(a) Recognition of Tax-Exempt Status

Whether a nonprofit organization is entitled to tax exemption, on an initial or continuing basis, is a matter of law. The U.S. Congress—not the IRS—defines the categories of organizations that are eligible for tax exemption, and it is up to Congress to determine whether an exemption from tax should be continued, in whole or in part. Except for state and local governmental entities, there is no constitutional right to a tax exemption.

Despite what is often thought, the IRS does not grant tax-exempt status. Congress, by means of sections of the Internal Revenue Code that it has enacted, performs that role. Rather, the function of the IRS in this regard is to recognize tax exemptions that Congress has created.

Consequently, when an organization applies to the IRS for a ruling or determination as to tax-exempt status, it is requesting the IRS to recognize a tax exemption that already exists (assuming the organization qualifies). Similarly, the IRS may determine that an organization is no longer entitled to tax-exempt status and revoke its prior recognition of exempt status.

For many nonprofit organizations that are eligible for tax exemption, it is not required that the exemption be recognized by the IRS. Whether a nonprofit organization seeks an IRS determination on the point is a management decision, which usually takes into account the degree of confidence the individuals involved have in the eligibility for the exemption and the costs associated with the application process. Many organizations in this position elect to pursue recognition of tax-exempt status. Organizations that are not required to pursue recognition of exempt status are termed by the IRS self-declarers.

Charitable organizations (and certain other categories of organizations) must, however, to be tax-exempt and to be charitable donees, file (successfully) with the IRS an application for recognition of the exemption.¹² Thus, by contrast, entities such as social welfare organizations, labor organizations, trade and professional associations, social clubs, and veterans' organizations need not (but may) file an application for recognition of tax-exempt status.¹³

Unlike most requests for a ruling from the IRS (which are commenced by a letter to the IRS), a request for recognition of tax exemption is initiated by filing a form, entitled “Application for Recognition of Exemption.” Charitable organizations file Form 1023; most other organizations file Form 1024.

Subject only to the authority in the IRS to revoke recognition of exemption for good cause (such as a change in the law), an organization that has been recognized by the IRS as being tax-exempt can rely on the determination as long as there are no substantial changes in its character, purposes, or methods of operation.¹⁴ Should material changes occur, the organization should notify the IRS by means of an annual information return and may have to obtain a reevaluation of its exempt status.

(b) Application Procedure

A ruling or determination letter may be issued by the IRS to a charitable fundraising organization in response to the filing of an application for recognition of its tax-exempt status. Two procedures are available in this regard.

Pursuant to the general approach, an organization seeking recognition of exemption electronically files an application (Form 1023) with the IRS Service Center in Cincinnati, Ohio.¹⁵ Usually the determination as to eligibility for exemption will be made at that level. If the application presents a matter of some controversy or an unresolved or novel point of law, however, technical advice from the IRS's Office of Associate Chief Counsel may be necessary.

Another approach entails the filing of a streamlined application for recognition of exemption (Form 1023).¹⁶ This application, the Form 1023-EZ, is available with respect to charitable organizations with gross receipts of no more than $50,000 and assets of no more than $250,000; moreover, this approach is unavailable in the case of more than 30 categories of public charities.¹⁷ Consequently, the streamlined application will be of little utility in the fundraising context.

This application process involving the filing of Form 1023 requires the organization to reveal some information about its fundraising program.

A ruling or determination will be issued to an organization, as long as the application and supporting documents establish that it meets the particular statutory requirements. The application must include a statement describing the organization's purposes, copies of its governing instruments (such as, in the case of a corporation, its articles of incorporation and bylaws), and either a financial statement or a proposed multiyear budget.

The application filed by a charitable organization must also include a summary of the sources of its financial support, its fundraising program, the composition of its governing body (usually a board of directors), its relationship with other organizations (if any), the nature of its services or products and the basis for any charges for them, and its membership (if any).

An application for recognition of exemption should be regarded as an important legal document and prepared accordingly. Throughout an organization's existence, it will likely be called on to provide its application for recognition of exemption to others for review. Indeed, a nonprofit organization is required by federal law to keep a copy of this application available for scrutiny or retention by anyone during regular business hours.¹⁸

(c) The Application

The core application for recognition of tax exemption filed by charitable organizations (Form 1023), amounting to 18 pages, is accompanied by instructions.¹⁹ Some of the information requested by this application expressly pertains to charitable fundraising.

This application for recognition of exemption filed by organizations seeking charitable status must be filed electronically. The law change concerning electronic filing occasioned modification of the application, in part by embedding narrative responses to questions in the application itself, eliminating the need (and opportunity) for exhibits and copies of documents. Revisions were made to the flow of the application, with many sets of questions reworked and/or expanded.

The core Form 1023 is divided into 10 parts. Part I seeks basic information about the applicant. Most of the questions are clear and the answers obvious. Note, however, that the application seeks the organization's website address (question 8). This is important because the IRS reviewer will likely visit the site, looking for inconsistencies between the content of the application and on the site, and for material on the site that is not in the application. The organization's trustees, directors, and/or officers are listed in this part (question 9).

A lawyer or other tax professional is not needed in connection with this filing. If an advisor is involved, a power of attorney (IRS Form 2848) must be filed on his or her behalf.

Part II focuses on the applicant organization's form. The application states that if the applicant is not a corporation, a trust, an unincorporated association, or a limited liability company, it cannot be tax-exempt. This part also inquires about bylaws (question 4) and asks whether the applicant is a successor to another organization (question 5). Concerning the latter, the IRS is taking a hardline (and incorrect) stance in this setting where the predecessor entity is or was a for-profit company.²⁰

Part III address application of the organizational test.²¹ There, the applicant organization is expected to provide citations, in its articles of organization, to its statement of purposes and its dissolution clause.

Part IV references the required narrative of the applicant organization's past, present, and planned activities (question 1). This is the single most important aspect of the application. As to each activity, the following questions are to be answered: what is the activity, who conducts the activity, where is the activity conducted, what percentage of the applicant's total time is allocated to the activity, how is the activity funded and what percentage of overall expenses is allocated to the activity, and how does the activity further the applicant's exempt purposes?

Part IV also asks the organization to enter the National Taxonomy of Exempt Entities code that best describes its activities (question 2). These codes are found in Appendix D to the instructions for the application.

Part IV further includes several questions about the applicant's activities. The IRS asks about attempts to influence legislation and political campaign activities (questions 5 and 6).²² One question asks whether any of the organization's programs limit the provision of goods, services, or funds to a specific individual or group of individuals; if the answer is yes, there likely is a private inurement or private benefit problem (question 3).²³ The same is true for the question concerning whether recipients of goods, services, or funds have a family or business relationship with any of the organization's trustees, directors, or officers, or with any of its highest compensated (over $100,000) employees or highest compensated independent contractors (question 4).

Still other questions in this part of the application inquire as to whether the applicant owns or has rights in intellectual property (question 7), provides information about credit counseling or personal finance (question 8), makes distributions to domestic or foreign organizations (questions 9–9i), operates in a foreign country or countries (questions 10–10c), maintains one or more donor-advised funds (question 11), operates a school (question 12), provides hospital or medical care (question 13), provides low-income housing (question 14), or provides educational grants to individuals (question 15).

This part of the application further asks questions about fundraising, which may strike some as odd inasmuch as there is little correlation between eligibility for tax exemption and whether and how the applicant engages in fundraising. If the organization undertakes fundraising, it is required to identify the type or types of fundraising activities (e.g., solicitations by means of a website or mail, foundation grant solicitations, government grant solicitations, or gaming activities) (question 16). A related question asks whether the organization engages in fundraising for other organizations (question 17).

Part V asks pointed questions about the applicant's compensation arrangements with its trustees, directors, officers, key employees, and independent contractors. (An organization's staff devoted to fundraising are employees; outside consultants [individuals or firms] are independent contractors.) Question 1 is straightforward, asking whether or not the applicant engages in the practice(s). If so, the IRS wants to know if the individuals who approve compensation practices follow a conflict-of-interest policy (question 1a) and whether the applicant approves compensation arrangements in advance of paying compensation (question 1b), documents the date and terms of approved compensation arrangements (question 1c), records the decision made by each individual who decided or voted on compensation arrangements (question 1d), has a basis for approving compensation (question 1e), and records the information or practices on which they relied to base compensation decisions and its source (questions 1f and 1g). Private inurement and excess benefits transactions issues²⁴ lurk here.

There is a question about the adoption of a conflict-of-interest policy (question 2, already asked in question 1a); these questions, plus the existence of a prototype policy in the instructions, illustrate the importance this policy has for the IRS. There are questions about nonfixed payments, such as discretionary bonuses or revenue-based payments (question 3);²⁵ the purchase or sale of goods and services among the persons (question 4); and leases, contracts, or loans with these persons or their controlled entities (question 5). The IRS asks whether the applicant contracts with another organization to develop, build, market, or finance its facilities (question 6). The IRS asks whether someone other than the organization's employees or volunteers manages, or will manage, the entity's activities or facilities (question 7). A question pertains to the organization's participation in any joint ventures, such as partnerships or limited liability companies (question 8).

Part VI seeks detailed financial data. The statement of revenues and expenses (Section A), which includes reporting of fundraising expenses (question 14), ranges over five years: the current year and the four prior years or two succeeding years. How this financial data is presented depends on the number of years the organization has been in existence. If the organization has completed less than one year, which is usually the case with these applicants, it must provide financial information for its current year and reasonable and good-faith projections for the ensuing two years.

If the organization has been in existence less than five years, it should complete the financial statement for each year in existence and provide projections of its likely revenues and expenses, based on a reasonable and good-faith estimate of its future finances, for a total of the years of financial information and the other years of projections. If the organization has been in existence for five or more years, it should complete the schedule for the most recent five years. Part IX also includes a balance sheet (Section B).

Part VII concerns the organization's public charity or private foundation status.²⁶ The first question asks the applicant organization to state its public charity status or identify as a private foundation. If the entity is a private foundation, it must provide information about the organizational test that applies to private foundations (question 1a).²⁷ Also, if the entity is a foundation, the applicant must explain whether it is a private operating foundation (question 1b).²⁸

Part VIII relates to the effective date of the determination letter (if favorable). Generally, a determination letter recognizing tax exemption is effective as of the date of the organization's formation if it has filed the application within 27 months of the end of the month in which it was formed.

Part IX of the application pertains to the annual filing requirements. This part asks whether the organization is claiming to be excused from filing an annual information return or notice (such as by being a church, an association of churches, an integrated auxiliary of a church, a mission society, or an affiliate of a governmental unit).²⁹ If it is, the organization must identify the basis for the excusal.

In addition to the core Form 1023, there are eight schedules, which are as follows:

• Schedule A—filed by churches seeking recognition of exemption (as discussed, churches can be tax-exempt without recognition)
• Schedule B—filed by schools, colleges, and universities
• Schedule C—filed by hospitals and medical research organizations
• Schedule D—filed by supporting organizations
• Schedule E—filed by organizations that are not submitting the Form 1023 within 27 months of formation
• Schedule F—filed by organizations providing low-income housing
• Schedule G—filed by successors to organizations
• Schedule H—filed by organizations providing scholarships, fellowships, educational loans, and/or other educational grants to individuals, and by private foundations requesting advance approval of their individual grant procedures

(a) Public Charities in General

Many institutions are automatically exempted from classification as private foundations because of the nature of their exempt function (such as by being churches,⁵² educational institutions,⁵³ hospitals,⁵⁴ medical research organizations,⁵⁵ or agricultural research organizations)⁵⁶ or of the nature of their relationship (a supportive one) to one or more other public charities.⁵⁷ The non–private foundation status of other types of charitable entities, however, is predicated not on the nature of their operations or structure but on the type of their financial support. In this context, fundraising and the federal tax law once again entwine.

(b) Public Support Rules

There are three categories of charitable organizations whose non–private foundation status wholly depends on the type of their financial support. A discussion of each follows.

1. One type of publicly supported organization is that which normally receives a substantial part of its financial support (other than income from an exempt function) from a governmental unit or from contributions from the public.⁵⁸ An organization can achieve public charity status pursuant to these rules in one of two ways: (1) where the total amount of its support normally derived from governmental or public sources, or both, is at least one-third of the total amount normally received, or (2) where a facts-and-circumstances test is met, in which case the total amount of governmental and/or public support normally received by the organization may be as low as 10 percent of its total support normally received. The amount of requisite public support (the numerator of the support fraction) is composed of contributions from an individual, trust, corporation, or other organization but only to the extent that the total amount of the contributions by any person during the computation period does not exceed 2 percent of the charitable organization's total support for the period. This 2 percent limitation does not apply to support received from governmental units or to contributions from certain types of public charities, nor are unusual grants taken into account in computing the applicable percentage. The extent of requisite public support generally is measured over a five-year, floating period.

   For example, one of the elements of the facts-and-circumstances test is the extent to which the organization is attracting public support. This element is satisfied where the organization can demonstrate an active and ongoing fundraising program, as described as follows:

   An organization must be so organized and operated as to attract new and additional public or governmental support on a continuous basis. An organization will be considered to meet this requirement if it maintains a continuous and bona fide program for solicitation of funds from the general public, community, or membership group involved, or if it carries on activities designed to attract support from governmental units or other organizations described in section 170(b)(1)(A)(i) through (vi). In determining whether an organization maintains a continuous and bona fide program for solicitation of funds from the general public or community, consideration will be given to whether the scope of its fundraising activities is reasonable in light of its charitable activities. Consideration will also be given to the fact that an organization may, in its early years of existence, limit the scope of its solicitation to persons deemed most likely to provide seed money in an amount sufficient to enable it to commence its charitable activities and expand its solicitation program.⁵⁹

2. Another type of publicly supported organization is that which normally receives more than one-third of its support in each tax year from any combination of (a) gifts, grants, contributions, or membership fees, and (b) gross receipts from admissions, sales of merchandise, performance of services, or furnishing of facilities in activities related to the organization's tax-exempt functions.⁶⁰ This support must derive from governmental units, certain types of public charities, and persons other than those who have a close relationship with the organization. In computing the amount of support received from gross receipts that is allowable toward the one-third requirement, gross receipts from related activities received from any person or from any bureau or similar agency of a governmental unit are includable in any tax year only to the extent that these receipts do not exceed the greater of $5,000 or 1 percent of the organization's support in that year. The extent of requisite public support generally is measured over a five-year, floating period.⁶¹
3. The third category of charitable organization that predicates its non–private foundation classification on the degree of its public support is the supporting foundation that provides financial assistance to public colleges and universities.⁶² This type of organization must normally receive a substantial part of its support (exclusive of income received in the exercise or performance of its exempt activities) from the United States, one or more states, or political subdivisions thereof, or from direct or indirect contributions from the public. As is the case with the other categories, the extent of requisite public support generally is measured over a five-year, floating period.⁶³

A charitable organization that fails to meet one or more sets of these rules (and that cannot otherwise qualify as a type of public charity) is denominated a private foundation and thus becomes subjected to the complex and restrictive rules applicable only to foundations. These rules prohibit, in effect, self-dealing, large business holdings, and jeopardizing investments; mandate annual distributions for charitable ends and a range of requirements concerning program expenditures; and levy a tax on investment income.⁶⁴ A charitable organization that can do so is well advised to qualify as an entity other than a private foundation.

