Nonprofit Law Prof Blog

Supreme Court: When Can Government Funding Have Speech-Related Strings

The Supreme Court of the United States heard oral arguments last month in a case that raises a very important issue for the many tax-exempt nonprofit organizations that receive government funding in one form or another:  when, if ever, can a government require that the recipient of government funding for a particular program adopt an explicit policy that would apply to all of the organization's activities whether government-funded or not?  In Agency for International Development v. Alliance for Open Society International, Inc., the specific issue is "Whether the United States Leadership Against HIV/AIDS, Tuberculosis, and Malaria Act of 2003, 22 U.S.C. § 7631(f), which requires an organization to have a policy explicitly opposing prostitution and sex trafficking in order to receive federal funding to provide HIV and AIDS programs overseas, violates the First Amendment."  The Second Circuit Court of Appeals panel that heard the case split 2-1, with the majority concluding that the requirement did violate the First Amendment.  The case involves application of the much criticized "unconstitutional conditions" document, and the questioning at oral argument did not provide a clear indication of how the Court will resolve the case, according to veteran Supreme Court observer Lyle Denniston's analysis.  The case is further complicated by the fact that Justice Kagen has recused herself, so there is the possibility of a 4-4 tie vote that has the effect of upholding the lower court decision but without clear guidance on this issue.  A decision is expected by the end of June.

LHM

Tax Reform & Exempt Organizations

In addition to the 501(c)(4) exemption application bombshell, attendees at this month's ABA Tax Section meeting also learned about the serious bipartisan tax reform effort being led by House Ways & Means Committee Chairman Dave Camp (R-Michigan) and Senate Finance Committee Chairman Max Baucus (D-Montana).  Because Representive Camp is approaching his term-limit as Ways and Means Chairman at the end of 2014 and Senator Baucus has already announced his retirement as of 2014, these two experienced members of Congress are somewhat insulated from the normal political pressures that might derail such an initiative.  Their effort has already generated a series of "option papers" that are actually what they say they are - a discussion of possible tax reform options in a variety of areas without endorsement of or partisan sniping regarding any particular set of possible changes.  It also has been the subject of 20 separate Ways and Means Committee hearings, as described on the Committee's Comprehensive Tax Reform website.

Tax reform has also been the focus of eleven Ways and Means Committee working groups, including one relating to Charitable/Exempt Organizations.  For a detailed summary of both the present law in this area and the suggestions and comments received by this working group and the other working groups, see the Joint Committee on Taxation report issued earlier this month.  The exempt organization sections can be found on pages 19-57 (present law) and 491-497 (suggestions and comments received).  Here are the headings for the latter section, which covered the whole gamut of possible options:

1.    The Charitable Deduction

General support for preservation of the charitable deduction or opposition to changes to
the charitable deduction

General support for reform of the charitable deduction

Charitable contributions of property

Other comments relating to the charitable deduction

2.    Tax-Exempt Status

In general

Public charity status and private foundation operating rules

Unrelated business income tax (“UBIT”)

Specific types of tax-exempt organizations

3.    Reporting, Disclosure, or Tax Administration

4.    Exclusion from Gross Income for Qualified Charitable Distributions fron an Individual Retireement         Arrangement ("IRA")

5.    Miscellaneous Comments Submitted by Indiana Tribal Governments

Having reviewed these materials and talked with some of the staffers at the ABA meeting, I actually am cautiously optimistic that tax reform is a possibility.  What effect any reform will have on exempt organizations is impossible to predict at this point, but certainly significant changes to both the charitable contribution deduction and the requirements for tax exemption are on the table.

LHM

Business Leagues - the New 501(c)(4)s?

Huffington Post reports that the conservative Koch brothers are launching a new organization to engage in political activities, but unlike previous such groups this one will be organized as a section 501(c)(6) tax-exempt business league.  The new entity, named the Association for American Innovation, received IRS recognition of its 501(c)(6) status in 2012 according to guidestar.org, but no Form 990 is available yet on Guidestar.  This development highlights the fact that while the focus of the media, campaign finance reform advocates, and a number of state officials and legislatures has primarily been on 501(c)(4) organizations and their ability to be involved in politics without disclosing their donors, both 501(c)(5) labor unions and 501(c)(6) business associations also enjoy this ability to combine (limited) political involvement with avoiding disclosure of their funding sources (unless election law disclosure rules apply).  The Koch brothers are far from the first to realize this is the case, but their new effort is the most prominent example of not only taking advantage of existing 501(c)(5) and (c)(6) entities but actually creating a new entity within this space to exploit these shared characteristics.

LHM

Colleges & Universities Under the Microscope

While hospitals continue to be criticized for failing to provide sufficient charity care and other benefits - criticism that is likely to only increase as more information about such activities becomes available because of section 501(r) - Congress, the IRS, and the media appear to have an increasing and skeptical interest in nonprofit colleges and universities.  Recent developments include:

• IRS Colleges & University Tax Compliance Report:  As previously reported, the report identified widespread underreporting of unrelated business taxable income, although the total amount involved for the 34 institutions examined was only $90 million, and various issues with compensation setting processes and reporting. 

