IRS Enforcement Reform and the Court

May 22, 2013
posted by Bob Bauer

One theme in the narrative about the IRS is that it faces a special challenge in enforcing the (c)(4) rules in the wake of Citizens United. A (c)(4) organization, which is typically a corporation, can make independent expenditures, so long as this campaign activity and others do not make up its primary purpose.

Two basic reform models have been advanced to protect against the misuse of these nonprofits to make these and other campaign-related expenditures. One is that the Service should generally employ more rigor in rooting out organizations that have exceeded their limit for political activity. Another is that the IRS should change its rules, switching the test from a “primary” social welfare purpose to an “exclusive one” without any campaign activity mixed in, and rid itself of the problem altogether: effectively, the no-tolerance option.

In both cases, however, the proposed solutions may have to scale steep walls erected by Supreme Court precedent. These issues have to be taken into account in judging the role that IRS enforcement can play in campaign finance regulation.

If the organization engages in explicit campaign activity, such as independent expenditures, the Services faces the problem that the Supreme Court has held that such expenditures are constitutionally protected. Under Regan v. Taxation with Representation of Washington, 461 U.S. 540 (l983), the Court held that Congress can refuse to subsidize an organization’s constitutionally protected activity, such as lobbying, but it assumed and expected that other means would be available to that organization to pursue it. In particular, a 501(c)(3) charity can be denied charitable deductions when lobbying because it can lobby, if it chooses, through an affiliated (c)(4). The Court found that it was not too much to ask the organization to run its lobbying through a parallel structure. Under this principle, the Court would allow tax exemptions to be denied to (c) tax-exempts engaged in independent expenditures only if the organization could make them in some other fashion—perhaps also through an affiliate.

So the IRS would be forcing the independent expenditures out of one tax exempt vehicle, the (c)(4), into another—presumably, a “527” political organization under the tax code. 26 U.S. § 527. The advantage from a reform perspective might be, in theory, the application of disclosure requirements that 527s must satisfy under the tax laws. 26 U.S,C. §527(j). The question Court precedent poses is whether this is necessarily the result. It may be a challenge to persuade a majority of the Justices that, to preserve its tax exempt status, a corporation possessing the constitutional right to make independent expenditures must run them through a political organization subject to significant regulatory requirements—that is, reporting obligations in addition to the mere reporting of the independent expenditure itself. And if the affiliate only conducts this political activity, it stands to be treated as a “political committee” under the Federal Election Campaign Act and compelled to submit to still more regulation.

Citizens United signals possible Court resistance to forcing the (c)(4) into this position. When considering whether corporations can be barred from making independent expenditures by affording them the opportunity to establish to “speak” through a separate political organization or committee, the Court majority stated:

A PAC is a separate association from the corporation. So the PAC exemption… does not allow corporations to speak. Even if a PAC could somehow allow a corporation to speak—and it does not—the option to form PACs does not alleviate the First Amendment problems with § 441b. PACs are burdensome alternatives; they are expensive to administer and subject to extensive regulations. For example, every PAC must appoint a treasurer, forward donations to the treasurer promptly, keep detailed records of the identities of the persons making donations, preserve receipts for three years, and file an organization statement and report changes to this information within 10 days. [citations omitted]

And that is just the beginning. PACs must file detailed monthly reports with the FEC, which are due at different times depending on the type of election that is about to occur

The Court concludes this discussion by stating that “PACs have to comply with these regulations just to speak. This might explain why fewer than 2,000 of the millions of corporations in this country have PACs.” 558 U.S. 310, 337-338.

This line of analysis, taken together with Regan, would appear to pose problems for forcing independent expenditures out of a (c)(4) and into a separate political organization that would have to meet enhanced regulatory requirements. While it is true that the Court in Citizens United upheld disclosure requirements, it sustained the reporting and disclaimer requirements that apply to all independent spenders as a class. Requiring (c)(4)s to relocate their political spending with the result that they incur additional regulatory obligations, including more stringent reporting requirements, is a different proposition altogether.

So if a (c)(4) affiliate making these independent expenditures could escape any such added requirements, the questions is raised: what precisely would be gained through this reform measure? A (c)(4) could still conduct these same political expenditures, operating on a fully tax exempt basis, except that it would fund the political activity through a controlled, affiliated organization with limited disclosure.

Assume now that the exempt organization eschews independent expenditures and funds activities that constitute “issue advertising” under the Court’s decision in Federal Election Commission v. Wisconsin Right to Life, 551 U.S. 449 (2007). These ads are widely viewed as political in nature, especially when, as recently noted by Floyd Norris, they are directed to the electorate, contain aggressively critical messages about elected officials and could be expected to have an election-influencing impact. It is proposed that the IRS be more vigilant in warning tax exempts against funding such ads and risking a finding that their purpose was not exclusively that of the “social welfare”. But, again, the Court has defined these ads as falling outside the campaign finance laws, regardless of intent or effect. Having done so, would the Court permit the IRS to rely on them to find “campaign intervention” in evaluating or scrutinizing a (c)(4) exemption?

Suggested reforms of the tax code will fall well short of expectation if they merely encourage shell games and the results for all practical purposes are the same as today—exempt organizations continuing to mix their social welfare function with activity that is more or less overtly “political” and to evade the detailed disclosure called for in many current reform proposals. The better, more realistic course may be to take the IRS out of the political business and attend to the enforcement of the campaign finance laws by an agency established and equipped to enforce them.

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