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Section 501(a) of the Internal Revenue Code generally exempts from federal income taxation numerous types of organizations. Among these are section 501(c)(3) organizations which include corporations:

organized and operated exclusively for religious, charitable, scientific . . . or educational purposes . . . 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, . . . and which does not participate in, or intervene in . . . any political campaign on behalf of (or in opposition to) any candidate for public office.
I.R.C. 501(c)(3). Organizations described in section 501(c)(3) are generally referred to as "charitable" organizations and contributions to such organizations are generally deductible to the donors. I.R.C. 170(a)(1), (c)(2).


The requirement that a 501(c)(3) organization be "organized and operated exclusively" for an exempt purpose has given rise to an "organizational test" and an "operational test." Failure to meet either test will prevent an organization from qualifying for exemption under section 501(c)(3). Treas. Reg. 1.501(c)(3)-1(a); Levy Family Tribe Foundation v. Commissioner, 69 T.C. 615, 618 (1978).

1. Organizational Test

To satisfy the organizational test, an organization must meet three sets of requirements. First, its articles of organization must: (a) limit its purposes to one or more exempt purposes, and (b) not expressly permit substantial activities that do not further those exempt purposes. Treas. Reg. 1.501(c)(3)-1(b)(1). Second, the articles must not permit: (a) devoting more than an insubstantial part of its activities to lobbying, (b) any participation or intervention in the campaign of a candidate for public office, and (c) objectives and activities that would characterize it as an "action" organization. Treas. Reg. 1.501(c)(3)-1(b)(3). Third, the organization's assets must be dedicated to exempt purposes. Treas. Reg. 1.501(c)(3)-1(b)(4). The IRS determines compliance with the organizational test solely by reference to an organization's articles of organization.

2. Operational Test

To satisfy the operational test, an organization must be operated "exclusively" for an exempt purpose. Though "exclusively" in this context does not mean "solely," the presence of a substantial nonexempt purpose will cause an organization to fail the operational test. Treas. Reg. 1.501(c)(3)-1(c)(1); The Nationalist Movement v. Commissioner, 102 T.C. 558, 576 (1994). The presence of a single non-exempt purpose, if substantial in nature, will destroy the exemption regardless of the number or importance of truly exempt purposes. Better Business Bureau of Washington, D.C. v. United States, 326 U.S. 276, 283 (1945); Manning Association v. Commissioner, 93 T.C. 596, 611 (1989).

To meet the operational test under section 501(c)(3) organization, the organization must satisfy the following requirements:

1. The organization must be operated for an exempt purpose, and must serve a public benefit, not a private benefit. Treas. Reg. 1.501(c)(3)-1(d)(1)(ii).

2. It must not be an "action" organization. Treas. Reg. 1.501(c)(3)-1(c)(3). An organization is an "action" organization if:

a. it participates or intervenes in any political campaign (Treas. Reg. 1.501(c)(3)-1(c)(3)(iii));

b. a substantial part of its activities consists of attempting to influence legislation (Treas. Reg. 1.501(c)(3)-1(c)(3)(ii)); or

c. its primary objective may be attained: only by legislation or defeat of proposed legislation, and it advocates the attainment of such primary objective (Treas. Reg. 1.501(c)(3)-1(c)(3)(iv)).

3. Its net earnings must not inure to the benefit of any person in a position to influence the organization's activities. Treas. Reg. 1.501(c)(3)-1(c)(2).
"[F]ailure to satisfy any of the [above] requirements is fatal to [an organization's] qualification under section 501(c)(3)." American Campaign Academy v. Commissioner, 92 T.C. 1053, 1062 (1989).

The application of these requirements, moreover, is a factual exercise. Id. at 1064; Christian Manner International v. Commissioner, 71 T.C. 661, 668 (1979). Thus, in testing compliance with the operational test, courts look "beyond the four corners of the organization's charter to discover 'the actual objects motivating the organization and the subsequent conduct of the organization.'" American Campaign Academy, 92 T.C. at 1064 (citing Taxation with Representation v. United States, 585 F.2d 1219, 1222 (4th Cir. 1978)); see also Sound Health Association v. Commissioner, 71 T.C. 158, 184 (1978) ("It is the purpose toward which an organization's activities are directed that is ultimately dispositive of the organization's right to be classified as a section 501(c)(3) organization.")

"What an organization's purposes are and what purposes its activities support are questions of fact." American Campaign Academy, 92 T.C. at 1064 (citing Christian Manner International v. Commissioner, 71 T.C. 661, 668 (1979)). Courts may "draw factual inferences" from the record when determining whether organizations meet the requirements of the tax-exempt organization laws and regulations. Id. (citing National Association of American Churches v. Commissioner, 82 T.C. 18, 20 (1984)).

a. "Educational" Organizations May Qualify for Exemption Under Section 501(c)(3)

As discussed above, an organization may qualify for exemption under section 501(c)(3) if it is "educational." The Regulations define the term "educational" as relating to:

(a) [t]he instruction or training of the individual for the purpose of improving or developing his capabilities; or

(b) [t]he instruction of the public on subjects useful to the individual and beneficial to the community.

Treas. Reg. 1.501(c)(3)-1(d)(3)(i). The Regulations continue:

An organization may be educational even though it advocates a particular position or viewpoint so long as it presents a sufficiently full and fair exposition of the pertinent facts as to permit an individual or the public to form an independent opinion or conclusion. On the other hand, an organization is not educational if its principal function is the mere presentation of unsupported opinion.
Id. Guidance on the phrase "advocates a particular position or viewpoint" can be found in the preceding section in the Regulations pertaining to the definition of "charitable."
The fact that an organization, in carrying out its primary purpose, advocates social or civil changes or presents opinion on controversial issues with the intention of molding public opinion or creating public sentiment to an acceptance of its views does not preclude such organization from qualifying under section 501(c)(3) so long as it is not an "action" organization . . . .
Treas. Reg. 1.501(c)(3)-1(d)(2).

In applying the Regulations under section 501(c)(3) pertaining to educational organizations, the IRS has stated that its goal is to eliminate or minimize the potential for any public official to impose his or her preconceptions or beliefs in determining whether the particular viewpoint or position is educational. Rev. Proc. 86-43, 1986-2 C.B. 729. IRS policy is to "maintain a position of disinterested neutrality with respect to the beliefs advocated by an organization." Id. The focus of the Regulations pertaining to educational organizations and of the IRS's application of these Regulations "is not upon the viewpoint or position, but instead upon the method used by the organization to communicate its viewpoint or positions to others." Id.

Two court decisions considered challenges to the constitutionality of the definition of "educational," in the Regulations cited above. One decision held that the definition was unconstitutionally vague. Big Mama Rag, Inc. v. United States, 631 F.2d 1030 (D.C. Cir. 1980). In National Alliance v. United States, 710 F.2d 868 (D.C. Dir. 1983), the court upheld the IRS's position that the organization in question was not educational. Without ruling on the constitutionality of the "methodology test" used by the IRS in that case to determine whether the organization was educational, the court found that the application of that test reduced the vagueness found in Big Mama Rag. The IRS later published the methodology test in Rev. Proc. 86-43 in order to clarify its position on how to determine whether an organization is educational when it advocates particular viewpoints or positions. As set forth in the Revenue Procedure:

The presence of any of the following factors in the presentations made by an organization is indicative that the method used by the organization to advocate its viewpoints or positions is not educational.
(a) The presentation of viewpoints or positions unsupported by facts is a significant portion of the organization's communications.

(b) The facts that purport to support the viewpoints or positions are distorted.

(c) The organization's presentations make substantial use of inflammatory and disparaging terms and express conclusions more on the basis of strong emotional feelings than of objective evaluations.

(d) The approach used in the organization's presentations is not aimed at developing an understanding on the part of the intended audience or readership because it does not consider their background or training in the subject matter.