• House Oversight Subcommittee Hearing:  In response to the above report (and lost once the the 501(c)(4) mess broke), this Ways and Means Subcommittee heard from Lois Lerner regarding the above report.

• Weekly Standard: Are Universities Above the Law?:  A wide-ranging critique of college and university governance, citing recent disputes ranging from the Robertson Foundation's litigation with Princeton University's to the Association of Alumni of Dartmouth's litigation against their alma mater. 

• Fiscal Times: Backroom Financial Dealings of a Top University:  This article highlights the generous compensation and loan packages provided by NYU, which became national news with the nomination of former NYU administrator Jack Lew for Treasury Secretary.

All of this scrutiny comes at a time when many colleges and universities are facing increasing criticism for too high tuition, too generous compensation packages, and exploitation of student athletes.  Of course such concerns are not new for nonprofit scholars, including co-blogger John Colombo, who in 1993 wrote Why is Harvard Tax Exempt? (And Other Mysteries of Tax Exemption for Private Educational Institutions), 36 Arizona Law Review 841, and more recently examined the tax treatment of college athletics.  But we may be seeing an unprecedented level of scrutiny that will may ultimately shift the nonprofit governance and tax exemption standards for such institutions.

LHM

Bob Dole on Veterans' Charities

In recognition of Memorial Day, Bob Dole authored a thoughtful Washington Post Opinion piece cautioning readers to be careful when giving to veterans' charities.  While the content will not be surprising to anyone who practices or studies in the tax-exempt nonprofit organization area, the piece does a good job of identifying the common fundraising issues in this particular part of the charitable sector, the limits on the ability of the federal and state government to regulate charitable solicitations, and the role of both the state attorneys general and the media in exposing poorly run and fraudulent veterans charities.  The subject of veterans charities has been a perennial one on this blog, with posts regarding investigations into groups including the Disabled Veterans National Foundation and the U.S. Navy Veterans Association, as well as more general congressional inquiries.

LHM

Hershey Trust & Pennsylvania AG Reach Settlement

Pennsylvania Attorney General Kathleen G. Kane recently announced that her office had resolved an investigation into the administration of the Milton Hershey School and the Hershey Trust Company by entering into an agreement with the School and Trust that implements a variety of governance reforms for both entities.  Attorney General Kane also noted that her office had not found any breach of fiduciary duty during its investigation.  The agreed upon reforms included:

• Limiting overlapping board members between the School and Trust on one hand and the for-profit Hershey companies on the other hand.

• Reduced board compensation, new procedures for any future adjustment to such compensation, and a new, more restrictive policy for reimbursement of board member expenses.

• A strengthened Conflicts of Interest Policy.

• Required reports to the AG relating to compliance with the agreement, increased AG access to various materials, and advance notice to the AG for certain real estate transactions.

For previous posts about the concerns that led to this investigation, see Eisenberg on the Hershey School, Pressure Continues on Hershey Trust Board of Directors, and Milton Hershey School Trust - Excessive Trustee Compensation?  It is far from clear that the report and agreement will satisfy those critical of how their respective boards have managed these charities - Pablo Eisenberg has already written a negative assessment of the investigation's resolution.

Media Coverage: Chronicle of Philanthropy (opinon); Philadelphia Inquirer.

LHM

New (Legal) Models for Philanthropy

The NY Times reports that a new generation of philanthropists is increasingly seeking ways to have "flexibility, freedom and anonymity" in its giving.  The article highlights the use by Laurene Powell Jobs, the widow of Steve Jobs, of a limited liability company (LLC) named Emerson Collective as the primary vehicle for her charitable activities.  LLCs of course avoid the public reporting to which a more traditional vehicle such as a family private foundation is subject.  Furthermore, LLCs owned by a single individual may be disregarded for federal income tax purposes, permitting the individual owner to take any permitted charitable contribution deductions.  Finally, the article notes that an LLC may be used for more than charitable giving - if the owner believes her goals may be better accomplished through for-profit investments (for example, in an L3C or benefit corporation) or through political expenditures, the LLC may engage in those transactions as well.

Hat tip:  Karla Simon

LHM

Views on the 501(c)(4) Mess - Part II (my thoughts)

Having read most of the news coverage of the current situation and written about at least some of the issues at the heart of it, here is my two cents (including, with self-promotion apologies, links to my relevant articles):

Contrary to John Colombo's proposal posted earlier on this blog, I believe that tax exemption (but not deductibility of contributions) for what are now classified as 501(c)(4)s is appropriate, and that exemption is also appropriate for what are now classified as 527s.  With respect to exemption, without a specific provision addressing the tax status of these groups a lot of uncertainty about their tax treatment would exist.  The uncertainty arises because of issues such as whether the contributions and dues they receive are “gifts” under IRC § 102 and so not includible in gross income, especially since their lobbying and political campaign intervention expenditures are generally not deducible under IRC § 162(e).  I also believe that most of these groups are formed (and contributed to) not for profit-making purposes but to pursue other goals, such as advancing a particular vision of the public good or to elect one or more candidates, and so exempting them from the corporate income tax is appropriate.  Donations to such groups should not be deductible, both because of concerns regarding the influence of special interest groups (discussed in a recent article by Brian Galle and to some extent in my previous lobbying article) and because allowing deductiblity would permit easy avoidance of IRC § 162(e).

