501(c)(3) and 501(c)(6) Issues For Medical Societies

Richard N. Peterson
General Counsel
American Academy of Orthopaedic Surgeons
March 2005

1. 501(c)(3) Organizations
   1. Requirements for 501(c)(3) Organizations

      Section 501(c)(3) of the Internal Revenue Code (IRC) exempts from federal taxation certain organizations organized and operated exclusively for “religious, charitable, scientific or educational purposes.” Some medical societies are 501(c)(3) organizations because of their educational functions. The IRS defines an “educational purpose” to be “the instruction or training of the individual for the purpose of improving or developing his capabilities, or the instruction of the public on subjects useful to the individual and beneficial to the public.”

      An organization must meet three requirements to qualify and remain a 501(c)(3) organization. They are:

      1. The organization must be organized and operated exclusively for charitable purposes;

      2. No part of the net earnings of the charitable organization may inure to the benefit of private individuals; and

      3. No substantial part of the activities of the organization can be devoted to lobbying or propaganda, and the organization cannot intervene in or participate in any political campaign on behalf of or against a candidate.

   2. What Constitutes Lobbying for IRS Purposes?

      The third requirement regarding lobbying has been of great interest to the medical societies in recent years. The IRC defines “lobbying” as “an attempt to influence legislation,” which in turn is broadly defined to include almost anything with which a legislature deals, including bills, referenda, constitutional amendments, etc. For IRS purposes, the term “lobbying” includes both federal and state lobbying as well as both grass roots lobbying (e.g. campaigns to solicit public letter writing or phone calling to influence legislation) and direct communications with legislators or legislative employees to influence federal, state or local legislation. For IRS purposes, lobbying does not include communications regarding regulations or administrative matters since no legislation is directly involved.

      The IRC allows 501(c)(3) organizations to participate in certain activities which otherwise might be consider lobbying. They include:

      1. Making the results of non-partisan analysis, studies and research available to the legislative body;

      2. Giving technical advice or assistance to a legislative body (or one of its committees), upon the written request of the legislative body;

      3. Communicating with members of the organization about legislation or proposed legislation that deals with matters of direct interest to the organization and/or its members [Mailings and other communications are not considered lobbying unless they state a position on specific legislation and directly encourage the recipient to take action. If the intent of the organization’s communication to its membership is for the members to influence legislation by communicating with a legislator or employees of a legislative body, it would be considered lobbying];

      4. Communicating with a government employee who is not a legislator or employee of a legislative body; and

      5. Communicating with any legislative official or employee, but only when the principal purpose of communication is not to influence legislation.

      If the communication regarding legislation does not fall into one of the above categories, it would likely be considered lobbying. As stated above, the IRC provides that “no substantial part of the activities of the [501(c)(3)] organization can be devoted to lobbying or propaganda.” The definition of “substantial” has been interpreted by both the courts and the U.S. Congress in IRC Sect. 501(h).

   3. The Court-Created Substantiality Test

      The courts have adopted certain factors that they will consider in determining whether a 501(c)(3) organization’s lobbying activities are impermissibly high, constituting a “substantial part” of its overall activities. Depending on the court and each organization’s unique facts, these factors include:

      1. If the organization uses less than 15% of its annual budget for lobbying, its lobbying activities are not usually considered substantial;

      2. The role of lobbying in the context of the organization’s overall activities;

      3. The quality and nature of the lobbying (passive vs. active);

      4. The extent to which the organization’s lobbying is tied to its charitable purpose, the more likely it is to be permissible;

      5. Whether the lobbying is accompanied by advertisements and public solicitation, in which case it is less likely to be permissible.

      Under the court-created substantiality test, there is only one sanction for excessive lobbying: revocation of the organization’s 501(c)(3) status.

   4. The IRC 501(h) Election

      In 1976, Congress enacted the IRC Sect. 501(h) “safe harbor” to establish specific monetary limits on the amount of lobbying in which a 501(c)(3) organization can participate without its running afoul of the IRS. A 501(c)(3) organization may elect to come under the provisions of IRC Sect. 501(h) or it may decide to be bound by the court-created substantiality test.

      If a 501(c)(3) organization elects to come under IRC Sect. 501(h), it is permitted to spend up to a specific amount on lobbying activities. Under IRC 501(h), the organization’s permitted amount of lobbying expenditures is determined on a sliding scale. The limit (for the combination of direct and grass-roots lobbying) is:

      1. 20% of the first $500,000 of the organization’s expenditures for exempt purposes for the year, plus

      2. 15% of the second $500,000, plus

      3. 10% of the third $500,000, plus

      4. 5 % of any additional expenditures.

