7.25.3  Religious, Charitable, Educational, Etc., Organizations (Cont. 3)

7.25.3.16 
Inurement, Private Benefit, and Intermediate Sanctions

7.25.3.16.8  (02-23-1999)
Permissible Benefits

  1. Tax advantages or other incidental benefit to an individual or entity from transactions with a controlled exempt organization does not necessarily result in private benefit or inurement of net earnings.

  2. A charity purchased securities from its creator for less than the fair market value. The creator claimed a charitable contribution equal to the difference between the fair market value of the securities and the price at which they were sold to the charity. Although the transaction may have resulted in an advantage to the creator the charity profited from the transaction and its exemption was not affected. Wiilam Waller, et al. v. Commissioner, 39 T.C. 665 (1963), acq., 1963–2 C.B. 5. See also Rev. Rul. 69–39, 1969–1 C.B. 148.

  3. Where a business corporation donated lands and money to a foundation to establish a public park, exemption was not jeopardized by the donor’s retention of the right to use as a brand symbol a scenic view located in the park. Rev. Rul. 66–358, 1966–2 C.B. 218.

  4. A corporation created an organization to operate a replica of an early 19th Century American village named after the corporation. The corporation donated the land upon which the village was located and provided a substantial amount of financial support. Although the corporation benefits by having its name mentioned in conjunction with the organization’s advertising program, such benefits are merely incidental to benefits flowing to the general public from access to the village and its historic structures. Rev. Rul. 77–367, 1977–2 C.B. 193.

  5. An organization subsidized recent law graduates who provided free legal services to low income residents of economically depressed communities. Any private benefit derived by the legal interns is incidental to the public charitable purpose. Rev. Rul. 72–559, 1972–2 C.B. 247.

7.25.3.16.9  (02-23-1999)
Digests of Precedent

  1. Nurses’ registers—A nonprofit community nursing bureau that maintains a register of qualified nursing personnel, including graduate nurses, unregistered nursing school graduates, licensed attendants and practical nurses, for the benefit of hospitals, health agencies, doctors and individuals, as a community project, qualifies for IRC 501(c)(3) exemption. It receives financial support from community organizations and public contributions. Rev. Rul 55–656, 1955–2 C.B. 262.

  2. Employee benefits—A trust organized to pay pensions to retired employees is not exempt under IRC 501(c)(3). Rev. Rul. 56–138, 1956–1 C.B. 202.

  3. Hospitals—The necessary criteria for a hospital to qualify for exemption as a public charitable organization are outlined. Modified by Rev. Rul. 69–545, to remove the requirement relating to caring for patients without charge or at rates below cost. Rev. Rul. 56–185, 1956–1 C.B. 202.

  4. Nurses’ registers; maintaining an employment registry—A nurses’ association that maintains an employment registry primarily for the employment of members is not entitled to IRC 501(c)(3) exemption. Rev. Rul. 61–170, 1961–2 C.B. 112.

  5. Research and development—An organization that makes research grants for the development of new machinery to be used in particular commercial operations and retains all the rights to the new developments does not qualify for exemption under IRC 501(c)(3). Rev. Rul. 65–1, 1965–1 C.B. 226.

  6. Business benefits—A nonprofit organization that makes funds available to authors and editors for preparing teaching materials and writing text books, and under the terms of the contract with the publisher receives royalties from the sales of published materials and then shares them with those individuals, does not qualify for exemption under IRC 501(c)(3). Rev. Rul. 66–104, 1966–1 C.B. 135.

  7. Trusts—reversionary interest—A trust that provides for the reversion of principal on termination to the creator does not qualify for exemption under IRC 501(c)(3). Rev. Rul. 66–259, 1966–2 C.B. 214.

  8. Public park—Where a business corporation donated lands and money to a foundation to establish a public park, exemption under IRC 501(c)(3) was not jeopardized by the donor’s retention of the right to use as a brand symbol a scenic view located in the park. Rev. Rul. 66–358, 1966–2 C.B. 218.

  9. Investments benefiting insiders; family controlled foundations—A foundation, controlled by the creator’s family and operated to enable the creator and his family to engage in financial activities beneficial to them, results in the foundation’s ownership of non-income-producing assets which prevents its carrying on a charitable program commensurate in scope with its financial resources. It is not entitled to exemption. Rev. Rul. 67–5, 1967–1 C.B. 123.

  10. Financial support of other organizations—An organization provides financial assistance to exempt organizations by distributing funds at periodic intervals. It carries on no operations other than to receive contributions and incidental investment income, not accumulated. It is exempt from tax. Rev. Rul. 67–149, 1967–1 C.B. 133.

  11. Private benefit; personal grants—An organization whose sole activity is the operation of a "scholarship fund" plan that makes payments to pre-selected, specifically named individuals, does not qualify for exemption. Rev. Rul. 67–367, 1967–2 C.B. 188.

  12. Commercial drug testing—A nonprofit organization primarily engaged in testing drugs for commercial pharmaceutical companies does not qualify for exemption under IRC 501(c)(3). Rev. Rul. 68–373, 1968–2 C.B. 206.

  13. Pension plan—An organization created pursuant to the will of a stockholder of a company to pay pensions to all retired employees of that company does not qualify for exemption under IRC 501(c)(3). Rev. Rul. 68–422, 1968–2 C.B. 207. See also Rev. Rul. 56–138, 1956–1 C.B. 202.

  14. Financial support of other organizations—An organization will not jeopardize its exemption even though it distributes funds to nonexempt organizations, provided it retains control and discretion over use of the funds for IRC 501(c)(3) purposes. Rev. Rul. 68–489, 1968–2 C.B. 210.

  15. Permissible benefits—A charitable organization’s exemption from tax will not be affected by purchasing securities from its creator (and sole trustee) at the price he paid for them and reselling them at a profit. Rev. Rul. 69–39, 1969–1 C.B. 148.

  16. School bus transportation—A nonprofit organization formed by parents of pupils attending a private school that provides school bus transportation for its members’ children serves a private rather than a public interest. Rev. Rul. 69–175, 1969–1 C.B. 149.

  17. Deferred or retained interests—The exempt status of an organization is not affected by the acceptance of an income-producing asset subject to a reserved life estate in the transferor or in exchange for an annuity specifically charged against the asset. Rev. Rul. 69–176, 1969–1 C.B. 150.

  18. Perpetual care—A testamentary trust established to make annual payments to exempt charitable organizations and to use a fixed sum from annual income for the perpetual care of the testator’s burial lot is not exempt under IRC 501(c)(3). Rev. Rul. 69–256, 1969–1 C.B. 150.

  19. Private benefit—An organization, formed and controlled by a medical doctor to conduct research programs consisting of examining and treating patients who are charged the prevailing fees for services rendered, is not exempt under IRC 501(c)(3). Rev. Rul. 69–266, 1969–1 C.B. 151.

  20. Private benefit—An irrevocable inter vivos trust which provides that a fixed percentage of income must be paid annually to the settlor with the balance to charity is organized and operated for private interests. Rev. Rul. 69–279, 1969–1 C.B. 152.

  21. Hospital specialist—The exempt status of a hospital under IRC 501(c)(3) will not be jeopardized where, after arms’ length negotiations, it enters into an agreement with a hospital based specialist for compensation on the basis of a fixed percentage of the departmental income. Rev. Rul. 69–383, 1969–2 C.B. 113. See also Rev. Rul. 69–545, 1969–2 C.B. 117.

  22. Hospital; office building leased to medical group—The leasing of its adjacent office building, and the furnishing of certain services, by an exempt hospital to a hospital-based medical group is not unrelated trade or business. Rev. Rul. 69–463, 1969–2 C.B. 131.

  23. Financial support of other organizations—A nonprofit organization, created to construct and maintain a building for the exclusive purpose of housing and serving exempt member agencies of a community chest, may be exempt. The performance of a particular activity that is not inherently charitable may nonetheless further a charitable purpose. The overall result in any given case is dependent on why and how that activity is actually being conducted. Rev. Rul. 69–572, 1969–2 C.B. 119.

  24. Industrial association—A nonprofit organization composed of members of a particular industry to develop a new and improved use for existing products of the industry is not exempt under IRC 501(c)(3) but may qualify under IRC 501(c)(6). Rev. Rul. 69–632, 1969–2 C.B. 120.

  25. Resource conservation—A nonprofit organization formed to preserve and improve a lake used extensively as a public recreational facility qualifies for exemption under IRC 501(c)(3). Rev. Rul. 70–186, 1970–1 C.B. 128.

  26. Day care center—A children’s day-care center that is primarily funded by Federal grants and is not restricted to children of employees of the sponsoring employer but instead is open to members of the community and selects children on the basis of financial needs and children’s needs, is exempt under IRC 501(c)(3). Rev. Rul. 70–533, 1970–2 C.B. 112.

  27. Cooperative art gallery—A cooperative art gallery formed and operated by a group of artists for the purpose of exhibiting and selling their works does not qualify for exemption under IRC 501(c)(3). Rev. Rul. 71–395, 1971–2 C.B. 228.

  28. City Bar Association—A city bar association exempt under IRC 501(c)(6) that primarily directs its activities to the promotion and protection of the practice of law may not be reclassified as an educational or charitable organization under IRC 501(c)(3). Rev. Rul. 71–505, 1971–2 C.B. 232.

  29. Low income housing—An organization formed to provide low income housing to families but giving preference for housing to employees of a farm proprietorship operated by the individual who created and controls the organization does not qualify for exemption under IRC 501(c)(3). Rev. Rul. 72–147, 1972–1 C.B. 147.

  30. Business benefits; legal aid—An organization formed to provide legal services for low income residents of economically depressed communities is exempt as a charitable organization under IRC 501(c)(3). Rev. Rul. 72–559, 1972–2 C.B. 247.

  31. Medical peer review—A nonprofit organization formed by members of a State medical association to operate medical peer review boards is primarily furthering the common business interests of members and exempt under IRC 501(c)(6) but not exempt under IRC 501(c)(3). Rev. Rul. 74–553, 1974–2 C.B. 168. See also Rev. Rul. 73–567, 1973–2 C.B. 178.

  32. Law library—An organization operating a law library whose rules limit use to members of a local bar association composed of substantially all of the members of the legal profession in the municipality qualifies for exemption under IRC 501(c)(3). Rev. Rul. 75–196, 1975–1 C.B. 155.

  33. Hospitals; purchase of intangible assets by related organization—The purchase, in a transaction not at arm’s length, of all the assets of a profit-making hospital by a nonprofit hospital corporation at a price that includes the value of intangible assets, determined by the capitalization of excess earnings formula by an independent appraiser, does not result in the inurement of the hospital’s net earnings to the benefit of any private shareholder or individual or serve a private interest precluding exemption. Rev. Rul. 76–91, 1976–1 C.B. 149.

  34. Educational; for-profit school converted to nonprofit school—An organization that purchases or leases at fair market value the assets of a former for-profit school and employs the former owners, who are unrelated to the current directors, at salaries commensurate with their responsibilities, is operated exclusively for educational and charitable purposes. An organization that takes over a school’s assets and its liabilities, which exceed the value of the assets and include notes owed to the former owners and current directors of the school, is serving the directors’ private interests and is not operated exclusively for educational and charitable purposes. Rev. Rul. 76–441, 1976–2 C.B. 147

  35. Testing cargo containers—An organization that inspects and certifies the safety of cargo shipping containers is not operated exclusively for the purposes of testing for public safety or for scientific purposes. Rev. Rul. 78–426, 1978–2 C.B. 175. Rev. Rul. 65–61 distinguished.

  36. Benefit to founder, rent-free facility—In an IRC 7428 action, the Tax Court upheld the Service’s determination that the organization, whose secondary purpose was promotion of the (hand) papermaking industry, was not described in IRC 501(c)(3). The organization also provided rent-free facilities to the founder, although the founder received no compensation for his work with the organization. The Service had determined that promotion of the papermaking industry was a substantial non-exempt purpose and that the organization provided private benefit to the founder. The court ruled that the organization had not carried its burden of proof to show the Service’s determination was erroneous. The Church of the Living Tree v. Commissioner, T.C. Memo 1996–291 (1996).

7.25.3.17  (02-23-1999)
Attempting to Influence Legislation

  1. IRC 501(c)(3) expressly limits the amount of lobbying an organization can do without jeopardizing exempt status, providing "no substantial part of the activities of which is carrying on propaganda, or otherwise attempting to influence legislation…"

    1. The limitation on the lobbying activities of IRC 501(c)(3) organizations was added to the statute by the Revenue Act of 1934. The legislative history is sparse.

  2. In Regan v. Taxation with Representation of Washington, 461 U.S. 540 (1983), the Supreme Court addressed the question of whether the IRC 501(c)(3) restriction on lobbying violates constitutional guarantees. The Court unanimously held that the IRC 501(c)(3) restriction on lobbying activities violates neither the freedom of speech guarantee of the First Amendment nor the equal protection doctrine of the Fifth Amendment. Concerning the First Amendment issue, the Court stated that this aspect of the case was controlled by its decision in Cammarano v. United States, 358 U.S. 498 (1959). In Cammarano, the Court upheld a Treasury Regulation (antecedent to the passage of IRC 162(e)), that denied business expense deductions for lobbying activities.

  3. As to TWR’s equal protection claim, the Court stated that the general rule of statutory classifications is that such classifications are valid if they bear a rational relation to a legitimate governmental purpose, and that "[l]egislatures have especially broad latitude in creating classifications and distinctions in tax statutes." 461 U.S. at 547. The Court noted that while statutes are subject to a higher level of scrutiny if they interfere with the exercise of a fundamental right, such as freedom of speech, the IRC 501(c)(3) legislative restriction does not infringe upon freedom of speech; therefore, the statutory distinction in treatment of IRC 501(c)(3) and IRC 501(c)(19) organizations need only have a rational basis. The Court found such a basis.

