Proposed Political Activity Regs Should Be Withdrawn, Commentators Say

This responds to Notice of proposed rulemaking on Political Action Spending by [Income Tax] Exempt Social Welfare Organizations published in the Federal Register November 29, 2013.

1. Summary of Comments. Particularly given the 2013 disarray in the Tax Exempt/Government Entities treatment of applications for Internal Revenue Code section 501(c)(4) income tax exemption, the Internal Revenue Service's proposals to rectify both exemption applications and exempt operations of (c)(4)s should be especially comprehensive and principled. Unfortunately, the proposed regulations are neither. They hark back to the "facts and circumstances" approach that got TE/GE and the IRS into trouble to begin with. They are unpleasantly reminiscent of certain recent politically panicked decisions or indecisions of the IRS.¹

Specifically, these comments will demonstrate: (a) "Exclusively" means "exclusively" in the context of the political campaign prohibitions or express electoral advocacy, whether applied to (c)(4)s, whose purpose must be exclusively the promotion of social welfare, or (c)(3)s; (b) the IRS proposal ignores Code section 504, the regulations thereunder and its legislative history, all of which are inconsistent with the proposed amended regulations; (c) Congress unquestionably intended all organizations, exempt and non-exempt, including (c)(5)s and (c)(6)s, that intervene in political campaigns by express electoral advocacy to be section 527 organizations; (d) all organizations that want to be exempted from income tax should apply to the IRS for determination letters; and (e) the IRS has no discretion not to enforce the gift tax, except where specific exemptions apply, for example, to (c)(3)s and 527s. Adoption of these principles will also further Congress's intent, in enacting section 527, which provides for contribution disclosure, universally considered salutary, especially in the case of large contributions. Such adoption would mean that (c)(4)s, which are not subject to any disclosure requirements, would no longer be able to devote more than "unsubstantial" undisclosed resources to political campaign interventions. Finally, the IRS proposal is inconsistent with the Free Speech decisions of the United States Supreme Court.

2. Incomplete and Misleading "Background." a. Exclusively. The "Background" discussion to the IRS proposal fails to give appropriate weight to "exclusively" which is used twice in section 501(c)(4). Not only is a (c)(4) tax exempt organization to be "operated exclusively for social welfare," but its net earnings are to be "devoted exclusively to charitable, educational or recreational purposes." (emphasis added)

"Exclusively" is not defined in either section 501(c)(4) or the regulations thereunder. However, it or "exclusive" appear in other subsections of section 501, for example, (c)(2), (c)(3), (c)(13). It is not defined in either (c)(2) or (c)(13) or in the regulations thereunder. But the implications of the (c)(2) Treasury Regulations, in denying Unrelated Business Income,² and the use of "solely" in Treasury Regulation section 1.501(c)(13)-1(b) indicate that "exclusively" means what it says, i.e., "preclusive," "interdictive," "barring."³

Most pertinent is the repeated use of "exclusively" in the (c)(3) regulations.⁴ "An organization will not be so regarded" as exempt "if more than an unsubstantial part of its activities is not in furtherance of an exempt purpose."⁵

In this context the revelations of IRS Exempt Organizations Determinations Units 1B and 2 with respect to (c)(4)s are truly shocking in their inconsistency with statute and regulations:

b. Charitable, Educational. Given the explicit reference in section 501(c)(4) to "charitable, educational" purposes, relevant also are the definitions of those terms in Treasury Regulation section 1.501(c)(3)-1(d)(2) and (3). They exclude from charitable or educational treatment an "Action organization," i.e. one which, among other things, "participates or intervenes directly or indirectly in any political campaign."⁷

c. The (c)(4) Political Campaign Prohibition. Background does quote Treasury Regulation section 1.501(c)(4)-1(a)(2)(ii), ". . . 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" (emphasis added).⁸ But it gives insufficient or even no weight to this, on its face, blanket prohibition. This prohibition is not only "similar to" but substantially identical to the "absolute" statutory prohibition in Code section 501(c)(3) and the regulations thereunder, let alone to section 501(c)(4)'s explicit incorporation by reference of the relevant content of the Treasury Regulation explaining the relationship of educational and charitable purposes to the political campaign intervention prohibitions. As we have seen, those Treasury Regulations are explicit in prohibiting more than "unsubstantial" political campaign interventions.

