Federal taxation of the political process.

• Author: Dellinger, Kip

EXECUTIVE SUMMARY

* Campaign finance laws are numerous, extensive and vastly different depending on whether Federal, state or local elections are involved, as each type of jurisdiction has its own rules.

* A political organization is usually created when its sponsors notify the Federal, state or local government of the formation of an organization to make expenditures for an exempt function.

* Sec. 527(e)(2) defines "exempt function" as the function of influencing or attempting to influence the selection, nomination, election or appointment of any individual to any Federal, state or local public office or office in a political organization, or the election of Presidential or Vice-presidential electors.

A candidate runs for office. What kind of organization is created? How is it taxed? What kinds of political activities can it engage in without losing exempt status? This article explains these issues and others that might arise in representing a political candidate, officeholder or organization.

Although politics play the lead role in the formation of all Federal tax law, the taxation of the various participants in the political process is not a frequent topic of conversation or analysis. Taxation of the political process and its participants is not an easy subject to grasp.

For the most part, the tax laws applicable in the political arena are a hodgepodge originating from a series of responses to various alleged "wrongs" or as a by-product of campaign finance legislation or reform. As a result, the tax law in this area is scattered throughout the Code in a rather haphazard fashion. For the practitioner suddenly confronted with a client subject to taxation of the political process--e.g., a political candidate, charity or corporation engaged in lobbying or other political activities or a political action committee (PAC)--navigating the Byzantine world of political money and its tax ramifications can be a daunting task.

Federal tax law contains two sets of rules on political expenditures. One set applies to the election of public officials at all levels of government; the second applies to expenditures intended to influence elected public officials on legislation, regulation and the appointment of persons to various positions in government or the judiciary. This article will discuss the first set of rules.

Campaign Finance Issues

Campaign finance laws are numerous, extensive and vastly different depending on whether Federal, state or local elections are involved, as each type of jurisdiction has its own rules. This article will focus solely on the Federal tax aspects of the political process and not address campaign finance issues. Nonetheless, there is some discussion of the various types of political expenditures to provide a framework for the relationship of such expenditures to the tax law.

Political Organizations

Sec. 527 provides the framework for political organizations. Such organizations--consisting principally of candidate committees, PACs and political party organizations--are the primary vehicles for the receipt and expenditure of political funds.

Organizational and Operational Framework

There is generally no specific form (e.g., trust, association, corporation) of organization for a political entity. Instead, a political organization is usually created when its sponsors notify the Federal, state or local government of the formation of an organization to make expenditures for an exempt function. Sec. 527(e)(2) defines "exempt function" as the function of influencing or attempting to influence the selection, nomination, election or appointment of any individual to any Federal, state or local public office or office in a political organization, or the election of Presidential or Vice-presidential electors.

A political organization may be a formal entity (e.g., an association, corporation or trust) or an informal one (e.g., a bank account). Prudence dictates that informal arrangements clearly reflect the facts and circumstances to ensure political organization status (e.g., 1998 John Jones State of x Senate Campaign Fund). If an individual maintains the funds for his own campaign, they must be clearly segregated from his other, personal funds, according to Regs. Sec. 1.527-2(b)(1).

Sec. 527 does not require formal operational characteristics such as adhering to by-laws, maintaining minutes, etc. Regs. Sec. 1.527-2(a)(3) explicitly provides that a political organization does not have to engage exclusively in exempt function activities. To date, the IRS has not elaborated on the level of expenditures or activities necessary to satisfy the primary purpose test. However, it has issued letter rulings granting political organization status to organizations that promote the passage or defeat of ballot initiatives and legislation, when the primary purpose of such activities was to secure the election of candidates for public office.(1) Otherwise, individuals, committees or similar groups that expend money to support or oppose ballot measures or initiatives ordinarily do not qualify for political organization status.(2) As a result, many of the potential tax implications associated with these campaigns and expenditures are unclear and have yet to be resolved. However, Sec. 501(c)(4)(A), (5) and (6) (i.e., social welfare, labor and business league organizations) are often used for such purposes,(3) because they can engage in some legislative and political activities.

PACs: The PAC is a creature of Federal election law(4); it is not defined in the tax law. States also have passed enabling legislation for PACs. For tax purposes, a PAC is ordinarily a "separate segregated fund" (SSF) defined in Sec. 527(f)(3) (discussed below under "Political Expenditures"). SSFs are usually established by Sec. 501(c) social welfare organizations, trade associations and business leagues. Sec. 501(c)(3) organizations (i.e., those formed for charitable, educational or religious purposes) cannot establish SSFs, except in very limited circumstances. They are prohibited from intervening in political campaigns.(5)

Unions, corporations and membership organizations can sponsor political organizations via "segregated funds" (not SSFs) to support candidates for public office. Under Federal and state election laws, the sponsor is generally permitted to fund the administrative costs and engage in limited fundraising for these organizations. These organizations are also commonly referred to as PACs.

Under Federal election law, multiple candidate political organizations are often formed by individuals (including public officeholders--e.g., Newt Gingrich's GOPAC) or groups of individuals. These are referred to as non-connected organizations and are also commonly known as PACs.(6)

While PACs formed under some state laws are permitted to engage in lobbying activities and ballot measure advocacy, if these activities are significant or the organization's only activities, it does not qualify as a political organization...