Arent Fox Alert: Federal Election Commission to Tackle Novel Internet Political Law Issues and Votes to Impose Limited Liability Company Classification Rule


ELECTION LAW DEBATE ON THE INTERNET'S ROLE IN FEDERAL ELECTORAL PROCESS TO UNFOLD IN COMING WEEKS

On April 21, 1999, the Federal Election Commission (FEC) agreed to open an inquiry into the extent to which the extraordinary growth of political activity on the Internet requires new regulation and/or modification of existing regulations.

For the past several years, the FEC has tentatively — and, at times, inconsistently — explored the implications of election and campaign finance activities in cyberspace. The FEC's action in the coming months will likely have a profound effect on the extent to which candidates, political parties, and political action committees (PACs) can engage in Internetrelated political activity, and may result in the development of significant opportunities or restrictions for political and nonpolitical entities seeking to use the Internet for Federal election law purposes.

As the Internet's bridging force between democracy and technology more fully develops, the coming FEC debate will affect the positioning of e-commerce players from ISPs and credit card companies to evolving information providers, advocacy groups, and the political fundraising arms of Presidential and Congressional campaigns. The Arent Fox Government Relations Group will be working to shape the contours of this debate on behalf of our diverse client base.

LIMITED LIABILITY COMPANIES FACE NEW RESTRICTIONS UNDER FEDERAL ELECTION COMMISSION RULE CHANGE

On April 29, 1999, the FEC voted to impose new classifying rules and restrictions on limited liability companies (LLCs). The Commission, on a 4-2 vote, directed the General Counsel's office to draft a final rule under which LLCs would be treated for Federal election law purposes either as corporations or partnerships, depending on how the LLC elects to be taxed by the Internal Revenue Service.

The import of this classification change is significant. Federal law prohibits corporations from contributing directly to Federal candidates. Therefore, an LLCs ability to participate in the Federal electoral process will be circumscribed should the LLC elect treatment as a corporation under Internal Revenue Code provisions. However, contributions from partnerships and individuals are permitted — subject to a limit of $1,000 per candidate per election. As discussed below, partnership contributions count against the $1,000 per candidate per election limit of both the "partnership" and the "individual" partners. An LLC that elects partnership treatment and its non-corporate members will face identical contribution and attribution rules.

The formal rule change comes on the heels of ad-hoc FEC efforts to articulate how LLCs should be treated for Federal election law purposes. Unlike corporations and partnerships, of which LLCs are a hybrid, Federal election law until now did not specifically provide for how contributions and expenditures in support of Federal candidates by LLCs should be considered. FEC Advisory Opinions have recently allowed LLCs to make contributions as "individuals," rather than as corporations or partnerships.
The new rule is designed to close a perceived loophole that arose from these Advisory Opinions and from the increasing popularity and use of the LLC form. After the FEC Advisory Opinions were issued, concerns increased that a person or group could create numerous LLCs — each of which would enjoy a separate "individual" $1,000 per candidate per election contribution limit — and possibly circumvent the Federal contribution limitations.

Accordingly, under the new rule:

(i) LLCs electing corporate status under the Internal Revenue Code will be considered "corporations" under Federal election law and will be prohibited from contributing to Federal candidates; and

(ii) LLCs choosing partnership treatment under the Internal Revenue Code will be classified as "partnerships" under Federal election law, with contributions by the LLC attributed to the LLC and each non-corporate member of the LLC in direct proportion to the member's share of LLC profit (or by other agreement of the LLC members).

LLCs, like other entities, are permitted to establish and operate PACs — irrespective of whether the LLC elects "corporate" or "partnership" treatment under the tax code.