Close Affiliations

Contrary to much popular belief, the IRS does not flick tax concepts out of the air, nor does it generally act precipitously. In fact, at the national level, the IRS has built up a vast library of material on questions of interpretation and application of the Internal Revenue Code. Much of this material is publicly available.

In 2000, Ward Thomas and Judith Kindell drafted a monograph for the Service's continuing professional education program entitled Affiliations Among Political, Lobbying and Educational Organizations. That paper noted that:

In an increasingly common arrangement, an IRC 501(c)(3) educational organization formally or informally affiliates with an IRC 501(c) (4), (5), or (6) lobbying organization with a related IRC 527 political organization or PAC. For instance, in a House ethics investigation of then-Speaker Newt Gingrich, Mr. Gingrich's counsel submitted an exhibit showing 26 such groups, including such well-known organizations as the National Organization of Women and the Sierra Club, where the organizations in each group shared a common address. . . . Such an affiliated group of organizations is typically committed to a certain idea or movement, such as civil rights, family values, or environmental preservation.

Are such affiliations of IRC 501(c)(3) organizations with non-IRC 501(c)(3) organizations permissible under IRC 501(c)(3)? Are any arrangements impermissible under Subchapter F? Does the form of the affiliation matter? Are there any potential problems to watch out for on audit? This article will address these issues, with a focus on the exemption of the IRC 501(c)(3) organization affiliated with other organizations engaged in political intervention and substantial lobbying.

The paper reached several conclusions. First, in analysing the relationship between IRC 501(c)(3) and 501(c)(4) entities:

[T]he Service will recognize the IRC 501(c)(4) subsidiary and its activities as separate from the IRC 501(c)(3) parent under the following circumstances:

1. The IRC 501(c)(4) subsidiary must be separately organized.

2. The IRC 501(c)(4) subsidiary must keep records and bank accounts separate from those of the IRC 501(c)(3) parent.

3. If there are overlapping paid officers, directors, or employees, their time must be allocated between the organizations based on the activities they work on for the respective organizations.

4. The organizations must reasonably allocate other shared goods, services, and facilities.

In essence, an organization affiliated with an IRC 501(c)(3) organization must observe the formalities of its separate organizational status and deal with the IRC 501(c)(3) organization at arm's length. Otherwise, its activities may be considered activities of the IRC 501(c)(3) organization, especially if the IRC 501(c)(3) organization provides any subsidy.

Second, with respect to the relationship between 501(c)(3) and 527 organizations, the report stated:

Where do we draw the line between an IRC 501(c)(3) organization "establishing" an IRC 527 organization, on the one hand, and IRC 501(c)(3) officials acting in their individual capacity establishing an IRC 527 organization, on the other? What does it mean for one organization to "establish" another? Basically, there are three requirements.

First, an IRC 501(c)(3) organization cannot formally control an IRC 527 organization. For instance, it cannot have the right to appoint (or approve) the board of the IRC 527 organization. The governing documents of the IRC 501(c)(3) or IRC 527 organization cannot say that the IRC 501(c)(3) board members constitute the IRC 527 board members. There should be no such formal affiliation.

Second, none of the IRC 501(c)(3) organization's assets can be used to set up or operate the IRC 527 organization. There are many ways in which IRC 501(c)(3) assets can be used to support an IRC 527 organization, which must be avoided. An organization's assets include its funds and investment assets, facilities and equipment, personnel, mailing lists, and its name or goodwill. If personnel, facilities, or equipment are shared, then there must be reasonable allocations of expenses based on arm's-length standards, and records kept to substantiate the allocations, including the time spent by shared employees working for each organization.

Unlike other assets of the IRC 501(c)(3) organization, its mailing list may be unique and so particularly valuable to one or more political organizations or candidates. Thus, the IRC 501(c)(3) organization may not sell or rent its mailing list to the IRC 527 organization without making it available to all other political organizations and candidates on an equal basis. Any dealings also must be on arm's-length terms.

