United States: Tax Reform Requires Reassessing Deductibility Of Trade Association Dues

Andrew Emerson is a Partner for Holland & Knight's Washington, D.C. office.

A relatively minor provision contained in last year's Tax Cuts and Jobs Act may have a big impact on Trade Associations that lobby local and tribal governments. Trade Associations should ensure that their annual estimate of their lobbying expenses fully accounts for all of their work related to the passage of legislation at the federal, state, and (now) the local level.

Local Lobbying Activity is No Longer a Deductible Business Expense

As we have previously writtenSection 162 of the Internal Revenue Code (IRC) generally prohibits businesses from taking a deduction for lobbying and political expenditures. As a result, IRS regulations prohibit deduction of dues paid to membership organizations (particularly trade associations) to the extent that an organization is engaged in lobbying and political activity. Reg. 1.162-20(c)(3). 

Before passage of the Tax Cuts and Jobs Act, this general prohibition only applied to activity to influence federal and state legislation, and specifically did not apply to "local councils and similar governing bodies," which the IRS broadly construed to include city and county counsels, as well as tribal governments.  

Trade associations and businesses and that engage in local lobbying lost this deduction as part of last year's final tax reform bill. During debate on the bill, the U.S. House Ways and Means Committee proposed to eliminate this exception as an $800 million offset to planned tax cuts. The Senate adopted a similar provision, which was retained in Conference and became effective as of the date of the bill's enactment – Dec. 22, 2017. As a result, costs paid for lobbying activity at the local and tribal levels are now non-deductible – resulting in the need for both business, and trade associations, to reevaluate the portion of their budgets that are non-deductible under Sec. 162.

Moving forward, trade associations and businesses should:

1) Evaluate how much, if any, of their efforts to influence legislation occur at the local level. This doesn't include commenting on regulatory action – but encompasses official actions by a governing legislative body like Congress or now a local council.

2) Determine the total amount of any additional expenses, including staff time, indirect expenses, and payment to third-party contractors.

3) Determine whether the current percentage of dues attributable to lobbying is more than the percentage previously provided as an estimate to members pursuant to IRC § 6033(e)(1)(A) – and then determine whether that disclosure needs to be updated.

Trade Association's May Need to Revise the Estimated Non-Deductible Lobbying Activity Percentage of Dues Provided to Members

Federal tax laws require that a trade association, or its members, pay taxes on any portion of dues payments (or similar amounts) that that are attributable to IRS-defined lobbying activity (influencing legislation). Since the passage of the Omnibus Budget Reconciliation Act of 1993, Section 162(e) of the Internal Revenue Code has required most trade associations (and some social welfare and agricultural groups that charge membership dues in excess of $50) to provide their members with a reasonable estimate of percentage of their dues (and any special payments or assessments used to conduct lobbying) that would be used for non-deductible lobbying activity. To the extent that a trade association (or other obligated non-profit) fails to provide this information to dues payers at the time of assessment or payment, the trade association will be liable for a "Proxy Tax" assessed at the highest corporate tax rate – which was previously 35 percent, and now 21 percent in 2018.

The IRS has determined that an organization must provide this information to its members or donors in "a conspicuous and easily recognizable format" at the time of assessment or payment of the dues. The IRS has provided guidance regarding how notice should be provided, see Notice 88-120, 1988-2 C.B. 454, but the information is most commonly provided in a stand-along paragraph on an association's invoices. For instance, an invoice may read:

"Contributions are 75 percent tax deductible as an ordinary and necessary business expense in accordance with the Lobbying and Political Campaign Activity provisions of the federal Omnibus Budget Reconciliation Act of 1993, but are not tax deductible as a charitable contribution for federal income tax purposes."

Over or under-estimation of the non-deductible lobbying percentage can generally be carried forward on Schedule C of the organization's Form 990, but this should be avoided to the extent possible because overestimating will result in lost income for members, while underestimating may present red flags to auditors as an unaddressed liability requiring future repayment. More importantly, failing to provide an estimate all together may present an immediate Proxy Tax liability for the trade association.

In order to avoid Proxy Tax liability, it is a common best practice for Trade Associations to regularly evaluate the amount they spend to "Influence Legislation," which includes "Direct Contact Lobbying," meetings, calls, or other communication with officials, "Grassroots Lobbying," i.e., attempting to influence legislation by affecting the opinions of the general public, and related supporting activity. 

Due to the recent changes to Sec. 162(e) implemented the Tax Cuts and Jobs Act, all trade associations should review their current lobbying activity and the associated non-deductibility estimates they have previously provided to their clients. 

Estimating Non-Deductible Lobbying Activity Percentage of Dues Provided to Members

The IRS has identified a number of methods to evaluate the percentage a group's funds spent on non-deductible lobbying activity, each of which is equally permissible. These include: 1) the Ratio Method, 2) the Gross-Up Method or Alternative Gross-up Methods; and 3) the IRC 263A Method. 

The Ratio Method described at Reg. 1.162-28(d), allows an organization to multiply its total costs of operations (excluding third-party costs) by a fraction to determine its internal lobbying costs. The fractional multiplier is determined by dividing the total lobbying hours of the organization by the overall total labor hours worked. The result is then added to third-party lobbying costs, resulting in the total costs of lobbying activity.

The Gross-Up method, described in Reg. 1.162-28(e)(1), requires an organization multiplies its basic labor costs for the lobbying labor hours of all personnel by 175 percent. Basic labor costs only include wages and other guaranteed payments for services, not indirect compensation such as pensions, profit sharing, or employee benefits. Third-party lobbying costs are then added to the result of the calculation to arrive at total lobbying costs.

In order to reduce administrative costs, the IRS has also found that an organization can use an Alternative Gross-up Method, described in Reg. 1.162-28(e)(2), to determine lobbying costs without including the labor hours attributable to secretarial, clerical or other administrative support activities. This method requires multiplying the lobbyists labor costs by 225 percent, rather than 175 percent.

The IRC 263A method relates to Uniform Capitalization Rules applicable to parties who, in the course of their trade or business, produce real property for use in the business or activity; produce real property for sale to customers; or acquire property for resale. This method is particularly important to businesses engaged in real estate development, but is not typically applicable for trade associations or other non-profits.

Next Step – Implement Best Practices

Although potentially concerning in the short-term, the recent extension of non-deductibility to local and tribal lobbying activity presents an excellent opportunity for Trade Associations to evaluate the means and methods they are using to properly evaluate potential proxy tax liability, and a renewed impetus to limit that liability by properly notifying members regarding the non-deductibility of their dues payments and other assessments that are used to support lobbying activity. We strongly recommend that organization's consider conducting an annual review of their lobbying activity prior to invoicing members – this best practice will ensure that the organization strikes an appropriate balance between its non-deductible estimate and actual spending on an annual basis.

For more on trade association lobbying activity and related disclosures, see First Quarter Lobbying Disclosures: Incorporating Trade Association Dues, or reach out to counsel for further information

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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