    1. Regan v. Taxation with Representation of Washington was foreshadowed by Christian Echoes National Ministry, Inc. v. United States, 470 F.2d 849 (10th Cir. 1972); cert. denied, 414 U.S. 864 (1973), where the Tenth Circuit dismissed a claim that the IRC 501(c)(3) prohibition on lobbying and political activities was an unconstitutional restriction on the organization’s freedom of speech.

  4. Reg. 1.501(c)(3)–1(c)(3) state that an organization is not operated exclusively for exempt purposes if it is an "action" organization. The term "action organization" describes both organizations that attempt to influence legislation and organizations that intervene in political campaigns, which are discussed in IRM 7.25.3.17.

  5. The two kinds of legislative action organizations are:

    1. An organization that attempts to influence legislation as a substantial part of its activities. Reg. 1.501(c)(3)–1(c)(3)(ii) provides that an organization will be regarded as attempting to influence legislation if it: contacts or urges the public to contact members of a legislative body for the purpose of proposing, supporting, or opposing legislation, or advocates the adoption or rejection of legislation.

    2. An organization with the two characteristic set out in Reg. 1.501(c)(3)–1(c)(3)(iv): its main or primary objective or objectives (as distinguished from its incidental or secondary objectives) may be attained only by legislation or a defeat of proposed legislation; and it advocates, or campaigns for, the attainment of such main or primary objective or objectives as distinguished from engaging in nonpartisan analysis, study, or research and making the results thereof available to the public. In determining whether an organization has such characteristics, all the surrounding facts and circumstances, including the articles and all activities of the organization, are to be considered.

7.25.3.17.1  (02-23-1999)
Attempts to Influence Legislation

  1. Attempts to influence legislation are not limited to direct appeals to members of the legislature (direct lobbying). Indirect appeals to legislators through the electorate or general public (indirect or "grass roots" lobbying) also constitute attempts to influence legislation. Both direct and indirect lobbying are nonexempt activities subject to the IRC 501(c)(3) limitation on substantial legislative action.

    1. Whether a communication or an appeal constitutes an attempt to influence legislation is determined on the basis of the facts and circumstances surrounding the communication in question.

    2. For IRC 501(c)(3) purposes, the distinction between direct and indirect lobbying becomes important for public charities making the IRC 501(h) lobbying election. (Discussed at IRM 7.25.3.17.2) There are separate limits for total lobbying—IRC 4911(c)(2) lobbying nontaxable amount—and for indirect Iobbying—IRC 4911(c)(4) grassroots nontaxable amount.

    3. In addition, certain communications made by an IRC 501(c)(3) organization to its members (described in IRC 4911(d)(2)(D)) are not considered attempts to influence legislation, while other communications to members (described in IRC 4911(d)(3)) are considered lobbying.

  2. Attempting to influence legislation includes requesting that an executive body support or oppose legislation. See, Rev. Rul. 67–293, 1967–2 C.B. 185, Roberts Dairy Company v. Commissioner, 195 F.2d 948 (8th Cir. 1952), cert. denied, 344 U.S. 865 (1952). American Hardware and Equipment Company v. Commissioner, 202 F.2d 126 (4th Cir. 1953), cert. denied, 346 U.S. 814 (1953).

  3. Attempting to influence legislation does not include appearing before a legislative committee in response to an official request for testimony.

    1. Rev. Rul. 70–449, 1970–2 C.B. 111, held that a university’s exemption would not be jeopardized when, in response to an official request, it sent representatives who could advise a congressional committee on the possible effects of specific legislation.

  4. The legislative restriction applies to activities undertaken by the organization itself. Thus in Rev. Rul. 72–513, 1972–2 C.B. 246, the legislative activities of a student newspaper did not jeopardize the exemption of the sponsoring university.

  5. Study, research, and discussion of matters pertaining to government and even to specific legislation, may, under certain circumstances, be educational activities rather than attempts to influence legislation. This is so where the study, research, and discussion do not serve merely as a preparatory stage for the advocacy of legislation. (Of course, the primary inquiry is the purpose of the study, research, or discussion.)

    1. In Rev. Rul. 64–195, 1964–2 C.B. 138, and Rev. Rul. 70–79, 1970–1 C.B. 127, a nonprofit organization was held exempt under IRC 501(c)(3) when it engaged in non-partisan study, research, and assembly of materials on prospective court reform legislation and disseminated those materials to the public.

    2. Compare, however, Rev. Rul. 62–71, 1962–1 C.B. 185, which precludes exemption to an organization that, as its primary objective, advocates the adoption of a doctrine or theory that can become effective only by the enactment of legislation.

7.25.3.17.1.1  (02-23-1999)
"Legislation" Defined

  1. Reg. 1.501(c)(3)–1(c)(3)(ii) provides that legislation includes: "... action by the Congress, by any State legislature, by any local council or similar governing body, or by the public in a referendum, initiative, constitutional amendment, or similar procedure."

  2. The term legislation includes foreign as well as domestic laws. Rev. Rul. 73–440, 1973–2 C.B. 177.

  3. Notice 88–76, 1988–27 I.R.B. 34, clarifies that attempts to influence the confirmation of a federal judicial nominee by the Senate is attempting to influence legislation.

  4. IRC 501(c)(3) does not distinguish between "good" legislation and "bad" legislation. For example, Rev. Rul. 67–293, 1967–2 C.B. 185, holds that an organization substantially engaged in promoting legislation to protect or otherwise benefit animals is not exempt under IRC 501(c)(3) even though the legislation it advocates may be beneficial to the community. Similarly, see Murray Seasongood v. Commissioner, 227 F.2d 907 (6th Cir. 1955); John F. Dulles, Exr. v. Johnson, 273 F. 2d 362 (2nd Cir. 1959).)

    1. Although there is contrary precedent, the majority of courts have held that it is not necessary or possible to distinguish between good and bad legislation. This is in accord with the traditional view dating back many years and now reenforced by dicta of the Supreme Court in Cammarano et ux. v. United States, 358 U.S. 498, 512 (1959), to the effect that the statutory restriction on attempts to influence legislation simply "made explicit" a longstanding judicial principle that "political agitation as such is outside the statute, however innocent the aim."

    2. Direct holdings include League of Women Voters of the United States v. United States, 180 F. Supp. 379 (Ct. CI. 1960), cert. denied, 364 U.S. 822 (1960), and Alan B. Kuper v. Commissioner, 332 F.2d 562 (3rd Cir. 1964), cert. denied, 379 U.S. 920 (1964)).

7.25.3.17.1.2  (02-23-1999)
"Substantial" Defined—No Election Made Under IRC 501(h)

  1. Attempts to influence legislation that are less than a substantial part of the organization’s activities will not deprive it of exemption. Whether a specific activity of an exempt organization constitutes a "substantial" portion of its total activities is a factual issue, and there is no simple rule as to what amount of activities is substantial.

    1. The earliest case on this subject, Seasongood v. Commissioner, supra, held that attempts to influence legislation that constituted five percent of total activities were not substantial.

    2. Seasongood provides only limited guidance because the court’s view of activities to measure is no longer supported by the weight of precedent. Further, it is not clear how the court arrived at the five percent figure.

  2. Most courts have not attempted to measure activities by percentage or have stated that a percentage test is not conclusive.

    1. In Christian Echoes National Ministry v. United States, 470 F.2d 849 (10th Cir. 1972), cert. denied, 414 U.S. 864 (1973), at 855, the court explicitly rejected using a percentage test to determine whether lobbying activities were substantial, stating "[a] percentage test to determine whether the activities were substantial obscures the complexity of balancing the organization’s activities in relation to its objectives and circumstances."

    2. In Haswell v. United States, 500 F.2d 1133 (Ct. Cl. 1974), cert, denied, 419 U.S. 1107 (1975), the court used percentage figures to find that an organization’s lobbying activities comprised between 16.6 percent to 20.5 percent of its expenditures in the years in issue. The court concluded that the organization was substantially engaged in lobbying activities. Although the court said that a percentage test is not the only measure of substantiality, it held that in this case the results of such a test were a strong indication that the organization’s purposes were no longer consistent with charity.

  3. Supporting activities, for example, research, must be analyzed to determine if they should be included with attempts to influence legislation. This can be difficult where the activity also serves educational purposes.

    1. In League of Women Voters of the United States v. United States, supra; and Alan B. Kuper v. Commissioner, supra, the courts held that attempts to influence legislation may begin before an organization first addresses itself to the public or to the legislature. Accordingly, they considered time spent discussing public issues, formulating and agreeing on positions, and studying them preparatory to adopting a position, and compared that time with the other activities in determining the substantiality of the attempts to influence legislation.

  4. A private foundation may be liable for Chapter 42 excise taxes on its legislative expenditures under IRC 4945 even though the attempts by an organization to influence legislation have been determined to be insubstantial and the organization’s exemption is not jeopardized by the legislative activity.

  5. For years beginning after December 22, 1987, certain organizations whose IRC 501(c)(3) status is revoked because of substantial lobbying activities are subject to a five-percent excise tax imposed by IRC 4912 on their lobbying expenditures. IRC 4912 also imposes a similar tax at the same rate on any manager of the organization who willfully and without reasonable cause consented to making the lobbying expenditures knowing the expenditures would likely result in the organization’s no longer qualifying under IRC 501(c)(3). There is no limit on the amount of this tax that may be imposed against either the organization or its managers.

  6. The IRC 4912 taxes do not apply to private foundations, which are subject to the tax imposed by IRC 4945. Nor do they apply to any organization that has elected to be subject to the lobbying limitations of IRC 501(h), or is not eligible to make the IRC 501(h) election (churches and certain church-related organizations).

7.25.3.17.1.3  (02-23-1999)
"Substantial" Defined for Organizations That Elect Under IRC 501(h)

  1. To establish more precise standards for determining whether an IRC 501(c)(3) exempt organization’s legislative activities are substantial, Congress enacted IRC 501(h) as part of the Tax Reform Act of 1976. (P.L. 94–455). Eligible public charities (listed in IRC 501(h)(4)) may elect the IRC 501(h) substantiality test. Non-electing organizations (whether eligible or not) will be subject to the ordinary facts and circumstances substantiality test of IRC 501(c)(3).

    Note:

    The IRC 501(h) substantiality test applies for taxable years beginning after December 31, 1976.

  2. On November 5, 1986, a Notice of Proposed Rulemaking (1986 NPRM), containing proposed regulations implementing IRC 501(h) and IRC 4911, was published in the Federal Register. Controversy ensued, particularly over the definition of grass roots lobbying and the allocation rules. The Service and Congress received more than ten thousand letters from charities and their members requesting withdrawal of the proposed regulations. These comments were generated by concerns that the regulations were overly restrictive and would have a "chilling effect" on charities’ involvement in the policy making process.

  3. The Service did not withdraw the 1986 proposed regulations, but publicly stated in an information release, IR–87–49 (April 9, 1987), that it would reconsider key portions of the regulations. Two days of public hearings were held in 1987. In June 1987, the Service announced the establishment of a Commissioner’s Exempt Organizations Advisory Group (as had been suggested by Rep. Dan Rostenkowski, Chairman of the Committee on Ways and Means). At public meetings held on September 17, 1987, and February 26, 1988, possible revisions to the 1986 proposed regulations were discussed with this Advisory Group. Substantial revisions to the regulations were published in proposed form in 1988.

    1. In contrast to the reception accorded the 1986 proposed regulations, the publication of the 1988 proposed regulations resulted in less than 100 written comments. The comments were almost uniformly favorable. The 1988 proposed regulations were discussed with the Commissioner’s Exempt Organizations Advisory Group at a public meeting held on January 10, 1989, and a formal public hearing was held on April 3, 1989.

  4. The final regulations were published in T.D. 8308, 55 FR 35579 (Aug. 31, 1990), and contained few technical changes from the 1988 proposed regulations. They were made effective as of the date of publication.

  5. IRC 501(h) establishes a sliding scale of permissible "lobbying non-taxable amounts" . Nontaxable amounts are computed for both total and grass roots lobbying. Nontaxable amounts are deemed insubstantial, and expenditures under the nontaxable amounts will result in neither tax nor revocation. Expenditures in excess of the nontaxable amounts are called "excess lobbying expenditures" . An excise tax under IRC 4911 is imposed on lobbying expenses that exceed permissible non-taxable amounts. If lobbying expenditures exceed both the permitted total lobbying amount and the grass roots amount, the IRC 4911 tax is imposed on whichever excess is greater.

    Note:

    "Affiliated" organizations are treated as one for purposes of lobbying expenditures.

  6. IRC 4911(a)(2) provides that, for purposes of IRC 4911, the term "excess lobbying expenditures" for a taxable year means the greater of the following amounts:

    1. The amount by which the lobbying expenditures made by the organization during the taxable year exceed the lobbying nontaxable amount for such organization during such taxable year, or

    2. The amount by which the grass roots expenditures made by the organization during the taxable year exceed the grass roots nontaxable amount for such organization for such taxable year.

  7. IRC 4911(c)(2) provides that the nontaxable amount of lobbying expenditures is the lesser of $1,000,000 or an amount determined under a sliding scale, set forth in the statute, of percentage of exempt purpose expenditures. The nontaxable amount of grassroots lobbying expenditures is 25 percent of the nontaxable amount of lobbying expenditures.

