such activity. This chapter provides only a brief overview of the tax and disclosure obligations and Internal Revenue Code requirements that affect organizations involved with campaign and lobbying expenditures.

II. POLITICAL ACTION COMMITTEES

A. INITIAL CONSIDERATIONS

Tax Exempt Status. Since 1975, Internal Revenue Code §527 has provided automatic nonprofit status to “political organizations” whose primary purpose is to influence the selection of federal, state or local candidates. Federal PACs, state PACs, and candidate campaign committees have tax exempt status under this provision. See a copy of IRC §527 in Appendix A.

Corporate Structure. Political organizations do not need formal corporate documents or structure. They are usually considered unincorporated entities under state corporations codes. However, under tax law, they must have their own bank account and file IRS Form SS-4 to obtain an employer identification number (“EIN”) even if they do not have or plan to have employees. Such organizations should not use the bank account, EIN or Social Security Number of an affiliated group or individual (such as a trade association, executive or candidate).

Political organizations may incorporate for limited liability or other reasons but must then comply with the corporate statutes of the state of incorporation. These requirements are not covered in this chapter.

Additional Reporting Requirements. Since July 1, 2000, many political organizations have registration and reporting obligations under §527, as detailed in Section VIII of this chapter.

B. INCOME TAXES ON PASSIVE EARNINGS AND NON EXEMPT ACTIVITY

Interest Earned. If political organizations use their funds, once received, to make investments (interest-bearing checking or savings accounts, money market accounts, or other investments), then the income from those investments is taxable at the highest corporate rate.

Non Exempt Functions. Fundraising primarily used for “non-exempt” purposes (that is, “non-political” purposes not related to influencing the selection of candidates, as discussed above) may also result in taxable income.

Raffle Example. For example, the IRS issued a technical advice memorandum on August 11, 1998 (TAM 9847006) that advised that a PAC needed to pay income taxes on proceeds from a raffle used in connection with its fund-raising efforts. However, in a field memorandum dated December 1, 1999, the IRS changed its position and clarified that a PAC would not need to pay taxes on raffle proceeds if the PAC makes clear on the tickets and at the event that the money raised will support political (“exempt”) goals.

Payment of Tax. Taxes on passive earnings and non-exempt activity of over $100 are paid on Form POL-1120, discussed in Section VIII of this chapter.

C. “NON-CHARITABLE” DISCLAIMER

Since December 1987, the Internal Revenue Code has required that fund-raising solicitations by large political and nonprofit organizations ($100,000 or more per year) must contain a disclaimer in the exact format provided by statute. (See IRC §6113 in Appendix B.) The organization must inform the potential contributor that

"contributions or gifts to [such organization] are not deductible as charitable contributions for federal income tax purposes."

The IRS has clarified a “safe harbor” for these requirements, including the size and placement of disclaimers in print, telephone, television and radio solicitations. IRS Notice 88-120 (11/25/88), available with an explanation on the IRS website, www.irs.gov.

D. NONDEDUCTIBLE TO DONORS

General. Contributions to candidate political committees and PACs are not deductible to donors.

Administrative Costs. The IRS believes the cost of a corporation to administer its connected PAC is also not a deductible business expense. (General Counsel Memo 39-1-60 (4/1/84), relying on (but not citing) Private Letter Rulings #8202019 and #8201021, issued on September 30, 1981.)

III. BALLOT MEASURE COMMITTEES

A. NON-PROFIT STATUS

Campaigning Versus Lobbying. Many states permit the creation of ballot measure committees to support or oppose initiatives, referenda or other forms of citizen legislation. Because the Internal Revenue Service has familiarity with candidate campaigns and PACs (IRC §527) and nonpolitical nonprofit organizations (IRC §501(c)), the tax laws, regulations and manuals governing them are detailed and comprehensive. However, the IRS considers a ballot measure committee not as a campaigning entity but as either a "lobbying" or "grassroots lobbying" entity.

Social Welfare and Business Leagues. Because the IRC defines candidate committees as automatically tax exempt under IRC §527 (see above), and because no similar automatic exemption applies to most ballot measure committees, tax attorneys have advised ballot measure committee organizers to apply for nonprofit status under IRC §501(c)(4) (social welfare organization when the support of the committee is broad-based) or §501(c)(6) (trade association when the support of the committee is from a unified economic interest).

