Election Year Update: Understanding Indirect Political Expenses

Although the upcoming election may make you want to go into hibernation until Inauguration Day, an election is an excellent opportunity for trade associations to advocate their mission with an effective voice. While trade associations are legally allowed to expend funds to influence legislation, it is imperative these organizations structure transactions in a way that does not elicit negative tax consequences.

Political expenditures are divided into two general categories; direct and indirect. Direct political expenditures are made for the process of influencing legislation or attempting to influence the nomination, election, or appointment to a public office. These are contributions to political candidates or causes the trade association supports. Indirect political expenditures are costs incurred in the day-to-day administration of the political funds[1]. This could include database management and overhead expenses paid in conjunction with any political activities.

When an otherwise tax-exempt trade association expends funds for a political function, it may be subject to a 35% tax, calculated on the lesser of the net investment income of the association, or the aggregate amount of direct political expenditures.[2] This is reported on Form 1120-POL. This method of assessment has potential to expose an association’s total investment income to taxation if not managed appropriately. The most effective strategy for limiting the tax exposure is to establish a “segregated fund.” The Internal Revenue Code allows trade associations to establish and maintain a segregated fund through which the association’s direct political expenditures may be paid[3], and not treated as expenditures of the association. This shifts the tax burden to the segregated fund to the extent it has investment income.

Since the segregated fund is administered by the trade association, the payment of indirect expenses on behalf of the fund may be necessary. Currently, there is no exclusion that prevents indirect expenses paid on the segregated fund’s behalf from being taxable to the association. However, the regulations dealing with the mechanism for assessing tax on indirect expenses have not been promulgated at this time and is an issue that has been reserved for IRS review since 1981[4]. It does not seem the IRS intends to impose a tax or filing requirement on associations solely for the day-to-day administration of a segregated fund. Supplementary information to the current regulations indicate that when a final resolution is adopted, it will be applied on a prospective basis[5]. Presently the de facto treatment of indirect expense payments are disclosed on Form 990, Schedule C, as exempt administrative transfers and do not prompt an additional filing requirement.

Based on current legislation, we urge trade associations to ensure any payments of indirect expenses are clearly traceable to specific invoices paid from the general treasury of the trade association. Contributing money to a segregated fund with the intention of using the funds to pay administrative fees is not considered payment of an indirect expenditure, but a direct political contribution from the association that could generate a tax liability[6].

If you have any questions regarding your organization’s payment of direct, or indirect political expenditures, please contact us.

 

[1] Treas. Reg. §1.527-2(c)(1) – (2)

[2] Treas. Reg. §1.527-6(a)

[3] IRC §527(f)(3)

[4] Treas. Reg. §1.527-6(b)(2)

[5] TD 7744, 1981-1 CB 360, 361

[6] PLR 9433001

 

Jason Jackson
Jason Jackson | Tax Administrator