Background states, "However, unlike the absolute prohibition that apples to charitable organizations described in section 501(c)(3), an organization that primarily engages in activities that promote social welfare will be considered under the current regulations to be operating exclusively for the promotion of social welfare and may qualify for tax-exempt status under section 501(c)(4), even though it engages in some political campaign interventions." (emphasis added). Background is disingenuous.

d. Code Section 504. Entirely omitted from Background is any discussion of Code section 504 and its regulations:

The emphasized sentence above makes it clear that (c)(4)s that violate social welfare exclusivity, because of political campaign interventions, can take refuge as (c)(3)s (presumably if they also meet (c)(3) criteria as many (c)(4)s may), because the (c)(3) political campaign prohibition is even more (if that is possible) "absolute" than the (c)(4), and the IRS's expectation must be that the sinning (c)(4) will go straight as a (c)(3). But by virtue of Code section 504, a sinning (c)(3) cannot flee to (c)(4) status, presumably because Congress thought its sin was even more heinous.

Section 504 was enacted by section 1307 of the Tax Reform Act of 1976.⁹ There was no such provision in the House bill, but it was in H.R. 13500, which was the subject of House Report 94-1210. The Senate Bill incorporated H.R. 13500. The focus of both bills' legislative history was the enactment of the Code section 501(h) lobbying election,¹⁰ available to public charities, except churches, and not to private foundations. So was the focus of House Conference Report No. 94-1515.¹¹ Nevertheless, Congress's section 504 intent was clear: to provide mechanical test relief for certain public charity lobbying but also to strengthen the political campaign prohibition and the consequences of its violation. Yet, Background ignores this history entirely.

e. Prior Revenue Rulings. Background's discussion of prior revenue rulings is also misleading. Whatever may be the merit or lack of merit of the "facts and circumstances" test the IRS has hitherto applied in political campaign intervention revenue rulings with respect to (c)(3)s, it does not necessarily follow that the same approach is appropriate for (c)(4)s.

Background does not indicate when the IRS began to use a primary purpose, "facts and circumstances" approach to (c)(4) political campaign intervention issues. No early published rulings adopt such an approach.¹²

The one revenue ruling Background cites as a (c)(4) precedent, Revenue Ruling 81-95,¹³ is perplexing. Its citation of almost only (c)(3) rulings for "other examples of what constitutes participation or intervention in political campaigns."¹⁴ adds nothing to the (c)(4) analysis. The only (c)(4) ruling it correctly cites, Revenue Ruling 67-368,¹⁵ holds that rating candidates for public office is not social welfare promotion. No facts and circumstances there. Revenue Ruling 20Q4-6¹⁶ really deals with the section 527 issues as they might relate to (c)(4)s (and (c)(3)s), an issue discussed infra in section 3.b.

3. Overview. One must agree with the Overview statement that "more definite rules . . . rather than the existing fact-intensive analysis" would be helpful. But then Treasury/IRS propose to identify "specific political activities" that "do not promote social welfare," i.e., back to facts and circumstances.

a. Interaction with Section 501(c)(3). If "political campaign intervention under section 501(c)(3) is absolutely prohibited," what is the need for "a more nuanced consideration of the totality of the facts"? Indeed, prohibited campaign intervention by (c)(3)s, especially by churches and other religious organizations, has hardly been "definitive" or "sharper" or provided "greater certainty."¹⁷

b. Interaction with Section 527. If an organization behaves like a political organization that is described in section 527, then that is how the IRS should treat it, regardless of how it may describe itself, apply or not apply for exemption or file 990s as if it were another exempt organization.

The application of section 527 will also resolve the (c)(4) issues in favor of disclosure of expenditures and contributions and public availability.¹⁸

Revenue Ruling 81-95, discussed supra section 2.e., also relates directly to the relationship between Code section 527 political organizations and (c)(4)s, although Overview ignores this. The Ruling correctly quotes from the legislative history of Public Law 93-625 (Jan. 3, 1975) that enacted section 527:

c. Interaction with Sections 501(c)(5) and 501(c)(6). Organizations exempt under sections 501(c)(5) and (c)(6) have never been subject to the political campaign prohibition.²² Many or their political action committees comply with the Federal Election Campaign Act and applicable state, local and other federal laws, and they should continue to do so.

