4.76.30  EO Examination Guidelines for IRC section 527 Political Organizations.

4.76.30.1  (06-04-2010)
Introduction

  1. This IRM section contains both technical guidance and examination procedures for an organizations exempt under IRC §527 and separate segregated funds under IRC §527(f). This manual provides examination techniques effective in identifying and developing issues commonly encountered during the examination of such organizations.

  2. For information on the political activities (and prohibition of said activities) of IRC §501(c)(3) organizations, see IRM 4.76.3 and IRM 4.76.4.

4.76.30.2  (06-04-2010)
Background Information

  1. The Revenue Act of 1954, credited with the current structure and numbering of the IRC, was passed with a floor amendment sponsored by then Senator Lyndon B. Johnson, adding the phrase "participate in, or intervene in (including the publishing or distributing of statements), any political campaign on behalf of any candidate for public office" to IRC §501(c)(3).

  2. The next significant action with regard to political activity came in 1969, when the Tax Reform Act of 1969 created IRC §4945, which imposed an excise tax on private foundation for taxable expenditures, including participation in political activities, subject to certain exceptions.

  3. In 1975, Public Law 93-625 was passed, establishing tax exemption for political organizations, and creating an income tax scheme for on-exempt purposes expenditures. This law also established exemption for funds used for political activities, created by organizations exempt under IRC §501(c) other than §501(c)(3).

  4. Public Law 106-230 was enacted in 2000, amending IRC §527 adding new four reporting and disclosure requirements on political organizations

  5. Public Law 107-276 was enacted in 2002, amending portions of IRC §527, creating revised reporting requirements with respect to political organizations.

4.76.30.3  (06-04-2010)
Reporting and Disclosure Requirements

  1. As many of the examination guidelines to follow require reviewing the reports filed by the organizations, the reporting and disclosure requirements are being covered prior to discussing what constitutes a political organization.

  2. On July 1, 2000, Public Law 106-230 was enacted, amending IRC §527. The new law imposes four reporting and disclosure requirements on political organizations:

    • An initial notice of status,

    • Periodic reports of contributions and expenditures,

    • Annual income tax returns, and

    • Annual information returns.

  3. On November 2, 2002, Public Law 107-276 was signed into law, altering filing requirements for certain political organizations that seek tax-exempt status under IRC §527. The new law generally reduces filing requirements for certain state/local political organizations that already disclose certain information to state agencies. In addition, the law relieves some political organizations from filing an annual income tax return or an annual information return.

  4. Public Law 107-276:

    • Exempts state and local candidate and party committees from filing Form 8871 and Form 990 (or 990-EZ),

    • Exempts qualified state and local political organizations (QSLPO) (as defined in IRM 4.76.30.4(3) below) from filing Form 8872,

    • Exempts political committees filing with the FEC from filing Form 990 (or 990-EZ),

    • Exempts political organization that are a caucus or association of state or local officials from filing Form 990 (or 990-EZ),

    • Requires additional information on Form 8871 and Form 8872,

    • Requires the filing of an amended Form 8871 after material changes to maintain tax-exempt status,

    • Increases reporting thresholds for certain Form 990 filers,

    • Changes the electronic filing requirements by requiring that Form 8871 be filed electronically (as opposed to both in writing and electronically), and

    • Requiring that any Form 8872 due after June 30, 2003, be filed electronically if the filing organization has or expects to have contributions or expenditures of more than $50,000 during the calendar year.

  5. The filing requirements in the chart below apply to those political organizations that:

    • Wish to be a tax-exempt political organization, and

    • Receive or expect to receive $25,000 or more in gross receipts in any taxable year.

    If You Are A: You May Be Required To File:
    FEC political committee, state or local candidate committee or state or local committee of a political party Form 1120-POL
    Qualified state or local political organization (QSLPO)* Form 8871; Form 1120-POL and Form 990
    Caucus or association of state or local officials* Form 8871; Form 8872; and Form 1120-POL
    Any other political organization, including other federal political organizations and other state or local political organizations. Form 8871; Form 8872; Form 1120-POL; and Form 990 or Form 990-EZ.

    Note:

    An organization may be both a QSLPO and a caucus or association of state or local officials. If so, it is not required to file Form 8872 and Form 990.

  6. Tax-Exempt IRC §527 Organizations must make their forms (other than Form 1120-POL) publicly available for inspection and copying at their principal place of business. The IRS also posts Form 8871 and Form 8872 on its website at http://forms.irs.gov/politicalOrgsSearch/search/basicSearch.jsp?ck.

4.76.30.3.1  (06-04-2010)
Notice Status

  1. Effective for taxable years after June 30, 2000, unless excepted (see Chart above), a political organization must file Form 8871. Political Organization Notice of 527 Status, with the IRS to be tax-exempt. Until it files the form, its income (including contributions) is subject to taxation.

  2. Form 8871 must be filed electronically, within 24 hours of the political organization's establishment.

  3. An amended Form 8871 must be filed within 30 days of any material change (including termination ), or any income (including contributions) it receives after the material change will be subject to taxation.

  4. A final notice must be filed upon termination of the organization.

4.76.30.3.2  (06-04-2010)
Periodic Reports of Contributions and Expenditures

  1. A political organization is required to periodically report certain contributions it receives and expenditures it makes.

  2. Tax-exempt political organizations, other than QSLPO, that file Form 8871 must file Form 8872, Political Organization Report of Contributions and Expenditures, to disclose information concerning:

    • Expenditures that aggregate $500 or more per person, per calendar year and

    • Contributions that aggregate $200 or more per person, per calendar year.