To so qualify, the organization's non–private foundation status may well depend on the extent of its public support. Thus, unlike most forms of federal and state regulation of fundraising for charity, which inhibit or make more costly the fundraising function, the type of regulation embodied in the private foundation definitional rules often promotes charitable solicitations of the public.

Consequently, the IRS may be monitoring the extent of a charitable organization's fundraising efforts to ascertain whether the organization qualifies as an entity other than a private foundation.

(c) Supporting Organizations

A category of organization that is a public charity is the supporting organization.⁶⁵ A supporting organization must be sufficiently related to one or more qualified supported organizations, which usually are institutions⁶⁶ and/or publicly supported organizations.⁶⁷

A supporting organization must be organized and operated exclusively for the benefit of, to perform the functions of, or to carry out the purposes of one or more qualified supported organizations.⁶⁸ This type of organization must be operated, supervised, or controlled by one or more qualified supported organizations, supervised or controlled in connection with one or more such organizations, or operated in connection with one or more such organizations.⁶⁹ A supporting organization may not be controlled, directly or indirectly, by one or more disqualified persons with respect to the organization (other than foundation managers and supported organizations).⁷⁰

An organization is not considered to be operated in connection with a supported organization (that is, be a Type III supporting organization) unless the organization (1) annually provides to each supported organization sufficient information to ensure that the organization is responsive to the needs or demands of the supported organization(s) and (2) is not operated in connection with any supported organization that is not organized in the United States.⁷¹ An organization is not considered to be operated, supervised, or controlled by a qualified supported organization or operated in connection with a supported organization if the organization accepts a contribution from a person (other than a qualified supported organization) who, directly or indirectly, controls, either alone or with family members or certain controlled entities, the governing body of a supported organization.⁷²

A supporting organization must engage solely in activities that support or benefit one or more supported organizations.⁷³ These activities may include making payments to or for the use of, or providing services or facilities for, individual members of the charitable class benefited by one or more supported charitable organizations. Generally, a supporting organization may, but need not, distribute income to a supported organization.⁷⁴ It may carry on an independent program that supports or benefits one or more supported organizations.⁷⁵ A supporting organization must be organized and operated to support or benefit one or more specified supported organizations, with the manner of the specification being dependent on which type of supporting organization is involved.⁷⁶

A supporting organization is operated in connection with one or more supported organizations (and thus is a Type III entity) only if it satisfies the notification requirement, the responsiveness text, and an integral part test.⁷⁷

An organization is an integral part of a supported organization if it is “significantly involved in the operations of the supported organization and the supported organization is dependent upon the supporting organization for the type of support the supporting organization provides.”⁷⁸ An organization is an integral part of a supported organization only if it satisfies the requirements for functionally integrated Type III supporting organizations or for non–functionally integrated Type III supporting organizations.⁷⁹

A supporting organization meets the responsiveness test if it is “responsive to the needs or demands” of a supported organization.⁸⁰ This test is generally satisfied in one of three ways. Also, the governing body of the supported organization must have a “significant voice” in the supporting organization's operations, such as investment policies and the making of grants.

The integral part test for functionally integrated Type III supporting organizations generally requires that the supporting organization engage in activities substantially all of which directly further the exempt purposes of one or more supported organizations.⁸¹ These are essentially activities that, but for the involvement of the supporting organization, would normally be engaged in by the supported organization. Activities that directly further the exempt purposes of one or more supported organizations do not include fundraising activities.

A supporting organization meets the integral part test as a non–functionally integrated Type III supporting organization in one of two ways. One way to satisfy this test is to meet a distribution requirement and an attentiveness requirement.⁸²

The private foundation excess business holding rules⁸³ are applicable to Type III supporting organizations, other than functionally integrated Type III supporting organizations.⁸⁴ A functionally integrated Type III supporting organization is a Type III supporting organization that is not required by the tax regulations⁸⁵ to make payments to supported organizations.⁸⁶ These excess business holdings rules also apply to a Type II supporting organization if the organization accepts a contribution from a person (other than a public charity, not a supporting organization) who controls, either alone or with family members and/or certain controlled entities, the governing body of a supported organization of the supporting organization.⁸⁷ Nonetheless, the IRS has the authority to not impose the excess business holdings rules on a supporting organization if the organization establishes that the holdings are consistent with the organization's tax-exempt status.⁸⁸

A nonoperating private foundation may not treat as a qualifying distribution⁸⁹ an amount paid to a Type III supporting organization that is not a functionally integrated Type III supporting organization or to any other type of supporting organization if a disqualified person with respect to the foundation directly or indirectly controls the supporting organization or a supported organization of the supporting organization.⁹⁰ An amount that does not count as a qualifying distribution under this rule is regarded as a taxable expenditure.⁹¹

(a) Meaning of Contribution

The federal tax law on the subject of the tax aspects of charitable giving is contained in the Internal Revenue Code and in the interpretations of that body of law found in court opinions, Treasury Department and IRS regulations, and IRS public and private rulings. This body of law is specific on such components of the law of charitable giving as qualification of charitable donees, percentage limitations on a year's deductibility, gifts of particular types of property (such as inventory and works of art), and eligibility of various planned giving vehicles.

Despite the extensive treatment of this aspect of the law, there is an omission in the developed rules concerning charitable giving. That is, the law is scarce on the meaning of the word gift. This is highly significant; obviously, there must be a gift before there can be a charitable gift.

Integral to the concept of the charitable contribution deduction, then, is the fundamental requirement that the cash or property transferred to a charitable donee be transferred pursuant to a transaction that is in fact a gift. Just because cash is paid, or property is transferred, to a charity does not necessarily mean that the payment or transfer is a gift. Consequently, when a university's tuition, a hospital's health care fee, or an association's dues are paid, there is no gift, and thus no charitable deduction for the payment.

There is some law (mostly generated by the federal courts) as to what constitutes a gift. (The Internal Revenue Code and the tax regulations are essentially silent on the subject.) Basically, a gift has two elements: it is a transfer that is voluntary and it is motivated by something other than consideration (namely, something being received in return for a payment). (Where payments are made to receive something in exchange, the transaction is more in the nature of a contract.) The law places more emphasis on the second element than on the first. Thus, the income tax regulations state that a transfer is not a contribution when made “with a reasonable expectation of financial return commensurate with the amount of the donation.”¹⁵³ Instead, this type of a payment is a purchase (of a product or a service). A corollary of this simple rule is that a single transaction can be partially a gift and partially a purchase, and only the gift portion is deductible when a charity is the payee.¹⁵⁴

Decades ago, the U.S. Supreme Court observed that a gift is a transfer motivated by “detached or disinterested generosity.”¹⁵⁵ (This is the factor frequently referred to as donative intent.) One federal court of appeals put the matter more starkly, succinctly observing that this is a “particularly confused issue of federal taxation.”¹⁵⁶ Not content with that summation, the court went on to portray the existing Internal Revenue Code structure on this subject as “cryptic,” and delivered the indictment that “neither Congress nor the courts have offered any very satisfactory definition” of the terms gift and contribution.¹⁵⁷

These concepts have been visited many times. One manifestation has been the availability of a charitable deduction for the transfer of money to a college or university, where the transferor is granted preferential access to good seating at the institution's athletic events. Although the IRS refused to regard these payments as gifts, finding that the payment results in receipt of a “substantial benefit,”¹⁵⁸ Congress enacted a special rule to accommodate these payments for tax purposes.¹⁵⁹ The IRS has struggled with this issue for years (e.g., in the early 1980s, when it was popular for homes to be auctioned, with benefits accruing to a charitable organization); the IRS ruled that those who purchase tickets from a charity are not making gifts. Other recent manifestations of this phenomenon include the various “tax shelter” programs involving gifts of artwork and the use of premiums and other items of property to donors in response to their contributions.

The U.S. Supreme Court's 1989 ruling¹⁶⁰ regarding what constitutes a charitable gift comports precisely with the IRS position, which, for years, has been that when a “donor” receives some benefit or privilege in return for a payment to charity, the payment may not, in whole or in part, constitute a deductible charitable gift.¹⁶¹

The quid pro quo law in the charitable contribution context gained national attention when the Department of the Treasury and the IRS used it to combat the efforts in some states to circumvent the $10,000 cap on the deductibility of state and local taxes¹⁶² by substituting an increased charitable deduction for a disallowed state or local tax deduction. Final regulations were issued providing rules stating the lack of availability of federal income tax charitable contributions deductions when a transfer of money or other property is made pursuant to one of these state and local tax (SALT) cap “workarounds.”¹⁶³ The general rule, under these regulations, is that if a person makes a payment or transfers property to or for the use of a charitable organization, the amount of the person's charitable contribution deduction must be reduced by the amount of any state or local tax credit that the person receives or expects to receive in consideration for the payment or transfer.¹⁶⁴ Nonetheless, a taxpayer may disregard a state or local tax credit if the credit does not exceed 15 percent of the taxpayer's payment or 15 percent of the fair market value of the property transferred by the taxpayer.¹⁶⁵ Treasury and the IRS stated, in the preamble to the proposed regulations, that “[c]ompelling policy considerations” mandate these rules, in that “[d]isregarding the value of all state tax benefits received or expected to be received in return for charitable contributions would precipitate revenue losses that would undermine and be inconsistent with the limitation on the deduction for state and local taxes adopted by Congress.”

(b) Qualified Donees

Qualified donees are charitable organizations (including educational, religious, and scientific entities),¹⁶⁶ certain fraternal organizations, most veterans' organizations, governmental entities, and certain cemetery companies.¹⁶⁷ Regarding charitable organizations, contributions to both private and public charities are deductible, although the law favors gifts to the latter.¹⁶⁸

Federal, state, and local governmental bodies are, under the tax law, charitable donees. Other laws may, however, preclude a governmental entity from accepting charitable gifts. In many instances, a charitable organization can be established to solicit deductible contributions for and make grants to governmental bodies. This is a common technique for public schools, colleges, universities, and hospitals.¹⁶⁹

In some instances, an otherwise nonqualifying organization may be the recipient of a deductible charitable gift, where the gift property is used for charitable purposes or received as agent for a charitable organization. An example of the former is a gift to a trade association that is earmarked for a charitable fund within the association.¹⁷⁰ An example of the latter is an additional amount paid by customers of a utility company, when paying their bills to the company, where the additional amounts are earmarked for a charitable organization that assists individuals with emergency energy-related needs.¹⁷¹

(c) Gift Properties

Aside from the eligibility of the gift recipient, the other basic element in determining whether a charitable contribution is deductible is the nature of the property given. Basically, the distinctions are between outright giving and planned giving, and between gifts of cash and gifts of property. In many instances, the tax law of charitable giving differentiates between personal property and real property, and between tangible property and intangible property (the latter being stocks and bonds). Often, the value of a qualified charitable contribution of an item of property is its fair market value.

The federal income tax treatment of gifts of property depends on whether the property is capital gain property. The tax law makes a distinction between long-term capital gain and short-term capital gain (although generally this net gain of either type is taxed as ordinary income). Property that is neither long-term capital gain property nor short-term capital gain property is ordinary income property. Short-term capital gain property is generally treated the same as ordinary income property. These terms are based on the tax classification of the type of revenue that would be generated on sale of the property. In general, therefore, the operative distinction is between capital gain property (actually long-term capital gain property) and ordinary income property.

Capital gain property is property that is a capital asset, has appreciated in value, and if sold, would create long-term capital gain.¹⁷² To result in long-term capital gain, property generally must be held for the long-term capital gain holding period, which is 12 months. Most forms of capital gain property are stocks, bonds, and real estate.

The charitable deduction for capital gain property is often equal to the fair market value of the property or at least is computed using that value. Gifts of ordinary income property generally produce a deduction equivalent to the donor's basis in the property. The law provides exceptions to the basis-only rule, such as in the instance of gifts by a corporation out of its inventory.¹⁷³

(d) Percentage Limitations

The deductibility of charitable contributions for a particular tax year is confined by certain percentage limitations, which, in the case of individuals, are a function of the donor's contribution base. An individual's contribution base is essentially their adjusted gross income.¹⁷⁴ There are seven of these percentage limitations. Again, the limitations depend on several factors—principally, the nature of the charitable recipient and the nature of the property donated. The examples in this section assume an individual donor (“Donor”) with a contribution base (adjusted gross income) each year in the amount of $100,000.

First, an individual's charitable contributions made during a tax year to one or more public charities, where the gifts are of money, are deductible to the extent that the contributions in the aggregate do not exceed 60 percent of the individual's contribution base for the tax year.¹⁷⁵ The report of the House Committee on Ways and Means that accompanied this temporary limitation states that a “robust charitable sector is vital to our economy, and that charitable giving is critical to ensuring that the sector survives,” adding that it is “desirable to provide additional incentives for taxpayers to provide monetary and volunteer support to charities.”¹⁷⁶ This increased limitation may not be quite so potent, however, inasmuch as it is “unavailable in many cases, in particular when donors are making gifts to both public charities and private foundations, or gifts of both cash and noncash items, such as stock, land or art.”¹⁷⁷ Thus, a donor could, in a tax year (after 2017), make up to $60,000 in deductible charitable gifts of cash.

Second, there is a percentage limitation of 50 percent of a donor's contribution base for contributions of cash and ordinary income property to public charities and private operating foundations.¹⁷⁸ Thus, Donor may, in any one year, make deductible gifts of cash to public charities up to a total of $50,000. Where an individual makes a contribution or contributions to one or more public charities (or operating foundations) to the extent that the 50 percent limitation is exceeded, the excess generally may be carried forward and deducted in one or more (up to five) subsequent years.¹⁷⁹ Thus, if Donor gave $60,000 to public charities in year one (and made no other charitable gifts), they would be entitled to a deduction of $50,000 in year one and $10, 000 in year two.

Another percentage limitation is 30 percent of contribution base for gifts of capital gain property to public charities and private operating foundations.¹⁸⁰ Thus, a donor may, in any one year, contribute up to $30,000 in qualifying stocks, bonds, real estate, and similar property to one or more public charities and enjoy a charitable deduction for that amount (assuming no other charitable gifts that year). Any excess is subject to the carryforward rule described earlier.¹⁸¹ Thus, if Donor gave $50,000 in capital gain property to public charities in year one (and made no other charitable gifts that year), they would be entitled to a charitable contribution deduction of $30,000 in year one and $20,000 in year two.

