Allowable Political Activities and Reporting Requirements for Tax-Exempt Entities

Editor: Valrie Chambers, Ph.D., CPA

Exempt Organizations

With the next presidential election only several months away, the chances are very good that CPAs will be asked for guidance related to political campaigns, and in particular with Sec. 527 political organizations. This is also a good time to advise tax-exempt organizations of the potential dangers of becoming too involved with a political campaign. Some charities, including churches, have incurred penalties and loss of tax-exempt status due to their involvement with political campaigns. This item provides basic guidance in the structure and operations of Sec. 527 organizations as well as some insight into allowable political activities for other tax-exempt organizations.

Sec. 527 was enacted after a long controversy over the tax treatment of political organizations. The legislative history states that Sec. 527(a) explicitly provides a tax exemption for political organizations, since political activity (including its financing) is not a trade or business that is appropriately subject to tax. The investment income generated by such organizations, however, is treated as an item of income subject to tax (Sec. 527(b); Regs. Sec. 1.527-4).

Before 1968, the IRS generally followed an informal policy that did not require political parties and organizations to file returns. The apparent reasoning was that the returns would be largely blank since donations were nontaxable gifts and political expenditures were not deductible; however, the IRS had ruled privately that receipts from sources other than donations could be taxable income (see generally the IRS description of pre-Sec. 527 law).

In 1972, the Federal Election Campaign Act, P.L. 92-225, became law, prohibiting federal campaign expenditures by corporations and unions. Some of these provisions were modified by the Supreme Court’s Citizens United ruling in 2010, which prohibited the government from limiting independent spending by corporations and unions for electioneering communications (Citizens United v. Federal Election Commission, 130 S. Ct. 876 (2010)).

In 1973, the IRS provided its first comprehensive public statement of its position regarding the tax treatment of political organizations (Announcement 73-84; see generally Rev. Rul. 74-21 and Rev. Rul. 74-475), which were taxed on interest, dividends, and capital gains from sales of securities, less deductible expenses directly attributable to producing that income, and were required to file Form 1120, U.S. Corporation Income Tax Return.

Sec. 527 was added to the Code in 1975 to apply to tax years beginning after December 31, 1974. For purposes of Sec. 527 a “political organization” is defined as “a party, committee, association, fund, or other organization” that is organized and operated primarily to accept contributions and/or make expenditures for an “exempt function” (Sec. 527(e)(1)). An “exempt function” is defined, in turn, as “influencing or attempting to influence the selection, nomination, election or appointment of any individual to any Federal, State, or local public office or office in a political organization, or the election of Presidential or Vice-Presidential electors” (Sec. 527(e)(2)). It is sufficient that the organization be operated “primarily” to accept contributions and/or make expenditures for political campaign purposes. Thus, a local political club is permitted to carry on incidental social activities (Regs. Sec. 1.527-2(a)(3)(iii)).

Taxation of Political Organizations (Including PACs)

While the taxation of corporations, trusts, partnerships, and individuals varies substantially under the Code, such entities are irrelevant in defining a Sec. 527 political organization. Rather, the focus is on the organization’s having a primarily political purpose. Even a segregated fund maintained by an individual candidate for receipt of contributions to his or her campaign is a political organization. In reality, political organizations probably are most commonly political parties, independent committees formed to support particular candidates, the candidate’s own campaign fund, the political action committee (PAC) of a business corporation, or the PAC of a Sec. 501(c) organization, particularly a labor union or a business league.

Influencing a public referendum generally is not an exempt function (TAM 9244003). This means that an organization formed to encourage the public to support a proposal in a referendum ballot cannot be an exempt political organization. It will be a taxable entity that cannot deduct its expenditures because it will be for grass-roots lobbying (which in this context includes efforts to attempt to influence the general public, or segments of the public, about elections, legislative matters, or referendums) unless the organization qualifies under Sec. 501(c)(4), (5), or (6) (civic leagues; employee unions; labor, agricultural, or horticultural organizations; business leagues; and chambers of commerce), in which case its contributors cannot deduct contributions for grass-roots lobbying on the referendum. Exceptions to this general rule may include a political organization that supports referendums as a means of helping the candidates it favors and an organization that can qualify as a governmental entity.

While PACs sometimes are allowed to lobby under state law, lobbying is not an exempt function. Thus, a PAC that lobbies substantially can fail to qualify as a Sec. 527 political organization, and a PAC that lobbies to any extent can have taxable income as a result of failing the segregated fund requirement that the fund be used solely for an exempt function (Regs. Sec. 1.527-2(b)).

Filing Requirements

Political organizations that have taxable income are required to report this income on annual return Form 1120-POL, U.S. Income Tax Return for Certain Political Organizations (Sec. 6012(a)(6)). Some political organizations that do not have taxable income nevertheless file a Form 1120-POL to start running the statute of limitation. The return must be filed on or before the 15th day of the third month after the end of the tax year of the political organization (Rev. Rul. 2003-49). Like any other taxpayer, the organization must have an employer identification number.

Political organizations are not required to apply for recognition of their status under Sec. 527. (Apparently, there is no formal procedure for determination letters on the exempt status of a political organization. If the organization desires a determination, it should seek a private letter ruling.) However, unless an organization meets one of the exceptions, it must notify the IRS of its Sec. 527 status by electronically filing Form 8871, Political Organization Notice of Section 527 Status, within 24 hours of its formation. The information provided on Form 8871 includes the organization’s name, address, and purpose; names and addresses of certain employees and directors; and name of and relationship to any related entities. An organization that fails to timely file the form online will not be treated as a Sec. 527 organization (i.e., it will be subject to tax on all income) for the period between its formation and the filing.

This notice requirement does not apply to a Sec. 527 organization that:

• Reasonably anticipates having gross receipts of less than $25,000 for any year;
• Is a political committee of a state or local candidate or political party; or
• Is required to report to the Federal Election Commission (FEC) as a political committee.

A Sec. 527 organization that accepts a contribution or makes an expenditure for an exempt function periodically files a disclosure report, Form 8872, Political Organization Report of Contributions and Expenditures, with the IRS for contributions in excess of $200 and expenditures made to a person who has received at least $500 during the year. The periodic reporting requirements of Form 8872 do not apply to a political organization that is not required to file Form 8871. The requirements also do not apply to any expenditure that is an independent expenditure (i.e., an expenditure that expressly advocates for a candidate but is made without the candidate’s cooperation).

While this item focuses on the federal income tax requirements related to political organizations, the various state and local ethics rules have additional reporting requirements that need to be reviewed. Most local elections (e.g., for school board or city council) follow the rules established by a state elections board or a state ethics commission. Careful review of the reporting and disclosure requirements is recommended for political organizations to avoid potential penalties and adverse publicity for failure to comply with state and local election reporting requirements.