Part I. Rulings — Internal Revenue Bulletin 2004-4

Section 62.—Adjusted Gross Income Defined

Mileage allowance; accountable plans. This ruling clarifies when a mileage allowance for local transportation expenses computed on a basis similar to that used in computing a courier’s compensation may be treated as paid under an accountable plan.

Rev. Rul. 2004–1

ISSUE

Whether a mileage allowance for local transportation expenses computed on a basis similar to that used in computing a courier’s compensation may be treated as paid under an accountable plan so that it will be excluded from the courier’s gross income and exempt from the withholding and payment of employment taxes.

FACTS

Situation One Employer, a courier company, hires employee drivers to deliver packages locally. Drivers must own or lease an automobile (including vans, pickups, or panel trucks) for use in connection with the performance of services as couriers. When delivering packages, drivers incur the ordinary and necessary expenses of operating an automobile.

Employer charges customers for deliveries based on location, time of day, expedited service (if requested), mileage between pickup and delivery, size and weight of a package, and other factors. This per package charge is referred to as the “tag rate.” The mileage component of the tag rate is computed as though each package were delivered separately. However, drivers often pick up multiple packages from one location, deliver multiple packages to another location, and travel overlapping routes between and among customers. Consequently, the tag rate may not accurately reflect the transportation expenses incurred with respect to a particular package.

Employer pays drivers a commission equal to X percent of the tag rate as com

pensation for services. Additionally, employer pays drivers a mileage allowance equal to Y percent of the tag rate to cover the expenses of operating their automobiles. Because the mileage allowance is computed based on a percentage of the tag rate, the mileage rate (cents per mile) paid with respect to any particular package varies depending on the number of miles traveled.

Employer determines the percentage of the tag rate paid as a mileage allowance annually and the percentage remains fixed throughout the calendar year. The percentage paid as a mileage allowance is based on employer’s review of a sample of documents submitted by drivers (including receipts, logbooks, and invoices) reflecting the drivers’ operating and fixed costs. Employer pays the mileage allowance only with respect to miles traveled while delivering packages.

Employer requires that, on a monthly basis, each driver provide information sufficient to substantiate the number of business miles traveled. Employer multiplies the number of miles traveled times the business standard mileage rate (as published by the Commissioner) to calculate the amount of travel expenses deemed substantiated. Employer subtracts the amount deemed substantiated from the mileage allowance paid and reports the excess as wages on the driver’s Form W–2.

Situation Two The facts are the same as in Situation One except employer pays drivers a commission equal to Z percent of the tag rate reduced by a mileage allowance equal to the number of miles traveled multiplied by the business standard mileage rate. Thus, drivers always receive Z percent of the tag rate, but the amount treated as a mileage allowance varies based on the number of business miles traveled and subsequently substantiated by drivers.

LAW

Section 61 of the Internal Revenue Code provides that gross income means all income from whatever source derived, including compensation for services, fees,

commissions, fringe benefits, and similar items.

Section 62(a)(2)(A) provides that, for purposes of determining adjusted gross income, an employee may deduct certain business expenses paid by the employee in connection with the performance of services as an employee of the employer under a reimbursement or other expense allowance arrangement.

Section 62(c) provides that, for purposes of section 62(a)(2)(A), an arrangement will in no event be treated as a reimbursement or other expense allowance arrangement if (1) the arrangement does not require the employee to substantiate the expenses covered by the arrangement to the person providing the reimbursement, and (2) the arrangement provides the employee the right to retain any amount in excess of the substantiated expenses covered under the arrangement.

Section 1.62–2(c)(1) of the Income Tax Regulations provides that a reimbursement or other expense allowance arrangement satisfies the requirements of section 62(c) if it meets the requirements of business connection, substantiation, and returning amounts in excess of expenses. If an arrangement meets these requirements, all amounts paid under the arrangement are treated as paid under an accountable plan. Amounts treated as paid under an accountable plan are excluded from the employee’s gross income, are not reported as wages or other compensation on the employee’s Form W–2, and are exempt from the withholding and payment of employment taxes. See section 1.62–2(c)(4). Conversely, amounts treated as paid under a nonaccountable plan are included in the employee’s gross income, must be reported as wages or other compensation on the employee’s Form W–2, and are subject to withholding and payment of employment taxes. See section 1.62–2(c)(5).