As a matter of cleaning up the tax laws, I like Ellen Aprill's idea of creating a new tax-exemption category for organizations that primarily lobby and expanding the 527 category to include any organization that engages in political campaign activities.  I have not thought this idea all the way through yet, however.  I have thought more about the possible constitutional issues raised by such a change (most recently flagged by Bob Bauer) and my conclusion is that the Supreme Court's Taxation with Representation decision is still relatively secure and would permit this kind of line drawing (for more details, see my post-Citizens United lobbying article; a recent article by Ellen Aprill also reaches this conclusion).  Bauer is right to flag this issue, however, since it is a live one, especially if the Supreme Court's Citizens United decision turns out to be only a way station to an even stronger reading of the First Amendment in this context as opposed to a high water mark.

Finally, with respect to requiring disclosure of political activities, including of donors whose funds support such activities, I favor not placing such requirements in the tax laws to be administered by the IRS but instead in the election laws to be administered by the admittedly far from perfect FEC for the institutional choice reasons described in my 527 regulation article.  As to what political activities should trigger disclosure (e.g., direct lobbying and grassroots lobbying as well as election-related political activity?) and what should have to be disclosed (e.g., donors above what dollar threshold?), I have written a couple of articles (here and here) that touch on these topics and am working on another article focusing specifically on what political activities, particular political activities such as grassroots lobbying and bundling that involve private-private interactions, should trigger disclosure (watch this space!).

LHM

Views on the 501(c)(4) Mess - Part I (selected Commentary & OpEds)

Others have done a great job of reporting the numerous news stories covering the 501(c)(4) exemption application mess at the IRS (see especially TaxProf Blog, which has been providing a daily "IRS Scandal" update).  So here I want to focus on commentary and opeds written by a number of thoughtful exempt organizations academics and practitioners:

• Ask the Experts: What to Make of the IRS "Tea Party" Scandal, CardHub (5/22/13):  Provides lengthy quotes from Ellen Aprill, David Gamage, Philip Hackney, Thomas Kelley, Nicholas Mirkay, and yours truly.

• Ellen P. Aprill, IRS and Scrutiny: Reviewing Review, Roll Call (5/23/13):  "Some media reports, however, imply that the IRS cannot and should not ask any questions of applicants for exemption, that any inquiry invades privacy and violates the First Amendment. That implication is wrong. An organization that seeks an IRS acknowledgment of its exempt status subjects itself to scrutiny — scrutiny designed to ensure that the group in fact qualifies for the benefit of tax exemption."  See also Ellen Aprill, The TIGTA Report on the IRS Scandal: Questions About the IRS and About the Report, TaxProf Blog (5/15/13).

• Gary D. Bass & Elizabeth J. Kingsley, Nonprofits Need Better Guidance on Tax-Exempt Standards, Washington Post (5/23/13):  "But we must not lose sight of the underlying problems that led to this situation: the lack of workable standards to determine what activity the Internal Revenue Service considers 'political' and how much of it a nonprofit group can do. . . . Much of this problem could be addressed by adopting objective, substantive criteria to define political intervention for nonprofit organizations."

• Roger Colinvaux, IRS Scandal Is About Donors, Not Tax, CNN (5/17/13):  "Obviously, mistakes were made in how the IRS examined the groups, but what should not get lost amid the resulting hue and cry is that this is fundamentally about disclosure of donors, not tax-exempt status."

• Victor Fleischer, Congress's Role in the I.R.S. Focus on Conservative Groups, NY Times DealBook (5/13/13):  "The reality is that this is a story of institutional incompetence. And Congress should share the blame."  See also Victor Fleischer, A Dickensian Delay at the I.R.S., NY Times DealBook (5/16/13).

• Phillip Hackney, The TIGTA Report on the IRS Scandal: Be on the Lookout for False Partisan Witchunts, TaxProf Blog (5/15/13): "Nevertheless, other than the disclosure problems, this TIGTA review gives an accurate picture of an organization that I came to know and love when I worked there.  Good people trying to do good work, but set for failure because provided poor clay in the Internal Revenue Code provisions on exempt organizations and too little staff and money to carry out the twin aims of accuracy and speed in molding that poor clay into a consistent good product."

• John Pomeranz, On the IRS Fiasco, Election Law Blog (5/11/13):  "Looking beyond the immediate scandal, I believe that part of the reason it was possible for the IRS to treat these groups this way was the failure of Congress, the Treasury Department, and the IRS to adequately define what and how much political activity is permitted for tax-exempt organizations."

LHM

Should the state of New York be concerned about nonprofits incorporating outside state lines?

New York lawmakers are currently in the process of reforming the state’s Not-For-Profit Corporation Law. Key players in the reformation process explain that they are trying to reconcile the differences in S3755 and S5198.