According to Rev. Proc. 86-43, the IRS uses the methodology test in all situations where the educational purpose of an organization that advocates a viewpoint or position is in question. However, "[e]ven if the advocacy undertaken by an organization is determined to be educational under [the methodology test], the organization must still meet all other requirements for exemption under section 501(c)(3) . . ." Rev. Proc. 86-43. That is, organizations deemed to be "educational" must also abide by the section 501(c)(3) prohibitions on: (a) private benefit, (b) participating or intervening in a political campaign, (c) engaging in more than insubstantial lobbying activities, and (d) private inurement.

b. To Satisfy the Operational Test, an Organization Must Not Violate the "Private Benefit" Prohibition

Section 501(c)(3) requires, inter alia, that an organization be organized and operated exclusively for one or more exempt purposes. Treas. Reg. 1.501(c)(3)-1(d)(1)(ii) provides that an organization does not meet this requirement:

unless it serves a public rather than a private purpose. Thus, . . . it is necessary for an organization to establish that it is not organized or operated for the benefit of private interests such as designated individuals, the creator or his family, shareholders of the organization, or persons controlled, directly or indirectly, by such private interests.
The "private benefit" prohibition serves to ensure that the public subsidies flowing from section 501(c)(3) status, including income tax exemption and the ability to receive tax-deductible charitable contributions, are reserved for organizations that are formed to serve public and not private interests. Treas. Reg. 1.501(c)(3)-1(c)(1) defines the application of the private benefit prohibition in the context of the operational test:
An organization will be regarded as "operated exclusively" for one or more exempt purposes only if it engages primarily in activities which accomplish one or more of such exempt purposes specified in section 501(c)(3). An organization will not be so regarded if more than an insubstantial part of its activities is not in furtherance of an exempt purpose.
The Regulations and cases applying them make it clear that the private benefit test focuses on the purpose or purposes served by an organization's activities, and not on the nature of the activities themselves. See, e.g., B.S.W. Group, Inc. v. Commissioner, 70 T.C. 352 (1978). Where an organization's activities serve more than one purpose, each purpose must be separately examined to determine whether it is private in nature and, if so, whether it is more than insubstantial. Christian Manner International v. Commissioner, 71 T.C. 661 (1979).

The leading case on the application of the private benefit prohibition in the context of an organization whose activities served both exempt and nonexempt purposes is Better Business Bureau v. United States, 326 U.S. 279 (1945). Better Business Bureau was a nonprofit organization formed to educate the public about fraudulent business practices, to elevate business standards, and to educate consumers to be intelligent buyers. The Court did not question the exempt purpose of these activities. The Court found, however, that the organization was "animated" by the purpose of promoting a profitable business community, and that such business purpose was both nonexempt and more than insubstantial. The Court denied exemption, stating (in language that is cited in virtually all later private benefit cases), that:

[i]n order to fall within the claimed exemption, an organization must be devoted to educational purposes exclusively. This plainly means that the presence of a single noneducational purpose, if substantial in nature, will destroy the exemption regardless of the number or importance of truly educational purposes.
Id. at 283.

Many of the cases interpreting the private benefit prohibition involve private benefits that are provided in a commercial context -- as in the Better Business Bureau case. Impermissible private benefit, however, need not be financial in nature. Callaway Family Association v. Commissioner, 71 T.C. 340 (1978), involved a family association formed as a nonprofit corporation to study immigration to and migration within the United States by focusing on its own family history and genealogy. The organization's activities included researching the genealogy of Callaway family members in order to publish a family history. The organization argued that its purposes were educational and intended to benefit the general public, asserting that its use of a research methodology focusing on one family's development was a way of educating the public about the country's history.

In Callaway, the court noted (and the IRS conceded) that the organization's activities served an educational purpose. The issue was not whether the organization had any exempt purposes, but whether it also engaged in activities that furthered a nonexempt purpose more than insubstantially. Agreeing with the IRS that "petitioner aimed its organizational drive at Callaway family members, and appealed to them on the basis of their private interests," the court concluded that the organization "engages in nonexempt activities serving a private interest, and these activities are not insubstantial." Id. at 343-44. Accordingly, the court held that the organization did not qualify for exemption under section 501(c)(3).

Kentucky Bar Foundation v. Commissioner, 78 T.C. 921 (1982), is one of the relatively few cases in which a court found private benefit to be insubstantial and therefore not to preclude exemption under section 501(c)(3). The Kentucky Bar Foundation was formed to conduct a variety of activities recognized by the IRS to serve exclusively educational purposes, including a continuing legal education program and the operation of a public law library. The IRS, however, asserted that the Foundation's operation of statewide lawyer referral service also served private purposes. Through the referral service, a person seeking a lawyer was referred to an attorney selected on a rotating basis within a convenient geographic area. The fee for an initial half-hour consultation was $10; any charge for further consultation or work had to be agreed upon by the attorney and the client. The court found that the purposes of the referral service were to assist the general public in locating an attorney to provide a consultation for a reasonable fee, to encourage lawyers to recognize the obligation to provide legal services to the general public, and to acquaint people in need of legal services with the value of consultation with a lawyer to identify and solve legal problems.

The IRS asserted that a purpose of the referral service was to benefit lawyers, particularly to help young law school graduates establish a practice, and that this was a substantial nonexempt purpose. Based on a careful examination of the facts, however, the court found that:

[t]he referral service is open to all responsible attorneys, and there is no evidence a selected group of attorneys are the primary beneficiaries of the service. The referral service is intended to benefit the public and not to serve as a source of referrals. We find any nonexempt purpose served by the referral service and any occasional economic benefit flowing to individual attorneys through a referral incidental to the broad charitable purpose served.
Id. at 926.

Reiterating the proposition that "the proper focus is the purpose or purposes toward which the activities are directed," the court found that the purpose of the legal referral service was to benefit the public, that any private benefit was broadly distributed, not conferred on any select group of attorneys and incidental to the public purpose, and that the organization qualified for exemption under section 501(c)(3). Id. at 923, 925-26 (citing B.S.W. Group v. Commissioner, 70 T.C. 352, 356-57 (1978)).

As the cases described above show, the determination as to whether private benefit is incidental (and therefore permissible) or more than incidental (and therefore prohibited) is inherently factual, and each case must be decided on its own facts and circumstances. See also Manning Association v. Commissioner, 93 T.C. 596 (1989). The IRS has issued several published and private rulings and general counsel memoranda that further explain the private benefit prohibition. For example, in Rev. Rul. 70-186, 1970-1 C.B. 128, an organization was formed to preserve a lake as a public recreational facility and to improve the lake water's condition. Although the organization's activities benefited the public at large, there were necessarily significant benefits to the individuals who owned lake-front property. The IRS, however, determined that the private benefit to the lake-front property owners was incidental because:

[t]he benefits to be derived from the organization's activities flow principally to the general public through the maintenance and improvement of public recreational facilities. Any private benefits derived by the lakefront property owners do not lessen the public benefits flowing from the organization's operations. In fact, it would be impossible for the organization to accomplish its purposes without providing benefits to the lakefront property owners.

In Rev. Rul. 75-196, 1975-1 C.B. 155, the IRS ruled that a 501(c)(3) organization operating a law library whose rules essentially limited access and use to local bar association members conferred only incidental benefits to the bar association members. The library's availability only to a designated class of persons was not a bar to recognition of exemption because:

[w]hat is of importance is that the class benefited be broad enough to warrant a conclusion that the educational facility or activity is serving a broad public interest rather than a private interest, and is therefore exclusively educational in nature.
Id. The library was available to a significant number of people, and the restrictions on the library's use were due to the limited size of its facilities. Although attorneys who used the library might derive personal benefit in their practice, the IRS ruled that this benefit was incidental to the library's exempt purpose and a "logical by-product of an educational process." Id.