Section 1.62–2(d)(1) provides that an arrangement meets the business connection requirements if it provides advances, allowances, or reimbursements only for business expenses that are allowable as deductions and that are paid or incurred by the employee in connection with the performance of services as an employee of the

2004-4 I.R.B. 325 January 26, 2004

ANALYSIS

Situation One In Situation One, the mileage allowance meets the business connection requirements of section 1.62–2(d). The mileage allowance is paid with respect to deductible employee business expenses reasonably expected to be incurred by the drivers. Employer reviews a sample of receipts, logbooks, and invoices annually to estimate the drivers’ operating and fixed costs and, correspondingly, to set the percentage of the tag rate paid as a mileage allowance. Although the mileage allowance is computed on a basis similar to that used in computing the driver’s compensation and, consequently, is paid at a variable mileage rate, the percentage of the tag rate paid as a mileage allowance remains fixed throughout the calendar year. Unlike the reimbursements at issue in Shotgun Delivery, Inc. v. United States, 269 F.3d 969 (9 ^th Cir. 2001), the mileage allowance in Situation One is paid with respect to expenses reasonably expected to be incurred and does not vary inversely with the commission based on the number of hours worked.

Similarly, in Situation One the mileage allowance meets the substantiation requirements of section 1.62–2(e). Specifically, the drivers are required to substantiate monthly the time, use, and business purpose, i.e., the number of business miles traveled, relating to their use of an automobile while delivering packages. In lieu of substantiating the actual amount of the driver’s deductible transportation expenses, an amount is deemed substantiated equal to the number of miles traveled multiplied by the business standard mileage rate. An allowance paid with respect to ordinary and necessary transportation expenses that is reasonably calculated not to exceed the amount of anticipated expenses and is paid at a flat rate or stated schedule constitutes a mileage allowance pursuant to section 1.274–5(g) and the rules promulgated thereunder. See Rev. Proc. 2003–76. While the mileage allowance in Situation One is paid at a variable mileage rate, it is nonetheless computed based on a fixed percentage of the tag rate and is considered paid at a flat rate or stated schedule. Thus, drivers are deemed to have substantiated expenses at the busi

employer. If, however, a payor arranges to pay an amount to an employee regardless of whether the employee incurs (or is reasonably expected to incur) deductible employee business expenses, the arrangement does not satisfy the business connection requirements and all amounts paid under the arrangement are treated as paid under a nonaccountable plan. See section 1.62–2(d)(3)(i); see also section 1.62–2(j), example (1) which describes the payment of a fixed amount as either compensation or travel allowance and concludes that the arrangement does not satisfy the business connection requirements.

Section 1.62–2(e)(2) provides that an arrangement reimbursing use of a passenger automobile meets the substantiation requirements if information sufficient to satisfy the substantiation requirements of section 274(d) is submitted to the payor. Section 274(d) provides that no deduction shall be allowed under section 162 with respect to any listed property (including passenger automobiles and any other property used as a means of transportation) unless the taxpayer complies with certain substantiation requirements. Section 1.274–5(g) grants the Commissioner the authority to prescribe rules relating to mileage allowances for ordinary and necessary expenses of using a vehicle for local transportation. Pursuant to this grant of authority the Commissioner may prescribe rules under which such allowances, if in accordance with reasonable business practice, will be regarded as (1) equivalent to substantiation of the amount of such transportation expenses, and (2) satisfying the requirements of an adequate accounting to the employer of the amount of such expenses. The Commissioner annually publishes a revenue procedure establishing a business standard mileage rate taxpayers may use to substantiate the amount of the deductible costs of operating an automobile for business purposes. See, for example, Rev. Proc. 2003–76, 2003–43 I.R.B. 924 (or any successor.) A taxpayer must nonetheless actually substantiate the elements of time, use, and business purpose relating to the expenses.

Section 1.62–2(f) provides that an arrangement meets the return requirements if it requires the employee to return to the payor within a reasonable period of time any amount paid under the ar

rangement in excess of substantiated expenses. However, section 1.62–2(f)(2) provides that a reimbursement or other expense allowance arrangement that provides mileage allowances for ordinary and necessary expenses of local travel will be treated as satisfying the return of excess requirements even though the arrangement does not require the employee to return the portion of such an allowance that relates to the miles of travel substantiated and that exceeds the amount of the employee’s expenses deemed substantiated. This exception applies only if the allowance is paid at a rate for each mile of travel that is reasonably calculated not to exceed the amount of the employee’s expenses or anticipated expenses and the employee is required to return to the payor within a reasonable period of time any portion of such allowance which relates to miles of travel not substantiated.