      In no event may the total amount of lobbying expenditures exceed $1,000,000 in any one year.

      Within this limit, a separate limit is placed on grass-roots lobbying. The amount attributable to grass roots lobbying may not exceed one-fourth of the total lobbying amount permitted (and consequently, cannot in any circumstance exceed $250,000 in any one year).

      Under IRC Sect. 501(h), disclosures of lobbying expenditures must be made to the IRS each year. If the organization exceeds the lobbying expenditure ceilings, the IRS will impose a penalty equivalent to a 25% excise tax. This may be viewed as a “warning shot” that the organization must carefully monitor its lobbying expenditures in future years. The organization’s 501(c)(3) status will be revoked if its expenditures for lobbying exceed the amount permitted by the calculated amount over a four-year period by 150%. Once the organization makes the IRC 501(h) election (by filing Form 5768), the election will extend to future tax years until it is revoked.

2. 501(c)(6) Organizations
   1. 501(c)(6) Organizations: Definition and Requirements

      Professional associations, business leagues, chambers of commerce and boards of trade are exempt from federal taxes under IRC Sect. 501(c)(6). Many medical societies are classified as 501(c)(6) organizations, particularly if they were organized during the 1970s or later. While a member’s dues to 501(c)(6) professional association are not deductible as charitable expenses, a large portion of the dues in such organizations may be deductible as a business expense (to the extent the dues do not involve lobbying expenses).

      An organization must meet all of the following requirements to qualify or remain a 501(c)(6) organization:

      1. The organization must not be organized for-profit;

      2. No part of the net earnings of the organization may inure to the benefit of any private shareholder or individual;

      3. The organization must be an association of persons or organizations having a common business interest;

      4. The organization’s purpose must be to promote a common business interest or interests. The IRS has construed “business” broadly to include almost any enterprise or activity conducted for remuneration;

      5. The activities of the organization must be directed to the improvement of conditions of one or more lines of business;

      6. The organization must not be engaged regularly in a business of the kind ordinarily carried on for profit;

      7. The activities of the organization must not be confined to the performance of particular services for individual members; and

      8. The organization must be a business league and in the same general class as a chamber of commerce or board of trade. The IRC defines a “business league” as “an association of persons who have some common business interest, the purpose of which is to promote such common interest and not to engage in a regular business of a kind ordinarily carried on for profit.”

   2. 501(c)(6) Professional Associations and Lobbying

      501(c)(6) professional associations are not limited regarding the extent to which they may engage in lobbying activities. In fact, the IRS has granted 501(c)(6) tax exemptions to groups whose activities are entirely lobbying. However, 501(c)(6) professional associations will have the deductibility of their members’ dues reduced to the extent of the associations’ expenditures for lobbying.

   3. 501(c)(6) Association Lobbying and Deductibility of Members’ Dues
      1. General

         The Omnibus Budget Reconciliation Act of 1993 provides that a member’s dues to a 501(c)(6) professional association are not deductible as business expenses to the extent of that association’s expenditures for lobbying (as compared to the association’s overall expenditures). For purposes of this Act, lobbying expenditures include not only communications with legislators and employees of legislative bodies, but also certain high level federal government officials. The definition of lobbying is also expanded to include the professional association’s research, preparation, planning and coordination to support attempts to influence legislation.

      2. Notice to the Member

         The 1993 Act requires professional associations to notify their members of the percentage of their dues are non-deductible as business expenses because of the association’s anticipated lobbying expenditures. In addition, the professional association must allocate all expenditures for federal and state lobbying against dues and similar income received by the association.

         As an alternative to informing the professional association members that the entire amount of their dues are not tax deductible as business expenses, associations may chose to pay a flat 35% proxy tax on their lobbying expenditures. This would allow the association to avoid notifying its members of the amount of dues deductibility.

      3. Reporting to the IRS

         Under the 1993 Act, a 501(c)(6) professional association must report annually to the IRS the total amount of lobbying expenditures and the total amount of dues and similar income to which the lobbying expenditures are allocated to determine dues deductibility. Lobbying expenditures incurred in a year are allocated against dues and similar income received during the same year.

   4. Funding of the 501(c)(6) Professional Association
      1. No Transfer of 501(c)(3) Assets Possible

         One of the most difficult issues in the creation of a 501(c)(6) professional association is its initial funding. If the association is expected to be active from the beginning, it will need to have sufficient resources (financial and staff) to perform its functions. A 501(c)(3) organization cannot directly contribute any funds to any other group than another 501(c)(3) organization, so the 501(3) organization’s reserves cannot be used to fund a new 501(c)(6) professional association.

