Overview

I seem to have been on a writing sabbatical for the last year. Over the course of the year, I have discovered a few new planning ideas to share going forward. From previous articles you already know that I grew up in the Panama Canal Zone where my family lived for approximately twenty-five years. I am Zonian! I am also a music lover. My soundtrack is mostly from the decade of the 1970’s. I am lover of horn bands – Chicago, Tower of Power, Blood, Sweat and Tears. I like to hear various artists cover the same song for comparison purposes. One of my favorite songs from this era is Hooked on a Feeling.

The song was written by Mark James in 1968 and has been recorded by various artists – BJ Thomas et al. Mark James was not a one hit wonder as a song writer. He wrote Suspicious Minds for Elvis Presley and Always On My Mind for Willie Nelson. The Swedish group Blue Swede recorded Hooked on a Feeling in 1973 and their version rose to Number 1 and was the twentieth top song of the year in 1973. The BJ Thomas, a version made it to Number 5 in 1969. The success of Blue Swede’s version is the inclusion of the horn section combined with the “ooga chaka.” chorus repetition. Let me know if you agree!

The planning idea that I am “hooked” on now is the 501(c)(4) social welfare organization. This article introduces the 501(c)(4) non-profit organization. Hopefully, readers will get “hooked” on the same feeling.

501(c)(4) Non-Profit Organizations

The Internal Revenue Code does not define “social welfare”, but the Treasury Regulations 1.501(c)(4)-1(a)(2) define this type of non-profit as an organization operated exclusively for the promotion of social welfare, promoting the common good and general welfare of the community. The promotion of social welfare includes everything under the traditional non-profit organization (charitable, educational, scientific, and religious). Additionally, “social welfare” may include other activities that promote the common good including attempts to influence legislation (lobbying) including politicizing, advertising, and propaganda.

The IRS published safe harbor requirements in IRS Fact Sheet 2013-18 created a 60&/40% guideline that would meet the “primarily engaged” requirements for a social welfare organization. The safe harbor provides that 60 percent or more of an organization’s expenditures must promote social welfare and forty percent or less may be spent for political campaign contributions. The organization does not have fixed distribution requirements like a private foundation but needs charitable operations that must be commensurate in scope with the organization’s assets.

The list of billionaires that have utilized 501(c)(4) organizations is impressive. Hedge fund guru Ray Dalio has approximately $3.5 billion in several 501(c)(4) organizations that he created. The Koch family has an exceptionally large 501(c)(4) organization. The founder of Patagonia, Yvon Chouinard, sold the company inside of a 501(c)(4) without taxation. The electrical device manufacturer Tripp Lite was also sold using a 501(c)(4) organization.

From the taxpayer and donor perspective, the most important quality of the so-called 501(c)(4) organization comparing it to a 501(c)(3) organization, boils down to one word, control. Control over the business of the donor. Control over political influence. Control over disclosure. Control over taxes. And, of course, control over the crucial soft power of charitable giving.

501(c)(4) Tax Considerations

Unlike contributions to a 501(c)(3), contributions to the 501(c)(4) are not deductible for income tax purposes. However, the 501(c)(4), has tax-exempt status for the sale of appreciated assets. Income producing assets also receive tax exempt treatment within the 501(c)(4) organization unless the income is Unrelated Business Taxable Income (UBTI). Transfers to the 501(c)(4) are not subject to federal gift taxes but will be included in the taxpayer’s estate for federal estate tax purposes if the taxpayer retained a degree of control at the time of death that would cause the charitable assets to be included in the taxpayer’s taxable estate. Donors may relinquish control to a third party to avoid estate inclusion. Additionally, some taxpayers have a provision that converts the 501(c)(4) organization to 501(c)(3) organization to avoid estate tax inclusion.

Taxpayers that own, and operate a business, and eventually sell that business, are always searching for a way to use a tax-exempt organization. Unlike private foundations, 501(c)(4) organizations are not subject to Internal Revenue Code self-dealing rules and excess business holding rules. However, 501(C)(4) organizations are subject to the excess benefit rules of IRC Sec 4958 which prevent the donor from receiving substantial direct or indirect benefit from the organization. Nevertheless, the donor (taxpayer) may enter fair market value transactions with the 501(c)(4) organization. This last point is a critical point in using the 501(c)(4) in tandem with the donor’s business. The combination of donor control during lifetime and greater latitude for political lobbying and contributions, makes the 501(c)(4) organization an interesting or better yet, ideal, charitable vehicle for charitable giving and tax planning. Now this is a planning idea to get “hooked” on!

Summary

Taxpayers and their counsel have scrutinized planning techniques to combine the tax benefits of charitable giving along with the taxpayer’s business. Inevitably, the self-dealing rules, excess business rules and excess benefit rules also seem to stand in the way of a taxpayer’s charitable giving. However, the taxpayer’s ability to engage in arms-length transactions with the 501(c)(4) organization and the taxpayer’s control offset the frequent limitations in charitable giving. The set up and operational costs and reporting requirements are not excessive. Successful closely held business owners should expand their tax planning considerations to include the 501(c)(4) organization as part of their charitable giving and tax planning.