  8. If an IRC 501(c)(3) organization engages in lobbying activities, and if it has elected to be covered by the provisions of IRC 501(h), lobbying may cause revocation of its exempt status only if the amounts spent on such lobbying "normally" exceed 150 percent of either of the permissible amounts over a base period, or grass roots expenditures exceed 150 percent of the grassroots lobbying nontaxable amount for the base years. Therefore, the tests of whether an organization is an "action" organization, set forth in Reg. 1.501(c)(3)–1(c)(3) and described below, should not be used to determine whether an organization that has made the IRC 501(h) election has engaged in substantial lobbying activities.

    Note:

    Reg. 1.501(h)–3(c)(7) provides that in general, the term "base years" means the determination year and the three taxable years immediately preceding the determination year. The base years, however, do not include any taxable year preceding the taxable year for which the organization is first treated as described in IRC 501(c)(3).

  9. Reg. 1.501(h)–3(b)(2), however, provides a special exception for an organization’s first election. Under this exception, for the first, second, or third consecutive determination year for which an organization’s first expenditure test election is in effect, the organization will not be denied exemption from tax by reason of IRC 501(h) if, taking into account as base years only those years for which the expenditure test election is in effect the following conditions are met:

    1. The sum of the organization’s lobbying expenditures for such base years does not exceed 150 percent of the sum of its lobbying nontaxable amounts for the same base years; and

    2. The sum of the organization’s grass roots expenditure for those base years does not exceed 150 percent of the sum of its grass roots nontaxable amounts for such base years.

  10. IRC 504 provides that IRC 501(c)(4) status is precluded (after October 3, 1976), for organizations once described as public charities (except for churches, conventions of churches, etc.), but no longer described as public charities because of excessive lobbying.

  11. IRC 504(b) authorized the Secretary of the Treasury to prescribe regulations to prevent avoidance of this rule, including avoidance by transferring all or part of the assets of an IRC 501(c)(3) organization to an organization that is controlled by the same persons who control the IRC 501(c)(3) organization. These regulations are set forth in Reg. 1.504–2.

  12. In determining whether an organization has attempted to avoid IRC 504 by transferring any of its assets, the term "transfer" includes any use by, or for the benefit of, the recipient, except transfers made for adequate and full consideration. Generally, a transfer that involves the following five elements will cause loss of exemption to the recipient:

    1. The transfer is from an IRC 501(c)(3) organization that is determined to be an "action" organization or is denied exemption by IRC 501(h);

    2. At the time of the transfer or at any time during the recipient’s next ten taxable years, the recipient is controlled (directly or indirectly) by the same persons who control the transferor;

    3. The transfer is made (1) after the date that is 24 months before the earliest of the effective date of the determination IRC 501(h) that the transferor is not exempt, the effective date of the Commissioner’s determination that the transferor is an "action" organization, or the date on which the Commissioner proposes to treat it as no longer described in IRC 501(c)(3), and (2) before the transferor again is recognized as an organization described in IRC 501(c)(3);

    4. The recipient is exempt from tax under IRC 501(a) but is neither an organization described in IRC 501(c)(3), nor a qualified pension plan described in IRC 401(a) to which the transferor contributes as an employer; and

    5. The amount of the transfer exceeds the lesser of 30 percent of the net fair market value of the transferor’s assets or 50 percent of the net fair market value of the recipient’s assets, computed immediately before the transfer.

7.25.3.17.2  (02-23-1999)
Exempt Purpose Expenditures for Organizations That Elect Under IRC 501(h)

  1. Reg. 56.4911–4 provides rules under IRC 4911(e) for determining an electing public charity’s "exempt purpose expenditures." The regulation also provides that, in determining exempt purpose expenditures, no expenditure shall be counted twice by an organization.

  2. Under Reg. 56.4911–4(b), amounts paid or incurred by an organization that are exempt purpose expenditures include the following:

    1. Amounts paid or incurred to accomplish a purpose enumerated in IRC 170(c)(2)(B) including certain transfers made by the organization;

    2. Amounts paid or incurred as current or deferred compensation for an employee’s services in connection with an IRC 170(c)(2)(B) purpose;

    3. The allocable portion of administrative overhead and other general expenditures attributed to accomplishing IRC 170(c)(2)(B) purposes;

    4. All lobbying expenditures;

    5. Amounts paid or incurred for activities that are not considered lobbying because they are described in Reg. 56.4911–2(c), e.g., nonpartisan analysis, study, and research, or member communications described in Reg. 56.4911–5 that are not lobbying expenditures;

    6. A reasonable allowance for exhaustion, wear and tear, obsolescence or amortization, of assets to the extent used for one or more of the above purposes computed on a straight-line basis; and

    7. Certain fund-raising expenditures (but see IRC 4911(e)(1)(C) and Reg. 56.4911–4(c)(3) and Reg. 56.4911–4(c)(4)).

  3. There are two types of transfers that will be treated as an exempt purpose expenditure:

    1. a transfer made to an organization described in IRC 501(c)(3) in furtherance of the transferor’s exempt purposes that is not earmarked for any purpose other than one described in IRC 170(c)(2)(B). Therefore, a payment of dues by a local or state organization to, respectively, a state or national organization that is described in IRC 501(c)(3) is considered an exempt purpose expenditure of the transferor to the extent it is not otherwise earmarked. Reg. 56.4911–4(d)(2).

    2. a "controlled grant," but only to the extent of the amounts that are paid or incurred by the transferee that would be exempt purpose expenditures if paid or incurred by the transferor. Reg. 56.4911–4(d)(3).

7.25.3.17.2.1  (02-23-1999)
Expenditures That Are Not Exempt Purpose Expenditures for Organizations That Elect Under IRC 501(h)

  1. Under Reg. 56.4911–4(c), exempt purpose expenditures do not include the following types of expenditures:

    1. Amounts paid or incurred that are not described in Reg. 56.4911–4(b);

    2. The amounts of any transfer described in Reg. 56.4911–4(e);

    3. Amounts paid to or incurred for a "separate fund raising unit" of the organization or of an affiliated organization;

    4. Amounts paid to or incurred for any person not an employee, or any organization not an affiliated organization, if paid or incurred primarily for fund raising, but only if such person or organization engages in fund-raising, fund-raising counseling or the provision of similar advice or services;

    5. Amounts paid or incurred chargeable to a capital account, determined in accordance with the principles that apply under IRC 263 or IRC 263A, with respect to an unrelated trade or business;

    6. Amounts paid or incurred for a tax that is not imposed in connection with the organization’s efforts to accomplish an IRC 170(c)(2)(B) purpose, such as taxes imposed under IRC 511(a)(1) and IRC 4911(a); and

    7. Amounts paid or incurred for the production of income.

  2. Reg. 56.4911–4(e) provides that three types of transfers cannot be considered exempt purpose expenditures:

    1. a transfer made to a member of any affiliated group (as defined in Reg. 56.4911–7(e)) of which the transferor is a member. Reg. 56.4911–4(e)(2).

    2. a transfer that the Commissioner determines artificially inflates the amount of the transferor’s or transferee’s exempt purpose expenditures. The regulation provides that this determination generally will be made if a substantial purpose of a transfer is to inflate those exempt purpose expenditures. When this determination is made, the transfer will not be considered an exempt purpose expenditure of the transferor; rather, it will be an exempt purpose expenditure of the transferee to the extent that the transferee expends the transfer in the active conduct of its charitable activities or attempts to influence legislation. Standards similar to those found in Reg. 53.4942(b)–1(b) (relating to operating foundations) may be applied in determining whether the transferee has expended amounts in the "active conduct" of its charitable activities or attempts to influence legislation. Reg. 56.4911–4(e)(3).

    3. a transfer that is not a "controlled grant" and is made to an organization not described in IRC 501(c)(3) that does not attempt to influence legislation. Reg. 56.4911–4(e)(4).

  3. Costs incurred by volunteers in carrying on grass roots lobbying (e.g., going door-to-door to seek signatures for petitions to be sent to legislators in favor of a specific bill) are not lobbying or exempt purpose expenditures made by the organization.

    1. Further, the volunteers may not deduct their out-of-pocket expenditures. See IRC 170(f)(6).

    2. However, the organization’s costs of soliciting the volunteers’ help and its costs of training the volunteers are grass roots expenditures, as are the costs of preparing, copying, distributing, etc., the petitions and any other materials on the same specific subject used in the door-to-door signature gathering effort.

7.25.3.17.3  (02-23-1999)
Lobbying Expenditures

  1. For public charities that elect to be covered by IRC 501(h), lobbying expenditures are expenditures made for the purpose of influencing legislation (as defined in IRC 4911(d)). IRC 501(h)(2)(A). An electing public charity’s lobbying expenditures for a year are the sum of its expenditures during that year for direct lobbying communications ( "direct lobbying expenditures" ) plus its expenditures during that year for grass roots lobbying communications ( "grass roots expenditures" ).

7.25.3.17.3.1  (02-23-1999)
Direct Lobbying

  1. "Direct" lobbying involves attempts to influence legislation through communication with any member or employee of a legislative body. It also involves attempts to influence legislation through communication with any government official or employee (other than a member or employee of a legislative body) who may participate in the formulation of the legislation, but only if the principal purpose of the communication is to influence legislation. IRC 4911(d)(1)(B); Reg. 56.4911–2(b)(1)(i).

  2. A communication with a legislator or government official will not be treated as a direct lobbying communication in accordance with Reg. 56.4911–2(b)(1) unless it both:

    • refers to "specific legislation" ; and

    • reflects a view on such legislation.

  3. Therefore, a position letter on a pending bill prepared by an organization’s employee and distributed to members of Congress or personal contacts by the employee with members of Congress or their staffs to seek support for the organization’s position on the bill would constitute direct lobbying. Reg. 56.4911–2(b)(4)(i), Example (1).

  4. In contrast, a letter sent to a member of Congress requesting that he or she write an administrative agency regarding proposed regulations recently published by that agency and also requesting that she state her support for a particular type of permit granted by the agency is not a direct lobbying communication. Reg. 56.4911–2(b)(4)(i), Example (2).

  5. Similarly, sending a paper to a state legislator on a particular state’s environmental problems that does not reflect a view on any specific legislation that the organization either supports or opposes likewise is not a direct lobbying communication. Reg. 56.4911–2(b)(4)(i), Example (3).

7.25.3.17.3.2  (02-23-1999)
Grass Roots Lobbying

  1. "Grass roots" lobbying is the attempt to influence legislation by affecting the opinions of the general public or any segment of the public. IRC 4911(d)(1)(A); Reg. 56.49 11–2(b)(2)(i).

  2. Reg. 56.4911–2(b)(2)(ii) sets forth a three-part test for determining whether communications with the general public will be treated as grass roots lobbying communications. The communication will be considered a grass roots lobbying communication only if it meets all three of the following requirements:

    1. The communication refers to specific legislation;

    2. The communication reflects a view on such legislation; and

    3. The communication encourages the recipient of the communication to take action with respect to such legislation.

  3. The third element (requiring the communication to encourage the recipient to take action) is commonly referred to as the "call to action" requirement. Essentially, what this requirement means is that no matter how clearly an organization identifies the specific legislation and comments on the merits of that legislation (for example, "passage of S. 549 would mean the end of civilization as we know it" ) when it communicates with the general public, the absence of any further statement that encourages the recipient to take action would mean that the communication could not be considered a grass roots lobbying communication.

  4. Reg. 56.4911–2(b)(2)(iii) provides a definition of encouraging a recipient to take action with respect to legislation. To be considered a "call to action," a communication must do any one of the following:

    1. state that the recipient should contact an individual described in Reg. 56.4911–2(b)(1)(i);

    2. state the address, telephone number, or similar information of a legislator or an employee of a legislative body;

    3. provide a petition, tear-off postcard or similar material for the recipient to communicate with any individual described in Reg. 56.4911–2(b)(1)(i); or

    4. specifically identify one or more legislators who will vote on the legislation as: opposing the organization’s view with respect to the legislation; being undecided with respect to the legislation; being the recipient’s representative in the legislature; or being a member of the legislative committee or subcommittee that will consider the legislation. Merely naming the main sponsor(s) of the legislation for purposes of identifying the legislation will not constitute encouraging the recipient to take action.

  5. Unless a communication with the general public meets all three of the Reg. 56.4911–2(b)(2)(ii) requirements, it will not be a grass roots lobbying communication.

  6. In certain cases, a communication that does meet all three of the requirements may not be a grass roots lobbying communication. Reg. 56.4911–2(b)(1)(iii) provides that, solely for purposes of IRC 4911, where a communication refers to and reflects a view on a measure that is the subject of a referendum, ballot initiative or similar procedure, the general public in the State or locality where the vote will take place constitutes the legislative body, and individual members of the general public are considered legislators. Accordingly, if such a communication is made to one or more members of the general public in that state or locality, the communication is a direct lobbying communication (unless it comes under the exception for nonpartisan analysis, study or research.

7.25.3.17.3.3  (02-23-1999)
Legislation

  1. Reg. 56.4911–2(d)(1)(i) provides that "legislation" includes action by the Congress, any state legislature, any local council, or similar legislative body, or by the public in a referendum, ballot initiative, constitutional amendment, or similar procedure.

  2. "Legislation" includes a proposed treaty required to be submitted by the President to the Senate for its advice and consent from the time the President’s representative begins to negotiate its position with the prospective parties to the proposed treaty.

  3. Under Reg. 56.4911–2(d)(1)(ii), "specific legislation" includes both legislation that has already been introduced in a legislative body and specific legislative proposals that the organization either support or oppose.