Becoming a nonprofit insures that the contributions received will not be taxed and also allows passive income earned by the committee to be non-taxable (unlike a candidate committee).

Candidate Related Ballot Measure Groups. The IRS has recently allowed ballot measure committees closely connected to a candidate to be organized under IRC §527, as explained below. The passive income of such organizations is taxed just like a candidate PAC (see Section II).

B. NONDEDUCTIBLE TO DONORS

Contributions to ballot measure committees are nondeductible by the donor. Rev. Rule 80-275.

C. GIFT TAX

Tax attorneys have long voiced concern over the potential applicability of the IRC §2501 gift tax to donors who make contributions to 501(c)(4) organizations. An American Bar Association task force has recommended, as recently as May 2004, that the IRS clarify whether the gift tax applies to contributors to ballot measure and other issue oriented organizations. Contributors should consult a tax professional.

IV. ISSUE ADVOCACY GROUPS, “SOFT PACS”AND §527 ORGANIZATIONS

A. INTRODUCTION

Issue Advocacy Versus Campaigning. "Issue advocacy" means communicating with the public on issues that relate to an election or the legislative process in a manner that does not make the expenditures a campaign expense subject to disclosure and limitations under the Federal Election Campaign Act (“FECA”), or similar state laws, as discussed in other chapters of this book.

Social Welfare and Business Leagues. Groups engaging in issue advocacy need to select a structure under tax law for the entity. Traditionally, because the organizers of the entity have represented that they "aren't campaigning," political and tax lawyers have advised them to organize under IRC §501(c)(4) (as a “social welfare” organization) or §501(c)(6) (as a “membership organization”), and then operate like any such nonprofit.

And because the entity does not "support or oppose" any identified candidates, it was assumed that the expenditures could not be so called "exempt function" ("candidate campaigning") expenditures which would be appropriate for a Section 527 organization.

Soft PACs. A series of Internal Revenue Service rulings and the increasing desire to make “political” expenditures outside regulation by FECA and similar state laws led to the rise of candidate-related “Soft PACs” in the 1990s. In contrast to organizations tax exempt status under Sections 501(c)(4) or 501(c)(6), Soft PACs are automatically tax exempt under Section 527. The evolving history of Soft PACs is discussed below (and in more detail in prior editions of this book).

B. THE RISE OF SOFT PACS 1997-2000

On October 1, 1996, and on March 24, 1997, the Internal Revenue Service issued two private letter rulings that expanded the use of Section 527 to cover certain "issue advocacy" expenditures in connection with candidate elections. On March 29, 1999, the IRS issued a private letter ruling in which it determined that a wide range of programs were qualified to be "exempt functions" under §527, including substantial expenditures for voter education and ballot measures. This ruling seemed to say that a candidate could establish a section 527 ballot measure committee to seek enactment of his or her public positions.

By early 1999 the private letter rulings were widely circulated and this new hybrid of Section 527 organization picked up the name "Soft PAC" -- or, at the time, “Stealth PAC” -- because their receipts and expenditures were not disclosed to the public.

Those who first decided to use this structure in conjunction with federal elections made communications "in connection with" candidates but did not "expressly advocate" for or against candidates. Soft PACs rose to national prominence in the months before presidential elections and showcased candidate’s votes on major legislation – raising millions of corporate and individual funds without disclosure to the public and linking candidates to major issues such as health care and gun control.

C. NEW REGULATION OF SOFT PACS

By early 2000, the proliferation of high profile Soft PACs became the focus of considerable media attention. Campaign finance reformers, unable to convince the Federal Election Commission to regulate Soft PAC activity under campaign law, urged Congress to create new tax registration and reporting requirements for §527 organizations similar to those required by the FEC.

Congress passed and the President signed on July 1, 2000 legislation requiring Soft PACs (but not other nonprofit organizations, such as social welfare organizations or trade associations) to file registrations within 24 hours of formation and report most receipts and expenditures to the IRS. This legislation had far-reaching and perhaps unintended consequences for traditional Section 527 organizations that do not engage in issue advocacy. The law was modified in 2002 to exempt federal PACs and most state PACs from many of the reporting requirements.

