Relationship Between Section 501(c)(3) Taxpayer and PAC Prohibited

| 2/20/2020
Relationship Between Section 501(c)(3) Taxpayer and PAC Prohibited

On Jan. 31, 2020, the IRS released Private Letter Ruling (PLR) 202005020, in which it concludes that the proposed operation of a political action committee (PAC) by a taxable subsidiary of a tax-exempt parent of a healthcare system (the taxpayer), as well as a resource-sharing agreement between the parties, constitutes prohibited participation or intervention in a political campaign. While a PLR may not be used or cited as precedent and is binding on only the taxpayer(s) to whom the ruling was issued, the ruling provides important insight into the IRS’ current thinking on these issues. Furthermore, a significant factor in the unfavorable ruling appears to be based on the resource-sharing agreement between the healthcare system and the taxable subsidiary that operated the PAC. 

The basic facts set forth in the ruling are as follows: The taxpayer provides management, consulting, and other services to its related healthcare facilities and educational institutions. The taxpayer is the sole shareholder of the taxable subsidiary. The taxpayer elects the subsidiary’s directors, who in turn select the PAC’s directors. Neither the taxable subsidiary nor the PAC has any employees of its own.

In addition, the facts describe measures the taxpayer will take to establish separation between itself and the subsidiary and PAC. The subsidiary and PAC each will maintain bank accounts, books and records, financial statements and reports, tax returns, letterheads, websites, and other materials separate from the taxpayer. The taxpayer also will adopt a board resolution prohibiting any director, officer, or employee from any involvement in the PAC on behalf of or as a representative of the taxpayer.

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Mailing list for soliciting PAC contributions

According to the ruling, the taxpayer will provide to the subsidiary and PAC a mailing list of its employees to be used to solicit contributions for the PAC and will charge fair market value for the list. In addition, the taxpayer will update the list and identify which employees are within the definition of executive or administrative personnel from whom the subsidiary and PAC are permitted to solicit contributions under federal election laws. 

The ruling concludes that creating and providing a specialized mailing list constitutes participation or intervention in a political campaign by the taxpayer. Furthermore, refining the list so that the PAC can identify employees who are able to contribute under federal election laws provides a direct benefit to the subsidiary and PAC and serves private rather than public interests. 

Resource-sharing agreement

The ruling also discusses the taxpayer’s agreement to provide management and administrative services to the subsidiary and PAC. 

  • Facilities and services. According to the ruling, the taxpayer agreed to provide facilities, equipment, and building maintenance and cleaning services, as well as a wide variety of other corporate, financial, and legal services, to the subsidiary and PAC. The ruling notes that the agreement “provides no guardrails or limitations with respect to services that might be inconsistent with [t]axpayer’s exempt purpose,” and that there is “no identified separation of roles” in connection with the subsidiary “directing and controlling” the taxpayer’s employees under the terms of the agreement. According to the ruling, under this arrangement the taxpayer essentially is providing the services that will cause the taxpayer to be operated for the benefit of private interests and will not further an exempt purpose. 
  • Costs. The subsidiary and PAC agreed to pay the taxpayer its share of direct and indirect costs. Indirect costs will be charged at a rate of 20% of direct costs. The ruling notes that even if the subsidiary and PAC fully reimburse the taxpayer for its direct and indirect costs, the taxpayer still is engaging in an activity that does not further an exempt purpose because “the activity of preparing and maintaining the employee list furthers only the political campaign activities of PAC.”
  • People. The taxpayer represented that if any of its directors, officers, or employees also serves as a director or officer of the subsidiary or PAC, that individual will not take any action with respect to the subsidiary or PAC on behalf of the taxpayer or in an official taxpayer capacity. The taxpayer also represented that time records will be maintained so that appropriate allocations can be made. The ruling concludes, however, that having the taxpayer’s employees solicit contributions to the PAC from other employees of the taxpayer and at the taxpayer’s offices during regular business hours, makes these activities inseparable from the taxpayer’s own operations and therefore furthers the political campaign purposes of the subsidiary and PAC. 

Looking ahead

Tax-exempt charitable organizations – whether healthcare systems or not – that have connected PACs should consider reviewing the structure of such entities within their organization to determine whether changes are needed given the narrow facts of this ruling. Because this is an election year, now may be a good time to undertake such a review. Furthermore, because the resource-sharing agreement between the exempt organization and its taxable subsidiary was a central focus in the ruling, organizations with similar agreements should review those agreements to ensure that they require sufficient expense detail, are consistent with actual operations, and do not have provisions that put the exempt status of the tax-exempt participant at risk.

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Nicole Bencik
Nicole Bencik
Managing Partner, Tax
Janice Smith
Janice Smith
Managing Director
Rachel Spurlock - social
Rachel Spurlock
Managing Partner, Exempt Organizations Tax Services, Office Managing Partner, Louisville