In Shotgun Delivery, Inc. v. United States, 269 F.3d 969 (9th Cir. 2001), a courier company paid its drivers a commission equal to 40 percent of the tag rate. The commission was allocated between compensation paid at the minimum wage and a variable mileage reimbursement. The district court found that “because Shotgun’s tag rates were not based solely on distance traveled, and since Shotgun drivers could double up on deliveries, Shotgun’s reimbursement arrangement, was in fact, reimbursing its drivers in a manner not correlated to expenses Shotgun’s employees incurred or were reasonably likely to incur.” Shotgun Delivery, Inc. v. United States, 85 F.Supp. 2d 962, 965 (N.D. Cal. 2000.) Consequently, the district court concluded that Shotgun’s reimbursement arrangement failed to meet the business connection requirements and held that the mileage reimbursements were paid under a nonaccountable plan. In affirming the district court’s holding, the Ninth Circuit observed that such arrangements blur “the fundamental distinction between taxable compensation and tax-exempt reimbursement which underpins this entire aspect of the tax system” and concluded that “requiring a demonstrable connection to actual business expenses prevents companies from improperly sheltering otherwise taxable compensation under the guise of reimbursement.” Shot- gun Delivery, 269 F.3d at 974.

January 26, 2004 326 2004-4 I.R.B.

ness standard mileage rate with respect to each mile of travel actually substantiated.

Finally, in Situation One the mileage allowance meets the return of excess requirements of section 1.62–2(f). Employer intends to pay the mileage allowance only with respect to miles of travel substantiated by the drivers. Consequently, drivers are not required to return the portion of the mileage allowance exceeding the amount of expenses deemed substantiated. See section 1.62–2(f)(2).

Having met the business connection, substantiation, and return of excess requirements of section 1.62–2(c)(1), the portion of the mileage allowance that is not in excess of the expenses deemed substantiated may be treated as paid under an accountable plan in accordance with section 62(c). Such amounts are excluded from the drivers’ gross income and are exempt from the withholding and payment of employment taxes. The portion of the mileage allowance that is in excess of the expenses deemed substantiated is treated as paid under a nonaccountable plan. These amounts must be included in the drivers’ gross income and are subject to the withholding and payment of employment taxes.

Situation Two In Situation Two, the reimbursement arrangement does not meet the business connection requirements of section 1.62–2(d). A variable allocation between commission and mileage allowance ensures that each driver receives Z percent of the tag rate regardless of the amount of deductible employee business expenses incurred by the driver. A bona fide reimbursement arrangement must preclude the recharacterization as a mileage allowance of amounts otherwise payable as a commission. See section 1.62–2(j), example (1); see also H.R. Conf. Rep. No. 998, 100 ^th Cong., 2d Sess. 202–206 (1988). Consequently, the reimbursement arrangement in Situation Two is treated as a nonaccountable plan, and all amounts paid under the plan must be included in the drivers’ gross income and are subject to the withholding and payment of employment taxes.

HOLDING

Under the circumstances set forth in Situation One, a mileage allowance for local transportation expenses computed on a basis similar to that used in computing a courier’s compensation may be treated as paid under an accountable plan. The portion of the mileage allowance that is not in excess of the expenses deemed substantiated is excluded from the courier’s gross income and is exempt from the withholding and payment of employment taxes. However, the portion of the mileage allowance that is in excess of the expenses deemed substantiated is treated as paid under a nonaccountable plan, must be included in the courier’s gross income, and is subject to the withholding and payment of employment taxes. Under the circumstances set forth in Situation Two, a variable allocation between commission and mileage allowance does not meet the business connection requirements. Consequently, the reimbursement arrangement is treated as a nonaccountable plan, and all amounts paid under the plan must be included in the drivers’ gross income and are subject to the withholding and payment of employment taxes.

DRAFTING INFORMATION

The principal author of this revenue ruling is Neil D. Shepherd of the Office of Division Counsel/Associate Chief Counsel (Tax Exempt and Government Entities). For further information regarding this revenue ruling, contact Neil D. Shepherd at (202) 622-6040 (not a toll-free call).

Section 274.—Disallowance of Certain Entertainment, etc., Expenses

26 CFR 1.274-5: Substantiation requirements.

exempt from the withholding and payment of employment taxes. See Rev. Rul. 2004-1, page 325.

Section 472.—Last-in, First-out Inventories

26 CFR 1.472–1: Last-in, first-out inventories.

LIFO; price indexes; department stores. The November 2003 Bureau of Labor Statistics price indexes are accepted for use by department stores employing the retail inventory and last-in, first-out inventory methods for valuing inventories for tax years ended on, or with reference to, November 30, 2003.

Rev. Rul. 2004–7

The following Department Store Inventory Price Indexes for November 2003 were issued by the Bureau of Labor Statistics. The indexes are accepted by the Internal Revenue Service, under § 1.472–1(k) of the Income Tax Regulations and Rev. Proc. 86–46, 1986–2 C.B. 739, for appropriate application to inventories of department stores employing the retail inventory and last-in, first-out inventory methods for tax years ended on, or with reference to, November 30, 2003.

