Democracy 21 and Campaign Legal Center Challenge Legality of IRS Regulations as Failing to Properly Limit Campaign Activity by 501(c)(4) Organizations

Democracy 21 and the Campaign Legal Center filed a petition today with the Internal Revenue Service challenging the legality of IRS regulations that define whether an organization that conducts campaign activity is entitled to obtain or maintain tax-exempt status as a section 501(c)(4) organization.

Under Section 553(e) of the Administrative Procedure Act, “Each agency shall give an interested person the right to petition for the issuance, amendment, or repeal of a rule.”

The petition states that existing IRS regulations permit section 501(c)(4) groups to make far more campaign expenditures than is allowed by the law.

“IRS regulations are improperly permiting 501(c)(4) groups to spend far more money on campaign activity than is allowed by the Internal Revenue Code and by court rulings interpreting the Code,” according to Fred Wertheimer, President of  Democracy 21, which took the lead in preparing the IRS petition filed today.  

“But even under these flawed IRS regulations, we believe that organizations like Crossroads GPS, the brainchild of Karl Rove and Priorities USA, recently formed by two former Obama White House officials, are still not entitled to 501(c)(4) tax-exempt status. The overriding purpose of these groups is to influence elections, not to engage in ‘social welfare’ activities,” Wertheimer said.

“Improper IRS regulations have resulted in widespread abuses of the tax laws and allowed  political organizations to operate under the guise of being section 501(c)(4) ‘social welfare’ groups in order to keep secret the donors who are financing their campaign expenditures. The IRS should promptly issue new regulations and start to properly enforce the laws,” Wertheimer said.

According to Paul Seamus Ryan, FEC Program Director & Associate Legal Counsel at the Campaign Legal Center,  “The IRS has a duty to issue a clear set of regulations that state what type and level of campaign activity 501(c)(4) groups may engage in and maintain their tax-exempt status.  What we have seen in recent years is a proliferation of c4 political front groups that abuse their privileged tax exempt status to evade campaign finance disclosure laws.  What was once a small trickle of abuse by these organizations is now a gusher.”

“It would be irresponsible of the IRS not to move promptly to rectify this shortcoming as section 501(c)(4) groups have become the vehicle of choice for anonymous, massively funded political attack ads.  A growing number of these organizations have nothing whatsoever to do with the promotion of ‘social welfare’ and everything to do with the promotion of ‘partisan warfare,’” Ryan stated.

The IRS Petition

According to the IRS petition, “Section 501(c)(4) of the IRC establishes tax-exempt status for “[c]ivic leagues or organizations not organized for profit but operated exclusively for the promotion of social welfare. . . .”  (emphasis added).

IRS regulations provide that "the promotion of social welfare does not include direct or indirect participation or intervention in political campaigns on behalf of or in opposition to any candidate for public office."

Existing IRS regulations, nevertheless, authorize section 501(c)(4) organizations to intervene and participate in campaigns as long as such campaign activities do not constitute the “primary” activity of the organization.  26 C.F.R. 1.501(c)(4)–1(a)(2)(i).

According to the petition:

The “primary” activity standard established by the IRS regulation is not further defined by the IRS.  Instead, a revenue ruling explains that “all facts and circumstances are taken into account in determining a 501(c)(4) organization’s primary activity.” Practitioners, however, have interpreted this “primary” activity requirement to mean that section 501(c)(4) organizations can spend up to 49 percent of their total expenditures in a tax year on campaign activities, without such campaign activities constituting the “primary” activity of the organization.

The claim that section 501(c)(4) groups can spend up to 49 percent of their total expenditures on campaign activity direct conflicts with court decisions holding that a section 501(c)(4) organization cannot engage in a substantial amount of  a “nonexempt activity,” such as campaign activity, according to the petition.

In Contracting Plumbers Coop. Restor. Corp. v. U.S., for example, the Second Circuit Court of Appeals held with regard to a section 501(c)(4) organization that “the presence of a single substantial non-exempt purpose precludes exempt status regardless of the number or importance of the exempt purposes,” 488 F.2d 684, 686 (2d. Cir. 1973).

In American Ass’n of Christian Sch. Vol. Emp. v. U.S., the Eleventh Circuit held that “the presence of a substantial non-exempt purpose precludes exemption under Section 501(c)(4),” 850 F.2d 1510, 1516, (11th Cir. 1988).

Under these court rulings, a section 501(c)(4) organization cannot engage in more than an insubstantial amount of campaign activity and comply with the statutory standard for tax exempt status under section 501(c)(4).  Any “substantial, non-exempt purpose” – such as intervention or participation in political campaigns – will defeat an organization’s tax-exempt status under section 501(c)(4).

