Groups Ask IRS to Investigate Political Activities of Tax-Exempt Organizations

Dear Commissioner Shulman and Director Lerner:

Democracy 21 and the Campaign Legal Center call on the Internal Revenue Service (IRS) to conduct an investigation into whether Crossroads GPS, Priorities USA, American Action Network and Americans Elect, all of which claim to be tax exempt groups organized under section 501(c)(4) of the Internal Revenue Code (IRC), 26 U.S.C. § 501(c)(4), are ineligible for the tax exempt status provided to section 501(c)(4) organizations.¹

Under the IRC, IRS regulations and court decisions interpreting the IRC, section 501(c)(4) organizations are required to primarily engage in the promotion of social welfare in order to obtain tax exempt status. Court decisions have established that in order to meet this requirement, section 501(c)(4) organizations cannot engage in more than an insubstantial amount of any non-social welfare activity, such as directly or indirectly participating or intervening in elections.

Thus, the claim made by some political operatives and their lawyers that section 501(c)(4) organizations can spend up to 49 percent of their total expenditures on campaign activity and maintain their tax exempt status has no legal basis in the IRC and is contrary to court decisions regarding eligibility for tax-exempt status under section 501(c)(4). An expenditure of 49 percent of a group's total spending on campaign activity is obviously far more than an insubstantial amount of non-social welfare activity.

The IRS applies the "primarily engaged" test on the basis of the "facts and circumstances" of an organization's formation and operations. Here, we believe, the "facts and circumstances" show that each organization has engaged in far more than an insubstantial amount of participation or intervention in elections and that the overriding purpose of each organization is to influence elections.

Thus, under the IRC and court decisions interpreting the IRC, these organizations are not eligible to receive section 501(c)(4) tax exempt status.

In a 2008 Letter Ruling, the IRS stated that a group is not eligible for tax exempt status under section 501(c)(4) where the facts and circumstances show that the group's "first and primary emphasis" is to get candidates elected to public office.

This standard is different than, and in conflict with, the standard applied by the courts. But even under this standard, we believe the "facts and circumstances" relating to the formation and activities of the four organizations discussed in this letter show that each group was organized and is operated for the overriding purpose of participating or intervening in elections.

Therefore, none of the four groups meets the standard for tax exempt status under section 501(c)(4) because they are not primarily engaged in "the promotion of social welfare."

By claiming tax-exempt status under section 501(c)(4), these groups allow their donors to evade the public disclosure requirements that would apply if the organizations were registered under section 527 as "political organizations." In fact, it appears that avoiding disclosure of their donors is the basic reason that these groups organized under section 501(c)(4).

Absent timely and appropriate action by the IRS, widespread abuses of the tax code by groups organized under section 501(c)(4) are likely to become commonplace in the 2012 presidential and congressional races. These abuses will come at the expense of the integrity and credibility of the tax laws and of the right of the American people to know the identity of the donors providing money to influence elections.

Accordingly, we request that the IRS promptly investigate the groups discussed in this letter and take appropriate enforcement action and impose appropriate penalties for any violations of section 501(c)(4) that the agency may find.

I. Crossroads GPS

On October 5, 2010, Democracy 21 and the Campaign Legal Center filed a letter with the IRS requesting an investigation into whether Crossroads GPS was operating in violation of the requirements for obtaining tax-exempt status under section 501(c)(4). Here, we supplement the information set forth in that earlier letter and continue our request for an investigation.

Crossroads GPS was organized in June, 2010 under section 501(c)(4) of the IRC "as an organization for the promotion of social welfare." ("GPS" stands for "Grassroots Policy Strategies.")

Crossroads GPS is affiliated with American Crossroads, a non-profit political organization registered under section 527 of the IRC. American Crossroads is registered with the Federal Election Commission (FEC) as a political committee under the Federal Election Campaign Act. As such, the major purpose of American Crossroads is to raise and spend money to influence federal campaigns. As a registered political committee, American Crossroads must report all of its contributions and expenditures to the FEC under federal campaign finance laws. As a section 501(c)(4) organization, Crossroads GPS does not publicly disclose its donors.