A donor who makes gifts of cash and capital gain property to public charities (and/or private operating foundations) in any one year generally must use a blend of these percentage limitations.¹⁸² For example, if Donor in year one gives $50,000 in cash and $30,000 in appreciated capital gain property to a public charity, his or her charitable deduction in year one consists of the $30,000 of capital gain property and $20,000 of cash (thereby capping the deduction with the overall 50 percent ceiling); the other $30,000 of cash is carried forward for deductibility (depending on Donor's other circumstances) in year two.

A donor of capital gain property to public charities and/or private operating foundations may use the 50 percent limitation, instead of the 30 percent limitation, where the amount of the contribution is reduced by all of the unrealized appreciation in the value of the property.¹⁸³ This election, which is irrevocable,¹⁸⁴ is usually made in situations where the donor wants a larger deduction in the year of the gift and the property has not appreciated in value to a great extent.

The fifth and sixth percentage limitations apply with respect to gifts to private foundations and certain other charitable donees (other than public charities and private operating foundations). These “other charitable donees” are generally veterans' and fraternal organizations. For contributions of cash and ordinary income property to private foundations and these other entities, the deduction may not exceed 30 percent of the individual donor's contribution base.¹⁸⁵ The carryover rules apply to this type of gift. Thus, if Donor gives $50,000 in cash to one or more private foundations in year one, their charitable deduction for that year (assuming no other charitable gifts) is $30,000, with the balance of $20,000 carried forward for potential deductibility in subsequent years.

These rules also blend with the percentage limitations applicable with respect to gifts to public charities. For example, if in year one Donor gave $65,000 to charity, of which $25,000 went to a public charity and $40,000 to a private foundation, their charitable deduction for that year would be $50,000, consisting of $30,000 of the gift to the private foundation and $20,000 of the gift to the public charity; the remaining $10,000 of the gift to the foundation and the remaining $5,000 of the gift to the public charity would be carried forward and made available for deductibility in year two.

The sixth percentage limitation is 20 percent of contribution base in the case of gifts of capital gain property to private foundations and other charitable donees (other than public charities and private operating foundations).¹⁸⁶ There is a carryforward for any excess deduction in the case of these gifts.¹⁸⁷ For example, if Donor gives appreciated securities, having a value of $30,000, to a private foundation in year one, their charitable deduction for year one (assuming no other charitable gifts) is $20,000; the remaining $10,000 would never be deductible. To avoid this situation, Donor would contribute $20,000 of the securities in year one and postpone the gift of the remaining $10,000 in securities until year two. Or, if the value of the stock may substantially decline and an immediate charitable deduction is of prime concern, Donor could, in year one, donate $20,000 of the securities to the private foundation and donate $10,000 of the securities to a public charity.

The 30 percent contribution base limitation on contributions of capital gain property by individuals is inapplicable to qualified conservation contributions. Rather, individuals may deduct the fair market value of any qualified conservation contribution to a public charity to the extent of the excess of 50 percent of the contribution base over the amount of all other allowable charitable contributions.¹⁸⁸ These contributions are not taken into account in determining the amount of other allowable charitable contributions.¹⁸⁹ Individuals are allowed to carry over any qualified conservation contributions that exceed the 50 percent limitation for up to 15 years.¹⁹⁰ In the case of an individual who is a qualified farmer or rancher for the tax year in which a contribution is made, a qualified conservation contribution deduction is allowable up to 100 percent of the excess of the individual's contribution base over the amount of all other allowable charitable contributions (the seventh of these limitations).¹⁹¹

Deductible charitable contributions by corporations in any tax year may not exceed 10 percent of pretax net income.¹⁹² Excess amounts may be carried forward and deducted in subsequent years (up to five years).¹⁹³ For gifts by corporations, the federal tax laws do not differentiate between gifts to public charities and private foundations. As an illustration, a corporation that grosses $1 million in a year and incurs $900,000 in expenses in that year (not including charitable gifts) may generally contribute to charity and deduct in that year an amount up to $10,000 (10 percent of $100,000); in computing its taxes, this corporation would report taxable income of $90,000. If the corporation instead gave $20,000 in that year, the foregoing numbers would stay the same, except that the corporation would have a $10,000 charitable contribution carryforward.

In the case of a corporation (the stock of which is not publicly traded) that is a qualified farmer or rancher for the tax year in which the contribution is made, a qualified conservation contribution is allowable up to 100 percent of the excess of the corporation's taxable income over the amount of all other allowable charitable contributions.¹⁹⁴ Any excess may be carried forward for up to 15 years as a contribution subject to the 100 percent limitation.¹⁹⁵

A corporation on the accrual method of accounting can elect to treat a contribution as having been paid in a tax year if it is actually paid during the first 2½ months of the following year.¹⁹⁶ Corporate gifts of property are generally subject to the deduction reduction rules discussed as follows.

(e) Deduction Reduction Law

A donor (individual or corporate) that makes a gift of ordinary income property to any charity (public or private) must confine the charitable deduction to the amount of the cost basis of the property.¹⁹⁷ That is, the deduction is not based on the fair market value of the property; it must be reduced by the amount that would, if sold, have been gain (ordinary income). As an example, if Donor gave to a charity an item of ordinary income property having a value of $1,000 for which they paid $600, the charitable deduction would be $600.

Any donor who makes a gift of capital gain property to a public charity generally can, as noted previously, compute the charitable deduction using the property's fair market value at the time of the gift, irrespective of basis and with no taxation of the appreciation (the capital gain inherent in the property). When a charitable gift of tangible personal property is made, the amount of the charitable deduction that would otherwise be determined must be reduced by the amount of gain that would have been long-term capital gain if the property contributed had been sold by the donor at its fair market value, determined at the time of the contribution, when (1) the use by the charitable donee is unrelated to the donee's tax-exempt purpose¹⁹⁸ or, when the donee is a governmental unit, if the use to which the contributed property is put is for a purpose other than an exclusively public purpose,¹⁹⁹ or (2) the property is applicable property that is sold, exchanged, or otherwise disposed of by the donee before the last day of the tax year in which the contribution was made and with respect to which the donee has not made the requisite certification.²⁰⁰

The tax benefit arising from a charitable contribution of tangible personal property, with respect to which a fair market value deduction was claimed and that is not used for charitable purposes, must, in general, be recovered. This recapture rule applies to applicable property, which is tangible personal property that has appreciated in value and that has been identified by the donee organization as for a use related to the donee's tax-exempt purpose or function and for which a charitable deduction of more than $5,000 has been claimed.²⁰¹

If a donee organization disposes of applicable property within three years of the contribution of the property (termed an applicable disposition),²⁰² the donor is subject to an adjustment of the donor's tax benefit. If the disposition occurs in the tax year of the donor in which the contribution was made, the donor's deduction generally is confined to the donor's basis in and not the fair market value of the property. If the disposition occurs in a subsequent year, the donor must include as ordinary income for the donor's tax in which the disposition occurs an amount equal to the excess (if any) of (1) the amount of the deduction previously claimed by the donor as a charitable contribution with respect to the property, over (2) the donor's basis in the property at the time of the contribution.²⁰³

An adjustment of this tax benefit is not required, however, if the donee organization certifies to the IRS, by written statement signed under penalties of perjury by an officer of the organization, that (1) the use of the property by the donee was related to the purpose or function constituting the basis for the donee's tax exemption, and describes how the property was used and how the use furthered the exempt purpose or function, or (2) the intended use of the property by the donee at the time of the contribution (as described) became impossible or infeasible to implement.²⁰⁴ The charitable organization must provide the donor with a copy of this certification.

A penalty of $10,000 may be imposed on a person who identifies applicable property as having a use that is related to a purpose or function constituting the basis for the donee's tax exemption, knowing that the property is not intended for such a use.²⁰⁵

Generally, a donor who makes a gift of capital gain property to a private foundation must reduce the amount of the otherwise allowable deduction by all of the appreciation element in the gift property.²⁰⁶ An individual is, however, allowed full fair market value for a contribution to a private foundation of certain publicly traded stock.²⁰⁷

A donor who makes a gift of a type of intellectual property to a charitable organization must confine the initial resulting charitable contribution deduction to the donor's basis in the property.²⁰⁸ This rule is applicable to a charitable contribution of a patent, copyright,²⁰⁹ trademark, trade name, trade secret, know-how, software,²¹⁰ or similar property, or applications or registrations of such property.

(f) Twice-Basis Deductions

As a general rule, when a corporation makes a charitable gift of property from its inventory, the resulting charitable deduction is confined to an amount equal to the donor's basis in the donated property. In most instances, this basis amount is rather small, being equal to the cost of producing the property. Under certain circumstances, however, corporate donors can receive a greater charitable deduction for gifts out of their inventory. Where the tests are satisfied, the deduction can be equal to cost basis, plus one-half of the appreciated value of the property.²¹¹ Nonetheless, this charitable deduction may not, in any event, exceed an amount equal to twice the property's cost basis.

Five requirements have to be met for this twice-basis charitable deduction to be available: (1) the donated property must be used by the charitable donee for a related use; (2) the donated property must be used solely for the care of the ill, the needy, or infants; (3) the property may not be transferred by the donee in exchange for money, other property, or services; (4) the donor must receive a written statement from the donee representing that the use and disposition of the donated property will be in conformance with these rules; and (5) where the donated property is subject to regulation under the Federal Food, Drug, and Cosmetic Act, the property must fully satisfy the applicable requirements of that statute on the date of transfer and for 180 days prior thereto.

Also, for these rules to apply, the donee must be a public charity; that is, it cannot be a private foundation, including a private operating foundation. Further, an “S corporation”—the tax status of many small businesses—cannot utilize these rules.

A similar rule applies with respect to contributions of scientific property used for research,²¹² and contributions of computer technology and equipment for educational purposes.²¹³

(g) Partial Interest Contributions

Most charitable gifts are of the totality of the donor's interests in property; that is, by giving, the donor parts with all right, title, and interest in the property. But a deductible gift may be made in the form of a contribution of less than a donor's entire interest in the property. This is termed a gift of a partial interest.

As a general rule, charitable deductions for gifts of partial interests in property, including the right to use property, are denied.²¹⁴ But, there are important exceptions, namely, gifts made in trust form (using a split-interest trust);²¹⁵ gifts of an outright remainder interest in a personal residence or farm;²¹⁶ gifts of an undivided portion of one's entire interest in a property;²¹⁷ and a remainder interest in real property that is granted to a public charity exclusively for conservation purposes.²¹⁸

Contributions of income interests in property in trust are basically confined to the use of charitable lead trusts.²¹⁹ Aside from the charitable gift annuity and the above-described gifts of remainder interests, there is no charitable deduction for a contribution of a remainder interest in property unless it is in trust and is one of three types: a charitable remainder annuity trust, a charitable remainder unitrust, or a pooled income fund.²²⁰

Defective charitable split-interest trusts may be reformed to preserve the charitable deduction where certain requirements are satisfied.²²¹

(h) Contributions of Certain Fractional Interests

The value of a donor's charitable contribution deduction for the initial contribution of a fractional interest in an item of tangible personal property (or collection of such items)²²² is determined, in part, on the fair market value of the property at the time of the contribution of the fractional interest²²³ and whether the use of the property will be related to the charitable donee's exempt purposes.²²⁴

Additional rules apply, however, in instances of gifts of fractional interests to charitable organizations after August 17, 2006.²²⁵ For example, for purposes of determining the deductible amount of each additional contribution²²⁶ of an interest (whether or not a fractional interest) in the same item of property, the fair market value of the item is the lesser of (1) the value used for purposes of determining the charitable deduction for the initial fractional contribution²²⁷ or (2) the fair market value of the item at the time of the subsequent contribution.²²⁸

Recapture of this income tax charitable deduction can occur in two circumstances. First, if a donor makes an initial fractional contribution and thereafter fails to contribute all of the donor's remaining interest in the property to the same charitable donee before the earlier of 10 years from the initial fractional contribution or the donor's death, the donor's charitable deduction(s) for all previous contribution(s) of interests in the item must be recaptured, plus interest.²²⁹ If the donee of the initial contribution is no longer in existence as of that time, the donor's remaining interest may be contributed to another charitable entity.

Second, if the charitable donee of a fractional interest in an item of tangible personal property fails to take substantial physical possession of the item during the above-described period or fails to use the property for an exempt use during the above-described period, the donor's charitable income tax deduction(s) for all previous contribution(s) of interests in the item must be recaptured, plus interest.²³⁰ In either of these circumstances, where there is a recapture, an additional tax is imposed in an amount equal to 10 percent of the amount recaptured.²³¹ An income tax charitable contribution deduction is not allowed for a contribution of a fractional interest in an item of tangible personal property unless, immediately before the contribution, all interests in the item are owned by the donor or by the donor and the donee charitable organization.²³² The IRS is authorized to make exceptions to this rule in cases where all persons who hold an interest in an item make proportional contributions of undivided interests in their respective shares of each item to the donee organization.²³³

(i) Contributions of Intellectual Property

Legislation enacted in 2004 added certain properties to the list of types of gifts that give rise to a charitable contribution deduction that is confined to the donor's basis in the property,²³⁴ although in this instance there may be one or more subsequent charitable deductions. This property consists of patents, copyrights (with exceptions), trademarks, trade names, trade secrets, know-how, software (with exceptions), or similar property, or applications or registrations of such property.²³⁵ Collectively, for purposes of rules concerning the deductibility of gifts of this type of property, these properties are termed qualified intellectual property.²³⁶

A person who makes a gift of this nature that is in compliance with these rules—termed a qualified intellectual property contribution²³⁷—is provided a charitable contribution deduction (subject to the annual percentage limitations)²³⁸ equal to a percentage of net income (if any) that flows to the charitable donee as the consequence of the gift of the property.²³⁹ This income is termed qualified donee income.²⁴⁰

Thus, a portion of qualified donee income is allocated to a tax year of the donor,²⁴¹ although this income allocation process is inapplicable to income received or accrued to the donee after 10 years from the date of the gift,²⁴² and the process is inapplicable to donee income received after the expiration of the legal life of the property.²⁴³

The qualified donee income that subsequently materializes (or may materialize) into a charitable deduction is determined by the applicable percentage, which is a sliding-scale percentage determined by the following table, which appears in the Internal Revenue Code:²⁴⁴

Thus, if, following a qualified intellectual property contribution, the charitable donee receives qualified donee income in the year of and/or following the gift, a percentage of that amount becomes a charitable contribution deduction (subject to the general limitations). If, for example, such income is received by the charitable donee 8 years after the gift, the donor receives a charitable deduction equal to 40 percent of the qualified donee income. As this table indicates, the opportunity for a qualified intellectual property deduction arising out of a qualified intellectual property contribution terminates after 12 years from the date of the gift.²⁴⁵

The reporting requirements rules, concerning certain dispositions of contributed property,²⁴⁶ encompass qualified intellectual property contributions. A donee of such a contribution is required to make a return, with respect to each applicable tax year of the donee, showing (1) the name, address, and tax identification number of the donor; (2) a description of the intellectual property contributed; (3) the date of the contribution; and (4) the amount of net income of the donee for the tax year that is properly allocable to the qualified intellectual property. A copy of this return must be timely furnished to the donor.

