Neighborhood Transformation

Neighborhood Transformation
COMMON QUESTIONS AND ANSWERS
ABOUT FEDERAL TAX EXEMPT STATUS

For Community Development Organizations

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1). What does "tax-exempt status" mean?

When an organization is described as having "tax-exemption status", this generally means that the organization is not liable for federal income tax on its net income (with certain exceptions). This status is based on the fact that the organization fits within one of numerous categories of special purpose organizations granted favorable treatment under the federal tax laws, so-called "Section 501" organizations.

2). Why does the government grant tax-exempt status to certain organizations?

One view is that tax-exempt status is granted to certain types of organizations because a policy judgment has been made that the government can conserve its resources by encouraging private organizations to conduct certain activities that benefit the public. Thus, historically, organizations conducting "charitable" activities have been granted special status.

Government encourages charitable organizations in two ways. First, by saying: "We are not going to assess any tax on your revenues." Second, by saying to donors: "If you give money to a charitable organization, you will be entitled to a deduction which will reduce your taxes."

3). What is the Internal Revenue Code framework under which organizations are granted tax-exempt status?

The starting place is Section 501(a) of the Internal Revenue Code, which states: "An organization described in subsection (c)...shall be exempt from taxation...." Organizations "organized and operated exclusively for...charitable... purposes" are described in subsection (c)(3). These are the so-called Section 501(c)(3) tax-exempt organizations.

But other organizations are described in subsection (c)--civic leagues or social welfare organizations; labor, agricultural, horticultural organizations; business leagues; social clubs, and 15 additional categories. So when we use the term "tax-exempt organization", it may mean any one of 22 different types of organizations, all of which are totally or partially exempt from federal income tax, subject to certain exceptions. The point to keep in mind is that the category "tax-exempt organization" is much broader than the category "charitable organization" or "Section 501(c)(3) organization". Thus, an organization may be a tax-exempt organization but not a charitable organization.

A Section 501(c)(3) organization has one important distinguishing feature from other tax-exempt organizations. Contributors to Section 501(c)(3) organizations are entitled to deduct their contributions for federal tax purposes, thus reducing their tax liabilities.

4). What are the advantages and restrictions involved in being recognized as a Section 501(c)(3) organization?

We've discussed two advantages already: tax exemption and deductibility of contributions. Some of the other advantages are: eligibility for grants from other charitable organizations; special mailing rates for certain Section 501(c)(3) organizations (this involves going through a process with the Post Office); and exemption from telephone and transportation excise taxes for certain Section 501(c)(3) organizations. For example, if your organization operates a school as part of its activities, it may be possible to avoid paying excise taxes on telephone service related solely to the school. Also, federal surplus property can be donated to certain types of Section 501(c)(3) organizations. Special pension arrangements are available to employees of Section 501(c)(3) organizations through the purchase of annuities which meet the requirements of Section 403(b) of the Internal Revenue Code. Some of the administrative and legal complexities involved in establishing regular qualified pension plans can be avoided by using a Section 403(b) annuity purchase program. For example, a Section 403(b) program can be set up for only one or two employees; coverage of all employees is not required.

Some restrictions are: limitations on engaging in political campaign activities; limitations on "lobbying", i.e., attempting to influence legislation; and limitations on business activities. In addition, a Section 501(c)(3) organization is usually subject to scrutiny by the Attorney General of the state in which it is organized. Therefore, in some cases, it may be more appropriate to conduct certain activities within the framework of a Section 501(c)(4) social welfare organization (which is not subject to the limitations on lobbying) or a non-profit organization which is not tax-exempt.

5). How does an organization qualify as a Section 501(c)(3) organization?

The IRS makes a determination as to whether or not an organization is entitled to recognition as a Section 501(c)(3) organization. The IRS normally makes this determination in response to an exemption application. The IRS also determines the organization's classification as a "public charity" or "private foundation".

Organizations established since 1969 cannot be exempt under Section 501(c)(3) unless they give notice to the IRS of their existence by filing an exemption application. Also, an organization will be treated as a "private foundation" unless it establishes that it is entitled to classification as a "public charity" and requests such classification in its exemption application.