  3. A tax-exempt political organization that does not disclose this information must pay an amount equal to the highest corporate tax rate (35 percent) multiplied by the amount of contributions and expenditures not disclosed.

  4. An organization required to file Form 8872, may choose to file on a monthly basis or on a quarterly basis/semiannually, but it must file on the same basis for the entire calendar year. Due dates also vary depending on whether the form is due for a reporting period that occurs during an even-numbered (election) or odd-numbered (non-election) year.

  5. For even numbered years, an organization may opt to file its reports on either a monthly or quarterly basis, but must file on the same basis for the entire calendar year. In addition, pre-election and post-general election reports may be required.

    1. For those opting to file monthly, an organization must file the first report for the first month of the calendar year in which it accepts a contribution or makes an expenditure. Reports are due by the 20th day after the end of the month. This report must reflect all reportable contributions accepted and expenditure made during the month for which the report is filed.

    2. No monthly reports are due for October and November. Instead, the organization must file a pre-general election report and a post-general election report. In addition, a year-end report must also be filed by January 31 of the following year instead of a monthly report for December.

    3. For those who instead opt to file quarterly, an organization must file its first report for the first quarter of the calendar year in which it accepts a contribution or makes an expenditure. Quarterly reports are due by the 15th day after the last day of each calendar quarter, except the year-end report which is due by January 31 of the following year. In addition, an organization may have to file a pre-election report, a post-general election report, or both.

  6. A pre-election report is a Form 8872 that must be filed before any election for which the organization made a contribution or expenditure. The pre-election report must reflect all reportable contributions accepted and expenditures made through the 20th day before the election. It must be filed by the:

    • 12th day before the election, or

    • 15th day before the election, if it is posting the report by certified or registered mail.

  7. Form 8872 must ge filed by the 30th day after the general election. It must reflect all reportable contributions accepted and expenditures made through the 20th day after the general election. General election, as used in establishing the due date for filing Form 8872, means:

    • An election for a federal office held in even numbered years on the Tuesday after the first Monday in November, or

    • An election held to fill a vacancy in a federal office (i.e., a special election) that is intended to result in the final election of a single individual to the office at stake in a general election.

  8. For odd numbered years, an organization may opt to file its reports on either a monthly or semi-annual basis, but it must file on the same basis for the entire calendar year. The due date for the report depends on whether it is filed on a semi annual or monthly basis.

    1. For those opting to file monthly, an organization must file the first report for the first month of the calendar year in which it accepts a contribution or makes an expenditure. Reports are due by the 20th day after the end of the month, except for the December report, which is due on January 31 of the following year.

    2. For those who instead opt to file sem-annually, an organization must file the mid-year report by July 31 for the January 1 - June 30 period. They then must file the year-end report by January 31 of the following year for the July 1 - December 31 period.

  9. A political organization is not required to file Form 8872 for any period of time that it is subject to tax on its income because it did not file or amend a Form 8871.

  10. Forms 8872 can be subject to penalties. The penalty is 35 percent of the total amount of contributions and expenditures to which a failure relates. A penalty will be imposed if an organization is required to file Form 8872 and it:

    • Fails to file the form by the due date,

    • Files the form but fails to report all of the information required or reports incorrect information.

  11. For assessment of penalties on Form 8872, see IRM 4.76.30.4.5.1 (7).

4.76.30.3.3  (06-04-2010)
Annual Returns

  1. A political organization that has taxable income in excess of the $100 specific deduction allowed under IRC §527, is required to file an annual income tax return on Form 1120-POL, Income Tax Regulations for Certain Political Organizations.

  2. Form 1120-POL is due by the 15th day of the 3rd month after the end of the organization's taxable year. Political organizations may request a six-month extension of the filing deadline by filing Form 7004, Application for Automatic Extension of Time to File Corporate Income Tax Return. This extension must be filed by the due date of Form 1120-POL. There is a penalty for failure to file Form 1120-POL.

  3. A political organization that fails to file a required Form 1120-POL timely must pay an additional amount equal to 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 shows that the failure was due to reasonable cause.

  4. Tax-exempt political organizations whose annual gross receipts are $25,000 or more must file Form 990, unless excepted. Any organization excepted from the requirements to file a Form 8871 and any political organization that is a caucus or association or state or local officials are excepted from the Form 990 filing requirement. Qualified state or local political organizations are only required to file Form 990 if they have annual gross receipts of $100,000 or more.

  5. A tax-exempt political organization does not use the three-year averaging test to determine whether it meets the $25,000 threshold.

  6. For calendar or fiscal years beginning in 2009, organizations with annual gross receipts less that $500,000 and total assets less than $1,250,000 at the end of the tax year can choose to file Form 990 or 990-EZ (Form 2008, these amounts were less than $1,000,000 in gross receipts and $2,500,000 in total assets.) Beginning in tax year 2010, organizations with annual gross receipts less than $200,000 and total assets less than $500,000 at the end of the tax year can file either Form 990 or 990-EZ.

  7. Political organizations are not required to submit Form 990-N.

4.76.30.4  (06-04-2010)
Political Organizations

  1. A political organization is a party, committee, association, fund or other organization, (whether or not incorporated), organized and operated primarily for the purpose of directly or indirectly accepting contributions or making expenditures for an exempt function.

  2. Political organizations are subject to tax on income other that contributions, dues, and fund-raising income used for political campaign purposes. For all other purposes, they are considered tax exempt organizations. IRC §527 also provides that a newsletter fund may qualify for the same tax treatment as a political organization is certain requirements are met. In addition, IRC §501(c) organizations that expend any money for political activity may be subject to tax under IRC §527. (For an explanation of newsletter funds, see Note at IRM 4.76.30.4.5(3)).