The current New York Not-For-Profit Corporation Law has not experienced significant changes since 1969. The law’s contemporary critics claim that its regulatory scheme is overly intrusive and has ultimately caused nonprofit organizations to incorporate outside of the state of New York.

New York is home to about 103,000 nonprofit organizations that employ somewhere around 1.25 million people. These numbers clearly indicate that New York nonprofits do a lot of good for the state in terms of providing public benefits and employment opportunities for New Yorkers. However, each year New York also loses millions of dollars in property taxes due to nonprofit tax exemptions. Is the state in which a nonprofit is incorporated a valid consideration when weighing the benefits and burdens associated with tax-exempt organizations? If a nonprofit organization chooses to be present and operate in New York, but simply elects to incorporate outside of the state, in what way is the state of New York affected?

http://www.newyorklawjournal.com/PubArticleNY.jsp?id=1202601454225&thepage=1

http://wcfcourier.com/lifestyles/faith-and-values/religious-groups-tax-exemptions-cause-division/article_1efb0c46-8741-11e2-9974-0019bb2963f4.html

dab 

MOOC accreditation

“MOOC” stands for massive open online courses and just last year the New York Times named 2012 “the year of the MOOC.” Additionally, several of the nation’s most prestigious schools have partnered with nonprofit educational organizations such as edX and Coursera to offer free online classes. Consequently, many people view free MOOCs as a way to provide an Ivy League education to those who either will not or cannot otherwise pay the costs of receiving an education at schools like Harvard and Yale.

However, one criticism and drawback of MOOCs is that they are not accredited. Consider, the Khan Academy, a 501(c)(3) nonprofit organization whose mission is to change “education for the better by providing a free-world class education for anyone anywhere.” The Khan Academy has around 6 million regular monthly users, and about 4,000 other people utilize the organization’s online tutorials. While the Khan Academy offers Ivy League quality courses, people who take the time to study the material and do the work often have trouble finding a market for their newly acquired skills.

If organizations like the Khan Academy eventually do receive accreditation, what impact if any, will their accreditation have on the nonprofit schools within the traditional education system? Should accreditation have an impact on the nonprofit status currently conferred to MOOCs?

http://www.nytimes.com/2012/11/04/education/edlife/massive-open-online-courses-are-multiplying-at-a-rapid-pace.html?ref=edlife

http://www.guardian.co.uk/education/2013/apr/23/sal-khan-academy-tutored-educational-website

http://www.khanacademy.org/about

dab

Schervish on wealth transfer and philanthropy

Boston College Sociologist Paul G. Schervish is one of the country’s prominent scholars of philanthropic studies. This August Schervish will be recognized for his contributions and presented with the 2013 ASA Distinguished Career Award.

Much of Schervish’s research relates to wealth transfer and philanthropy. In 2003, Schervish helped to found the Wealth & Giving Forum, a “peer-centered endeavor” designed to encourage wealthy families and individuals to “make more resources available for good causes.” The Wealth & Giving Forum seems to have adopted a “with great wealth comes great responsibility” approach to charitable solicitation and giving.

The structure of the Wealth & Giving Forum offers an interesting way for people to consider charitable giving in a very particular context. A brochure of the Wealth & Giving Forum explains, “The Wealth & Giving Forum is for high-net-worth individuals and families who want to harness their creativity and resources to meet the human, cultural, and environmental challenges of the 21st century.” Additionally, the Wealth & Giving Forum is “directed by and for wealth holders” and it operates by “invitation-only gatherings, regional and topical programs, and publications.”

Is there anything alarming about the exclusivity of the Wealth & Giving Forum’s approach? If so, is the exclusivity offset by the benefits derived from the Wealth & Giving Forum?

http://www.bc.edu/content/bc/offices/pubaf/news/2013-may-jun/bc-sociologist-receives-ASA-distinguished-career-award.html

http://www.wealthandgiving.org/

http://www.wealthandgiving.org/uploads/WGF%20Oct%2004,%20full%20brochure.pdf

dab

Vulnerability blinds patients of phony nonprofit health clinic

A few weeks ago, a federal judge in California sentenced 58 year-old Christine Daniel to 14 years in federal prison. Daniel, a former doctor and Pentecostal minister, ran a health clinic used to offer Daniel’s “herbal treatments.” Daniel encouraged her cancer patients to stop chemotherapy treatments and charged them hundreds of thousands of dollars for these treatments which she claimed could cure cancer, diabetes, hepatitis, and many other diseases and conditions.

Daniel tried to make her patients believe the clinic was a credible nonprofit organization by telling her patients to classify their payments for “medical services” as donations to the clinic. At trial, prosecutors introduced evidence that Daniel’s failure to report taxable income resulted in tax losses to the government in the amount of $73,895.

