Private Operating Foundations

Some private foundations qualify as private operating foundations. These are types of private foundations that, although lacking general public support, make qualifying distributions directly for the active conduct of their educational, charitable, and religious purposes, as distinct from merely making grants to other organizations for these purposes.

Most of the restrictions and requirements that apply to private foundations also apply to private operating foundations. However, there are advantages to being classified as a private operating foundation. For example, a private operating foundation (as compared to a private foundation) can be the recipient of grants from a private foundation without having to distribute the funds received currently within 1 year, and the funds nevertheless may be treated as qualifying distributions by the donating private foundation; charitable contributions to a private operating foundation qualify for a higher charitable deduction limit on the donor's tax return; and the excise tax on net investment income does not apply to an exempt operating foundation.

Private operating foundation   means any private foundation that meets the assets test, the support test, or the endowment test, and makes qualifying distributions directly, for the active conduct of its activities for which it was organized, of substantially all (85% or more) of the lesser of its:

1. Adjusted net income, or
2. Minimum investment return.

Assets test.   A private foundation will meet the assets test if substantially more than half (65% or more) of its assets are:

1. Devoted directly to the active conduct of its exempt activity, to a functionally related business, or to a combination of the two,
2. Stock of a corporation that is controlled by the foundation (by ownership of at least 80% of the total voting power of all classes of stock entitled to vote and at least 80% of the total shares of all other classes of stock) and substantially all (at least 85%) the assets of which are devoted as provided above, or
3. Any combination of (1) and (2).

This test is intended to apply to organizations such as museums and libraries.

Support test.   A private foundation will meet the support test if:

1. Substantially all (at least 85%) of its support (other than gross investment income) is normally received from the general public and five or more unrelated exempt organizations,
2. Not more than 25% of its support (other than gross investment income) is normally received from any one exempt organization, and
3. Not more than 50% of its support is normally received from gross investment income.

This test is intended to apply to special-purpose foundations, such as learned societies and associations of libraries.

Endowment test.   A foundation will meet the endowment test if it normally makes qualifying distributions directly for the active conduct of its exempt function of at least two-thirds of its minimum investment return.

The minimum investment return for any private foundation for any tax year is 5% of the excess of the total fair market value of all assets of the foundation (other than those used directly in the active conduct of its exempt purpose) over the amount of indebtedness incurred to acquire those assets.

In determining whether the amount of qualifying distributions is at least two-thirds of the organization's minimum investment return, the organization is not required to trace the source of the expenditures to determine whether they were derived from investment income or from contributions.

This test is intended to apply to organizations such as research organizations that actively conduct charitable activities but whose personal services are so great in relationship to charitable assets that the cost of those services cannot be met out of small endowments.

Exempt operating foundations.   The excise tax on net investment income does not apply to an exempt operating foundation. An exempt operating foundation for the tax year is any private foundation that:

1. Is an operating foundation, as described previously,
2. Has been publicly supported for at least 10 tax years or was an operating foundation on January 1, 1983, or for its last taxable year ending before January 1, 1983,
3. Has a governing body that, at all times during the tax year, is broadly representative of the general public and consists of individuals no more than 25% of whom are disqualified individuals, and
4. Does not have any officer, at any time during the tax year, who is a disqualified individual.

The foundation must obtain a ruling letter from the IRS recognizing this special status.

New organization.   If you are applying for recognition of exemption as an organization described in section 501(c)(3) and you wish to establish that your organization is a private operating foundation, you should complete Schedule E of your exemption application (Form 1023).

Lobbying Expenditures

In general, if a substantial part of the activities of your organization consists of carrying on propaganda or otherwise attempting to influence legislation, your organization's exemption from federal income tax will be denied. However, a public charity (other than a church, an integrated auxiliary of a church or of a convention or association of churches, or a member of an affiliated group of organizations that includes a church, etc.) may avoid this result. Such a charity can elect to replace the substantial part of activities test with a limit defined in terms of expenditures for influencing legislation. Private foundations cannot make this election.

Making the election.    Use Form 5768, Election/Revocation of Election By an Eligible Section 501(c)(3) Organization To Make Expenditures To Influence Legislation, to make the election. The form must be signed and postmarked within the first tax year to which it applies. If the form is used to revoke the election, it must be signed and postmarked before the first day of the tax year to which it applies.

Eligible section 501(c)(3) organizations that have made the election to be subject to the limits on lobbying expenditures must use Part VI - A of Schedule A (Form 990) to figure these limits.