  3. On November 2, 2002, Public Law 107-276 was enacted, further amending §527. The law created a new sub-category of political organization --qualified state or local political organization (QSLPO). A state or local organization may be a QSLPO, if it meets the following criteria:

    • All of its political activities relate solely to state or local public office (or office in a state or local political organization),

    • It is subject to state law that requires it to report (and it does report) to a state agency information about contributions and expenditures that is similar to the information that the organization would otherwise be required to report to the IRS,

    • The state agency and the organization make the reports publicly available, and

    • No Federal candidate or office holder controls it or materially participates in its direction, solicits contributions for it, or directs any of its disbursements.

4.76.30.4.1  (06-04-2010)
Organizational Test

  1. A political committee, association, fund, or other organization must meet both the organizational test of Regulation §1.527-2(a)(2) and the operational test of Regulation §1.527-2(a)(3) to be subject to tax only as a political organization under IRC §527.

  2. To satisfy the organizational test, the organization must be organized for the primary purpose of carrying on exempt function activities as defined in IRC §527.

  3. The organization does not need to be formally chartered or established as a corporation, trust, or association.

  4. A separate bank account in which political campaign funds are deposited and disbursed only for political campaign expenses can qualify as a political organization. (See Revenue Ruling 79-11, 1979-1 C.B. 207).

  5. When there are no formal organizational documents, consideration is given to statements of the members of the organization at the time of its formation that they intend to operate the organization primarily to carry on exempt function activities. Regulations §1.527-2(a)(2).

  6. All organizations claiming exemption under IRC §527 are required to obtain Employer Identification Numbers (EINs), even if they have no employees.

4.76.30.4.1.1  (06-04-2010)
Examination Guidelines: Organizational Test

  1. Determine whether the organization has created a formal charter or has been established as a corporation, trust or association.

    1. If formally organized, review the organizing document for the purposes of the organization.

    2. If not, identify the person(s) who created the organization and interview them to determine if they have any records concerning the formation of the organization. Review any documentation provided for the intentions of the creators(s) and apply a facts and circumstances test.

  2. For organizations that are not formally chartered, determine whether there is a financial account into which political contributions have been deposited and political expenditures have been made.

  3. Obtain the Employer Identification Number (EIN) of the organization. As of 2002, all political organizations are required to have identification numbers.

  4. Verify that the EIN is unique to the financial account/political organization.

    1. Where the EIN is actually an SSN or an EIN of a business entity (corporation, partnership, sole-proprietorship, or an organization exempt under §501(c)), the organization has failed to establish a separate identity, and is treated as taxable to the person/entity who owns the account.

    2. By filing an online Form SS-4 at www.irs.gov, the organization can establish future exemption as a political organization for years subsequent to the filing of the Forms SS-4.

      Note:

      Situations involving the failure to obtain an EIN will primarily arise in examinations of the related entities, such as an SB/SE examination of an individual or business, or an EO examination of a §501(c) organization.

4.76.30.4.2  (06-04-2010)
Operational Test

  1. To satisfy the operational test, the organization's primary activities must be exempt function activities as define in IRC §527. Per Regulation §1.527-2(a)(3), the organization may engage in activities that are not exempt function activities, but these may not be its primary activities.

  2. IRC §527(e)(2) defines "exempt function" as"the function of influencing or attempting to influence the selection, nomination, election, or appointment of any individual to any Federal, State, or local public office or office in a political organization, or the election of Presidential or Vice-Presidential electors, whether or not such individual or electors as selected, nominated, elected or appointed."

  3. Per Regulation §1.527-2(a)(1) promoting the nomination of an individual for an elective public office in a primary election or in a meeting or caucus of a political party, also in an exempt function activity.

  4. For taxable years beginning after December 31, 1986, the exempt function of a political organization also includes making expenditures relating to a public office that would be allowable as a deduction under IRC §162(a) if incurred by the office holder.

  5. Exempt function does not include:

    1. Attempts to influence legislative matters,

    2. Expenditures for nonpartisan activities, including voter registration drives and campaigns.

  6. Political organizations can continue to qualify under IRC §527 between elections even though not supporting a particular candidate, if the organization is engaged in activities that are related to and support the selection process.

    Example:

    An organization established for a single campaign can continue to qualify as a political organization after the election to wind up its affairs as long as its primary activities are exempt function activities.

4.76.30.4.2.1  (06-04-2010)
Examination Guidelines: Operational Test

  1. Prior to the initial interview, determine whether the organization has files any reports at the state or federal level. For state reports, see http://www.irs.gov/charities/political/article/0,,id=176406.00.html for a listing of websites for each state's political activity public records. For federal, check either www.fec.gov or the political organization filer database at http://forms.irs.gov/politicalOrgsSearch/search/basicSearch.jsp?ck. Forms available on the IRS website mentioned above include Forms 990, 8871, and 8872. Form 1120-POL can be downloaded from On-line SEIN (http://sein.osc.irs.gov).

  2. Any records filed should give a record of contributions received, listing the amounts, names, and addresses of contributors, as well as the expenditures made, identifying the payees, addresses, and amounts.

  3. Using these records, revise your initial interview accordingly. Interview the officers and/or managers who run the political organization. At a minimum, ask the following questions:

    1. What are the organization's activities?

    2. What is the organizations's primary activity?

    3. Who determines where monies are expended?

    4. Who is involved with the organization?

  4. If available, review minutes or other records of deliberations of the activities of the organization.

    Note:

    Be alert for any unusual comments regarding activities, which might raise questions as to the organization's primary activities.

