Contributions to MLR Do Not Affect a Lake Association’s Charitable Exemption

by John James, former Commissioner of MN Department of Revenue

A concern has arisen about whether joining and contributing to Minnesota Lakes and Rivers Advocates would put a lake association which is a tax exempt charitable organization under Internal Revenue Code Section 501(c)(3) at risk of losing its tax exemption because MLR engages in lobbying. There is absolutely no risk of a lake association’s support of MLR having that disastrous result. Here’s why.

While both the statute and the applicable regulation state that such exemption is available only to organizations organized and operated “exclusively” for one or more enumerated purposes, one of which is charitable, which is the purpose under which lake associations can qualify for exemption, “exclusively” does not literally mean exclusively. The statute makes this clear by stating that exemption is not barred if “no substantial part of the activities [of the organization] is carrying on propaganda, or otherwise attempting, to influence legislation (except as otherwise provided in subsection (h)) …” I’ll refer here to those categories of activities as “lobbying.”

The question is whether lobbying constitutes a “substantial part” of the activities of a lake association. MLR does do some lobbying. But the test for a lake association is not how much lobbying MLR does, but rather whether lobbying constitutes a substantial part of the activities of a contributing lake association.

Reg. Sec. 1.501(c)(3)-1(a) sets forth both organizational and operational tests which an organization must meet to qualify for the exemption on which you rely. The concern with membership in and contributions to MLR pertains to the operational test; i.e., the act of contributing to MLR would be part of the lake association’s operations.

Reg. Sec. 1.501(c)(3)-1(c) deals with the operational test. The operational test is defined as follows: “(c) Operational test – (1) Primary activities. An organization will be regarded as operated exclusively for one or more exempt purposes only if it engages primarily in activities which accomplish one or more of such exempt purposes specified in section 501(c)(3). An organization will not be so regarded if more than an insubstantial part of its activities is not in furtherance of an exempt purpose. (Emphasis added.) Joining and contributing to MLR actually is an activity which tends to accomplish the exempt charitable purpose of taking care of the lake environment with which any lake association is largely concerned. Thus, it should further solidify any charitable lake association’s charitable purpose.

Note, however, that, notwithstanding that organizations exempt under Section 501(c)(3) must be operated exclusively for an exempt purpose or purposes, it suffices under both the statute and regulations that they operate primarily for those purposes and that having an insubstantial part of activities be for other than exempt purposes does not disqualify them from qualification under Section 501(c)(3). Lobbying is not an exempt purpose. But MLR’s lobbying does not taint contributing lake associations. The question is whether a lake association’s lobbying (plus other non-exempt activities) constitutes a substantial part of what the lake association does, in which case it would not be operated primarily for exempt purposes and would therefore violate the exclusivity requirement.

The regulation gets more specific about the impact of lobbying on the operational test. Reg. Sec. 501(c)(3)-1(c)(3)(i) provides in relevant part: “An organization is not operated exclusively for one or more exempt purposes if it is an action organization…” Subparagraph (ii) provides in relevant part:
“An organization is an action organization if a substantial part of its activities is attempting to influence legislation by propaganda or otherwise. For this purpose, an organization will be regarded as attempting

to influence legislation if the organization: (a) contacts, or urges the public to contact, members of a legislative body for the purpose of proposing, supporting or opposing legislation; or (b) advocates the adoption or rejection of legislation. The term legislation, as used in this subdivision, includes action by the Congress, by any State legislature, by any local council or similar governing body, or by the public in a referendum, initiative, constitutional amendment, or similar procedure. An organization will not fail to meet the operational test merely because it advocates, as an insubstantial part of its activities, the adoption or rejection of legislation…. (Emphasis added.)

Note that the test here is applied to the lake association’s activities, not to those of MLR. A lake association can safely support MLR, secure in the knowledge that MLR will be looking out at the Capitol for the interests of all Minnesotans concerned with legislative issues impacting the lakes and rivers of Minnesota, without having MLR’s activities attributed to the lake association. With lake associations being primarily focused on the concerns of the particular lake or lakes, the issues for which are what attracts members to the lake associations, there is simply no basis in fact or law for the IRS to attribute MLR’s activities to the lake associations and thereby threaten to revoke a lake association’s tax exemption under Section 501(c)(3).