An article in Politico, dated April 29, 2011, notes that Crossroads GPS was "founded under the guidance of GOP strategists [Karl] Rove and Ed Gillespie. . . ." and that it "accepts unlimited contributions from donors whose identities can be kept secret."² The article notes:

In February, 2011, Crossroads GPS launched a radio ad campaign that was specifically designed to counter ads run by the Democratic Congressional Campaign Committee. According to one report:

President Obama announced his candidacy for re-election in the 2012 presidential race on April 4, 2011, well before the Crossroads GPS ads were run.

One report notes that Crossroads GPS is already spending money in Missouri as part of an effort to defeat Senator Claire McCaskill, who is up for reelection in 2012:

Karl Rove, one of the founders of the Crossroads groups, was recently quoted at an appearance in Ohio as discussing their plans for campaign spending in Ohio in 2012:

This may reflect the fact that Crossroads has been more successful in its fundraising of undisclosed contributions through the section 501(c)(4) arm. According to one report, the section 527 arm "has seen its fundraising lag behind its non-disclosing sister group. In the first six months of 2011, . . . it raised only $3.9 million."¹⁴

The same report described the evolution of the Crossroads groups as moving toward reliance on the section 501(c)(4) arm as a way to shield donors from disclosure:

On September 9, 2011, a published report stated that American Crossroads and Crossroads GPS have set a new fundraising goal that is at least twice the $120 million announced earlier this year.¹⁵ According to the published report:

II. Priorities USA.

Priorities USA announced its formation as a social welfare organization under section 501(c)(4) of the tax code by a memorandum distributed "to interested parties" on April 29, 2011. The memorandum makes clear that Priorities USA (and its companion section 527 political organization, Priorities USA Action), are intended to work for the reelection of President Obama by mimicking the structure and function of Crossroads GPS (and American Crossroads). According to the Priorities USA memorandum:

American Action Network (AAN) was founded in 2010 by Fred Malek, a leading national Republican fundraiser, and is chaired by former Republican Senator Norm Coleman. According to published reports, AAN shares offices with Crossroads GPS and other related groups.²⁴ AAN made numerous independent expenditures in the 2010 elections. For instance, according to one report:

As one report notes, "Republican political operatives bestow immense credit for their party's competitiveness in 2010 on organizations such as Crossroads GPS and the American Action Network, both 501(c)(4) organizations. These groups can accept large donations that they do not have to disclose. . . ."³¹

American Action Network, like Crossroads GPS, also spent to influence a special congressional election in May, 2011. According to a published report, American Action Network spent $94,694 on an election in the New York 26^th congressional district.³²

In other spending in 2011, American Action Network has undertaken a $1 million direct mail and newspaper campaign that "charges Democrats with attempting to 'balance the budget on the backs of seniors'. . ."³³ The mail campaign "will reach 22 congressional districts in 14 states, all of them represented in Congress by Republicans. . . . Most of the 22 are freshmen first elected in November 2010." Id. According to another news report, the group subsequently "added 10 vulnerable freshmen House Republicans to its advocacy campaign defending Republicans on Medicare."³⁴ According to this report, the mailing sent to one Florida congressional district reads, "Florida seniors can count on Congressman Allen West to stand up against the Obama Medicare plan." Id.

IV. Americans Elect

Americans Elect was initially organized as a "political organization" under section 527 of the tax code, but in October, 2010 changed its designation to a "social welfare" organization under section 501(c)(4) of the tax code. ³⁵ It is seeking to gain a place on the 2012 ballot in all 50 states for a presidential candidate it intends to nominate.

According to one article, "Its mission is to upend the traditional party primary process by selecting an alternate presidential ticket through an online, open nominating convention." Id. This report also notes that the manner in which the group is pursuing its aims:

The same article notes that the organization plans to nominate a candidate for president:

According to The Detroit Free Press on September 9, 2011, "Bureau of Elections spokesman Fred Woodhams said American Elect submitted nearly 68,000 petition signatures in May, more than double the 32,261 needed to qualify for the Michigan ballot as a minor party."³⁹

According to The Oregonian on September 19, 2011, Americans Elect "has already qualified for the ballot in six states and appears to have turned in enough signatures -- more than 1.6 million -- to make the 2012 ballot in California."⁴⁰

As these examples show, American Elect is not only devoted to intervening in the 2012 elections, it is actually qualifying itself as a political party for purposes of state ballot access laws. A political party is not eligible to qualify as a section 501(c)(4) tax exempt organization.