It is safe to assume that cancer patients and their families are among some of those most vulnerable people nonprofit organizations seek to help. Consequently, while classifying payments for services as donations in most circumstances may seem a bit alarming, people desperate for life preserving medical treatment may disregard such traditional red flags if doing so means there is an opportunity to try something they believe could save their life or the life of a loved one. Certainly, this conception of the vulnerability of cancer patients isn’t novel. However, what, if anything, can be done within the nonprofit sector to safeguard against people taking advantage of this vulnerability?

http://www.dailymail.co.uk/news/article-2326851/Christine-Daniel-Doctor-claimed-herbal-concoction-cure-cancer-duped-1m-patients-jailed.html?ito=feeds-newsxml

http://articles.latimes.com/2011/sep/28/local/la-me-0928-minister-20110928

http://losangeles.cbslocal.com/2011/09/27/doctor-convicted-for-defrauding-patients-with-bogus-cancer-cure/

dab

New Jersey mayor calls nonprofits to pay more in taxes

In his state of the township speech, Lawrence, New Jersey Mayor Jim Kownacki suggested the city’s weak budget is partially attributable to the fact that it loses $287 million in property taxes because of local nonprofit property tax exemptions. However, Kownacki was quick to explain that he wasn't trying to attack nonprofit organizations and he acknowledged that nonprofits “do a lot of work for [the community] and help us in a lot of ways.”

Lawrence officials have asked the community’s nonprofit organizations for financial help in the past by asking that the organizations donate a certain percentage of the property taxes they would owe if not for the exemption.

Does this proposed collaboration between the public and nonprofit sector conflict with any of the justifications for the charitable tax exemption?

http://www.nj.com/mercer/index.ssf/2013/05/lawrence_mayor_asks_nonprofits.html

dab 

Follow Up: Section 501(c)(4) criminal issues

Just to follow up on my post from earlier this week, at this point there seem to be two leading contenders for the criminal issues involved in the Section 501(c)(4) investigation:

1.  Unauthorized disclosure and use of taxpayer information, specifically including the release of some information to ProPublica; and

2.  If today's hearing was any indication, some members seemed to be interested in pursuing whether IRS officials made full disclosures to Congress in prior hearings. 

EWW

 

The 501(c)(4) TIGTA Report: My Random Thoughts

I have now had the opportunity to go through the TIGTA report as well as listen to this morning’s Ways & Means hearing. Here are some random thoughts and questions on the matter:

1. The report refers to a “BOLO” list (“be on the look out”) of terms that would trigger an additional look. I note this from the report: “[b]ased on our review of other BOLO listing criteria, the use of organization names on the BOLO listing is not unique to potential political cases.” (TIGTA Report, page 6 (my references refer to the .pdf version on the website)). When I read that, the first thing that came to my mind was credit counseling organizations – and in fact, Steve Miller mentioned credit counseling organizations in this respect today. From what I can tell, I think we know that these were not the only terms on the BOLO list, but I don’t think we know what else is on there. Footnote 16 specifically states, “[w]e did not review the use of other named organizations on the BOLO listing to determine if their use was appropriate.”

2. The report’s primary problem with the use of these terms was that “the criteria [in the BOLO listing] focused narrowly on the names and policy positions of organizations instead of tax-exempt laws and Treasury Regulations. Criteria for selecting applications for the team of specialists should focus on the activities of the organizations and whether they fulfill the requirements of law. Using the names or policy positions of organizations is not an appropriate basis for identifying applications for review by the team of specialists.” (TIGTA Report, p. 7). The TIGTA report does NOT appear to say that the actual scrutiny given was inappropriate – in fact, if the same organizations had been selected for scrutiny using different criteria, that appears to have been appropriate in most cases. Of the 298 applications that were selected for special scrutiny, the Inspector General thought that there were no indicia of additional political activity for 91 (or 31%) of the cases (note that the IRS disagreed with this finding, by the way.) As far as I can tell, we don’t know how many of these 91 cases were “Tea Party”, “912,” or “Patriot” organizations.

3. I am amused and dismayed that suddenly people are worried about Form 1023/1024 processing delays at the IRS. Where have they been? This is new and unique to advocacy 501(c)(4)s, right? Of course it’s not – all of this who work in the nonprofit sector (including the IRS) have complained about Form 1023/1024 processing times for years. Steve Miller was pretty clear today – they simply don’t have the people. Not that I think the IRS hasn’t been entirely clear about this point that in the past. That being said, the TIGTA report does make the point that the cases selected for special scrutiny sat for significantly longer than average for “regular” cases, at least in part due to the fact that it took the Determinations Unit “more than 20 months (February, 2010 to November, 2011) to receive draft written guidance from the Technical Unit for processing potential political cases.” (TIGTA Report, p. 12). To me, this is one of the most troubling aspects of this issue - I am truly concerned about why it took so long to provide that type of guidance. (Side note: the IRS letter indicating that it would cease using resources to look at gift tax return issues with regard to contributions to Section 501(c)(4) organizations was issued on July 7, 2011).

4. The TIGTA report also is concerned that IRS agents have asked for inappropriate information, such as donor lists. I agree – this was probably not appropriate to request donor lists. But, again, this isn’t a new issue. One need only revisit the nonprofit sector’s concerns regarding the governance questions on the redesigned Form 990 to see that we’ve struggled with this problem for some time. In my view, it is yet another side effect of the long standing personnel and budget issues at the IRS. Along these lines, another disturbing (but unfortunately, not surprising) part of the report for me is the finding that the Determinations Unit was sufficiently confused about what constituted appropriate Section 501(c)(4) activity that the IRS had to provide employees with a two-day workshop on the topic – in May, 2012. (TIGTA, p. 14).

