Tax-exempt organizations under § 501(c)(3) of the Internal Revenue Code face strict rules about regulating lobbying activities. Breaking these rules can result in severe consequences such as loss of tax-exempt status and excise tax penalties. For those § 501(c)(3) organizations that wish to expand their operations to encompass lobbying activities, two primary options exist.
1. Create and Operate an Affiliated § 501(c)(4) organization
Unlike § 501(c)(3) organizations, § 501(c)(4) organizations may engage in unlimited lobbying activities with the caveat that the § 501(c)(4)’s primary purpose must be to promote social welfare, not to support or oppose a political candidate or party. It is common for § 501(c)(3) organizations to create affiliated § 501(c)(4) organizations to lobby for causes important to the § 501(c)(3). Creating a § 501(c)(4) is similar to creating many other nonprofit legal entities. The new corporate entity must file articles of incorporation with the secretary of state, appoint a board of directors, and draft bylaws and an IRS compliant conflict of interest policy.
Operating an affiliated § 501(c)(4) is more difficult than forming one. Most importantly, the activities of the § 501(c)(4) may not be imputed to the § 501(c)(3). This principle creates many operational complications. To name a few, the § 501(c)(4) must (1) have its own board of directors, (2) file its own tax returns, (3) reimburse the § 501(c)(3) for its share of any common expenses, and (4) be functionally distinguishable from the § 501(c)(3) to the general public. Violation of these or other similar rules can lead to loss of tax exempt charitable status and imposition of excise taxes on the § 501(c)(3) entity.
2. Elect § 501(h) Treatment
Alternatively, § 501(c)(3) entities may elect § 501(h) treatment on IRS Form 5768. Making this election permits § 501(c)(3) entities to engage in limited lobbying activities. Limits are defined by a mechanical formula in § 501(h) that caps actual expenditures for “exempt purposes” and “lobbying expenditures.” Separate caps exist for total lobbying expenditures and grassroots lobbying expenditures. The quantitative limits provided in § 501(h) provide certainty to the § 501(c)(3) about how much lobbying is permissible.
Organizations that spend $500,000 or less per year on “exempt purposes” may spend up to 20% of the amount spent for “exempt purposes” on “lobbying expenditures.” Of this 20% figure, no more than 25% may be used for “grassroots expenditures.” For example, if an organization spends $400,000 per year for “exempt purposes,” it can spend up to $80,000 per year on “lobbying expenses.” Of that $80,000, only $20,000 may be spent on grassroots lobbying. Different, tiered caps exist for organizations that spend more than $500,000 for “exempt purposes” in a given year.
This option is simpler on both the front end and in continuing operations than the § 501(c)(4) option. But, it may not be the right fit for organizations that wish to spend more on lobbying than § 501(h) allows.