Two other revenue rulings with similar fact patterns are also helpful in understanding the application of the "incidental benefits" concept. In one ruling, the IRS ruled that an organization that limited membership to the residents of one city block did not qualify as a 501(c)(3) organization because the organization's members benefited directly, thus not incidentally, from the organization's activities. Rev. Rul 75-286, 1975-2 C.B. 210. In another, the IRS ruled that an organization dedicated to beautification of an entire city qualified as a 501(c)(3) organization because benefits flowed to the city's entire population and were not targeted to the organization's members. Rev. Rul. 68-14, 1968-1 C. B. 243. The benefits to the organization's members of living in a cleaner city were considered incidental. The IRS issued a recent warning about the importance of the private benefit prohibition in Rev. Proc. 96-32, 1996-20 I.R.B. 14, a Revenue Procedure issued for the purpose of establishing standards as to whether organizations that own and operate low income housing (an activity conducted by both nonprofit and for-profit organizations) may qualify for exemption under section 501(c)(3). After reviewing the substantive criteria that must be present to establish that the organization is formed for a charitable purpose, the IRS added a final caution:

If an organization furthers a charitable purpose such as relieving the poor and distressed, it nevertheless may fail to qualify for exemption because private interests of individuals with a financial stake in the project are furthered. For example, the role of a private developer or management company in the organization's activities must be carefully scrutinized to ensure the absence of inurement or impermissible private benefit resulting from real property sales, development fees, or management contracts.

One of the most detailed explanations of the private benefit prohibition is contained in G.C.M. 39862 (Nov. 22, 1991), involving the permissibility of a hospital's transaction with physicians. In the G.C.M., the IRS explained the prohibition as follows:

Any private benefit arising from a particular activity must be "incidental" in both a qualitative and quantitative sense to the overall public benefit achieved by the activity if the organization is to remain exempt. To be qualitatively incidental, a private benefit must occur as a necessary concomitant of the activity that benefits the public at large; in other words, the benefit to the public cannot be achieved without necessarily benefiting private individuals. Such benefits might also be characterized as indirect or unintentional. To be quantitatively incidental, a benefit must be insubstantial when viewed in relation to the public benefit conferred by the activity.

The IRS also explained that the insubstantiality of the private benefit is measured only in relationship to activity in which the private benefit is present, and not in relation to the organization's overall activities:

It bears emphasis that, even though exemption of the entire organization may be at stake, the private benefit conferred by an activity or arrangement is balanced only against the public benefit conferred by that activity or arrangement, not the overall good accomplished by the organization.

In G.C.M. 39862, the IRS balanced the private benefits to the physicians from the transaction at issue with the public purposes served by that particular activity -- and not the public purposes served by the hospital as a whole. Finding the private purposes from the activity at issue to be more than incidental in relation to the public purposes, the IRS determined that the hospital had jeopardized its exemption under section 501(c)(3).

Although most of the cases and IRS rulings (both public and private) follow the general analysis described above in determining whether or not private benefit is insubstantial, a fairly recent Tax Court case, American Campaign Academy v. Commissioner, 92 T.C. 1053 (1989) adopts a slightly different approach. In that case, the primary activity of American Campaign Academy ("ACA" or "the Academy") was the operation of a school to train people to work in political campaigns. The IRS denied ACA's application for exemption under section 501(c)(3), and ACA appealed the denial to the Tax Court. The Tax Court upheld the IRS's denial of ACA's application for exemption because ACA's activities conferred an impermissible private benefit on Republican candidates and entities.

The school operated by ACA was an "outgrowth" of programs the National Republican Congressional Committee ("NRCC") once sponsored to train candidates and to train campaign professionals for Republican campaigns. The Academy program, however, differed from its NRCC predecessor in that it limited its students to "campaign professionals." Id. at 1056. Without discussion, the IRS stated that the Academy did not train candidates, participate in any political campaign or attempt to influence legislation. Id. at 1056-57. The Academy did not use training materials developed by the NRCC, generally did not use NRCC faculty, and developed its own courses. Id. at 1057. Students were not explicitly required to be affiliated with any particular party, nor were they required to take positions with partisan organizations upon graduation. Id. at 1058.

The Academy had a number of direct and indirect connections to Republican organizations. The NRCC contributed furniture and computer hardware to the Academy. Id. at 1056. One of the Academy's three directors, Joseph Gaylord, was the Executive Director of the NRCC; another director, John McDonald, was a member of the Republican National Committee. Id. Jan Baran, General Counsel of the NRCC at the time of the Academy's application to IRS, incorporated the Academy. Id. at 1070. The National Republican Congressional Trust funded the Academy. Id. The Academy curriculum included studies of the "Growth of NRCC, etc." and "Why are people Republicans," but did not contain comparable studies pertaining to the Democratic or other political parties. Id. at 1070-71. People on the admissions panel were affiliated with the Republican Party. Id. at 1071. Furthermore, while the applicants were not required to declare a party affiliation on their application, the political references students were required to submit "often permit[ted] the admission panel to deduce the applicant's political affiliation." Id. Finally, the Court found that all but one of the Academy graduates who could be identified as later serving in political positions ended up serving Republican candidates or Republican organizations. Id. at 1060, 1071, 1072.

In light of these facts, the Tax Court upheld the IRS's denial of the Academy's application for exemption under section 501(c)(3) because the Academy "conducted its educational activities with the partisan objective of benefiting Republican candidates and entities." Id. at 1070. Any one of the facts listed in the previous paragraph did not alone support the IRS's finding or the court's holding that the Academy was organized for a non-exempt purpose. The IRS did not argue, and the court did not hold, for example, that individuals who are all members of the same political party are prohibited from operating a 501(c)(3) organization, or that an organization may not receive an exemption under section 501(c)(3) if a partisan organization funds it. Rather, the Tax Court focused on the purpose behind ACA's activities. In determining this, it drew "factual inferences" from the record to discern that purpose. Those inferences led to the court's conclusion that the Academy "targeted Republican entities and candidates to receive the secondary benefit through employing its alumni . . . ." Id. at 1075.

The Tax Court's analysis distinguished between "primary" private benefit and "secondary" private benefit, and made clear that the latter can be a bar to section 501(c)(3) qualification. In this case, the students received the primary private benefit of the Academy, and this benefit was permissible and consistent with the Academy's educational purposes. The students' ultimate employers, Republican candidates and entities, received the secondary benefits of the Academy. "[W]here the training of individuals is focused on furthering a particular targeted private interest [e.g., Republican candidates and entities], the conferred secondary benefit ceases to be incidental to the providing organization's exempt purposes." Id. at 1074.

For the Academy to have prevailed, according to the Tax Court, it needed to demonstrate: (1) that the candidates and entities who received the benefit of trained campaigned workers possessed the characteristics of a "charitable class," and (2) that it did not distribute benefits among that class in a select manner. Id. at 1076. The Academy argued that Republican candidates and entities were "charitable" because the Republican party consists of millions of people with "like 'political sympathies'" and their activities benefited the community at large. Id. The Court ruled, however, that size alone does not transform a benefited class into a charitable class and that ACA had failed to demonstrate that political entities and candidates possessed the characteristics of a charitable class. Id. At 1077. Moreover, the Tax Court held that even if political candidates and entities could be found to constitute a "charitable class," ACA's benefits were distributed in a select manner to Republican candidates and entities. Id.

Finally, the Academy argued that although it hoped that alumni would work in Republican organizations or for Republican candidates, it had no control over whether they would do so. Absent an ability to control the students' employment, the Academy argued, it lacked the ability to confer secondary benefits to Republican candidates and entities. Id. at 1078. The Court found that there was no authority for the proposition that the organization must be able to control non-incidental benefits. Furthermore, the Court reiterated that the record supported the IRS's determination that the Academy was formed "with a substantial purpose to train campaign professionals for service in Republican entities and campaigns, an activity previously conducted by NRCC." Id. According to the Court, accepting the Academy's argument regarding its inability to control non-incidental benefits would "cloud the focus of the operational test, which probes to ascertain the purpose towards which an organization's activities are directed and not the nature of the activities themselves." Id. at 1078-79 (citing B.S.W. Group v. Commissioner, 70 T.C. 352, 356-57 (1978)). The Court noted that had the record demonstrated that "the Academy's activities were nonpartisan in nature and that its graduates were not intended to primarily benefit Republicans," the Court would have found for the Academy. Id. at 1079.

