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  Tax Exemption Home: Non Profit / Exemption Information: Exemption Workshop - Chapter 3 - Jeopardizing Status
 

Exemption Workshop - Chapter 3 - Jeopardizing Status

Jeopardizing Tax Exempt Status

In order to take advantage of tax exempt status, a 501c3 organization must act in a certain manner. The activities in which an organization participates in must meet the exemption purposes. Participating in activities that don’t accomplish these purposes can jeopardize an organization’s status.

A 501(c)(3) is not to be run in order to benefit an individual.  The income produced may also not be used to benefit organization members. These organizations are only able to participate in legislative activities on a limited basis, and are not able to participate in political activities.  A 501(c)(3) organization can lose its tax exempt status if it doesn’t follow its main organizational purpose.

An organization also has reporting responsibilities that must be met.  This includes filing Form 990-EZ, 990-N, or Form 990 annually.  Not doing so may mean an organization loses its tax exempt status.

Private Benefit

A 501(c)(3) organization must only serve for the public interest. If the organization attempts to act in a way that serves both the public and private interests, the private benefit must only be incidental.

Inurement

An organization is unable to use its money to insure to the benefit of an individual or private shareholder. An organization and its directors, officers, and employees are only able to use assets to pay a reasonable compensation for products or services. 

If inurement occurs, a 501(c)(3) organization may lose its tax exempt status and may be subject to excise tax. Reasonable payment for services and payments made for the fair market value or property or real estate are not prohibited.

All private benefits are not inurement, but all inurement is private benefit.

Inurement:  Excess Benefit Transactions

If a disqualified person benefits from an excess benefit transaction and if an organization leader participates in the transaction, the IRS may impose excise tax.  This type of transaction occurs between a disqualified person and a 501(c)(3) organization or exempt organization and the disqualified person benefits by receiving an economic benefit that is greater than it should be.  For example, if the disqualified person receives unreasonable compensation, this occurs.

A disqualified person is someone who is able to exercise extreme influence over the organization and its affairs.

Preventing Private Benefit and Inurement with the Use of Internal Controls

Internal controls can be used to stop private benefit and inurement from occurring within an organization.  This can help a 501(c)(3) organization keep its tax exempt status. Some controls that can be put into place include the following:

  • Requiring a second set of signatures on large checked
  • Segregating financial duties between members
  • Keeping track of inventory
  • Conducting internal audits
  • Proper recordkeeping

 
Preventing Private Inurement with the use of a Conflict of Interest Policy

With the use of a conflict of interest policy, an organization can prevent inurement from occurring. The policy may include the following:

  • Procedure for disclose by people with a financial interest
  • Procedures to decide if a person with financial interest is a conflict of interest
  • Procedures for proper recordkeeping of actions taken
  • Procedures for ensuring that a policy is distributed to all officers, trustees, and members with authority

Lobbying and Political Activities

A 501(c)(3) organization is only able to participate in a limited amount of lobbying activities.  It is unable to intervene in political campaigns.

Lobbying Activity

An organization can conduct lobbying activities if they’re insubstantial in relation to the organization’s exempt purpose activities.  Lobbying is, “the attempt by an organization to influence legislation.”

Legislation may include action by any state legislature, Congress, local council, or other governing body, with respect to resolutions, acts, bills, ballet initiative, public in referendum, constitutional amendment, or other activities and procedures.  Legislation doesn’t include actions by judicial, executive, or administrative bodies.

An organization is found to be attempting to influence legislation if it reaches out to contact or asks the public to contact employees or members of a legislative body in order to support, propose, or oppose legislation.  An organization is also found to be attempting to influence legislation if it advocates the adoption or rejection of a specific legislation.
Organizations are able to participate in public policy issues.  This includes conducting educational meetings as well as preparing and distributing materials for the purpose of education.  These activities will not interfere with an organization’s tax exempt status.