    1. In the case of a referendum, ballot initiative, constitutional amendment, or other measure that is placed on the ballot by petitions signed by a required number or percentage of voters, an item becomes "specific legislation" when the petition is first circulated among voters for signature.

  4. Before amendment in 1990, the regulations under IRC 4945 provided that "attempts to influence legislation" included communications "with respect to legislation being considered by, or to be submitted imminently to, a legislative body." Reg. 53.4945–2(a)(1) (1990). When the regulations under IRC 4911 were finalized, the standard "to be submitted imminently" was not used in Reg. 56.4911–2(d)(1)(ii) and it was deleted from the IRC 4945 regulations. As the Preamble to the regulations explains, a temporal standard is inappropriate and underinclusive given the nature of the legislative process.

    Example:

    long before many specific legislative proposals are formally introduced as a bill, they are subject to intensive scrutiny, debate, and controversy. Also, effective lobbying could prevent a bill from ever being introduced. Consequently, reference to legislation proposed or adopted in one state that urges its adoption in another state constitutes a specific legislative proposal in the other state even though no such bill has been introduced there. Reg. 56.4911–2(d)(1)(iii), Example (2).

  5. Legislation may be identified either by its formal name or by a term that has been widely used in connection with specific pending legislation,e.g., "the President’s plan for a drug-free America." Reg. 56.4911–2(b)(4)(ii)(B), Example (1).

  6. Legislation may also be identified merely by its content and effect. See Reg. 56.4911–2(d)(1)(iii), Example (1).

7.25.3.17.4  (02-23-1999)
Organizations Eligible to Elect Under IRC 501(h)

  1. IRC 501(h)(3) provides that the provisions of IRC 501(h) will apply to any eligible IRC 501(c)(3) organization that has elected to have those provisions apply.

  2. To be eligible to make the IRC 501(h) election, the IRC 501(c)(3) organization must be an organization described in IRC 501(h)(4) and it must not be a disqualified organization described in IRC 501(h)(5).

  3. The IRC 501(c)(3) organizations described in IRC 501(h)(4) are as follows:

    1. Educational institutions as described in IRC 170(b)(1)(A)(ii);

    2. Hospitals and medical research organizations as described in IRC 170(b)(1)(A)(iii);

    3. Organizations that support government schools as described in IRC 170(b)(1)(A)(iv);

    4. Organizations publicly supported by charitable contributions as described in IRC 170(b)(1)(A)(vi);

    5. Organizations publicly supported by admissions, sales, etc. related to their exempt purpose as described in IRC 509(a)(2); and

    6. Organizations that are public charities because they are a supporting organization described in IRC 509(a)(3) of an IRC 501(c)(3) organization that is described in IRC 509(a)(1) or IRC 509(a)(2).

7.25.3.17.4.1  (02-23-1999)
Organizations Not Eligible to Elect Under IRC 501(h)

  1. IRC 501(c)(3) organizations may not elect to be covered by the provisions of IRC 501(h) if they are not described under IRC 501(h)(4) or if they are disqualified under IRC 501(h)(5).

  2. The organizations that are ineligible to make an IRC 501(h) election are as follows:

    1. Churches or conventions or associations of churches as described in IRC 170(b)(1)(A)(i);

    2. Integrated auxiliaries of a church or convention or association of churches (IRC 508(c) and IRC 6033);

    3. Organizations described in IRC 501(c)(3) and affiliated with at least one church or convention or association of churches or an integrated auxiliary (an "affiliated group" within the meaning of IRC 4911(f)(2));

    4. Organizations that are public charities because they are a supporting organization described in IRC 509(a)(3) of certain organizations exempt under IRC 501(c)(4), IRC 501(c)(5), or IRC 501(c)(6);

    5. Organizations engaged in testing for public safety and thus described in IRC 509(a)(4); and

    6. Private foundations.

7.25.3.17.4.2  (02-23-1999)
How IRC 501(h) Election is Made

  1. An eligible organization makes the election under IRC 501(h) by filing the Form 5768. Under IRC 501(h)(6), the election is effective with the beginning of the taxable year in which the Form 5768 is filed.

    Example:

    an eligible organization with the calendar year as its taxable year files Form 5768 making the IRC 501(h) election on December 31, 1996. The organization’s IRC 501(h) election is effective for its taxable year beginning January 1, 1996.

  2. Once the IRC 501(h) election is made, Reg. 1.501(h)–2(a) provides that it is effective (without again filing Form 5768) for each succeeding taxable year for which the organization is an eligible organization and which begins before a notice of revocation is filed.

  3. A newly created organization may submit Form 5768 to elect the expenditure test under IRC 501(h) at the time it submits its Form 1023, Application for Recognition of Exemption.

    1. If the organization is determined to be eligible under IRC 501(h), the election will be effective with the beginning of the taxable year in which the Form 5768 is filed.

    2. If the organization is determined by the Service not to be eligible to make an IRC 501(h) election, Reg. 1.501(h)–2(c) provides that the election will not be effective and the substantial part test will apply from the effective date of its IRC 501(c)(3) classification.

7.25.3.17.4.3  (02-23-1999)
Revocation of IRC 501(h) Election

  1. An organization may voluntarily revoke an expenditure test election by filing a notice of voluntary revocation (Form 5768) with the Ogden Service Center. IRC 501(h)(6)(B) provides that a voluntary revocation is effective with the beginning of the first taxable year after the taxable year in which the notice is filed.

    Example:

    an eligible organization with the calendar year as its taxable year files Form 5768 revoking its IRC 501(h) election on May 31, 1996. The organization’s IRC 501(h) election remains in effect for its taxable year beginning January 1, 1996, but is no longer in effect for its taxable year beginning January 1, 1997.

  2. When an organization voluntarily revokes its election, Reg. 1.501(h)–2(d)(1) provides that the substantial part test of IRC 501(c)(3) (as discussed above) will apply to the organization’s activities in attempting to influence legislation beginning with the taxable year the voluntary revocation is effective.

  3. An organization that voluntarily revokes its election under IRC 501(h) may make the IRC 501(h) expenditure test election again. However, under Reg. 1.501(h)–2(d)(2), the new election may be effective no earlier than the taxable year following the first taxable year for which the voluntary revocation is effective.

  4. Reg. 1.501(h)–2(d)(3) furnishes the following example:

    Example:

    X, an organization whose taxable year is the calendar year, plans to voluntarily revoke its expenditure test election effective beginning with its taxable year 1985. X must file its notice of voluntary revocation on Form 5768 after December 31, 1983, and before January 1, 1985. If X files a notice of voluntary revocation on December 31, 1984, the revocation is effective beginning with its taxable year 1985. The organization may again elect the expenditure test by filing Form 5768. Under Reg. 1.501(h)–2(d)(2), the election may not be made for taxable year 1985. Under Reg. 1.501(h)–2(a), a new expenditure test election will be effective for taxable years beginning with taxable year 1986, if the Form 5768 is filed after December 31, 1985, and before January 1, 1987.

  5. If, while an election under IRC 501(h) by an eligible organization is in effect, the organization ceases to qualify as an eligible organization, its election is automatically revoked.

    1. The revocation is effective at the beginning of the first full taxable year it is determined that the organization is not an eligible organization.

    2. If an organization’s expenditure test election is involuntarily revoked but the organization continues to be described in IRC 501(c)(3), Reg. 1.501(h)–2(e) provides that the substantial part test of IRC 501(c)(3) will apply to the organization’s activities in attempting to influence legislation beginning with the first taxable year the involuntary revocation is effective.

7.25.3.17.5  (02-23-1999)
"Action" Organizations

  1. Reg. 1.501(c)(3)–1(c)(3)(i) provides that an organization is not operated exclusively for one or more exempt purposes if it as an "action" organization. An organization is an "action organization" if a substantial part of its activities is attempting to influence legislation by propaganda or otherwise. Reg. 1.501(c)(3)–1(c)(3)(ii).

  2. Reg. 1.501(c)(3)–1(c)(3)(iv) also describes a special kind of "action" organization that has a main or primary objective attainable only by legislation and advocates attainment of that main objective as distinguished from engaging in non-partisan analysis, study, or research. See Rev. Rul. 62–71, supra.

  3. A nonprofit organization formed to implement an orderly change of administration of the office of Governor of a State by assisting the Governor-elect, during the period between his election and inauguration in screening and selecting applicants for State appointive offices and preparing a legislative message and program reflecting the party’s platform and budget, was held to be an "action" organization and did not qualify for exemption. Rev. Rul. 74–117, 1974–1 C.B. 128.

  4. A nonprofit organization that attempts to influence and advocates changes in the laws of a foreign country is an "action" organization within the meaning of Reg. 1.501(c)(3)–1(c)(3), and therefore does not qualify for exemption under IRC 501(c)(3). Rev. Rul. 73–440, 1973–2 C.B. 177.

  5. The Supreme Court, upheld the restriction on lobbying in Regan v. Taxation with Representation of Washington, 461 U.S. 540 (1983). An organization contended that the IRC 501(c)(3) restriction on lobbying was unconstitutional on the grounds that it violated both the freedom of speech guarantee of the First Amendment and the equal protection doctrine of the Fifth Amendment. The Court, in a unanimous decision, held the restriction to be constitutional. Concerning the First Amendment issue, the Court held that, in enacting the lobbying restriction, Congress had not infringed on any First Amendment activity, but simply had chosen not to subsidize the lobbying of organizations otherwise described in IRC 501(c)(3). As to the Fifth Amendment claim, which was based on the contention that veterans organizations that qualify for IRC 501(c)(19) exemption and for deductible contributions under IRC 170(c)(3) have no restrictions on their lobbying, whereas IRC 501(c)(3) do, the Court stated that the general rule of statutory classification is that classifications are valid if they bear a rational relation to a legitimate government purpose. It also noted that legislatures have especially broad latitude in creating classifications and distinctions in tax statutes. The Court then found it was not irrational for Congress to decide that, even though it will not subsidize lobbying by charities generally, it will subsidize lobbying by veterans organizations.

7.25.3.18  (02-23-1999)
Intervention in Political Campaigns

  1. IRC 501(c)(3) precludes exemption for an organization that participates in or intervenes in (including the publishing or distributing of statements) any political campaign on behalf of or in opposition to any candidate for public office. This is an absolute prohibition, with no requirement that the activity be substantial.

7.25.3.18.1  (02-23-1999)
Political Activities

  1. Prohibited political activities include, but are not limited to, the publication or distribution of written or printed statements or the making of oral statements on behalf of or in opposition to a candidate. Reg. 1.501(c)(3)–1(3)(iii).

7.25.3.18.1.1  (02-23-1999)
Candidate for Public Office

  1. The term "candidate for public office" means an individual who offers himself, or is proposed by others, as a contestant, for an elective public office, whether such office be national, State or local. Reg. 1.501(c)(3)–1(3)(ii). School board candidates were held to be candidates for public office despite the fact that no candidates were affiliated with any political party. Rev. Rul. 67–71, 1967–1 C.B. 125. Attempting to influence the Senate confirmation of an individual nominated to serve as a federal judge does not constitute intervention or participation in a political campaign within the meaning of IRC 501(c)(3), since a federal judgeship is an appointive office, rather than an elective one. Notice 88–76, 1988–27 I.R.B. 34.

7.25.3.18.1.2  (02-23-1999)
Voter Education Activities

  1. Certain "voter education" activities conducted in a non-partisan manner by an IRC 501(c)(3) organization may not constitute prohibited political activity.

    1. Public forums, conducted by an IRC 501(c)(3) organization in a congressional district during a congressional election campaign in which all legally qualified congressional candidates are invited to participate; topics discussed cover a broad range of issues of interest to the public; questions are prepared and presented by a nonpartisan, independent panel; and each candidate receives an equal opportunity to present his or her views on each issue discussed, do not constitute participation or intervention in any political campaign within the meaning of IRC 501(c)(3). The facts and circumstances establish that both the format and content of the forums are presented in a neutral manner. Rev. Rul. 86–95, 1986–2 C.B. 73.

    2. An organization that annually prepares and makes generally available to the public a compilation of voting records of all Members of Congress on major legislative issues involving a wide range of subjects was held to be exempt under IRC 501(c)(3). The publication contains no editorial opinion, and its contents and structure do not imply approval or disapproval of any Members or their voting records. Rev. Rul. 78–248, 1978–1 C.B. 154, Situation 1.

    3. An organization distributing a questionnaire to all candidates for governor in a particular State was held to be exempt under IRC 501(c)(3). The questionnaire solicits a brief statement of each candidate’s position on a wide variety of issues which are published in a voters guide that is made generally available to the public. Neither the questionnaire nor the voters guide, in content or structure, evidences a bias or preference with respect to the views of any candidate or group of candidates. Rev. Rul. 78–248, 1978–1 C.B. 154, Situation 2.

    4. An IRC 501(c)(3) organization that monitors and reports on governmental activities and developments considered by it to be of important social interest is not participating or intervening in any political campaign when it publishes and distributes a non-partisan newsletter to interested members and others, who together number only a few thousand nationwide. The newsletter is politically non-partisan and consists of congressional incumbents’ voting records on selective issues, along with an expression of the organization’s position on the issues. Publication occurs after congressional adjournment and will not be geared to the timing of any federal election. Rev. Rul. 80–282, 1980–2 C.B. 178.

  2. However, other so-called "voter education" activities may be proscribed by the statute.

    1. An organization that sends a questionnaire to candidates for major public offices and uses the responses to prepare a voters’ guide that is distributed during an election campaign was held not to be exempt under IRC 501(c)(3) since some of the questions evidenced a bias on certain issues. Rev. Rul. 78–248, 1978–1 C.B. 154, Situation 3.