The American Campaign Academy case follows existing precedent. In reaching its decision, the court relies on Better Business Bureau and Kentucky Bar Foundation, among other cases, for the legal standards governing the private benefit prohibition. The court recognizes that the ACA's activities were intended to serve multiple purposes, including the education of students (the permissible primary benefit) and the provision of trained campaign professionals for candidates and entities (the secondary benefit). Finding the secondary benefit to be targeted to a select group -- Republican candidates and entities -- the court concludes that such benefit is more than incidental and therefore precludes exemption under section 501(c)(3).

c. To Satisfy The Operational Test, An Organization Must Not Be An "Action" Organization

An organization is not operated exclusively for one or more exempt purposes if it is an "action" organization. Treas. Reg. 1.501(c)(3)-1(c)(3). Such an organization cannot qualify for exemption under section 501(c)(3). Treas. Reg. 1.501(c)(3)-1(c)(3)(v). An organization is an action organization if:

(i) it "participates or intervenes, directly or indirectly, in any political campaign on behalf of or in opposition to any candidate for public office;"

(ii) a "substantial part" of its activities consists of "attempting to influence legislation by propaganda, or otherwise;" or

(iii) its primary objective may be attained "only by legislation or a defeat of proposed legislation," and "it advocates, or campaigns for, the attainment" of such primary objective.

Treas. Reg. 1.501(c)(3)-1(c)(3).

(i) If an Organization Participates in a Political Campaign, It is an Action Organization Not Entitled to Exemption Under Section 501(c)(3)

Section 501(c)(3) provides that an organization is not entitled to exemption if it "participate[s] in, or intervene[s] in (including the publishing or distributing of statements) any political campaign on behalf of (or in opposition to) any candidate for public office." The reason for this prohibition is clear. Contributions to section 501(c)(3) organizations are deductible for federal income tax purposes, but contributions to candidates and political action committees ("PACs") are not. The use of section 501(c)(3) organizations to support or oppose candidates or PACs would circumvent federal tax law by enabling candidates or PACs to attract tax-deductible contributions to finance their election activities. As the U.S. Court of Appeals for the Tenth Circuit explained, "[t]he limitations in Section 501(c)(3) stem from the congressional policy that the United States Treasury should be neutral in political affairs and that substantial activities directed to attempts to . . . affect a political campaign should not be subsidized." Christian Echoes National Ministry, Inc. v. United States, 470 F.2d 849, 854 (1972), cert. denied, 419 U.S. 1107 (1975) (emphasis in original).

The prohibition on political campaign intervention was added to the Internal Revenue Code as a floor amendment to the 1954 Revenue Act offered by Senator Lyndon Johnson, who believed that a section 501(c)(3) organization was being used to help finance the campaign of an opponent. In introducing the amendment, Senator Johnson said that it was to "deny[] tax-exempt status to not only those people who influence legislation but also to those who intervene in any political campaign on behalf of any candidate for any public office." 100 Cong. Rec. 9604 (1954) (discussed in Bruce R. Hopkins, The Law of Tax-Exempt Organizations, 327 (6th ed. 1992)). No congressional hearing was held on the subject and the conference report did not contain any analysis of the provision. Judith E. Kindell and John F. Reilly, Election Year Issues, 1993 Exempt Organizations Continuing Professional Education Technical Instruction Program 400, 401 (hereinafter "IRS CPE Manual").

Although the prohibition on political campaign intervention was not formally added to section 501(c)(3) until 1954, the concept that charities should not participate in political campaigns was not new. As the Second Circuit noted, "[t]his provision merely expressly stated what had always been understood to be the law. Political campaigns did not fit within any of the specified purposes listed in [Section 501(c)(3)]." The Association of the Bar of the City of New York v. Commissioner, 858 F.2d 876, 879 (2d Cir. 1988) (hereinafter "New York Bar") (quoting 9 Mertens, Law of Federal Income Taxation 34.05 at 22 (1983)). Furthermore, congressional concerns that the government not subsidize political activity have existed since at least the time when Judge Learned Hand wrote "[p]olitical agitation . . . however innocent the aim . . . . must be conducted without public subvention . . . ." Slee v. Commissioner, 42 F.2d 184, 185 (2d Cir. 1930), quoted in New York Bar, 858 F.2d at 879.

In 1987, Congress amended section 501(c)(3) to clarify that the prohibition on political campaign activity applied to activities in opposition to, as well as on behalf of, any candidate for public office. Omnibus Budget Reconciliation Act, Pub. L. No. 100-203, 10711, 101 Stat. 1330, 1330-464 (1987). The House Report accompanying the bill stated that "[t]he prohibition on political campaign activities . . . reflect[s] congressional policies that the U.S. Treasury should be neutral in political affairs . . . ." H.R. Rep. No. 100-391, at 1625 (1987); see also S. Rep. No. 91-552, at 46-49 (Tax Reform Act of 1969) (interpreting section 501(c)(3) to mean that "no degree of support for an individual's candidacy for public office is permitted").

The scope of the prohibition on political campaign intervention has been the subject of much discussion. While certain acts are clearly proscribed, others may be permissible or prohibited, depending on the purpose and effect of the activity. The regulations interpreting the prohibition add little to the statutory definition:

Activities which constitute participation or intervention in a political campaign on behalf of or in opposition to a candidate 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 such a candidate.
Treas. Reg. 1.501(c)(3)-1(c)(3)(iii). Under this provision, a section 501(c)(3) organization is prohibited from making a written or oral endorsement of a candidate and from distributing partisan campaign literature. IRS CPE Manual at 410. Following the enactment of section 527 of the Code in 1974 (governing the federal tax treatment of PACs), the prohibition also prevents section 501(c)(3) organizations from establishing or supporting a PAC. IRS CPE Manual at 437. (The application of the prohibition in this context is discussed further below.)

It is clear, however, that section 501(c)(3) organizations also may violate the prohibition by engaging in activity that falls short of a direct endorsement, and even may -- on its face -- appear neutral, if the purpose or effect of the activity is to support or oppose a candidate. The IRS CPE Manual describes a variety of situations in which section 501(c)(3) organizations may violate the prohibition without engaging in a direct candidate endorsement, including inviting a particular candidate to make an appearance at an organization event, holding candidate forums or distributing voter guides which evidence a bias for or against a candidate, and similar activities that may support or oppose a particular candidate. IRS CPE Manual at 419-424, 430-432. In a recent election year news release, the IRS reminded 501(c)(3) organizations of the breadth of the prohibition, stating not only that they cannot endorse candidates or distribute statements in support of or opposition to candidates, but also that they cannot "become involved in any other activities that may be beneficial or detrimental to any candidate." IRS News Release IR-96-23 (Apr. 24, 1996).

While it is easy for the IRS to determine whether the prohibition on political campaign intervention has been violated when a section 501(c)(3) organization endorses a candidate or distributes partisan campaign literature, it is more difficult to determine whether there is a violation if the activity at issue is not blatant or serves a nonpolitical purpose as well. The IRS relies on a "facts and circumstances" test in analyzing ambiguous behavior to determine whether there has been a violation. According to the IRS:

[i]n situations where there is no explicit endorsement or partisan activity, there is no bright-line test for determining if the IRC 501(c)(3) organization participated or intervened in a political campaign. Instead, all the facts and circumstances must be considered.
IRS CPE Manual at 410.

