Taxes and Politics Collide in New IRS Guidelines for 501(c)(4) Organizations: IRS Proposes to Restrict Political Activities of Some Non-Profits

11 December 2013       Authors: Robert B. Womble, Mary Burke Baker, Tim L. Peckinpaugh, Karishma Shah Page, Richard L. Sevcik, Stephen P. Roberts

On November 29, 2013, the Internal Revenue Service (“IRS”) issued proposed rules, “Guidance for Tax-Exempt Social Welfare Organizations on Candidate-Related Political Activities” (78 Fed. Reg. 71535-71542 (Nov. 29, 2013)), which could substantially change how certain groups approach political spending.  In recent elections, record-breaking spending of independent expenditures has been driven, in part, by Internal Revenue Code (“IRC”) 501(c)(4) social welfare organizations.  If the IRS proposed guidance is implemented without changes, political spending may shift away from these groups, instead focusing on labor unions, trade associations, “Super PACs,” and extensive “joint fundraising committees” that may become popularized through a pending Supreme Court decision.

The proposed regulations do not resolve the ongoing controversy regarding 501(c)(4) social welfare organizations.  Moreover, it is possible that the proposed regulations could have broad implications beyond 501(c)(4) tax exempt groups.  Notably, the IRS has asked for comments on the possible extension to other exempt organizations of some of the concepts in the proposed regulations.

Ongoing Controversy
The proposed regulations were issued in the midst of a significant and ongoing debate regarding 501(c)(4) social welfare organizations.  Like IRC 501(c)(3) charitable organizations, these groups are entitled to an exemption from federal income taxes but, unlike contributions to 501(c)(3)s, contributions to 501(c)(4)s are not tax-deductible.  However, donors to 501(c)(4) organizations are not publicly disclosed, generating concerns about the lack of transparency of political activity being conducted by these organizations.  Further, lack of clarity between the tax statute and the regulations regarding the degree of political activity that can be carried out by a 501(c)(4) has led to even more dispute, including scrutiny of the IRS’s review procedures for applications requesting approval of tax-exempt status by such organizations. [1]  

After Citizens United and related decisions in lower courts, 501(c)(4) organizations may engage in independent expenditures at the federal and state levels that directly advocate for or against a candidate.  While, in most circumstances, donors to a 501(c)(4) need not be disclosed for independent expenditures regarding a federal election, laws on disclosure vary at the state level.  A California regulatory body recently levied a record fine against a 501(c)(4) organization for failing to disclose the sources of its contributions. 

The 501(c)(4) social welfare organization debate erupted again earlier this year, when the IRS admitted it had engaged in extra scrutiny of conservative organizations applying for 501(c)(4) status between 2010 and 2012.  The admission sparked significant criticism, resulting in resignations of senior IRS officials and prompting bipartisan Congressional oversight and investigations into whether the IRS’s actions were a poor attempt to manage an unexpected uptick in 501(c)(4) applications or were intentional discrimination.

Proposed Regulations
IRS and Treasury officials state the purpose of the regulations is to ensure that standards for tax exemption are clear and consistent.  However, some may perceive the regulations as an effort to curtail the use of 501(c)(4) social welfare organizations as a vehicle to engage in political campaign activity, or as a preemptive action by the IRS to quell the controversy over its actions. 

The proposed regulations define a new type of activity, known as “candidate-related political activity,” for purposes of determining the level of political activity conducted by a 501(c)(4) organization.  This term would replace the current “intervention in political campaign” rules.  One reason for the new definition is to avoid confusion of the new rules – which would be applicable to  501(c)(4) social welfare organizations only – with the present “intervention in political campaign” rules that are applicable to other exempt organizations including  501(c)(3) charitable organizations (where such activity is prohibited) and 501(c)(6) chambers of commerce and business leagues (where, as with 501(c)(4) organizations, such activity cannot be their primary activity). 

The new definition of “candidate-related political activity” moves away from the largely facts and circumstances test of the current regulations to a more objective test, often borrowing from similar concepts used in the federal election laws.  Besides specifying certain actions that will per se constitute “candidate-related political activity,” other “public communications” within 30 days of a primary election or 60 days of a general election would also constitute “candidate-related political activity.”  Those actions that constitute per se “candidate-related political activity” include the conduct of voter registration or “get out the vote” drives and the preparation or distribution of voter guides by or on behalf of a candidate or by an IRC 527 political organization.  The effect of this new definition is to expand the types of activities and expenditures that constitute “political” activity.

The definition of “candidate-related political activity” is very similar to the definition applied by the IRS in connection with its “fast track” exemption procedure that was implemented earlier this year to address those organizations whose 501(c)(4) determination letter requests were pending for more than 120 days as of May 28, 2013.  Such organizations could have received expedited approval if they were able to certify to the IRS that, with regard to their activities, less than 40 percent of both the organization’s total expenditures and its total time (measured by employee and volunteer hours) are devoted to direct or indirect participation or intervention in any political campaign on behalf of or in opposition to any candidate for public office.  The announcement of this procedure followed the IRS’s admission of targeting conservative groups.  Following this announcement, the IRS published a list of activities that constitute “political campaign intervention” for purposes of this expedited review process; a list that includes virtually the same activities identified in the proposed rules. 