    2. An organization that publishes and distributes to the public a voters’ guide containing voting records of Members of Congress on the single issue of land conservation was held not to be exempt under IRC 501(c)(3) because the emphasis on one area of concern indicates a partisan purpose and constitutes a proscribed political activity. Rev. Rul. 78–248, 1978–1 C.B. 154, Situation 4.

    3. A bar association did not qualify under IRC 501(c)(3) because its practice of rating, and publishing the ratings of, candidates for elective judicial office constituted intervention in a political campaign, although it comprised only a small portion of the association’s total activities, it was clearly in the public interest, and it was conducted on a nonpartisan basis. The Association of the Bar of the City of New York v. Commissioner, 858 F.2d 876, 881 (1988).

7.25.3.18.1.3  (02-23-1999)
Public Discussion of Political Issues

  1. An organization that conducted public forums, lectures, and debates on controversial social, political, and international questions was held to be educational. Although the speakers were frequently controversial, the organization adopted an unbiased position. Rev. Rul. 66–256, 1966–2 C.B. 210.

  2. An organization that operated a broadcasting station was not participating in political activities by providing reasonable air time equally available to all legally qualified candidates for election to public office in compliance with the Federal Communications Act of 1934. The organization neither endorsed a candidate nor any viewpoint expressed by a candidate. Rev. Rul. 74–574, 1974–2 C.B. 161.

  3. An organization formed to elevate the standards of ethics and morality in the conduct of political campaigns that disseminates information concerning general campaign practices, furnishes teaching aids to political science and civics teachers, and publicizes its proposed code of fair campaign practices without soliciting the signing or endorsement of the code by candidates, qualifies as an educational organization under IRC 501(c)(3). Rev. Rul 76–456, 1976–2 C.B. 151.

7.25.3.18.1.4  (02-23-1999)
Student Education

  1. An IRC 501(c)(3) university did not participate in a political campaign when it offered a course in the basic techniques of effective participation in the electoral system. Although the students were required to work on a campaign, the university did not influence the student in his choice of candidate or control the student’s campaign work. Rev. Rul. 72–512, 1972–2 C.B. 246.

  2. An IRC 501(c)(3) university is not participating in political activities when it supports the publication of a daily student newspaper that provides training for students in various aspects of publishing, editing, and managing a daily newspaper, including coverage of political news and the preparation of editorial comments. Rev. Rul. 72–513, 1972–2 C.B. 246

7.25.3.18.2  (02-23-1999)
Excise Taxes

  1. IRC 501(c)(3) organizations that make political expenditures will be subject to an excise tax under IRC 4955.

  2. Any amount paid or incurred by an IRC 501(c)(3) organization in connection with any intervention in a political campaign on behalf of, or in opposition to, any candidate for public office is a political expenditure subject to the excise tax under IRC 4955. The initial tax is equal to 10 percent of the amount involved. An additional tax of 100 percent of the amount involved is also imposed if the organization fails to correct the expenditure in a timely manner. The initial tax may be abated if the organization can establish that its making of the expenditure was not willful and flagrant. The tax is imposed even if the political expenditure gives rise to a revocation of the organization’s IRC 501(c)(3) status.

  3. An initial tax of 21/2 percent of the political expenditure (limited to $5,000 of tax with respect to any one expenditure) is imposed on any manager of the organization who, knowing that the expenditure is a political expenditure, agrees to the making of the expenditure, unless such agreement is not willful and is due to reasonable cause. A manager who refuses to agree to part or all of the required correction of the political expenditure also may be subject to an additional tax of 50 percent of the political expenditure (subject to a $10,000 maximum).

  4. When tax is imposed under IRC 4955 to a private foundation, the expenditure in question will not be treated as a taxable expenditure under IRC 4945.

7.25.3.18.3  (02-23-1999)
Candidate Controlled Organizations

  1. Candidate controlled organizations are organizations formed primarily to promote the candidacy or prospective candidacy of an individual for public office, as well as organizations that are effectively controlled by a candidate or prospective candidate and that are availed of primarily for those purposes. IRC 4955(d)(2).

  2. For candidate controlled organizations, amounts paid or incurred for any of the following purposes are deemed political expenditures:

    1. Remuneration to the individual (the candidate or prospective candidate) for speeches or other services;

    2. Travel expenses of the individual;

    3. Expenses of conducting polls, surveys, or other studies, or preparing papers or other material for use by the individual;

    4. Expenses of advertising, publicity, and fund-raising for the individual;

    5. Any other expense that has the primary purpose of promoting public recognition, or otherwise primarily accruing to the benefit, of the individual.

7.25.3.18.4  (02-23-1999)
Termination Assessments and Injunctions

  1. The Service is authorized to make an immediate determination and assessment of income tax, or of the tax imposed by IRC 4955, for the current or preceding year of an IRC 501(c)(3) organization, if the Service finds that the organization has made political expenditures and that such expenditures constitute a flagrant violation of the prohibition against making political expenditures. For this purpose, the organization’s current taxable year is treated as if it terminates on the date taxability is determined. IRC 6852. Any taxes assessed under IRC 6852 against the organization or its managers become due and payable immediately.

  2. The Service may seek an injunction to bar political expenditures by an IRC 501(c)(3) organization after it has notified the organization of its intention to seek an injunction if the organization does not immediately cease making political expenditures and after the Commissioner personally has determined that the organization has flagrantly participated in a political campaign and that an injunction is appropriate to prevent further abuse. The Service also may seek such other injunctive relief as may be appropriate to ensure that the organization’s funds are preserved for IRC 501(c)(3) purposes. IRC 7409.

7.25.3.18.5  (02-23-1999)
Disqualification for IRC 501(c)(4)

  1. IRC 504 precludes qualification under IRC 501(c)(4) for any organization (except for churches, conventions of churches, etc.) that ceases to qualify under IRC 501(c)(3) by reason of participating in, or intervening in, any political campaign on behalf of, or in opposition to, any candidate for public office.

7.25.3.18.6  (02-23-1999)
Effect of IRC 527

  1. An IRC 501(c) organization is subject to tax on any amount that it spends on the selection, nomination, election, or appointment of a candidate for public office, but only to the extent of its net investment income. IRC 527(f). An IRC 501(c) organization may set up a separate segregated fund that is used to carry out the political activities of the IRC 501(c) organization. IRC 527(f)(3)

  2. IRC 527 was not intended to affect the prohibition against IRC 501(c)(3) organizations engaging in political activities. Thus, notwithstanding IRC 527, charities may not engage in political activities on behalf of or in opposition to candidates for elective public office nor may they set up separate segregated funds to engage in such activities without endangering their IRC 501(c)(3) exempt status.

7.25.3.18.7  (02-23-1999)
Digests of Precedent Rulings

  1. A corporation created to encourage greater participation in government and political affairs through the use of seminars, non-partisan workshops, and through the distribution of educational materials does not qualify for exemption as an educational organization under IRC 501(c)(3). Rev. Rul. 60–193, 1960–1 C.B. 195. Modified by Rev. Rul. 76–456.

  2. A nonprofit organization formed to conduct public forums at which lectures and debates on social, political, and international matters are presented qualifies for exemption even though some of its programs include controversial speakers or subjects. Rev. Rul. 66–256, 1966–2 C.B. 210.

  3. A nonprofit organization created to improve a public educational system is not exempt from tax where it campaigns on behalf of candidates for election to the school board. Rev. Rul. 67–71, 1967–1 C.B. 125.

  4. A university is not participating in political campaigns on behalf of candidates for public office by providing a political science credit course that requires students’ participation in political campaigns of candidates of their choice. Rev. Rul. 72–512, 1972–2 C.B. 246.

  5. A university that provides facilities and faculty advisors for a campus newspaper that publishes the students’ editorial opinions on political and legislative matters has not attempted to influence legislation or participate in political campaigns. Rev. Rul. 72–513, 1972–2 C.B. 246.

  6. An IRC 501(c)(3) organization that operates a broadcasting station presenting religious, educational, and public interest programs, is not participating in political campaigns on behalf of public candidates in violation of the provisions of that section by providing reasonable air time equally available to all legally qualified candidates for election to public office in compliance with section 312(a)(7) of the Federal Communications Act of 1934, as amended, and endorsing no candidate or viewpoint. Rev. Rul. 74–574, 1974–2 C.B. 160.

  7. An organization formed to elevate the standards of ethics and morality in the conduct of political campaigns that disseminates information concerning general campaign practices, furnishes teaching aids to political science and civics teachers, and publicizes its proposed code of fair campaign practices without soliciting the signing or endorsement of the code by candidates qualifies as an educational organization. Rev. Rul. 76–456, 1976–2 C.B. 151.

  8. Certain "voter education" activities conducted in a nonpartisan manner by an organization recognized as exempt under IRC 501(c)(3) will not constitute prohibited political activity disqualifying the organization from exemption. Rev. Rul. 78–248, 1978–1 C.B. 154.

  9. Certain publications of congressional incumbents’ voting records on selected issues in a nonpartisan newsletter do not constitute participation or intervention in any political campaign within the meaning of IRC 501(c)(3). Rev. Rul. 80–282, 1980–2 C.B. 178.

  10. The conduct of public forums involving qualified congressional candidates in which both the format and content of the forums are presented in a neutral manner, by an organization otherwise described in IRC 501(c)(3), will not constitute participation or intervention in any political campaign within the meaning of IRC 501(c)(3). Rev. Rul. 86–95, 1986–2 C.B. 73.

  11. Attempts by an organization recognized as exempt under IRC 501(c)(3) to influence the Senate confirmation of a federal judicial nominee constitute attempts to influence legislation, but do not constitute prohibited political activity. Notice 88–76, 1988–27 I.R.B. 34.

7.25.3.19  (02-23-1999)
Engaging in a Trade or Business

  1. Reg. 1.501(c)(3)–1(e)(1) provides that an organization may meet the requirements of IRC 501(c)(3) even though it operates a trade or business as a substantial part of its activities, unless its primary purpose is carrying on of a trade or business that does not further charitable purposes.

    1. Whether an organization meets the requirements of IRC 501(c)(3) even though it operates a trade or business depends on "the purposes toward which an organization’s activities are directed, and not the nature of the activities." B.S.W. Group, Inc. v. Commissioner, 70 T.C. 352 (1978).

  2. A parallel provision in IRC 502, Feeder Organizations, provides that an organization operated for the primary purpose of carrying on a trade or business shall not be exempt on the ground that all of its profits are payable to an exempt organization.

7.25.3.19.1  (02-23-1999)
Substantial Nonexempt Purpose Test

  1. Regs. 1.501(c)(3)–1(c)(1) and 1.501(c)(3)–1(e)(1) provide that the fact that an organization’s primary activity is a trade or business does not, in itself, disqualify the organization from exemption, provided the trade or business furthers or accomplishes exempt purposes. See also, Dumaine Farms v. Commissioner, 73 T.C. 650 (1080).

  2. If an activity serves a substantial nonexempt purpose, however, the organization does not qualify for exemption even if the activity also furthers an exempt purpose. See Schoger Foundation v. Commissioner, 76 T.C. 380 (1981).

7.25.3.19.2  (02-23-1999)
Facts and Circumstances

  1. Determining whether an activity serves an exempt purpose requires considering all facts and circumstances. The following factors are especially important:

    1. The manner in which the activities are conducted;

    2. The degree the activities are carried on with a "commercial hue" ;

    3. Competition with commercial firms;

    4. The existence and amount of annual or accumulated profits; and

    5. How the organization sets its prices or fees (are they at or below cost, or at a substantial markup?).

  2. An organization operated for the primary purpose of carrying on a trade or business under the test in (1), above, will not qualify for exemption even though:

    1. All its profits are payable to an exempt organization; or

    2. It has certain religious purposes, its property is held in common, and its profits do not inure to private shareholders or individuals. However, such an organization may qualify under IRC 501(d).

7.25.3.19.3  (02-23-1999)
Commercial Acquisitions or Lease Arrangements

  1. Rev. Rul. 64–182, 1964–1 C.B. 186, describes a foundation that derived its income principally from operating a commercial office building yet qualified for exemption under IRC 501(c)(3). Although the organization had no exempt activities other than distributing its funds in contributions and grants and its principal source of income was from the business operation, its contributions and grants constituted a "charitable program commensurate in scope with its financial resources."

    Note:

    It was not necessary to dispose of any IRC 502 problem because IRC 502 has a specific exception for rental income. Similarly, the exclusion of rental income for purposes of the unrelated business income tax obviated any problem in that area.

  2. However, Rev. Rul. 54–420, 1954–2 C.B. 128, holds that a foundation is not exempt under IRC 501(c)(3) where it acquires all of the outstanding stock of a business corporation, dissolves the corporation, and sells, leases, or licenses the assets to an operating company, receiving a substantial portion of the profits of the operating company in return, and using those profits to liquidate the indebtedness incurred in acquiring the business.

  3. In University Hill Foundation v. Commissioner, 446 F.2d 701 (9th Cir. 1971), rev’g 51 T.C. 548 (1969), cert. den., 405 U.S. 965 (1972), the court held an organization that engaged in several transactions to provide funds for an exempt university to be nonexempt under IRC 501(c)(3). The court concluded that the organization was engaged in the business of purchasing and selling businesses and was thus trading on its purported tax exemption. The court also noted that the business was engaged in solely to produce a profit for disbursement to the university and none of the acquired businesses were in any way related to the university’s exempt purposes.