  5. Review copies of materials generated by the organization. These can vary from campaign signs and flyers to recordings of radio and television advertisements, as well as websites developed and operated by the organization.

4.76.30.4.3  (06-04-2010)
Exempt Function Income

  1. Receipts of a political organization must meet two requirements to be considered exempt function income. First, they must be amounts received by the political organization as:

    1. A contribution of money or other property,

    2. Membership dues, fees, or assessments from a member of the political organization,

    3. Proceeds from a political fund-raising or entertainment event or from the sale of political campaign materials, which are not received in the ordinary course of any trade or business, or

    4. Proceeds from conducting bingo games that are defined in IRC §513(f)(2).

  2. Second, under IRC §527(c)(3), receipts must be set aside in a segregated fund to be considered exempt function income. As defined by Regulation §1.527-2(b)(1), a segregated fund is a fund established and maintained by a political organization or individual, separate from other assets, the purpose of which is to receive and segregate exempt function income and earnings on such income, for use only for exempt function purposes.

  3. Amounts received by a political organization in exchange for its promise to exercise political influence on the payor's behalf or in exchange for some other quid pro quo are likewise not exempt function income. Revenue Ruling 75-103, 1975-1 C.B. 17.

  4. Investment income or income from a trade or business (such as renting excess office space to an unrelated organization) of a political organization is not exempt function income.

4.76.30.4.3.1  (06-04-2010)
Examination Guidelines: Exempt Function Income

  1. Check http://forms.irs.gov/politicalOrgsSearch/search/basicSearch.jsp?ck for any Form 8872 filed by the organization.

    1. If present, review the list of contributions received.

    2. Compile a spreadsheet of dates, contributors, and contributions received.

    3. Determine the total amount of contributions reported for the year.

    4. Identify any other sources of income reported on Form 8872.

  2. Check the state website, listed at http://www.irs.gov/charities/political/article/0,,id=176406,oo.html for any information returns filed with the state.

    1. If present, review the list of contributions received.

    2. Compile a spreadsheet of dates, contributors, and contributions received.

    3. Determine the total amount of contributions reported for the year.

    4. Compare the expenditures reported with the Forms 8872, if filed, to identify any discrepancies.

    5. Identify any other sources of income reported to the state.

  3. If there are no reports filed with the state, check the FEC filings as www.fec.gov.

    1. If present, review the list of contributions received.

    2. Compile a spreadsheet of dates, contributors and contributions received.

    3. Determine the total amount oc contributions reported for the year.

    4. Compare the expenditures reported with the Forms 8872, if filed, to identify any discrepancies.

    5. Identify any other sources of income reported to the FEC.

  4. Obtain a copy of any Forms 1120-POL filed by the organization, available from On-line SEIN (http://sein.osc.irs.gov).

    1. Review to see whether the organization erroneously reported any non-taxable income on the return.

    2. If additional non-exempt income was identified in reviewing the Forms 8872, state or FEC reports, compare to the amount reported on Form 1120-POL.

    3. If amounts reported do not match, make a note to discuss with the organization . This discrepancy may lead to a report of examination (RAR and manually complete Form 4549).

  5. Check On-Line SEIN (http://sein.osc.irs.gov)to see if any Forms 990 or 990-EZ were filed by the organization. All income, taxable or otherwise should be reported. A political organization that files Form 8872 is not required to disclose on Schedule B of Form 990 the name and addresses of any contributor that it did not disclose on Form 8872. It must disclose the amount of the contribution and that it paid the amount specified under section 527(j)(1) for that contribution.

    1. Review the Form 990, core schedule, Part VIII for the sources of income (if filed). Review page 1 of the Form 990-EZ if filed in lieu of the Form 990.

    2. Match the investment income reported, if any, against the amounts reported on Form 1120-POL.

    3. Compare the amounts reported on Form 990 as gross receipts against the amounts reported on Forms 8872, state or FEC reports.

    4. Identify any discrepancies in amounts reported.

    5. Review Part IV of the Form 990 core schedule for answers to Lines 3, 17, 18, 19, 29, and 34.

    6. Review Schedules C, G, and M, if attached.

  6. Review the books of the organization.

    1. For accounts at financial institutions, review the bank statements for deposits and interest income amounts.

    2. If interest was accrued, compare the total to the amount reported on Form 1120-POL, Form 990, or Form 990-EZ.

    3. Match the deposits to the amounts reported on the Form 8872, state or FEC reports.

    4. Discrepancies identified between Form 8872 and the books can result in penalties of 35 percent of the amount incorrectly reported. IRC §527(j)(1), (Form 8278, Page 2). See IRM 4.76.30.3.2(8) for a discussion of the penalty.

    5. If interest was identified and no Form 1120-POL was filed, determine whether the amount of non-exempt function income exceeded the $100 specific deduction.

    6. Prior to pursuing assessment of tax, interview the officers to collect any additional facts to add to the fact pattern and to discuss the issue prior to generating any reports.

4.76.30.4.4  (06-04-2010)
Exempt Function Expenditures

  1. IRC §527(e)(4) provides that the term "expenditures " has meaning given in IRC §271(b)(3), whose definition of expenditures inclusively lists "a payment, distribution, loan, advance, deposit, or gift, of money or anything of value and includes a contract promise or agreement to make an expenditure, whether or not legally enforceable." Generally, these expenditures include anything that supports and individual's campaign.

  2. The regulations divide exempt function activities (expenditures) into "directly related expenses" (Regulation §1.527-2(c)(1)) and "indirect expenses" (Regulation §1.527-2(c)(2)).