The IRS is authorized to issue antiabuse rules that may be necessary to prevent avoidance of this new body of law, including preventing (1) the circumvention of the reduction of the charitable deduction by embedding or bundling the patent or similar property as part of a charitable contribution of property that includes the patent or similar property; (2) the manipulation of the basis of the property to increase the amount of the initial charitable deduction through use of related persons, pass-through entities, or other intermediaries, or through the use of any provision of law or regulation (including the consolidated return regulations); and (3) a donor from changing the form of the patent or similar property to property of a form for which different deduction rules would apply.²⁴⁷

The IRS subsequently issued guidance concerning qualified intellectual property contributions, with emphasis on the notification requirements imposed on donors.²⁴⁸

(j) Contributions of Vehicles

Legislation enacted in 2004 added substantiation rules for contributions of motor vehicles, boats, and airplanes—collectively termed qualified vehicles.²⁴⁹ These rules supplant, in cases of contributions of qualified vehicles, the general gift substantiation rules²⁵⁰ where the claimed value of the gift exceeds $500.

Pursuant to these rules, a federal income tax charitable contribution deduction is not allowed unless the donor substantiates the contribution by a contemporaneous written acknowledgment of the contribution by the donee organization and includes the acknowledgment with the donor's income tax return reflecting the deduction.²⁵¹

The amount of the charitable deduction for a gift of a qualified vehicle depends on the nature of the use of the vehicle by the donee organization. If the charitable organization sells the vehicle without any “significant intervening use or material improvement” of the vehicle by the organization, the amount of the charitable deduction may not exceed the gross proceeds received from the sale.²⁵²

The acknowledgment must contain the name and taxpayer identification number of the donor and the vehicle identification number or similar number.²⁵³ If the gift is of a qualified vehicle that was sold by the charity without such use or improvement, the acknowledgment must also contain:

• A certification that the vehicle was sold in an arm's-length transaction between unrelated parties.
• A statement as to the gross proceeds from the sale.
• A statement that the deductible amount may not exceed the amount of the gross proceeds.²⁵⁴

If there is such use or improvement, the acknowledgment must include:

• A certification as to the intended use or material improvement of the vehicle and the intended duration of the use.
• A certification that the vehicle will not be transferred in exchange for money, other property, or services before completion of the use or improvement.²⁵⁵

The IRS is authorized to issue regulations or other guidance that exempts sales of vehicles that are in direct furtherance of the donee's charitable purposes from the requirement that the charitable deduction be confined to the amount equal to the gross proceeds from the sale and the requirement that the donee issue the certification.²⁵⁶ This guidance may be appropriate, for example, if a charitable organization directly furthers its charitable purposes by selling automobiles to needy individuals at a price significantly below fair market value.²⁵⁷

It is congressional intent that the IRS is to strictly construe the terms significant use and material improvement. To meet the significant use test, an organization must actually use the vehicle to substantially further the organization's regularly conducted activities, and the use must be significant. A donee will not be considered to significantly use a qualified vehicle if, under the facts and circumstances, the use is incidental or not intended at the time of the contribution. Whether a use is significant also is dependent on the frequency and duration of use. With respect to the material improvement test, a material improvement includes major repairs to a vehicle in a manner that significantly increases the vehicle's value. Cleaning the title, minor repairs, and routine maintenance do not constitute a material improvement.²⁵⁸

As an illustration of the significant use rule, as part of its regularly conducted activities, a charitable organization delivers meals to needy individuals. The use requirement is met if the organization actually used a donated qualified vehicle to deliver food to the needy. Use of the vehicle to deliver meals substantially furthers a regularly conducted activity of the organization. The use must also be significant, however; this element depends on the nature, extent, and frequency of the use. If this organization used the vehicle only once or a few times to deliver meals, the use would not be considered significant. By contrast, if the organization used the vehicle to deliver meals every day for one year, the use would be considered significant. If the organization drove the vehicle 10,000 miles while delivering meals, such use would likely be considered significant. Use of a vehicle in this type of activity for one week or for several hundreds of miles generally would not be considered a significant use.²⁵⁹

There is a penalty for the furnishing of a false or fraudulent acknowledgment, or an untimely or incomplete acknowledgment, by a charitable donee to a donor of a qualified vehicle.²⁶⁰ If the vehicle is sold without any significant intervening use or material improvement by the donee, the penalty is the greater of (1) the product of the highest rate of income tax and the sales price stated in the acknowledgment or (2) the gross proceeds from the sale of the vehicle. In the case of an acknowledgment pertaining to any other qualified vehicle, the penalty is (1) the product of the highest rate of income tax and the claimed value of the vehicle or (2) $5,000.

The IRS subsequently issued interim guidance concerning the rules for deductible charitable contributions of qualified vehicles.²⁶¹ One feature of this guidance is the addition of a third exception, which is for circumstances where the charity gives or sells the vehicle at a significantly below-market price to a needy individual, as long as the transfer furthers the charitable purpose of helping a poor individual who is in need of transportation.

This guidance explains how to determine the fair market value of a vehicle. Distinctions are made among trade-in, private-party, and dealer retail prices. For charitable deduction purposes, the fair market value can be no higher than the private-party price. The guidance also explains the requirements for the content²⁶² and the due dates for the acknowledgments. The IRS solicited comments concerning this notice and suggestions for future guidance as to these rules. In particular, comments are being requested on which markets are appropriate for measuring the fair market value of vehicles and for determining whether a sale was at a price significantly below fair market value.²⁶³

(k) Noncharitable Donees

Fundraisers commonly focus on the solicitation of contributions for charitable organizations.²⁶⁴ Occasionally, however, contributions are made to tax-exempt noncharitable organizations, most likely social welfare organizations,²⁶⁵ business leagues,²⁶⁶ or social clubs.²⁶⁷ The emphasis of the federal tax law on charitable giving tends to be on the income tax deduction; charitable gifts by living individuals also qualify for the federal gift tax deduction,²⁶⁸ although this latter element of the tax law is usually given little consideration. Donors and fundraisers generally understand that contributions to exempt noncharitable organizations do not yield a federal income tax charitable contribution deduction; in this context, the federal gift tax rules tend to be overlooked. This can be problematic because of the prospect of taxable gifts.²⁶⁹

Thus, there generally is no federal gift tax deduction or exclusion available in an instance of a gift tax–exempt noncharitable organization. Usually, however, the per-donee annual exclusion can be utilized;²⁷⁰ currently this exclusion is for gifts not exceeding $13,000. Consequently, caution must be exercised in a circumstance where a gift is made to an exempt noncharitable organization that is in excess of the per-donee exclusion.²⁷¹

(a) Special Events

Special events (or benefit events) are social occasions that use ticket sales and underwriting to generate revenue. These events are typically the most expensive and least profitable method of charitable fundraising. Nonetheless, they have a great value in public relations visibility, both for the charitable organization involved and for its volunteers.²⁷²

Examples of these special events include annual balls, auctions, bake sales, car washes, dinners, fairs and festivals, games of chance (such as bingo, raffles, and sweepstakes), luncheons, sports tournaments (particularly golf and tennis), and theater outings.

There is some confusion in the law as to exactly what a special event, in the charitable fundraising context, is. For instance, one court defined a fundraising event as a “single occurrence that may occur on limited occasions during a given year and its purpose is to further the exempt activities of the organization.”²⁷³ These events were contrasted with activities that “are continuous or continual activities which are certainly more pervasive a part of the organization than a sporadic event and [that are] … an end in themselves.”²⁷⁴ A wide variety of fundraising methods, other than special events, however, are “continuous” and “pervasive.” Moreover, the purpose of special events is rarely to “further the exempt activities of the organization”; these events usually have no relationship to a charitable organization's exempt purposes and activities, and are engaged in largely to generate some funds and favorable publicity which, in turn, help the organization advance its tax-exempt activities. Finally, a fundraising activity is rarely an end in itself, yet many charitable organizations and institutions have major, ongoing fundraising and development programs that are permanent fixtures among the totality of the organizations' functions.

It has been the view of the IRS for years that charitable organizations that conduct special events have the obligation to notify the participants in these events of the amount (if any) expended for their participation in the event that is deductible as a charitable gift.²⁷⁵ Also, legislation requires charitable organizations to make a good-faith estimate of the value of benefits, services, and/or privileges provided to a donor as the consequence of a gift, and to notify the donor that only an amount in excess of that value is deductible.²⁷⁶

(b) Donor Recognition Programs in General

(a) Introduction

Rates for all classes of mail are determined in rate cases, which are public proceedings administered by the Postal Rate Commission. The mandate for the USPS is to recover all its operating costs from the rates it charges. The rate-making consists of assigning USPS's projected costs in two categories to each class of mail; combining the categories yields the rate. The categories are (1) attributable costs, which are costs that are directly measurable and traceable to a particular class of mail (such as nonprofit mailings), and (2) institutional costs, which are the overhead costs of the USPS, recovered by being assigned to each class in the form of a markup, stated as a percentage of the attributable cost.

The preferred rate for nonprofit organizations has existed because Congress, in 1970,³⁰² had undertaken to give the USPS an annual appropriation (revenue forgone) in lieu of the markup that nonprofit organizations would otherwise pay. That is, nonprofit organizations paid the attributable cost portion only (which became the nonprofit rate) and the federal government absorbed the institutional costs.

Throughout the 1980s, a steady increase in the volume of mail sent by nonprofit organizations helped increase the need for revenue forgone; this was true for all postal rate classes, which reached nearly $1 billion for the government's fiscal year 1995. Congress became reluctant to appropriate the funds necessary to support the revenue forgone subsidy. Absent full funding, the USPS was authorized to raise the nonprofit postal rates.

In the intervening years, nonprofit organizations faced ongoing uncertainty as to the levels of the postal rates. There have been increases from rate cases (at approximately three-year intervals) and struggles with Congress over appropriations to avoid annual increases in the nonprofit rates. Congress threatened changes to the eligibility rules; indeed, it has enacted two of them since 1990. By 1992, all involved were anxious for a solution: Congress and the USPS did not want any more pressure from the nonprofit community about the revenue forgone amounts. Commercial mailers using the third-class rates were fearful that they would be required to assume the burden of rate increases. Nonprofit organizations were wary of these uncertainties and were concerned about the prospects of a severe increase in the applicable postal rates.

Compromise legislation was enacted in 1993: the Revenue Forgone Reform Act of 1993.³⁰³ This measure eliminated revenue forgone and ensured continued preferred rates by establishing a favorable markup for nonprofit organizations. For fiscal 1994 and thereafter, the markup for each class of nonprofit rates was set at one-half of the comparable commercial markup amount. This legislation provided a phasing-in schedule to cushion nonprofit organizations from the effects of the new system. This schedule produces annual increases in the range of 2–3 percent (unless or until the intervention of a Postal Regulatory Commission rate case).

Today, the special rate for nonprofit organizations is termed, by the USPS, the nonprofit standard mail rate. This rate provides authorized organizations an opportunity to realize significant savings in postage compared with that charged at the regular standard mail bulk rates.

On April 25, 2012, the Senate approved the 21st Century Postal Service Act,³⁰⁴ designed to ensure the future of the USPS for millions of American people and businesses. This legislation passed on a bipartisan vote of 62–37. The four Senate coauthors of the legislation hailed the action as a strong effort to put the USPS back on solid financial footing. With the approval of this legislation, some have predicted that discounts for nonprofit mail could likely be phased out. The Alliance of Nonprofit Mailers has claimed that a provision of the bill, which would gradually raise postage rates for nonprofit mailers, would be removed from the legislation when the House considers this legislation.³⁰⁵

(b) Qualifying Organizations

The nonprofit standard mail rates are available for qualified nonprofit organizations. A qualifying organization must have a primary purpose relating to at least one of the following categories: religious, educational, scientific, philanthropic (charitable), agricultural, labor, veterans', and/or fraternal ends.³⁰⁶ This purpose must be reflected in the manner in which the organization is both organized and operated. Organizations that occasionally or incidentally engage in qualifying activities are not eligible for the special mailing rates.³⁰⁷

(c) Nonqualifying Organizations

These and similar organizations do not qualify for the nonprofit standard mail prices, even if organized on a nonprofit basis: (a) automobile clubs; (b) business leagues; (c) chambers of commerce; (d) citizens' and civic improvement associations; (e) individuals; (f) mutual insurance associations; (g) political organizations (other than those specified in 1.3); (h) service clubs (e.g., civilian, Kiwanis, Lions, Optimist, and Rotary); (i) social and hobby clubs; (j) associations of rural electric cooperatives; and (k) trade associations.³¹⁹

State, county, and municipal governments are generally not eligible for the nonprofit standard mail prices. However, a separate and distinct state, county, or municipal governmental organization that meets the criteria for any one of the specific categories in 1.2 may be eligible, notwithstanding its governmental status.³²⁰

(d) Application for Authorization

In general, an organization must file an application for use of the nonprofit standard mail (Form 3624) at each post office where it wants to deposit mailings. The applicant must show on the application the qualifying category or organization under which it seeks authorization.³²¹ There is no filing fee.³²²

The application must be accompanied by evidence that the applicant meets the standards of a qualifying category and that the organization is a nonprofit entity. This evidence includes a copy of its organizing document (such as articles of incorporation), its bylaws, a financial statement prepared by a responsible, independent person, a list of the activities in which the organization engaged during the previous 12 months, a statement of receipts and expenditures for the past fiscal year, a copy of its budget for the current year, and documentation that illustrates the operations of the organization (such as bulletins, minutes of meetings, and brochures).³²³

Form 3624 filed by an organization seeking authorization as a qualified political committee must include evidence that the applicant meets the standards of one of the qualifying categories of political committees; evidence of nonprofit status is not required.³²⁴

Once an organization is authorized, it may mail at nonprofit standard mail prices at any USPS location that accepts presorted mailings. The Postal Service will issue a national nonprofit standard mail authorization number to each organization authorized to mail at the nonprofit standard mail prices. Authorized organizations must display this number in the appropriate space on each postage statement that accompanies a mailing at nonprofit standard mail prices.³²⁵

An authorized organization (or organization pending authorization) wishing to mail at a non-PostalOne! post office must file a Form 3623, Request for Confirmation of Authorization (or Pending Authorization) to Mail at Nonprofit Standard Mail Prices, with the postmaster prior to mailings being made.³²⁶ There is no filing fee.³²⁷

If the organization name on the Form 3623 is different from the one on USPS records, the applicant must revise the organization's original application to reflect a name change by providing evidence that the organization name was officially changed (e.g., an official amendment to the organization's articles of incorporation stating the former name and the new name and a letter issued by the IRS recognizing the name change).³²⁸ It is unclear whether both an amendment and IRS determination letter are needed to send mail under an organization's new name. The statute reads: “(e.g., an official amendment to the organization's Articles of Incorporation stating the former name and the new name and a letter issued by the Internal Revenue Service recognizing the name change).” However, Form PS 6015, the form to officially request a name change, states: “Required documentation, such as an amendment to your articles of incorporation or letter from the IRS must be attached” (emphasis added). Thus, an organization may be able to send mail under its new name after submitting an amendment showing its name change while waiting for the IRS to issue its determination letter.