Attempting to influence legislation.   Attempting to influence legislation, for this purpose, means:

1. Any attempt to influence any legislation through an effort to affect the opinions of the general public or any segment thereof (grass roots lobbying), and
2. Any attempt to influence any legislation through communication with any member or employee of a legislative body or with any government official or employee who may participate in the formulation of legislation (direct lobbying).

However, the term attempting to influence legislation does not include the following activities.

1. Making available the results of nonpartisan analysis, study, or research.
2. Examining and discussing broad social, economic, and similar problems.
3. Providing technical advice or assistance (where the advice would otherwise constitute the influencing of legislation) to a governmental body or to a committee or other subdivision thereof in response to a written request by that body or subdivision.
4. Appearing before, or communicating with, any legislative body about a possible decision of that body that might affect the existence of the organization, its powers and duties, its tax-exempt status, or the deduction of contributions to the organization.
5. Communicating with a government official or employee, other than:
   1. A communication with a member or employee of a legislative body (when the communication would otherwise constitute the influencing of legislation), or
   2. A communication with the principal purpose of influencing legislation.

Also excluded are communications between an organization and its bona fide members about legislation or proposed legislation of direct interest to the organization and the members, unless these communications directly encourage the members to attempt to influence legislation or directly encourage the members to urge nonmembers to attempt to influence legislation, as explained earlier.

Lobbying expenditures limits.   If a public charitable organization makes the election to be subject to the lobbying expenditures limits rules (instead of the substantial part of activities test), it will not lose its tax-exempt status under section 501(c)(3), unless it normally makes lobbying expenditures that are more than 150% of the lobbying nontaxable amount for the organization for each tax year or normally makes grass roots expenditures that are more than 150% of the grass roots nontaxable amount for the organization for each tax year. See Tax on excess expenditures to influence legislation, later, in this section.

Lobbying expenditures.   These are any expenditures that are made for the purpose of attempting to influence legislation, as discussed earlier under Attempting to influence legislation.

Grass roots expenditures.   This term refers only to those lobbying expenditures that are made to influence legislation by attempting to affect the opinions of the general public or any segment thereof.

Lobbying nontaxable amount.   The lobbying nontaxable amount for any organization for any tax year is the lesser of $1,000,000 or:

1. 20% of the exempt purpose expenditures if the exempt purpose expenditures are not over $500,000,
2. $100,000 plus 15% of the excess of the exempt purpose expenditures over $500,000 if the exempt purpose expenditures are over $500,000 but not over $1,000,000,
3. $175,000 plus 10% of the excess of the exempt purpose expenditures over $1,000,000 if the exempt purpose expenditures are over $1,000,000 but not over $1,500,000, or
4. $225,000 plus 5% of the excess of the exempt purpose expenditures over $1,500,000 if the exempt purpose expenditures are over $1,500,000.

The term exempt purpose expenditures means the total of the amounts paid or incurred (including depreciation and amortization, but not capital expenditures) by an organization for the tax year to accomplish its exempt purposes. In addition, it includes:

1. Administrative expenses paid or incurred for the organization's exempt purposes, and
2. Amounts paid or incurred for the purpose of influencing legislation, whether or not the legislation promotes the organization's exempt purposes.

Exempt purpose expenditures do not include amounts paid or incurred to or for:

1. A separate fundraising unit of the organization, or
2. One or more other organizations, if the amounts are paid or incurred primarily for fundraising.

Grass roots nontaxable amount.   The grass roots nontaxable amount for any organization for any tax year is 25% of the lobbying nontaxable amount for the organization for that tax year.

Years for which election is effective.   Once an organization elects to come under these provisions, the election will be in effect for all tax years that end after the date of the election and begin before the organization revokes this election.

Note.   These elective provisions for lobbying activities by public charities do not apply to a church, an integrated auxiliary of a church or of a convention or association of churches, or a member of an affiliated group of organizations that includes a church, etc., or a private foundation. Moreover, these provisions will not apply to any organization for which an election is not in effect.

Expenditures of affiliated organizations.   If two or more section 501(c)(3) organizations are members of an affiliated group of organizations and at least one of these organizations has made the election regarding the treatment of certain lobbying expenditures, then the determination as to whether excess lobbying expenditures have been made and the determination as to whether the expenditure limits, described earlier, have been exceeded by more than 150% will be made as though the affiliated group is one organization.

If the group has excess lobbying expenditures, each organization for which the election is effective for the year will be treated as an organization that has excess lobbying expenditures in an amount that equals the organization's proportionate share of the group's excess lobbying expenditures. Further, if the expenditure limits, described in this section, are exceeded by more than 150%, each organization for which the election is effective for that year will lose its tax-exempt status under section 501(c)(3).