  3. Direct expenditures include anything that supports the individual's campaign. Expenditures that are necessary to support the directly related activities of a political organization are indirectly related to its exempt function. Expenditures that are considered necessary to support the activities of a political organization are those attributed to overhead, record keeping, and fund-raising.

  4. Travel, lodging, food, and similar expenses of a candidate and the candidate's spouse for campaign-related travel are considered to be for an exempt function.

  5. Under Regulation §1.527-2(c)(5), expenditures for attending a testimonial dinner to aid a campaign effort or expenditures for voice and speech lessons to improve a candidate's skills are for an exempt function.

  6. Regulation §1.527-2(c)(1) provides that it is not necessary for the individual to be an announced candidate for the office; whether he or she ever becomes a candidate is, in fact, not crucial.

    1. In Private Letter Ruling 82-43-142 (July 28, 1982), an organization supporting an individual who was "testing the waters" for a possible presidential bid qualified for treatment as an IRC 527 organization, even though it was not required to file with the FEC.

    2. In Technical Advice Memorandum 93-20-002 (Jan. 14, 1993), an organization was maintained on behalf of a former member of the U.S. House of Representatives for a possible campaign for the U.S. Senate, although the individual did not run for election during the period at issue and ultimately did not run for the Senate seat.

  7. The activities do not need to be related to a particular candidate's or office holder's own campaign.

    1. In Revenue Ruling 79-12, 1979-1 C.B. 208, the payment of the expenses of an elected legislator to attend a political party's convention as a delegate by the legislator's campaign committee from a prior election is held to be an exempt function activity because it involves the selection process.

    2. In Revenue Ruling 79-13, 1979-1 C.B. 208, the payment of expenses for voter research, public opinion polls, and voter canvasses on behalf of a candidate is an exempt function activity, even when the funds expended were contributed to the organization in connection with the candidate's campaign for different public office.

    3. Per Regulation §1.527-2(c)(5)(viii), expenditures for seminars and conferences that are intended to generate support for candidates with political philosophies in harmony with that of an IRC §527 organization are also for an exempt function.

    4. The common practice whereby a candidate or officeholder uses funds accumulated in his or her campaign committee to make contributions to support other candidates for public office is an exempt function activity.

  8. Expenditures for an election night party for political campaign workers are "an inherent part of, and the traditional public culmination of, the selection process;" therefore, these are exempt function expenditures. Revenue Ruling 87-119, 1987-2 C.B. 151, Q&A 1.

  9. Cash awards to campaign workers after an election are for an exempt function if the amount given each worker is reasonable, considering the exempt function services the worker rendered and the amount of other compensation, if any, already paid. Revenue Ruling 87-119, 1987-2 C.B. 151, Q&A 2.

  10. Regulation §1.527-2(c)(5)(vii) states that expenditures by an IRC §527 organization between elections to train staff members for the next election, draft party rules, implement party reform proposals, and sponsor a party convention are for an exempt function.

  11. Under the proper circumstances, payment of a salary to a candidate for the candidate's service to the campaign committee may constitute an exempt function expenditure.

    1. In Technical Advice Memorandum 95-16-006 (Jan. 10, 1995), which concluded that payment to the candidate was an exempt function expenditure, the candidate worked over 80 hours per week for the campaign, performing services substantially similar to those he had preformed in his pre-campaign employment. He was paid reasonable salary for those services, amounting to 37 percent of the amount he earned from his regular employment and 60 percent of the amount he would earn if elected to public office.

    2. However when campaign committee makes payments for the personal benefit of a candidate that are not paid as compensation and are not treated as compensation by the organization. In that case the amounts paid are not exempt function expenditures, although they are considered to be income to the candidate in accordance with Regulation §1.527-5(a)(1).

  12. Payment of a spouse's expenses in connection with a political campaign may be considered an exempt function activity so long as there is a nexus established between the spouses's activity and the exempt function of attempting to influence the selection, nomination, election or appointment of an individual to public office. Regulation §1.527-2(c)(5)(ii), Example (2).

  13. An activity that is in furtherance of the process of terminating an IRC §527 organization's existence is an exempt function activity per Regulation §1.527-2(c)(3). For example, where an organization is established to further a single campaign, its post-campaign activities of paying campaign debts, winding up the campaign, and putting its records in order are for an exempt function.

  14. Illegal expenditures are not exempt function expenditures even though made in connection with the selection process.

  15. The following types of expenditures are not considered exempt function expenditures:

    1. Expenditures directly related to the appearance of IRC §501(c) organizations before legislative bodies in response to a written request for the purpose of influencing the appointment or confirmation of an individual to a public office.

    2. Expenditures for nonpartisan activities such as voter registration drives and "get out the vote" campaigns.

4.76.30.4.4.1  (06-04-2010)
Examination Guidelines: Exempt Function Expenditures

  1. Check http://forms.irs.gov/politicalOrgsSearch/search/basicSearch.jsp?ck for any Forms 8872 filed by the organization.

    1. If present, review the list of expenditures made. These can include contributions to other political organizations.

    2. Compile a spreadsheet of dates, payees, and expenditures made.

    3. Determine the total amount of expenditures reported for the year.

    4. Make notes of expenditures that do not clearly appear to be exempt in nature. Include these as interview questions and/or requests for information on these expenditures.

  2. Check the state website, listed at http://.irs.gov/charities/political/article/0,,id=176406,00.html, for any information returns filed with the state.