Despite the lack of bright-line standards concerning all aspects of the prohibition, there is a substantial body of authority concerning what section 501(c)(3) organizations can and cannot do, and many section 501(c)(3) organizations have little difficulty applying existing precedents to develop internal guidelines for what activities are permissible and prohibited. For example, the Office of General Counsel of the United States Catholic Conference issued guidelines on political activities to Catholic organizations on February 14, 1996, in anticipation of the 1996 election season. The guidelines outline the parameters of permissible activity, including unbiased voter education, nonpartisan get-out-the-vote drives, and nonpartisan public forums. They also describe what activity is prohibited, including the endorsement of candidates, the distribution of campaign literature in support or opposition to candidates, and the provision of financial and in-kind support to candidates or PACs. With respect to the latter, the guidelines state flatly that:

[A] Catholic organization may not provide financial support to any candidate, PAC, or political party. Likewise, it may not provide or solicit in-kind support, such as free or selective use of volunteers, paid staff, facilities, equipment, mailing lists, etc.
Political Activity Guidelines for Catholic Organizations, (United States Catholic Conference, Office of the General Counsel, Washington, D.C.), Feb. 14, 1996, reprinted in Paul Streckfus' EO Tax Journal, November 1996 at 35, 42.

The generally accepted aspects of the campaign intervention prohibition, as well as some areas of uncertainty, are discussed below.

(a) The Prohibition is "Absolute."

The prohibition on political campaign intervention or participation is "absolute." IRS CPE Manual at 416. Unlike the prohibition on lobbying, there is no requirement that political campaign participation or intervention be substantial. New York Bar, 858 F.2d at 881. It is, therefore, irrelevant that the majority, or even all but a small portion, of an organization's activities would, by themselves, support exemption under section 501(c)(3). United States v. Dykema, 666 F.2d 1096, 1101 (7th Cir. 1981); see also G.C.M. 39694 (Jan. 22, 1988) ("An organization described in section 501(c)(3) is precluded from engaging in any political campaign activities") and P.L.R. 9609007 (Dec. 6, 1995). ("For purposes of section 501(c)(3), intervention in a political campaign may be subtle or blatant. It may seem to be justified by the press of events. It may even be inadvertent. The law prohibits all forms of participation or intervention in 'any' political campaign.")

Although the prohibition on political campaign intervention under section 501(c)(3) is absolute, Congress recognized that the sanction of loss of tax exemption could, in some cases, be disproportionate to the violation. In 1987, Congress added section 4955 to the Code, which imposes excise tax penalties on section 501(c)(3) organizations that make "political expenditures" in violation of the prohibition, as well as organization managers who knowingly approve such expenditures. The legislative history provides that the enactment of section 4955 was not intended to modify the absolute prohibition of section 501(c)(3), but to provide an alternative remedy that could be used by the IRS in cases where the penalty of revocation seems disproportionate to the violation:

i.e., where the expenditure was unintentional and involved only a small amount and where the organization subsequently has adopted procedures to assure that similar expenditures would not be made in the future.
H.R. Rep. No. 100-391, at 1623-24 (1987).

The legislative history also provides that the excise tax may be imposed in cases involving significant, uncorrected violations of the prohibition, where revocation alone may be ineffective because the organization has ceased operations after diverting its assets to an improper purpose. In these cases, the excise tax penalty on organization managers may be the only effective way to penalize the violation. Id. at 1624-25.

The IRS has shown an inclination to impose the excise tax under section 4955 in lieu of revocation of exemption in cases where the violation appears to be minor in relation to the organization's other exempt purpose activities. For example, P.L.R. 9609007 (Dec. 6, 1995) involved a section 501(c)(3) organization that sent out a fundraising letter linking the organization to issues raised in the particular campaigns. The IRS concluded that the letters evidenced a bias for one candidate over the other. The organization sought to defend itself by saying only a few of the letters were sent to the states whose elections were mentioned in the letters. The IRS rejected this defense, stating that:

[I]t is common knowledge that in recent times the primary source of a candidate's support in such elections is often derived from out-of-state sources. Although a particular reader may not have been eligible to actually vote for the described candidate, he or she could have been charged by [the organization], in our view, to participate in the candidate's campaign through direct monetary or in-kind support, volunteerism, molding of public opinion, or the like.
Id. The IRS found that the organization violated the political campaign intervention prohibition and imposed an excise tax on the organization under section 4955; it did not, however, propose revocation of the organization's exemption under section 501(c)(3).

(b) Section 501(c)(3) Organizations May Not Establish or Support a PAC

Although organizations exempt from tax under some categories of section 501(c) are permitted to establish or support PACs, those exempt under section 501(c)(3) are not. When section 527 (governing the tax treatment of PACs) was added to the Code in 1974, the legislative history provided that "this provision is not intended to affect in any way the prohibition against certain exempt organizations (e.g., sec. 501(c)(3)) engaging in 'electioneering'. . . ." S. Rep. No. 93-1357 (1974), reprinted in 1975-1 C.B. 517, 534. The regulations under section 527 reflect this congressional intent:

Section 527(f) and this section do not sanction the intervention in any political campaign by an organization described in section 501(c) if such activity is inconsistent with its exempt status under section 501(c). For example, an organization described in section 501(c)(3) is precluded from engaging in any political campaign activities. The fact that section 527 imposes a tax on the exempt function income (as defined in section 1.527-2(c)) expenditures of section 501(c) organizations and permits such organizations to establish separate segregated funds to engage in campaign activities does not sanction the participation in these activities by section 501(c)(3) organizations.
Treas. Reg. 1.527-6(g).

Since the enactment of section 527 in 1974, it has been clear that a section 501(c)(3) organization will violate the prohibition on political campaign intervention by providing financial or nonfinancial support for a PAC. IRS CPE Manual at 438-40. While the use of a section 501(c)(3)'s facilities, personnel, or other financial resources for the benefit of a PAC is impermissible, the prohibition does not stop there. In its CPE Manual, the IRS also noted that "[a]n IRC 501(c)(3) organization's resources include intangible assets, such as its goodwill, that may not be used to support the political campaign activities of another organization." Id. at 440. Some leading practitioners have interpreted this provision to prohibit a charity from allowing its name to be used by a PAC, even if the charity provides no financial support or assistance; by allowing a PAC to use its name, the charity implies to its employees and to the public that it endorses the activity of the PAC. See Gregory L. Colvin et al., Commentary on Internal Revenue Service 1993 Exempt Organizations Continuing Professional Education Technical Instruction Program Article on "Election Year Issues," 11 Exempt Org. Tax Rev. 854, 871 (1995) [hereinafter "EO Comments"].

(c) "Express Advocacy" is Not Required, and Issue Advocacy is Prohibited if Used to Convey Support for or Opposition to a Candidate

An organization does not need to violate the "express advocacy" standard applied under federal election law for it to violate the political campaign prohibition of section 501(c)(3). T.A.M. 8936002 (May 24, 1989). That is, it is not necessary to advocate the election or defeat of a clearly identified candidate to violate the prohibition. IRS CPE Manual at 412-13.

Moreover, an organization may violate the prohibition even if it does not identify a candidate by name. The IRS has stated that "issue advocacy" may serve as "the opportunity to intervene in a political campaign in a rather surreptitious manner" if a label or other coded language is used as a substitute for a reference to identifiable candidates. Id. at 411.

The concern is that an IRC 501(c)(3) organization may support or oppose a particular candidate in a political campaign without specifically naming the candidate by using code words to substitute for the candidate's name in its messages, such as "conservative," "liberal," "pro-life," "pro-choice," "anti-choice," "Republican," "Democrat," etc., coupled with a discussion of the candidacy or the election. When this occurs, it is quite evident what is happening -- an intervention is taking place.
Id. 411-412. Furthermore:

[a] finding of political campaign intervention from the use of coded words is consistent with the concept of "candidate" -- the words are not tantamount to advocating support for or opposition to an entire political party, such as "Republican," or a vague and unidentifiably large group of candidates, such as "conservative" because the sender of the message does not intend the recipient to interpret them that way. Code words, in this context, are used with the intent of conjuring favorable or unfavorable images--they have pejorative or commendatory connotations.
Id. at 412 n. 6.

