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Establishing A Non-Profit

 

 

§ 501(c)(3) Federal Tax-Exempt Status

 

• DETERMINATION OF 501(c)(3) STATUS
• PROHIBITED ACTIVITIES OF A FEDERALLY TAX- EXEMPT ORGANIZATION
• EXEMPTION FROM TAX ON CORPORATIONS, CERTAIN TRUSTS, ETC
• GUIDE TO 501(c)(3) LOBBYING ACTIVITES

(For more information, contact the Center for a non-profit starter kit)

 

 

 

IN ORDER TO BE EXEMPT UNDER § 501(c)(3), AN ORGANIZATION MUST FILE AN APPLICATION FOR AN EXEMPTION OF FORM 1023 SHOWING THAT THE ORGANIZATION MEETS THE FOLLOWING TESTS:

(1) It must be organized and operated exclusively for religious, charitable, scientific, literary or educational purposes, for the prevention of cruelty to children or animals, or for the purpose of testing consumer products for public safety, or to foster national or international amateur sports competition (but only if no part of its activities involves provision of athletic facilities or equipment);

(2) Its net income must not be used, in whole or in part, to the benefit of private shareholders or individuals;

(3) It must not as any substantial part of its activities attempt to influence legislation by propaganda or otherwise except for certain lobbying activities.

 

DETERMINATION OF 501(c)(3) STATUS:

The Internal Revenue Service uses two tests to determine whether to grant an organization 501(c)(3) status: an Organizational Test and an Operational Test.

1. The Organizational Test

The organizational test requires that the articles of organization (e.g., corporate charter, an article of association, or trust instrument) of a legal entity seeking exempt status contain some general and specific provisions:

In meeting this requirement, an organization's purposes, as stated in its articles, may be as broad as (e.g., a statement that the organization is formed for "charitable purposes" will ordinarily suffice), or more specific than (e.g., a statement that sets forth the purpose of the organization and that describes in detail the manner of operation), the exempt purposes mentioned in § 501(c)(3). If the stated purposes of an organization make only vague and general statements of an intent to comply with § 501(c)(3), the IRS will focus on the operational test to see if the organization's proposed activities serve an exempt purpose.

(b) Do not expressly empower the organization to engage, except as an insubstantial part of its activities, in activities which in themselves are not in furtherance of one or more exempt purposes.

 

 

(c) Must provide that its assets be dedicated to one or more exempt purpose. The articles must provide that upon dissolution of the organization, its assets will be distributed to another organization that is exempt under Code 501(c)(3) or to the government (federal, state or local) for public purposes. Furthermore, the organization's assets may not be distributed to its members or shareholders. This may be accomplished either by reason of a provision in the organization's articles or by operation or law.

 

2. The Operational Test

The operational test requires that a 501(c)(3) organization be operated "exclusively for" the prescribed exempt purposes. The organization must engage primarily in activities that accomplish one or more of the exempt purposes. It is not regarded as exempt if more than an insubstantial part of its activities is not in furtherance of an exempt purpose.

 

PROHIBITED ACTIVITIES OF A FEDERALLY TAX- EXEMPT ORGANIZATION

(a) No substantial part of a charitable organization's activities may consist of carrying on propaganda, or otherwise attempting to influence legislation. The organization may not engage in or intervene in, including by publishing or distributing statements, any political campaign on behalf of or in opposition to candidate for public office. An excise tax will be imposed if any prohibited expenditure is made.

1. "Influencing legislation":

a. contact or urges the public to contact members or a legislative body for the purpose of proposing, supporting, or opposing legislation; or

b. advocates the adoption or rejection of legislation.

 

2. Exempt status is not jeopardized, however, by a provision in the organization's articles that empower it to elect the "expenditure test" under Code § 501(h) with respect to influencing legislation.

The articles may also authorize the organization to make lobbying or grass roots expenditures that do not normally exceed the limits set out in Code Sec. 501(h) if such an election is made.

