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Group of State AGs Say Donor Disclosure Regs Are Bad News

DEC. 9, 2019

Group of State AGs Say Donor Disclosure Regs Are Bad News

DATED DEC. 9, 2019
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December 9, 2019

Steven T. Mnuchin, Secretary of the Treasury
Charles P. Rettig, Internal Revenue Service Commissioner
Internal Revenue Service
1111 Constitution Avenue NW
Washington, D.C. 20224

RE: Notice of Proposed Rulemaking (RIN: 1545-BN28) Guidance Under Section 6033 Regarding the Reporting Requirements of Exempt Organizations

Dear Secretary Mnuchin and Commissioner Rettig:

The Attorneys General of New Jersey, New York, California, Connecticut, Colorado, Delaware, the District of Columbia, Hawaii, Illinois, Iowa, Maine, Maryland, Massachusetts, Minnesota, Nevada, New Mexico, Oregon, Pennsylvania, Rhode Island and Virginia write to express our concerns with respect to the proposed Guidance Under Section 6033 Regarding the Reporting Requirements of Exempt Organizations, RIN 1545-BN28, 84 Fed. Reg. 47,447 (proposed September 10, 2019).

For nearly fifty years, IRS regulations have required 501(c) tax-exempt entities to include in their annual filings the name, address, and donation amount for each of their most substantial donors. As one part of an exempt organization's federal information return, this donor information enables the IRS and its state agency counterparts to evaluate whether the filing organization meets the substantive requirements to qualify for tax-exempt status and remains in compliance with governing federal and state law concerning private inurement, private benefit, non-distribution and charitable mission requirements. By its own estimate, approximately 200,000 annual exempt organization filers presently submit to the IRS a non-public Form 990 Schedule B that lists key-donor information.1 Some state taxing authorities and officials responsible for overseeing organizations that are “public charities” under state law (including certain 501(c)(4) organizations) rely on the IRS to perform this vetting and enforcement function, and many adopt the IRS's determination of an organization's right to exempt status as applying for purposes of state law without further or separate review.

The IRS now proposes to eliminate the donor disclosure requirements for approximately 27 types of 501(c)-exempt nonprofits, including 501(c)(4) social welfare organizations that must operate, as a matter of law, “exclusively for the promotion of social welfare” in order to remain exempt from federal income taxes. The IRS has been clear in its regulations that a (c)(4) organization is operated exclusively for the promotion of social welfare only “if it is primarily engaged in promoting in some way the common good and general welfare of the people of the community. An organization embraced within this section is one which is operated primarily for the purpose of bringing about civic betterments and social improvements.” 26 C.F.R. § 1.501(c)(4)-1. It has been reported that some (c)(4) social welfare organizations have been organized not for “civic betterments and social improvements,” but primarily to facilitate privately-funded political activity by their supporting donors while evading federal and state disclosure requirements that apply to Section 527 organizations.2

The IRS's proposal does not accompany any change in federal exemption standards for the affected organizations, and the IRS proposes to continue collecting donation amount totals, stripped of any accompanying information that could identify associated donors. The only details that will no longer be required from affected organizations are the names and addresses of their key supporters. Because the affected organizations must continue to maintain complete donor information in their own records, the proposed change operates only to remove the identity of supporting donors from regular federal agency review and from review by state agencies that have also collected the Form 990 Schedule B.

The IRS previously attempted to accomplish the same policy change through a 2018 Revenue Procedure that it issued without public notice and without an opportunity for public comments to be heard. That Revenue Procedure, Revenue Procedure 2018-38, was met with a bipartisan resolution of disapproval in the Senate, S.J. Res. 64, 115th Cong. (passed Dec. 12, 2018), and a federal court order declaring the change invalid. See Bullock v. IRS, ___ F. Supp. 3d ___, 2019 WL 3423485, 2019 U.S. Dist. LEXIS 126921 (D. Mont. July 30, 2019). The renewed policy, now subject to notice and comment, remains certain to reduce accountability for tax-exempt organizations and significantly hamper the enforcement of state laws. We, the undersigned Attorneys General, oppose the proposed rule insofar as it would eliminate the annual reporting of donor information for 501(c)(4)s and other categories of 501(c) exempt organizations.

The Elimination of Federal Donor Disclosures Would Impair State Law Enforcement While Leaving Exempt Organizations Subject to Disparate State Reporting Requirements.