On the other hand, we have no objection to applying the political campaign intervention prohibition to them, and consequently, such organizations that wish to engage in such prohibited transactions should also comply with section 527 or form section 527 organizations, if they have not already done so. Section 527 was intended to apply to them as well as to all organizations exempt under Section 501(c)(3), as is provided in section 527(f) and the regulations thereunder. Section 527(f), in effect, taxes the lesser of the (c)s net investment income (as defined) or the aggregate amount directly or indirectly expressed for political campaigns (as defined in section 527(e)(2)). The legislative history is clear.

d. Additional guidance. As we have seen, supra, "Operated exclusively for the promotion of social welfare" does not mean operated "primarily" for the promotion of social welfare. (emphasis added)

4. Issues Not Addressed. In addition to the issues raised supra section 3.a about application of the political campaign intervention prohibition to churches as well as to all (c)(3)s, the proposal does not address the following issues:

a. Self-Certification. Given the difficulties the IRS has experienced with respect to organizations that only assert they are exempt under (c)(4) (and other (c)s) and do not apply for exemption, all such organizations, except perhaps churches and other religious organizations that do not intervene in political campaigns, should be required to apply for exemption and to pay a user fee to cover the additional IRS resources that will be required. Form 990 will have to be modified or new annual reporting forms developed.

b. Gift Tax. When the so-called "Tea Party" controversy arose, the IRS alluded to the applicability of gift taxes and then promptly retreated.²⁴ The issues are comprehensively discussed in John R. Valentine, The Gift Tax and Contributions to Social Welfare Organizations.²⁵ Notwithstanding the reference to social welfare organizations in the title, his analysis is not limited to (c)(4)s, but also raises gift tax issues with respect to (c)(6)s and (c)(7)s.

No gift tax exemption or deduction is provided by the Code for transfers to (c)(4)s and to other organizations,²⁶ and the IRS should enforce the law, as in 1982 it said it would.²⁷

5. Candidate Related Activity. The way to provide greater certainty to (c)(4)s is to enforce social welfare exclusivity and to require (c)(4)s and other (c)s that wish to intervene in political campaigns, in more than unsubstantial amounts, to form section 527 political organizations. The way not to provide "certainty" is to "draw key concepts from the federal election campaign laws." First, the IRS's function is not to enforce those laws. Second, as the currently often-dead-locked Federal Election Commission and the courts change their interpretations and applications of those laws, is the IRS going to change its?²⁸ Third, has the IRS considered the possible impact of Citizens United v. Federal Election Commission?²⁹ For example, is the charitable deduction sufficient to distinguish (c)(3)s from the implications of Citizens United for the constitutionality of their political campaign intervention prohibition? Does Code section 504, other subsequent developments and the arguments made in these comments undermine the rationale of Regan v. Taxation with Representation?³⁰ Because the charitable deduction does not apply to gifts to (c)(4)s, they would seem more vulnerable to a Citizens United attack. Fourth, the proposed definitions apply to the 50 state and myriad local government campaigns laws and regulations throughout the United States. Do they comport with all those laws and regulations? Overview speaks of having "modified" the FEC concepts to take state and local laws into account. How and how accurately?

6. Recommendations. Accordingly, the Internal Revenue Service should completely rethink the proposed regulation.³¹ Any new regulation should meet the following tests:

a. The Service should be prepared and equipped to enforce it.

b. Gift tax should apply to all transfers to all individuals and organizations that are not exempted from gift tax.

c. Because "exclusively" does not mean "primarily", the political campaign intervention prohibition should be enforced with respect to all exempt organizations that are subject to it, i.e., (c)(3)s, (c)(4)s, (c)(29)s and, by implication, (c)(21)s (Black Lung Trusts).

d. Exempt organizations, including churches and other religious organizations, that wish to intervene in political campaigns, should do so in accordance with Code section 527 and the regulations thereunder.

e. The Service should not become a second enforcer of the Federal Election Campaign Act as the proposed regulation purports to make it.

f. The Service should not become an enforcer of state and local campaign financing laws as the proposed regulation purports to make it.

g. The Service should abandon any "facts and circumstances" approach to the political campaign intervention prohibition, wherever applicable. Its jurisprudence has been inconsistent and provides no reliable guidance either to taxpayers or to itself.

h. Any new proposed regulation must take into account Code section 504, the regulations thereunder and the Congressional context in which it was enacted.