To qualify under Section 501(c)(3), an organization must meet an "organizational test". Its organizational documents--articles of incorporation, bylaws, etc.--must state that: (1) the organization is organized and operated exclusively for specified charitable purposes; (2) none of its earnings or assets can be distributed to officers, directors or other private individuals (although payment of reasonable compensation for services is permitted); and (3) if it dissolves, the organization's assets are to be transferred to another charitable organization, i.e., its assets are permanently dedicated to charity. Also, its organizational documents cannot authorize it to engage in political campaign activities or substantial "lobbying" activities. If these requirements are met, then the organizational test is satisfied.

Second, an operational test must be met. An organization must operate exclusively for charitable purposes. Initially, the IRS makes a tentative determination based on the organization's statement of proposed activities in its exemption application.

However, you won't know if your organization actually meets the organizational test until the IRS comes in and looks at your organization's operations, particularly if its current activities are not the same as those described in its application.

6). What does operating "exclusively" for charitable purposes mean?

"Exclusively" is a legal term of art. You would think it means that an organization can't do anything but conduct charitable activities. However, the IRS and the courts have interpreted "exclusively" to mean "substantially". That is, an organization can carry on "incidental" non-charitable activities. For example, a charitable organization can conduct some business activities that are unrelated to its charitable purposes without losing its tax-exempt status.

The main point to remember is that although the statute uses the word "exclusively", there is some flexibility. But, the IRS will look closely at organizations that operate in a manner that makes charity appear to be only a secondary purpose.

An organization can fail to operate exclusively for charitable purposes if its assets are used to benefit private individuals connected with the organization, so-called private "inurement" or "benefit".

Examples of private "inurement" or "benefit" are unreasonable salary payments or transactions that are not at arm's length between the organization and members of its governing board or its officers, such as letting such individuals use the organization's property rent-free or for less than fair rental.

Also, an organization cannot benefit private, non-charitable interests. For example, Rev. Rul. 70-585 [1970-2 C.B. 115] illustrates how fine distinctions are drawn by the IRS concerning benefit to non-charitable interests.

Rev. Rul. 70-585 dealt with two organizations. The first organization formulated plans for the renewal and rehabilitation of a lower-income area of a city. The area had deteriorated housing. As part of a renewal project it rehabilitated apartments for rental to low and moderate income families. Held: "charitable", because the organization combats community deterioration.

A second organization was formed to build housing for rental to moderate income families at cost. Held: "not charitable", because its program was not directed at providing relief to the poor or carrying out any other specific charitable purpose. Benefits were provided to members of a non-charitable class.

Note that the rental of some apartments by the first organization to moderate income families (i.e., non-charitable beneficiaries) was permissible because the organization's primary purpose was rehabilitation of a deteriorated area. This was not a clear facto with respect to the second organization's activities. The fact that it sold houses on a non-profit basis (i.e., at cost) was not sufficient in itself.

7). What are the advantages of having "public charity" status?

A Section 501(c)(3) organization classified as a "public charity" has the following advantages: It pays no tax on its investment income (if it has any), while a private foundation pays a 2% tax. More importantly, private foundations are subject to significant restrictions on their activities. Also, the rules governing the deductibility of contributions to public charities are more favorable than those for private foundations. For example, if a donor has a choice between giving appreciated property (i.e., property which has increased in value on its original cost) to a private foundation or to a public charity, he or she can obtain a larger tax deduction if the gift is made to a public charity.

Certain organizations are public charities by the nature of their activities, e.g., schools, hospitals, religious organizations. Others qualify because they are affiliated with or controlled by another public charity. However, the organizations you represent usually will be classified as "public charities" because of their sources of support. In general, they qualify because a sufficient amount of their support comes from public sources-- contributions from the general public or grants from governmental agencies.

8). What is the difference between a "public charity" and a "private foundation"?

The distinction has to do with the sources of an organization's support. For example, The Ford Foundation is a "private foundation" because it does not get any support from the general public or the government and it is not affiliated with or controlled by another organization which itself gets public support. In contrast, your local United Way is a "public charity" because it receives broad public support.

If an organization receives at least one third of its support from the public or the government and it does not receive too much income form investments, it can qualify as a public charity under Section 509(a)(1) or Section 509(a)(2) and will not be subject to the restrictions applicable to private foundations.

Even if an organization loses government support and has to rely on private foundation money, its status would not change immediately. There is a one-year transition period before its status changes.