    1. If present, review the list of expenditures made.

    2. Compile a spreadsheet of dates, payees, and expenditures made.

    3. Determine the total amount of expenditures reported for the year.

    4. Compare the expenditures reported with the Forms 8872, if filed, to identify any discrepancies.

    5. Make notes of expenditures that do not clearly appear to be exempt in nature. Include these as interview questions and/or requests for information on these expenditures.

  3. If there are no reports filed with the state, check the FEC filings at www.fec.gov.

    1. If present, review the list of expenditures made.

    2. Compile a spreadsheet of dates, payees, and expenditures made.

    3. Determine the total amount of expenditures reported for the year.

    4. Compare the expenditures reported with the Forms 8872, if filed, to identify any discrepancies.

    5. Make notes of expenditures that do not clearly appear to be exempt in nature. Include these as interview questions and/or requests for information on these expenditures.

  4. Obtain a copy of any Forms 1120-POL filed by the organization, available from On-line SEIN(http://sein.osc.irs.gov)

    1. The political organization may only deduct those expenses that are directly related to earning taxable income. For example, the organization may not deduct the salary of its campaign director. However, if the political organization hires a broker to manage its stock portfolio, it can deduct that expense from taxable dividend and capital gain income derived.

    2. Review the Form 1120-POL to see if any non-exempt function expenditures were reported on Line 7.

    3. Compare the expenses, if any, reported on the Form 1120-POL to those of the Forms 8872, state or FEC reports, to identify any discrepancies.

    4. Identify any expenses reported on Lines 9 through 15, and discuss these with the organization's officer. Determine whether there are exempt function expenditures that have been erroneously deducted.

    5. If exempt function expenditures have been erroneously deducted, prepare a report of examination (RAR and manually completed Form 4549).

  5. Check On-Line SEIN (http://sein.osc.irs.gov)to see if any Forms 990 or 990-EZ were filed by the organization. All expenses, taxable or otherwise should be reported.

    1. Review the Form 990, core schedule, Part IX for the expenses reported (if filed). Review page 1 of the Form 990-EZ if filed in lieu of the Form 990.

    2. Match the investment expenses reported, if any, against the amounts reported on Form 1120-POL.

    3. Compare the amounts reported on Form 990 as expenditures against the amounts reported on Form 8872, state or FEC reports.

    4. Identify any discrepancies in amounts reported.

    5. Review Part IV of the Form 990 core schedule for answers to Lines 3, 17, 18, 19, 29, and 34.

    6. Review Schedules C, G, and M, if attached.

  6. Review the books of the organization.

    1. For accounts at financial institutions, review the bank statements for expenditures, withdrawal, and transfer amounts.

    2. For withdrawals and transfers, ask officer(s) of the organization as to the purpose and end use of the funds withdrawn/transferred. Obtain documentation supporting their statements, if available.

    3. Match the expenditures to the amounts reported on the Forms 8872, state or FEC reports.

    4. Discrepancies identified between Form 8872 and the books can result in penalties of 35 percent of the amount incorrectly reported. IRC §527(j)(1). (Form 8278, Page 2.) See IRM 4.76.30.3.2(8) for a discussion of the penalty.

    5. If non-exempt expenditures, withdrawals, or transfers have been identified, that were not reported on Form 1120-POL, prepare a report of examination (RAR and manually completed Form 4549), in the event the taxable income is in excess of the $100 specific deduction.

4.76.30.4.5  (06-04-2010)
Political Organization Taxable Income

  1. Political organizations are taxed on their non-exempt function income, non-exempt function expenditures and illegal expenditures. This taxable income is reported on Form 1120-POL.

  2. The most common type of political organization taxable income is investment income, including:

    • Interest

    • Dividends

    • Rents

    • Royalties

    • Net gains from the sale or exchange of assets

  3. To compute the political organization taxable income use the following formula:

    1. Non-exempt function income

    2. Plus non-exempt function expenditures

    3. Plus illegal expenditures

    4. Less deductions allowed by law

    5. Less specific deduction of $100 (Not permitted for newsletter funds.)

    6. Equals taxable income.

      Note:

      For a newsletter fund to be described in IRC §527(g), a fund must meet three requirements. First, it must be established and maintained by an individual who holds, has been elected to or is a candidate for nomination or election to, any federal, state, or local elective public office. Second, the fund must be established for use by such individual exclusively to prepare and circulate the individual's newsletter (the "organizational test" ). IRC §527(g)(1); Regulation §1,527-7(a),

  4. Regulation §1.527-4(c)(1) provides that expenses, depreciation, and similar items are deductible only if they satisfy both of the following requirements:

    1. The must qualify as deductions allowed under Chapter 1; and

    2. They must be "directly connected" with producing political organization taxable income.

  5. To be "directly connected" a deduction item must have a proximate and primary relationship to producing taxable income and have been incurred in producing such income. Regulation §1.527-4(c)(2). If an item is attributable solely to producing taxable income, it is allowed under IRC §527.

  6. IRC §527(c)(2) provides three modifications:

    1. A specific deduction of $100 is provided. IRC §527(c)(2)(A). ("Newsletter funds" however, may not take the $100 deduction.)

    2. No net operating loss deduction under IRC §172 is allowed. IRC §527(c)(2)(B).

    3. The dividends received deduction and other special deductions available to taxable corporations under Part VIII of subchapter B of the Code (IRC §§241-249) are not allowed. IRC §527(c)(2)(C).

