CONTENTS INTRODUCTION I. THE SUBSTANTIAL PART TEST A. What We Can Surmise from the Legislative History B. IRS and Treasury Illumination C. Hints from the Courts II. THE EXPENDITURE TEST A. Legislative History B. How it Works C. Benefits of the Expenditure Test III. PROPOSAL I: ABANDON RESTRICTIONS ON LEGISLATIVE ACTIVITY BY PUBLIC CHARITIES A. Policy Reasons For and Against Permitting Unlimited Charitable Legislative Speech 1. Policy Arguments For Unlimited Lobbying 2. Policy Arguments Against Lobbying B. Technical Reasons For and Against Permitting Unlimited Charitable Legislative Speech 1. Technical Reasons For Permitting Unlimited Charitable Legislative Speech 2. Technical Reasons Against Permitting Unlimited Charitable Legislative Speech IV. PROPOSAL II: FIX THE EXPENDITURE TEST A. Expand the List of Eligible Organizations 1. Private Foundations 2. Churches B. Eliminate the $1 Million Cap and Regressive Sliding Scale C. Eliminate the Distinction Between Direct and Grassroots Lobbying D. Other Corrections E. Make the Expenditure Test the Default Test CONCLUSION INTRODUCTION
There is a common misperception among charity (1) leaders and the public that public charities are prohibited from lobbying and legislative activities. Nothing could be further from the truth. As discussed more fully below, section 501(c)(3) of the Internal Revenue Code does restrict the amount of lobbying that charities can do by prohibiting a charity qualifying for exemption from federal income tax under that provision from engaging in legislative activities as a "substantial part" of its activities. (2) Section 170(c)(2)(D) contains a similar restriction for organizations eligible to receive tax-deductible contributions. (3) But charities making an election under section 501(h) are not subject to the "substantial part" test ("Substantial Part Test"). (4) Rather, organizations electing under 501(h) can engage in certain lobbying activity to the extent of specified limits, which are expressed solely in terms of dollar amounts. (5) Section 501(h) permits eligible organizations to elect the "expenditure test" ("Expenditure Test") as a substitute for the Substantial Part Test. (6) In fact, charities that make the 501(h) election can engage in extensive legislative activities, almost without limitation, if the lobbying is properly structured. Confusion over the lobbying limitations imposed by both the Substantial Part Test and the Expenditure Test, rather than any real and substantive limits on lobbying by public charities, actually limits legislative activity by charities. This, in turn, limits the unique benefits that public charities can provide to society.
This Article first explores the Substantial Part Test and the Expenditure Test, focusing on their basic structures and the legislative history surrounding the enactment of each test. The next Part examines the policy reasons for permitting public charities to lobby without restriction (7) and notes the lack of convincing policy explanations for the restrictions contained in the Code.
The Article concludes that the restrictions on lobbying under 501(c)(3) are ambiguous, confusing, and ineffective. Indeed, most charities electing the Expenditure Test under section 501(h) can lobby extensively, provided that the charity properly structures its lobbying to take advantage of the liberal rules and definitions under section 501(h) and utilizes "cheap" methods of lobbying. Given the benefits of increased and improved legislative discourse through lobbying by charities and the inefficacy and innate complexity of the restrictions on lobbying, section 501(c)(3) should be amended to permit unlimited legislative activities by all public charities. As a distant second choice, this Article suggests improving and simplifying the Expenditure Test and making it the default test for legislative activities by public charities.
THE SUBSTANTIAL PART TEST
The Substantial Part Test, derived from the language of section 501(c)(3), is the standard used to measure the lobbying activity of most public charities. (8) Section 501(c)(3) provides that organizations organized and operated for certain specified purposes will be entitled to exemption from federal income tax if, inter alia, "no substantial part of the [organization's] activities ... is carrying on propaganda, or otherwise attempting, to influence legislation (except as otherwise provided in subsection (h))...." (9) Accordingly, the Substantial Part Test causes an organization to lose its exemption (and incur an excise tax) if a "substantial part" of the organization's activities consist of carrying on propaganda or otherwise attempting to influence legislation. (10) An organization that fails the Substantial Part Test becomes an action organization, and is deemed not to be operated exclusively for exempt purposes. (11) Organizations that forfeit exemption for flunking the Substantial Part Test also are subject to an excise or penalty tax in an amount equal to 5 percent of lobbying expenditures incurred in the year that exemption is lost. (12) Managers also may be subject to penalty taxes. (13) A 501(c)(3) organization is subject to the Substantial Part Test unless it affirmatively elects the Expenditure Test. (14) In other words, the Substantial Part Test is the default test for determining whether an organization has engaged in excessive lobbying.