In late 2003, a federal appeals court overruled a lower court finding that certain provisions of the law concerning disclosure of federal and state contributions were unconstitutional penalties. (Mobile Republican Assembly v. United States, 353 F.3d 1357 (2003).)

The IRS registration and reporting requirements of Section 527 organizations are discussed in Section VIII of this chapter.

D. THE RISE OF "NEW" SOFT MONEY

In 2002, campaign reformers succeeded in their long-term goal of further regulating corporate money in politics. The Bipartisan Campaign Reform Act (BCRA) extended the coverage of federal campaign law to reach activities previously performed by Soft PACs and issue advocacy organizations (such as voter registration and broadcast issue advertisements made near election time). This law, and its regulations, are covered in other chapters of this book.

In early 2004, in anticipation of the presidential campaign, the IRS provided new guidance on assessing tax consequences of issue advertisements and other communications by a §501(c)(4) group in an election year. (IRS Rev. Rul. 2004-6.) At the same time a dizzying array of §501(c)(4) and 527 groups approached corporations, unions and wealthy donors promising to take advantage of perceived gaps between tax and campaign finance laws to marshal "new" soft money to influence the 2004 presidential campaign.

In May of 2004, an American Bar Association task force called on the IRS to clarify persisting uncertainties over the extent to which a §501(c)(4) organization can engage in political activities before becoming subject to the disclosure and tax provisions of §527 and as to whether contributors to a §501(c)(4) organization must pay a gift tax. (See Section III(C) above.)

V. CHARITABLE ORGANIZATIONS

A. CHARITABLE DEDUCTION

The IRS permits donors to an organization that qualifies under § 501(c)(3) of the Internal Revenue code to take a charitable deduction for the contribution.

B. NO CANDIDATE ENDORSEMENT OR COMMENTARY

Charitable (including educational) organizations under §501(c)(3) may not expend money to support or oppose a candidate, and in fact cannot even endorse a candidate, without jeopardizing their tax-exempt status, or being subjected to tax penalties (IRC §§ 4955, 6882) and court-issued injunctions (IRC § 74091).

Publications of opinionated commentary, even where it merely reflects only the opinions of the public on their views of candidates, violates this campaign prohibition.

The IRS has also ruled that the prohibition covers subtle as well as blatant campaign intervention.

C. NO SUBSTANTIAL LOBBYING WITHOUT TAX PENALTIES

The 1934 legislation creating charitable organizations permits them to undertake an "insubstantial part" of their activities on lobbying and grassroots lobbying without jeopardizing their tax-exempt status or being required to pay a penalty tax for such expenditures. A person not familiar with charitable tax law should consult a specialist regarding the parameters of this limitation.

D. SECTION 501(h) ELECTION

The Congress in 1976 responded to the concern that the "no substantial part" test might be too vague for many charitable organizations by enacting IRC §501(h) and IRC §4911 that provide an option to a number of charities including ballot measure committees. These sections now authorize (regulations finalized in 1990) a specific mathematical formula to determine how much money can be spent on lobbying activity (including ballot measure campaigns) without triggering a penalty tax. A person not familiar with charitable tax law should consult a specialist regarding these questions.

Because the 1976 law did not index the thresholds to rise over time, a group of non-profit have attempted (but have not succeeded) in having Congress enact such amendments.

VI. TRADE ASSOCIATIONS

A. NON-DEDUCTIBILITY FOR LOBBYING

After January 1, 1994, businesses no longer may deduct so-called "direct lobbying expenses" for federal income tax purposes. (Section 13222 of the Omnibus Budget Reconciliation Act of 1993, 107 Stat 477; See IRC §162(e) in Appendix C.)

In addition, dues paid by businesses to trade associations are nondeductible to the extent that the associations use them to finance such lobbying efforts. In other words, only the non-lobbying portion of the dues paid to associations is tax deductible. (IRC Reg.162-20(c); 162-15(c).) Associations which lobby either have to (1) advise their members at the time that they collect dues what portion of dues the association estimates will not be deductible, or if the association does not provide such notice to its members (presumably the members took their full deduction) (2) pay a "proxy tax" on their lobbying expenditures. Under either option, associations will have to report to the IRS their total lobbying expenditures and nondeductible expenditures on an annual basis.