  7. Where facilities or personnel are used both for exempt function and taxable purposes, deduction relating to that use must be allocated between exempt function and taxable income. Regulation §1.527-4(c)(3) requires that such an allocation be "on a reasonable and consistent basis. "

  8. Time spent on exempt function and taxable activities is a permitted basis for allocating salaries of personnel.

  9. Indirect expenses are not deductible. The legislative history states, "Indirect expenses (such as general administrative expenses) are not to be allowed as deductions, since it is expected that these amounts will be relatively small and eliminating these deductions will greatly simplify tax calculations." . Rep. No. 93-1374, 93d Cong., 2d Sess. 29 (1974), 1975-1 C.B. 517, 533.

  10. With the exception of principal campaign committee, the rate of tax on taxable income of political organizations is the highest rate specified in IRC §11(b). As of the 2008 Form 1120-POL, this amount was 35 percent.

  11. A political organization that is a principal campaign committee of a candidate for U.S. Congress computes its tax in the same manner as provided in IRC §11(b) for corporations. The formula can be found on Form 1120-POL, Page 6.

    Note:

    For purposes of IRC §527, a "principal campaign committee" is the political campaign committee designated by a candidate for Congress as the candidate's principal campaign committee for purposes of §302(e) of the FECA (2 U.S.C. §432(e)). IRC §527(h)(2)(A). Therefore, principal campaign committees of candidates for public offices other than those in the United States Congress cannot qualify for treatment as a "principal campaign committee" under IRC §527.

4.76.30.4.5.1  (06-04-2010)
Examination Guidelines: Political Organization Taxable Income

  1. Complete the reviews of income and expenses outlined in IRM 4.76.30.4.3.1.

  2. Using the spreadsheets generated, identify all amounts of taxable income, illegal expenditures, and non-exempt function expenditures.

  3. Verify whether these amounts have been reported on Form 1120-POL.

  4. If the Form 1120-POL matches your calculations, close the Form 1120-POL as a no change (unless penalties were determined to apply to Forms 8872. See (7) below).

  5. If no Form 1120-POL has been filed, create a module on RCCMS for the delinquent tax period and update to status 12, suing push code 036, and alpha code EE. (This is preferable to the 8 week period for processing a delinquent return).

    1. Create a report of examination (RAR), documenting the records reviewed, the law applicable to the taxable income, and the tax computed.

    2. Prepare a Form 4549 manually (cannot be generated by RGS) to accompany the report.

    3. Issue the report via a preliminary findings report (draft RAR) to the organization, in order to preserve the right to seek a Fast Track Settlement.

    4. If no response to the 30 day draft report, issue formal report via certified mail using Letter 3621. Use Form 4549-A in lieu of Form 4549 and include Form 4620.

    5. Use Letter 3607 for closing as agreed, prepared with a photocopy of the signed Form 4549 and a copy of the Form 886-A

  6. If the Form 1120-POL has been filed and the amounts do not match:

    1. Create a report of examination (RAR), documenting the records reviewed, the law applicable to the taxable income, and the tax computed.

    2. Prepare a Form 4549 manually (cannot be generated by RGS) to accompany the report.

    3. Issue the report via a preliminary findings report (draft RAR) to the organization, in order to preserve the right to seek a Fast Track Settlement.

    4. If no response to the 30 day draft report, issue formal report via certified mail using Letter 3621. Use Form 4549-A in lieu of Form 4549 and include Form 4620.

    5. Use Letter 3607 for closing as agreed, prepared with a photocopy of the signed Form 4549 and a copy of the Form 886-A.

  7. If penalties are to be proposed with respect to missing Form 8872, or incorrect information on Form 8872, create a civil penalty file to be associated with the Form 1120-POL file. See IRM 4.76.30.3.2(8) for a discussion of the penalty.

    1. Prepare Form 8278 to record the amount of penalty proposed. Instructions for completion of the Form 8278 are located on Page 5 of the Form 8278.

    2. Prepare a Penalty Case File folder, including Form 5772, 886-A, 8278, 3198-A, 4620, and 3244-A (if applicable).

    3. Obtain managerial approval to assess the penalty.

    4. Associate the Penalty Case File folder with the folder of the primary return involved in the examination of the entity.

4.76.30.5  (06-04-2010)
IRC §527(f)(3) Separate Segregated Funds

  1. In order to avoid the application of tax on political expenditures made by IRC §501(c) organizations, the organization may create a separate segregated fund under IRC §527(f)(3) for the purpose of making political expenditures that will be treated as a separate political organization.

  2. The earnings and expenditures made by the segregated fund will not be attributed to the IRC §501(c) organization.

  3. In order for the segregated fund to qualify as a political organization:

    1. The purpose of the fund must be receive and segregate exempt function income, and earnings on such income, for use only for an exempt function or for an activity necessary to fulfill an exempt function.

    2. If more than an insubstantial amount is spent on non-exempt function activities, the fund will not be treated as a segregated fund for that year.

    3. A segregated fund does not have to meet the operational test. It can be simply a checking account, as long as it is clearly identified and established for the purpose intended. Such funds are required to have their own Employer Identification Number (EIN), separate from that of the parent §501(c) organization.

  4. An IRC §501(c) organization may solicit contributions or membership dues for a separate segregated fund or organization. The transfer of such funds to the separate organization will not be treated as an expenditure for an exempt purpose if:

    1. The transfer is made promptly after receipt and directly to the separate segregated fund,

    2. A transfer is considered to be made "promptly" if the procedure followed satisfy applicable federal and state campaign law and regulations,

    3. The IRC §501(c) organization maintains adequate records to show the amounts transferred were political contributions and dues and not investment income, and

    4. The political contributors and dues were not used to earn investment income for the IRC §501(c) organization.

  5. Exempt function expenditures of an IRC §501(c) organization include all expenditures that are directly related to the selection process, including indirect expenditures made through another organization.