The Department Store Inventory Price Indexes are prepared on a national basis and include (a) 23 major groups of departments, (b) three special combinations of the major groups - soft goods, durable goods, and miscellaneous goods, and (c) a store total, which covers all departments, including some not listed separately, except for the following: candy, food, liquor, tobacco, and contract departments.

2004-4 I.R.B. 327 January 26, 2004

BUREAU OF LABOR STATISTICS, DEPARTMENT STORE INVENTORY PRICE INDEXES BY DEPARTMENT GROUPS

(January 1941 = 100, unless otherwise noted)

Percent Change from Nov. 2002

to Nov. 2003 ^¹

Groups

Nov. Nov. 2002 2003

Piece Goods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 473.3 480.5 1.5
Domestics and Draperies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 571.3 548.6 -4.0
Women’s and Children’s Shoes . . . . . . . . . . . . . . . . . . . . . . . . . . . . 652.4 649.8 -0.4
Men’s Shoes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 899.2 845.3 -6.0
Infants’ Wear . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 622.7 598.3 -3.9
Women’s Underwear. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 551.8 514.2 -6.8
Women’s Hosiery . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 345.3 343.3 -0.6
Women’s and Girls’ Accessories . . . . . . . . . . . . . . . . . . . . . . . . . . . 559.1 555.8 -0.6
Women’s Outerwear and Girls’ Wear . . . . . . . . . . . . . . . . . . . . . . . 373.5 375.7 0.6
Men’s Clothing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 572.1 549.5 -4.0
Men’s Furnishings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 603.6 598.3 -0.9
Boys’ Clothing and Furnishings . . . . . . . . . . . . . . . . . . . . . . . . . . . . 461.3 451.0 -2.2
Jewelry. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 871.7 866.8 -0.6
Notions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 793.1 797.2 0.5
Toilet Articles and Drugs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 972.5 976.2 0.4
Furniture and Bedding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 622.2 612.9 -1.5
Floor Coverings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 600.6 594.5 -1.0
Housewares. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 738.6 712.6 -3.5
Major Appliances. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 221.6 210.0 -5.2
Radio and Television. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47.5 44.3 -6.7
Recreation and Education ² . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84.6 82.2 -2.8
Home Improvements ² . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 125.2 124.9 -0.2
Automotive Accessories ² . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111.7 112.0 0.3

Groups 1–15: Soft Goods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 575.9 567.7 -1.4 Groups 16–20: Durable Goods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 404.5 388.9 -3.9 Groups 21–23: Misc. Goods ² . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95.4 93.9 -1.6

Store Total ³ . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 513.0 503.1 -1.9

1Absence of a minus sign before the percentage change in this column signifies a price increase. 2Indexes on a January 1986 = 100 base. 3The store total index covers all departments, including some not listed separately, except for the following: candy, food, liquor, tobacco and contract departments.

DRAFTING INFORMATION

The principal author of this revenue ruling is Michael Burkom of the Office of Associate Chief Counsel (Income Tax and Accounting). For further information regarding this revenue ruling, contact Mr. Burkom at (202) 622–7924 (not a toll-free call).

Section 527.—Political Organizations

26 CFR 1.527–2: Definitions. (Also § 501.)

Public advocacy; public policy issues. This ruling concerns certain public advocacy activities conducted by social welfare organizations, unions and trade associations. The guidance clarifies the tax implications of advocacy that meets the definition of political campaign activity.

Rev. Rul. 2004–6

Organizations that are exempt from federal income tax under § 501(a) as organiza

tions described in § 501(c)(4), § 501(c)(5), or § 501(c)(6) may, consistent with their exempt purpose, publicly advocate positions on public policy issues. This advocacy may include lobbying for legislation consistent with these positions. Because public policy advocacy may involve discussion of the positions of public officials who are also candidates for public office, a public policy advocacy communication may constitute an exempt function within the meaning of § 527(e)(2). If so, the organization would be subject to tax under § 527(f).

January 26, 2004 328 2004-4 I.R.B.

Section 527(j) provides that, unless excepted, a tax-exempt political organization that has given notice under § 527(i) and does not timely make periodic reports of contributions and expenditures, or that fails to include the information required, must pay an amount calculated by multiplying the amount of contributions and expenditures that are not disclosed by the highest corporate tax rate. An organization described in § 501(c) that does not set up a separate segregated fund, but makes exempt function expenditures subject to tax under § 527(f), is not subject to the reporting requirements under § 527(j).

Section 1.527–2(c)(1) provides that the term “exempt function” includes all activities that are directly related to and support the process of influencing or attempting to influence the selection, nomination, election, or appointment of any individual to public office or office in a political organization. Whether an expenditure is for an exempt function depends on all the facts and circumstances.

