IRS Rejects Tax Exemption for Political Groups

The Internal Revenue Service has issued letters denying tax-exempt status to three unidentified political groups that had applied for the exemption as Section 501(c)(4) groups.

In redacted letters recently made public on the IRS Web site, Lois G. Lerner, director of the IRS’s Exempt Organizations unit, wrote, “This is our final determination that you do not qualify for exemption from Federal income tax under Internal Revenue Code section 501(a) as an organization described in Code section 501(c)(4). We made this determination for the following reason(s): You are not operated primarily to promote social welfare because your activities are conducted primarily for the benefit of a political party and a private group of individuals, rather than the community as a whole.”

The redacted letters did not include the names of the organizations that received the IRS warning. However, the names of the groups were later revealed to be three units of Emerge America: Emerge Nevada, Emerge Maine and Emerge Massachusetts, according to The New York Times. The organizations cultivate female political candidates from the Democratic Party.

Groups such as Crossroads GPS, Americans for Prosperity and the American Action Network that have been set up as 501(c)(4) tax-exempt organizations raised large amounts of money for the 2010 election cycle, particularly for Republican candidates in the wake of the Supreme Court’s Citizens United decision allowing unlimited corporate contributions.

Unlike Section 527 organizations, which used to be the preferred tax-exempt vehicle for funneling political donations, 501(c)(4) groups do not need to disclose their donors. However, the Section 501(c)(4) tax exemption is supposed to be for social welfare organizations, and not for political campaigns.

The IRS warned the groups that they may now be subject to taxes and penalties on the contributions they received from donors while their tax-exempt status was pending.

“You must file Federal income tax returns on the form and for the years listed above within 30 days of this letter, unless you request an extension of time to file,” wrote Lerner. “File the returns in accordance with their instructions, and do not send them to this office. Failure to file the returns timely may result in a penalty.”

The letters were sent in April, but were made public this week on the IRS’s Web site, and were linked to by blogs such as the Election Law blog and the TaxProf blog.

Senate Finance Committee Chairman Max Baucus, D-Mont., wrote to IRS Commissioner Doug Shulman last September asking the agency to investigate the tax-exempt status of political organizations (see Senator Asks IRS to Probe Political Groups). “Political campaigns and powerful individuals should not be able to use tax-exempt organizations as political pawns to serve their own special interests,” Baucus said. “The tax exemption given to nonprofit organizations comes with a responsibility to serve the public interest, and Congress has an obligation to exercise the vigorous oversight necessary to ensure they do. When political campaigns and individuals manipulate tax-exempt organizations to advance their own political agenda, they are able to raise and spend money without disclosing a dime, deceive the public and manipulate the entire political system.”

Earlier this year, the IRS sent letters to five unidentified political donors informing them that they might be subject to the gift tax for their donations in 2008 to unidentified 501(c)(4) organizations (see IRS May Tax Political Donations as Gifts). “Donations to 501(c)(4) organizations are taxable gifts, and your contribution in 2008 should have been reported on your 2008 Federal Gift Tax Return (Form 709),” the IRS wrote.

However, the letters led to a backlash among Republican congressional leaders, who demanded to know why the IRS had reversed a 30-year-long tradition of not subjecting such donations to the gift tax (see Senators Question IRS on Gift Tax Enforcement and Political Influence and Congress Demands Answers from IRS on Gift Tax Probe).

Earlier this month, the IRS announced that it was backing away from the inquiry and would stop examining the donors (see IRS Suspends Gift Tax Examinations of Political Donors). The IRS said it would review the need to issue further guidance on the issue of the gift tax and leave it to Congress to decide if it wanted to take legislative action to decide on the applicability of the gift tax to 501(c)(4) organizations. It is unclear if the IRS is now taking a different tack by denying 501(c)(4) status to the organizations entirely.