         It is interesting to note that if the 501(c)(6) professional association were to become successful financially, it could give money to a 501(c)(3) organization.

      2. Possible Revenue Streams to Initially Fund a 501(c)(6) Professional Association

         If the 501(c)(3) medical society were to develop a new 501(c)(6) professional association, at least two revenue streams exist which could help to initially fund it. They are:

         • All membership dues (if the 501(c)(6) were a membership organization); and

         • Division of and assignment of certain of the 501(c)(3) organization’s current revenue-generating activities to the 501(c)(6) organization.

         The revenue streams are not mutually exclusive; it would be possible to employ both, at least for the initial funding of the 501(c)(6) organization.

3. Political Action Committees - affiliated with 501(c)(6) Professional Associations
   1. General

      501(c)(6) professional associations may solicit funds and make contributions to candidates for federal office through Political Action Committees (PACs). The Federal Election Campaign Act of 1971, as amended, permits the formation of PACs by corporations, included professional associations, and allows the corporations to pay the costs of organizing, operating and soliciting contributions to the PAC. Federal legislation, Federal Election Commission (FEC) regulations, and IRS advisory opinions provide detailed guidance for establishing and administering PACs.

   2. Reasons for a Professional Association to Have a PAC

      According to Jacobs, Association Law Handbook, reasons for a 501(c)(6) professional association to form and operate a PAC include:

      1. To direct campaign funds to candidates for federal office;

      2. To help effectively present positions on legislative matters important to the association by aiding the campaigns of candidates who support the passage of such legislation;

      3. To counterbalance the influence of campaign funding and lobby groups already taking strong positions on federal legislative matters;

      4. To give notice that a professional association is interested in affecting the government process generally and with respect to specific issues;

      5. To take advantage of higher limits on PAC contributions to candidates than are permitted by individual contributors;

      6. To provide a convenient and direct way for professional association members to support election campaigns--with significant tax advantages; and

      7. To involve professional association members in the political process.

   3. How Professional Association PACs are Successful

      A number of professional associations have met their goals for the receipt of PAC contributions and in reinforcing their government affairs efforts by making contributions to candidates sympathetic to their legislative positions. These PACs have been successful because they have made:

      1. Conscientious attempts to establish and administer the PAC in full compliance with all applicable law and regulations;

      2. Consistent professional efforts at effective fund-raising through direct mail, presentations at meetings, and personal contact with professional association members;

      3. Systematic distribution of PAC contributions to candidates to further the legislative aims of the professional association by supporting candidates who support the association’s objectives, regardless of party affiliation; and

      4. Pacing of PAC activities to ensure momentum is carried over from election years to non-election years.

   4. Use of 501(c)(6) Professional Association Funds To Operate the PAC

      Professional association funds may be used to pay for PAC administrative and solicitation costs. Professional association funds cannot be used as contributions to the PAC or as contributions to political candidates through the PAC. Examples of administrative costs that may be paid by 501(c)(6) professional association funds include:

      • Printing, mailing, and other expenses for PAC solicitations;

      • Salaries of PAC employees or professional association employees assigned to the PAC;

      • Rent and other expenses in maintaining the PAC offices; and

      • Fees of attorneys, accountants, or other professional advisors to the PAC.

      In addition, professional associations may donate merchandise for PAC fund-raising.

   5. Who Can Be Solicited by the Professional Association PAC

      Generally, a professional association PAC may solicit contributions only from individual members of the association and from association staff, and then under certain, circumscribed circumstances. A PAC may not solicit or accept contributions from corporations. A professional association PAC may not accept a contribution from an individual who is not a U.S. citizen, contributions made in the name of another individual or corporation, or more than $5000 from any one individual in a year.

   6. Check-Offs on Member Dues Statements

      The FEC has advised that a 501(c)(6) professional association may place a voluntary check-off designation for a PAC contribution on its dues statements as long as no corporate PAC contributions are solicited and no portion of the dues is used as a political contribution. A suggested PAC contribution amount, but not a minimum amount, also may be used if it is made clear that one may contribute more or less than the suggested amount (include no contribution) with no adverse consequences or reprisals of any kind.

   7. Implications of the 1993 Lobbying Act

      The professional association’s expenses in administering the PAC are considered lobbying for purposes of the 1993 Act disallowing federal income tax deductibility for association members’ dues to the extent of the association’s lobbying expenses.

TF – C6: 501(c)(6) Basics