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Aug. 21, 2013

Rep. Van Hollen, Reform Groups Sue IRS for Proper Regulation of 501(c)(4) Organizations Abusing Their Tax-Exempt Status to Make Secret Political Donations

WASHINGTON, D.C. – U.S. Rep. Chris Van Hollen (D-Md.), joined by Democracy 21, the Campaign Legal Center and Public Citizen, filed a lawsuit today in federal district court in Washington, D.C., challenging the IRS regulations that govern eligibility for tax-exempt status as a section 501(c)(4) “social welfare” organization.

Attorneys from the three organizations are representing the plaintiffs in the case, with Scott Nelson of Public Citizen serving as the lead counsel.

The existing IRS regulations were adopted more than a half century ago in 1959. The lawsuit charges that the regulations are contrary to the explicit statutory language of the Internal Revenue Code and to court decisions interpreting the code.

The lawsuit comes more than two years after Democracy 21 and the Campaign Legal Center filed a petition at the IRS on July 27, 2011, challenging the regulations at issue in the case and calling on the IRS to conduct a rulemaking proceeding to adopt new regulations that properly interpret the statute. The IRS did not act on the rulemaking petition.

Since the U.S. Supreme Court’s Citizens United decision in January 2010, there has been an explosion in the number of groups claiming tax-exempt status as “social welfare” organizations under section 501(c)(4). This has included a number of organizations who have abused the tax laws to claim section 501(c)(4) tax-exempt status in order to keep secret from the American people the donors financing their campaign expenditures.

According to Democracy 21 President Fred Wertheimer:

Democracy 21, joined by the Campaign Legal Center, petitioned the IRS more than two years ago to issue new regulations to stop the tax laws from being misused by section 501(c)(4) groups to launder secret contributions into federal elections.  If the IRS had acted on our petition it would have shut down the massive abuses of the tax laws that resulted in more than $250 million in secret contributions being spent by section 501(c)(4) groups in the 2012 federal elections. The IRS also would have avoided the issues that have arisen regarding the targeting of certain groups.

Today’s lawsuit would force the IRS to take the action we petitioned the IRS for two years ago and would require the IRS to issue new regulations to put an end to huge sums of secret money being spent in federal elections. Until this problem is addressed, the big losers here are voters being denied the campaign finance information they have a basic right to know and taxpayers seeing the tax laws being seriously abused by section 501(c)(4) groups for their own political purposes.

According to Public Citizen attorney Scott Nelson:

Congress has specified in the Internal Revenue Code that a section 501(c)(4) organization must devote itself “exclusively” to social welfare activity, yet the IRS has for decades allowed (c)(4)’s to engage in substantial electoral spending even though electoral activity falls outside the agency’s own definition of social welfare activity. And the IRS has done nothing to correct the mismatch between the law and its regulations even after it received a rulemaking petition explaining the problem and the urgency of addressing it to prevent (c)(4) organizations from being transformed into vehicles for massive electoral spending without donor disclosure. 

It shouldn’t take many years for the IRS to understand that when a law passed by Congress says one thing and the IRS’s regulations and policies allow just the opposite, something needs to be done.

According to the Campaign Legal Center Senior Counsel Paul Ryan:

This flawed IRS regulation on the books for more than a half-century, together with recent Supreme Court decisions in Wisconsin Right to Life (2007) and Citizens United (2010) permitting 501(c)(4) corporations to pay for election ads, have produced a perfect storm that has flooded recent elections with funds from undisclosed sources.

In the 2012 cycle, federal election-related spending by section 501(c)(4) organizations exceeded $256 million, triple the amount spent by such groups in the 2008 presidential election cycle ($82.7 million) and an astounding thirty-three times the amount spent by such groups in the 2004 presidential cycle ($7.6 million)

According to the lawsuit:

Section 501 of the IRC provides that organizations meeting specified criteria are exempt from federal income taxation. Section 501(c)(4) provides such tax exemption to “civic leagues or organizations not organized for profit but operated exclusively for the promotion of social welfare ….” (Emphasis added.)

