One of the questions we ask as part of our screening process for new nonprofit clients is whether the organization engages, or plans to engage, in any legislative, political, or advocacy activities.
If so, we would likely recommend that the organization critically review those activities to determine if its interests would best be served by making an election to use the expenditure test under Section 501(h) of the Internal Revenue Code to measure its lobbying activities. For a primer on the types of activities the IRS regards as lobbying by 501(c)(3) nonprofits, please see last month’s Pro Bono Partnership Pundit post.
Public charities cannot devote a substantial part of their activities to “carrying on propaganda, or otherwise attempting to influence legislation” and there is no objective measure of what is considered to be “substantial” under this prohibition.
The lack of an objective measure provides the IRS significant discretion in determining whether a nonprofit has engaged in too much lobbying. In addition, the limitation imposed by this “substantial part” test is based broadly on the organization’s activities, not how much money is spent on those activities, making the measurement even more subjective and difficult.
The Section 501(h) election provides an objective measure of a 501(c)(3) nonprofit’s lobbying activities, which is based upon a percentage of the organization’s annual exempt-purpose expenditures.
There are separate limits for total direct lobbying expenditures and for indirect, or grassroots, lobbying expenditures. These specific limits give organizations that do engage in lobbying the clarity of knowing how their activities will be measured by the IRS. In addition to the clarity of a formula, the definitions and related rules under the expenditure test include examples to which organizations can compare their activities to help determine if they result in lobbying expenditures.
Another important benefit of the expenditure test is that compliance with the limitations is generally measured on an average over a four-year period. An organization that exceeds the limitations by 150 percent over that period might lose its exempt status (this will result in its income during the entire period being taxable). Under the substantial part test, it is conceivable that an organization could lose its exempt status based on its lobbying activities in just one year.
Generally speaking, most organizations that are eligible to elect the expenditure test will benefit not only from the clarity of the test but also from the fact that the lobbying limits may be more generous than those under the substantial part test. For example, under the substantial part test unpaid lobbying activities, such as those undertaken by volunteers (including unpaid board members), would be counted in determining whether the activities are substantial.
In contrast, under the expenditure test those activities have no dollar value and thus don’t count against a nonprofit’s annual and four-year lobbying expenditure dollar limits.
Please note that the expenditure test may have some disadvantages for an organization. For example, a 25 percent excise tax is imposed on the amount by which lobbying expenditures exceed the annual limitations. Also, if an organization plans to undertake a fair amount of grassroots lobbying, the expenditure test may be more restrictive than the substantial part test.
On balance, we think the ability to objectively plan for and determine compliance outweighs any potential disadvantages for most organizations.
There will still be a fair amount of analysis and quantification necessary to ensure compliance with the limitations. Organizations still have to evaluate which activities constitute lobbying. They must determine how to measure expenditures for those activities to, for example, include preparation time and allocate overhead and administrative expenses to the amount.
They have to determine the amount of their annual exempt-purpose expenditures in order to perform the necessary calculations. They also must comply with additional record keeping and reporting requirements.
If your organization does engage in lobbying activities, we suggest that you consider whether the level of those activities may warrant a closer look at the benefits of the 501(h) election. It provides organizations with a good basis for planning their activities and budgeting related expenses so that they stay within the limitations of the expenditure test.
Sidebar: To make the 501(h) election, a nonprofit must file IRS Form 4506-A. To learn more about the rules governing lobbying, see the following IRS publications:
- Measuring Lobbying Activity: Expenditure Test;
- Measuring Lobbying: Substantial Part Test; and
- Lobbying Expenditures, Direct Lobbying Communications, and Grass Roots Lobbying Communications, which includes numerous examples of how the IRS applies the rules governing lobbying.
Kent E. Hansen is a senior staff attorney with Pro Bono Partnership, Inc. Pro Bono Partnership provides free business and transactional legal services to nonprofits serving the disadvantaged or enhancing the quality of life in neighborhoods in New York, New Jersey, and Connecticut.