If lobbying activities are found to be substantial, an organization may fail the operational test and may lose its tax exempt status. The following tests measure substantiality:

  • The substantial part test
  • The expenditure test

Measuring Lobbying Activity with the Substantial Part Test

The substantial part test is often used to determine substantiality.  It works by looking at the specific facts and incidents of each case.  The IRS considers many factors when determining substantiality.  This includes considering how much time an organization spends devoting to the particular activity.
If the substantial part test finds that an organization is participating in extensive lobbying, it may lose its tax exempt status.  The organization can also be held accountable to excise tax of up to 5 percent of its lobbying expenditures for the entire year. 

Additionally, a tax equal to 5 percent of the lobbying expenditures for the entire year may be forced upon organization leaders, such as managers.  This is the case for any leader who agrees to the actions and expenditures with knowledge that it could interfere with the organization’s tax exempt status.

Measuring Lobbying Activity with the Expenditure Test

If the substantial part test is not used, the expenditure test may be used.  This is an objective mathematical test that an organization is able to elect to use.  It uses a sliding scale to determine the amount of expenditures that is allowed.  Any amount over the nontaxable amount is subject to a 25 percent excise tax.  The organization may also lose its exemption if it continues to spend over 150 percent of the nontaxable amount during a 4 year period.

Churches and organizations that are church related organizations are unable to use the expenditure test.

If an organization chooses to use the expenditure test, it must file Form 5768, Election/Revocation of Election by an Eligible IRC Section 501(c)(3) Organization to Make Expenditures to Influence Legislation, during the current tax year.  Unless revoked by the organization, the election remains in effect for the following years.  The election is cancelled for the following year after the cancellation was filed.

Political Campaign Activity

501 (c)(3) organizations are unable to participate in political campaigns, whether directly or indirectly.  The organization is prohibited from participating on behalf of or in opposition of a candidate.  If contributions are made to a political campaign fund or if public statements are made, the organization will be in violation.  If an organization is found to be in violation of this prohibition, the organization may lose its tax exempt status.  It may also be subject to excise tax, based on the amount of the political expenditure. 

If an organization holds voter education courses or events that favor a particular candidate, oppose a candidate, or have the appearance of favoring a particular political viewpoint, the organization will be found in violation of the prohibition.

Some activities may be allowed, based on the individual situation.  This includes educational events or activities that encourage voting in a non-partisan manner or the publication of voter education guides.  These types of activities don’t violate the prohibition.

Individual Activity by Organization Leaders

Leaders of organizations are able to have free expression on political affairs, as long as they do so as individuals.  They are also able to discuss important public policy issues.  Leaders are unable to make partisan comments at organizational events or in organization publications.  Doing so can result in the loss of an organization’s tax exempt status.

Whether writing or speaking, organization leaders should take extra care to make note that their comments are their own individual opinion.  This can help to show that their views are not a representation of the organization’s political views.

Inviting a Candidate to Speak

An organization may be able to invite a political candidate to speak at an event or service without having to worry about losing its tax exempt status.  This is dependent on the individual situation.  A candidate may be invited to speak as a political candidate or as an individual.

If a candidate is invited to speak at an organization sponsored event, the organization must take extra care to ensure the following:

  • The event provides an equal opportunity to other candidates who are seeking to hold the same office
  • The event doesn’t show support or opposition for the candidate
  • The event doesn’t allow political fundraising

When taking care to ensure that candidates are presented with an equal opportunity, the organization should consider the event as well as the type of presentation that will occur.

An organization shouldn’t choose to invite one candidate to a popular banquet, and then invite an opposing candidate to attend an unpopular and unattended general meeting.  If this type of activity occurs, an organization may risk losing its tax exempt status.

An organization may decide to hold a public forum and may choose to invite several candidates.  This type of event may qualify as an educational activity.  The forum should not be in held in a manner that shows a bias for or against a particular candidate.  If this activity occurs, an organization may risk losing its tax exempt status.

