News: CJ Exclusives

Call for Disclosing 501 Donors Runs Afoul of IRS Regulations

Courts have protected privacy to prevent donor harrassment

Recent calls by President Obama, Democratic Party officials, and left-wing activists demanding the disclosure of donors to conservative nonprofit issue advocacy groups have ignored the complexity of the federal regulations the groups face. At its core, there’s a tension between tax code compliance and public disclosure. Organizations created as nonprofits must comply with the Internal Revenue Code as interpreted by the IRS. And the IRS is concerned primarily with tax liability, not public disclosure of revenue sources.

“The IRS cares if you pay your taxes,” said Allison Hayward, vice president of policy at the Center for Competitive Politics in Alexandria, Va. “The IRS does not care so much about transparency.”

This lack of disclosure of all donors and revenue sources for groups organized under section 501 of the tax code has critics calling for new filing requirements based on the disclosure regulations mandated by the Federal Election Commission. Congress twice has failed to pass the DISCLOSE Act (H.R. 5175/S. 3628), which would apply to organizations engaging in “electioneering communications” and require the disclosure of the names of donors who give $1,000 and above. Nonprofit organizations opposed the bill, citing the potential for the harassment of their donors.

Hayward, a former law professor at George Mason University and counsel to former Federal Elections Commission member Bradley A. Smith, notes that supposed fixes like the DISCLOSE Act would create new problems. A $1,000 disclosure ceiling would give donors a new incentive to bundle larger contributions. Such bundiing would create pressure to require the disclosure of all donors to the IRS.

In the case of 501(c)4 groups — which are allowed to engage in political activity so long as it is not the group’s primary purpose — a blanket disclosure mandate could lump donors who contributed to a group’s nonpolitical, “social welfare” activities along with those who supported the group’s political activities. Depending on the nature of the organization, its social welfare projects could range from voter education and registration drives to support for volunteer firefighting services. As for business and trade organizations and Chambers of Commerce operating under 501(c)6 of the code, an FEC-style mandate could force all dues-paying members to become public.

Such overly broad disclosure would constitute “a sea of junk,” Hayward said, which would both be invasive and fail to focus on the political actions of the 501 groups — the supposed target of the reformers.

“The IRS is just not built to regulate political speech,” Hayward said. “I think it is an insanely bad idea.”

In the past, the IRS has been used to target the political opponents of those in power. In 1966, President Lyndon Johnson’s IRS moved to revoke the tax-exempt status of the Sierra Club after the group ran ads in opposition to a plan to flood the Grand Canyon to generate electricity. And U.S. Rep. Dan Lungren, R-Calif., recently noted that a 1958 U.S. Supreme Court decision permitted the NAACP to refuse to disclose its donors to officials of the state of Alabama. The group’s refusal was met with a $100,000 fine by the state. A 9-0 opinion found the disclosure demand unconstitutional under the First Amendment.

Concerns over this election cycle’s new breed of (c)4 groups, which have raised millions of dollars for political advocacy, have neglected the longstanding worries about government disclosure requirements for politically active citizens. Advocates of tougher disclosure, including the liberal groups Democracy 21 and the Campaign Legal Center, have demanded that the IRS investigate organizations like Crossroads GPS — a 501(c)4 founded by former Bush administration political director Karl Rove — even before the group’s first fiscal year has ended.

This demand comes even though the IRS uses the fiscal year as its way to measure tax compliance. This disconnect illustrates another divergence between IRS regulation and FEC regulation — the IRS is on a tax-year timetable, while the FEC revolves around election seasons and election days.

In theory, once the fiscal year is in the books, in 2011 the IRS could find that groups like Crossroads GPS violated their tax status by overspending on political activity. As is often the case with the tax code, however, the lines are fuzzy. The general rule of thumb is that c(4)s can maintain nonprofit status so long as no more than 50 percent of their spending is on political activity.

Another possible outcome is that a (c)4 may find itself reclassified as a 527 tax-exempt political group as result of its political spending. These 527s must follow some FEC reporting guidelines, but the requirements are not as stringent as those of political action committees or candidate campaigns. Unlike (c)4s, 527s can dedicate themselves fully to political activity and 527 donors explicitly are exempted from federal gift tax on donations above $13,000 for individuals or $26,000 for couples. The gift tax rate is 35 percent.

So large donors may face a trade-off — contribute to a c(4), pay gift tax, and “buy” full anonymity. Or donate to a 527, surrender some privacy, and pay lower taxes. IRS compliance and tax-payment concerns under current law would still trump public disclosure demands.

Jeff A. Taylor is a contributor to Carolina Journal and writes for the John Locke Foundation’s Meck Deck blog.