Also, an organization can have as little as 10% public support and still qualify as a public charity. But it has to meet a subjective "facts and circumstances" test as contrasted with the "mechanical" one-third test. The IRS will look at a number of factors: Does the organization have a program for trying to get public support? Does it have a board of trustees which is representative of various segments of the community?

Alternatively, an organization can maintain its public charity status by affiliating with another public charity, such as a church or a local university, and qualifying as a "supporting organization" under Section 509(a)(3). This is not a perfect solution because it means that another organization has to have some degree of control over your organization. But if your organization would be totally cut off from private foundation money if it lost its public charity status, it might have to choose some form of affiliation in order to continue to receive sufficient funding to operate.

9). What are the restrictions on organizations which are "private foundations"?

Penalty taxes are imposed on the private foundation and/or its "foundation managers", i.e., trustees or directors, officers, etc., if (1) it uses its funds for political campaigns, payments to certain government officials, voter registration activities, lobbying or non-charitable activities; (2) there are financial transactions between the foundation and its "disqualified persons"--directors or trustees, officers, substantial contributors and certain government officials and members of their families or improper uses of the foundation's assets for the benefit of such persons, i.e., "self-dealing"; (3) improper investments are made; or (4) it fails to pay out annually for charitable purposes at least 5% of its investment assets. There also are special requirements that must be met if grants are made to individuals.

Also, a private foundation has to go through a more elaborate procedure called "expenditure responsibility" if it makes a grant to another private foundation. It has to use a more detailed grant agreement and require more reports from the grantee and do more checking on how the money is actually spent. So, from a private foundation's standpoint, it would prefer to make grants to public charities because there is less "red tape". As a result, many private foundations have a policy of not making grants to other private foundations.

10). Can our organization, as a public charity, serve as a "fiscal agent" for an organization which is not a Section 501(c)(3) organization? That is, can it "pass through" a grant from a private foundation to another organization?

A private foundation cannot use your organization as a "conduit" simply to pass through a grant to another organization which is not a public charity or which is not a Section 501(c)(3) organization.

The private foundation can't treat such a grant as a grant to your organization if it is required to distribute the grant funds to another organization. However, it can make a grant to your organization to support activities that involve making funds available to other organizations, as long as your organization assumes responsibility for the conduct of the activities funded by the grant, has control over the ultimate use of the grant funds and has the power to select which organizations will receive funds. If the private foundation "earmarks" the grant for another group, i.e., requires that your organization give the grant to another group which the foundation selects, then the grantor foundation will have problems if that group isn't a public charity.

11). What can a community group do to promote business activities in its neighborhood without affecting its Section 501(c)(3) status?

Promotion of business in itself is not a charitable activity, even though there may be benefits to the community. In Rev. Rul. 77-111 [1977-1 C.B. 144, Situation 2.], an organization formed to revive retail sales in an area of economic decline by constructing a shopping center was held not to be organized and operated for a charitable purpose. The private business interests of the owners of the stores in the shopping center were viewed as the primary beneficiaries of the organization's activities. The group involved in this situation may not have adequately linked the business activity to a specific charitable objective.

But, in Rev. Rul. 76-419 [1976-2 C.B. 146], development of an industrial park in a low-income neighborhood in order to provide employment opportunities to low-income residents was held to be in furtherance of a charitable purpose.

Thus, promotion of business activities which create employment or training opportunities may be charitable. But, not in every case. In Rev. Rul. 73-127 [1973-1 C.B. 222], an organization which operated a supermarket to provide food at lower cost to residents of a poverty area was held to be operated for non-charitable purposes, even though it also provided on-the-job-training to unemployed residents. Its operations were considered the same as normal commercial activity, notwithstanding the type of customers it served or the job training activities it conducted (which were not large relative to the overall operations).

However, in Rev. Rul. 73-128 [1973-1 C.B. 222], it was held that operation of a toy factory to provide vocational training was charitable. The organization provided a full range of supportive social services to its employees. The key difference was that the training activities were the primary focus and the manufacturing activities were only a means to achieve that end. In contrast, in Rev. Rul. 73-127 the operation of a supermarket was considered to be the primary focus because job training activities were not a significant part of the operation.

The key point to keep in mind is that the business activities being promoted or conducted have to be linked to a defined charitable purpose (i.e., providing jobs or training to low income persons). Otherwise, they are indistinguishable from regular business activities.