Confirmation or authorization to mail at nonprofit standard mail prices does not relieve the mailer's obligation to obtain mailing permits and pay the required fees for mailing at presorted prices.³²⁹

An organization may not mail at nonprofit standard mail prices at a post office before a Form 3624 or Form 3623, if required, is approved.³³⁰ While an application, or confirmation of authorization, is pending, postage must be paid at applicable first-class mail or priority mail prices, or at applicable standard mail prices. The USPS records the difference between postage paid at regular standard mail prices and the postage that would have been paid at nonprofit standard mail process. No record is kept if postage is paid at first-class mail or priority mail prices.³³¹ If an authorization to mail at nonprofit standard mail prices is issued, the mailer may be refunded the postage paid at the post office where pending mailings were made for any amount that exceeds the nonprofit standard mail prices, since the effective date of the authorization. No refund is made (a) if the application on Form 3624 is denied and no appeal is filed; (b) if postage was paid at first-class mail or priority mail prices; (c) for the period before the effective date of the authorization; and (d) if confirmation of authorization using Form 3623 is denied.³³²

The effective date of the nonprofit standard mail price authorization is the date of the application or the date of the organization's eligibility, whichever is later.³³³ The mailer may continue to mail in a pending status until a final decision is reached on an appeal or a denied application.³³⁴

The Pricing and Classification Service Center (PCSC) manager may request additional information or evidence to support or clarify the application. Failure to provide this information is sufficient grounds for an application to be denied.³³⁵ The PCSC manager rules on Form 3624 and Form 3623 and notifies the applicant directly.³³⁶ If the application on Form 3624 or Form 3623 is denied, the applicant may submit a written appeal to the postmaster where the application was filed within 15 days of the applicant's receipt of the decision. After reviewing the file, if the PCSC manager still believes that the organization does not qualify to be authorized at nonprofit standard mail rates, or the request for confirmation of the authorization is not able to be confirmed, the appeal is forwarded to the manager of Product Classification, who issues the final agency decision.³³⁷

The PCSC manager may initiate at any time a review of any organization authorized to mail at the standard nonprofit standard mail prices.³³⁸ If it is found that authorization has been given to an organization that was not qualified at the time of application or later became unqualified, the PCSC manager notifies the organization of the proposed revocation and the reasons for it.³³⁹ Revocation for cause takes effect 15 days from the organization's receipt of the notice, unless the organization files a written appeal within that time through the PCSC with the manager of Product Classification.³⁴⁰ The PCSC revokes an authorization to mail at nonprofit standard mail prices if no nonprofit standard mail price mailings are made by the authorized organization during a two-year period. The PCSC notifies the organization of the revocation for nonuse.³⁴¹

(e) Eligible and Ineligible Matter

An organization authorized to mail at the nonprofit standard mail rates may mail only its own matter at those rates. This matter, which generally must substantially relate to the organization's program purposes, is termed eligible matter. Disqualified material is known as ineligible matter.³⁴² An authorized organization may not delegate or lend the use of its authorization to mail at the special rates to any other person. A person may not mail, or cause to be mailed by agreement or otherwise, any ineligible matter at the special rates. Material soliciting charitable contributions may be mailed at these rates.³⁴³

Cooperative mailings—mailings made under the auspices of two or more organizations (perhaps in the nature of a joint venture)—may be made at the nonprofit rates only when each of the cooperating organizations is authorized to mail at the special rates at the post office where the mailing is deposited. Cooperative mailings involving the mailing of any matter on behalf of or produced for an organization not authorized to mail at the special rates at the post office where the mailing is deposited must be paid at the applicable regular rates.³⁴⁴

An exception to this cooperative rate rule is available for certain matter soliciting monetary contributions, mailed by an organization authorized to mail at the nonprofit standard mail rates and sharing the economic risk of the solicitation with a professional fundraiser, to the authorized mailer and not promoting or otherwise facilitating the sale or lease of any goods or services. This exception is applicable only where the authorized organization is provided a list of each donor, contact information for each, and the amount of the contribution; the organization may waive in writing the receipt of this list.³⁴⁵

To be substantially related, the sale of the product or the provision of the service must contribute importantly to the accomplishment of one or more of the qualifying purposes of the organization. This means that the sale of the product or the provision of the service must be directly related to accomplishing one or more of the purposes on which the organization's authorization to mail at the nonprofit rates is based. The sale of the product or the provision of the service must have a causal relationship to the achievement of the exempt purposes of the authorized organization. The selling of a product or service is not a related activity simply because the resulting income is used to accomplish the purposes of the authorized organization.³⁴⁶ The determination as to relatedness must be made in accordance with federal tax standards.³⁴⁷

Nonprofit standard mail prices may not be used for the entry of material that advertises, promotes, offers, or, for a fee or consideration, recommends, describes, or announces the availability of:

1. Any credit, debit, or charge card or similar financial instrument or account, provided by or through an arrangement with any person or organization not authorized to mail at the nonprofit standard mail rates at the entry post office.
2. Any insurance policy, unless the organization promoting the purchase of such policy is authorized to mail at the nonprofit standard mail prices at the entry post office; the policy is designed for and primarily promoted to the members, donors, supporters, or beneficiaries of that organization; and the coverage provided by the policy is not generally otherwise commercially available.
3. Any travel arrangement, unless the organization promoting the arrangement is authorized to mail at the nonprofit standard mail prices at the entry post office; the travel contributes substantially (aside from the cultivation of members, donors, or supporters, or the acquisition of income or funds) to one or more of the purposes that constitute the basis for the organization's authorization to mail at the nonprofit standard mail prices; and the arrangement is designed for and primarily promoted to the members, donors, supporters, or beneficiaries of that organization.
4. Any other product or services unless one of these exceptions is met:
   1. The sale of the product or the provision of such service is substantially related to the exercise or performance by the organization of one or more of the purposes used by the organization to qualify for mailing at the nonprofit standard mail prices. The criteria in Treasury regulations,³⁴⁸ supplemented by the definitions in DMM 703, part 1.6.6, are used to determine whether an advertisement, promotion, or offer for a product or service is for a substantially related product or service and, therefore, eligible for nonprofit standard mail prices.
   2. The product or service is advertised in standard mail material meeting the prescribed content requirements for a periodical publication. The criteria in DMM 703, part 1.6.8 are used to determine whether the Standard Mail material meets the content requirements for a periodical publication.³⁴⁹

The phrase not generally otherwise commercially available applies to the actual coverage stated in an insurance policy, without regard to the amount of the premiums, the underwriting practices, and the financial condition of the insurer. When comparisons with other policies are made, consideration is given by the USPS to policy coverage benefits, limitations, and exclusions, and to the availability of coverage to the targeted category of recipients.³⁵⁰ The types of insurance considered generally otherwise commercially available include homeowners', property, casualty, marine, professional liability (including malpractice), travel, health, life, airplane, automobile, truck, motor home, motorcycle, boat, accidental death, accidental dismemberment, catastrophic case, nursing home, and hospital indemnity insurance.³⁵¹ Coverage is not considered generally otherwise commercially available, however, if the coverage is provided by the nonprofit organization (that is, it is the insurer) or the coverage is provided or promoted by the nonprofit organization in a mailing to its members, donors, supporters, or beneficiaries in such a way that these persons may make tax-deductible contributions to the organization of their proportional shares of any income in excess of costs that the nonprofit organization receives from the purchase of the coverage by these persons.³⁵²

Rules allow the mailing of low-cost items and items contributed to the organization at the special rates.³⁵³ Advertisements mailed at the special rates, however, do not have to meet the substantially related test if the material of which the advertisement is a part meets the content requirements of a periodical publication.³⁵⁴

The USPS issued rules allowing certain personal information to be included in nonprofit organization fundraising mailings (such as the amount of a previous gift) where the mailpiece contains an explicit solicitation for a contribution, all of the personal information is directly related to the solicitation, and the exclusive reason for inclusion of the personal information is to support the solicitation.³⁵⁵

The USPS subsequently issued guidance in this area, clarifying the type of information charitable organizations can include in these mailpieces, noting that a solicitation is any type of support pertaining to an organization's programs (not simply a request for a gift) and cautioning that organizations must refrain from using language that constitutes acknowledgments of charitable gifts.³⁵⁶

All matter mailed at the nonprofit standard mail rates must identify the authorized nonprofit organization. The name and return address of the authorized nonprofit organization must be either on the outside of the mailpiece or in a prominent location on the material being mailed. Pseudonyms or bogus names of organizations or other persons may not be used. If the mailpiece bears any name and return address, it must be that of the authorized nonprofit organization. A well-recognized alternative designation or abbreviation (such as “The March of Dimes” or the “AFL-CIO”) may be used rather than the full name of the organization.

(f) Postage Statement

A postage statement must be prepared and signed by the authorized organization or its agent for each nonprofit rate mailing. This statement is a certification that (1) the mailing does not violate the postal laws; (2) only the organization's matter is being mailed; (3) the mailing is not a cooperative mailing with other persons who are not entitled to special bulk mailing privileges; (4) the mailing has not been made by the organization on behalf of or produced for another person not entitled to special bulk mailing privileges; and (5) the organization will be liable for and agrees to pay (subject to an appropriate appeal) any postage deficiency assessed on the mailing, whether due to a finding that the mailing was a cooperative one or for any other reason.

(a) Introduction

The most significant federal tax law issue today—or set of issues—facing charitable organizations and those who engage in fundraising for them arises out of use by these organizations of the Internet through websites and other forms of social media.⁴²³ Certainly, recent years have brought extensive use of the Internet by charitable (and other tax-exempt) organizations; this use is expanding exponentially. Some aspects of Internet communications directly affect the federal laws pertaining to fundraising, such as the substantiation requirements⁴²⁴ and the unrelated business rules,⁴²⁵ and some tangentially pertain to the process, such as the lobbying and political campaign activities limitations.⁴²⁶

Despite this significance, there is no discrete law on the point, in the sense of a statute, regulation, or court opinion. The IRS has not issued any guidance; there are no answers from the agency to the many tax questions this form of Internet use is generating. It is nonetheless clear that the federal tax law does not provide any unique treatment to transactions or activities of charitable organizations simply because the Internet is the medium of communication. As the IRS quite saliently observed, the “use of the Internet to accomplish a particular task does not change the way the tax laws apply to that task. Advertising is still advertising and fundraising is still fundraising.”⁴²⁷

Thus, the most that can be done, at this time, is to extrapolate from existing federal law principles to determine the aspects of Internet use that directly relate to charitable fundraising.

(b) IRS Request for Comments

The IRS, in late 2000, requested comment on a range of questions pertaining to Internet activities by tax-exempt organizations.⁴²⁸ Here are the questions raised by the IRS that are generally relevant in the fundraising context:

• Are the gift substantiation rules, concerning written acknowledgments for contributions of $250 or more,⁴²⁹ satisfied with a written webpage confirmation or copy of a confirmation by email from the donee charitable organization?
• Does an organization meet the requirements of the quid pro quo contribution rules⁴³⁰ with a webpage confirmation that may be printed out by the contributor or by sending a confirmation by email to the donor?
• Are solicitations for contributions made on the Internet (either on an organization's website or by email) in written or printed form for purposes of the disclosure rules applicable to noncharitable organizations?⁴³¹

Here are the questions posed by the IRS that are pertinent to fundraising for charitable organizations from the perspective of the unrelated business income rules:⁴³²

• To what extent are business activities conducted on the Internet regularly carried on? What facts and circumstances are relevant in making this determination?
• Are there any circumstances under which the payment of a percentage of sales from customers referred by a tax-exempt organization to another website would be substantially related to the organization's exempt purpose?
• Does a website constitute a single publication or other form of communication? If not, how should it be separated (fragmented) into distinct publications or communications?
• When allocating expenses for a website, what methodology is appropriate? For example, should allocations be based on webpages (which, unlike print publications, may not be of equal size)?

Here are two pertinent questions posed by the IRS, relevant to fundraising, concerning other aspects of use of the Internet by charitable organizations:

• Unlike other publications of a tax-exempt organization, a website may be modified on a daily basis. To what extent and by what means should an exempt organization maintain the information from prior versions of the organization's website?
• To what extent are statements made by subscribers to a forum, such as a listserv or newsgroup, attributable to an exempt organization that maintains the forum? Would attribution vary, depending on the level of participation of the exempt organization in maintaining the forum (e.g., where the organization moderates the discussion or acts as editor)?

Reportedly, the IRS received thousands of responses to this request for comments. Yet, formal guidance will not be provided by the IRS, at least for the foreseeable future.

(c) Internet Communications Issues

(a) Overview of Federal Election Law

Participation in the electoral process—whether by individuals, for-profit corporations, or tax-exempt organizations—entails forms of political speech, thus implicating the free speech principles of the First Amendment.⁴⁴⁶ Ample tension between free speech principles and regulation of political campaign activity has existed since the outset of this type of statutory law.

This body of law includes limitations on the amounts and timing of contributions and expenditures for political campaign purposes, soft money restrictions, establishment and maintenance of separate segregated funds, use of political committees, and disclosure requirements.

