Armanino Blog

Nonprofit Tax Issues Part 2: Political Activity, Grants

by Kelly Gillette
May 08, 2017

With Form 990 filing season coming up, your nonprofit’s governance practices will soon be scrutinized by the IRS, donors and potential funders.  To protect your tax-exempt status and your mission, you need to make sure these stakeholders have a full understanding of your organization’s activities and how they further support your exempt purpose, including your political activities and grants or contributions to foreign entities.

Political Activity
For many nonprofits, advocacy is a core part of their mission and tax-exempt purpose. Public charities are prohibited from supporting or opposing a candidate for public office, but they can engage in non-partisan activities, such as voter education and voter registration.

Nonprofits are even permitted to lobby for specific legislation, if those activities are an “insubstantial part” of the nonprofit’s overall activities. These political and lobbying activities must be reported on Schedule C of the Form 990.

The challenge, however, is that the IRS has not drawn a clear line regarding what “substantial” means, stating that it considers facts and circumstances such as time and expenditures devoted by the organization to the activity.

Lobbying expenditures can mushroom into “substantial” territory unexpectedly. If your organization gets swept up lobbying against a new piece of legislation that has a direct negative impact on your constituents, and your other expenses are more modest than expected, your lobbying efforts can suddenly appear to be significant.

To avoid this scenario, nonprofits should consider filing Form 5768, Election/Revocation of Election by an Eligible IRC Section 501(c)(3) Organization to Make Expenditures to Influence Legislation. This simple form allows nonprofits to elect the less onerous “expenditure test,” which provides clear guidelines regarding the permissible amount of lobbying activity.

For organizations with $500,000 or less in exempt purpose expenditures, the permissible amount is 20% of the exempt purpose expenditures. Organizations that exceed their limit must pay an excise tax equal to 25% of the excess, but they will not lose their tax-exempt status, unless they engage in excessive lobbying over a four-year period.

By contrast, Section 501(c)(3) organizations that fail the nebulous “substantial part test” are at risk of losing their tax-exempt status plus paying an excess tax equal to 5% of their lobbying expenditures for the year, and a 5% tax can also be imposed upon certain organization managers, jointly and severally.

Foreign Grants and Contributions
Fighting terrorism might not seem to be a nonprofit tax issue. However, if your organization distributes funds to foreign organizations, the U.S. government expects you to keep an eye on how those funds are used—both to make sure they further the organization’s exempt purpose and to keep those assets out of the hands of terrorists.

The IRS requires Form 990 filers to fully describe their policies regarding the oversight of funds granted to foreign organizations in a number of scenarios, including if you provide more than $5,000 of grants or assistance to a foreign organization. Private foundations have additional expenditure responsibilities, and public charities that issue grants from donor-advised funds are bound by the same restrictions.

The stakes are high. If a U.S. public charity distributes funds to foreign organizations and (in the view of the IRS) does not exercise reasonable care to ensure those funds are used for charitable purposes, it could lose its tax-exempt status.

So how does a nonprofit demonstrate that it is in control of its foreign grants or other contributions? These are a few best practices that can help keep your organization on the right side of the law:

  • Make sure organizational bylaws state that the board of directors retains discretion and control of funds contributed to any other charity.
  • Any grant agreement should state how the funds will be used and how often the recipient will report back on the use of those funds.
  • Adopt the U.S. Treasury Department’s voluntary best practices for charities to comply with anti-terrorist financing guidelines.
  • Before making an overseas gift or grant, check to see if the recipient is on the Office of Foreign Assets Control sanctions list of individuals and organizations.

Know Your Requirements
A tricky thing about Form 990 is that you don’t know what you don’t know. If your nonprofit only sporadically engages in political activities or makes infrequent foreign grants, it can be all too easy to miss one of these requirements and end up with an incomplete return—which can lead to substantial late filing penalties or even trigger an audit.

If you have questions about your organization’s Form 990, talk to your local Armanino nonprofit expert.

May 08, 2017

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