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Proxy Tax: Definition & Meaning

Updated: February 24, 2023

The practice of lobbying is contentious and frequently misunderstood. As defined by the First Amendment and supported by the U.S. Supreme Court, lobbying is the process of notifying elected authorities of the desires of a group of citizens. This is a cornerstone of democratic governance. Corporations can participate in this discussion since they are thought to have some citizenship rights in the U.S.

However, when certain tax-exempt organizations engage  in lobbying, they may be subject to a proxy tax.

But what exactly is a proxy tax? Read on as we give you a definition, show you how proxy taxes are calculated, and give an example of a proxy tax at work.

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    KEY TAKEAWAYS

    • A proxy tax is a penalty tax paid by organizations that are mostly tax-exempt.
    • Any organization that is under 501(c)(4), 501(c)(5), and 501(c)(6) of the U.S. tax code can be subject to a proxy tax.
    • If an organization estimates the amount of money they spend on lobbying activities incorrectly, then they have to pay a marginal corporate tax rate. This would be a large tax.
    • Organizations that engage in lobbying are at risk of a proxy tax.

    What Is a Proxy Tax?

    A proxy tax is a tax penalty. It is imposed on organizations that are mostly tax-exempt but could have to pay taxes on funds that are used to pay for lobbying activities. 

    Lobbying and political campaign expenses are not deductible. An exempt organization may provide a notice that contains a reasonable estimate of the amount allocated to lobbying and political expenses to its members when they pay dues. If it does not give notice, it must pay a proxy tax on its lobbying and political expenditures at the highest rate imposed, which is currently 35%.

    If a tax-exempt group underestimates the amount of money it will spend on lobbying operations in a given year, the organization will be subject to a proxy tax. The highest marginal corporate tax rate applicable for that tax year would be used as the proxy tax rate in this situation. However, this tax may be waived if the organization agrees to include the excess lobbying and political expenses in the following year’s notices.

    The tax-exempt organization may elect not to provide its members with a notice in which case it will be required to pay the tax (the proxy tax option).

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    How Does Proxy Tax Work?

    Proxy tax is a worry for groups like professional associations, business leagues, or chambers of commerce that are tax-exempt but also take part in lobbying and political campaigns. The majority of these organizations’ membership dues are tax deductible.

    According to Internal Revenue Service (IRS) regulations, in order to qualify for tax-exempt status, these organizations have to be “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.” Such companies are prohibited from existing for the financial gain of one or more of their owners, and their main purpose must be to enhance market conditions more generally.

    How Is Proxy Tax Calculated?

    A proxy tax is calculated on any expenses that exceed the allowable amount that the IRS sets. So if the allowable amount for a particular company is $30,000, and they exceed that by $10,000, then the tax would be calculated on that extra $10,000.

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    Exemptions From Proxy Tax

    Organizations that are potentially subject to a proxy tax will include those that are organized under certain tax codes. The tax codes in question are:

    • 501(c)(4)
    • 501(c)(5)
    • 501(c)(6) 

    Any organization that falls under these tax codes may be subject to a proxy tax, or an exemption from the proxy tax.

    Example of Proxy Tax

    Let’s say that Company X pays $10,000 in annual dues to their local business league. They pay this amount under the assumption that only 60% of the money is spent on lobbying activity. If at the end of the tax period, it turns out that 80% of the money was spent for the purpose of lobbying, then the business league would be responsible for paying a proxy tax. This would be a tax on the 20% difference.

    Summary

    A proxy tax is the IRS’s way to gain penalty fees from tax-exempt organizations. It happens when the organization has miscalculated the amount of money that they end up spending on any lobbying activities. 

    Tax-exempt businesses should keep a close eye on their lobbying activity spending to make sure that they don’t incur a proxy tax.

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    Sandra Habinger headshot

    Written by Sandra Habiger

    Sandra Habiger is a Certified Public Accountant with a Bachelor’s Degree in Business Administration from the University of Washington. Sandra’s areas of focus include advising real estate agents, brokers, and investors. She supports small businesses in growing to their first six figures and beyond. Learn more about her work at http://www.sixfiguresaccounting.com/ .

    Sandra Habinger headshot

    Written by Sandra Habiger

    Sandra Habiger is a Certified Public Accountant with a Bachelor’s Degree in Business Administration from the University of Washington. Sandra’s areas of focus include advising real estate agents, brokers, and investors. She supports small businesses in growing to their first six figures and beyond. Learn more about her work at http://www.sixfiguresaccounting.com/ .

    FAQS on Proxy Tax

    Who Needs to File a 990T?

    Any organization that is exempt and has $1,000 or more gross income from a different, unrelated business or needs to report proxy tax liability has to file Form 990–T.

    What Is a 6033(e) Notice?

    A 6033(e) notice imposes reporting and notice requirements on tax-exempt organizations that incur non deductible lobbying and political expenses.

    Can I File 990T Without 990?

    Form 990-T is used by tax-exempt organizations to report unrelated business income and proxy tax liability. Form 990 is an annual information return required to be filed with the IRS by most organizations that are exempt from income tax, depending on the organization’s gross receipts and total assets.

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