American Fields: how a tax code can silence a sector

Ok, I promised you a blog on American tax law and nonprofit registration types, so here goes.

(It’s really a blog on charity campaigning though, don’t worry.)

To start with, here’s a table with the 29 different ways to be a nonprofit – or more explicitly to have tax-exempt status:

(From Charity Navigator – thanks!)

We can simplify this a little bit (and minimize the amount of tax code I need to decipher) by splitting these into ‘public benefit’ organisations and ‘mutual aid’ groups, which actually starts to make it sound a lot more like the English sector, by its very broadest definition. There are a couple of very culturally specific classifications like armed forces organisations; and the Black Lung Benefit Trusts created by the Black Lung Benefits Act of 1973 is an interesting very specific classification, but then our benefits legislation back home makes explicit provisions for those with Creutzfeld-Jakob Disease (CJD) and survivors of the contaminated blood products disaster in the 1970s and ‘80s, and Trusts have been established by governments in the past to the same end. As I’ve mentioned elsewhere some states additionally have a B-Corps designation which is like a social enterprise: part profit mission, part social mission.

So, I’m interested in the ‘public benefit’ organisations, for the most part (I love co-operatives, but one has to limit oneself). This principally means 501(c)3s, but I’ve also got an interest in 501(c)4s for reasons that will become obvious.

If you’re a formal organization (rather than a loose band of pals) with an income, you basically have to file your articles of incorporation at a state level, then register with the Internal Revenue Service at the federal level for tax exemption status. Otherwise you’ll be subject to federal income tax (and state, and local, and property tax, and whatever other weird taxes you find) and your donors won’t receive tax relief on donations, which is a bigger deal here than in the UK. There is a ‘streamlined’ process for smaller charities (which looks like it’s defined as income below $50,000), although ironically you have to complete a 30-question checklist to see if you qualify. Regulation happens at a state level, in different ways. In Oregon this is through the Charitable Activities division of the Department of Justice, in Washington with the Office of the Secretary of State, in New Jersey with the Division of Consumer Affairs, and in Pennsylvania with the Department of State. You file your annual report with the state, or your statement of expenditure, or whatever that state requires. If you’re operating in multiple states, you need to be registered in all of them (although there’s some ambiguity in what ‘operating’ might mean). In Washington there is a separate ‘charitable organisation’ registration alongside nonprofit corporation. Gosh the bureaucracy.

To return to the more solid ground of the federal tax code (and this trip is making me appreciate the Charity Commission’s material more and more tbh), the section on 501(c)3s includes a few statements on campaigning. This is probably the most significant one:

The organization won’t, as a substantial part of its activities, attempt to influence legislation (unless it elects to come under the provisions allowing certain lobbying expenditures) or participate to any extent in a political campaign for or against any candidate for public office.

The stated risk of breaching this rule is losing your tax exempt status. You might be forgiven, on the basis of this, for thinking that this means a nonprofit can’t campaign. But that’s really not the case. 501(c)3s cannot campaign on behalf of a political candidate, just like back home. In fact, organisations like the National Council of Nonprofits have been fighting to protect this restriction, known as the Johnson Amendment, which the Trump Administration has characterized as an attack on free speech, particularly for churches. The Council and lots of religious and non-religious groups see this as a vital protection against party politicization, and phony political groups. Organisations also cannot have political campaigning as their sole purpose – one of the issues that the Institute for Economic Affairs in England is currently being investigated for – but ‘voter education activities or public forums conducted in a nonpartisan manner may not be prohibited political activity’, says the code. Super straightforward. There is some additional guidance on what’s called the ‘Insubstantial Part Test’ here, but, as the National Council of Nonprofits says, it’s about as clear as mud: ‘The definition of “insubstantial” has not been provided by Congress or the IRS, and the line between an “insubstantial” and a “substantial” amount of legislative lobbying activities is hazy at best, especially because it depends on how the IRS retroactively weighs the “facts and circumstances” of each situation.’ Bolder Advocacy, pointing to a 1952 federal court ruling, suggests it equates to about 5% of an organisation’s activity and spend. Nonprofits then have to report lobbying activity, in detail, to the IRS every year (and some states will have different requirements on top of this – Washington State has a lobbying register and organizational reporting requirements). Noncompliance, as well as loss of tax-exempt status, also looks like it carries financial penalties for individuals, equal to five percent of the lobbying expenditure.

The problem for any organization is that all of this is ambiguous, negatively framed, and just kinda scary.

Jeffrey M. Berry picks up this point in his 2005 book A Voice For Nonprofits. He starts (and I v much enjoy his writing): “That this part of the tax code is confusing should hardly be surprising. What part of the tax code is simple and straightforward? Yet the fact that the tax code is generally impenetrable does not mean that its complexity is not without consequences.” His team sent out surveys to 501(c)3s asking them what activities they believed they were allowed to engage in. They found that only 54% of these nonprofits knew they have the right to take a stand on government legislation, and only 61% knew they could take a general policy position, without reference to any kind of Bill. 68% of organisations thought they could not lobby because they were in receipt of a government grant. Now, I’m aware we have issues with gagging clauses in contracts and perceived impacts on independence relating to taking government money back home, but the perception of a choice between either taking money or being able to speak out seems much starker here.