7. Constitutional Free Speech Issues -- Issue Advocacy That Mentions Candidates. The IRS's proposal to regulate Free Speech is wholly outside its jurisdiction and competence. Worse, its proposal is contrary to applicable First Amendment law.

a. Some election campaign finance regulators have regarded what some exempt organizations, both right, left and center³² -- may do as express electoral advocacy, especially during an "election period," even though such activities do not include any express advocacy of the election or defeat of particular candidates. However, both United States v. National Committee on Impeachment³³ and ACLU v. Jennings³⁴ vindicate the First Amendment rights of issue speech, notwithstanding the mention of specific candidates, even during what was called an "election period," unless they expressly advocated the election or defeat of a candidate.

The District of Columbia Circuit Court of Appeals in Buckley v. Valeo³⁵ reaffirmed those decisions. The Supreme Court acknowledged that reaffirmance in Buckley v. Valeo.³⁶Buckley also held that even express electoral advocacy could not be constitutionally limited, if it was independent, that is uncoordinated with candidates or their parties.³⁷ Nonetheless, on many occasions, and under the guise of regulating electoral speech, the FEC attempted to regulate issue speech against the ACLU and many other, smaller groups, both right, left and neutral, but ultimately the FEC backed off when challenged or yielded to court rulings.

b. In 2002, the so-called McCain-Feingold law, the Bipartisan Campaign Reform Act of 2002³⁸ resurrected the regulation of what it called "electioneering speech" -- issue speech that mentioned a candidate -- during an election period (defined as 60 days before a general election and 30 days before a primary). In rejecting a facial challenge to the constitutionality of BCRA in McConnell v. Federal Election Comms.,³⁹ the Supreme Court in effect upheld the Act's restrictions on such "electioneering speech," even if it was not express electoral advocacy, thus effectively overruling the protections for such speech previously established in National Committee and ACLU v. Jennings. But in 2006, in Federal Election Commission v. Wisconsin Right to Life,⁴⁰ the Supreme Court in effect reinstated the ACLU v. Jennings standard, holding that a court could not inquire into the intent or speculate as to the effect of speech that was not express electoral advocacy or its equivalent. In Citizens United, the Court reaffirmed that position by, among other things, overruling McConnell's facial determination that had upheld the constitutionality of BCRA's section 203 extension of Federal Election Campaign Act section 441b restrictions on corporate independent expenditures.⁴¹

Because many of these 527 organizations, right, left and center, did not engage in express electoral advocacy, they properly escaped FEC jurisdiction. But because disclosure of contributions to 527s is required by statute, some or many donors used or reverted to (c)(4)s to protect such gifts from disclosure. This might never have happened if the gift tax required by statute had been enforced by IRS on gifts to (c)(4)s.

The IRS's proposed resurrection of the "electioneering speech" standard threatens with a loss of tax exemption all exempt organizations, right, left and center, (c)(3)s and (c)(4)s, that engage in public advocacy that only mentions candidates, either without express electoral advocacy or with only an unsubstantial amount of express advocacy. This constitutes a clear violation of the First Amendment under decades of applicable case law.

The IRS's commingling of tax law and campaign finance law makes a mess of both, and the proposal should be withdrawn.

If under Buckley it would be unconstitutional for the FEC to regulate speech that is both independent and does not include express electoral advocacy, it has to be equally unconstitutional to do exactly the same through the Internal Revenue Code.