V. The IRS Should Investigate Whether Each Organization Is Ineligible for Section 501(c)(4) Tax Status Because Each Is Engaged In More Than An Insubstantial Amount of Campaign Activity.

According to IRS regulations, "An organization is operated exclusively for the promotion of social welfare if it is primarily engaged in promoting in some way the common good and general welfare of the people of the community." 26 C.F.R. § 1.501(c)(4)-1(a)(2)(i) (emphasis added).

Political activity -- spending to influence campaigns -- does not constitute promoting social welfare. Section 1.501(c)(4)-1(a)(2)(ii) of the regulations provides that political campaign activities do not promote social welfare as defined in section 501(c)(4). The regulation states, "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." 26 C.F.R. § 1.501(c)(4)-1(a)(2)(ii) (emphasis added).

Although the promotion of social welfare does not include political campaign activities, IRS regulations do not impose a complete ban on such activities for section 501(c)(4) organizations. Thus, "an organization may carry on lawful political activities and remain exempt under section 501(c)(4) as long as it is primarily engaged in activities that promote social welfare." Rev. Rul. 81-95, 1981-1 C.B. 332 (emphasis added).

According to court decisions, the statutory requirement for a section 501(c)(4) organization to be "operated exclusively" for "the promotion of social welfare" means that the organization cannot engage in more than an insubstantial amount of activity that is not in furtherance of its social welfare function. This means that section 501(c)(4) organizations cannot engage in more than an insubstantial amount of campaign activities.

The "insubstantial" standard established by the courts certainly does not allow a section 501(c)(4) organization to spend up to 49 percent of its total expenditures in a tax year to participate or intervene in elections and still maintain its tax-exempt status, as some practitioners believe.

Under the statutory language of section 501(c)(4), a social welfare organization must be "operated exclusively" for social welfare purposes. The courts have interpreted this "operated exclusively" standard the same way they have interpreted a parallel provision of section 501(c)(3) that requires an organization that is tax exempt under that provision to be "organized and operated exclusively" for charitable, education or similar purposes.

In Better Business Bureau v. U.S., 326 U.S. 279, 283 (1945), the Supreme Court construed a requirement that a non-profit organization be "organized and operated exclusively" for educational purposes to mean that "the presence of a single non-educational purpose, if substantial in nature, will destroy the exemption regardless of the number or importance of truly educational purposes." (emphasis added).

Based on the Better Business Bureau decision, the courts have concluded that the word "exclusively" in the context of sections 501(c)(3) and 501(c)(4) is "a term of art" that does not mean "exclusive" as that term is normally understood and used.

The courts instead have said that, in the context of section 501(c)(4) of the IRC, this term means "that the presence of a single substantial non-exempt purpose precludes tax-exempt status regardless of the number or importance of the exempt purposes." Contracting Plumbers Coop. Restor. Corp. v. U.S., 488 F.2d 684, 686 (2d. Cir. 1973) (section 501(c)(4)); American Ass'n of Christian Sch. Vol. Emp. v. U.S., 850 F.2d 1510, 1516 (11^th Cir. 1988) ("the presence of a substantial non-exempt purpose precludes exemption under Section 501(c)(4)"); Mutual Aid Association v. United States, 759 F.2d 792, 796 (10^th Cir. 1985) (same; section 501(c)(4)).

The courts have similarly held, in the context of section 501(c)(3) organizations, that the "operated exclusively" test means that "not more than an insubstantial part of an organization's activities are in furtherance of a non-exempt purpose." Easter House v. United States, 12 Ct. Cl. 476, 483 (1987) (group not organized exclusively for a tax exempt purpose under section 501(c)(3)); New Dynamics Foundation v. United States; 70 Fed. Cl. 782, 799 (Fed. Cl. Ct. 2006) (same); Nonprofits Ins. Alliance of California v. U.S., 32 Fed. Cl. 277, 282 (Fed. Cl. Ct. 1994) (same).