Section 1.527–6(f) provides that an organization described in § 501(c) that is exempt under § 501(a) may, if it is consistent with its exempt status, establish and maintain a separate segregated fund to receive contributions and make expenditures in a political campaign.

Rev. Rul. 2003–49, 2003–20 I.R.B. 903 (May 19, 2003), discusses the reporting and disclosure requirements for political organizations in question and answer format. In Q&A–6, the ruling holds that while a § 501(c) organization that makes an expenditure for an exempt function under § 527(e)(2) is not required to file the notice required under § 527(i), if the § 501(c) organization establishes a separate segregated fund under § 527(f)(3), that fund is required to file the notice in order to be tax-exempt unless it meets one of the other exceptions to filing.

Certain broadcast, cable, or satellite communications that meet the definition of “electioneering communications” are regulated by the Bipartisan Campaign Reform Act of 2002 (BCRA), 116 Stat. 81. An exempt organization that violates the regulatory requirements of BCRA may well jeopardize its exemption or be subject to other tax consequences.

ISSUE

In each of the six situations described below, has the organization exempt from federal income tax under § 501(a) as an organization described in § 501(c)(4), § 501(c)(5), or § 501(c)(6) that engages in public policy advocacy expended funds for an exempt function as described in § 527(e)(2)?

LAW

Section 501(c)(4) provides exemption from taxation for civic leagues or organizations not organized for profit, but operated exclusively for the promotion of social welfare.

Section 1.501(c)(4)–1 of the Income Tax Regulations states an organization is operated exclusively for the promotion of social welfare if it is primarily engaged in promoting in some way the common good and general welfare of the people of the community.

Section 501(c)(5) provides exemption from taxation for labor, agricultural, or horticultural organizations.

Section 1.501(c)(5)–1 requires that labor, agricultural, or horticultural organizations have as their objects the betterment of the conditions of those engaged in such pursuits, the improvement of the grade of their products, and the development of a higher degree of efficiency in their respective occupations.

Section 501(c)(6) provides exemption from taxation for business leagues, not organized for profit and no part of the net earnings of which inures to the benefit of any private shareholder or individual.

Section 1.501(c)(6)–1 provides that a business league is an association of persons having some common business interest, the purpose of which is to promote such common interest and not to engage in a regular business of a kind ordinarily carried on for profit. A business league’s activities should be directed to the improvement of business conditions of one or more lines of business as distinguished from the performance of particular services for individual persons.

Section 527 generally provides that political organizations that collect and expend monies for exempt function purposes as described in § 527(e)(2) are exempt

from Federal income tax except on their investment income.

Section 527(e)(1) defines a political organization as a party, committee, association, fund or other organization (whether or not incorporated), organized and operated primarily for the purpose of accepting contributions or making expenditures, or both, for an exempt function.

Section 527(e)(2) provides that the term “exempt function” for purposes of § 527 means the function of influencing or attempting to influence the selection, nomination, election, or appointment of any individual to any Federal, State, or local public office or office in a political organization, or the election of Presidential or Vice-Presidential electors, whether or not such individual or electors are selected, nominated, elected, or appointed. By its terms, § 527(e)(2) includes all attempts to influence the selection, nomination, election, or appointment of the described officials.

Section 527(f)(1) provides that an organization described in § 501(c) and exempt from tax under § 501(a) is subject to tax on any amount expended for an exempt function described in § 527(e)(2) at the highest tax rate specified in § 11(b). The tax is imposed on the lesser of the net investment income of the organization for the taxable year or the amount expended on an exempt function during the taxable year. A § 501(c) organization is taxed under § 527(f)(1) only if the expenditure is from its general treasury rather than from a separate segregated fund described in § 527(f)(3).

Section 527(f)(3) provides that if an organization described in § 501(c) and exempt from tax under § 501(a) sets up a separate segregated fund (which segregates monies for § 527(e)(2) exempt function purposes) that fund will be treated as a separate political organization described in § 527 and, therefore, be subject to tax as a political organization under § 527.

Section 527(i) provides that, in order to be tax-exempt, a political organization is required to give notice that it is a political organization described in § 527, unless excepted. An organization described in § 501(c) that does not set up a separate segregated fund, but makes exempt function expenditures subject to tax under § 527(f) is not subject to this requirement. § 527(i)(5)(A).

2004-4 I.R.B. 329 January 26, 2004

primary activities are described in the appropriate subparagraph of § 501(c); and

All advocacy communications described also include a solicitation of contributions to the organization.

