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22 January 2010

What Are The Tax Implications of Citizens United?

Citizens United allows corporations to make independent political expenditures in political campaigns, this comes with a tax price that remains steep. But, tax law still strongly favors charitable donations or bona fide commercial advertising that may simultaneously further a political cause without being considered political campaign spending over actual spending in a political campaign.

The option of direct corporate spending on political campaigns is cheaper for the control group of large publicly held companies than the previously common practice of giving bonuses to senior employees with the understanding that some of the funds would be used for campaign contributions, but the tax savings is modest (a direct contribution requires about 3.3% less untaxed earnings to product the same amount of funding as one financed through a bonus to an employee).

Citizens United has essentially no tax impact on a well counseled S corporation.

Constitutional Tax Implications

The unconstitutionality of a ban on independent corporate campaign spending also raises serious doubts about the constitutionality of Internal Revenue Code Section 162(e), which in its current form is a broad based denial of a tax deduction for spending in connection with political campaigns and lobbying.

All of the activities denied a deduction, other than direct contributions to a candidate in connection with a political campaign, involve speech that is protected by the First Amendment under Citizens United v. FEC. Prior to Citizens United, the fact that Congress was believed to have the power to prohibit corporate political speech, at least in the context of partisan elections, made the related tax treatment based on content based distinctions about speech seem a fortiori also constitutional.

But, in the wake of Citizens United can it be constitutional to tax an expenditure for a television spot asking people to buy widgets or give to the United Way different than a television spot identical in every way except its content, and likewise prepared without any coordination or communication with a candidate, that urges views to Vote For John Doe?

As shown below, for a large profitable publicly held corporation, that is now free to buy such political advertisement as a result of the Citizens United case, there is still a roughly 65% tax on the political television spot relative to a television spot with a commercial or charitable purpose.

There are a handful of cases that provide precedent for the principle that taxes that make content based distinctions on constitutionally protected speech are unconstitutional under the First Amendment. The corruption justification used in Citizens United to refrain at that time from rendering an opinion so sweeping that it would invalidate the ban on direct contributions to candidates by corporations and unions might very well be extended to IRC 162(e)(1)(D) (direct lobbying of public officials), but it is easy to imagine that at least some of IRC 162(e) could be invalidated on the basis of Citizens United and the First Amendment tax cases.

A court choosing to invalidate IRC 162(e) in the near future, at least as applied to independent campaign expenditures, can also do so knowing that the revenue impact on the United States will be almost nil, because prior to Citizens United, corporations, including all public held companies, were legally prohibited from making such expenditures and few closely held for profit businesses that were not corporations, in fact, made such expenditures.

Tax Analysis

While Citizens United make it legal for a for profit corporations to engage in campaign spending through independent expenditures (something that about 2000 corporations do indirectly now, via political action committees), contributions from the corporate treasury don't qualify for a tax deduction the way that charitable contributions and almost everything else that a corporation spends money upon does. So under current law, campaign contributions are still taxed much more heavily than expenses like advertising and charitable contributions that serve similar purposes for a corporation in establishing its reputation.

We may see a new flurry of tax disputes over whether mixed purpose ads that promote a product and favor a political candidate still qualify for a tax deduction as a business advertising expense. If corporate spending is classified as a political expense, than the corporation cannot deduct that spending pursuant to Section 162(e) of the Internal Revenue Code:

IRC Section 162(e)
(e) Denial of deduction for certain lobbying and political expenditures
(1) In general
No deduction shall be allowed under subsection (a) for any amount paid or incurred in connection with -
(A) influencing legislation,
(B) participation in, or intervention in, any political campaign on behalf of (or in opposition to) any candidate for public office,
(C) any attempt to influence the general public, or segments thereof, with respect to elections, legislative matters, or referendums, or
(D) any direct communication with a covered executive branch official in an attempt to influence the official actions or positions of such official.

Impact In C Corporations

In a C corporation, this means that political spending is effectively taxed at the applicable corporate income tax rate (15% to 35% with a 38% marginal bubble rate, plus state taxes), but is not subject to the employee or shareholder tax rates that would apply if the funds were instead distributed as employee compensation (varies greatly) or as dividends or redeemed shares (usually 15%, plus the applicable state tax rate, for upper middle income and wealthy taxpayers). So, there is still a tax benefit to making contributions directly from the corporation, rather than having employees or shareholders make the contributions with distributed corporate funds in C corporations.

In big business organized as C corporations, the corporation's marginal tax rate is generally 35% federal (plus additional state taxes), and owners face a 15% federal tax (plus additional state taxes) when taking money out of the company. For $100,000 of campaign spending, having the corporation pay directly, rather than distributing the funds and having shareholders do the campaign spending leads to $15,000 less in federal taxes for the transaction as a whole (a bit more than $19,600 in taxes for a big business with a Colorado based owner).

While this is a big tax savings, it isn't much of a deal compared to a charitable contribution. A charitable contribution of $100,000 reduces corporate level federal income taxes by %35,000, and by an additional amount (about $4,600) in state income taxes.

To show how the complex tax code works in this kinds of situations, the aggregate tax in ten different scenarios involving Colorado C corporations in the top marginal income tax bracket that make $100,000 contributions directly to the beneficiary, or by distributing funds to shareholders as diviends or to employees as bonuses who turn around and make an after tax contribution of $100,000 to the beneficiary are set forth below. All shareholders and employees are assumed to pay federal tax at a 15% marginal rate on qualified dividends and capital gains and to be residents of Colorado subject to its flat 4.63% income tax rate. Rates below are top marginal tax rates on ordinary income.