Paragraph Fourth of Acting Commissioner Werfel's November 5, 2013 AICPA speech is symptomatic, Bloomberg BNA Daily Tax Report, Nov. 13 2013. What is the virtue of reducing the inventory of section 501(c)(4) applications, if self-certification was allowed, and/or no principled review was undertaken? For another example, on May 31, 2011, then Commissioner Douglas Shulman wrote to Senator John Thune (R. S.D.) that gift tax letters sent to section (c)(4) donors resulted from an internal referral. Bloomberg BNA Daily Tax Report, June 6, 2011. In an apparent response to some negative congressional reactions, on July 7, then Deputy Commissioner Steven T. Miller directed that no "examination resources . . . be expended on this issue." Memorandum for Commissioner, Small Business, Self-Employed Division, Commissioner, Tax Exempt and Government. Bloomberg BNA Daily Tax Report, Memorandum to SB/SE Commissioner from Steven Miller. July 8, 2011. In 2004, an American Bar Association Tax Section task force had recommended resolution of this issue. Bloomberg BNA Daily Tax Report, July 8, 2011. Yet, ten years later the issue remains unresolved. Similarly, the IRS has not, since 2009, resolved the internal issue of who may authorize audits of churches and other religious organizations. See William Josephson, Political Campaign Interventions by Religious Organizations. 72 Exempt Organization Tax Review 613, 614 (2013).

²See Treas. Reg § 1.501(c)(2)-1(a).

³See Roget's Thesaurus of Words and Phrases § 55 (rev. ed. 1941).

⁴See Treas. Reg. § 1.501(c)(3)-1(a)(1); (b)(1)(i), (ii), (iii) & (iv), (3) & (4); (c)(1), (2) & (3); (d)(1)(c) & (ii).

⁵ Treas. Reg. § 1.501(c)(3)-1(c)(1) (emphasis added).

⁶ Bloomberg BNA Daily Tax Report, IRS Training Materials for Applicants for 501(c)(4) Status, Jan. 24, 2014. [add discussion from background]

⁷ See Treas. Reg. § 1.501(c)(3)-1(c)(3)(iii).

⁸ As Background notes, the (c)(4) regulations were adopted in 1959. They have only been amended once, in 1990, in a manner not relevant here. They are short. They are explicit.

⁹ Pub. L. No. 94-455, 90 Stat. 1720-29 (1976).

¹⁰See S. Rep. No. 94-938 Part II, 84^th Cong., 2d Sess. 79-85 (1976) in 4 U.S.C.C.A.N. 4030, 4104-09 (1976).

¹¹See 4 U.S.C.C.A.N. 4118, 4230-31 (pages 532-36 of the Report itself).

¹²E.g., Rev. Rul. 75-384, 1975-2 C.B. 204 (anti war protest organization not entitled to (c)(4) exemption); Rev. Rul. 71-530, 1975-2 C.B. 237 (tax policy lobbying organization entitled to (c)(4) exemption).

¹³ 1981-1 C.B. 332.

¹⁴ Rev. Rul. 67-71, 1967-1 C.B. 125 (school board election organization not exempt under section 501(c)(3)); Rev. Rul. 74-574, 1974-2 C.B. 160 (501(c)(3) provides free airtime to all legally qualified candidates); Rev. Rul. 76-456, 1976-2 C.B. 252 (501(c)(3) promotes fair campaign practices); Rev. Rul. 78-248, 1978-1 C.B. 154 (501(c)(3) voter education activities); Rev. Rul. 80-282, 1980-2 C.B. 178 (publication of voting records by 501(c)(3)). How are these relevant to the (c)(4) issues?

¹⁵ 1967-2 C.B. 194.

¹⁶ 2004-1 C.B. 338.

¹⁷See William Josephson, Political Campaign Interventions by Religious Organizations. 72 Exempt Organization Tax Rev. 613 (2013); Revenue Rulings, supra note 14.

¹⁸ IRC § 527(j) & (k). See David S. Karp, Taxing Issues: Reexamining The Regulation of Advocacy by Tax-Exempt Organizations Through the Internal Revenue Code, 77 N.Y.U. L. Rev. 1805, 1806 & n.3, 1808 & nn.14-18, 1830 & nn.127-31 & 1831-33 (2002) (hereinafter "Taxing Issues").

¹⁹ S. Rep. No. 93-1357, 93rd Cong., 2d Sess. 29 (1974) in 4 U.S.C.C.A.N. 7505 (1974) (emphasis added).