The Bipartisan Campaign Reform Act (BCRA) is the most recent federal enactment designed to “purge national politics of what was conceived to be the pernicious influence of ‘big money’ campaign contributions.”⁴⁴⁷ The first of these enactments, in 1907, completely banned corporate contributions of money in connection with a federal election. This law was extended in 1925, 1942, 1947, 1971 (FECA), and 1974.⁴⁴⁸

The Supreme Court in 1976 characterized this body of law as an “intricate statutory scheme.”⁴⁴⁹ These rules were made more complex in 2002, with enactment of the BCRA. The Court wrote that “BCRA's central provisions are designed to address Congress' concerns about the increasing use of soft money and issue advertising to influence federal elections.”⁴⁵⁰

The Supreme Court upheld nearly all of the provisions of the BCRA, in response to free speech and other challenges, as being constitutional on its face.⁴⁵¹ Yet, this decision was initially misunderstood in some quarters, in that this action by the Court did not immunize this body of law from lawsuits asserting unconstitutionality of it when applied to a specific set of facts—known as as-applied challenges.⁴⁵²

The IRS is of the view that a tax-exempt organization that violates the regulatory requirements of the FECA may well “jeopardize its exemption or be subject to other tax consequences.”⁴⁵³

(b) Federal Election Commission

The Federal Election Commission⁴⁵⁴ administers and formulates policy with respect to the federal election campaign laws.⁴⁵⁵ The powers of the FEC include the development of implementing rules and forms, conduct of investigations and hearings, rendering of advisory opinions, maintenance of an Internet-based repository of election reports, and initiation of litigation.⁴⁵⁶

The FEC took a substantial hit from the Supreme Court—one of the harshest the Court has been on a regulatory agency—when the Court, in its 2010 opinion striking down limits on independent political expenditures by corporations, reiterated its view of the “importance of speech itself to the integrity of the election process.”⁴⁵⁷ Yet, the Court added, “[a]s additional rules are created for regulating political speech, any speech arguably within their reach is chilled.”⁴⁵⁸ This was a reference, of course, to rules promulgated by the FEC, which was characterized, as the Court did 45 years earlier, as a “censor.”⁴⁵⁹ In 2010, the Court stated that the FEC was engaging in an “unprecedented governmental intervention into the realm of speech.”⁴⁶⁰

Citing an amicus curiae brief, the Court stated that the FEC's campaign finance regulations now impose “unique and complex rules” on “71 distinct entities.”⁴⁶¹ These entities are subject to “separate rules for 33 different types of political speech.”⁴⁶² The FEC “has adopted 568 pages of regulations, 1,278 pages of explanations and justifications for those regulations, and 4,771 advisory opinions since 1975.”⁴⁶³ “In fact,” the Court admonished, after it adopted an “objective ‘appeal to vote’ test for determining whether a communication was the functional equivalent of express advocacy,”⁴⁶⁴ the FEC “adopted a two-part, 11-factor balancing test to implement“ the Court's ruling.⁴⁶⁵

The Court wrote that “[t]his regulatory scheme may not be a prior restraint on speech in the strict sense of that term, for prospective speakers are not compelled by law to seek an advisory opinion from the FEC before the speech takes place.”⁴⁶⁶ The Court continued: “As a practical matter, however, given the complexity of the regulations and the deference courts show to administrative determinations, a speaker who wants to avoid threats of criminal liability and the heavy costs of defending against FEC enforcement must ask a governmental agency for prior permission to speak.”⁴⁶⁷ And: “These onerous restrictions thus function as the equivalent of prior restraint by giving the FEC power analogous to licensing laws implemented in 16th- and 17th-century England, laws and governmental practices of the sort that the First Amendment was drawn to prohibit.”⁴⁶⁸

The Court referenced an earlier decision where it wrote that because the FEC's “business is to censor, there inheres the danger that [it] may well be less responsive than a court—part of an independent branch of government—to the constitutionally protected interests in free expression.”⁴⁶⁹ When the FEC “issues advisory opinions that prohibit speech,”⁴⁷⁰ the Court wrote, quoting from another opinion, “[m]any persons, rather than undertake the considerable burden (and sometimes risk) of vindicating their rights through case-by-case litigation, will choose simply to abstain from protected speech—harming not only themselves but society as a whole, which is deprived of an uninhibited marketplace of ideas.”⁴⁷¹ Consequently, the “censor's determination may in practice be final.”⁴⁷²

The Court earlier wrote that First Amendment standards “must eschew ‘the open-ended rough-and-tumble of factors,’ which ‘invit[es] complex argument in a trial court and a virtually inevitable appeal,”⁴⁷³ Yet, the Court wrote, the FEC “has created a regime that allows it to select what political speech is safe for public consumption by applying ambiguous tests.”⁴⁷⁴ The Court continued: “If parties want to avoid litigation and the possibility of civil and criminal penalties, they must either refrain from speaking or ask the FEC to issue an advisory opinion approving of the political speech in question. Government officials pore over each word of a text to see if, in their judgment, it accords with the 11-factor test they have promulgated. This is an unprecedented governmental intervention into the realm of speech.”⁴⁷⁵

The Court concluded its thrashing of the FEC by stating that the “ongoing chill upon speech that is beyond all doubt protected makes it necessary … to invoke the earlier precedents that a statute which chills speech can and must be invalidated where its facial invalidity has been demonstrated.”⁴⁷⁶ The Court then proceeded to do just that in its decision regarding the funding of electioneering communications from the general treasuries of corporations.⁴⁷⁷

(c) Free Speech Principles Overview

The First Amendment to the U.S. Constitution provides, in part, that “Congress shall make no law … abridging the freedom of speech.” Inasmuch as various ways to participate in federal (and state and local) political election campaigns constitute speech, an initial conclusion might be that all statutes regulating the electioneering process are unconstitutional.⁴⁷⁸ But the courts have never taken this “absolutist” approach. Today, the constitutional power of Congress to regulate federal elections is well established. Nonetheless, there are robust debates as to the boundaries and contours of that power, despite the strict scrutiny accorded these laws.⁴⁷⁹

The general standard is that “[l]aws that burden political speech are accordingly subject to strict scrutiny, which requires the Government to prove that the restriction furthers a compelling interest and is narrowly tailored to achieve that interest.”⁴⁸⁰

(d) Contribution and Expenditure Limitations

Campaign contributions and expenditures are forms of speech within the protection of the First Amendment. The Court wrote that “contribution and expenditure limitations operate in an area of the most fundamental First Amendment activities.”⁵²¹ A federal appellate court wrote that the Court “has never strayed from that cardinal tenet, notwithstanding some passionate objections.”⁵²²

Another overarching principle in this context is that government cannot limit campaign contributions and expenditures to achieve equalization—that is, it cannot restrict the speech of some so that others might have equal voice or influence in the electoral process. Thus, the Court stated that the “concept that government may restrict the speech of some elements of our society in order to enhance the relative voice of others is wholly foreign to the First Amendment.”⁵²³ The Court added that the government's interest in “equalizing the relative ability of individuals and groups to influence the outcome of elections” does not justify regulation.⁵²⁴

As discussed, the government's interest in precluding corruption is the rationale underlying limitations on contributions and expenditures. This anticorruption interest is, of course, implicated by contributions to candidates. Thus, the Court wrote that, “[t]o the extent that large contributions are given to secure a political quid pro quo from current and potential office holders, the integrity of our system of representative democracy is undermined.”⁵²⁵ Later, the Court stated that, in its 1976 opinion, it “identified a single narrow exception to the rule that limits on political activity were contrary to the First Amendment”: the exception relates “to the perception of undue influence of large contributors to a candidate.”⁵²⁶

A federal appellate court wrote that, “[b]ased on the close relationship between candidates and parties and record evidence demonstrating that political parties sold access to candidates in exchange for contributions, the [Supreme] Court has held that the anticorruption interest also justifies limits on contributions to parties.”⁵²⁷ From the outset of the Court's election law jurisprudence, it has taken the position that Congress was “surely entitled” to conclude that “contribution ceilings were a necessary legislative concomitant to deal with the reality or appearance of corruption inherent in a system permitting unlimited financial contributions” (even where adequate disclosure is required).⁵²⁸ It has written that contribution limitations “in themselves do not undermine to any material degree the potential for robust and effective discussion of candidates and campaign issues by individual citizens, associations, the institutional press, candidates, and political parties.”⁵²⁹ Contribution limits on individuals are constitutional, in that the “weighty interests served by restricting the size of financial contributions to political candidates are sufficient to justify the limited effect upon First Amendment freedoms caused” by such a limit.⁵³⁰ Contribution limits on political committees are justified because they “serve the permissible purpose of preventing individuals from evading the applicable contribution limitations by labeling themselves committees.”⁵³¹

In applying this anticorruption rationale, the Court has “afforded stronger protection to expenditures by citizens and groups (for example, for advertisements, get-out-the-vote efforts, and voter registration activities) than it has provided to their contributions to candidates or parties.”⁵³² The Court “has explained that contributions to a candidate or party pose a greater risk of quid pro quo corruption than do expenditures.”⁵³³ At the same time, the Court “has stated that limits on contributions to candidates or parties pose only a ‘marginal restriction upon the contributor's ability to engage in free communication.’”⁵³⁴

By contrast, expenditure limitations limit “political expression at the core of our electoral process and of the First Amendment freedoms.”⁵³⁵ A “restriction on the amount of money a person or group can spend on political communication during a campaign necessarily reduces the quantity of expression by restricting the number of issues discussed, the depth of their exploration, and the size of the audience reached.”⁵³⁶ Originally, the Court stated that, in order to preserve a limitation on political expenditures, it must be construed to apply only to expenditures for “communications that in express terms advocate the election or defeat of a clearly identified candidate for federal office.”⁵³⁷ In summary, the Court's jurisprudence in this regard reflects a “fundamental constitutional difference between money spent to advertise one's views independently of the candidate's campaign and money contributed to the candidate to be spent on his campaign.”⁵³⁸

The Court has been “somewhat more tolerant of regulation of for-profit corporations and labor unions,” permitting “statutory limits on contributions that for-profit corporations and unions make from their general treasuries to candidates and parties.”⁵³⁹ Also, the Court has “upheld laws that prohibit for-profit corporations and unions from making expenditures for activities expressly advocating the election or defeat of a federal candidate”⁵⁴⁰ permitting these expenditure limits on the ground that they restrain the “corrosive and distorting effects of immense aggregations of wealth that are accumulated with the help of the corporate form and that have little or no correlation to the public's support for the corporation's political ideas.”⁵⁴¹

A federal appellate court summed up this aspect of the law this way: “In reconciling the competing interests, the Supreme Court has generally approved statutory limits on contributions to candidates and political parties as consistent with the First Amendment. The Court has rejected expenditure limits on individuals, groups, candidates, and parties, even though expenditures may confer benefits on candidates. And the Court has upheld limits on for-profit corporations' and unions' use of their general treasury funds to make campaign contributions to candidates or political parties or to make expenditures for activities expressly advocating the election or defeat of federal candidates.”⁵⁴²

(e) Political Committees

The federal election law addresses the matter of political committees⁵⁴³ and their organization. A principal requirement is that a political committee must have a functioning treasurer; contributions and expenditures may not occur in the absence of this officer.⁵⁴⁴ An expenditure may not be made for or on behalf of a political committee without the authorization of the treasurer or his or her agent.⁵⁴⁵ Accounting requirements apply to political committees and authorized political committees,⁵⁴⁶ as well as record-keeping and records preservation requirements.⁵⁴⁷ Candidates for federal office must designate a political committee to serve as the principal campaign committee of the candidate.⁵⁴⁸

Authorized campaign committees, separate segregated funds, and other political committees are required to timely file statements of organization with the FEC.⁵⁴⁹ The law stipulates the contents of these statements⁵⁵⁰ and provides a termination procedure.⁵⁵¹ Treasurers of political committees must timely file reports of receipts and disbursements.⁵⁵² The types of reports to be filed depend on whether the committee is the principal campaign committee of a candidate for the House of Representatives or Senate, the principal campaign committee of a candidate for the U.S. presidency, or other political committee.⁵⁵³ The election law stipulates the contents of these reports.⁵⁵⁴

Every person, other than a political committee, who makes independent expenditures,⁵⁵⁵ in an amount or value in excess of $250 in the course of a calendar year, must file with the FEC a statement of contributions received.⁵⁵⁶ Every person who makes a disbursement for the direct costs of producing and airing electioneering communications⁵⁵⁷ in an amount in excess of $10,000 during a calendar year must timely file a statement with the FEC.⁵⁵⁸

(f) Limitations on Contributions

In general, a person⁵⁵⁹ may not make contributions⁵⁶⁰ to (1) any candidate and their authorized political committees with respect to an election for federal office that exceed $2,000; (2) the political committees established and maintained by a national political party, that are not the authorized political committees of a candidate, in any calendar year that exceed $25,000; (3) a political committee established and maintained by a state committee of a political party in a calendar year that exceed $10,000; and (4) any other political committee in a calendar year that exceed $5,000.⁵⁶¹ Other limitations apply with respect to contributions by multicandidate political committees.⁵⁶² Some of these limitations are indexed for inflation.⁵⁶³

All contributions made by political committees established, financed, maintained, or controlled by a corporation are considered to have been made by a single political committee.⁵⁶⁴ In a case where a corporation establishes, finances, maintains, or controls more than one separate segregated fund, all such funds are treated as a single segregated fund for purposes of the limitations on contributions.⁵⁶⁵ For contribution limitation purposes, all contributions made by a person, either directly or indirectly, on behalf of a candidate, including contributions that are in any way earmarked or otherwise directed through an intermediary or conduit to such candidate, are treated as contributions from the person to the candidate.⁵⁶⁶ The intermediary or conduit must report the original source and the intended recipient of the contributions to the FEC and the intended recipient.⁵⁶⁷

An individual may not make contributions to authorized national committees of candidates aggregating more than $36,500.⁵⁶⁸ Contributions to national party committees otherwise may be made up to $109,500 annually.⁵⁶⁹

(g) Corporate Independent Expenditures

Before and after enactment of the BCRA, federal law prohibited corporations and labor organizations⁵⁷⁰ from using their general treasury funds to make direct contributions to candidates or independent expenditures that expressly advocate the election or defeat of a candidate, by means of any form of media, in connection with certain federal elections.⁵⁷¹ These rules were considered to be applicable to tax-exempt, nonprofit advocacy corporations.⁵⁷² The Supreme Court, however, held that these financing restrictions are unconstitutional as applied to advertisements that an exempt social welfare organization⁵⁷³ intended to run before an election because the advertisements were not express advocacy or its functional equivalent.⁵⁷⁴

This prohibition on contributions and expenditures does not extend to communications by a corporation to its stockholders and executive and administrative personnel and their families, or by a labor organization to its members and their families.⁵⁷⁵ The prohibition also does not apply with respect to nonpartisan registration and get-out-the vote campaigns by a corporation or labor organization aimed at these classes of persons.⁵⁷⁶ Moreover, this prohibition does not bar a corporation or labor organization from establishing, administering, and soliciting contributions for a separate segregated fund to be utilized for political purposes.⁵⁷⁷

These rules do not prevent a trade association,⁵⁷⁸ or a separate segregated fund⁵⁷⁹ established by an association, from soliciting contributions from the stockholders and executive or administrative personnel, and their families, of its member corporations, to the extent that the solicitation has been approved by the member corporation and the corporation does not approve a solicitation of this nature by more than one trade association in a calendar year.⁵⁸⁰

The BCRA brought a rule prohibiting corporations and unions from making any electioneering communications.⁵⁸¹ An electioneering communication is defined as “any broadcast, cable, or satellite communication” that “refers to a clearly identified candidate for Federal office” and is made within 30 days of a primary or 60 days of a general election.⁵⁸² Thus, corporations and unions were barred from using their general treasury funds for express advocacy or electioneering communications. They were allowed to establish (and still are), however, a separate segregated fund for these purposes.⁵⁸³ The monies received by the segregated fund are limited to donations from stockholders and employees of the corporation or, in the case of unions, members. These limits on electioneering communications were held by the Court, in 2003, to be facially constitutional.⁵⁸⁴

This holding in 2003 rested to a large extent on a decision from the Court in 1990, which essentially held that political speech may be banned on the basis of the speaker's corporate identity.⁵⁸⁵ A dissenting justice in that case, who became the author of the majority opinion in 2010 striking down the ban on independent corporate political expenditures (and overruling the 1990 case), wrote that the Court “uph[eld] a direct restriction on the independent expenditure of funds for political speech for the first time in [the Court's] history.”⁵⁸⁶ In the 2010 opinion, he returned to the theme: “No case before [the 1990 one] had held that Congress could prohibit independent expenditures for political speech based on the speaker's corporate identity.”⁵⁸⁷

In the 1990 case, the Court identified, and then relied on, a new governmental interest in limiting political speech: an antidistortion interest.⁵⁸⁸ There, the compelling governmental interest was said to be prevention of the “corrosive and distorting effects of immense aggregations of wealth that are accumulated with the help of the corporate form and that have little or no correlation to the public's support for the corporation's political ideas.”⁵⁸⁹

In its arguments before the Court in the 2010 case, the government basically abandoned reliance on the antidistortion rationale; it asserted instead two other compelling interests supporting the notion that corporate expenditure restrictions are constitutional: an anticorruption interest⁵⁹⁰ and a shareholder-protection interest.⁵⁹¹ All three of these arguments failed.