(d) Educational Activities May Constitute Participation or Intervention

As discussed above, the IRS considers activities that satisfy the "methodology test" to be "educational." Just as educational activities may result in impermissible private benefit, however, so too may they violate the prohibition on political campaign intervention. The IRS takes the position that "[a]ctivities that meet the methodology test . . . may nevertheless constitute participation or intervention in a political campaign." IRS CPE Manual at 415.

New York Bar, 858 F.2d 876 (2d Cir. 1988), referred to above, is the leading case on point. In that case, a bar association published ratings of judicial candidates. The ratings were distributed to bar members and law libraries. The Association also issued press releases regarding its ratings, but did not conduct publicity campaigns to announce its ratings. Id. at 877. The Second Circuit held that although the Association's publications were educational, the distribution of the publications constituted prohibited campaign intervention. By disseminating the educational publications with the hope that they would "'ensure' that candidates whom [the Association] consider[ed] to be 'legally and professionally unqualified'" would not be elected, the court held that the Association "indirectly" participated in a political campaign on behalf of or in opposition to a candidate for public office. Id. at 881.

An implication of the holding in New York Bar is that one must consider not only whether the activity itself, e.g., publishing educational materials such as candidate ratings, violates the political campaign prohibition, but also whether the intended consequences of the activity violates the prohibition. The need to consider the consequences of an otherwise educational activity is clear from a review of several IRS rulings finding that an organization violated the prohibition by disseminating material that was deemed educational, but nonetheless affected voter preferences in violation of the prohibition.

For example, in Rev. Rul. 67-71, 1967-1 C.B. 125, the IRS ruled that a 501(c)(3) organization created to improve the public educational system by engaging in campaigns on behalf of candidates for school board was not exempt. Every four years, when the school board was to be elected, the organization considered the qualification of the candidates and selected those it thought most qualified. The organization then "engage[d] in a campaign on their behalf by publicly announcing its slate of candidates and by publishing and distributing a complete biography of each." Id. Although the selection process "may have been completely objective and unbiased and was intended primarily to educate and inform the public about the candidates," the IRS nonetheless ruled it to be intervention or participation in a political campaign. Id.

In Rev. Rul. 76-456, 1976-2 C.B. 151, the IRS ruled that an organization formed for the purpose of elevating the morals and ethics of political campaigning was nevertheless intervening in a political campaign when it solicited candidates to sign a code of fair campaign practices and released the names of those candidates who signed and those candidates who refused to sign. The IRS stated that this was done to educate citizens about the election process and so that they could "participate more effectively in their selection of government officials." Id. at 152. Nonetheless, such activity, although educational, "may result . . . in influencing voter opinion" and thus constituted a prohibited participation or intervention in a political campaign. Id.

(e) Nonpartisan Activities May Constitute Prohibited Political Campaign Participation

The IRS takes the position that the nonpartisan motivation for an organization's activities is "irrelevant when determining whether the political campaign prohibition" has been violated. IRS CPE Manual at 415. As support for this position, the IRS cites Rev. Rul. 76-456 and New York Bar, both of which are discussed above. In those cases, the court or the IRS found that the activities in question were nonpartisan, but nevertheless held that they constituted participation in a political campaign. As noted by the IRS in its CPE Manual, the court in New York Bar "made the rather wry observation [that] [a] candidate who receives a 'not qualified' rating will derive little comfort from the fact that the rating may have been made in a nonpartisan manner." IRS CPE Manual at 416. Similarly, in G.C.M. 35902 (July 15, 1974), the IRS stated:

The provision in the Code prohibiting participation or intervention in "any political campaign" might conceivably be interpreted to refer only to participation or intervention with a partisan motive; but the provision does not say this. It seems more reasonable to construe it as referring to any statements made in direct relation to a political campaign which affect voter acceptance or rejection of a candidate . . . .
(f) The IRS Has Found Violations of the Prohibition on Political Campaign Participation When an Activity Could Affect or Was Intended to Affect Voters' Preferences

As discussed above, the courts and the IRS have found prohibited political campaign intervention when the activity in question, although educational, affected or could reasonably be expected to affect voter preferences, even where the organization's motives in undertaking the activity were nonpartisan. G.C.M. 35902 is to similar effect. In that case, the IRS held that a public broadcasting station's nonpartisan educational motivation was irrelevant in determining whether its provision of free air time to candidates for elective office was permissible under section 501(c)(3). The IRS found that the station's procedures for providing air time, including an equal time doctrine for all candidates and an on-air disclaimer of support for any particular candidate, were sufficient to ensure that the activity would not constitute an impermissible political campaign intervention. The fact that the station's motivation was to educate the public and not to influence an election, however, was deemed to be irrelevant.

The cases and rulings cited above make it clear that simply having an educational or nonpartisan motive for engaging in prohibited political activity is not a defense to a finding of violation. The relevance and irrelevance of motive is sometimes misstated, however. While the absence of an improper political motivation is irrelevant, evidence showing the existence of a political motivation is relevant and one of the facts and circumstances that the IRS will consider in determining whether there is a violation. Indeed, the IRS has found the existence of evidence showing an intent to participate in a political campaign to be sufficient to support a finding of violation, despite the lack of evidence that the activity achieved the intended results.

For example, in G.C.M. 39811 (Feb. 9, 1990), a religious organization encouraged its members to seek election to positions as precinct committee-persons in the Republican or Democratic Party structures. Although none of the organization's members actually ran for such positions, the IRS found that urging its members to become involved in the local party organizations was part of the organization's larger plans to "someday control the political parties."

The first step in the Foundation's long-term strategy was to encourage members to be elected as precinct committeemen. These individuals could then exert influence within the party apparatus, beginning with the county central committee. Precinct committeemen could sway the precinct caucuses, a step in the selection of delegates to the party's presidential nominating convention. . . . Intervention at this early stage in the elective process in order to influence political parties to nominate such candidates is, we believe, sufficient to constitute intervention in a political campaign.
Id. The IRS went on to say:
In its discussion of the Tax Court opinion [in New York Bar], the [Second Circuit] observed that the ratings of candidates were "published with the hope that they will have an impact on the voter." The effort, and not the effect, constituted intervention in a political campaign. Therefore, whether anyone heeded the call to run for precinct committee, whether that individual was elected, and if so, what he or she subsequently did are all immaterial.

In G.C.M. 39811, the IRS did not contend that the organization's urging of members to run for office alone constituted the violation. Rather, the organization's "long-term strategy" of seeking to influence the political parties' nomination of candidates by having its members elected to office, and its urging of members to run for office so as to carry out that strategy, were sufficient to support a finding of impermissible campaign participation, despite the fact that the effort was not successful.

Other cases and rulings have also looked to an organization's intent as an important element of a finding of prohibited participation or intervention. In 1972, a court held that an organization violated the participation or intervention prohibition when it "used its publications and broadcasts to attack candidates and incumbents who were considered too liberal." Christian Echoes National Ministry, Inc. v. United States, 470 F.2d 849, 856 (10th Cir. 1972). The court did not discuss whether the activities actually influenced voters or were reasonably likely to do so. Rather, it concluded that the organization's "attempts to elect or defeat certain political leaders reflected [the organization's] objective to change the composition of the federal government." Id.

The IRS also found an organization's intent relevant in P.L.R. 9117001 (Sept. 5, 1990). As described in that ruling, an organization mailed out material indicating that it was intending to help educate conservatives on the importance of voting in the 1984 general election. According to facts stated in the ruling letter, the material contained language "intended" to induce conservative voters to vote for President Reagan, even though his name was not included in the materials. The IRS thus concluded that "the material was targeted to influence a segment of voters to vote for President Reagan." Id.

