The Shape of Tax to Come

A Tax & Estate Planning blog for 21st-century Texans

Citizens United: A Time-bomb for Non-profit Law?

The Supreme Court recently released Citizens United v. FEC, which held that the McCain-Feingold Act imposed an unconstitutional restriction upon First Amendment rights by restricting political speech by corporations. Citizens United was a non-profit organization that had its tax-exempt status revoked after releasing Hillary: The Movie. This represents a change in law by overturning decades-old precedent prohibiting corporate political speech, but is there is a legal time bomb for non-profits buried within the decision as well?

Congress enacted the non-profit provisions of the Internal Revenue Code to provide a subsidy to groups that provide benefits that the government is either unwilling or unable to provide. In exchange for relieving the government of those responsibilities, qualifying organizations are rewarded with non-profit status. The major benefit of non-profit status for organizations is that they are exempt from most federal taxes. This status also translates into exemption from many state and local taxes as well. Because the government is forgoing revenue by not taxing these groups, the government is in effect providing these groups with tax subsidy. Rather than directly spending money on the services offered by non-profits, the government subsidizes the actions by not imposing tax upon them, which is another form of government spending.

The Code offers many non-profit forms, and the most well-known is the § 501(c)(3) organization. To qualify as a § 501(c)(3) organization, the Code requires the following:

Corporations, and any community chest, fund, or foundation, organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition (but only if no part of its activities involve the provision of athletic facilities or equipment), or for the prevention of cruelty to children or animals, 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 (except as otherwise provided in subsection (h)), and which does not participate in, or intervene in (including the publishing or distributing of statements), any political campaign on behalf of (or in opposition to) any candidate for public office.

26 U.S.C. § 501(c)(3)(emphasis added). While this does allow for some room for charities to lobby, it is an explicit ban upon political campaigning. If the non-profit is involved a political campaign, its tax-exempt status may be revoked. With the decision in Citizens United, does this mean that the restriction on campaign activity has been lifted?

The Supreme Court has previously upheld the restrictions on political speech imposed by § 501(c)(3). In Reagan v. Taxation Without Representation of Washington, the Court held that § 501(c)(3) did not abridge or restrict any First Amendment rights, nor did it regulate any First Amendment activities. While these groups had First Amendment protection, they were still bound by the restrictions imposed by the Code if they wished to maintain their tax-exempt status. Thus, the restrictions of § 501(c)(3) only applied if organizations wished to maintain their status. If they preferred to engage in political activity, then the Federal government merely would not pay for such activity with tax subsidy.

Given that holding, it would seem that the Supreme Court just found one of provisions of the Code unconstitutional as well as overruling itself. That answer is, however, incorrect.

Among other things, Citizens United was a § 501(c)(4) corporation. While also tax-exempt, it was subject to different requirements under the Code. Section 501(c)(4) organizations are defined in the Code as:
Civic leagues or organizations not organized for profit but operated exclusively for the promotion of social welfare, or local associations of employees, the membership of which is limited to the employees of a designated person or persons in a particular municipality, and the net earnings of which are devoted exclusively to charitable, educational, or recreational purposes.

26 U.S.C. § 501(c)(4)(A). The definition does not include the same prohibition upon political campaign activity that § 501(c)(3) organizations are subject. Thus, § 501(c)(4) organizations have the ability to engage in political activity without jeopardizing their tax-exempt status. So while the Supreme Court has held that § 501(c)(4) organizations cannot be limited in their speech, § 501(c)(3) organizations can still limited in political speech under Reagan.

What does this mean? While § 501(c)(3) organizations are still prevented from engaging in political activity, there will be greater pressure for other non-profits to do so. For § 501(c)(3) organizations, this means setting up companion § 501(c)(4) organizations to engage in political activities. In fact, it is not at all uncommon for § 501(c)(3) organizations to set up sister § 501(c)(4) organizations to engage in any political campaign activity that might be useful or necessary. While the § 501(c)(3) will not be able to transfer any of the charitable contributions it receives to the § 501(c)(4), it will be able to solicit donations on behalf of the companion organization. This should result in greater political giving going to non-profits, § 501(c)(4) and § 527 organizations, and less money going directly to the political parties.

February 1, 2010 - Posted by | Uncategorized

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