The social welfare activities to which the IRC requires section 501(c)(4) organizations to be “exclusively” devoted do not include intervention in election campaigns. IRS regulations provide that “[t]he promotion of social welfare does not include direct or indirect participation in political campaigns on behalf of or in opposition to an candidate for public office.” TR § 1.501(c)(4)-1(a)(2)(ii)

The IRS has not enforced section 501(c)(4)’s requirement that a tax-exempt organization be operated “exclusively” to promote social welfare. Instead, contrary to the plain meaning of the statute, the IRS has permitted section 501(c)(4) organizations to engage in substantial activity that does not qualify as promotion of social welfare, including election campaign intervention. In 1959, the IRS promulgated TR § 1.501(c)(4)-1(a)(2)(i), which provides that “[a]n 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” (emphasis added). As the IRS explained in an August 24, 2012, letter to U.S. Senator Carl Levin, the IRS has “interpreted ‘exclusively’ as used in section 501(c)(4) to mean primarily.”

The effect of the IRS’s regulatory redefinition of section 501(c)(4)’s exclusivity requirement is to allow section 501(c)(4) organizations to engage in substantial amounts of activity that does not promote social welfare as long as they are “primarily” engaged in social welfare activities. Thus, although by the IRS’s own definition social welfare activities do not include participation or intervention in election campaigns, the IRS takes the view that “an organization may carry on lawful political activities and remain exempt under section 501(c)(4) as long as it is primarily engaged in activities that promote social welfare.” Rev. Ruling 81-95, 1981-1 C.B. 332.

The substantial spending on election campaign intervention in which the IRS permits a section 501(c)(4) organization to engage is contrary both to the statutory requirement that section 501(c)(4) organizations must be operated “exclusively” to promote social welfare and to court decisions interpreting that statutory requirement to prohibit “substantial” non-social welfare activity.

The IRS’s replacement of the statutory requirement that section 501(c)(4) organizations operate exclusively to promote social welfare with a regulatory standard that allows them to engage in substantial election campaign activity has resulted in a flood of electoral spending by ostensible section 501(c)(4) organizations. Because these organizations do not report the sources of their contributions, as is required of political committees and other section 527 organizations, election-related spending by section 501(c)(4) organizations deprives other participants in the political process, including voters, candidates, and political organizations, as well as persons and organizations who desire to study the sources of influence on the political process, of critical information about the financial interests served by electoral campaign spending.

The increase in election campaign activity by section 501(c)(4) organizations is primarily responsible for a corresponding increase in electoral spending that is not accompanied by donor disclosure. Because section 501(c)(4) organizations, unlike political parties, political candidate committees, other FECA-regulated political committees (including PACs and “Super PACs”) and other section 527 tax-exempt political organizations, are not required to disclose their donors publicly, their electoral campaign expenditures are almost entirely unaccompanied by donor disclosure.

The huge electoral campaign expenditures without donor disclosure by section 501(c)(4) organizations are directly attributable to the IRS’s regulation permitting such organizations to engage in substantial electoral campaign activity as long as they are “primarily” engaged in promoting social welfare. Politically active section 501(c)(4) organizations operate on the understanding that they will retain their tax exemption as long as they can plausibly maintain that more than 50% of their activity is aimed at promoting social welfare, even though they engage in substantial election campaign intervention that itself is outside the scope of social welfare activity under section 501(c)(4). If the IRS were instead to enforce the requirement that section 501(c)(4) organizations engage exclusively in activity to promote social welfare, and thus refrain from engaging in substantial amounts of election campaign activity and expenditures, much of the electoral campaign spending currently carried out by section 501(c)(4) organizations would shift to other types of organizations—specifically, political committees regulated by FECA and other section 527 tax-exempt organizations—that are subject to donor-disclosure requirements. The resulting disclosures would materially advance the public’s “interest in knowing who is speaking about a candidate shortly before an election.” Citizens United v. Federal Election Comm’n, 558 U.S. 310, 369 (2010).

 

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