A Labor Union can minimize taxes if it makes political contributions through a separate segregated fund, commonly known as a Political Action Committee (PAC) Fund. A PAC Fund is treated as a separate organization from the Labor Union that establishes, maintains and funds it as long as it satisfies the requirements of the Internal Revenue Code.
When a Labor Union contributes to its PAC Fund, it must act as a conduit between the contributor and the PAC Fund. In other words, the Labor Union is simply collecting contributions from its individual union members and then transferring them to the PAC Fund. It is not a contribution from the Labor Union, it is a contribution from its members.
Political contributions made from a Labor Union's general fund checking account may lead to unintended tax consequences. The Labor Union's combined investment earnings from all cash and investments would be potentially taxable. To isolate income to the PAC, best practice is to maintain a separate bank account for the PAC activity under the Local Union's employer identification number (EIN) or to set up a separate PAC entity with its own EIN (also known as an IRC 527 PAC). Taxable income would thereby be limited to the investment earnings for the separate PAC account or PAC entity. Using a non-interest bearing account for the PAC activity is often a valid consideration for the Local Union, to eliminate taxable income all together.
Typically, PAC contributions are received with the periodic receipt of member dues. It is important for the Labor Union to determine the allocation or amount of the members' PAC contributions promptly and to transfer/deposit the contributions into the separate PAC bank account or separate 527 PAC, to avoid the appearance of using PAC contributions and related interest income, if any, for funding general fund expenses.
If the Labor Union doesn’t follow the rules and makes political contributions from its general funds, it will need to file Form 1120-POL and will be subject to tax on the lesser of its net investment income or the total political contributions made during the year.
See the three examples below. In each of the examples, the Labor Union made political contributions of $12,000 during the year. In example #1, the net investment income is less than $100 and there is no tax due. In example #2, the net investment income is less than the political contributions and the tax based on the net investment earnings is $1,715. And in example #3, net investment income is greater than the political contributions and the tax is $4,165 based on the political contributions.
Net investment income
Tax at 35%
Again, if the PAC Fund is maintained properly, the Labor Union will probably not be required to file Form 1120-POL because only the net investment income earned by the separate PAC Fund account in excess of $100 would be taxable.
In conclusion, a Labor Union needs to set up and operate a PAC Fund as explained above. Most importantly, PAC Funds need to be held in a separate segregated account and must not be commingled with other general Union funds.