 

 

3. Nonpartisan analysis, study, research is permitted if the results are made available to the general public. This may be done to advocate a particular position or viewpoint as long as there is a sufficiently full and fair exposition of the pertinent facts to enable the public or an individual to form an independent opinion or conclusion.

b) The operational test requires that no private increment results from the net income of the organization. An organization will lose its tax-exempt status if any part of the organization's net earnings inure to the benefit of any private shareholder or individual (i.e. persons having a personal and private interest in the activities of the organization).

1. An organization must not be organized or operated for the benefit of private interests such as designated individuals, the creator or his family, shareholders of the organization, or person controlled, directly or indirectly, by such private interests

2. This does not prohibit payments to stockholders or individuals, but instead is generally directed at payments that are made to shareholders or individuals for purposes other than as reasonable compensation for goods or services.

3. Payments necessary to perform exempt functions such as administrative expenses are exempt unless amount is unreasonable. Sales and loan transactions result in private benefit if not on arm's-length basis.

4. All salaries paid to individuals of the organization must be reasonable relative to the type of services such individuals provide to the organization.

(c) Violating fundamental public policy against racial discrimination, employment discrimination and illegal activities results in loss of organization's tax-exempt status. The policy is established by legislation, judicial and administrative decisions.

Unless an organization can meet these two tests, the organization will not obtain, nor can it maintain, a 501(c)(3) status 26 USC §501.

EXEMPTION FROM TAX ON CORPORATIONS, CERTAIN TRUSTS, ETC.

(a) Exemption from taxation. -- An organization described in subsection (c) or (d) or section 401(a) shall be exempt from taxation under this subtitle unless such exemption is denied under section 502 or 503.

(b) Tax on unrelated business income and certain activities
An organization exempt from taxation under subsection (a) shall be subject to tax to the extent provided in parts II, III, and VI of this subchapter, but (notwithstanding parts II, III, and VI of this subchapter) shall be considered an organization exempt from income taxes for the purpose of any law which refers to organizations exempt from income taxes.

(c) List of exempt organizations. The following organizations are referred to in subsection (a): --

(3) Corporations, and any community chest, fund, or foundation, organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition (but only if no part of its activities involve the provision of athletic facilities or equipment), or for prevention of cruelty to children or animals, no part of the net earnings of which inures to the benefit of any private shareholder or individual, no substantial part of the activities of which is carrying on propaganda, or otherwise attempting, to influence legislation (except as otherwise provided in subsection (h)), and which does no participate in or intervene in (including the publishing or distributing of statements), any political campaign on behalf of (or in opposition to) any candidate for pubic office.

(4) Civic leagues or organizations not organized for profit but operated exclusively for the promotion of social welfare, or local associations of employees, the membership of which is limited to the employees of a designated person or persons in a particular municipality, and the net earnings of which are devoted exclusively to charitable, educational, or recreational purposes.

(h) Expenditures by public charities to influence legislation

(1) General Rules
In the case of an organization to which this subsection applies, exemption from taxation under subsection (a) shall be denied because a substantial part of the activities of such organization consists or carrying on propaganda, or otherwise attempting , to influence legislation, but only if such organization normally --

A) makes lobbying expenditures in excess of the lobbying ceiling amount for such organization for each taxable year, or

B) makes grass roots expenditures in excess of the grass roots ceiling amount for such organization for each taxable year.

(2) Definitions - For purposes of this subsection --

(A) Lobbying expenditures : The term "lobbying expenditures" means expenditures for the purpose of influencing legislation (as defined in section 4911(d)).

(B) Lobbying ceiling

The lobbying ceiling amount for any organization for any taxable year is 150 percent of the lobbying nontaxable amount for such organization for such taxable year, determined under section 4911.

 

501(c)(3) LOBBYING ACTIVITIES

As a charitable, tax-exempt, 501(c)(3) (of the United States Internal Revenue Code) organization, an organization is forbidden from engaging in any partisan political activity and substantial lobbying activities. Furthermore, an organization may "elect" under the Internal Revenue Code 501(h), meaning that the organization is allowed to engage in significantly greater lobbying activities than non-electing organizations, provided that records are kept that document that the organization remains under a ceiling set by the Code.(1)

WHAT IS LOBBYING?