B. DEFINITION OF LOBBYING

The definition of "lobbying" under the 1993 Tax Act differs from existing definitions under federal and most state disclosure laws. (See chapter of this book on Interaction of Federal and State Lobbying Laws).

After the 1993 Tax Act, four activities are nondeductible: 1) influencing federal and state legislation; 2) campaigning for or against candidates; 3) attempting to influence the general public regarding elections, legislation or referendum; and 4) attempting to influence certain high-level federal executive officials. (IRC §162(e)(1); see Appendix C.)

"Legislation" is defined as "acts, bills, resolutions or similar items by the Congress, any state Legislature, ... or by the public in a referendum, initiative, constitutional amendment, or similar procedure." (IRC §§162(e)(4)(B) and 4911(c)(2).)

"Lobbying expenses" for this purpose include the cost of attempting to influence legislation (but not regulations) at the federal or state (but not local) levels, along with attempts to influence certain high‑ranking federal administrative officials.

Overhead, research and planning relating to lobbying activities is also nondeductible. (IRC Reg. 1.162-28(c).)

Merely monitoring and summarizing legislation is not considered lobbying. (IRC Reg. 1.162-29(c)(3).)

Communicating with state officials on administrative matters, such as regulations and agency policies, is not defined as lobbying under the 1993 Tax Act. (IRC Reg. 1.162-29(b)(4) & (6).) In addition, local lobbying -- including attempts to influence city, county and special district members -- is explicitly exempted from the law despite language in the definition of "legislation" to the contrary. (IRC §162(e)(2); see Appendix C.)

Thus, the definition of lobbying under the 1993 Tax Act differs from the definition of lobbying under either the current federal lobbying disclosure law (2 U.S.C. sections 261-270) or many state lobby laws.

C. DETERMINING NON-DEDUCTIBILITY OF ASSOCIATION DUES

Member dues are nondeductible in the same proportion as the associations' lobbying expenditures are to total expenditures. Members may not deduct the percentage of their dues (and special assessments) that the association expects to spend on lobbying (as that term is defined under the 1993 Tax Act).

For instance, if the association collects $1 million in dues in a year and expects to spend $250,000 on lobbying, members must be told not to deduct 25 percent ($250,000/$1 million) of their dues as a business expense; if a company's dues are $100,000, $25,000 will therefore be nondeductible.

1. Annual Reporting

For each taxable year, the 1993 Tax Act requires an association to report to the IRS on its annual tax return (Form 990, discussed below) its total lobbying expenditures and the total amount of its dues financing this lobbying activity.

2. Proxy Tax Option

Associations may avoid the need to estimate their future lobbying by paying taxes themselves on their lobbying expenses (at the highest corporate rate). In other words, an association could pay a "proxy tax" of 35 percent on its total lobbying expenditures when it files its Form 990 after the end of the year, instead of its members decreasing their deductible business expenses by the amount of their dues relating to lobbying.

If an association chooses this option, it will not be required to notify its members of estimated lobbying expenses at the beginning of the year. If the association pays this proxy tax, its members' dues will continue to be fully deductible as ordinary and necessary business expenses.

3. Notifying Members of Non-Deduction

If the association does not want to pay a proxy tax, the association will have to provide members with a "reasonable" estimate of the portion of their dues that will be nondeductible for the coming year as part of its annual dues assessment sent to members. (IRC § 6033(e)(I).)

If the association's actual lobbying expenses for a given year exceed the estimate provided to members at the beginning of the year, then it must either pay the "proxy tax" (see above) on the excess amount, or add the excess amount to the following year's disallowance estimate.

4. New Bookkeeping

The new rules require trade associations that engage in lobbying activities to keep careful records of employee time and expenses, along with outside contracts for nondeductible lobbying. Most associations will have redrafted their monthly questionnaire to affected personnel so that it asks questions relating both to state and federal lobbying reporting and federal tax deductibility; the questionnaire will now have to differentiate 1) state lobbying, 2) "1993 Tax Act lobbying," 3) local lobbying and 4) possibly federal lobbying (using the 1993 tax rules for federal lobbying disclosure is one permitted option).