5. As I indicated below as I watched the hearings, I am troubled by the notion that follow up questions from the IRS are now burdensome and inappropriate. The organization is asking to be exempt from federal taxation – presumably, we want that status to go only to those organizations that are so qualified. Unnecessary does not equal burdensome. When necessary, a tax-exempt organization should have to shoulder some burden for the privilege of not paying taxes.

From the tenor of today’s hearing, I’m sure there will be more to follow on this issue. EWW

Happening Now: Ways & Means Hearing on CSPAN

Here's the link... it's still going.   I'll try to post the transcript when done. EWW

Update 1 - Just a quick thought as Rep. Earl Blumenauer of Oregon talks about staffing and Congress' role in this issue.   The real lesson to me in all of this is there is a consequence to the long term budget cuts and the attrition in personnel (hiring freeze/retirements, etc.) at the IRS.  I'll say it... it is infuriating to hear some of these folks be shocked ... *shocked I tell you*... that after what's happened with staffing at the IRS over the last 10-15 years that there would overworked staffers and issues with management at the IRS.   The IRS and the bar have been telling you this for years, Congress...

Update 2 - I'm really sort of shocked that Congress people are surprised that asking about a nonprofit's relationship with various individuals is somehow per se inappropriate.   And asking for board member resumes and copies of websites.  I'm not going to say that all of these requests were appropriate, however, the IRS does have to ask follow up questions, folks - follow up questions are not in and of themselves in burdensome.  

Update 3 - Again, my opinion only... this has turned into an anti-IRS free-for-all that, as a tax professional, is hard to watch.  I'm not going to say that the IRS is without fault but this is really troubling.

Update 4 - Apparently, CSPAN will replay the hearing in full tonight at 8 p.m. EST.

EWW

 

 

 

A Solution to the (c)(4) Problem: Get Rid of Them

As you all must know by now, either from prior posts on this blog or any of a million other sources, the IRS is in deep trouble for its handling of certain 501(c)(4) applications.  I’m not going to comment directly on what the IRS did or didn’t do in its administrative systems that resulted in the current mess.  But I do think it is time to comment on the root of all the trouble, which is the existence of 501(c)(4) itself.

Today in the NYT on-line "Room for Debate" feature, which you can view here, I proposed my solution: just get rid of 501(c)(4) (there are also very thoughtful contributions from Lloyd Mayer - who also posts on this blog, Ellen Aprill, Doug Mancino and Rosemary Fei).  But I was limited to 300 words in that format; here I have the freedom to flesh out my argument a bit more, so I’m going to take advantage.

The argument boils down to this: the administrative havoc created by the (c)(4) designation in conjuntion with the Citizens United case simply does not outweigh whatever marginal public benefit the (c)(4) designation produces.  Accordingly, we should repeal it.  

So let’s begin with some background.  Have you ever asked what the difference is between a "social welfare" organization under (c)(4) and a charity under (c)(3)?  My students in my Tax-exempt Organizations class do so every year.  And here is the convoluted, though ultimately simple, answer.

A 501(c)(4) organization is one that, according to IRS regulations, “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. An organization embraced within this section is one which is operated primarily for the purpose of bringing about civic betterments and social improvements.”  Now it should be fairly obvious that “bringing about civic betterments and social improvements” is a charitable purpose that would qualify an organization for tax-exemption under 501(c)(3), rather than 501(c)(4).  Indeed, “improving society” is a core rationale for the existence of charity.  So why do we have 501(c)(4) at all?  Why aren’t these organizations simply exempt under 501(c)(3)? 

The answer lies principally in two acute differences in the statutory language between 501(c)(3) and 501(c)(4).  501(c)(3) states that an organization qualifies for exemption under that section only if “no substantial part of the activities of which is carrying on propaganda, or otherwise attempting, to influence legislation . . . and which does not participate in, or intervene in (including the publishing or distributing of statements), any political campaign on behalf of (or in opposition to) any candidate for public office.”  In other words, 501(c)(3) organizations cannot engage in a “substantial” amount of lobbying, and cannot engage AT ALL in political campaign activity.  In contrast, 501(c)(4) contains no such limitations, and in fact the IRS’s view is that lobbying to advance social welfare is itself a social welfare purpose.  As a result, a (c)(4) can engage in an unlimited amount of lobbying, contrary to the (c)(3) limitation.  On the other hand, the regulations under (c)(4) confirm that political campaign activity is NOT a social welfare purpose; but note that (c)(4) does not have the absolute prohibition against political campaign activity that a (c)(3) does.  Accordingly, a (c)(4) also can engage in political campaign activity, as long as its primary purpose remains promotion of social welfare.  

So when you boil all this down, a 501(c)(4) is essentially an organization with a charitable purpose that either engages in too much lobbying or too much (i.e., ANY) political campaign activity to qualify as a 501(c)(3) organization. And that in turn leads to the ultimate question: why should we grant tax exemption to an organization that would qualify as a charity but essentially violates the limitations on political activity in 501(c)(3)? 