12). Can a community economic development group which provides direct assistance to for-profit businesses or entrepreneurs get a tax exemption under Section 501(c)(3)?

Yes. The fact that an activity undertaken to further charitable purposes results in benefit to private business interests does not prevent the activity from qualifying as "charitable" if the private benefit is "incidental" or "insubstantial" (i.e., relatively small) and not unreasonable in relationship to the primary public benefit resulting from the activity. In Rev. Rul. 74-587 [1974-2 C.B. 162], it was held that a non-profit organization providing financial assistance to various businesses in a depressed area was exempt under IRC Section 501(c)(3). The funds were distributed to businesses or individuals unable to obtain funds from conventional sources. The organization combated community deterioration. The IRS concluded that the organization's thrust was not to promote business but rather to accomplish a charitable purpose--combating community deterioration. The recipients of the financial assistance were the "instruments" or means by which this charitable purpose was sought to be accomplished.

A similar result was reached in Rev. Rul. 81-284 [1981-2 C.B. 131], in which a non-profit small business investment company which provided financial assistance in the form of low cost loans to various businesses located in economically depressed areas was held to be exempt under IRC Section 501(c)(3). The organization gave preference to businesses that would provide training and employment opportunities for the unemployed or underemployed residents of economically depressed areas.

Thus, it has been recognized that there are situations, in the context of community development, where the benefit to the community may be best accomplished by channeling funds through non-charitable entities, such as for-profit businesses, even though such entities or their owners may derive some direct or indirect benefit.

Careful structuring is needed if activities involve assistance to businesses. The businesses being assisted must be identified as instruments or the "means" to an "end" -- achievement of a charitable purpose. In Rev. Rul. 77-111 [1977-1 C.B. 144, Situation 2], a community organization thought that promotional activities directed at increasing patronage at local stores in a depressed area would aid the economic well-being of the community and therefore were charitable. The IRS said, in effect, "No, aiding business is not a charitable instrument in this situation. This is because the direct beneficiaries of the assistance are the businesses and not the community." In this situation, the community organization may not have adequately emphasized the tangible benefits to the community that would result from providing assistance to businesses. It did not adequately demonstrate how promotion of business could help achieve a charitable objective. It did not require businesses being assisted to make commitments to provide direct benefits to members of a charitable class, e.g. by agreeing to provide jobs to low-income individuals, nor did it limit assistance to businesses which were owned by members of a disadvantaged minority group.

The key to making business development activities fit within a charitable framework is to tie such activities to identifiable charitable objectives such as providing employment opportunities to the unemployed (relief of the disadvantaged); providing financial assistance to businesses owned by members of disadvantaged minority groups who have been unable to obtain financial assistance from conventional sources (alleviation of the effects of racial discrimination); or requiring businesses obtaining assistance to upgrade their stores, make changes in their storefronts, etc. (combating or preventing community deterioration).

13). What happens if our organization's articles of incorporation do not specifically authorize it to conduct economic or business development activities?

If the "purpose" clause of your organization's articles of incorporation is stated in sufficiently broad terms, there should be no problem. State law normally authorizes a corporation to conduct any and all activities related to carrying out its stated purposes. There might be a problem if your organization's purposes are narrowly defined, e.g. if there is no general language, such as "combating community deterioration".

A more important question is whether engaging in such activities will affect the organization's Section 501(c)(3) tax-exempt status if the organization's exempt application did not indicate that this type of activity would be undertaken.

If such activities were not described in the organization's exemption application and they are a significant departure from its current activities, then such activities must be reported to the IRS by attaching a description of such activities to the organization's annual information return or by sending a letter to the IRS.

In some cases, it may be advisable to request a ruling in advance from the IRS that your organization's tax-exempt status will not be lost if it engages in such activities, particularly if the economic business development activities will completely overshadow your organization's current activities.

14). Can a Section 501(c)(3) organization lose its tax-exemption if it earns business income? Can its business income be taxed?

Section 501(c)(3) organizations can have two kinds of business income--related business income, which is not taxed, and unrelated business income, which is subject to tax at regular corporate rates--16% on the initial $25,000 of taxable income (gross business income less deductible business expenses), increasing on a graduated basis to 46% on taxable income in excess of $100,000. The first $1000 of unrelated business taxable income is not subject to tax.