Under these court rulings, a section 501(c)(4) organization cannot engage in more than an insubstantial amount of campaign activity and remain in compliance with the statutory requirements for tax-exempt status under section 501(c)(4). Any "substantial, non-exempt purpose" (such as campaign activity) will defeat an organization's tax-exempt status under section 501(c)(4). Christian Sch. Vol. Emp., supra at 1516.

There is nothing, furthermore, in these rulings, in IRS regulations or in other IRS actions to support the proposition that spending 49 percent of total expenditures on campaign activities constitutes an insubstantial amount of non-exempt activity.⁴¹

Section 527(e)(2) of the Internal Revenue Code describes what constitutes political campaign (i.e., "exempt function") activity for purposes of the tax code:

Revenue Ruling 2004-6, 2004-4 I.R.B. 328, provides a detailed explanation of what constitutes "exempt function" political campaign activity -- illuminating the line between political activities and activities to promote social welfare. The IRS Revenue Ruling states:

Revenue Ruling 2004-6 explains that, because section 501(c)(4) public policy advocacy "may involve discussion of the positions of public officials who are candidates for public office, a public policy advocacy communication may constitute an exempt function (a political activity) within the meaning of § 527(e)(2)." Rev. Rul. 2004-6 at 1. The Ruling states:

Thus, even if an ad discussing an issue does not express advocacy, it may nonetheless be treated as "exempt function" electioneering activity under IRS regulations, depending on the "facts and circumstances." Therefore, even where an ad discusses an "issue," and where the ad does not contain express advocacy or the functional equivalent of express advocacy, it can still be treated as "direct or indirect participation or intervention in political campaigns" under IRS standards for purposes of determining whether a 501(c)(4) organization is "primarily engaged" in the promotion of social welfare.

Rev. Rul. 2004-6 lists six factors that "tend to show" that an advertisement is "exempt function" political campaign activity, and five competing factors that "tend to show" that an advertisement is not. Rev. Rul. 2004-6 at 3-4. These factors are not in themselves dispositive. In the end, the regulations require a determination to be made based on "the facts and circumstances" of each advertisement.

The "factors that tend to show that an advocacy communication on a public policy issue is for an exempt function (political activity) under § 527(e)(2)" include the following:

The "factors that tend to show that an advocacy communication on a public policy issue is not for an exempt function under § 527(e)(2)" include the following:

Under this "facts and circumstances" test, each of the organizations discussed in the letter is engaged more than an insubstantial amount of campaign activity and, in fact, is primarily engaged in activities for the purpose of participating and intervening in political campaigns.

In the case of Crossroads GPS and American Action Network, both organizations were created just months before the 2010 congressional elections, and were conceived, organized and staffed by leading political party strategists and operatives. Both organizations defined their activities as spending money to influence the 2010 House and Senate races, and both were closely affiliated with other organizations similarly spending large sums to influence the 2010 elections.

The activities of both groups were targeted to battleground states involving key congressional races, and to supporting Republican candidates or opposing Democratic candidates in those elections.

The ads run by both organizations identified candidates by name, discussed their position on issues in the midst of a campaign, and did so in ways that supported those candidates or criticized their opponents.

Finally, the timing of the groups' activities did not correspond with external events outside the control of the groups, such as a legislative vote on an issue, but rather corresponded with congressional election campaigns.

With regard to Priorities USA, statements by the founders of the organization make clear that it is modeled on Crossroads GPS, and is to play a similar function with the overriding purpose of conducting campaign activities to support the re-election of President Obama.

Finally, with regard to Americans Elect, the sole thrust of the organization is to obtain ballot access to use to nominate candidates for president and vice president. The organization is qualifying on ballots as a political party. These activities are per se campaign activities in connection with an election.

Accordingly, each of the section 501(c)(4) organizations discussed above has engaged in more than an insubstantial amount of campaign activity, has a "substantial, non-exempt purpose" of participating or intervening in elections and is not entitled to tax-exempt status under section 501(c)(4).