* * * * *

Third, any IRC 501(c)(3) officials assisting the IRC 527 organization must truly be acting only in their individual capacity, which is a factual issue. Agency principles determine whether the IRC 501(c)(3) organization has authorized or ratified the acts of those individuals as official acts of the IRC 501(c)(3) organization. For instance, the following statements and other acts would ordinarily be attributable to the IRC 501(c)(3) organization, absent other facts:

• Transaction of business of the IRC 527 organization on stationery bearing the letterhead of the IRC 501(c)(3) organization or signed by IRC 501(c)(3) officials in such capacity (e.g., "John Doe, President of IRC 501(c)(3) organization").

• Acts explicitly authorized by the IRC 501(c)(3) organization's board of directors.

• Statements published by the IRC 501(c)(3) organization in its official publications (including Internet sites) or in mass media advertisements or programs acknowledged as produced by the organization, except where the statement is clearly attributed to someone other than persons who normally speak for the organization.

• Statements made by officials at official events of the IRC 501(c)(3) organization.

Even if the IRC 501(c)(3) organization did not establish the IRC 527 organization, it might indirectly intervene in a campaign or operate for a substantial nonexempt purpose if it improperly coordinates or colludes with the IRC 527 entity. For example:

• Joint fundraising mailings or events.

• Coordinating the content, timing, or distribution of information materials;

• Distribution by the IRC 501(c)(3) organization of materials prepared by the IRC 527 organization, or vice versa. Reg. 56.4911-2(b)(2)(v) may provide general guidance in this regard.

Readers may recall that last October I commented on a WaPo story that reported that money moved, via a pre-arranged plan, from a Jack Abramoff client to a Grover Norquist-controlled 501(c)(3) or 501(c)(4) and thence to a "shell" 527 organization. The transaction would have been clearly verboten if the intermediary organization was the 501(c)(3). Whether it violated 501(c) rules if the intermediary was the 501(c)(4) is not as clear. As noted in the IRS's CPE paper, "Without tangible evidence, or (in the rare case) reliable insider testimony, it is difficult to prove that the IRC 501(c)(3) directed and controlled the political intervention activities of the IRC 501(c)(4) or IRC 527 organizations."

The report summarized its conclusions as follows:

[S]ome important matters to consider in examining relationships between IRC 501(c)(3), IRC 501(c), and IRC 527 organizations include the following:

1. The organizations must be separately organized, including having separate employer identification numbers. However, the organizational test for IRC 527 organizations is very informal.

2. The organizations should maintain separate records and finances.

3. The IRC 501(c)(3) organization should not subsidize any political intervention activity or substantial lobbying activity of the affiliated organizations in any manner. A subsidy can take several forms:

a. Direct transfer of funds to the other organization.

b. Paying expenses of the other organization.

c. Non-arm's-length dealing for shared facilities or employees.

d. Use of the IRC 501(c)(3) mailing list on a preferential or non-arm's length basis.

4. The IRC 501(c)(3) officials should not direct or assist in the political intervention activities of other organizations in their capacity as IRC 501(c)(3) officials.

5. The IRC 501(c)(3) organization should not coordinate its activities with a non-IRC 501(c)(3) organization for partisan political purposes, including any coordination with a candidate or IRC 527 organization.

In summary, organizations, despite affiliations, must observe the formalities of their status as organizations separate from the IRC 501(c)(3) organization, the IRC 501(c)(3) organization must deal with them on an arm's length basis, and the organizations must confine their activities to those permitted by their respective exempt Code sections.

(Emphasis mine.)

There seems to be little question but that the various 501(c) organizations operated by Norquist were political and their activities were carefully coordinated. I don't think that a civil challenge to their 501(c) status or asserting penalties for their violation of the rules under 501(c) would be unduly difficult. At the least, the civil side of the IRS should put Norquist out of business.

However, a criminal prosecution with respect to their operation, in general, would face significant problems. Not the least of these would be that Norquist could likely point to some professional who had given the arrangement his or her blessing.

All that said, however, the specific transaction described in the WaPo story and similar transactions may be in a different class. After all, it is fairly obvious that the money chain was pre-arranged and was undertaken in an attempt to surreptitiously support a lobbying effort that was unrelated to any possible legitimate purpose of Norquist's 501(c) organizations. In other words, the 501(c) organizations were merely cover for Norquist's personal lobbying business.