If your organization runs a business activity, the first question that has to be asked and answered is--is this a related activity or an unrelated activity? Does it contribute importantly to the achievement of your organization's charitable objectives as specified in your organization's articles of incorporation and its exemption application. If it does, it is a related business activity. "Relatedness" is determined by the way the activity is conducted. It is essentially a "purpose" test--why is the organization doing this? Is it doing this to make money or is it doing this to achieve a charitable goal? Are the means or methods appropriate?

For example, if an organization's objective is to develop housing for low-income persons in order to combat neighborhood deterioration and the organization sells some of the houses to upper income persons to make money to help support its low-income housing activities, the IRS will view the income from such sales as unrelated business income because the sales are not made to members of a charitable class (e.g. low-income individuals), and the purpose is to obtain funds. However, income from sales to low-income persons would be regarded as related business income because such sales are made for the purpose of achieving the charitable goal of providing housing to low-income persons and the revenue objectives are assumed to be of lesser importance.

To establish that a business activity is a related business you must be able to show that it is merely an instrument to achieve a charitable purpose and not an end in itself, i.e., that it is not conducted to produce income in a commercial manner.

If your organization cannot show how operation of a business helps to achieve a charitable objective rather than an economic objective, then the business is not a related business. In this case, the question to be answered is whether the business activity is large in relation to the organization's other activities. Generally, having unrelated business income will not affect your organization's tax-exempt status unless the business activity is at such a significant level that the IRS can question whether the organization is running a business or a charity.

The other point to keep in mind about unrelated business income is that the government is very fair. It does not tax your organization on 100% of its gross unrelated business revenue. It lets your organization deduct its expenses and taxes only its net unrelated business revenue. The tax is simply the price your organization will have to pay to obtain revenue. An evaluation should be made of the business activity to determine if the economic return, after payment of tax, is sufficient in light of the time and money that has to be diverted from charitable activities to the business activity.

15). Let's say we, as a community group, are setting up a factory to manufacture prefabricated building components and we are going to make a profit on these components by selling them to contractors. But we are also going to provide employment for the disadvantaged individuals and are going to sell the components at cost to low-income individuals who are rehabilitating or rebuilding their homes. Is this a related business?

The fact that you plan to sell components at cost to low-income individuals does not make the business a related business. The IRS has ruled that selling products at a lower cost to poor people is not a charitable activity. Rev. Rul. 73-127 [1973-1 C.B. 221] involved a supermarket in a low-income neighborhood which sold food at low prices to poor people. The IRS concluded that the group was merely running a supermarket business which was the same as other supermarkets. Similarly, if you are running a housing component business, how does the IRS distinguish your operation from a regular manufacturer? Providing poor people with something at a lower cost does not make an activity charitable.

However, providing employment to member of a charitable class may cause the business to be a related business if the focus is on helping the employees, e.g. through providing supportive social services, training, and other assistance that an employer normally would not furnish so that it is clear that the business is not being operated to achieve profits but for other objectives. The business operation must have factors that make it different from similar commercial businesses.

16). Can a Section 501(c)(3) organization's investment income be taxed?

Yes; if the organization is a private foundation, it will be subject to a 2% tax on its net investment income. It will also be subject to tax, even if it is a public charity, on investment income which is "debt-financed income". Generally, "passive" income (i.e., income earned without actively participating in business operations), such as dividends, interest, rent and royalties, is not subject to tax as unrelated business income. However, if the organization borrows money and uses it to acquire income-producing property for purposes not related to its program activities, a portion of the income from that property will be subject to unrelated business income tax even though the income would otherwise be exempt from tax because it is "passive" investment income.

The portion of the income from the debt-financed property that will be subject to income tax will depend on the relationship between the amount of debt and the cost of acquiring the property. In general, if the property is 50% financed, 50% of the net income from the property will be taxed as if it were unrelated business income.

So, if an organization is borrowing money to acquire property or investments which generate income and which are not related to its charitable program, it can wind up getting less income than it expected because it will have to pay tax on this income. However, if the organization borrows to acquire property that is used to carry out its program activities, e.g. an office building to house its administrative offices or an apartment building to carry out its program of providing housing to the disadvantaged, such property will not be "debt-financed property" because its use is substantially related to the organization's charitable program.

