Forbidden Activities

1. Inurement

Federal tax law allows a public charity 501(c)(3) to make payments to
insiders as long as the amounts are reasonable and the goods and/or
services are actually rendered. 

When a charity pays unreasonable compensation, or allows insiders to
exploit the charity with "sweetheart" deals, the IRS calls this "inure-
ment."  501(c)(3) does not allow any part of an organi-zation’s net
earnings to inure to the benefit of a private shareholder or individual.
Inurement can result in revocation of a 501(c)(3) organization's exempt
status.

Revocation of an organization's tax exempt status often seemed too
drastic, given the good that non-profits can do, so in 1996, Congress
enacted section 4958 of the Internal Revenue Code, im-posing a tax on
"Excess Benefit" transactions.  The IRS can now impose fines on insiders
who receive, and on board members who approve, unreasonable
payments.  (In extreme cases, the organization can still lose its tax
exempt status.) 

If insiders will receive compensation of any kind, it is imperative for
the board to rely on independent data to insure that any payments made
are fair.  Never let a board member vote on his or her own compensa-
tion or on the compensation of anyone related to him or her. Fully
document the decision-making process in the minutes, including copies
of all relevant information - salary surveys, job descriptions, résumés,
prior salary history, independent appraisals, etc.

Political activity (support of, or opposition to, candidates for public
office) is absolutely prohibited for 501(c)(3) organizations, and will lead
to revocation of exempt status as well as penalty taxes. (Do not confuse
political activity with lobbying, or legislative activity, described below.)

Some examples of forbidden political activity:

- Contributions to political campaign funds.
- Written or oral statements in support of or in opposition to a candidate.
- Candidate rating (of any kind - even scrupulous objectivity is
no defense).
- Making mailing lists, office space, or other services or facilites
available only to a favored candidate.
- Establishment of a PAC.

In addition to revocation of 501(c)(3) status, the IRS can impose a 10%
tax on the political expenditure, and require recovery of the political
expenditure. A 100% tax can be imposed if the funds are not recovered.
A 501(c)(3) that has had its exemption revoked because of political
activity is prohibited by law from applying for 501(c)(4) status.

The non-partisan educational activities listed below are permitted, but
be very careful. Do not engage in any of the listed activities without
knowledgeable professional advice.

- Publication of voting records
- Publication of candidates responses to questionnaires
- Public forums
- Voter registration activities
- Political science courses at universities 
- News stories; news reporting

Activities Which Are Permitted, But Must Be Limited

1. Lobbying

Basic Rule

501(c)(3) organizations may engage in insubstantial amounts of lobbying
or legislative activity. The courts have generally interpreted this to mean
5% or less of overall activities, financial expenditures, staff hours
or other measurable standards. Organizations that exceed this guideline
will have their 501(c)(3) status revoked, unless they have filed IRS
Form 5768 to elect the more liberal limits of section 501(h). (Not all
501(c)(3)’s are eligible to make this election.)  The rules that follow
apply only to those organizations that have made the election.

Direct Lobbying, Electing Organizations

I. Definition

General discussion of controversial issues does not, alone, constitute
lobbying. In order for the IRS to find that direct lobbying has taken
place, there must be three elements:

a. Specific Legislation
This could be a bill or other piece of legislation already introduced in
the legislature, or a specific legislative proposal.
b. Reflecting A View
In order to be lobbying, a discussion must take a position with respect
to (support or oppose) the specific legislation.
c. A communication with a legislator or a government official

Special rule - Discussion of initiatives and referenda are considered direct
lobbying (subject to more generous percentage limits) even though
communication is with the general public.

II. Limitations

If all three of these elements are present, you have "Direct Lobbying."
The rules governing direct lobbying for an organization which has
made the section 501(h) lobbying election are as follows:

a. The organization is allowed to spend up to 20% of its overall budget
on direct lobbying without penalty.
b. If more than 20%, but less than 30%, of the budget is spent on direct
lobbying, there will be a penalty tax, but the 501(c)(3) status is not in
jeopardy.
c. If expenditures for direct lobbying average more than 30% of the
organization's overall expenditures over a four year period, the IRS can
take away the 501(c)(3) tax exempt status.

(Caution! If the organization's budget exceeds $500,000 per year, these
"safe harbor" percentages are reduced!)

III. Recordkeeping

a. Keep track of the total amount spent directly for this kind of lobbying
- long distance phone calls, postage, travel, payments to lobbyists.
b. Paid employees, if any, should keep logs to determine the percentage
of their salaries and benefits to be allocated to lobbying.
c. Arrive at a reasonable method for allocating overhead and similar
costs to the lobbying activity.