Two organizations will be considered members of an affiliated group of organizations if:

1. The governing instrument of one of the organizations requires it to be bound by decisions of the other organization on legislative issues, or
2. The governing board of one of the organizations includes persons who:
   1. Are specifically designated representatives of the other organization or are members of the governing board, officers, or paid executive staff members of the other organization, and
   2. Have enough voting power to cause or prevent action on legislative issues by the controlled organization by combining their votes.

Tax on excess expenditures to influence legislation.    If an election for a tax year is in effect for an organization and that organization exceeds the lobbying expenditures limits, an excise tax of 25% of the excess lobbying expenditures for the tax year will be imposed. Excess lobbying expenditures for a tax year, in this case, means the greater of:

1. The amount by which the lobbying expenditures made by the organization during the tax year are more than the lobbying nontaxable amount for the organization for that tax year, or
2. The amount by which the grass roots expenditures made by the organization during the tax year are more than the grass roots nontaxable amount for the organization for that tax year.

Eligible organizations that have made the election to be subject to the limits on lobbying expenditures and that owe the tax on excess lobbying expenditures (as computed in Part VI - A of Schedule A (Form 990)) must file Form 4720, Return of Certain Excise Taxes on Charities and Other Persons Under Chapters 41 and 42 of the Internal Revenue Code, to report and pay the tax.

Organization that no longer qualifies.   An organization that no longer qualifies for exemption under section 501(c)(3) because of substantial lobbying activities will not at any time thereafter be treated as an organization described in section 501(c)(4). This provision, however, does not apply to certain organizations (churches, etc.) that cannot make the election discussed earlier.

Tax on disqualifying lobbying expenditures.    The law imposes a tax on certain organizations if they no longer qualify under section 501(c)(3) by reason of having made disqualifying lobbying expenditures. An additional tax may be imposed on the managers of those organizations.

Tax on organization.   Organizations that lose their exemption under section 501(c)(3) due to lobbying activities generally will be subject to an excise tax of 5% of the lobbying expenditures. The tax does not apply to private foundations. Also, the tax does not apply to organizations that have elected the lobbying limits of section 501(h) or to churches or church-related organizations that cannot elect these limits. This tax must be paid by the organization.

Tax on managers.   Managers may also be liable for a 5% tax on the lobbying expenditures that result in the disqualification of the organization. For the tax to apply, a manager would have to agree to the expenditures knowing that the expenditures were likely to result in the organization's not being described in section 501(c)(3). No tax will be imposed if the manager's agreement is not willful and is due to reasonable cause.

Excise taxes on political expenditures.    The law imposes an excise tax on the political expenditures of section 501(c)(3) organizations. A two-tier tax is imposed on both the organizations and the managers of those organizations.

Taxes on organizations.   An initial tax of 10% of certain political expenditures is imposed on a charitable organization. A second tax of 100% of the expenditure is imposed if the political expenditure that resulted in the imposition of the initial (first-tier) tax is not corrected within a specified period. These taxes must be paid by the organization.

Taxes on managers.   An initial tax of 2½% of the amount of certain political expenditures (up to $5,000 for each expenditure) is imposed on a manager of an organization who agrees to such expenditures knowing that they are political expenditures. No tax will be imposed if the manager's agreement was not willful and was due to reasonable cause. A second tax of 50% of the expenditures (up to $10,000 for each expenditure) is imposed on a manager if he or she refuses to agree to a correction of the expenditures that resulted in the imposition of the initial (first-tier) tax. For purposes of these taxes, an organization manager is generally an officer, director, trustee, or any employee having authority or responsibility concerning the organization's political expenditures. These taxes must be paid by the manager of the organization.

Political expenditures.   Generally, political expenditures that will trigger these taxes are amounts paid or incurred by a section 501(c)(3) organization in any participation or intervention in any political campaign for or against any candidate for public office. Political expenditures include publication or distribution of statements for these purposes. Political expenditures also include certain expenditures by organizations that are formed primarily to promote the candidacy (or prospective candidacy) of an individual for public office and by organizations that are effectively controlled by a candidate and are used primarily to promote that candidate.

Correction of expenditure.   A correction of a political expenditure is the recovery, if possible, of all or part of the expenditure and the establishment of safeguards to prevent future political expenditures.

Status after loss of exemption for lobbying or political activities.   As explained earlier, an organization can lose its tax-exempt status under section 501(c)(3) of the Code because of lobbying activities or participation or intervention in a political campaign on behalf of or in opposition to a candidate for public office. If this happens to an organization, it cannot later qualify for exemption under section 501(c)(4) of the Code.

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