5. De Minimis Rule

The 1993 Tax Act exempts certain in-house lobbying expenditures of trade associations totaling $2,000 or less. If in-house lobbying expenses (such as employee salaries, overhead costs, etc.) do not exceed $2,000, then member dues are entirely deductible; if in-house lobbying expenses exceed $2,000, however, then all of the lobbying expenses (including the $2,000) are nondeductible. (IRC Reg. 162(e)(5)(B)(I).)

6. Associations with Non-Business Members

If a trade association receives 90 percent or more of its dues from members who are not entitled to deduct their dues (most likely because they are not businesses), then is exempt from the 1993 Tax Act's non-deductibility rules.

D. LOBBYING-EXPENSE ALLOCATION

The IRS adopted allocation rules explaining how taxpayers are to attribute expenses between tax-deductible non-lobbying activities and non-tax-deductible lobbying activities. (26 CFR Part 1; 58 FR 68330; IRC Reg. 1.162-28.)

E. CAMPAIGN CONTRIBUTIONS

1. INTRODUCTION

Trade associations generally understand the tax considerations of their lobbying expenditures, as discussed in Section VI. Their candidate campaign contributions are normally made by their connected PAC, and their ballot measure contributions are made by a separate committee organized as discussed in Section III.

But sometimes trade associations want to make candidate contributions from their own funds, which is legal, but has tax consequences under IRC § 527(f).

2. IRC §527(f)

Prior to the 1993 legislation that amended IRC §162(e) -- which provides for trade associations to fund their exempt expenditures with deductible dues and their legislative and political expenditures with non-deductible dues; or if they receive only deductible dues, to pay a proxy tax -- the IRS allowed trade associations to collect all their dues as deductible if all but an insubstantial amount of their expenditures were for exempt purposes. But if they wanted to spend some of this dues money on candidate contributions, then they had to pay a tax.

IRC §527(f) requires that trade associations pay this tax on the lesser of the total of (1) their annual candidate contributions or (2) the organization's passive income. This tax is paid on IRS Form 1120 POL (discussed in Section VIII below) after the end of the fiscal year.

The relationship between IRC §527(f) and IRC §162(e)(3) is important to understand. Since §162(e)(1) lists four categories of non-deductible expenditures (three types of lobbying and candidate contributions that for a trade association must be paid by non-deductible revenues or on which a proxy tax is owed), logically, if a trade association made contributions from its nondeductible funds, one would think that IRC §527(f) would not apply. But it does.

IRC §6033(e)(1)(B)(iii) clarifies that a trade association should always pay its §527(f) tax on any candidate contributions it makes but then not consider these expenditures in its calculations on non-deductible expenditures required under §162(e).

VIII. TAX FILING REQUIREMENTS FOR THESE ORGANIZATIONS

Nonprofit organizations are subject to the following filing requirements.

A. SECTION 527 ORGANIZATIONS

Until a new law that went into effect on July 1, 2000, PACs and other “political organizations” (discussed in Sections II and IV of this chapter) were not required to file tax returns with the IRS unless they made $100 or more in interest or non-exempt income, in which case they filed Form 1120-POL (discussed in Section II.)

Some of the new registration, reporting and tax filing requirements imposed in 2000 were scaled back, on a retroactive basis, in legislation passed in November 2002 (Pub. Law 107-276). Current law is outlined below.

1. Registration – Form 8871

Section 527 organizations must file Form 8871 within 24 hours of being organized and within 30 days of any material change (including termination). The filing must be done electronically at the IRS website, www.irs.gov First time users can file immediately; repeating filers log in using a password.

The law exempts all committees that file with the FEC. The law also exempts any organization that “reasonably anticipates” its gross receipts will always remain under $25,000 per year.

As amended in November 2002, the law exempts state and local candidate and party committees from filing Form 8871. It does not exempt state and local PACs from this registration requirement.

Failure to register could result in the loss of an organization’s tax exempt status and subject it to income tax at the highest corporate taxable rate.