Based on the above, the IRS position is that an organization can violate the political campaign prohibition by either: (a) conducting activities that could have the effect of influencing voter acceptance or rejection of a candidate or group of candidates (the "effect" standard), or (b) engaging in activities that are intended to influence voter acceptance or rejection of a candidate or group of candidates, whether they do so or not (the "effort" standard). Most of the uncertainty over the scope of the prohibition on political campaign intervention relates to the "effect" standard -- the possibility that an organization may, without intending to do so, engage in an activity that could have the effect of influencing voter acceptance of a candidate and, as a result, place its tax exemption in jeopardy and/or risk incurring excise tax penalties under section 4955. The legislative history of section 4955 makes it clear that an inadvertent action may indeed violate section 501(c)(3), and suggests that the IRS may appropriately apply the excise tax penalty rather than revocation as a sanction in such situations. Nevertheless, some practitioners have expressed the view that, in interpreting whether ambiguous behavior is violative of the campaign intervention prohibition, primary reliance should be placed on whether there was a political purpose to the behavior at issue. See EO Comments at 856-57. In other words, "to violate the 501(c)(3) prohibition, the organization's actions have to include an intentional 'tilt' for or against one or more people running for public office." Id. at 857. In this regard, it was noted that:

In most cases, the presence of a political purpose will be clear from the charity's paper trail, because organizational activities in the political arena are usually accompanied by assertive behavior, much internal discussion, and explicit written communications. . . .

To date, the IRS has shown no intention to abandon its position that an organization may violate the prohibition against political campaign intervention based on the unintended or inadvertent effect of its actions, as well as by an engaging in activities with "an intentional tilt" in favor of a candidate or in support of a PAC. Indeed, its recent election year warning to section 501(c)(3) organizations not to "become involved in any other activities that may be beneficial or detrimental to any candidate" (discussed above) evidences an apparent intention to adhere to a broad interpretation of the prohibition. IRS News Release IR-96-23 (Apr. 24, 1996).

(ii) If a Substantial Part of an Organization's Activities is Attempting to Influence Legislation, or its Primary Goal can only be Accomplished through Legislation, it is an "Action" Organization

Section 501(c)(3) provides that an organization cannot be tax-exempt if a "substantial part" of its activities is "carrying on propaganda, or otherwise attempting, to influence legislation." Although there is virtually no legislative history on the prohibition, courts have declared that the limitations in section 501(c)(3) "stem from the policy that the United States Treasury should be neutral in political affairs and that substantial activities directed to attempts to influence legislation should not be subsidized." Haswell v. United States, 500 F.2d 1133, 1140 (Ct. Cl. 1974), cert. denied, 419 U.S. 1107 (1975). (The court also noted that "[t]ax exemptions are matters of legislative grace and taxpayers have the burden of establishing their entitlement to exemptions." Id.)

The Regulations provide that an organization is an "action" organization if "a substantial part of its activities is attempting to influence legislation by propaganda or otherwise." Treas. Reg. 1.501(c)(3)-1(c)(3)(ii). The Regulations also provide that an organization is an "action" organization if it has the following two characteristics:

(a) Its main or primary objective or objectives (as distinguished from its incidental or secondary objective) may be attained only by legislation or a defeat of proposed legislation; and

(b) 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.

Treas. Reg. 1.501(c)(3)-1(c)(3)(iv).

To determine whether a substantial part of an organization's activities is attempting to influence legislation, two alternative tests exist. Each test contains its own definition of "legislation" and what constitutes an attempt to influence legislation. The two tests also contain different ways of determining substantiality. One test is referred to as the "substantial-part test." The other test, referred to as the "expenditure test," was added to tax law in 1976 at sections 501(h) and 4911 as a result of uncertainty over the meaning of the word "substantial."

The "expenditure test" sets forth specific, dollar levels of permissible lobbying expenditures. Section 501(h) did not amend section 501(c)(3), but rather provided charitable organizations an alternative to the vague "substantial-part" limitations of section 501(c)(3). A charitable organization may elect the "expenditure test" as a substitute for the substantial-part test. A public charity that does not elect the expenditure test remains subject to the substantial-part test. Treas. Reg. 1.501(h)-1(a)(4).

The substantial-part test is applied without regard to the provisions of section 501(h). The law, regulations and rulings regarding the expenditure test may not be used to interpret the law, regulations and rulings of the substantial-part test. Section 501(h)(7) ("nothing [in section 501(h)] shall be construed to affect the interpretation of the phrase 'no substantial part of the activities of which is carrying on propaganda, or otherwise attempting, to influence legislation,' under [section 501(c)(3)]").

Determining whether an organization violated the lobbying limitation requires an understanding of what constitutes:

i. "legislation;"

ii. an attempt to "influence" legislation; and

iii. a "substantial" part of an organization's activities.

It is also necessary to understand the circumstances under which an organization's "objectives can be achieved only through the passage of legislation."

(a) Definition of "Legislation"

The Regulations define "legislation" to include "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." Treas. Reg. 501(c)(3)-1(c)(3)(ii). "Action by the Congress" includes the "introduction, amendment, enactment, defeat, or repeal of Acts, bills, resolutions, or similar items." G.C.M. 39694 (Jan. 22, 1988). This definition does not include Executive Branch actions, or actions of independent agencies. P.L.R. 6205116290A (May 11, 1962). Requesting executive bodies to support or oppose legislation, however, is prohibited. The IRS does not recognize a distinction between "good" legislation and "bad" legislation. For example, in Rev. Rul. 67-293, 1967-2 C.B. 185, the IRS ruled that an organization substantially engaged in promoting legislation to protect animals was not exempt even though the legislation would have benefited the community.

(b) Definition of "attempting to influence legislation"

Under the Regulations, an organization will be regarded as "attempting to influence legislation" if it:

(a) contacts members of a legislative body for the purpose of proposing, supporting, or opposing legislation (Treas. Reg. 1.501(c)(3)-1(c)(3)(ii)(a)) (referred to as "direct lobbying");

(b) urges the public to contact members of a legislative body for the purpose of proposing, supporting, or opposing legislation (id.) (referred to as "grassroots lobbying"); or

(c) advocates the adoption or rejection of legislation (Treas. Reg. 1.501(c)(3)-1(c)(3)(ii)(b)).

Section 4945(e) of the Internal Revenue Code provides additional guidance regarding the meaning of "attempting to influence legislation." According to that provision, a taxable expenditure includes any amount paid or incurred for:
(a) any attempt to influence any legislation through an attempt to affect the opinion of the general public or any segment thereof, and

(b) 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 (except technical advice or assistance provided to a government body or to a committee or other subdivision thereof in response to a written request by such body or subdivision . . . .) other than through making available the results of nonpartisan analysis, study, or research.

Treas. Reg. 53.4945-2(d)(4), which is applicable to non-electing public charities, discusses "nonpartisan analysis, study, or research" as follows:
Examinations and discussions of broad social, economic, and similar problems are [not lobbying communications] even if the problems are of the type with which government would be expected to deal ultimately . . . . For example, [an organization may discuss] problems such as environmental pollution or population growth that are being considered by Congress and various State legislatures, but only where the discussions are not directly addressed to specific legislation being considered, and only where the discussions do not directly encourage recipients of the communication to contact a legislator, an employee of a legislative body, or a government official or employee who may participate in the formulation of legislation.
Even if specific legislation is not mentioned, however, an indirect campaign to "mold public opinion" may violate the legislative lobbying prohibition. In Christian Echoes National Ministry, Inc. v. United States, 470 F.2d 849 (10th Cir. 1972), the organization in question produced religious radio and television broadcasts, distributed publications, and engaged "in evangelistic campaigns and meetings for the promotion of the social and spiritual welfare of the community, state and nation." Id. at 852. The court found the publications attempted to influence legislation "by appeals to the public to react to certain issues." Id. at 855.

Under the expenditure test, "grassroots lobbying" is "any attempt to influence legislation through an attempt to affect the opinions of the general public or any segment thereof." Treas. Reg. 56.4911-2(b)(2)(i). Such a communication will be considered grassroots lobbying if it:

(a) refers to specific legislation,

(b) reflects a view on such legislation,

(c) [e]ncourages the recipient to take action with respect to such legislation.