VI. The IRS Also Should Investigate Whether Each Organization Is Ineligible for Section 501(c)(4) Tax Status Because the Organization Is "Primarily Engaged" in Campaign Activity

In a 2008 Letter Ruling, the IRS applied the "primarily engaged" standard to mean that a section 501(c)(4) organization's primary activities cannot constitute direct or indirect political intervention.

This interpretation of the statutory standard is in conflict with the court rulings interpreting section 501(c)(4), discussed above, that require an exempt organization to engage in no more than an insubstantial amount of campaign activity.

Nevertheless, the organizations discussed in this letter also fail to comply with the standard set forth in this Revenue Ruling. In the 2008 Ruling, the IRS found an organization did not qualify for tax exempt status under section 501(c)(4) because it was not primarily engaged in promoting "social welfare." The IRS said:

In the Letter Ruling, the IRS considered the organization's claim that it was primarily engaged in lobbying, not campaign intervention. The Letter Ruling states:

Therefore, the organization did not qualify for tax exemption under section 501(c)(4):

Here, we believe that an IRS investigation will show that the "first and primary emphasis" of each of the four organizations discussed above is "on getting people elected to public office." In particular, the IRS should investigate whether the "facts and circumstances" show that each of the organizations discussed in the letter is primarily engaged in activities which constitute direct or indirect participation or intervention in political campaigns under IRS regulations. For reasons discussed above, we believe each organization has overriding purpose to engage in campaign activities, and thus is operating contrary to the requirements of section 501(c)(4).

VII. Conclusion.

In the 2010 congressional races, section 501(c) organizations spent more than $135 million on campaign activities that were financed by secret contributions. The bulk of these expenditures were made by section 501(c)(4) organizations. The amount of secret contributions funding campaign expenditures by section 501(c)(4) organizations is expected to grow dramatically in the 2012 presidential and congressional races.

Crossroads GPS, Priorities USA, American Action Network and Americans Elect are each organized under section 501(c)(4) of the Internal Revenue Code. Based on the information about each organization set forth above, the IRS should conduct an investigation of whether each such organization has engaged in more than an insubstantial amount of non-exempt activity by participating or intervening in political campaigns and accordingly is not primarily engaged in the promotion of social welfare. The IRS should also conduct an investigation of whether each organization's primary activity is campaign activity and is accordingly not primarily engaged in the promotion of social welfare.

If the IRS investigation determines that the facts and circumstances show that the organizations discussed above are not primarily engaged in "the promotion of social welfare," because they have engaged in more than an insubstantial amount of campaign activity or because the organization's primary activity is campaign activity, the organizations should be denied or should lose tax-exempt status. In addition, appropriate penalties should be imposed by the IRS for violations the agency finds. The penalties should take into account the need for strong deterrence to stop similar violations from occurring in the future.

² J. Cummings, "New Dem money group takes on GOP," Politico (April 29, 2011) (emphasis added).

³ M. O'Brien, "Obama alumni launch new outside group to boost reelection," The Hill (April 29, 2011).

⁴ K. Vogel, "SEIU, American Crossroads look back at 2010 spending," Politico (Dec. 13, 2010) (emphasis added).

⁵ B. Mullins, "2012 Election Spending Race Heats Up," The Wall Street Journal (March 1, 2011) (emphasis added).

⁶ P. Stone, "Democrats desperately seeking their own Rove," Center for Public Integrity -iWatch News (March 14, 2011).

⁷ M. O'Brien, "Rove-backed group spends to bolster 19 targeted Republicans," The Hill (Feb. 3, 2011).

⁸ P. Stone, "Obama groups raise $4-5 million in first two months," Center for Public Integrity- iWatch News (June 24, 2011).

⁹ K. Vogel, "Both sides now in dash for anonymous cash," Politico (Aug. 9, 2011).

¹⁰ J. Hancock, "Both sides spending big to win Missouri Senate seat," St. Louis Post-Dispatch (Aug. 15, 2011).

¹¹ D. Eggen, "Political groups, now free of limits, spending heavily ahead of 2012," The Washington Post (May 21, 2011).

¹² J. Hallett, "Rove-affiliated PACs to spend big in Ohio," The Columbus Dispatch (Sept. 21, 2011).