2. Periodic Reporting – Form 8872

Most registered Section 527 organizations must file Form 8872 disclosing all receipts of $200 or more and all expenditures of $500 or more on schedules similar to the ones required for committees registered with the FEC. A registered organization must electronically file Form 8872 if it has, or expects to have, contributions or expenditures exceeding $50,000 for the calendar year; organizations under this threshold can file on paper or electronically.

The law, as amended November 2002, exempts qualified state or local political organizations. A state or local PAC is “qualified” for this exemption if it limits its activity solely to state and local (not federal) activity, if a federal candidate or officer does not control or solicit contributions for the organization, and if state law requires public disclosure of the activity as specified in the new law.

Reports are due semi-annually in years without a federal election (odd-numbered years), with an option to file monthly. An organization must use the same filing method for the entire year.

During federal election years (even-numbered years), a Section 527 organization may file quarterly or monthly. If the organization selects the quarterly option, it must also file a post-election report after the general election; a quarterly filer must additionally file pre-election reports for any federal election in which it makes contributions or expenditures. Note than a federal “election” includes general, special, primary or runoff election and selection of delegates to national nominating conventions.

Section 527 organizations which do not disclose expenditures or contributions within the thresholds described above are subject to a tax equal to the highest corporate rate multiplied by the amount of contributions and expenditures not disclosed. Some organizations choose not to disclose contributors and pay this tax as the "price" for non-disclosure.

3. Taxable Income – Form POL-1120

This form is used to disclose any taxable income and pay taxes on any taxable income over $100 (as described in Section II(B) above).

As amended in November 2002, current law reverts to the law in place before July 1, 2000 by only requiring a Section 527 organization to file Form POL-1120 if it has taxable income as described above; filing is no longer dependent on the amount received or spent by the organization.

The form is due on the 15th day of the third month after the end of a tax year – or March 15for organizations with a calendar tax year.

A political organization that fails to timely file a required Form 1120-POL must pay 5 percent of the tax due for each month (or partial month) the return is late up to a maximum of 25 percent of the tax due, unless the organization can show “reasonable cause” for the failure to file.

4. Annual Returns – Form 990

Political organizations which file Form 8871 and have gross receipts of over $25,000 in a taxable year must also file an annual return. Organizations with gross receipts under $100,000 and assets under $250,000 may file the short form, Form 990-EZ.

Under the law as amended in November 2002, (1) all federal PACs and (2) qualified state and local PACs (as described above) with gross receipts under $100,000 need not file the annual return.

The IRS has modified the Form 990 for other non-profit organizations (discussed below) for this purpose. Section 527 filers are not required to fill out several portions of the form, but now must detail the source of funds by broad category (for example, whether they were membership dues), the purpose of expenditures (for example, salaries, fundraising fees, travel and legal expenses), program accomplishments for the year and a current list of officers, directors and highly compensated employees.

5. Other Public Disclosure

In addition to the posting of Section 527 periodic reports on the IRS’s webpage (as discussed above), all Section 527 organizations, like other nonprofit organizations, must make tax forms available for public inspection or face significant fines. Unlike other nonprofit organizations, contributor information must be made available upon request.

For a comprehensive discussion of these requirements in a “question and answer” format, see IRS Rev. Ruling 2003-49 (Appendix E), which supercedes Ruling 2000-49. Also see the IRS’s revised search engine and filing page, launched in July 2003.

B. SOCIAL WELFARE ORGANIZATIONS AND BUSINESS LEAGUES

1. Application Required

Organizations tax exempt under IRC § 501(c)(4) or (c)(6) – ballot measure committees, trade association and issue advocacy organizations which choose not to file under § 527 – are required to file for and receive a tax determination letter granting tax exempt status.

2. Annual Returns

These organizations with revenue of $25,000 or more must file IRS Form 990 for federal purposes (and usually a similar return for state purposes) within 5 1/2 months after the end of each fiscal year. Form 990 summarizes income received and the expenditures made. An attached Schedule B (not made public) identifies donors of $5,000 or more.

3. Other Public Disclosure

The 1996 Amendments to the IRC discussed above require nonprofits to release copies of their Form 990s for the last three years upon request from the public. However, the list of contributors of $5,000 need not be released by the nonprofit.