Treas Reg. 56.4911-2(b)(2)(ii).

(c) Definition of "Substantial"

A bright-line test for determining when a "substantial" part of an organization's activities are devoted to influencing legislation does not exist. Neither the regulations nor case law provide useful guidance as to whether the determination must be based on activity or expenditures or both. In Seasongood v. Commissioner, 227 F.2d 907 (6th Cir. 1955), the court held that attempts to influence legislation that constituted less than five percent of total activities were not substantial. The percentage test of Seasongood was, however, explicitly rejected in Christian Echoes National Ministry, Inc.

The political [i.e. legislative] activities of an organization must be balanced in the context of the objects and circumstances of the organization to determine whether a substantial part of its activities was to influence legislation. (citations omitted.) A percentage test to determine whether the activities were substantial obscures the complexity of balancing the organization's activities in relation to its objects and circumstances.
Id. at 855. Yet in Haswell v. United States, 500 F.2d 1133, 1145 (Ct. Cl. 1974), the court determined that while a percentage test is not the only measure of substantiality, it was a strong indication that the organization's purposes were no longer consistent with charity. In that case, the court concluded that approximately 20 percent of the organization's total expenditures were attributable to attempts to influence legislation, and they were found to be substantial. Id. at 1146.

The IRS has characterized the ambiguity over the meaning of "substantial" as a "problem [that] does not lend itself to ready numerical boundaries." G.C.M. 36148 (January 28, 1975). In attempting to give some guidance on the subject, however, the IRS said:

the percentage of the budget dedicated to a given activity is only one type of evidence of substantiality. Others are the amount of volunteer time devoted to the activity, the amount of publicity the organization assigns to the activity, and the continuous or intermittent nature of the organization's attention to it.

(d) Circumstances under which an organization's "objectives can be achieved only through the passage of legislation"

The Regulations require that when determining whether an organization's objectives can be achieved only through the passage of legislation that "all the surrounding facts and circumstances, including the articles and all activities of the organization, are to be considered." Treas. Reg. 1.501(c)(3)-1(c)(3)(iv). There is little additional IRS or court guidance on the subject. In one of the few comments on this section of the Regulations, the IRS said in G.C.M. 33617 (Sep. 12, 1967) that an organization that was "an active advocate of a political doctrine" was an action organization because its objectives could only be attained by legislation. In its publications, the organization stated that its objectives included:

the mobilization of public opinion; resisting every attempt by law or the administration of law which widens the breach in the wall of [redacted by IRS] working for repeal of any existing state law which sanctions the granting of public aid to [redacted by IRS]; and uniting all 'patriotic' citizens in a concerted effort to prevent the passage of any federal law [redacted by IRS]. . . . "

By advocating its position to others, thereby attempting to secure general acceptance of its beliefs; by engaging in general legislative activities to implement its views; by urging the enactment or defeat of proposed legislation which was inimical to its principles: the organization ceased to function exclusively in the educator's role of informant in that its advocacy was not merely to increase the knowledge of the organization's audience, but was to secure acceptance of, and action on, the organization's views concerning legislative proposals, thereby encroaching upon the proscribed legislative area.

In Rev. Rul. 62-71, 1962-1 C.B. 85, an organization was formed "for the purpose of supporting an educational program for the stimulation of interest in the study of the science of economics or political economy, particularly with reference to a specified doctrine or theory." It conducted research, made surveys on economic conditions available, moderated discussion groups and published books and pamphlets. The research activities were principally concerned with determining the effect various real estate taxation methods would have on land values with reference to the "single tax theory of taxation." "It [was] the announced policy of the organization to promote its philosophy by educational methods as well as by the encouragement of political action." Id. The tax theory advocated in the publications, although educational within the meaning of section 501(c)(3), could be put into effect only by legislative action. Without further elaboration of the facts involved or how the theory could only be put into effect through legislative action, the IRS ruled the organization was an action organization, and thus not operated exclusively for an exempt purpose.

In G.C.M. 37247 (Sept. 8, 1977), the IRS discussed whether a organization whose guiding doctrine was to propagate a "nontheistic, ethical doctrine" of volunteerism could be considered a 501(c)(3) organization. The "ultimate goal" of the guiding doctrine was "freedom from governmental and societal control." According to the IRS:

[t]his objective can obviously only be attained legally through legislation, including constitutional amendments, or illegally through revolution. If [the organization] should advocate illegal activities, then it is not charitable; if it advocates legal attainment of its doctrine's goal through legislation, then it is an action organization.
The IRS did not conclude that organization was an action organization, only that there was such a possibility and further investigation was warranted. Research has not uncovered further

information about this case.

d. To Satisfy the Operational Test, an Organization Must Not Violate the "Private Inurement" Prohibition

To qualify for tax-exempt status, section 501(c)(3) provides that an organization must be organized and operated so that "no part of [its] net earnings . . . inures to the benefit of any private shareholder or individual." The Regulations add little clarification to this provision other than saying that "[a]n organization is not operated exclusively for one or more exempt purposes if its net earnings inure in whole or in part to the benefit of private shareholders or individuals." Treas. Reg. 1.501(c)(3)-1(c)(2).

Although the private benefit and private inurement prohibitions share common and often overlapping elements, the two are distinct requirements which must be independently satisfied. American Campaign Academy, 92 T.C. at 1068. The private inurement prohibition may be "subsumed" within the private benefit analysis, but the reverse is not true. "[W]hen the Court concludes that no prohibited inurement of earnings exists, it cannot stop there but must inquire further and determine whether a prohibited private benefit is conferred." Id. at 1069. It should be noted that the private inurement prohibition pertains to net earnings of an organization, while the private benefit prohibition can apply to benefits other than those that have monetary value. Furthermore, unlike with the private benefit prohibition, the prohibition on private inurement is absolute. "There is no de minimis exception to the inurement prohibition." G.C.M. 39862 (Nov. 22, 1991).

The IRS has described "private shareholders or individuals" as "persons who, because of their particular relationship with an organization, have an opportunity to control or influence its activities." Id. "[I]t is generally accepted that persons other than employees or directors may be in a position to exercise the control over an organization to make that person an insider for inurement purposes." Hill, F. and Kirschten, B., Federal and State Taxation of Exempt Organizations 2-85 (1994). "The inurement prohibition serves to prevent anyone in a position to do so from siphoning off any of a charity's income or assets for personal use." G.C.M. 39862 (Nov. 22, 1991). Furthermore, the IRS has stated that:

[I]nurement is likely to arise where the financial benefit represents a transfer of the organization's financial resources to an individual solely by virtue of the individual's relationship with the organization, and without regard to accomplishing exempt purposes.
G.C.M. 38459 (July 31, 1980). Also IRS Exempt Organizations Handbook (IRM 7751) 381.1(4) ("The prohibition of inurement in its simplest terms, means that a private shareholder or individual cannot pocket the organization's funds except as reasonable payment for goods or services"); and Hopkins, supra, at 267 (Proscribed private inurement "involves a transaction or series of transactions, such as unreasonable compensation, unreasonable rental charges, unreasonable borrowing arrangements, or deferred or retained interests in the organization's assets").

Other Sections of the Gingrich Ethics Report

I. Introduction
II. Summary of Facts Pertaining to American Citizens Television
III. Summary of Facts Pertaining to "Renewing American Civilization"
IV. Ethics Committee Approval of Course
V. Legal Advice Sought and Received
VI. Summary of the Report of the Subcommittee's Expert
VII. Summary of Conclusions of Mr. Gingrich's Tax Counsel
VIII. Summary of Facts Pertaining to Statements Made to the Committee
IX. Analysis and Conclusion
X.Summary of Facts Pertaining to Use of Unofficial Resources
XI.Availability of Documents to Internal Revenue Service

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