Situation 1 . N, a labor organization recognized as tax exempt under § 501(c)(5), advocates for the betterment of conditions of law enforcement personnel. Senator A and Senator B represent State U in the United States Senate. In year 200x, N prepares and finances full-page newspaper advertisements supporting increased spending on law enforcement, which would require a legislative appropriation. These advertisements are published in several large circulation newspapers in State U on a regular basis during year 200x. One of these full-page advertisements is published shortly before an election in which Senator A (but not Senator B ) is a candidate for re-election. The advertisement published shortly before the election stresses the importance of increased federal funding of local law enforcement and refers to numerous statistics indicating the high crime rate in State U . The advertisement does not mention Senator A ’s or Senator B ’s position on law enforcement issues. The advertisement ends with the statement “Call or write Senator A and Senator B to ask them to support increased federal funding for local law enforcement.” Law enforcement has not been raised as an issue distinguishing Senator A from any opponent. At the time this advertisement is published, no legislative vote or other major legislative activity is scheduled in the United States Senate on increased federal funding for local law enforcement.

Under the facts and circumstances in Situation 1, the advertisement is not for an exempt function under § 527(e)(2). Although N ’s advertisement identifies Senator A, appears shortly before an election in which Senator A is a candidate, and targets voters in that election, it is part of an ongoing series of substantially similar advocacy communications by N on the same issue during year 200x. The advertisement identifies both Senator A and Senator B, who is not a candidate for re-election, as the representatives who would vote on this issue. Furthermore, N ’s advertisement does not identify Senator A ’s position on the issue, and law enforcement has not been raised as an issue distinguishing Senator A from any

ANALYSIS OF FACTUAL SITUATIONS

An organization exempt from federal income tax under § 501(a) as an organization described in § 501(c) that, consistent with its tax-exempt status, wishes to engage in an exempt function within the meaning of § 527(e)(2) may do so with its own funds or by setting up a separate segregated fund under § 527(f)(3). If the organization chooses to establish a separate segregated fund, that fund, unless excepted, must give notice under § 527(i) in order to be tax-exempt. A separate segregated fund that has given notice under § 527(i) is then subject to the reporting requirements under § 527(j). See Rev. Rul. 2003–49. If the organization chooses to use its own funds, the organization is not subject to the notice requirements under § 527(i) and the reporting requirements under § 527(j), but is subject to tax under § 527(f)(1) on the lesser of its investment income or the amount of the exempt function expenditure.

All the facts and circumstances must be considered to determine whether an expenditure for an advocacy communication relating to a public policy issue is for an exempt function under § 527(e)(2). When an advocacy communication explicitly advocates the election or defeat of an individual to public office, the expenditure clearly is for an exempt function under § 527(e)(2). However, when an advocacy communication relating to a public policy issue does not explicitly advocate the election or defeat of a candidate, all the facts and circumstances need to be considered to determine whether the expenditure is for an exempt function under § 527(e)(2).

In facts and circumstances such as those described in the six situations, factors that tend to show that an advocacy communication on a public policy issue is for an exempt function under § 527(e)(2) include, but are not limited to, the following:

a) The communication identifies a candidate for public office;

b) The timing of the communication coincides with an electoral campaign;

c) The communication targets voters in a particular election;

d) The communication identifies that candidate’s position on the public policy issue that is the subject of the communication;

e) The position of the candidate on the public policy issue has been raised as distinguishing the candidate from others in the campaign, either in the communication itself or in other public communications; and

f) The communication is not part of an ongoing series of substantially similar advocacy communications by the organization on the same issue.

In facts and circumstances such as those described in the six situations, factors that tend to show that an advocacy communication on a public policy issue is not for an exempt function under § 527(e)(2) include, but are not limited to, the following:

a) The absence of any one or more of the factors listed in a) through f) above;

b) The communication identifies specific legislation, or a specific event outside the control of the organization, that the organization hopes to influence;

c) The timing of the communication coincides with a specific event outside the control of the organization that the organization hopes to influence, such as a legislative vote or other major legislative action (for example, a hearing before a legislative committee on the issue that is the subject of the communication);

d) The communication identifies the candidate solely as a government official who is in a position to act on the public policy issue in connection with the specific event (such as a legislator who is eligible to vote on the legislation); and

e) The communication identifies the candidate solely in the list of key or principal sponsors of the legislation that is the subject of the communication.

In all of the situations, the advocacy communication identifies a candidate in an election, appears shortly before that election, and targets the voters in that election. Even though these factors are present, the remaining facts and circumstances must be analyzed in each situation to determine whether the advocacy communication is for an exempt function under § 527(e)(2).