7.25.3.19.4  (02-23-1999)
Merchandising Activities

  1. An organization engaged in the retail sale, on a commission basis, of handicraft items produced by needy and deserving women was held to be a charitable organization in Rev. Rul. 66–104, 1966–1 C.B. 135. Although the retail sale of goods is normally a business activity, the ultimate test is purpose. Under the circumstances it was clear that the primary purpose was the charitable purpose of enabling the women to support themselves.

  2. Similarly, a corporation organized for the purpose of operating a book and supply store and a cafeteria on the campus of a university was held exempt under IRC 501(c)(3) in Rev. Rul. 58–194, 1958–1 C.B. 240. The organization was operated for the convenience of the students and faculty, and carried a line of necessary, "everyday" merchandise that could be obtained elsewhere only with some inconvenience. On those facts, Rev. Rul. 58–194 concluded the store was operated primarily to further the educational purposes of the university.

  3. In United Missionary Aviation, Inc. v. Commissioner, T.C.M. (CCH) 1990–566, the Tax Court held an organization formed to support religious missionary work not exempt under IRC 501(c)(3) because it had a substantial nonexempt commercial purpose. The court focused on how the organization carried on its primary activity, a tape and equipment supply division. Although no one factor was determinative, the court considered the following particularly relevant:

    1. The supply division was operated in the same manner as any profitable commercial enterprise;

    2. The majority of equipment and tapes sold by the organization were also sold by commercial firms;

    3. The organization priced its merchandise approximately 20 percent above cost, which produced a net profit margin of approximately eight percent;

    4. The organization had substantial annual and accumulated profits.

  4. In Living Faith, Inc. v. Commissioner, 950 F.2d 365 (7th Cir. 1991), the Court of Appeals upheld a Tax Court decision, CCH T.C. Memo. 1990–484, that an organization operating restaurants and health food stores in a manner consistent with the doctrines of the Seventh Day Adventist Church does not qualify under IRC 501(c)(3). The court found substantial evidence to support a conclusion that the organization’s activities furthered a substantial nonexempt purpose, including;

    1. The organization’s operations were presumptively commercial;

    2. The organization competed directly with other restaurants and food stores;

    3. The organization used profit-making pricing formulas common in the retail food business;

    4. The organization engaged in a substantial amount of advertising;

    5. The organization’s hours of operation were competitive with other commercial enterprises; and

    6. The organization lacked plans to solicit donations.

7.25.3.19.5  (02-23-1999)
Student Loans and Employment

  1. Making interest-bearing loans to students was held to be a charitable purpose within the meaning of IRC 501(c)(3) in Rev. Rul. 63–220, 1963–2 C.B. 208, and Rev. Rul. 61–87, 1961–1 C.B. 191. Although making personal loans may be a commercial activity in some circumstances, the low interest rate and the surrounding circumstances showed the primary purpose was to further the education of students.

  2. On the other hand, merely employing students so they can earn enough to continue their education is not in itself an exempt activity. Rev. Rul. 69–177, 1969–1 C.B. 150, held that a subsidiary of a tax-exempt college that hired students to manufacture and sell wood products at a profit was not exempt under IRC 501(c)(3). The students were not employed for the purpose of receiving instruction or training. In effect, the subsidiary was engaging in a trade or business to obtain funds for scholarship purposes. Therefore, IRC 502 precluded exemption.

7.25.3.20  (02-23-1999)
Foreign Organizations

  1. Foreign organizations that meet the requirements of IRC 501(c)(3) may establish exemption from United States income tax, or establish their charitable status for purposes of the estate and gift taxes. However, apart from treaty provisions, contributions to foreign charities are not deductible under IRC 170(c).

    Note:

    Foreign organizations may, for various reasons, seek recognition of exemption under IRC 501(c)(3) even if they have no taxable income in this country. The Service will recognize their exempt status if they meet the requirements applicable to domestic organizations.

  2. Some foreign charitable organizations may be eligible for recognition of exempt based on a specific provision in a tax treaty their country has with the United States. However, treaties that provide for "reciprocal recognition" generally require that the countries agree in a separate agreement that their exemption standards are "comparable" , or establish the scope of recognition, before the treaty takes effect.

    1. Currently, Canada is the only country in which charitable organizations recognized by a foreign government are recognized exempt under IRC 501(c)(3) without applying to the Service. Canadian organizations are presumed to be private foundations, however, and a Canadian charity must request a determination from the Service if it wants to be considered a public charity eligible for the 50 percent limit on contributions.

    2. The United States has several other treaties that have not yet been fully implemented.

7.25.3.20.1  (02-23-1999)
Deductibility of Contributions for Income Tax Purposes

  1. Contributions to charitable foreign organizations are not deductible in computing United States income tax. Under IRC 170(c)(2)(A) of the Code, charitable contributions by donors to organizations formed either outside the United States or under foreign law are not deductible.

  2. Under certain tax treaties, contributions to foreign organizations may be deductible to a limited extent. Generally, tax treaties limit deductibility to the applicable percentage of the taxpayer’s income derived from the treaty-partner.

    1. A contribution to a charitable organization in a country with a fully-implemented tax treaty (currently limited to Canada) may be claimed as a charitable deduction to the extent allowed, even though the organization has not applied for recognition of exemption in the United States.

    2. An organization in a country that has a tax treaty that is not fully implemented through a competent authority agreement can receive deductible contributions to the extent allowed by the particular treaty if it establishes its exempt status with the Service.

7.25.3.20.2  (02-23-1999)
Deductibility of Contributions for Estate and Gift Tax Purposes

  1. Bequests to charitable foreign organizations are deductible in computing the taxable estate of a deceased resident or citizen of the United States for United States estate tax purpose under IRC 2055 and 2106.

  2. Gifts of property to foreign charitable organizations are deductible in computing the United States gift tax of a resident or citizen of the United States under IRC 2522.

7.25.3.20.3  (02-23-1999)
Application Process for Foreign Organizations

  1. Unless excepted by provisions of a tax treaty, a foreign organization seeking exemption under IRC 501(c)(3) must file an application on the Form 1023 in the same manner as a domestic organization.

7.25.3.21  (02-23-1999)
Application for Recognition of Exemption

  1. Before the Tax Reform Act of 1969 there was no statutory requirement that an organization make a notice or application with the Service in order to be exempt. An organization was exempt if it met the requirements of IRC 501(c)(3). Although most organizations filed exemption applications, Form 1023, in order to have their exempt status recognized, some did not. The Tax Reform Act changed this.

  2. Under IRC 508(a) an organization organized after October 9, 1969 (except for organizations noted in 3(14)2), shall not be treated as described in IRC 501(c)(3) unless it has given notice to the Service in the manner prescribed by regulations that it is applying for recognition of IRC 501(c)(3) status. This is commonly referred to as the "508(a) notice."

  3. Reg. 1.508–1(a)(2)(i) states that the notice is given by submitting a properly completed and executed exemption application (Form 1023).

  4. Reg. 1.508–1(a)(1)(ii) provides that the application must be filed within 15 months of the end of the month in which the organization was organized or incorporated. However, Reg. 301.9100–1, which provides circumstances under which extensions of time limits for making elections established by regulation may be granted, provides an automatic 12-month extension to the 15-month period established by Reg. 1.508–1(a)(1)(ii). In addition Reg. 301.9100–1 provide circumstances under which an organization can establish reasonable cause for a further extension to be granted.

7.25.3.21.1  (02-23-1999)
Exceptions to Notice Requirement

  1. The following organizations whose exempt status is based upon IRC 501(c)(3) are excepted from the IRC 508(a) notice requirements:

    1. churches, their integrated auxiliaries, and conventions or associations of churches,

    2. organizations that normally have gross receipts not in excess of $5,000, and are not private foundations, and

    3. subordinate organizations (other than private foundations) covered by a group exemption letter.

  2. The regulations provide a formula for what constitutes gross receipts normally not in excess of $5,000. Under that formula, if an organization’s gross receipts do not exceed $7,500 during the first taxable year, $12,000 during the first two taxable years, and $15,000 during the first three taxable years, the organization’s gross receipts are deemed to be normally less than $5,000. The regulations also provide detailed rules for the notice requirement of organizations that start out within the formula but exceed the "normally $5,000 test" in a subsequent year. See Reg. 1.508–1(a)(3)(ii).

7.25.3.21.2  (02-23-1999)
Organization’s Date of Formation

  1. An organization must have a written document to establish its existence for purposes of the organizational test under IRC 501(c)(3).

  2. The written document is variously referred to as "articles of organization" under Reg. 1.501(c)(3)–1(b)(2) and as the "organizing or enabling document" under Rev. Proc. 90–27, 1990–1 C.B. 514. The terms are interchangeable.

  3. State law determines the date of formation of a corporation incorporated under the laws of the State. The date is generally the date the organizing document (usually called the articles of incorporation) is filed with and approved by an appropriate State official. See Rev. Rul. 75–290, 1975–2 C.B. 215.

  4. For trusts and associations, the date of formation is generally the date the organizing document is signed (or otherwise adopted) by the relevant parties. See the organizational test under IRC 501(c)(3). For 508(a) purposes, a trust created by will is not considered organized before the date of the first distribution of trust corpus to the trustee, or, if earlier, the date the decedent’s estate is considered terminated for federal tax purposes.

  5. An organization is not considered organized for 508(a) purposes until it is described in IRC 501(c)(3) (without regard to IRC 508(a)). See Reg. 1.508–1(a)(2)(iii). For example, if a split-interest trust changes to an exclusively charitable trust by expiration of the non-charitable interests, then the 508(a) filing period begins at the time of the change. However, if an organization’s organizing document requires only a nonsubstantive amendment to comply with the organizational test under IRC 501(c)(3) (e.g., the addition of a proper dissolution clause) and the organization makes the amendment (either on its own initiative or when requested by the Service), the organization will be regarded as satisfying the organizational test from its formation. See Rev. Proc. 84–47, 1 C.B. 545; Rev. Proc. 90–27, 1990–1 C.B. 514.

7.25.3.21.3  (02-23-1999)
Untimely and Incomplete Notices

  1. If an organization files its Form 1023 after the 15 month period provided in Reg. 1.508–1(a)(1)(ii) (and the period of any additional extensions granted) it may be recognized as exempt only from the date its application was filed. It follows that the organization may be a taxable organization under such circumstances (and thus would be unable to attract charitable contributions) for the period which precedes the date the application was filed.

    1. Rev. Rul. 77–114, 1977–1 C.B. 152, provides that for purposes of IRC 508(a) the date of notice is the date of the U.S. postmark stamp or, if no postmark, the date the application is stamped as received by the Service.

  2. As mentioned in IRM 7.25.3.21(4), Reg. 301.9100–1 provides an automatic 12-month extension to the 15-month period established by Reg. 1.508–1(a)(1)(ii). In addition, Reg. 301.9100–1 provides that a further extension can be granted if:

    1. the organization establishes that it took all reasonable actions in good faith to make the application; and

    2. granting an extension would cause no detriment to the interests of the Government.

  3. An "incomplete" application does not constitute notice under IRC 508(a). However, an application is not incomplete merely because it needs to be perfected. A completed application may need additional information before a determination of exempt status may be made. In such cases the notice requirement of IRC 508(a) has been met whether or not the additional information is timely received. However, absence of the following information will cause an application to be incomplete:

    1. copy of governing instrument

    2. copy of bylaws or internal rules of operation

    3. balance sheets (last 4 years, if available, or proposed if organization has not been in operation for that long)

    4. classified statements of receipts and disbursements (last 4 years, if available, or proposed if organization has not been in operation for that long) or

    5. any other basic data required by the application or its instructions

  4. Reg. 1.508–1(a)(2)(ii) provides that an incomplete application will be considered timely filed if the organization supplies the necessary additional information requested by the Service within the additional time period provided for in the request.

7.25.3.21.3.1  (02-23-1999)
Exemption Under IRC 501(c)(4) for Late Filer

  1. An organization that otherwise qualifies for recognition of exemption as an organization described in both IRC 501(c)(3) and IRC 501(c)(4), but fails to file timely for purposes of IRC 508, may apply for and obtain exemption as an organization described in IRC 501(c)(4) from the date of its inception to the date it files Form 1023. Rev. Rul. 80–108, 1980–1 C.B. 119.

7.25.3.21.3.2  (02-23-1999)
Employment Tax Liability of a Late Filer

  1. A religious organization (other than a church excepted from the notice requirement) that applies for recognition of exempt status more than 15 months from the end of the month in which it is organized will not be treated as a IRC 501(c)(3) organization for the period before its application was filed. As set out in Rev. Rul. 76–262, 1976–2 C.B. 310, services performed by its employees during that period are not excepted from employment for FICA and FUTA purposes.

7.25.3.21.4  (02-23-1999)
Application for Exemption After Reorganization

  1. Organizations that are recognized exempt but change their organizational form must file an application for exemption to establish that the new organization qualifies for exemption. Rev. Rul. 67–390, 1967–2 C.B. 179, describes four specific circumstances under which the new organization must apply for recognition of exemption. They are:

    1. an exempt trust which reorganizes into a corporation;

    2. an exempt association which incorporates,

    3. an exempt corporation reincorporated under Act of Congress; and

    4. an exempt corporation which is reincorporated under the laws of another state.

  2. Rev. Rul. 74–490, 1974–2 C.B. 171, provides that a private foundation remaining in existence after terminating its private foundation status under IRC 507(b)(1)(A), must file a new application, unless specifically excepted by IRC 508(c).

7.25.3.21.5  (02-23-1999)
Group Exemption Applications

  1. Exemption from Federal income tax may be obtained on a group basis for subordinate organizations affiliated with and under the general supervision or control of a central organization. A complete description of the requirements for submitting a group exemption application is provided by revenue procedure.