The antidistortion rationale collapsed (because the 1990 decision was overruled). The Court in 2010 wrote that, “[i]f the First Amendment has any force, it prohibits Congress from fining or jailing citizens, or associations of citizens, for simply engaging in political speech.”⁵⁹² It that this antidistortion standard “permits the Government to ban the political speech of millions of associations of citizens.”⁵⁹³ The Court wrote that the “censorship we now confront is vast in its reach,” in that the government has “muffle[d] the voices that best represent the most significant segments of the economy.”⁵⁹⁴ And: “By suppressing the speech of manifold corporations, both for-profit and nonprofit, the Government prevents their voices and viewpoints from reaching the public and advising voters on which persons or entities are hostile to their interests.”⁵⁹⁵ Further: “The purpose and effect of this law is to prevent corporations, including small and nonprofit corporations, from presenting both facts and opinions to the public.”⁵⁹⁶ The antidistortion rationale went down with this: “When Government seeks to use its full power, including the criminal law, to command where a person may get his or her information or what distrusted source he or she may not hear, it uses censorship to control thought. This is unlawful. The First Amendment confirms the freedom to think for ourselves.”⁵⁹⁷

The anticorruption rationale was rejected, with the Court concluding that “independent expenditures, including those made by corporations, do not give rise to corruption or the appearance of corruption.”⁵⁹⁸ The Court wrote that that compelling interest applies only in instances of “quid pro quo corruption.”⁵⁹⁹ It added that “there is only scant evidence that independent expenditures even ingratiate”; “[i]ngratiation and access, in any event, are not corruption.”⁶⁰⁰ The shareholder-protection rationale⁶⁰¹ was rejected, in part because the statute is “overinclusive,” in that it “covers all corporations, including nonprofit corporations and for-profit corporations with only single shareholders.”⁶⁰² This “regulatory mechanism,” based as it is on speech, “contravenes the First Amendment.”⁶⁰³

And so the 1990 decision was overruled.⁶⁰⁴ As prelude to doing so, the Court wrote that “[o]ur precedent is to be respected unless the most convincing of reasons demonstrates that adherence to it puts us on a course that is sure error.”⁶⁰⁵ In the prior year, the Court wrote: “Beyond workability, the relevant factors in deciding whether to adhere to the principle of stare decisis include the antiquity of the precedent, the reliance interests at stake, and of course whether the decision was well reasoned.”⁶⁰⁶ Another test is whether “experience has pointed up the precedent's shortcomings.”⁶⁰⁷ As the Court stated before, it “has not hesitated to overrule decisions offensive to the First Amendment.”⁶⁰⁸

Bluntly, the Court wrote that the 1990 decision “was not well reasoned.”⁶⁰⁹ That decision was said to be “undermined by experience since its announcement,” in that “[p]olitical speech is so ingrained in our culture that speakers find ways to circumvent campaign finance laws.”⁶¹⁰ And: “Our Nation's speech dynamic is changing, and informative voices should not have to circumvent onerous restrictions to exercise their First Amendment rights.”⁶¹¹

The overruling of the 1990 decision, of course, invalidated the statutory prohibition⁶¹² on the use of corporate treasury funds, in the form of independent expenditures, for express advocacy. It also led to the overruling of the portion of the earlier decision finding this prohibition valid on its face.⁶¹³ The Court stated it was returning to the principle that the government “may not suppress political speech on the basis of the speaker's corporate identity,” inasmuch as “[n]o sufficient governmental interest justifies limits on the political speech of nonprofit or for-profit corporations.”⁶¹⁴

(h) Soft Money Restrictions

In general, a committee of a national political party (or its agent) may not solicit, receive, or direct to another person a contribution or other transfer of funds, or expend funds, which are not subject to the limitations, prohibitions, and reporting requirements of the federal election campaign laws (that is, funds that are soft money).⁶¹⁵ State, district, and local party committees may not use soft money for activities that affect federal elections.⁶¹⁶ An amount spent by these committees to raise funds that are used, in whole or in part, for expenditures for a federal election activity⁶¹⁷ must be made from funds that are subject to the federal election campaign laws (hard money).⁶¹⁸

A national, state, district, or local committee of a political party, or a controlled entity or agent, is not permitted to solicit funds for, or make or direct any contributions to, a tax-exempt organization that engages in electioneering activities.⁶¹⁹

Federal candidates and officeholders are restricted from receiving, spending, or soliciting soft money in connection with federal elections; they are limited in their ability to do so in connection with state and local elections.⁶²⁰ The law prevents circumvention of the restrictions on national, state, and local party committees by prohibiting state and local candidates from raising and spending soft money to fund advertisements and other public communications that promote or attack federal candidates.⁶²¹

These provisions, constituting Title I of the BCRA, are, wrote the Court, Congress's effort to “plug the soft-money loophole.”⁶²² The “cornerstone” of Title I is the first of these provisions,⁶²³ which “prohibits national party committees and their agents from soliciting, receiving, directing, or spending any soft money.”⁶²⁴ This provision, said the Court, “takes national parties out of the soft-money business.”⁶²⁵ The remaining provisions of this body of law “largely reinforce” the restrictions in this first provision.⁶²⁶

The Court observed that, since 1976,⁶²⁷ it has “subjected restrictions on campaign expenditures to closer scrutiny than limits on campaign contributions.”⁶²⁸ Contribution limits, the Court said then, “entai[l] only a marginal restriction upon the contributor's ability to engage in free communication.”⁶²⁹ Contribution limits “may bear more heavily” on the right of association than on the freedom to speak.⁶³⁰ Limits on contributions also prevent the “actual corruption threatened by large financial contributions” and the “eroding of public confidence in the electoral process through the appearance of corruption.”⁶³¹

These restrictions, said the Court, “have only a marginal impact on the ability of contributors, candidates, officeholders, and parties to engage in effective political speech.”⁶³² “Complex as its provisions may be,” wrote the Court, this body of law, “in the main, does little more than regulate the ability of wealthy individuals, corporations, and unions to contribute large sums of money to influence federal elections, federal candidates, and federal officeholders.”⁶³³

The relevant inquiry, said the Court, in reviewing this law, is “whether the mechanism adopted to implement the contribution limit, or to prevent circumvention of that limit, burdens speech in a way that a direct restriction on the contribution itself would not.”⁶³⁴ The Court concluded the mechanism does not do that.

National parties are prohibited from receiving or spending nonfederal (soft) money; state party committees are prohibited from spending nonfederal money on federal election activities. “[N]either provision in any way,” wrote the Court, “limits the total amount of money parties can spend.”⁶³⁵ Rather, “they simply limit the source and individual amount of donations” and “[t]hat they do so by prohibiting the spending of soft money does not render them expenditure limitations.”⁶³⁶

The Court concluded that the solicitation provisions,⁶³⁷ which restrict the ability of national party committees, federal candidates, and federal officeholders to solicit nonfederal funds, “leave open ample opportunities for soliciting federal funds on behalf of entities subject to FECA's source and amount restrictions.”⁶³⁸ The provision⁶³⁹ that “on its face enacts a blanket ban on party solicitations of funds to certain tax-exempt organizations, nevertheless allows parties to solicit funds to the organizations' federal PACs.”⁶⁴⁰ That latter section “places no limits on other means of endorsing tax-exempt organizations or any restrictions on solicitations by party officers acting in their individual capacities.”⁶⁴¹

The Court applied the “less rigorous scrutiny applicable to contribution limits” to evaluate the constitutionality of this body of law, noting that Congress enacted this provision “as an integrated whole to vindicate the Government's important interest in preventing corruption and the appearance of corruption.”⁶⁴²

As noted, national committees of political parties are prohibited from receiving or spending nonfederal (soft) money.⁶⁴³ The Court said the “main goal” of this section (which was said to be “modest”) is to “effect[] a return to the scheme that was approved in Buckley and that was subverted by the creation of the FEC's allocation regime, which permitted the political parties to fund federal electioneering efforts with a combination of hard and soft money.”⁶⁴⁴

This section was upheld, against free speech and overbreadth challenges, because of “substantial evidence” that supported Congress's determination that “large soft-money contributions to national political parties give rise to corruption and the appearance of corruption.”⁶⁴⁵ As noted, state party committees are prohibited from spending nonfederal money on federal election activities.⁶⁴⁶ This provision was also upheld.

Another provision, as noted, on its face enacts a blanket ban on party solicitations of funds to certain tax-exempt organizations, yet nevertheless allows parties to solicit funds to the organizations' federal PACs.⁶⁴⁷ The government defended this law as being necessary to prevent circumvention of the limits on contributions of soft money to national, state, and local party committees, a justification the Court found “entirely reasonable.”⁶⁴⁸ The Court wrote that, absent this provision, these committees “would have significant incentives to mobilize their formidable fundraising apparatuses, including the peddling of access to federal officeholders, into the service of like-minded tax-exempt organizations that conduct activities benefiting their candidates.”⁶⁴⁹ Also: “All of the corruption and appearance of corruption attendant on the operation of those fundraising apparatuses would follow.”⁶⁵⁰

This provision, said the Court, is “closely drawn” to prevent political parties from using exempt organizations as “soft-money surrogates.”⁶⁵¹ This section restricts solicitations only to tax-exempt groups⁶⁵² that make expenditures or disbursements in connection with an election for federal office and to political organizations.⁶⁵³ Parties remain free to solicit hard-money contributions to an exempt organization's federal PAC and to political organizations that already qualify as federal PACs.

This section also prohibits national, state, and local party committees from making or directing any contributions to qualifying tax-exempt, including political, organizations. This, too, was defended as an anticircumvention measure, as to which the Court agreed “insofar as it prohibits the donation of soft money.”⁶⁵⁴ The Court “narrowly construe[d]” this provision “to apply only to donations of funds not raised in compliance with FECA.”⁶⁵⁵ Thus, political parties “remain free to make or direct donations of money to any tax-exempt organization that has otherwise been raised in compliance with FECA.”⁶⁵⁶

(i) Disclosure Requirements

Whenever a person makes disbursements totaling more than $10,000 during a calendar year for the direct costs of producing and airing electioneering communications, the person must file a statement with the FEC, identifying the person making the expenditure, the amount of the expenditure, the election to which the communication was directed, and the names of certain contributors.⁶⁵⁷ If the disbursements are made from a corporation's or labor union's segregated account,⁶⁵⁸ or by a single individual who has collected contributions from others, the statement must identify all persons who contributed $1,000 or more to the account or the individual during the calendar year.⁶⁵⁹

The statement must be filed within 24 hours of each disclosure date, which is defined to include the first date and all subsequent dates on which a person's aggregate undisclosed expenses for electioneering communications exceed $10,000 for that calendar year.⁶⁶⁰ The execution of a contract to make a disbursement is treated as a disbursement for purposes of these disclosure requirements.⁶⁶¹

The Court's practice is to subject disclosure (and disclaimer) requirements in this context to “exacting scrutiny,” which requires a “substantial relation” between the disclosure requirement and a “sufficiently important” governmental interest.⁶⁶² The Court, in 2003, found these rules, added by the BCRA, to be constitutional on their face.⁶⁶³ The basic rationale is that these disclosures can be justified on the basis of a governmental interest in “provid[ing] the electorate with information” about the sources of election-related spending.⁶⁶⁴ Disclosure requirements “may burden the ability to speak,”⁶⁶⁵ but they “impose no ceiling on campaign-related activities”⁶⁶⁶ and “do not prevent anyone from speaking.”⁶⁶⁷

That last observation, however, is not without controversy. The Court acknowledged, in facially upholding the BCRA's additions, that as-applied challenges to these disclosure requirements would be available if an organization could show a “reasonable possibility” that disclosure of its contributors' names “will subject them to threats, harassment, or reprisals from either Government officials or private parties.”⁶⁶⁸ In the corporate independent political expenditures case, however, the petitioner involved did not offer any evidence that its members may face similar threats or reprisals.⁶⁶⁹

The Court, however, anticipated the problem. It wrote: “With the advent of the Internet, prompt disclosure of expenditures can provide shareholders and [other] citizens with the information needed to hold corporations and elected officials accountable for their positions and supporters.”⁶⁷⁰ The Court majority nonetheless dismissed the looming problem with this: “The First Amendment protects political speech; and disclosure permits citizens and shareholders to react to the speech of corporate entities in a proper way. This transparency enables the electorate to make informed decisions and give proper weight to different speakers and messages.”⁶⁷¹

A dissent rejected this dismissal of the problem. It stated that submissions by amici show why the Court's upholding of disclosure and reporting requirements, added by the BCRA, “will ultimately prove as misguided (and ill-fated) as was its prior approval” of the limitations on independent electioneering communications by corporations.⁶⁷² An example was provided where opponents of a state ballot proposition used information the state government posted on the Internet to create websites with maps showing the location of homes or businesses of proposition supporters; many of these supporters (or their customers) “suffered property damage, or threats of physical violence or death as a result.”⁶⁷³ The directors of a nonprofit theater and a film festival were forced to resign after disclosure of their gifts in support of the proposition. The dissent justice wrote that the “success of such intimidation tactics has apparently spawned a cottage industry that uses forcibly disclosed donor information to pre-empt citizens' exercise of their First Amendment rights.”⁶⁷⁴ Evidence of threats of retaliation from elected officials was submitted by amici.