²⁰Id. at 7508 (1974).

²¹ 1981-1 C.B. at 333.

²²See Taxing Issues, supra note 18 at 1813 n.30 and authorities, particularly Review Rulings, cited; Kenneth P. Doyle, Spokesman Says Freedom Partners Did Not Deviate From IRS Application, Bloomberg BNA Daily Tax Report, Oct. 2, 2013.

²³ S. Rep. No. 93-1357, supra note 19 at 7505 (emphasis added).

²⁴ See http://www.irs.gov/uac/IRS-statement-on-applicability-of-gift-tax-on-501(c)(4)-organization-contributions and authorities cited supra note 1.

²⁵ 25 Taxation of Exempts 27 (2013).

²⁶ As we have seen, a gift tax exemption now applies to contributions to Code section 527 political organizations. IRC § 2501(a)(4). Contributions to (c)(3)s are deductible from gift tax under Code section 2522(a)(2). Contributions are deductible, under certain conditions, to certain fraternal societies and to certain veterans organizations, under section 2522(3) and (4), respectively.

²⁷ Revenue Ruling 82-216, 1982-C.B. 220, held that gift tax would not apply to contributions to section 527 political organizations made prior to the May 7, 1974 effective date of the section 2501(5) (now (4)) gift tax exemption. However, the Service stated:

²⁹ 558 U.S. 50 (2010).

³⁰ 461 U.S. 540 (1983). See William Josephson, Political Campaign Interventions by Religious Organizations, 72 Exempt Organization Tax Rev. at 613-14 & n.6. That rationale, particularly that of the concurring justices, was that a government subsidized (by tax exemption and contribution deduction) (c)(3) had political campaign intervention alternatives, political action committees, (c)(4)s, 527s. Because of Code section 504 and the regulations thereunder, and of our proposed IRS enforcement of the (c)(4) political campaign intervention prohibition, at least one of those alternatives may be less adequate. For Justice Anthony Kennedy's discussion of the apparent lack of utility of political action committees, see Citizens United v. Federal Election Commission, 558 U.S. 50, __, 130 S. Ct. 876, 897-99 (2010).

³¹ Legislative solutions exist, but are unlikely in the present Congress. E.g., John L. Buckley & Dallas Woodrum, The Intersection of the Tax Code and Citizens United, 71 Exempt Organization Tax Rev. 485 (2013); Pablo Eisenberg, Congress Has Only Itself to Blame for IRS Troubles. Chronicle of Philanthropy, Jan. 26, 2013; John D. McKinnon, Rep. Camp Seeks to Halt IRS Curbs on Some Groups' Political Activities, Wall Street J., Jan. 14, 2014; Patrick Caldwell, Did These 68 Words Just Kill IRS Oversight of Dark Money?, Mother Jones, Jan. 22, 2014. H.R. 3865, 113^th Cong., 2d Sess. was reported by the House Ways and Means Committee and committed to the Committee of the Whole House on the State of the Union. H. Rep. No. 113-383, 113^th Cong., 2d Sess. (Feb. 18, 2014). It would, for one year after enactment, maintain the "standards and definitions as in effect on January 1, 2010" for determining (c)(4) status. But what are they?

³²E.g., the NAACP, ACLU abortion groups pro and con, gun control groups pro and con, tax reform groups.

³³ 469 F.2d 1135 (2d Cir. 1972)

³⁴ 366 F. Supp. 1041 (D.D.C. 1973) (three-judge court), vacated as moot sub nom. Staats v. American Civil Liberties Union. 422 U.S. 1030 (1975).

³⁵ 519 F.2d 821, 864 n.112 (1975).

³⁶ 424 U.S. 1, 10 n.7 (1976)

³⁷Id. at C.1

³⁸ Pub. Law No. 107-155, 116 Stat. 81, 107^th Cong, 2d Sess. (2002) [hereinafter "BCRA"]

³⁹ 540 U.S. 93 (2003)

⁴⁰ 551 U.S. 449, 481 (2006)

⁴¹ 558 U.S. at ___, 130 S.Ct. at 913.