I wouldn’t be me if I didn’t look for the historical reasons for this. Peter Dobkin Hall outlines some of the modern history (and the older stuff too) in the 2006 Non-Profit Sector Research Handbook; universal income tax was introduced in 1943, and after the Second World War this revenue was crucial for funding an expanded state. It also, according to Dobkin, generated powerful incentives for tax avoidance, both from individuals and corporations – through, say, donations or philanthropic foundations. This was a means of channeling private resources into areas in which the government was interested. Nonprofits were the providers of services in these areas (often alongside for-profit companies), and were further incentivized through subsidies and policy measures shaping the space for this new nonprofit sector. The number of tax-exempt organisations increased by 20 times between 1950 and 1968, the majority of which were new establishments (rather than re-classifications), ‘more often than not firms established to take advantage of direct and indirect federal funding and to serve as private agencies for implementing government policies’. Legal challenges led to growth areas too (and there are some similarities with the UK here): Dobkin Hall says ‘suits challenging the treatment of the mentally disabled [his phrase] led to the court-ordered dismantling of state mental institutions and training schools and the rise of a huge government-funded nonprofit group home industry’. Overall the flow of ‘direct federal subsidies’ to nonprofits increased from $30 billion in 1974 to just shy of $160 billion in 1994. The Bush (Snr) administration in the 1990s sought to dismantle ‘big government’ in favour of social welfare provision via nonprofits and community organisations, dubbed ‘a thousand points of light’ (and by the way the observant among you will notice the link between this and the Prime Minister’s scheme launched in 2014); ‘aggressive privatisation’ and devolution of responsibility to state and local government actually probably represented more a continuation than anything, but the rhetoric carved out more strongly this space for nonprofits.

Today, budgets are shrinking, programmes are being cut and income bases are diversifying for sure, but the kinds of service organisations I’m talking to now are still up to 80 or 90% funded from federal, state, city or county government sources. This may well play a part in deciding whether to engage in advocacy, particularly for organisations working on so-called ‘wicked’ issues. Zachary Wood writes about this in the context of homelessness nonprofits; ‘[human services nonprofits] serving the homeless, given the less attractive nature of their work and the increased challenges of funding stability, may have both the most risk and highest need to engage in policy advocacy, especially those tactics deemed less cooperative and more confrontational in nature.’ Despite the need, the perceived risk of losing substantial funding drives competition among organisations, creates a culture lacking in trust, and can inhibit groups’ willingness to speak out publicly. It can also lead to a kind of advocacy that is more about self-preservation, in funding terms, than representing beneficiaries. Add to that confusion over 501(c)3 restrictions, and in some places a political culture where organisations believe that the legislature will just. never. listen., and you might get a pretty quiet sector. And yet, as Zach points out, different nonprofits still engage in different ways to different degrees. Plenty see advocacy and system change as key to what they do, but that kind of thinking relies on so many historical, political and cultural factors. It also requires an understanding that such activity is allowed in the first place. (Zach is also, incidentally, my sponsor here at Rutgers, and is teaching me a lot – thanks buddy!)

To end on a practical note, there are different options for nonprofits that know they want to campaign more than the tax code allows them, providing they have the resources to understand it in the first place, in addition to the campaigning they are definitely already allowed to do. The 501(c)4 classification I’ve mentioned a few times across this series allows organisations a much more explicitly political role; they can endorse political candidates, and campaign on ballot measures. The canvassing I did with NARAL Pro-Choice Oregon all those weeks ago would have been done under their 501(c)4 registration. NARAL will have to keep separate funds and comply with separate sets of reporting requirements for each branch of the organization; it quickly becomes clear that you need a certain level of capacity and capability to be able to engage with these systems. The other, simpler option is to take the 501(h) election. This, according to the National Council of Nonprofits, ‘simply allows that nonprofit to opt out of the vague “substantial” activity test and use the friendlier expenditure test.’ It’s been around since 1976 (although not fully agreed until the 1990s); the IRS provides specific spending limits for lobbying activity depending on the size of your organization, which seems infinitely easier to comply with. Nevertheless, according to Berry, only 0.5% of 501(c)3s go down this route.

There is something here about the impact of bureaucracy and over-legislating which I’ll leave for another day, partly for fear of coming off a bit ‘health and safety gone mad’, words I never thought I’d associate with myself. As always, fire me any questions, challenge any misinformation, and check out this list of advocacy resources from Washington Nonprofits, another infrastructure organization I met with a few weeks back.

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