The point of the dissent is to “demonstrate—using real-world, recent examples—the fallacy”⁶⁷⁵ in the Court majority's conclusion that disclosure rules “do not prevent anyone from speaking.”⁶⁷⁶ The dissent observes: “Disclaimer and disclosure requirements enable private citizens and elected officials to implement political strategies specifically calculated to curtail campaign-related activity and prevent the lawful, peaceful exercise of First Amendment rights.”⁶⁷⁷ Stating that the majority's “promise that as-applied challenges [to disclosure and like requirements] will adequately protect speech is a hollow assurance,” because improper uses of information will chill speech long before a plaintiff could prevail on a challenge, the dissenter wrote that he “cannot endorse a view of the First Amendment that subjects citizens of this Nation to death threats, ruined careers, damaged or defaced property, or pre-emptive and threatening warning letters as the price for engaging in core political speech, the ‘primary object of First Amendment protection.’”⁶⁷⁸

(j) Coordinated Communications and Expenditures

Disbursements for electioneering communications that are coordinated with a candidate or party are treated as contributions to and expenditures by that candidate or party.⁶⁷⁹ An expenditure made by a person in cooperation, consultation, or concert with, or at the request or suggestion of, a candidate, their authorized political committee, or their agents, is considered to be a contribution to that candidate.⁶⁸⁰ In 2002, the same rule was added applicable to expenditures coordinated with a national, state, or local committee of a political party.⁶⁸¹ The Court upheld this rule as being constitutional on its face.⁶⁸²

(k) Reporting of Independent Expenditures

A disclosure requirement is applicable to persons making independent expenditures of $1,000 or more during the 20-day period immediately preceding an election.⁶⁸³ This provision treats the execution of a contract to make a disbursement as the functional equivalent of a payment for the goods or services covered by the contract. The Court upheld this rule as being constitutional on its face.⁶⁸⁴

(l) Establishment and Maintenance of Segregated Funds

Corporations can avoid the federal law limits placed on contributions and expenditures⁶⁸⁵ by creating a separate segregated fund (SSF).⁶⁸⁶ The limit against a corporation making contributions or expenditures in relation to an election to a political office does not extend to the “establishment, administration, and solicitation of contributions to a separate segregated fund to be utilized for political purposes by a corporation, labor organization, cooperative, or corporation without capital stock.”⁶⁸⁷ A corporation can lawfully incur the cost of office space, telephones, salaries, utilities, supplies, legal and accounting fees, fundraising, and other expenses involved in organizing and operating a SSF established by a corporation.⁶⁸⁸

The sponsoring corporation may wholly control the SSF.⁶⁸⁹ The SSF, as long as it complies with federal law regarding registration and disclosure of activities, is free to make contributions and expenditures in connection with federal elections.⁶⁹⁰ The SSF allows “corporate political participation without the temptation to use corporate funds for political influence, quite possibly at odds with the sentiments of some shareholders or members, and it lets the government regulate campaign activity through registration and disclosure.”⁶⁹¹

Although an SSF can solicit and collect contribution on its own behalf,⁶⁹² it is restricted as to whom it can solicit and collect contributions from. The SSF cannot lawfully solicit contributions from any person other than “its stockholders and their families and its executive or administrative personnel and their families.”⁶⁹³ A corporation, or an SSF established by a corporation, can make two written solicitations for contributions during the calendar year from any stockholder, executive or administrative personnel, or employee of a corporation or the families of these persons.⁶⁹⁴ A corporation without capital stock, or an SSF established by a corporation without capital stock, can solicit contributions to the SSF from members of the corporation.⁶⁹⁵ Therefore, a tax-exempt organization that establishes a SSF should have members from which it may solicit contributions. When soliciting an employee for a contribution to an SSF, the employee, at the time of solicitation, must be informed of the political purposes of the fund and that the employee has the right to refuse to contribute without reprisal.⁶⁹⁶

The Court, in its decision in 2010, revisited the notion that a ban on corporate political speech is permissible if the corporation is allowed to establish and maintain a political action committee.⁶⁹⁷ The Court wrote that the law it struck down is a “ban on corporate speech notwithstanding the fact that a PAC created by a corporation can still speak.”⁶⁹⁸ It wrote that a PAC is a “separate association from the corporation,” so the “PAC exemption” from the corporate expenditure ban “does not allow corporations to speak.”⁶⁹⁹

Aside from that, said the Court, PACs are “burdensome alternatives; they are expensive to administer and subject to extensive regulations.”⁷⁰⁰ For example, “every PAC must appoint a treasurer, forward donations to the treasurer promptly, keep detailed records of the identities of the persons making donations, preserve receipts for three years, and file an organization statement and report changes to this information within 10 days.”⁷⁰¹ Also: “And that is just the beginning. PACs must file detailed monthly reports with the FEC, which are due at different times depending on the type of election that is about to occur.”⁷⁰² These reports “must contain information regarding the amount of cash on hand; the total amount of receipts, detailed by 10 different categories; the identification of each political committee and candidate's authorized or affiliated committee making contributions, and any persons making loans, providing rebates, refunds, dividends, or interest or any other offset to operating expenditures in an aggregate amount over $200; the total amount of all disbursement, detailed by 12 different categories; the names of all authorized or affiliated committees to whom expenditures aggregating over $200 have been made; persons to whom loan repayments or refunds have been made; the total sum of all contributions, operating expenses, outstanding debts and obligations, and the settlement terms of the retirement of any debt or obligation.”⁷⁰³

PACs “have to comply with these regulations just to speak,” the Court observed.⁷⁰⁴ And this does not take into account the federal tax law requirements.⁷⁰⁵

(m) Political Campaign Financing and Exempt Organizations

Absent a radical change in the federal tax law, it seems clear that tax-exempt organizations will continue to have a major role in fundraising and spending for political campaign purposes. Social welfare and labor organizations, in particular, certainly will be financial powerhouses in this regard. Congress may enact donor disclosure rules in connection with this type of fundraising but is not likely to do more. Consequently, unless the Supreme Court changes its mind about free speech principles in this context or the U.S. Constitution is amended—both highly unlikely developments—political campaign financing utilizing exempt organizations will continue apace, annually raising millions of dollars, while the charitable community presumably will continue to raise billions of dollars every year.

(a) General Principles

The IRS observed that its records indicate that “over 12,000 exempt organizations are listed as having fund raising as a major purpose,” adding that “it seems logical that there are tens of thousands of additional organizations that engage in fund raising programs to various degrees.”⁷⁰⁷ And that was written in 1982.

It has been IRS policy since 1924 that a nonprofit organization that carries on operations that involve generation and receipt of contributions (and presumably investment income) and distribution of its income to public charities is eligible to receive recognition of tax exemption as a public charity.⁷⁰⁸ This principle was restated by the IRS in 1967, holding that an organization that meets the following description qualifies for tax exemption as a charitable entity: “An organization was formed for the purpose of providing financial assistance to several different types of organizations which are exempt from Federal income tax under section 501(c)(3) of the Internal Revenue Code of 1954. It carries on no operations other than to receive contributions and incidental investment income and to make distributions of income to such exempt organizations at periodic intervals.”⁷⁰⁹

In a 1960s case considered by the IRS, a resulting technical advice memorandum stated that “[c]haritable organizations have traditionally engaged in fund raising activities as a means of raising funds to carry out their charitable purposes.” This TAM concluded: “The mere fact that an organization derives its income primarily from such fund-raising activity is not considered to defeat either the primary purposes or the substantial activity tests of section 1.501(c)(3)-1(c) of the Income Tax Regulations.”⁷¹⁰

Another case reviewed by the IRS in the 1970s involved a “social fund raiser,” the objective of which was to “raise money for charity through members, family and friends sponsoring socials, lunches and dinners, and donations for the affairs to be given for various charitable organizations.” This entity owned a clubhouse where these events (including birthday parties) took place. In a TAM, the IRS wrote: “Many charitable organizations do not engage in active charitable undertakings themselves, but rather assist the work of religious, charitable, educational or similar organizations by contributing money to them,” adding that “[p]roviding financial assistance to such organizations is a charitable activity justifying exemption.”⁷¹¹

In another case from the 1970s, an organization operated a beer “kegger” for the benefit of local charities. The parties produced a considerable profit. The IRS ruled that the organization qualified for exemption as a charitable entity.⁷¹²

An early version of the IRS's Exempt Organizations Handbook contained this observation: “Many charitable foundations do not engage in active charitable undertakings themselves, but rather assist the work of religious, charitable, educational, or similar organizations by contributing money to them. The foundation's funds may be dedicated to purposes, as broad as but no broader than, the purposes set out in IRC [§] 501(c)(3). These foundations are charitable in the broad sense of the word.”⁷¹³

A court observed: “It seems well settled that an organization need not engage in a functional charitable activity to be organized and operated for charitable purposes within the meaning of section 501(c)(3)…. Such charitable purposes may be accomplished solely by providing funds to other exempt organizations.”⁷¹⁴ Another court stated: “In determining whether an activity is organized for educational purposes and so exempt from social security taxes, the purposes for which it spends its income and not the means whereby it obtains income are conclusive.”⁷¹⁵

(b) Application of Commensurate Test

Because the IRS and courts regard grantmaking to charities as charitable activity, the IRS has concerns where the grantor organization is distributing what the agency regards as insubstantial amounts. The IRS has termed these entities “unproductive” fundraising organizations.⁷¹⁶ The agency measures this productivity by means of application of the commensurate test.

Pursuant to the commensurate test, the IRS assesses whether a charitable organization is engaging in program activities that are commensurate in scope with its financial resources.⁷¹⁷ In the facts underlying an IRS pronouncement in 1964, the organization engaged in rental activities and derived most of its income from rents. The organization, nonetheless, was successful in preserving its tax-exempt status as a charity because it satisfied the test by engaging in an adequate amount of charitable functions notwithstanding the extent of its rental activities.⁷¹⁸

The IRS often combines application of the commensurate test with its consideration of the unrelated business rules, usually leading to a favorable outcome for the organization involved when the activity, considered by the organization to be fundraising, is protected from unrelated business income taxation by reason of a statutory exception.⁷¹⁹ As the IRS has said, taken in conjunction with these exceptions, the agency “has often granted IRC [§] 501(c)(3) exemption status to the typical fund raiser [organization] if there has been a sufficient turnover of funds to charity.”⁷²⁰

The IRS has said that, assuming the fundraising activity is not an unrelated business, [recognition of] tax exemption “cannot be legally denied under IRC [§] 501(c)(3)” if the agency “find[s] that the fund raising organization through these events produce commensurately in scope with their financial resources.” “This is true,” the IRS added, “because a commensurately producing typical fund raising organization cannot be held to be organized or operated for the primary purpose of operating a trade or business for purposes of Reg. [§] 1.501(c)(3)-1(e).”⁷²¹

If an organization engages in a form of fundraising but makes few or no distributions for charitable purposes, the organization cannot be tax-exempt as a charitable entity, by reason of the commensurate test. For example, an organization conducted bingo games as its principal activity; its stated purpose was to conduct these games and provide financial assistance for the care of needy children and children's charities. The organization made grants to charitable entities that were insubstantial when compared to the gross receipts from the bingo games. A court held that this organization did not qualify for exemption as a charitable entity because it did not engage in any charitable activities and principally operated the bingo game business.⁷²² Similarly, the IRS ruled that an organization conducting bingo games was not an exempt charitable entity inasmuch as it made no distributions for its ostensible exempt purpose, which was the making of scholarship grants.⁷²³

In sum, rather than following a set percentage formula, a threshold factor of the extent of charitable grantmaking should be fully analyzed in context with all the operative facts. The IRS's lawyers have written:

The “commensurate test” does not lend itself to rigid numerical distribution formulas—there is no fixed percentage of income that an organization must pay out for charitable purposes. The financial resources of any organization may be affected by such factors as start-up costs, overhead, scale of operations, whether labor is volunteer or salaried, phone or postal rates, etc. In each case, therefore, the particular facts and circumstances of the fund-raising organization must be considered. Accordingly, a low payout percentage does not automatically mandate the conclusion that the fund-raising organization under consideration has a primary purpose that is not charitable. In each case, it should be ascertained whether the failure to make real and substantial contributions for charitable purposes is due to a reasonable cause.⁷²⁴

The IRS wrote that “[w]hether an organization is carrying on a real and substantial program reasonably commensurate in scope with its financial resources and capabilities is an essentially factual matter.” In the fundraising context, the IRS stated that a “threshold consideration rests on an organization's production of funds distributed for charitable use.”⁷²⁵

The IRS occasionally fails to apply the commensurate test in the fundraising context, when it should. Following are two examples of this oversight.

An organization functioning as a Mardi Gras society, replete with masked parade and ball, and that promotes cultural festivals, sought recognition of exemption as a charitable entity. The festivals are free to the public, with family activities such as live music and fireworks. It advised the IRS that it attempts to “intertwine the festivals with sharing and preserving the history of local pirates or privateers.” The organization makes grants for charitable and educational purposes. The IRS declined the recognition, ruling that the entity's social and recreational purposes “override” its grantmaking functions.⁷²⁶ This is not the state of the law. The IRS should have applied the commensurate test to determine if the level of grantmaking was commensurate with the organization's resources; if it was, the entity should have been recognized as an exempt charitable organization, with what it does to raise funds being irrelevant.

A nonprofit corporation was formed for “cultivation and promotion of civic and community improvements, to promote social interaction with members, and to promote the sport of fishing” in its region. It advised the IRS that its primary function is to engage in fundraising activities to provide funding for local civic purposes, including a scholarship program. This organization raises funds by holding an annual fishing tournament. About 10 percent of this organization's revenue is used to fund scholarships. The IRS declined to recognize this organization as a tax-exempt charitable entity, on the ground that it is operating for the substantial nonexempt purpose of conducting the fishing tournament.⁷²⁷ Technically, the reasoning in this ruling is incorrect, in that this entity's primary function is fundraising, not operation of a tournament. The conclusion is correct, although it should have been based on failure to satisfy the commensurate test.

(c) Other Exemption Issues

As is the case in many aspects of the law, the general rules can be abused, leading, in this context, to denial of recognition of, or to revocation of, tax-exempt status. The abuses in the fundraising context include, as discussed, failure to meet the commensurate test (because of high administrative and fundraising expenses and/or inadequate distributions for charitable purposes), violation of the private inurement doctrine (such as payment of excessive compensation to a service provider that is an insider or other inappropriate involvement of this type of service provider),⁷²⁸ violation of the private benefit doctrine,⁷²⁹ and/or application of the doctrine of commerciality.⁷³⁰ As the following discussion indicates, it is clear that the IRS will not recognize the exempt status, as a charitable entity, of an organization that facilitates online fundraising for charity and will go to great lengths to adhere to that policy.