Donors should be aware that there may be significant tax benefits to funding advocacy and election-related activity with stock instead of cash. This article discusses the tax treatment of donations of appreciated stock to social welfare or advocacy organizations exempt under section 501(c)(4) of the Internal Revenue Code (the Code) and to political organizations exempt under section 527 of the Code.
Transfers to Social Welfare Organizations
A social welfare organization is generally exempt from federal income tax under section 501(c)(4) of the Code. Social welfare organizations primarily engage in lobbying and issue advocacy, but they are also allowed to engage in a limited amount of political activity without losing their tax-exempt status. Under the Code, lobbying is an attempt to influence specific legislation, while political activity is an attempt to influence an election by supporting or opposing one or more candidates for public office.
- Tax Treatment of Donor: Generally, a donation of appreciated stock to a social welfare organization is not a taxable transaction. The donor does not pay capital gains tax on the appreciation, and, as confirmed in the December 2015 PATH Act, the transfer is not subject to gift tax.
- Tax Treatment of Recipient: The social welfare organization takes a carryover basis in the stock, which means that the organization's basis in the stock is the same as the donor's. As a tax-exempt organization, the social welfare organization is not required to pay tax on capital gains. Therefore, when the social welfare organization sells the stock, generally it will not pay tax on any appreciation. The tax treatment is different, however, if the social welfare organization engages in political activity. Although a social welfare organization is permitted to engage in a limited amount of political activity without losing its tax exemption, it is required to pay a tax on its political expenditures. The tax is imposed at the highest corporate tax rate – currently 35% – on the lesser of the organization's political expenditures or its net investment income, including capital gains, for the year. To avoid this tax, the organization should avoid making political expenditures directly or indirectly in the same tax year in which it has net investment income. Therefore, the donor should transfer and the 501(c)(4) organization should sell the appreciated stock in the year prior to engaging in political activities.
Transfers to Political Organizations
The tax treatment of transfers of appreciated stock to section 527 political organizations is not as favorable. A political organization is generally exempt from federal income tax under section 527 of the Code. Section 527 organizations include political parties, candidate committees, political action committees and so-called "SuperPACs." These organizations do not pay tax on their "exempt function income," which generally includes donations and other fundraising proceeds that are used for political activities. Section 527 organizations are required to pay tax on other types of income, including investment income from the appreciation of stock.
- Tax Treatment of Donor: A donation of appreciated stock to a political organization is a taxable transaction. For transfers of stock to political organizations, the Code treats the donor as having sold the stock to the political organization. The donor pays tax on the difference between the fair market value of the stock at the time of the transfer and the donor's adjusted basis in the stock. The donor will pay tax at capital gains rates for stock held for more than one year or at ordinary income rates for stock held for one year or less. However, the transfer is not subject to gift tax.
- Tax Treatment of Recipient: The political organization will not be subject to tax on the contribution of stock, provided the stock proceeds are used solely for political activity. The political organization takes the donor's basis in the stock, increased by the amount of gain recognized to the donor. If the stock appreciates in value after it is donated to the political organization, the organization will pay net investment income tax on the appreciation at the highest corporate income tax rate – currently 35%. To avoid the net investment income tax, the political organization should sell the stock after the transfer but before the stock appreciates in value.
Another concern for potential donors is donor privacy. Social welfare and political organizations are subject to different requirements with respect to the disclosure of donor information.
A social welfare organization is not required to publicly disclose the identity of its donors, but it is required to file Schedule B to IRS Form 990 each year. The Form 990 is the annual information return that most tax-exempt organizations are required to file with the IRS, and Schedule B to Form 990 contains information about contributions to the organization. For each contributor who donates money or other property of US$5,000 or more, Schedule B requires the name and address of the contributor, and the amount, date, and type of contribution. The IRS is required to withhold the names and addresses of contributors to social welfare organizations, but all other information on Schedule B is available for public inspection (provided it does not "clearly identify" the donor).
A political organization is required to file annually Form 990, including Schedule B. Unlike social welfare organizations, political organizations are required to publicly disclose the identities of their donors. Political organizations are also required to file periodic reports with the IRS on Form 8872, or, if the organization is a federally registered PAC, with the FEC. For each periodic report with the IRS, the political organization is required to disclose the name and address of each person or entity that contributes US$200 or more to the organization, and the amount and date of the contribution. The IRS makes this information available for public inspection on its website.
In general, a donor does not pay tax on the donation of appreciated stock to a social welfare organization. The social welfare organization receiving the stock does not pay tax unless the organization makes political expenditures in the same tax year. For transfers of stock to political organizations, the donor pays tax on the difference between the fair market value of the stock at the time of the transfer and the donor's adjusted basis. The political organization does not pay tax on the contribution of stock, but it will pay tax to the extent the stock appreciates in value after the transfer.
In addition to tax treatment, donors should be aware that social welfare and political organizations are subject to different disclosure requirements. Unlike social welfare organizations, political organizations are required to publicly disclose the identity of their donors. Social welfare organizations are required to disclose major donors to the IRS, but the identity of donors is not open to public inspection.