“Court rulings make clear that a section 501(c)(4) organization cannot devote up to 49 percent of its expenditures to campaign activity, or anything remotely like that, and maintain its tax exempt status under the Internal Revenue Code,” Wertheimer said. “In fact, the court cases go in the completely opposite direction to limit spending to no more than an insubstantial amount of campaign expenditures.”

The petition states that contrary to the court decisions:

[T]he regulations permit 501(c)(4) organizations to engage in substantial campaign activity, as long as this nonexempt activity falls just short of  being the organization’s “primary” activity.  Thus the regulations permit far more campaign activity by a 501(c)(4) organization than the limited amount allowed by the statute and court decisions.  The IRS’s regulations conflict with the IRC and court decisions interpreting the IRC, and are contrary to law.

The petition calls on the IRS “to expeditiously adopt new regulations to provide that an organization that intervenes or participates in elections is not entitled to obtain or maintain tax- exempt status under section 501(c)(4) if the organization spends more than an insubstantial amount of its total expenditures in a tax year on campaign activity.”

The petition states:

In order to provide a clear definition of what constitutes an insubstantial amount of campaign activity, the IRS regulations should include a bright-line standard that specifies a cap on the amount that a section 501(c)(4) organization can spend on campaign activities.  See, e.g., 26 U.S.C. 501(h) (providing specific dollar limits on spending for lobbying activities by section 501(c)(3) organizations).  In order to comply with court decisions that limit spending for non-exempt purposes to an insubstantial amount, the bright line standard in the regulations should limit campaign expenditures to no more than 5 or 10 percent of the expenditures in a taxable year by a section 501(c)(4) organization.

According to the petition:

Such a bright-line standard is necessary to ensure that the public and the regulated community have clear and proper guidance on the total amount of campaign activity that a section 501(c)(4) organization can conduct and to assist the IRS in obtaining compliance with, and in properly enforcing, the IRC.

The petition also states:

The new regulations should ensure that a section 501(c)(4) organization cannot do indirectly through transfers what it is not permitted to do directly through its own spending.  In order to accomplish this, the new regulations should provide that a section 501(c)(4) organization may not obtain or maintain its tax-exempt status if the it transfers funds to a section 527 organization or to any other person with the intention or reasonable expectation that the recipient will use those funds to intervene or participate in campaigns if, during the same taxable year, the amount of funds so transferred, when added to the amount spent directly for campaign activity by the section 501(c)(4) organization, exceeds an insubstantial amount of the total spending for the taxable year by the section 501(c)(4) organization.  

The petition calls on the IRS to act promptly to ensure that new regulations are put in place and made effective on a timely basis for the 2012 elections.  “The IRS must recognize the urgent need to prevent section 501(c)(4) organizations from being improperly used to spend  hundreds of millions of dollars in secret contributions to influence the 2012 presidential and congressional elections,” the petition states.

The petition further states:

IRS regulations that are contrary to law are enabling section 501(c)(4) organizations to conduct impermissible amounts of campaign activities and in doing so to keep secret from the American people the sources of tens of millions of dollars being spent by the section 501(c)(4) organizations to influence federal elections.  In so doing, the IRS regulations are serving to deny citizens essential campaign finance information that the Supreme Court in Citizens United said “permits citizens and shareholders to react to the speech of corporate entities in a proper way.  This transparency enables the electorate to make informed decisions and give proper weight to different speakers and messages.” 130 S.Ct. at 916.

The petition concludes:

By an 8-1 vote, the Supreme Court in Citizens United held that disclosure of campaign activities by corporations, including tax-exempt corporations, is constitutional and serves important public purposes.  Such disclosure, however, is being widely circumvented and evaded by section 501(c)(4) organizations as a result of improper IRS regulations and the failure of the IRS to properly interpret and enforce the IRC to prohibit section 501(c)(4) organizations from making substantial expenditures to influence political campaigns.  This failure comes at great expense to the American people who have a right to know who is providing the money that is being spent to influence their votes.

The large scale spending of secret contributions in federal elections by section 501(c)(4) organizations is doing serious damage to the  integrity and health of our democracy and political system.  The IRS needs to act promptly to address this problem by issuing new regulations to stop section 501(c)(4) organizations from being improperly used to inject tens of millions of dollars in secret contributions into federal elections.  The new regulations must conform with the IRC and with court rulings interpreting the IRC.  The regulations should provide a bright-line standard that implements the insubstantial expenditures standard set forth by the courts  and specifies a limit on the amount of campaign activity that a section 501(c)(4) organization may undertake consistent with its tax-exempt status.  The IRS needs to act expeditiously to ensure that the new regulations are in effect in time for the 2012  elections.