¹³ J. Gillum, "Priorities USA Raises $5 Million to Counter Attack Ads From Karl Rove-Backed Crossroads GPS," Associated Press (July 31, 2011).

¹⁴ K. Vogel, "Both sides now dash for anonymous cash," Politico (Aug. 9, 2011).

¹⁵ P. Stone, "Karl Rove-linked Crossroads has more than doubled its earlier fundraising goal of $120 million," Center for Public Integrity- iWatch News (Sept. 8, 2011).

¹⁶ B. Smith, "In memo, Priorities USA defends secret-money shift," Politico (April 29, 2011).

¹⁷ B. Montopoli, "Democrats launch outside spending group; conservatives charge hypocrisy," CBS News (April 29, 2011).

¹⁸ J. Rutenberg, "Democrats Form Fund-Raising Groups," New York Times (April 29, 2011).

¹⁹ A. Kornblut, "Democrats gear up to match GOP fundraising effort," The Washington Post (April 29, 2011).

²⁰ P. Stone, "Obama groups raise $4-5 million in first two months," Center for Public Integrity- iWatch News (June 24, 2011) (emphasis added).

²¹ J. Gillum, "Priorities USA Raises $5 Million to Counter Attack Ads From Karl Rove-Backed Crossroads GPS," Associated Press (July 31, 2011).

²² A Fitzgerald, "Rove Tops President Obama as Drawing Card in Democrat Burton's Fundraising," Bloomberg News (June 29, 2011).

²³ K. Vogel, "Both sides now in dash for anonymous cash," Politico (Aug. 9, 2011).

²⁴ H. Bailey, "A guide to the shadow GOP": the groups that may define the 2010 and 2012 elections," Yahoo News-The Uphot (August 5, 2010).

²⁵ K. Doyle, "Campaign Spending Reports Filed with FEC," BNA Money in Politics Report (Aug. 12, 2010).

²⁶ J. Zwick, "Coleman's American Action Network Infuses Cash into Close Senate Races," Washington Independent (Oct. 4, 2010).

²⁷ K. Vogel, "Rove: Obama's attacks are helping," Politico (Oct. 13, 2010).

²⁸ M. Crowley, "The New GOP Monday Stampede," Time (Sept. 16, 2010).

²⁹ J. Rutenberg, "Pro-Republican Groups Prepare Big Push at End of Races," New York Times (Oct. 25, 2010).

³⁰ M. Luo and G. Palmer, "Who Got the Most Bang for their Bucks?" New York Times (Nov. 4, 2010).

³¹ A. Becker and D. Drucker, "Members Weigh In on Draft Disclosure Order," Roll Call (May 24, 2011).

³² P. Overby, "Outside Groups Spend Big in N.Y. Special Election," NPR (May 25, 2011).

³³ A. Burns, "Ads to back GOPers on Medicare," Politico (July 27, 2011).

³⁴ C. Joseph, "Conservative group defending 10 more House Republicans on Medicare," The Hill (Aug. 3, 2011).

³⁵ M. Gold, "Americans Elect seeks to upend primary system," Los Angeles Times (July 28, 2011).

³⁶ P. Jonsson, "Americans Elect launches centrist third-party bid amid Washington dysfunction," Christian Science Monitor (July 29, 2011).

³⁷ E. Ackerman, "An online political convention," Politico (Aug. 10, 2011).

³⁸ M. Casey, "Americans Elect party to appear on '12 ballot," Arizona Daily Star (July 30, 2011).

³⁸ D. Bell, "State to vote on certifying new group with 2012 presidential hopes," The Detroit Free Press (Sept. 9, 2011) (emphasis added).

⁴⁰ J Mapes, "New effort to establish centrist presidential campaign seeks to qualify for Oregon ballot," The Oregonian (September 19, 2011)

⁴⁰ On July 27, 2011, Democracy 21 and the Campaign Legal Center filed a petition for rulemaking with the IRS which seeks revisions in the regulations implementing section 501(c)(4). In particular, the petition contends that the "primarily engaged" standard in section 1.501(c)(4)-1(a)(2)(i) does not correctly implement the statutory "operated exclusively" standard in section 501(c)(4) of the IRC, as interpreted by the courts.