The income tax incurred by an S corporation from spending $100,000 on advertising that is not related to a political campaign is zero.

Charitable contrib. directly from C corp: $0
Charitable contrib. by shareholder of C corp (SH has 35% fed tax rate): $44,744.65
Charitable contrib. by shareholder of C corp (SH has 15% fed tax rate): $64,744.65
Charitable contrib. by employer of C corp (Employee has 35% fed tax rate and is over FICA limit): $2,900
Charitable contrib. by employee of C corp (Employee has 15% fed tax rate and is not over FICA limit): $15,000 (also, charitable deduction may have to be spread over multiple years).

Thus, direct charitable contributions from highly profitable C corporations have a tax benefit over any other alternative, a providing employees with funds to make charitable contributions via employee bonuses is much preferred to providing shareholders with funds to make charitable contributions with dividend distributions form a tax perspective.

Campaign spending directly by C corp: $64,744.65
Campaign spending (SH has 35% fed tax rate): $104,906.27
Campaign spending (SH has 15% fed tax rate): $104,906.27
Campaign spending (Employee has 35% fed tax rate and is over FICA limit): $70,448.90
Campaign spending by employee of C corp (Employee has 15% fed tax rate and is not over FICA limit): $43,088.22

* In practice, an employee receiving a bonus large enough to make a $100,000 of campaign spending with the after tax proceeds of the bonus would probably not be able to stay in this tax bracket, so this really reflects a distribution of bonuses to multiple employees in this tax bracket in after tax amounts that sum up to $100,000 and are subsequently used for campaign spending.

Thus, it takes about 3.3% less before tax earnings in a profitable C corporation to finding campaign spending directly, rather than distributing a bonus to a high income employee who uses the funds for campaign spending.

Corporate level campaign spending by profitable C corporations is considerably less expensive from a tax persepctive than distributing dividends to shareholders who use the funds for campaign spending, and in a publicly held corporation (which makes up a large share of all corporations that owe net corporte income taxes in any signficiant amount despite making up a small share of all corporations), it is for all practical purposes impossible to coordinate shareholder action towards a common campaign spending goal once a corporation issues a dividend.

Corporate level campaign spending involves a higher tax cost than paying bonuses in an identical aggregate amount to lower income employees who use these bonsues to engage in campaign spending.

Campaign spending is still much more expensive for C corporations either directly, or through their shareholders or employees, than charitable contributions, despite the fact that each kind of spending can have a similar reputational effect for the C corporation.

Put another way, Citizens United makes campaign spending much less expensive for owners of companies who control closely held profitable C corporations and slightly less expensive for senior employees of profitable C corporations who control those companies, but not for anyone else.

But, as the analysis below will show, even after Citizens United, it is still more costly to use funds from profitable C corporations for the ultimate purpose of campaign spending than it is for people who control S corporations and closely held businesses which are not corporations (including their owners) to do so.

Impact In S corporations

In an S corporation, the non-deductibility of campaign spending means that political spending is effectively paid for out of the after tax profits of the company, with shareholders each paying their own marginal tax rate on their respective shares of the funds used to make the contributions.

The income tax incurred by an S corporation from spending $100,000 on advertising that is not related to a political campaign is zero.

If the contribution otherwise would have been made by a single taxpayer in an S corporation with multiple shareholders, the contributors contribution is being subsidize by his fellow shareholders from the after tax value of their entitlement to distributions. Empirically, S corporation shareholders are usually few in number, half of S corporations have owners from only one family, and the vast majority have fewer than ten owners.

Charitable contrib. directly from S corp (SH has 35% fed tax rate): $0
Charitable contrib. directly from S corp (SH has 15% fed tax rate): $0
Charitable contrib. by shareholder of S corp (SH has 35% fed tax rate): $0
Charitable contrib. by shareholder of S corp (SH has 15% fed tax rate): $0
Charitable contrib. by employer of S corp (Employee has 35% fed tax rate and is over FICA limit): $2,900
Charitable contrib. by employee of S corp (Employee has 15% fed tax rate and is not over FICA limit): $15,000 (also, charitable deduction may have to be spread over multiple years).

Thus, direct charitable contributions from highly profitable C corporations or shareholders have a slight tax benefit charitable contributions made through employees from bonus money.

Campaign spending directly by S corp (SH has 35% fed tax rate): $64,744.65
Campaign spending directly by S corp (SH has 15% fed tx rate): $24,424.54
Campaign spending by SH of S corp (SH has 35% fed tax rate): $64,744.65
Campaign spending by SH of S corp (SH has 15% fed tax rate): $24,424.54
Campaign spending (Employee has 35% fed tax rate and is over FICA limit): $70,448.90
Campaign spending by employee of C corp (Employee has 15% fed tax rate and is not over FICA limit): $43,088.22

Thus, in an S corporation, there is substantial benefit to paying for campaign spending out of the corporation, or with distributions of profits to shareholders, rather than using employee bonsues to provide employees with the means to engage in campaign spending.

Citizens United does not change the after tax cost of campaign spending for owners of S corportions who control those corporations. But, Citizens United does make it logistically easier for one owner of an S corporation to obtain assistance from fellow shareholders to spend funds for campaigning, but reducing the transactional steps involved and allowing for action on behalf of all shareholders by majority rule.

The impact on S corporations after Citizens United, was the status quo in entities taxed as partnership or as sole proprietorships prior to Citizens United.

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