7.25.3.22  (02-23-1999)
Amateur Athletic Organizations

  1. Organizations associated with amateur athletics may qualify for recognition of exemption under IRC 501(c)(3) under one of several different rationales.

7.25.3.22.1  (02-23-1999)
Amateur Athletic Organizations as "Educational" or "Charitable"

  1. Although most of the attention has focused in recent years on amendments to IRC 501(c)(3) provided in the Tax Reform Act of 1976 and on new IRC 501(j), organizations involved with sports may be recognized as described in IRC 501(c)(3) based on prior law:

    1. As "educational" on the grounds that they taught sports to youth or is affiliated with an exempt educational organization (Rev. Rul. 80–215, 1980–2 C.B. 174; Rev. Rul. 77–365, 1977–2 C.B. 192; Rev. Rul. 67–291, 1967–2 C.B 184; Rev. Rul. 64–275, 1964–2 C.B. 142; Rev. Rul. 55–587, 1955–2 C.B. 261);

    2. As "charitable" on the grounds that they combatted juvenile delinquency or lessened the burdens of government (Rev. Rul. 80–215, 1980–2 C.B. 174; Rev. Rul. 59–310, 1959–2 C.B. 146).

  2. The "educational" and "charitable" rationales continue to be valid bases for recognition of exemption, particularly in cases where the applicant’s activities are directed at children or adolescents.

    1. Organizations that qualify as "educational" or "charitable" can avoid the complexities of the "amateur athletic" provisions of IRC 501(c)(3) and IRC 501(j).

7.25.3.22.2  (02-23-1999)
Tax Reform Act of 1976

  1. The Tax Reform Act of 1976 amended IRC 501(c)(3) to include organizations that "foster international amateur sports competition (but only of no part of its activities involve the provision of facilities and equipment." (But see the discussion of IRC 501(j), below.)

  2. This amendment posed two problems for the Service:

    1. No guidance was provided as to what was meant by "foster[ing] national or international amateur sports competition."

    2. Most organizations that teach or promote a sport provide some facilities or equipment.

7.25.3.22.3  (02-23-1999)
"Qualified Amateur Sports Organizations" Under IRC 501(j)

  1. In an attempt to clarify the amateur athletic provision, Congress amended lRC 501(c) in 1982 by adding IRC 501(j).

  2. IRC 501(j)(1) provides generally that a "qualified amateur sports organization" that otherwise satisfies the requirements of IRC 501(c)(3) will qualify as exempt regardless of whether it provides athletic facilities or equipment and regardless of whether its membership is local or regional in nature.

  3. IRC 501(j)(2) defines a "qualified amateur sports organization" as an organization organized and operated primarily to conduct or to support and develop amateur athletes for national or international competition in sports.

7.25.3.22.4  (02-23-1999)
"National or International Sports Competition"

  1. Although IRC 501(j) solved the facilities and equipment dilemma, many other questions remain unresolved. For example, what is the meaning of the phrase "national or international sports competition?"

  2. The legislative history of the Tax Reform Act of 1976 indicates that the amateur athletic provisions were not intended to grant exemption to "social clubs or organizations of casual athletes" or to organizations "whose primary purposes are the recreation of their members." It is therefore necessary to distinguish between social/recreational organizations and organizations that promote serious competition.

  3. The following factors may be relevant in determining whether an organization fosters national or international competition:

    1. Is the sport that the organization supports an event in the Olympic or Pan-American Games?

    2. Are the athletes that the organization supports in the age group from which Olympic-quality athletes are normally chosen?

    3. Are the athletes of a caliber that makes them serious contenders for the Olympic or Pan-American games?

    4. Do the athletes have to demonstrate a certain level of talent and achievement in order to receive support from the organization?

    5. Does the organization provide intensive, daily training, as opposed to sponsoring weekend events that are open to and attract a broad competitors?

    6. Is the organization devoted to improving the performance of a small group of outstanding athletes or does it emphasize the improvement in health of the general public?

    7. Is the organization a member of the United States Olympic Committee?

  4. Although all the facts and circumstances must be considered, these factors are not exhaustive. A "yes" response to these questions, however, strongly indicates that the organization qualifies under IRC 501(j).

7.25.3.22.5  (02-23-1999)
Local or Regional Organizations

  1. In some cases the organization’s activities are so clearly local in scope and so far removed from any relationship to national or international competition that however IRC 501(j) is interpreted, the organization cannot qualify.

  2. If an organization is composed of local amateur athletes who primarily play other local teams, the fact that occasionally games are scheduled with teams or organizations in another state would not cause the organization to qualify unless those games can be shown to be part of national competition.

  3. Similarly, even if the organization provides a regional tournament, some link to national or international competition must be established. Such a national or international nexus could possibly be established through the organization’s membership in a national sports association. An assertion by an organization that its is a training ground for collegiate, professional, and/or Olympic players, absent some evidence that there is a reasonable probability that the members will participate in national or international competition, would not suffice to qualify the organization for exemption.

Exhibit 7.25.3-1  (02-23-1999)
"Instrumentality" Exemption Application

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A municipal hospital, municipal hospital district, fire department, public library, park district, water district, and port authority are examples of organizations that may be created by, controlled by, or closely affiliated with government. A municipal hospital or municipal hospital district should be considered under the health care guidance provided through the Corporate Education Introduction To The Health Care Industry Coursebook, (Catalogue Number 83846) and the applicable checksheets for a municipal hospital. Organizations affiliated with Indian tribal governments also may be processed with the use of this checksheet. The term "instrumentality" has been applied to these types of organizations as a kind of shorthand. Technically the term "instrumentality" only has application under the FICA and FUTA provisions. Therefore, there are special paragraphs that should be included in an exemption letter regarding FICA and FUTA tax obligations. However, for convenience, this guide will also refer to these organizations as instrumentalities. A comprehensive discussion of the issues embraced in the foregoing checksheet is included above at IRM 7.25.3.12 under the heading "Instrumentalities." See also the FY 1996 CPE article entitled "State Institutions — Instrumentalities," and the FY 1997 CPE article entitled "Update on State Institutions — Instrumentalities." There are situations where an organization such as a tourist bureau or a soil and water conservation district that is an instrumentality closely affiliated with government may not qualify under IRC 501(c)(3) but would qualify under IRC 501(c)(4), (5) or (6) if it meets the requirements particular to that exemption provision.

1. Operated Exclusively for Charitable Purposes

An organization, even if affiliated with government, must engage primarily in activities which accomplish one or more exempt purposes specified in IRC 501(c)(3). In addition, it may not serve private interests more than as an insubstantial part of its activities, its net earnings may not inure to the benefit of private individuals, and it may not be an "action organization." Reg. 1.501(C)(3)–1(c). Organizations affiliated with governments may meet any of the charitable purposes set forth in IRC 501(c)(3). Many affiliated organizations meet the "lessening of the burdens of government" purpose set forth in Reg. 1.501(c)(3)–1(d)(2). Also see Rev. Ruls. 85–1 and 85–2, 1985–1 C.B. 178, for a description of the factors that help demonstrate that an organization qualifies under the lessening of the burdens of government purpose.

2. Separately Organized Entity

IRC 501(c)(3) requires the existence of a separately organized entity: a corporation, a trust, or an association. Reg. 1.501(c)(3)–1(b). A separate corporation, trust or association, even if it is owned by a state or municipality, may qualify under IRC 501(c)(3). Rev. Rul. 60–384, 1960–2 C.B. 172, amplifying Rev. Rul. 55–319, C.B. 1955–1, 119. The separately organized entity requirement is generally met if the organization is incorporated under state corporation law. Likewise, if the organization is organized and operated as a trust, it is regarded as a separately organized entity.
If not established as a trust or incorporated under state corporation law, any entity that is considered a "corporation" for federal tax law purposes will be considered a separately organized entity. Under IRC 7701(a)(3), the term "corporation" includes associations. Reg. 301.7701–2 lists six major characteristics that are ordinarily found in a pure corporation. As administratively adapted to cases involving classification of non-profit organizations, these characteristics are: (i) associates, (ii) an objective by the associates to carry on the activity for which the organization was formed, (iii) continuity of life, (iv) centralized management, (v) limited liability, and (vi) free transferability of interests. An organization is an association that will be treated as a corporation and, therefore, separately organized, if it has at least four of these corporate characteristics. Many times an entity can be created by legislation. We would look at the enabling legislation to determine whether a separate organization was created because, for example, it has (1) associates (board of directors), (2) an objective to carry on the purposes for which it was formed (providing health care services to the residents of a particular area), (3) continuity of life (board of directors continue even after death, resignation, retirement, etc.), (4) centralization of management (legislation provided for appointment of an administrator). Many times such legislation will activate the organization as a public body corporate and politic pursuant to a resolution filed by a local governmental legislative body, such as a city or county council, approved by an elected official or the voters, and filed with the secretary of state. See Rev. Rul. 60–384, Examples (1) and (2).

3. Organizational Test — State Corporation

Where an organization is incorporated under a state’s nonprofit, corporation law, it is likely that the enabling document satisfies the organizational test under Reg. 1.501(c)(3)–1(b) (charitable purpose and dedication of assets).

4. Organizational Test — Legislation

Satisfying the organizational test often poses a problem when an instrumentality is created pursuant to a state statute, a local ordinance, or similar enabling legislation. This is so because the enabling document may contain neither "exclusive purposes" language nor a standard dissolution clause. The situation is further compounded by the difficulty an instrumentality faces in having such an enabling instrument amended. Nevertheless, if a careful reading of the enabling document clearly shows that it will operate exclusively for exempt purposes, it will be deemed to have met that portion of the organizational test. Further, if an enabling document, or in the alternative, a state law provision creating an entity or controlling an entity, provides that, upon dissolution, all of an instrumentality’s assets will be transferred to the state or any political subdivision thereof, it will be deemed to have met the dedication of assets portion of the organizational test. In those cases, absent any clear indication that the assets will be distributed for private use, the assumption is that the assets will be used for a public purpose as is required by Reg. 1.501(c)(3)–1(b)(4). Where there is a question of whether an entity satisfies the organizational test, the law of the State in which the organization is created controls for purposes of construing terms. Reg. 1.501(c)(3)–1(b)(5). Therefore, it would be incumbent on the organization to establish by convincing reference to relevant court decisions, opinions of the State attorney-general, or other evidence of applicable state law that its language satisfies the organizational test. In rare circumstances, it may be necessary to require that a separately incorporated entity be established to satisfy the organizational test. Example:
As authorized by state statute an Older Persons’ Commission ( "Commission" ) was established under an Interlocal Agreement between local Townships (Note: Commission was not incorporated under state non-profit corporation law). The activities of Commission included the operation of an older persons’ activity center for the purpose of improving the social, legal, health, housing, educational, emotional, nutritional, recreational, and mobility status of older persons. Under the Interlocal Agreement (i) each of the Townships who were parties thereto made a capital contribution to acquire or construct the activity center; (ii) a Board of Commissioners was elected by the Township Boards and City Council; (iii) Commission was established as an independent entity, separate and distinct from the Townships; (iv) Commission hired its own employees, who could not be employees of the Townships; (v) the funds received by Commission were held in a separate fund and accounted for separately from the other funds of the Townships; (vi) Commission was authorized to hire a director; (vii) upon dissolution, all remaining assets would be distributed to the Townships based on a percentage of their initial contributions for the acquisition of or construction of the activity center, and; (viii) Commission had no sovereign powers.
In this example, Commission was operated exclusively for one or more exempt purposes (the operation of an older persons’ activity center) and it met the requirements of the four major issues as follows: (1) it was a separate entity because under the enabling legislation (Interlocal Agreement) it had (i) associates (Board of Commissioners), (ii) an objective to carry on the purposes for which it was formed (providing activities to older citizens of the community), (iii) continuity of life (Board of Commissioners continued even after death, resignation, retirement, etc.), (iv) centralization of management (Interlocal Agreement provided for the hiring of a director); (2) it satisfied the organizational test because a reading of the Interlocal Agreement showed that it was formed to operate exclusively for exempt purposes (older persons’ activities), and upon dissolution, assets would be distributed to the Townships. There was no indication that the assets would be distributed for private use, so it could be assumed that they would be used for a public purpose as is required by Reg., 1.501(c)(3)–1(b)(4); (3) it was not an integral part of the Townships because the Townships were not substantially involved in its activities, and; (4) it had no disqualifying sovereign powers. Commission is excepted from filing an annual information return on Form 990, Return of Organization Exempt from Income Tax because it is an "affiliate of a governmental unit" within the meaning of section 4 of Rev. Proc. 95–48, 1995–2 CB. 418. Commission is an "affiliate of a governmental unit" within the meaning of section 4 of Rev. Proc. 95–48 in that (1) Commission is controlled by governmental units (its Board of Commissioners is elected by the Township Boards and City Council); (2) Commission satisfies two of the five affiliation factors listed in the revenue procedure (it was created by one or more governmental units, and upon dissolution its assets will be distributed to one or more governmental units), and (3) Commission’s filing of Form 990 is not otherwise necessary for efficient tax administration.