Interestingly, the proposed regulations do not attempt to cure what many perceive to be the root of the problem, which is that the word “exclusively” as used in 501(c)(4) has been interpreted by the current regulations as meaning “primary.”  While the proposed regulations do not change this standard, the IRS does invite comments on this question.

Depending on if and how they are finalized, the rules could impact many traditional 501(c)(4) organizations.  Also, as noted above, the IRS has asked for comments on the possible extension to other exempt organizations, meaning the implications could be even broader to include  501(c)(3) charitable organizations, 501(c)(5) labor and agricultural organizations, and  501(c)(6) chambers of commerce and business leagues. 

Additionally, the proposed rules are likely to result in political spending being shifted to other kinds of groups.  For some types of spending, an independent expenditure-only committee (or “Super PAC”) may be the best option.  These organizations carry significant disclosure obligations for donations to the committee, as well as disbursements, but every dollar may be used for political advocacy.  Others may opt to use a “hybrid PAC,” also with full disclosure similar to a Super PAC, but with the added ability to make contributions directly to a federal campaign committee.  Additionally, with the pending Supreme Court decision in McCutcheon et al. v. FEC, new avenues for political spending – such as joint fundraising committees combining national and state party committees and Super PACs – may emerge. 

For those that prefer to make contributions that avoid disclosure, the proposed rules create substantial uncertainty moving forward.  Although the existing system of unlimited political spending by labor unions and business leagues continues to be in place, the proposed rules request comment on whether the rules should be expanded to cover such groups.

Even if new rules were expedited, it is unlikely that any new rules would be in effect in time to have an impact in the 2014 midterm election cycle.  The deadline to submit comments is February 27, 2014, after which the Treasury Department and IRS must review the comments and draft final rules, which is likely to take some time.  Interestingly, these proposed rules come at a time during which the Securities and Exchange Commission appears to have dropped its controversial proposal to force publicly traded companies to disclose their political spending, including contributions to 501(c)(4) and 501(c)(6) organizations.

Congressional Reaction
The proposed regulations have prompted strong partisan reaction, only escalating the ongoing controversy over 501(c)(4) social welfare organizations. 

Democrats have been generally supportive of the Treasury Department’s issuance of the proposed regulations.  For example, Senate Finance Committee Chairman Max Baucus (D-MT) said the proposed regulations were “an important step” and that “clear standards and equal footing for the treatment of tax-exempt social welfare organizations” were needed. 

Republicans, however, have been more critical.  House Ways and Means Committee Chairman Dave Camp (R-MI) said, "Before rushing forward with new rules, especially ones that appear to make it harder to engage in public debate, I would hope Treasury would let all the facts come out first – something they could achieve by fully cooperating with Congress in the investigation.  This smacks of the administration trying to shut down potential critics.”

Similarly, House Government and Oversight Committee Chairman Darrell Issa (R-CA) said, “This new effort by the Obama Administration to limit traditional advocacy efforts by social welfare organizations will have a much more profound impact on grassroots and community organizations than on the well-heeled groups it supposedly targets.  The fact that the administration’s new effort only applies to social welfare organizations – and not powerful unions or business groups – underscores that this is a crass political effort by the administration to get what political advantage they can, when they can.”

The proposed rules demonstrate the complexities and challenges faced by tax-exempt organizations when tax law and federal election rules collide, and are certain to generate much debate.  Interested stakeholders should consider the impact of the proposed rules and whether to submit comments to the IRS.  The Treasury Department and IRS have invited written comments by February 27, 2014, and will schedule a public hearing if there is sufficient interest in doing so.   Given the Congress’ interest in these matters, stakeholders may also consider engaging with Congressional members regarding the guidance. 

[1] IRC 501(c)(4) provides that social welfare organizations must be engaged “exclusively” in “social welfare” activities.  The regulations have long held that a IRC 501(c)(4)  organization may intervene in political campaigns, so long as the organization’s “primary” activity is the promotion of social welfare.  Although the word “primary” as used in this context has never been officially defined or judicially construed, many have interpreted it to mean greater than 50 percent.  As a result, IRC 501(c)(4) social welfare organizations have been used as a vehicle for political advocacy through independent expenditures because, unlike IRC Section 527 political organizations (which are also tax exempt to the extent their income is “exempt function income,” which is the income associated with their political activity), the donors to IRC 501(c)(4)s need not be disclosed (at least for federal tax or election law purposes). 

This publication/newsletter is for informational purposes and does not contain or convey legal advice. The information herein should not be used or relied upon in regard to any particular facts or circumstances without first consulting a lawyer. Any views expressed herein are those of the author(s) and not necessarily those of the law firm’s clients.

Taxes and Politics Collide in New IRS Guidelines for 501(c)(4) Organizations: IRS Proposes to Restrict Political Activities of Some Non-Profits

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