The Substantial Part Test is an entirely subjective test. No one, including the Internal Revenue Service ("Service" or "IRS"), knows when lobbying becomes "substantial." (15) Courts (and presumably the IRS as well) generally make the determination of substantiality by applying a balancing, or facts-and-circumstances, test. (16) The results are both imprecise and inconsistent. (17) Although a few early cases attempted to devise a quantitative test, (18) more recently, courts have opted for a more subjective balancing test under which all of the facts and circumstances are weighed "in the context of the objectives and circumstances of the organization." (19) This balancing test is no more than a "smell test"; it is quite vague and provides almost no guidance to an organization wishing to influence legislation in furtherance of its exempt purposes without jeopardizing its exempt status.
In addition to absence of clarity on the concept of substantiality, critical concepts and terms are undefined under the Substantial Part Test. Even the term "lobbying" is not well defined. The Substantial Part Test fails even to address consistently the fundamental question of what activities lobbying is to be measured against. (20)
The most significant danger of the vagueness in the Substantial Part Test is its propensity to scare charities into non-activity on the legislative front with its lack of direction and guidance and the severity of its penalty. (21) Furthermore, the lack of clarity in the Substantial Part Test may actually provide flexibility for charities not interested in compliance to circumvent limitations on lobbying. The Subcommittee on Oversight suggested in 1987 that "the opportunities for some exempt organizations to circumvent the law today are too numerous." (22) It said of the Substantial Part Test:
[T]he penalty that generally exists for violation of these rules and restrictions by a tax-exempt organization, i.e., revocation of an organization's tax-exempt status, is often inappropriate and ineffective and can have little deterrent effect. For those organizations deeply concerned about being in complete compliance of the law, the lack of clear guidelines coupled with the threat of the revocation sanction may inhibit many organizations from engaging in even permissible activities. (23) As the two men with primary responsibility for drafting and reviewing the 1988 Treasury regulations promulgated under section 501(h) surmised, "the Subcommittee found that the statutory and regulatory provisions governing lobbying by charities fail to deter abusers, but do deter nonabusers." (24) Both Congress and Treasury evidently were aware of the shortcomings of the Substantial Part Test and its negative impact on the voice of the charitable sector.
What We Can Surmise from the Legislative History
The Substantial Part Test was added to the Code in 1934. (25) The rationale for its introduction is unclear, and the legislative history is sparse. (26) Both the available legislative history and its sparseness, however, may be instructive as to congressional intent. (27)
There appears to have been little initial controversy among Senate Finance Committee members when the idea of limiting the ability of charities to lobby was first introduced at a committee meeting on March 21, 1934. In contrast to many of the other motions passed that day, Committee Chairman Pat Harrison's motion that, "no deductions from gross income should be allowed in the case of contributions made to organizations carrying on propaganda, attempting to influence legislation or participating in partisan politics" passed without requiring even a "record vote" and was not debated. (28) This apparent ease of passage is particularly noteworthy because the motion appears far broader than the eventual codified language. (29) Harrison's motion seems to imply that there would be no deduction for an organization "carrying on" any lobbying activities. (30)
The gap in the legislative history between introduction and vote is somewhat surprising. By the time the amendment had been submitted to the entire House of Representatives on April 2, 1934, language specifying that disqualification would occur only where a "substantial part" of an organization's activities were lobbying-related had been added to the amendment. (31) Senator Harrison may not, however, have considered this language significant to his motion in committee, as he introduced a large group of the Finance Committee's amendments on the floor (including the new "no substantial part"...