[Side note here: Ms. Fei and Mr. Mancino note that there are a few organizations that don’t engage in excessive lobbying but are (c)(4)’s because they don’t meet some other requirement of (c)(3) status, like the strict private benefit rule.  I’ll pen a longer response to that at some point, but my quick response is pretty much the same: even if that is true – and I think the IRS hasn’t been entirely clear on these points – it shouldn’t be.  Why give a tax break to organizations that don’t serve a broad enough charitable class or generate private benefits that would disqualify them from charitable status?]  

My answer is, we shouldn’t.  Part of the problem with answering questions like this is that we do not have any coherent theory for why we give “charities” tax exemption – or indeed, what a “charity” is for exemption purposes.  But most people agree that charities are organizations that provide a “public benefit” by offering services otherwise unavailable from the private market and which government either chooses not to provide or is affirmatively prohibited from providing (e.g., religion).  Different folks explain this differently - the economists talk about market failure; the political scientists and sociologists talk about “pluralism” and so forth.  But the general concept is the same: we can think of charities as organizations that are “gap fillers” – they fill the holes left by the private market and government.  Exemption is a partial government subsidy to help these organizations provide their services – partial, because the government can’t or won’t fully fund the activities of these organizations, but government can “help” by freeing them from tax payments (it also helps by permitting a tax deduction for charitable contributions to these organizations  and permitting them to issue tax-exempt bonds). 

If you buy this explanation (and admittedly not everyone does), then the (c)(4) essentially is filling a highly specialized niche – it’s a charity that lobbies too much, or engages in political campaign activity.  So my question is whether this is a kind of market failure (or pluralism or whatever) that justifies the partial government subsidy of tax exemption.  My answer is “no” – why should government subsidize organizations to lobby the government?  Do we really believe there is a serious market failure in lobbying?  That there is too little lobbying in the world?  So much so that the government should give a partial subsidy for lobbying?

But, you may respond, don’t (c)(4) organizations lobby on behalf of groups that otherwise have little voice in government?  Suppose that an organization’s primary purpose is to lobby for more government programs for the poor.  Surely that is something that is worth subsidizing, right?  I disagree.  Note that a charity exempt under 501(c)(3) and conducting some kind of active program for the poor can in fact engage in SOME lobbying – just not a “substantial amount” of lobbying.  I think one can make a good case that if you are concerned about “giving voice” to otherwise-disenfranchised groups, that voice is best expressed by groups that have active programs involving services to those disenfranchised, rather than organizations that do nothing but purport to represent those groups in legislation.  And if your primary activity is conducting a charitable program other than lobbying, you get exemption under 501(c)(3) AND you can lobby (some).  But even if you disagree with this argument, I come back to the following point: if we think too much lobbying (and ANY political campaign activity) is "bad" for a charity, what is the justification for creating a "charity lite" category that permits these things?

So my bottom line is this.  The (c)(4) designation doesn’t get us much public benefit that we couldn’t get with a (c)(3) that has an active program of service and lobbies on the side.  And yet as we have seen over the past two years, the (c)(4) presents virtually insoluble administrative problems of line-drawing regarding when political campaign activity is “primary” and between “issue advocacy” and lobbying (completely permitted) and “political campaign activity” (permitted as long as it is not the “primary purpose”).  Despite Ms. Fei and Mr. Mancino's pleas for better enforcement, I'm highly doubtful that the IRS will ever be able to adequately enforce these lines in the (c)(4) context.  They can't even enforce them in the (c)(3) context very well, where the backdrop is an absolute prohibition on political campaign activity coupled with a softer limit on lobbying.  So what would make anyone think there is some "magic formula" that will make these things enforceable in the (c)(4) context with even less-well-defined limits?

So my solution: get rid of the (c)(4).  It just isn’t worth the angst.

JDC

Your 501(c)(4)-gate daily update

First, thanks to Darryll for his insights last night - for the record, I whole heartedly agree.  Lost in this whole discussion is that there is a serious tax compliance issue that needs to be addressed.  As I read all of the news, I can only think of the Ways & Means hearings that were held a few months ago.  I distinctly remember how many pointed questions on Section 501(c)(4)s the committee asked the panel, even though it was really off topic.  I fear that the IRS has been simultaneously told to give guidance and yet do nothing (see also, gift taxes and Section 501(c)(4) contributions) that will mess up the status quo.  I do not envy the position of the folks at the IRS, may of whom I've had the pleasure of working with personally and know to be dedicated civil servants.

The two biggest updates from yesterday in 501(c)(4) gate:

• Yesterday, the Treasury Inspector General for Tax Administration released its report, entitled "Inappropriate Criteria Were Used to Identify Tax-Exempt Applications for Review."   The link is here, but I will try to update my post below so it's one-stop shopping.   My hope is to provide a more comprehensive review of the IG's report tomorrow for you all.
• To some degree more shocking to me, AG Holder has indicated that a criminal investigation into the issue.   I know many of us are thinking - criminal, really?  On what basis?  The primary speculation at this point is release/misuse of confidential taxpayer information, but there may be other causes of action floating around.  I will try to collect those and do an additional update on that point as well.  