Each of the situations assumes that:

All payments for the described activity are from the general treasury of the organization rather than from a separate segregated fund under § 527(f)(3);
The organization would continue to be exempt under § 501(a), even if the described activity is not a § 501(c) exempt activity, because the organization’s

January 26, 2004 330 2004-4 I.R.B.

tisement is an exempt function expenditure under § 527(e)(2) and, therefore, is subject to tax under § 527(f)(1).

Situation 4 . R, an entity recognized as tax exempt under § 501(c)(4), advocates for improved public education. Governor E is the governor of State X . R prepares and finances a radio advertisement urging an increase in state funding for public education in State X, which requires a legislative appropriation. The radio advertisement is first broadcast on several radio stations in State X beginning shortly before an election in which Governor E is a candidate for re-election. The advertisement is not part of an ongoing series of substantially similar advocacy communications by R on the same issue. The advertisement cites numerous statistics indicating that public education in State X is under-funded. While the advertisement does not say anything about Governor E ’s position on funding for public education, it ends with “Tell Governor E what you think about our under-funded schools.” In public appearances and campaign literature, Governor E ’s opponent has made funding of public education an issue in the campaign by focusing on Governor E ’s veto of an income tax increase the previous year to increase funding of public education. At the time the advertisement is broadcast, no legislative vote or other major legislative activity is scheduled in the State X legislature on state funding of public education.

Under the facts and circumstances in Situation 4, the advertisement is for an exempt function under § 527(e)(2). R ’s advertisement identifies Governor E, appears shortly before an election in which Governor E is a candidate, and targets voters in that election. Although the advertisement does not explicitly identify Governor E ’s position on the funding of public schools issue, that issue has been raised as an issue in the campaign by Governor E ’s opponent. The advertisement does not identify any specific legislation, is not part of an ongoing series of substantially similar advocacy communications by R on the same issue, and is not timed to coincide with a legislative vote or other major legislative action on that issue. Based on these facts and circumstances, the amount expended by R on the advertisement is an exempt function expenditure under § 527(e)(2) and, therefore, is subject to tax under § 527(f)(1).

opponent. Therefore, there is nothing to indicate that Senator A ’s candidacy should be supported or opposed based on this issue. Based on these facts and circumstances, the amount expended by N on the advertisement is not an exempt function expenditure under § 527(e)(2) and, therefore, is not subject to tax under § 527(f)(1).

Situation 2 . O, a trade association recognized as tax exempt under § 501(c)(6), advocates for increased international trade. Senator C represents State V in the United States Senate. O prepares and finances a full-page newspaper advertisement that is published in several large circulation newspapers in State V shortly before an election in which Senator C is a candidate for nomination in a party primary. The advertisement states that increased international trade is important to a major industry in State V . The advertisement states that S. 24, a pending bill in the United States Senate, would provide manufacturing subsidies to certain industries to encourage export of their products. The advertisement also states that several manufacturers in State V would benefit from the subsidies, but Senator C has opposed similar measures supporting increased international trade in the past. The advertisement ends with the statement “Call or write Senator C to tell him to vote for S. 24.” International trade concerns have not been raised as an issue distinguishing Senator C from any opponent. S. 24 is scheduled for a vote in the United States Senate before the election, soon after the date that the advertisement is published in the newspapers.

Under the facts and circumstances in Situation 2, the advertisement is not for an exempt function under § 527(e)(2). O ’s advertisement identifies Senator C, appears shortly before an election in which Senator C is a candidate, and targets voters in that election. Although international trade issues have not been raised as an issue distinguishing Senator C from any opponent, the advertisement identifies Senator C ’s position on the issue as contrary to O ’s position. However, the advertisement specifically identifies the legislation O is supporting and appears immediately before the United States Senate is scheduled to vote on that particular legislation. The candidate identified, Senator C, is a government official who is in a position to take action on the public policy issue in connection with the

specific event. Based on these facts and circumstances, the amount expended by O on the advertisement is not an exempt function expenditure under § 527(e)(2) and, therefore, is not subject to tax under § 527(f)(1).

Situation 3 . P, an entity recognized as tax exempt under § 501(c)(4), advocates for better health care. Senator D represents State W in the United States Senate. P prepares and finances a full-page newspaper advertisement that is published repeatedly in several large circulation newspapers in State W beginning shortly before an election in which Senator D is a candidate for re-election. The advertisement is not part of an ongoing series of substantially similar advocacy communications by P on the same issue. The advertisement states that a public hospital is needed in a major city in State W but that the public hospital cannot be built without federal assistance. The advertisement further states that Senator D has voted in the past year for two bills that would have provided the federal funding necessary for the hospital. The advertisement then ends with the statement “Let Senator D know you agree about the need for federal funding for hospitals.” Federal funding for hospitals has not been raised as an issue distinguishing Senator D from any opponent. At the time the advertisement is published, a bill providing federal funding for hospitals has been introduced in the United States Senate, but no legislative vote or other major legislative activity on that bill is scheduled in the Senate.