The IRS considers any attempt to influence legislation as lobbying. Legislation includes actions taken by legislative bodies, Congress, state legislatures, local council, or similar governing bodies, or by the public in a referendum, ballot initiative, constitutional amendment, or similar procedure. Also, the IRS considers lobbying on confirmation of Executive Branch and Judicial appointees "lobbying on legislation." Legislation does not include action taken by executive, judicial or administrative bodies (such as school boards, housing authorities and zoning boards, whether elective or appointive).

PROHIBITED ACTIVATES

No substantial part of a charitable organization's activities may consist of carrying on propaganda, or otherwise attempting to influence legislation.(2) Commonly known as the "lobbying limitation," this prohibition includes:

 

1)grass roots lobbying ("any attempt to influence legislation through an attempt to affect the opinion of the general public..."); and

 

2) direct lobbying ("any attempt to influence legislation through communication with any member or employee of a legislative body, or with any other government official or employee who may participate in the formulation of the legislation..."(3) The organization may not engage in or intervene in, including by publishing or distributing statements, any political campaign on behalf of or in opposition to candidates for public office.

PERMITTED ACTIVITIES

Section 501(c)(3) organizations may engage in non-partisan (4) analysis, study or research if the results are made available to the general public. This may be done to support a particular position or viewpoint (including a position which might be the subject of contemporaneous legislative deliberation) as long as the public or an individual is able to form an independent opinion or conclusion based on a sufficiently full and fair exposition of the pertinent facts.(5) This non-partisan analysis is permissible even though there is a possibility that the same research and analysis may subsequently be used in a a lobbying campaign, provided that the initial use of the analysis constitutes a "substantial nonlobbying distribution." (6)

Additionally, if a 501(c)(3) organization has developed an expertise in a particular area, it may be called upon to render technical advice or assistance to a legislative committee or subcommittee(7) only if the entity is given a written invitation by the committee or subcommittee(7) to do so. This "expert testimony" even if it contain opinions or recommendations on proposed legislation(8) is not considered a lobbying activity under the Internal Revenue Code.(9)

A 501(c)(3) organization also may participate in or sponsor public discussions on issues of general concern, provided that the discussions do not address the merits of specific legislative proposals, and do not directly encourage participants to take action with respect to legislation, even if the discussions are with members of legislative bodies or government employees.(10)

Lastly, a 501(c)(3) organization may engage in communications with a legislative body to protect the organization's self-interest, such as lobbying on behalf of its powers, existence, tax-exempt status, duties, or the dectibility or contributions to the organization (but not grass roots lobbying communication). As noted handbook on nonprofit management state, the law provides "more lobbying leeway than 99% of all nonprofits will every need - or want."

Endnotes:

• 1. An origination that has "elected" is limited in its expenditures for lobbying activities to 20% of the expenditures spent on exempt purposes. IRC 4911(c)(2).
• 2. Internal Revenue Code 4945(d)(1).
• 3. Internal Revenue Code 4945(e).
• 4. "Based on, influence by, affiliated with, or supporting no single political party." Defeination from The American Heritage College Dictionary, 3d, edition, Houghton Mifflin Company, 1993.
• 5. Reg. 53.4945-2(d)(1)(ii).
• 6. Reg. 56.4911-2(b)(2)(v)(E).
• 7. Not just an individual member of the committee or subcommittee.
• 8. Only if requested by the committee or subcommittee. This request may be in the form of an open-ended invitation to present views relevant to the subject matter of the proposed legislation.
• 9. Reg. 53.4945-2(d)(2).
• 10. Reg. 53.4945-2(d)(4).

The Citizen Advocacy Center has made reasonable efforts to provide correct information as of the date these materials were created, but we cannot be responsible for the current accuracy of or application of any of the information -- including the legal information -- contained in these documents. Updates, additions, and corrections to our information are always welcome and should be sent to our email address at cac@citizenadvocacycenter.org.