What Is the Proxy Tax for Exempt Organizations?
Understand the tax liabilities that arise when exempt organizations use member dues for lobbying and how to maintain compliance with IRS rules.
The proxy tax is a federal tax that can apply to certain tax-exempt organizations to address situations involving member dues and lobbying activities. Many members, such as businesses, deduct the dues they pay to these organizations as a business expense. The issue arises when the organization uses a portion of this dues income for political or lobbying activities, which are generally not tax-deductible.
The tax serves as a substitute, or proxy, for the tax deduction that would have been disallowed at the member level. This mechanism prevents an indirect subsidy for lobbying that would occur if members could deduct dues used for non-deductible political purposes. It places the compliance responsibility on the organization rather than on its individual members.
Determining When the Proxy Tax Applies
The proxy tax is triggered when a tax-exempt organization, such as a 501(c)(4), 501(c)(5), or 501(c)(6) organization, incurs expenses for lobbying or political campaigns. These expenditures include attempts to influence legislation and participation in any political campaign for or against a candidate for public office. The costs associated with these activities, from direct payments to overhead, are all considered part of the total expenditure amount.
Under Internal Revenue Code Section 6033, an organization in this position has a choice. Its primary option is to provide a notice to its members when dues are paid, which must include a reasonable estimate of the portion of dues allocable to non-deductible lobbying and political expenditures. This notice informs members that they cannot claim a business expense deduction for that portion of their dues.
If the organization chooses not to send this notice, it must pay the proxy tax. The tax is also due if the organization underestimates its lobbying expenses on the notice and does not carry the excess amount over to the next year’s estimate. One exception is the in-house lobbying de minimis rule, which exempts organizations if their in-house lobbying expenditures do not exceed $2,000 for the year. Another exception applies to organizations where a substantial portion of their dues comes from members who would not be able to deduct them as business expenses.
Calculating the Proxy Tax Liability
To calculate the proxy tax, an organization must first determine the total amount of lobbying and political expenditures for the tax year. This includes direct costs and a reasonable allocation of administrative and overhead expenses that support these activities. The organization must also identify the total amount of dues and similar payments it received from members during the same period.
The tax is calculated by multiplying the lobbying expenditures by the highest corporate income tax rate, which is currently 21%. The amount of lobbying expenses subject to the tax cannot exceed the total amount of dues received for the year. This flat rate is applied to the total non-deductible lobbying amount that was not disclosed to members.
For example, an organization received $500,000 in member dues and spent $80,000 on lobbying activities without notifying its members. To calculate the proxy tax, the organization would multiply its lobbying expenses by the highest corporate tax rate. The tax liability would be $80,000 multiplied by 21%, resulting in a proxy tax of $16,800.
Reporting and Paying the Tax
The proxy tax is reported and paid using Form 990-T, Exempt Organization Business Income Tax Return. While this form is primarily for unrelated business income, it contains specific sections for the proxy tax liability. The calculated tax is entered on a designated line within Part III of the form.
The filing deadline for Form 990-T is the 15th day of the 5th month after the end of the organization’s tax year. For organizations on a calendar year, the deadline is May 15th. The form can be filed electronically or by mail. Payment of the tax is due by the filing deadline and can be made through the Electronic Federal Tax Payment System (EFTPS) or by mail with a payment voucher.