For more than a century — and for the entire existence of the modern income tax — there has been a strong federal policy of sharing federal tax information with state governments. The IRS has long supported this relationship between federal and state tax regulators through an established practice — expressly contemplated by the confidentiality provisions in the Internal Revenue Code — of directly providing federally-filed tax information to state enforcement officials. Although the names and addresses of an organization's substantial donors are not generally subject to public disclosure, 26 U.S.C. §6104(b), the Internal Revenue Code authorizes the IRS to share federally-filed donor information with state government officials for use in administering state laws, see, e.g., id. §§ 6103(d), 6104(c). To that end, many state agencies have entered into information-sharing agreements with the IRS that enable them to obtain federal tax information not otherwise available to the general public in order to facilitate their administration of state laws.

In addition to supporting state tax regulators, access to federally-filed information also equips state charities regulators with a powerful tool to enforce state non-profit and consumer-protection laws. Many states have designed their own non-profit filing requirements around the IRS's longstanding donor reporting regime and the accompanying IRS review and enforcement activity, allowing charitable organizations to satisfy state reporting obligations in part by filing with the State complete copies of their federally-filed Form 990. Three states currently require inclusion of the Schedule B. See, e.g., 11 CCR 301 (California); N.J.A.C. 13:48-4.3, -5 (New Jersey); 13 NYCRR 91.5(c) (New York). Other states rely on the availability of an organization's Schedule B for purposes of law enforcement (e.g., through subpoena). Because the donor information presently captured in an exempt entity's Schedule B is not currently available from any other source, the current Schedule B reporting requirements enable state regulators to obtain unique information already collected for disclosure to the IRS at minimal administrative cost to the reporting entities.

It is no accident that the IRS's annual reporting requirements have led to federal-state cooperation. Congress expects the IRS to adopt policies that facilitate such cooperation in order to advance the efficient administration of the internal revenue laws. See, e.g., Staff of Joint Comm. on Taxation, 94th Cong., General Explanation of the Tax Reform Act of 1976 (Comm. Print 1976), 1976 WL 35242, at *32 (noting that “many States have only a few, if any, of their own tax auditors and rely largely (or entirely) on Federal tax information in enforcing their own tax laws”). In the 1980s, the IRS worked with state charity regulators and the National Association of Attorneys General specifically to design a Form 990 that would serve state as well as federal purposes, and “subsequent changes to Form 990 have reflected states' needs as well as federal initiatives.” See IRS TE/GE, Advisory Committee on Tax Exempt and Government Entities, 2013 Report of Recommendations at 7-8, available at https://www.irs.gov/pub/irs-tege/tege_act_rpt_12.pdf. The IRS recognized in its public rollout of a 2008 redesign to the Form 990 that: “Form 990 is used by the IRS as the primary tax compliance tool for tax-exempt organizations,” but “[i]n addition, most states rely on the form to perform charitable and other regulatory oversight, and to satisfy state income tax filing requirements for organizations claiming exemption from state income tax. . . . [The Form 990] is the key transparency tool relied on by the public, state regulators, the media, researchers, and policymakers to obtain information about the tax-exempt sector and individual organizations.”3 The States' ability to rely on exempt organizations' annual reports to the IRS has “provided extensive savings in data processing costs to the states and accounting costs to the [exempt organization] community.” 2013 Report of Recommendations, at 7. Indeed most states have reduced, totally eliminated or never developed state-specific forms that would require duplicative reporting and its related costs.

Less than four months ago, the Bullock court recognized that the IRS's attempt to exempt 501(c)(4)s and other entities from donor disclosure requirements would upend decades of cooperative federalism through which States have efficiently leveraged federal reporting to facilitate their enforcement of state laws governing tax-exempt organizations and charitable fundraising. See Bullock, 2019 WL 3423485 at *6 & *10 (reviewing Plaintiff State allegations that they rely on the acquisition of substantial-contributor information, the dissemination of that information, and federal exemption determinations to make exemption determinations under state law, and noting that “Revenue Procedure 2018-38 explicitly upend[ed] [a] fifty-year practice” at the IRS of requiring the information on which numerous state regulators directly depend). See also Ams. for Prosperity Found. v. Becerra, 903 F.3d 1000, 1011 (9th Cir. 2018) (illustrating how a state charities regulator can use information from federal Form 990, Schedule B to combat fraud and other unlawful practices); Citizens United v. Schneiderman, 882 F. 3d 374, 382-383 (2d Cir. 2018) (same). Nothing in the IRS's proposed rule addresses this regulatory cost.