Now suppose that a lake association’s executive director or board looks at a particular piece of legislation on which MLR is (or is not) lobbying and concludes that it is really important to take the position that MLR is taking (or, for that matter, an opposing position). Then the lake association might urge its members, or members of the general public, to also take the position its executive director or board favors. That would be lobbying by the lake association. That would raise the question addressed in the foregoing regulation: Is such lobbying by the lake association a substantial part of its activities? The answer almost invariably would be no, but the Code and Regulations provide an elaborate safe harbor that charitable organizations can avail themselves of in order to be certain that they are not doing too much lobbying themselves.

Internal Revenue Code Section 501(h) allows some charitable organizations, including lake associations exempt as charitable organizations under Section 501(c)(3), to elect to be covered by Section 501(h) and maintain their tax exempt status notwithstanding making what might otherwise be considered substantial lobbying expenditures. There is no point in lengthening this analysis with a full explanation of the safe harbor, but it allows for lobbying expenditures in a year to constitute up to 30% of exempt purpose expenditures if the exempt purpose expenditures are not over $500,000, with an addition of gradually reduced percentages of exempt purpose expenditures over $500,000, and a maximum amount of lobbying expenditures of $1,500,000 for really big organizations, without putting the organization’s exempt status at risk. Section 501(h) also applies to grass roots expenditures, which are a subset of lobbying expenditures, and for the safe harbor to apply, they would have to be no more than 37.5% of the allowable lobbying expenditures for an organization of any particular size. If either the lobbying expenditures or the grass roots expenditures exceed the safe harbor amounts, then tax exemption can be lost if such expenditures “normally” exceed such amounts. The statute does not define “normally”, but Reg. Sec. 1.501(h)-3 provides for a rolling four year determination period. In other words, a year or two of lobbying expenses that are excessive under the foregoing standard will not result in loss of exempt status, unless they are so excessive as to put the entire four year period out of compliance. A word of caution: lobbying expenditures that are somewhat less than the foregoing ceilings can lead to the imposition of the excise tax on excess expenditures to influence legislation under Internal Revenue

Code Section 4911. Minnesota lake associations seldom, if ever, would be at any risk of that tax applying, much less having exempt status revoked.

Any lake association tax exempt under Section 501(c)(3) that wants to engage, on its own behalf, in extensive lobbying can avail itself of the Section 501(h) exemption and keep its exemption so long as it does not normally exceed the safe harbor limits, which are so high that it is hard to imagine any lake association ever approaching them. This is not a recommendation for lake associations to make the Section 501(h) election. That adds complication and administrative expense which for probably practically every lake association would be utterly unnecessary.

The point of mentioning the safe harbor here is to show roughly how far from exclusivity organizations can go and still maintain Section 501(c)(3) status. Without a Section 501(h) election being made, the IRS could claim that a lesser magnitude of lobbying expenses is substantial. The chances of a lake association that primarily attends to issues involving its lake or lakes being alleged to have engaged in lobbying as a substantial part of its activities seem inherently very slim, though this is not a legal opinion that there could never be a problem. That would require examination of the facts of the particular situation.

Most importantly, the rules limiting lobbying apply to lobbying by the Section 501(c)(3) organization. They do not in any way put at risk a decision by such an organization’s board to contribute a few, or hundreds or thousands of, dollars to MLR due to the board’s good faith belief that MLR’s activities, which include some lobbying, further such exempt charitable purposes of the lake association as protecting or improving the ecological and/or recreational conditions of the waters in the lake or lakes or throughout Minnesota.

I would be happy to discuss the applicability of the lobbying limitations to any specific set of facts that has a lake association concerned that it might run afoul of the lobbying limitations on Section 501(c)(3) organizations.

John P. James