There is another exception to the general rule that "passive" investment income is not unrelated business income. If an organization receives rent, interest or royalties from an exempt or non-exempt organization controlled by it, all or part such of income may be treated as unrelated business income. In general, control is defined as ownership of 80% of the voting power of a stock corporation or direct or indirect control of 80% of the directors or trustees of a non-stock or non-profit corporation.

17). What are the limits on investment activities of charitable organizations for community development purposes?

Such investments must either be "prudent" investments or must further a "charitable purpose". Relevant "charitable purposes" may include:

a. Relief of the poor and distressed or of the underprivileged, e.g. providing low-income housing, developing employment opportunities;

b. Lessening the burdens of government, e.g. providing community social service facilities, supplementing government assistance programs;

c. Combating community deterioration, e.g. commercial area revitalization programs, housing rehabilitation, increasing or improving housing stock; and

d. Eliminating prejudice and discrimination, e.g. home purchase programs related to neighborhood integration programs, minority business assistance.

It should be recognized, however, that "lessening burdens of government" and "combating community deterioration" are general catch-alls which also cover many non-traditional charitable activities. Therefore, a careful description is needed of the "charitable purposes" to be achieved by the investment.

When investment activities are undertaken to encourage business activities, caution is needed because benefit to private, non-charitable interests will have to be adequately justified. Investments have to be analyzed under a two-step test:

a. Does the investment further a defined charitable purpose?

b. If it does, is the investment a reasonable method in light of the purpose being sought and the benefit, if any, to private interests?

Use of investments as the means for achieving charitable purposes is a difficult concept. The problem is that the Internal Revenue Service is uncomfortable when they see investment activities in a charitable context. Therefore, it is important to fully document the charitable objective of each such investment.

In many instances, it is important for the charitable organization to choose the right piece of a project to assure that it can demonstrate that its investment furthers charitable purposes.

For example, a charitable organization might finance the construction of a facility for charitable activities (e.g., a school, health care facility, or social service agency, etc.) which can be a key element of a larger development project oriented toward business or commercial objectives.

Similarly, in the case of housing development activities, the charitable organization might limit its investment to the portion of a project directed at providing housing to members of a charitable class, i.e., low-income individuals or the elderly.

If economic development activities such as commercial real estate development are being financed, then the charitable organization might structure its investment to assure that there is benefit to members of a charitable class by, for example, requiring the recipients of its investment to provide jobs to low income individuals.

18). From a tax standpoint, when should development activities be conducted through a separate organization?

Problems in meeting the "charitable purpose" test often arise with "single purpose" organizations. In contrast, organizations which provide comprehensive assistance aimed at rehabilitating disadvantaged areas and which assist or operate businesses as only part of their activities have found it easier to obtain and maintain "charitable" status.

Therefore, if a business activity is to be undertaken and it will need financing with charitable dollars, it may be better to initially conduct the business activities within the framework of an existing charitable organization rather than through a separate organization. However, at some point, to protect the charitable organization's tax-exempt status, consideration should be given to "spinning off" the business activity into a separate for-profit subsidiary, particularly if the size and scope of the business activity becomes relatively large in relation to the organization's other activities.

19). Can a charitable organization involved in development activities enter into partnership arrangements?

Partnership or joint venture arrangements with for-profit entities will be closely scrutinized by the IRS. The IRS often views such arrangements as giving private interests the benefit of charitable assets, particularly if the charitable organization is to be the sole general partner. This is because a general partner can be held liable for all of a partnership's debts. Alternatively, the partnership arrangement should be structured to minimize financial risk to the charitable organization, e.g., by having a co-general partner which has adequate financial resources. This is an evolving area because the IRS is beginning to recognize that certain types of partnership arrangements are appropriate for charitable organizations. However, in some cases it may be advisable for a charitable organization to use a subsidiary corporation as a vehicle for a partnership arrangement rather than entering into a direct relationship with a for-profit entity or private investors. This would protect the charitable organization's assets from the claims of partnership creditors.

20). What political activities are permitted for Section 501(c)(3) organizations?