To be sure, States that currently rely on the IRS's annual collection of donor information through Schedule B and the IRS's related review and enforcement activity could respond to the proposed rule by independently amending their laws to require that non-(c)(3) entities begin reporting to the State the same information that they previously reported to the IRS. Indeed, New Jersey adopted such a rule in response to Revenue Procedure 2018-38. See 50 N.J.R. 2549(a) (December 17, 2018); 51 N.J.R. 637(a) (May 6, 2019). But this approach imposes on States the costs of establishing and enforcing new state-specific reporting requirements and training staff and reporting organizations on the new requirements. The alternative regulatory regime that would result could subject filing entities to many different annual disclosure standards — an exponential increase in the filing burden to affected nonprofits. Instead of satisfying their federal and state reporting obligations by filing multiple copies of a single, completed Schedule B (or retaining copies for production as required by state law enforcement), as they do now, affected organizations likely will be faced with the prospect of having to prepare a patchwork quilt of different state-specific submissions. States in turn can expect lower rates of filer compliance as state and federal disclosure standards diverge, because the States will no longer be able to rely on the prospect of federal reporting enforcement to ensure complete state-level disclosure. And while the IRS's current reporting system allows States to obtain from the IRS donor information about an entity that complies only with its federal obligations, the proposed rule will deprive them of that option.

The IRS has proposed its new rule, in part, as an attempt to address the “increase[d] compliance costs for affected tax-exempt organizations” of annually reporting complete donor information. A system comprising multiple new reporting obligations cannot reasonably be expected to prove less burdensome to the reporting entities. Maintaining a well-established federal requirement that also satisfies state needs will continue to streamline reporting and minimize the very regulatory burden on which the IRS has focused.

The IRS Proposal Ignores the Significance of Donor Information to Effective Regulation for Non-(c)(3) Entities.

The IRS suggests in its Notice of Proposed Rulemaking that it will be able to use other information from exempt organizations' annual reports to evaluate possible private benefit or inurement, but it does not claim that its current rule and the proposed rule would each leave the agency equally capable of performing that work. See 84 Fed. Reg. at 47,451-52. Donor information as it is presently reported enables the IRS to identify and consider potentially unlawful activity and control from the face of an entity's regular annual filing. Of course the agency will be less equipped to evaluate private benefit or inurement and identify organizations that warrant further scrutiny if it can only obtain such information through a formal examination. Cf. Ams. for Prosperity Found., 903 F.3d at 1010 (discussing some relative difficulties in obtaining charitable organizations' information through audits as opposed to routine reporting). Schedule L disclosures, which the IRS cites as an adequate substitute for donor information, address only the particular circumstance in which an interested party conducts some financial transaction with the filing entity. Schedule L cannot identify, for example, those organizations or individuals likely to exert influence or control over a non-(c)(3) exempt entity simply by virtue of their regular donations. It would not identify foreign donors to a (c)(4) who may be legally prohibited from supporting the organization's advocacy work. It would not identify the victims of, or witnesses to, deceptive solicitations, or the source of in-kind donations that may be used to obscure an entity's operating revenue and costs. Nor would Schedule L identify a 501(c)(3) donor whose contributions to a (c)(4) exceed legal restrictions and require the revocation of tax-exempt status.

The ability to analyze donor information without requesting the information from the organization also allows the IRS and those state agencies that require Schedule B reporting to advance their enforcement efforts without taking overt action that might compromise their effort or alert the organization under scrutiny. This approach reduces the risk that a target may hide or dissipate assets, or may fabricate, alter or destroy records of the information that would otherwise be reported on a routine basis. The IRS has not explained why its proposal to collect donor information only after initiation of a formal examination would not compromise federal and state enforcement activities. As a practical matter, the absence of regularly-reported donor information will naturally eliminate one major basis on which the IRS could initiate the examination process that it now offers as an adequate regulatory control.

Exempt organizations that are subject to annual donor reporting requirements have a strong incentive to avoid unlawful conduct that could be detected through donor information. Without annual reporting, exempt organizations will have far less reason to expect that any such improprieties will be uncovered by federal and state regulators. Indeed, many may read the proposed rule as broadcasting a message that the IRS is not concerned about where 501(c)(4) and other tax-exempt organizations get their funds.

The IRS Proposal Overstates the Costs of Maintaining Longstanding Donor Reporting Requirements for 501(c)(4) and Other Exempt Organizations.

The IRS proposal understates the value of maintaining the status quo even as it considerably overstates the benefit of its proposed changes. The proposed rule will not significantly reduce filer compliance costs, the risk of inadvertent disclosures of confidential donor information, or the time that the IRS devotes to redacting donor names and addresses from exempt organizations' annual reports before they are disclosed to the public.