If an organization decides to invite multiple candidates to speak at a public forum, the organization must take extra care to consider the following:

  • Whether an independent panel is creating and preparing the questions

  • Whether all of the topics discussed touch on a variety of issues

  • Whether each candidate is given a fair and equal opportunity when presenting and sharing views

  • Whether the candidates are asked to speak on behalf of or against the organization’s position on a matter

  • Whether a moderator offers comments or questions that imply approval or disapproval of a particular candidate

An organization is able to invite candidates to speak on non-candidate issues. When considering inviting a candidate to speak, some of the following may be true:

  • The candidate may currently hold or may have formerly held public office

  • The candidate may be considered to be an expert in a field unrelated to politics

  • The candidate is considered to be a celebrity or has led a legal, military, or public service career that is considered to be distinguished

If a candidate is invited to speak as a non-candidate, the organization doesn’t have to allow equal opportunities for other political candidates.  The organization should ensure that the following is true:

  • The candidate is asked to speak for other reasons other than his or her candidacy

  • The candidate only speaks as a non-candidate

  • No one mentions the speaker’s candidacy or references the election

  • The event is non-partisan in nature

  • No campaign related activities occur at the event

The organization should take an extra effort to mention the reason for the candidate’s appearance.  No one should mention the speaker’s candidacy or mention the upcoming election, when announcing the event.

Voter Guides

An organization may choose to distribute voter guides as a way to offer an educational activity.  These guides include information about the upcoming election and discuss how candidates feel about certain issues.
In order to determine if an organization’s publication of voter guides violates the prohibition, the following will be considered:

  • Whether the candidates’ positions are related or compared to the organization’s position on a matter

  • Whether the voter guide discusses a variety of issues that are important to the public and the candidates

  • Whether the issues are described in a neutral manner

  • Whether all candidates are included in the voter guide

  • Whether candidates’ positions are described by including the candidates’ own words in response to certain questions

  • Whether the candidates’ positions are described by including an unbiased and neutral collection of all candidates’ positions

Business Activity

There may be issues as to whether an organization’s business activity includes participation in a political campaign.  This may include activities such as leasing office space, renting or mailing lists, or accepting paid political advertisements.  Some factors that may be considered in this situation include the following:

  • Whether services, goods, and or facilities are offered to candidates on an equal basis

  • Whether services, goods, and or facilities are available to the candidates only, and not the general public

  • Whether the fees charged to the candidates follow the organization’s regular rates

  • Whether the activity is one that normally occurs, or if it’s only conducted for a candidate

Consequences of Political Campaign Activity

A 501(c)(3) organization may lose its tax exemption status and its eligibility to receive contributions that are tax deductible.  An organization may also be subject to excise tax based on its expenditures related to political campaign activities.  These expenditures include amounts that are paid or debts that occur while the organization is participating in a political campaign. The tax may be enforced in addition to or in lieu of the withdrawal of the organization’s tax exempt status. In order to avoid further tax responsibilities, the organization must correct the issue.
Excise Tax

The tax imposed on an organization is 10 percent of the expenditures that were spent on political activities.  Additionally, a tax at the rate of 2.5 percent of the expenditures is also imposed against the managers of the organization who agreed to the expenditures, knowing that they were for political purposes. The tax directed toward management may not exceed $5,000, with respect to any one expenditure.

Once an organization has a tax imposed, it must correct the problem within a given time period.  If not, an additional tax will be imposed against the organization.  This tax is equal to 100 percent of the expenditures.  Additionally, a tax that is equal to the rate of 50 percent of the expenditures will be imposed against organizational managers who don’t take the steps needed to correct the problem.  The tax imposed on managers can’t exceed $10,000 with respect to any one expenditure.

Correction of Expenditure

In order to correct a political expenditure, the organization must recover the expenditure, as much as possible, and must create a plan to prevent future political expenditures from occurring.

Failure to Comply with Reporting Obligations

501(c)(3) organizations are exempt from unemployment tax and federal income tax, however, they’re required to follow reporting obligations.  An organization can meet these requirements by filing Form 990-EZ, Form 990, or Form 990-N. 
If an organization doesn’t file one of the required forms, it may lose its tax exempt status.  If the organization doesn’t file for up to 3 consecutive years, the tax exempt status will be taken away on the filing due date of the third return.  If an organization loses its status for this reason, it must reapply by filing Form 1023 or Form 1024.  The organization is also required to pay the required fee in order to have its tax exempt status reinstated.  If an organization is able to show why it was unable to file, the tax exemption status reinstatement may be backdated.
More information can be found by reading the following documents. 