5. Integral Part

An instrumentality that is operated as an integral part of government is not eligible for IRC 501(c)(3) exemption even if it is separately established and it satisfies the organizational test since it would not be subject to federal income taxation under the broad reach of the intergovernmental immunity doctrine. Rev. Rul. 60–384. For example, a committee created by executive order of a governor of a state as an official state agency was an integral part of the state and, therefore, did not come within the scope of IRC 501(c)(3). Rev. Rul. 62–66, 1962–1 C.B. 83. A Lawyer Trust Account Fund was held not to qualify under IRC 501(c)(3) as an integral part of a state because it was created by order of the State supreme court; it operated under rules established by the court; the court had the power to abolish the Fund; the court appointed the Fund’s governing body subject to removal, with or without cause; the court had the authority to require the Fund to maintain records; the Fund’s administrative functions were performed by state employees; the Fund did not have its own employees, and the court had the authority to require the Fund to submit periodic reports. Rev. Rul. 87–2, 1987–1 C. B. 18. It is unusual for an otherwise separately formed organization to be disqualified from exemption because it is operated as an integral part of government. The basis for such a determination is all of the facts and circumstances. Example:
A state statute provided for the creation of a hospital district to construct and operate a county hospital. The enabling statute was worded so that the hospital district was required to serve the health needs of the residents. Under the statute, (i) management of the hospital was vested in a Board of Control; (ii) County Commissioners appointed the members of the Board of Control; (iii) the members of the Board of Control took an oath in the form required of county officers; (iv) the Board of Control was authorized to employ an administrator; (v) bond proceeds were deposited in the county treasury and paid out upon order of the County Commissioners; (vi) contracts for the hospital construction were let out by bid like any other county project; (vii) the administrator and the treasurer of the Board of Control were bonded under the county blanket bond; (viii) the District Attorney, or his assistant, served as attorney for the Board of Control; (ix) the Board of Control had authority to make contributions to the Public Employees’ Retirement System, and; (x) four copies of the audit report for each fiscal year were filed, one with the County Commissioners, one in the county clerk’s office, one with the District Attorney, and one with the State Auditor and Inspector.
This organization had enough corporate characteristics to be considered a separately organized entity both for the purpose of section 501(c)(3) of the Code and Rev. Rul. 60–384, 1960–2 C.B. 172. These characteristics were (i) associates (Board of Control), (ii) an objective by the associates to carry on the activity for which the instrumentality was formed (hospital), (iii) centralized management (hiring of administrator), and (iv) continuity of life (Board of Control continues in perpetuity). Moreover, a broad reading of the enabling statute satisfied the organizational test. However, the hospital in this case was an integral part of the county government and, therefore, under Rev. Rul. 60–384, not described in section 501(c)(3) based on all the facts and circumstances.

An Indian tribal government or political subdivision of an Indian tribal government is not eligible for exemption under IRC 501(a) because it is treated as a state or a political subdivision of a state. An organization formed by an Indian tribal government or a political subdivision of an Indian tribal government does not share the same tax status as the Indian tribal government or political subdivision. It could qualify for exemption as a separately organized entity. To qualify under IRC 501(c)(3), it would have to meet the organizational and operational tests (including the absence of sovereign powers). Similarly, an Indian organization formed under state law may qualify for exemption under IRC 501(c)(3) if it otherwise meets the applicable exemption requirements. An Indian tribal government and its political subdivisions, including Alaska Native governments and their political subdivisions, are treated like states for federal tax purposes. IRC 7871, 7871(d), 7701(a)(40) and Rev. Proc. 67–284, 1967–2 C.B. 55. Rev. Proc. 83–87, 1983–2 C.B. 606, amplified by Rev. Proc. 92–19, 1992–1 C.B. 685, provides a list of Indian tribal governments that are treated as states. Rev. Proc. 84–36, 1984–1 C.B. 510, provides a list of entities that are treated as political subdivisions of states. In addition, Rev. Rul. 81–295, 1981–2 C.B. 15, and Rev. Rul. 94–16, 1994–1 C.B. 17, provide that organizing under sections 16 or 17 or the Indian Reorganization Act of 1974 qualifies an entity for exclusion from federal income tax as a governmental entity. Rev. Rul. 94–65, 1994–1 C.B. 14, provides that a tribal corporation organized under section 3 of the Oklahoma Welfare Act also qualifies an organization for exclusion from federal income tax as a governmental entity. Rev. Proc. 84–37, 1984–1 C.B. 513, provides guidance as to how Indian groups can qualify for treatment as a state or a political subdivision.

6. Regulatory or Enforcement Powers

Rev. Rul. 60–384 provides that even though a wholly-owned state or municipal instrumentality may be a separately organized entity, it is not entitled to IRC 501(c)(3) exemption if it is clothed with powers other than those described in IRC 501(c)(3). For example, where an instrumentality exercises substantial regulatory or enforcement powers in the public interest, it will not qualify. These powers are referred to as sovereign powers.
Three generally acknowledged sovereign powers by which the government governs are the power to tax, the power of eminent domain, and the police power. However, not all government powers are necessarily enforcement or regulatory powers. Thus, the fact that an organization has one of the sovereign powers listed above does not automatically preclude the organization from qualifying under IRC 501(c)(3).
Rev. Rul. 67–290, 1967–2 C.B. 183, holds that a public hospital which has the power to acquire, through eminent domain, property essential to its purposes, qualifies for recognition of exemption as an organization described in IRC 501(c)(3). Thus, the power of eminent domain, if limited to furthering a hospital’s or hospital district’s charitable purpose, does not constitute an enforcement or regulatory power within the meaning of Rev. Rul. 60–384.
Similarly, a limited power to determine a tax rate necessary to support an organization’s operations, a power related more to the disposition of tax revenues than to the exercise of the taxing power of the political unit involved, does not constitute a regulatory or enforcement power within the meaning of Rev. Rul. 60–384. See Rev. Rul. 74–15, 1974–1 C.B. 126, which held that an exempt organization is permitted to certify or determine a tax rate. For purposes of qualification under IRC 501(c)(3), solely, there is no distinction between the power to recommend or certify a tax rate, the power to determine a tax rate, and the power to levy, assess, or impose a tax. The regulatory or enforcement power is the power to collect the tax. Thus, if an organization has the power to collect the tax, it will be disqualified from being recognized as exempt.
Finally, Rev. Rul. 77–165, 1977–1 C.B. 21, considers a public university with a governmental power limited to preserving order and providing for public safety within the confines of its own real property, such as policing and traffic control on the campus. The revenue ruling holds that the organization’s powers are insufficient to constitute the exercise of the state’s police power. Therefore, a limited power equivalent to a university or college campus police force would not disqualify an otherwise qualified instrumentality.
Conversely, Rev. Rul. 74–14, 1974–1 C.B. 125, holds that a public housing authority formed to investigate whether unsanitary or unsafe housing conditions exists does not qualify for exemption under IRC 501(c)(3). In this case, the housing authority has the power to conduct investigations by entering property and issuing subpoenas. Further, it is authorized to make the information it collects available to other agencies for use in enforcing local ordinances. The power to subpoena involves the power to compel testimony under threat of imprisonment if the testimony is not forthcoming. The power to punish is a power of the state alone. In this case, the housing authority’s powers are not limited to those needed to protect its proprietary interests. It possesses powers more related to governance than to the furtherance of a charitable purpose. Thus, Rev. Rul. 74–14 concludes that the housing authority’s investigative powers are enforcement or regulatory powers.

7. Exception From Filing Form 990

Unless specifically excepted, an organization that is recognized as exempt under IRC 501(c)(3) is required to file an annual information return on Form 990, Return of Organization Exempt From Income Tax. Rev. Proc. 95–48, 1995–2 C.B. 418, relieves some organizations that are closely associated with local or state governments from the filing requirement. This revenue procedure supplements Rev. Proc. 83–23, 1983–1 C.B. 687, and specifies two additional classes of organizations that are not required to file the annual information return. These two classes are (1) governmental units, and (2) affiliates of governmental units that are exempt from federal income tax under IRC 501(a). The majority of cases under this revenue procedure will involve "affiliates of governmental units." For most of these organizations to be treated as an "affiliate of a governmental unit" and be excepted from filing the annual information return on Form 990, the following two requirements must be satisfied:
First, the organization must be controlled by a governmental unit. This means that a governmental unit (or a public official acting in his official capacity) must appoint the majority of the members of the organization’s governing body. A governing body elected by the public also satisfies this requirement. For purposes of this control test, a governmental unit is a state, a possession of the United States, or a political subdivision of one of them; the United States; the District of Columbia; or a federally recognized Indian tribal government. Indirect control also satisfies this requirement. Thus, an organization controlled by an organization that is itself a qualifying "affiliate of a governmental unit" under the revenue procedure also qualifies.
Second, the organization must satisfy two of the following five affiliation factors listed in the revenue procedure indicating actual oversight of its financial affairs and activities by the governmental unit.
(a) The organization was created by one or more governmental units, organizations that are affiliates of governmental units, or public officials acting in their official capacity.
(b) The organization’s support is received principally from taxes, tolls, fines, government appropriations, or fees collected pursuant to statutory authority. Amounts received as government grants or other contract payments are not qualifying support under this paragraph.
(c) The organization is financially accountable to one or more governmental units. This factor is present if the organization is (i) required to report to governmental unit(s), at least annually, information comparable to that required by Form 990; and (ii) is subject to financial audit by the governmental unit(s) to which it reports. A report submitted voluntarily by the organization does not satisfy clause (i). Also. reports and audits pursuant to government grants or other contracts do not alone satisfy this paragraph (c).
(d) One or more governmental units, or organizations that are affiliates of governmental units, exercise control over, or oversee, some or all of the organization’s expenditures (although it is not financially accountable to governmental units as described in paragraph (c) of this section).
(e) If the organization is dissolved, its assets will (by reason of a provision in its articles of organization or by operation of law) be distributed to one or more governmental units, or organizations that are affiliates of governmental units within the meaning of section 4 of the revenue procedure.
Finally, the exception under Section 4.02(b) was not intended to except otherwise qualifying entities where efficient administration of the internal revenue laws would be hampered. This would involve situations where the organization is part of an extensive health care system consisting of exempt and taxable entities (such as joint ventures with taxable entities and taxable subsidiaries), or where there is a considerable potential for overly serving private interests.

8. Charitable Hospital

Municipal hospitals and hospital districts that operate health care facilities must also qualify as charitable under IRC 501(c)(3), which can be determined by completing Schedule C of the Form 1023 (this schedule concerns hospitals and medical research organizations).

Exhibit 7.25.3-2  (02-23-1999)
Pattern Information Letter for Instrumentalities

Dear Sir or Madam:

This responds to your letter requesting information concerning your federal tax status.

No provision of the Internal Revenue Code imposes a tax on the income of governmental units (such as states and their political subdivisions). It has therefore long been the position of the Service that income of governmental units is not generally subject to federal income taxation. If, however, an entity is not itself a governmental unit (or an "integral part" thereof), its income will be subject to tax unless an exclusion or exemption applies.
One exclusion is provided by section 115(1) of the Code, which excludes from gross income, income (A) derived from the exercise of any essential governmental function, and (B) accruing to a state or political subdivision.
Your income may not be subject to tax, either because you are a governmental unit (or an "integral part" thereof), or because your income is excluded under section 115 of the Code. In addition, you may also be eligible to receive charitable contributions which are deductible for federal income, estate, and gift tax purposes; and you are probably exempt from many federal excise taxes.
You may obtain a letter ruling on your status under section 115 of the Code, following the procedures specified in Revenue Procedure 96–1 or its successor (the first Revenue Procedure published each year). You must also pay a user fee as described in that Revenue Procedure.
You may also qualify for exemption from federal income tax as an organization described in section 501(c)(3) of the Code. If you are an entity separate from the state, county, or municipal government, and if you do not have powers or purposes inconsistent with exemption (such as the power to tax or to exercise enforcement or regulatory powers), you would qualify under section 501(c)(3). To apply for exemption, you would need to complete Form 1023 and pay the required user fee.
Sometimes governmental units are asked to provide proof of their status as part of a grant application. If you are applying for a grant from a private foundation, it may be requesting certain information from you because of the restrictions imposed by the Code on such foundations. One such restriction imposes a tax on private foundations that make any "taxable expenditures." Under section 4945(d) and (h) of the Code, "taxable expenditures" include (1) any grant to an organization (unless excepted), unless the foundation exercises "expenditure responsibility" with respect to the grant; and (2) any expenditure for non-charitable purposes. Under section 4942 of the Code, private foundations must also distribute certain amounts for charitable purposes each year— "qualifying distributions" —or incur a tax on the undistributed amount. "Qualifying distributions" include certain amounts paid to accomplish charitable purposes.
Private foundation grants to governmental units for public or charitable purposes are not taxable expenditures under these provisions, regardless of whether the foundation exercises "expenditure responsibility." Under section 53.4945–5(a)(4)(ii) of the Foundation and Similar Excise Taxes Regulations, expenditure responsibility is not required for grants for charitable purposes to governmental units (as defined in section 170(c)(1) of the Code). Similarly, grants to governmental units for public purposes are "qualifying distributions" , under section 53.4942(a)–3(a) of the regulations; and, if they are for charitable purposes, will not be taxable expenditures, under section 53.4945–6(a) of the regulations. Most grants to governmental units will qualify as being for charitable (as well as public) purposes. Because of these restrictions, some private foundations require grant applicants to submit a letter from the Service determining them to be exempt under section 501(c)(3) and classified as a non-private foundation. Such a letter, or an underlying requirement that a grantee be a public charity, is not legally required to be relieved from the restrictions described above, when the prospective grantee is a governmental unit and the grant is for qualifying (public or charitable) purposes.
We believe this general information will be of assistance to you. This letter, however, is not a ruling and may not be relied on as such. If you have any questions, please feel free to contact the person whose name and telephone number are listed in the heading of this letter.

Sincerely,


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