Under the facts and circumstances in Situation 3, the advertisement is for an exempt function under § 527(e)(2). P ’s advertisement identifies Senator D, appears shortly before an election in which Senator D is a candidate, and targets voters in that election. Although federal funding of hospitals has not been raised as an issue distinguishing Senator D from any opponent, the advertisement identifies Senator D ’s position on the hospital funding issue as agreeing with P ’s position, and is not part of an ongoing series of substantially similar advocacy communications by P on the same issue. Moreover, the advertisement does not identify any specific legislation and is not timed to coincide with a legislative vote or other major legislative action on the hospital funding issue. Based on these facts and circumstances, the amount expended by P on the adver

2004-4 I.R.B. 331 January 26, 2004

Under the facts and circumstances in Situation 6, the advertisement is for an exempt function under § 527(e)(2). T ’s advertisement identifies Governor H, appears shortly before an election in which Governor H is a candidate, targets the voters in that election, and identifies Governor H ’s position as contrary to T ’s position. The advertisement is not part of an ongoing series of substantially similar advocacy communications by T on the same issue. In addition, the advertisement does not identify and is not timed to coincide with a specific event outside the control of the organization that it hopes to influence. Based on these facts and circumstances, the amount expended by T on the advertisement is an exempt function expenditure under § 527(e)(2) and, therefore, is subject to tax under § 527(f)(1).

HOLDINGS

In Situations 1, 2, and 5, the amounts expended by N, O, and S are not exempt function expenditures under § 527(e)(2) and, therefore, are not subject to tax under § 527(f)(1). In Situations 3, 4, and 6, the amounts expended by P, R and T are exempt function expenditures under § 527(e)(2) and, therefore, are subject to tax under § 527(f)(1).

DRAFTING INFORMATION

The principal author of this revenue ruling is Judith E. Kindell of Exempt Organizations, Tax Exempt and Government Entities Division. For further information regarding this revenue ruling, contact Judith E. Kindell at (202) 283–8964 (not a toll-free call).

Situation 5 . S, an entity recognized as tax exempt under § 501(c)(4), advocates to abolish the death penalty in State Y . Governor F is the governor of State Y . S regularly prepares and finances television advertisements opposing the death penalty. These advertisements appear on several television stations in State Y shortly before each scheduled execution in State Y . One such advertisement opposing the death penalty appears on State Y television stations shortly before the scheduled execution of G and shortly before an election in which Governor F is a candidate for re-election. The advertisement broadcast shortly before the election provides statistics regarding developed countries that have abolished the death penalty and refers to studies indicating inequities related to the types of persons executed in the United States. Like the advertisements appearing shortly before other scheduled executions in State Y, the advertisement notes that Governor F has supported the death penalty in the past and ends with the statement “Call or write Governor F to demand that he stop the upcoming execution of G .”

Under the facts and circumstances in Situation 5, the advertisement is not for an exempt function under § 527(e)(2). S ’s advertisement identifies Governor F, appears shortly before an election in which Governor F is a candidate, targets voters in that election, and identifies Governor F ’s position as contrary to S ’s position. However, the advertisement is part of an ongoing series of substantially similar advocacy communications by S on the same issue and the advertisement identifies an event outside the control of the organization (the scheduled execution) that the organization hopes

to influence. Further, the timing of the advertisement coincides with this specific event that the organization hopes to influence. The candidate identified is a government official who is in a position to take action on the public policy issue in connection with the specific event. Based on these facts and circumstances, the amount expended by S on the advertisements is not an exempt function expenditure under § 527(e)(2) and, therefore, is not subject to tax under § 527(f)(1).

Situation 6 . T, an entity recognized as tax exempt under § 501(c)(4), advocates to abolish the death penalty in State Z . Governor H is the governor of State Z . Beginning shortly before an election in which Governor H is a candidate for re-election, T prepares and finances a television advertisement broadcast on several television stations in State Z . The advertisement is not part of an ongoing series of substantially similar advocacy communications by T on the same issue. The advertisement provides statistics regarding developed countries that have abolished the death penalty, and refers to studies indicating inequities related to the types of persons executed in the United States. The advertisement calls for the abolishment of the death penalty. The advertisement notes that Governor H has supported the death penalty in the past. The advertisement identifies several individuals previously executed in State Z, stating that Governor H could have saved their lives by stopping their executions. No executions are scheduled in State Z in the near future. The advertisement concludes with the statement “Call or write Governor H to demand a moratorium on the death penalty in State Z .”

January 26, 2004 332 2004-4 I.R.B.