Publication 557, Tax-Exempt Status for Your Organization

Publication 1828, Tax Guide for Churches and Religious Organizations

Publication 4221, Compliance Guide for 501(c)(3) Tax-Exempt Organizations

Form 1120-POL, U.S. Income Tax Return for Certain Political Organizations

Case Study 1

Jane Doe is the President and founder of a 501(c)(3) organization, XYZ Charity.  The bylaws state that the President is a voting member of the seven-person Board of Directors.  Jane is also an owner of 49% of a for-profit advertising agency, M Corporation, which is run by her husband. Jim, her husband, owns the other 51% of the agency.  In need of an advertising campaign to promote the charity’s annual appeal, XYZ Charity signed a $200,000 advertising contract with M Corporation.  Before discussing the issue with the Board of Directors, Jane signed the contract on behalf of the charity. Jim knows that there won’t be competitive bidding for the advertising contract, so he bills at the rate of 120% of the fair market value for the work that will be completed. He calls the contract the “M Company Deluxe Package,” but it’s the same level and types of services that his company provides to other customers.

  • Does this scenario show an example of inurement or private benefit?  If so, why?
  • If inurement or private benefit occurred, what could the charity have done to prevent it?

Case Study 2

DEF Hospital is a busy and productive tax exempt hospital.  It has a busy emergency room, houses 250 beds, and offers many surgical and medical specialties. Bob, the CEO of the hospital, is paid $300,000 annually.  This compensation was determined by the compensation committee of the Board of Directors. He’s not a member of this committee and his salary fits in with other comparable salaries paid to people on his position at similarly sized health care organizations.  Bob’s compensation agreement also requires him to be provided with a BMW in which he can use for both company and personal reasons.  He keeps close documentation of his personal use of the vehicle on his Form W-2.  Within the last few years, his personal use of the car has averaged about $11,000 annually.

  • Does this scenario show an example of inurement or private benefit?  If so, why?
  • If inurement or private benefit occurred, what could the charity have done to prevent it?


Case Study 3

(Take a look at both scenarios and come to a separate conclusion for each scenario)

Scenario A – Individual Activity by an Organization’s Leader

President B is the President of University K, which is a 501(c)(3) organization.  The University publishes a monthly alumni newsletter that is used to distribute to the University’s alumni.  President B has his own column that is titled “My Views.” In the publication that is delivered a month before the election, President B states, “it is my personal opinion that Candidate U should be reelected.” For that issue, the President decides to use his own funds to pay for a portion of the cost of the newsletter for his “My Views” column.

Question: What factors should help determine whether or not the President violated the political intervention prohibition?

After considering some of the above factors, do you think the President’s actions constitute political campaign intervention attributable to the University?  Why or why not?

Scenario B – Candidate Appearances

President E is the president of Society N, which is a 501(c)(3) organization that is a historical society.  A month before an election, the President invites the four Congressional candidates from the district to address the members at Society N.  The President decides that the meetings will be held on successive weeks. Each candidate is able to speak on a wide variety of issues and is given an equal opportunity to address the members. One candidate chooses not to attend the meetings.  Society N announces the upcoming meetings as well as the dates for each candidate’s speech.  Society N also states that the order in which the speakers will present was chosen randomly and also indicates that a candidate declined the invitation to present.  When President E introduces each candidate, he makes no mention as to their qualifications and shows no preference over a particular candidate.

Question: What factors should help determine whether or not the President violated the political intervention prohibition?

After considering some of the above factors, do you think the President’s actions constitute political campaign intervention attributable to the University?  Why or why not?

Has President E engaged in political activity attributable to his organization? Why or why not?


  Chapter 4 - Unrelated Business Income->  


 

 

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