That's all for now... more to follow tomorrow (now that grading is over!) EWW 

Targeting Conservative (c)(4)'s and the Next IRS Watergate Scandal: Service Workers between a rock and a hard place.

The good thing about blogs is that you can always add some "op-ed."  Let me just add a little op-ed to Elaine's helpful post below.

A long time ago, a federal district court judge imposed sanctions on the Nixon Watergate imploding Whitehouse for what it viewed as improper political interference in process by which applications for exemptions were reviewed: 

A looming issue in this case has been whether political interference or intrusion has played a role in the Internal Revenue Service's consideration of the Plaintiff's exemption application. Should this specter prove to have substance, the complexion of this case changes. A showing of political influence renders the Service's ruling null and void. It is outside the law.

The Court is concerned not only with direct political intervention, but also with the creation of a political atmosphere generated by the White House in the Internal Revenue Service which may have affected the objectivity of those participating in the ruling in the Plaintiff's case. The inference of political intervention has been unmistakenly raised: (1) by the handwritten memo in the Plaintiff's file indicating "perhaps White House pressure"; (2) by John Dean's testimony before the Ervin Committee; (3) by the memoranda Mr. Dean submitted to the Ervin Committee; (4) by the testimony of Patrick J. Buchanan, White House Staff Member, before the same committee (September 27, 1973);(5) by the Deposition of Roy Kinsey, Assistant to Mr. Dean, (July 30, 1973, at 10-18); and (6) by the four documents submitted for in camera inspection. These indicia of political intervention, combined with the unusual and protracted processing of the Plaintiff's application, have triggered a warning signal requiring the Court to fully investigate the issue. Through its Discovery Orders, the Court has endeavored to obtain all the information necessary to make an informed evaluation of the issue. However, the time has come for the Court to make that evaluation, and the Court is without the requested materials to do so.

The Defendants have failed to comply with the Court's Order of July 6. Within the scope of the Order were all White House files plus the Treasury and the IRS files regarding tax-exempt organizations since Jan. 20, 1969, and certain tape recordings now before Judge Sirica.

Neither of the two searches of the White House files met the scope of the Order. The first was limited solely to materials in the White House files which mentioned the Plaintiff. In addition, Mr. Kehrli's affidavit regarding the first search of "all White House 872*872 files" was misleading. As his deposition indicates, he did not in fact search all of the White House files. He did not search the impounded files of Messrs. Colson, Ehrlichman, Haldeman, Dean or Caulfield.

The second time, the Defendants limited the search to documents, memoranda or writings in the White House central and special files which either related to or mentioned the Plaintiff or related to "White House interest in the tax-exempt status of left-wing activist organizations." Mr. Buzhardt's affidavit indicated that he conducted a complete search of the files which produced four documents which he submitted for in camera inspection.  Mr. Buzhardt's complete search, however, failed to produce the documents, memoranda, and writings relating to this issue which were specifically referred to by Mr. Dean and Mr. Buchanan in their Ervin Committee testimony and by Mr. Kinsey in his deposition.

Center on Corporate Responsbility, Inc. v. Shultz, 368 F. Supp. 863 (1973). What's old is new again.  Readers are no doubt well aware, by now, of the bruhaha over the controversy sorrounding the Service's admitted over-scrutinization of conservative 501(c)(4)'S.  As Center for Corporate Responsibitility indicates, these matters are not simply political fodder but can have impact on an organization's entitlement to exempt status.  It appears that heads will eventually roll for all of this, I' m sorry to say. 

I think the IRS workers and their leaders in The Service were caught in a trap not of their own making.  Ever since Citizens United, its been no secret that most (c)(4)'s are hardly organized for "social welfare" as that term is apparently intended in the regulations -- i.e., something other than political action.  On the one hand, the IRS has been faulted for not doing enough to make sure (c)(4)'s are not simply political action committees in disguise, but on the other they are faulted for looking more closely at (c)(4)'s that appear to have an exclusively political purpose.  And while it is certainly wrong to target just one side of the political spectrum, I am not sure that is what happened.  The press is on a virtual feeding frenzy but there is evidence that the Service simply looked for "political buzz words" in the title of the 'social welfare" organizations before deciding to give enhanced scrutiny to certain groups.  The fault lies in the disparate impact -- more conservative groups ended up being subjected to enhanced scrutiny than did liberal groups, if that is what happened.  Even the WSJ, hardly left leaning, admits that the Service personnel were looking for "political" labels, not just "conservative" labels in deciding whether to scrutinize applications from (c)(4)'s. If that be the case, then the only fault lies in whether the result was that conservative leaning groups were more often or more likely subjected to enheanced scrutiny because the Service looked for catch phrases more often used by conservative groups in identifying which (c)(4) applications to pull. In other words, the Service might be faulted only for having a limited vocabulary, not necessarily a political bias.  Hopefully the soon to be released Inspector General report will enlighten us all.  In the meantime, let's not get the lynch mob all riled up just yet. 

dkj