TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Monday, September 11, 2017

Schmalbeck Presents Nonprofit Organizations And Political Campaigns At Northwestern

Schmalbeck (2016)Richard L. Schmalbeck (Duke) presented Nonprofit Organizations and Political Campaigns at Northwestern as part of its Advanced Topics in Taxation Workshop Series hosted by Sarah Lawsky:

This story involves three organizational forms, and two broad policy considerations. There are more than a score of different nonprofit organizational categories described in the IRC, but only three are relevant here: the organizations described in sections 501(c)(3), 501(c)(4), and 527. All are exempt from federal income taxes on any excess of revenue over expense that they might experience in any tax year. The first category (charitable organizations under section 501(c)(3)) allows use of deductible contributions to advance its programmatic ends, and also permits anonymous donations. The second (social welfare organizations under section 501(c)(4)) allows anonymous donations (but no deduction for contributions). The third (political organizations under section 527) is subject to rules that compel disclosure of the names of contributors and amounts of their contributions.

From these rules, a hierarchy of organizational types can be inferred, from the viewpoint of a potential donor to political campaigns: if possible, a charitable organization is best, allowing both deductions and anonymity; social welfare organizations are next in line, allowing at least anonymity; and political organizations are the least attractive, offering neither deductions nor anonymity.

The first policy desideratum is that participation in political campaigns should be done on an after-tax basis; that is, neither individuals nor entities (regardless of whether or not they seek profits) should be allowed deductions for the costs of campaign participation. The second is that campaign finance should be reasonably transparent, as a check on undue influence or even outright corruption.

Campaigning by Charities

The first of these policy features is served by the rule that flatly prohibits charities, including churches, from any participation in electoral campaign activities. This rule sensibly disallows use of pre-tax dollars for political campaigns, thereby leveling the political playing field. It also serves to protect charities from being appropriated for uses other than the ones for which they were intended. (Churches may be particularly vulnerable to appropriation of this sort due to the lighter regulatory oversight regime that results from Congressional and administrative efforts to avoid excessive entanglement with religion.)

However, this article argues that the rule mandating total prohibition on campaign participation extends beyond its most persuasive rationale. If an organization does no more than simply to endorse a candidate, it has not devoted to a campaign financial resources that were generated by charitable deductions. We should start with a strong presumption favoring free speech by individuals and institutions, and if no inappropriate subsidy is involved, that speech should not be curtailed. This article discusses in some detail which situations should be regarded as using significant resources, and which ones should not. Only the former should be banned by section 501(c)(3).

In fact, the IRS enforcement effort has been relaxed in recent years, and as far as I am aware, no institution has lost its exempt status merely for endorsing a candidate. This is just as well, I argue; de minimis violations of the absolute bar on campaign activity should not cause loss of exempt status, and do little harm to the principle of the bar on use of after-tax funds in campaigns.

Campaigning by Social Welfare Organizations

The 501(c)(4) option is an attractive one for social welfare organizations that are not engaged in campaign activity as their primary purpose. But it is not an appropriate vehicle for organizations that have electoral goals as the principal or exclusive purpose. Such organizations should be subject to the rules regarding disclosure of donors and donations, which serve an important function in a democracy that depends on substantial sums for campaign finance.

The social welfare organizational form has been abused by blatantly political organizations that claim to qualify as 501(c)(4)s. However, their claim is faulty. It is based on 1) an excessively generous IRS interpretation of the law, to the effect that as little as 51% of a social welfare organization’s activities must advance social welfare; and 2) a misunderstanding of the rules on lobbying, specifically, that advertisements that are intended primarily to disparage a candidate for office can masquerade as “lobbying” (which 501(c)(4)s can engage in without limit) merely by a superficial reference to an item of current legislation.

This article suggests a two-step adjustment in IRS policies, which could probably be adopted merely by rulings. The first is to insist that a much larger share than the current 51% of a social welfare organization’s activities must be in pursuit of social welfare. Section 501(c)(4)’s language says that such organizations must be exclusively engaged in such activities. Because a small de minimis zone would also be valuable in this case, a total ban would not be indicated. Instead, the IRS should adopt a rule to the general effect that substantially all—90-95%--of a social welfare organization’s activities should be in pursuit of social welfare.

The second step would be to issue rulings on what constitutes lobbying for social welfare organization purposes. Since the effort is to control abuse that takes the form of faux lobbying, these rules should be drafted narrowly, so that only genuine lobbying efforts could qualify as such.

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