Section 501(c)(3) organizations cannot support or oppose political candidates. No partisan political campaign activities, however minimal, are allowed. Section 501(c)(3) groups can distribute non-partisan "voter education" information, but such information should be carefully reviewed to make sure it is a fair presentation of information about all candidates and is not "slanted". It cannot be anything that can be construed as an attempt to sway the public one way or the other. Also, a Section 501(c)(3) organization is not permitted to allow groups or individuals to use its facilities and equipment to campaign for candidates. However, a limited amount of legislative activity, i.e. "lobbying" for the enactment or defeat of legislation, is permissible.

21). Are all activities involving legislative contacts considered "lobbying"?

No, certain activities are not treated as "lobbying". These include: (1) talking to legislators about legislation that might affect an organization's tax-exempt status or existence--but this does not include budgetary or funding matters; (2) activities related to non-legislative decisions, such as opposing or supporting the issuance of regulations; (3) making available the results of non-partisan studies; and (4) responding to requests to testify before legislative committees.

I want to emphasize four technical points about testimony before a legislative committee. First, your organization has to be invited by the chairman of the committee, not just a member of the committee. Second, the invitation must be in writing. Third, the invitation should request your organization's opinion on the topic begin considered. Fourth, any information provided must be made available to all members of the committee.

22). How much "lobbying is permitted for a Section 501(c)(3) organization?

An "insubstantial" or incidental amount of lobbying is permitted if an organization is a public charity. These terms are difficult to quantify. Five percent is sometimes used as an informal guideline, i.e., an organization's staff should not devote more than 5% of its time and/or 5% of the organization's annual budget to lobbying. But, this is not an official IRS guideline.

However, a public charity can make lobbying expenditures up to certain specified levels if it files a special "election" form, Form 5768 (See Form 6.3) with the IRS under Section 501(h) of the Internal Revenue Code. Even if the organization exceeds the specified expenditure levels, the worst that can happen is that it will have to pay a tax of 25% of its excessive lobbying expenditures. It doesn't lose its exemption unless it keeps exceeding the limits in subsequent years.

If the Section 501(h) election form is filed the permitted level of lobbying expenditures is set forth in Section 4911(c)(2) and is based on specified percentages of an organization's program expenditures--starting at 20% of the initial $500,000 of program expenditures, with lower percentages as program expenditures reach higher levels. For example, if an organization has a program budget of $200,000, it could spend 20%, or $40,000, on lobbying. No more than 25%, or $10,000, could be expended on "grass roots" lobbying--direct communications with the public.

All Section 501(c)(3) organizations have to report on their annual information return, Form 990, how much they spent on lobbying--even those that don't make the Section 501(h) election. This means that organizations have to keep records and make allocations. For example, if an organization sends out a newsletter urging people to contact their legislators about certain pending legislation, the IRS doesn't regard the cost of this lobbying effort as consisting of only the out-of-pocket costs for the mailing, i.e., paper, postage, printing, etc. It also includes the cost of staff time and an allocable portion of overhead--rent, utilities, etc.

23). Do the limitations on lobbying or political campaign activities extend to activities of individuals who are members or employees of an organization, but who are acting as individuals?

To the extent that individuals can "separate" themselves from the organization, they can engage in lobbying and political campaign activities. If you are attending meetings after work or on the weekends, you are clearly doing this on your own time and there should be no problem. But, you must be careful to make it clear that you are acting in your individual capacity, not as an employee of the organization. You must be extra cautious because there is no "safe harbor" for political campaign activities. If your activities can be regarded as activities of the organization, the IRS can revoke the organization's tax-exempt status.

24). Let's say that you're working for a charitable organization but you are also on the board of directors of a national or local lobbying group which is not a Section 501(c)(3) organization. As long as you do this work for this organization outside of your office hours and do not use your office telephone, is that permissible?

Yes. But, you have to keep your lobbying activities separate from your work as an employee of the Section 501(c)(3) organization. You should not conduct such activities on any regular basis during office hours. As a practical matter, the fact that you make one or two phone calls from your office probably isn't going to create a problem. However, you should not send letters relating to affairs of the national group on your organization's letterhead. When you are making a speech for the lobbying group or permitting your name to be used in a newspaper ad, you should make it clear that you are not acting in your capacity as an employee of the Section 501(c)(3) organization. The usual way to do this is to add a statement that use of your organization's name in connection with yours is for identification purposes only and is not intended to represent the official views of your organization.