Grass Roots Lobbying, Electing Organizations

I. Definition

General discussion of controversial issues does not, alone, constitute
lobbying. In order for the IRS to find that grass roots lobbying has
taken place, there must be three elements:

a. Specific Legislation
This could be a bill or other piece of legislation already introduced in
the legislature, or a specific legislative proposal.
b. Reflecting A View
In order to be lobbying, a discussion must take a position with respect
to (support or oppose) the specific legislation.
c. A Call To Action
Includes urging people to contact legislators, giving out legislators'
addresses or phone numbers, or identifying legislators who are either in
favor of, or opposed to, the specific legislation.

Special rule - In some cases, communications with an organization’s
own members may receive more lenient treatment.

II. Limitations

If all three of these elements are present, you have "Grass Roots Lobby-
ing." The rules governing grass roots lobbying for an organization
which has made the section 501(h) lobbying election are as follows:

a. The organization is allowed to spend up to 5% of its overall budget
on grass roots lobbying without penalty.
b. If more than 5%, but less than 7.5%, of the budget is spent on grass
roots lobbying, there will be a penalty tax, but the 501(c)(3) status is
not in jeopardy.
c. If expenditures for grass roots lobbying average more than 7.5% of
the organization's overall ex-penditures over a four year period, the IRS
can take away the 501(c)(3) tax exempt status.

(Caution! If the organization's budget exceeds $500,000 per year, these
"safe harbor" percentages are reduced!)

III. Recordkeeping

a. Keep track of the total amount spent directly for postage, travel and
other grassroots lobbying. Also keep track of print space (column
inches) in newsletters or other publications. Divide the amount devoted
to grass roots lobbying by the total to determine a percentage to be
applied to all costs of producing and distributing the publications.
b. Paid employees, if any, should keep logs to determine the percentage
of their salaries and benefits to be allocated to grass
roots lobbying.
c. Arrive at a reasonable method for allocating overhead and similar
costs to the grass roots lobbying activity.

Note: Permitted grass roots lobbying amounts DO NOT INCREASE
the overall lobbying limits.  For instance, if an organization spends
20% of its overall budget on direct lobbying, then any additional
amounts spent on grass roots lobbying will be taxable.

Although 501(c) organizations are generally exempt from federal
income tax, they do have to pay tax when carrying on regular business
activities which are unrelated to their exempt purposes. The law
governing unrelated business income (UBI) is a complex maze of
exceptions, exclusions and modifications. The following list of
"threshold" questions can be used to narrow down the field.

a. Is the income producing activity a trade or business?
A "no" answer means the income is not taxed as UBI.

b. Is the activity regularly carried on?
A "no" answer means the income is not taxed as UBI.

c. Does the activity contribute importantly to the accomplishment c
of the organization's exempt purpose?
A "yes" answer means the income is not taxed as UBI.

d. Is the activity carried on with substantially all volunteer help?
A "yes" answer means the income is not taxed as UBI.

e. If the activity involves the sale of merchandise, has substantially
all of the merchandise been donated?
A "yes" answer means the income is not taxed as UBI.

f. Is the activity carried on primarily for the convenience of the organi-
zation's members, students, patients, officers or employees? (This ex-
ception applies only to 501(c)(3) organizations.)
A "yes" answer means the income is not taxed as UBI.

If, after answering these questions, it appears the income under discus-
sion might still be UBI, con-sider the following "modifications," set
forth in section 512(b) of the Internal Revenue Code. Generally, none
of these types of income is taxable.

- interest
- dividends
- rents (from real property only)
- royalties
- annuities
- gains and losses

Of course, there are a few exceptions within each category. A major
overriding exception is "debt-financed" income. If there is an out-
standing indebtedness with respect to the income producing property
(such as a mortgage), the income produced will be taxed in proportion
to the debt.

Finally, there are miscellaneous exclusions for certain trade shows, and
for bingo, but not for any other type of gambling activity. And 501(c)(3)s
who rent their mailing lists to other 501(c)(3)s are not taxed.

Ordinary and necessary expenses, as defined by normal income tax
rules, may be deducted in de-termining net income from an unrelated
business, and the tax rate is the same as regular corporate rates (or trust
rates for non-profits organized as trusts). Some special rules apply to
the computation of charitable contributions and net operating losses,
and there is a $1,000 "specific deduction" - the exempt organization
equivalent of a personal exemption.

The form used to pay unrelated business income tax is Form 990-T, due
at the same time as the Form 990 (the 15th day of the fifth month after
the close of the accounting period). Exempt organi-zations are required
to make estimated tax deposits if they expect to owe $500 or more of
UBI tax. Caution: Form 990-T must be filed if gross unrelated income
is $1,000 or more, whether there is any tax due or not.

The most common form of unrelated business taxable income for small
501(c)(3) organizations is paid advertising in a newsletter or other peri-
odical. Fortunately, this type of income is only taxed if the publication
as a whole is operated at a profit.