A good summary of these rules and the regulations implementing them is found in the July-August 1999 Journal of Taxation of Exempt Organizations, by Damien M. Prather (pages 3-11). Also, see the summaries on the IRS webpage, www.irs.ustreas.gov (click “Charities and Nonprofits”)

Often states have corporate charitable trust provisions which require similar filings with the state attorney general or some similar official.

C. CHARITABLE ORGANIZATIONS

The complex application and reporting requirements of an organization tax exempt under Internal Revenue Code § 501(c)(3) are not discussed in this book.

However, such organizations are generally permitted to sponsor associated organizations with tax exempt status under §§ 501(c)(4) or (6) but not §527. Such organizations then have independent filing requirements, as discussed above.

IX. AUDITS, INVESTIGATIONS AND ENFORCEMENT

For some years now, the IRS has placed increased emphasis on political activity and unrelated business income of nonprofits. The result of IRS interest, however, has been decidedly uneven.

Audits and Investigations. In addition to scrutinizing the purposes and proposed activities of nonprofit organizations at the time of formation, the Internal Revenue Service has audited nonprofit organizations for compliance with the rules set forth in this chapter. For example, it has examined nonprofits that raise money by providing services to seek income taxes on the earned income and nonprofits with high overhead costs. The IRS also performs random audits of newly formed nonprofits (although historically, such audits are rare).

Some of the IRS's emphasis is due to Congressional interest, when one or more Senators or Representatives "uncovers" a nonprofit organization with sufficient clout to oppose that public official's legislative program. Another pressure to investigate comes from news coverage and Congressional hearings on nonprofits that "appear" to have participated in the Presidential elections. Complaints against nonprofits are frequently filed but not often acted upon.

Recognizing the difficulty many political organizations had complying with the new registration and reporting requirements under §527, the IRS provided amnesty for political organizations that failed to file as required under the 2000 law – as long as they filed or amended all overdue forms by July 15, 2002. Many political committees received “warning” letters during and immediately following the amnesty period, but change in the law created new confusion in November 2002. Although the penalties for noncompliannce are severe, it is still unclear how aggressively the IRS will pursue non-filers.

Many tax exempt organizations also face regulation by Attorneys General and other state officers for the misuse of funds under state corporate and charitable trust laws.

Recent Developments. An interesting case study is the investigation of former U.S. House of Representatives Speaker Newt Gingrich. The original investigations are discussed from the tax law viewpoint in the May-June 1997 Journal of Taxation of Exempt Organizations ("Money and Politics Clash With Tax Exemption" by Greg Colvin) and the January-February 1998 Journal ("Intent is Not Relevant in Distinguishing Between Education and Politics") by Jeff Yablon and Ed Coleman. Even after the initial uproar, the IRS reaffirmed the tax exempt status of the Progress and Freedom Foundation as a § 501(c)(3) charitable organization because its programs were truly educational, even if taught by Congressman Gingrich. Moreover, in early 2003, the IRS reversed itself on its initial ruling revoking the tax exempt status of the Lincoln Opportunity Foundation, a charity that the House’s ethics committee found had spent money on political activities.

The Christian Coalition has also been the focus of IRS scrutiny. In June 1999, the Christian Coalition announced that it had decided to withdraw its long investigated application to be a §501(c)(4) organization but immediately announced that it would continue its advocacy activity through its already exempt Texas chapter. By July 2000, the IRS conceded that Christian Coalition was operating as a 501(c)(4) and did not owe taxes. On March 1, 2001, a federal court awarded the group attorneys fees for its protracted battle with the IRS over its tax obligations. Continuing litigation may clarify the extent to which a §501(c)(4) organization can engage in the political process.

In early 2004, a §501(c)(3) charity associated with House Majority Leader Tom DeLay planned events during the Republican National Convention in New York, prompting watchdog groups to urge the House’s ethics committee to more rigorously regulate corporate-sponsored events at political conventions. The Congressional ethics rules applicable to the involvement of legislators in such events are discussed in other chapters of this book.

Also in 2004, the U.S. Senate held hearings and considered new legislation that would overhaul how §501(c)(3) nonprofits maintain tax exempt status, disclose activity to the IRS, and make information available to the public.