As noted above, the IRS proposal is unlikely to generate any meaningful cost savings to affected exempt organizations. In fact, the potential alternative to current reporting requirements — complying with as many as 50 disparate state standards — could prove far more burdensome. That concern, of course, was central to the creation of a uniform Form 990. The IRS's characterization of cost savings under the new proposed regime also disregards that affected organizations will continue to incur costs to comply with unchanged IRS record-keeping requirements, even if they are excused from actually reporting on those records in their federal return. The proposal reflects no assessment of a marginal cost of reporting information that organizations will be required to maintain in any event.

The risk of inadvertent donor disclosures and the burden associated with redacting protected donor information are likewise insubstantial. According to its own internal records, the IRS estimated last year that only 14 Schedule B forms have been inadvertently disclosed since 2010, from among at least 1.8 million filed with the agency (a rate of roughly seven millionths of one percent).4 As noted in the proposal, the IRS has nonetheless already taken other steps to address the risk of inadvertent disclosure. See 84 Fed. Reg. at 47,452. Similarly, the IRS has already reduced redaction-related costs by adopting a policy that it will not produce an exempt organization's Schedule B in response a request for its Form 990 unless the requester specifically requests the Schedule B information. See I.R.M. 3.20.12.2.4(2) (Jan. 1, 2019). Moreover, because the vast majority of Schedules B are submitted by 501(c)(3) organizations, which must continue to report their donors, the IRS's staff itself has concluded — contrary to the IRS's assertions in the proposal — that the risk of inadvertent disclosure and the burden associated with redaction will remain “essentially unchanged” under the proposed policy. See Appendix C, IRS TE/GE, Disclosure Risk on Form 990, Schedule B and Rev. Proc. 2018-38, Briefing Document (Aug. 2018) (FOIA doc. on file with NJ and NY) (noting that Revenue Procedure 2018-38 affects fewer than 14,000 out of over 180,000 Schedules B filed annually, so that “the IRS redaction process remains essentially unchanged along with the disclosure risk”).

* * *

The IRS's longstanding donor reporting rules have served exempt organizations, the IRS, States, and the public well for nearly fifty years. For the reasons described above, they should not be amended to broadly curtail the disclosure of donor support by 501(c)(4) social welfare organizations and other categories of exempt organization. The IRS should continue to collect complete donor information from all 501(c) exempt organization filers in order to maintain robust federal and state agency oversight within the nonprofit sector and avoid the imposition of costly new requirements at the individual state level. Thank you for your consideration of our views.

Sincerely,

GURBIR S. GREWAL
Attorney General of New Jersey

LETITIA JAMES
Attorney General of New York

XAVIER BECERRA
California Attorney General

WILLIAM TONG
Connecticut Attorney General

KARL A. RACINE
District of Columbia Attorney General

KWAME RAOUL
Illinois Attorney General

AARON M. FREY
Maine Attorney General

PHIL WEISER
Colorado Attorney General

KATHLEEN JENNINGS
Delaware Attorney General

CLARE E. CONNORS
Hawaii Attorney General

TOM MILLER
Iowa Attorney General

BRIAN E. FROSH
Maryland Attorney General

MAURA T. HEALY
Massachusetts Attorney General

AARON FORD
Nevada Attorney General

ELLEN F. ROSENBLUM
Oregon Attorney General

PETER F. NERONHA
Rhode Island Attorney General

KEITH ELLISON
Minnesota Attorney General

HECTOR BALDERAS
New Mexico Attorney General

JOSH SHAPIRO
Pennsylvania Attorney General

MARK R. HERRING
Virginia Attorney General

FOOTNOTES

1See Appendix A, July 10 2018 Schedule B Talking Points (FOIA doc. on file with NJ and NY: April 2019 IRS Production at 106).

2In total, “dark money” groups including 501(c)(4) organizations are estimated to have spent $176 million in the 2018 midterm cycle, and the amounts will likely increase for 2020 due to the presidential race. Both political parties have already begun to raise millions, as corporations, wealthy individuals, and special interests seek to influence politics without leaving fingerprints Daniel C. Kirby, The Legal Quagmire of IRC § 501(c)(4) Organizations and the Consequential Rise of Dark Money in Elections, 90 Chi.-Kent L. Rev. 223 (2015). The revised donor reporting requirements that the IRS now proposes are certain to make federal and state review of this spending far more difficult if not impossible.

3See Appendix B, IRS Background Paper, “Summary of Form 990 Redesign Process,” at 1 (Aug. 19, 2008), available at https://www.irs.gov/pub/irs-tege/summary_form_990_redesign_process.pdf.

4See Appendix A, July 10 2018 Schedule B Talking Points (FOIA doc. on file with NJ and NY: April 2019 IRS Production at 106).

END FOOTNOTES

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