  6. However, depending on the facts and circumstances, an IRC §501(c) organization that takes reasonable steps when it transfers funds to an individual or organization to ensure that the transferee does not use the funds for an exempt function will not be absolutely liable under IRC §527(f), even if the transferee eventually uses the funds for political activities.

  7. If a separate segregated fund does not meet the requirements for a political organization under IRC §527(e)(1), it is subject to tax, as a taxable organization, under general tax principles.

  8. If a fund loses its status as a separate segregated fund under applicable federal or state law, it is no longer treated as a separate organization for federal tax purposes, under IRC §527(f)(3). In that event, expenditures made from such a fund will subject the IRC §501(c) organization that maintains it to tax, pursuant to IRC §527(f)(1).

4.76.30.5.1  (06-04-2010)
Examination Guidelines: IRC §527(f)(3) Separate Segregated Funds

  1. When examining a §501(c) organization (other than §501(c)(3), determine whether the organization has any political activities. These can include:

    • Radio/television/newspaper attack/"information" advertisements

    • Partisan voter guide

    • Guest speakers at events

    • Rallies

    • Dinner Fund-raisers

    • Debates

    • Newspaper editorials

    • Endorsements

      Note:

      Such activities may be mentioned during the initial interview, however, these will more likely appear in web searches or amongst the organization's materials.

  2. If there are political activities, determine whether the organization has properly established a separate segregated fund, complete with requisite EIN:

    1. If so, obtain permission from management to open the tax year on RCCMS.

    2. Consider opening subsequent and prior years of the segregated fund, contingent upon statute considerations.

    3. If Forms 1120-POL have been filed for the fund, open the module on RCCMS, and issue a Letter 3606 to open the examination.

    4. If Forms 1120-POL have not been filed for the fund, open the module on RCCMS, with push code 036, alpha code EE, and issue a Letter 3606 to open the examination.

  3. Review the organization's own records to determine if any political expenditures were made directly by the organization instead of via the fund. Such expenditures may include:

    • Checks to candidates

    • Checks to committees

    • Advertising & publicity

    • Honorarium

    • Travel expenses

    • Polls, surveys, white papers

    • Fund-raisers

    • Newsletters

      Caution:

      Review Big Mama Rag, Inc. v. U.S., 80-2 U.S.T.C. prior to making any determinations that a newsletter expense is political in nature and not educational.

  4. If political expenditures were made directly from the organization and not through the fund, prepare a report as outlined in IRM 4.76.30.4.5.1(5) above, using the EIN of the organization. The organization is subject to the highest rate under IRC §11(b).

    Note:

    Verify that the amount to be taxed meets the Form 1120-POL filing requirement threshold ($100 specific deduction) before proceeding with this step.

  5. If the organization failed to establish a segregated fund, and made political expenditures, prepare a report as outlined in IRM 4.76.30.4.4.1(5) above, using the EIN of the organization. The organization is subject to the highest rate under IRC §11(b).

    Note:

    Verify that the amount to be taxed meets the Form 1120-POL filing requirement threshold ($100 specific deduction) before proceeding with this step.

  6. If the organization properly established the segregated fund, determine whether all of the political expenditures made via the fund are for exempt purposes. For those expenditures that are determined to be for non-exempt purposed or are illegal expenditures, verify whether the amounts were properly reported on Form 1120-POL.

    1. If Form 1120-POL was not filed, prepare a report as outline in IRM 4.76.30..4.5.1(5) above, using the EIN of the organization. The organization is subject to the highest rate under IRC §11(b)

    2. If Form 1120-POL was filed, and the amounts do not match, prepare a report as outline in IRM 4.76.30..4.5.1(6) above, using the EIN of the organization. The organization is subject to the highest rate under IRC §11(b).

    3. If the amounts are less than the filing requirement (the $100 specific deduction), close as a no change with advisory.

  7. Determine whether the segregated fund had taxable income of its own.

    1. Verify the amounts against any Forms 1120-POL filed.

    2. If no Form 1120-POL was filed and there was taxable income, verify that the amount to be taxed meets the Form 1120-POL filing requirement threshold ($100 specific deduction).

    3. If Form 1120-POL was not filed, and the taxable income exceeds the $100 specific deduction, prepare a report as outlined in IRM 4.76.30.4.5.1(5) above, using the EIN of the organization. The organization is subject to the highest rate under IRC §11(b)

    4. If Form 1120-POL was filed and the amounts do not match, prepare a report as outlined in IRM 4.76.30.4.5.1(6) above, using the EIN of the organization. The organization is subject to the highest rate under IRC §11(b).

    5. If no Form 1120-POL was filed and the taxable income (with non-exempt function expenditures) do not exceed $100, close as a no-change case with advisory.

  8. Determine whether transfers to the fund from the §501(c) organization met the requirements outlined in IRM 4.76.30.5(4) above.

    1. General Counsel Memorandum 39837 held that in facts particular to the case, transfers from interest bearing checking accounts of Code §501(c)(5) and Code §501(c)(6) organizations to separate segregated funds were made "promptly and directly" within the meaning of Regulation §1.527-6(e). In this particular case, dues were received daily, deposited into a general interest bearing checking account, and transferred twice a month to its separate segregated fund, within the federal and state election guidelines. Internal accounting records allocated the amounts received between dues and PAC funds, indicating the retention of the interest income in the union's coffers.

    2. If the transfers meet neither the requirements outlined in IRM 4.76.30.5(4) or General Counsel Memorandum 39837, prepare a report as outlined in IRM 4.76.30.4.5.1(5) above, using the EIN of the organization. The organization is subject to the highest rate under IRC §11(b).


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