The IRS and the Tea Parties: Should You File That Form?

As the scandal over the proposed IRS rules attacking citizen activists grows, the administration digs in.  It is a good bet that the rules will be finalized soon, though perhaps the IRS will rethink some of the most blatantly unconstitutional sections, such as those forbidding all mention of the names of candidates.  Even if the House voted to delay the rules, the double-whammy of Senate inaction and a presidential veto would kill the effort, so the Democratic grandees have no reason to bend.  

The prospect of quick action raises an interesting question: should citizen activists pay any attention to rules?  Why not just ignore them?

Most of the commentary accepts the progressive narrative that the rules would indeed shut down citizen-activists.

To reach this conclusion requires two assumptions:

(1) that a citizen activist organization must obtain advance IRS approval of its tax-exempt status; and

(2) that obtaining tax-exempt status matters.

The first of these is wrong, and the second is dubious.  After consultation with good tax lawyers, any activist group might well conclude that it can damn the torpedoes and go full speed ahead.

First, the approval issue.

A basic division in the non-profit world concerns the ability of donors to deduct contributions from their personal income taxes.  Foundations, charities, churches, and schools are called “(c)(3)s” because their exempt status is contained in section 501(c)(3) of the Internal Revenue Code.  Anyone who gives to a (c)(3) can deduct the gift.  501(c)(3) explicitly forbids (c)(3)s to engage in politics – including lobbying, grassroots organizing, and electoral activity.

In addition, section 508(a) says that a (c)(3) must file an application with the IRS.  If the agency approves, the tax-exempt status is retroactive, but the approval must be obtained.

Citizen-activist groups are “social welfare” organizations, called “(c)(4)s” because they are covered by section 501(c)(4).  Contributions to (c)(4)s are not deductible by the donor; “tax-exempt” means only that the group pays no taxes on its own income (assuming it has any).

Two other important differences between (c)(4)s and (c)(3)s exist.

First, the prohibitions on political activity contained in 501(c)(3) do not apply to (c)(4)s.

The latter are allowed to lobby and engage in grassroots organizing.  However, in a series of weird ipse dixits dating back to 1959, the IRS declared that electoral activity is not within the meaning of the term “social welfare,” but that a (c)(4) can still engage in such politicking as long as it is connected to the main mission and does not constitute too great a proportion of the group’s activities.  (The pending proposal is the latest in this series.) 

The second big distinction between (c)(3)s and (c)(4)s is that the requirement that the IRS approve an application for exemption does not apply to (c)(4)s.

This distinction derives from the minutiae of the Internal Revenue Code.  Subsection 501(a) says that organizations described in subsection 501(c), including all its subsections, “shall be exempt.”  Then, section 508(a) says that an organization seeking exemption under 501(c)(3) must file an application – but 508(a) does not refer to (c)(4)s.

Within the tax trade, the fact that the statute refers to (c)(3)s and does not mention (c)(4)s  means that a (c)(4) is not required obtain IRS approval of its exemption.  Various IRS documents confirm this, as in a 2012 IRS letter to Sen. Orrin Hatch: “The law allows section 501 (c)(4) organizations to self-declare and hold themselves out as tax-exempt.”

The IRS does not like to call attention to this reality, so its language is usually opaque, but the point is well-established in the legal literature on non-profits.

Thus it is open to a social welfare group to create a non-profit corporate entity under state law without filing anything with the IRS.  (Thereafter, it must file annual Form 990 tax returns.)

Indeed, there are sound reasons to follow this course.  If the organization files for approval, then the IRS can ask for promises about the group’s proposed activities.  These can be more restrictive than the law requires, but if the organization agrees, it will have signed under penalty of perjury.

In the opinion of many lawyers, the proposed rules exceed the agency’s authority, violate the First Amendment, and are unlikely to survive judicial review.  (See the materials collected by the Center for Competitive Politics.)  So an activist organization could make its own judgment as to what the law requires, and fight over the issue some years down the road if the IRS disputes its future annual returns.  (Over 93,000 social welfare organizations file 990s.) 

The second question is, what happens if a social welfare organization is not tax-exempt?  For a (c)(3), which needs to assure donors that they can take a deduction, denial of exempt status is a disaster.  But this is not so for (c)(4)s, which are funded with after-tax dollars.  The organization would be subject to a tax on its income, but most activist organizations do not have any, and donations would not be income under some previous IRS rulings.  So it is hard to see serious tax consequences if a group operates without the benefit of (c)(4) status.

Some difficulties might arise under yet another section of the code, section 527, which covers political organizations created to collect and spend money for candidates.  Under 527, a (c)(4) that engages in electoral activities might be taxed on the lesser of the expenditure or its investment income, but what citizen-activist group has investment income?   

On the whole, many conservative spokesmen are doing the cause no favors by fear-mongering.  Their emphasis on mobilizing to stop the IRS from crippling citizen-activists leaves the false impression that if rules are not stopped, then the Tea Party organizations will indeed be crippled. 

This is not the case, and the spokesmen should be explaining the situation, not sowing panic.  Granted, all tax rules are tricky, careful legal advice is needed, and compliance with the campaign finance laws creates a separate set of important issues.  But the IRS rules need not inhibit the citizen-activist movement.

The citizens should demand one thing of Congress, though.  While no law is possible, the Republicans should be pressured to pass a sense-of-the-House resolution that the IRS rules are illegitimate, illegal, and unconstitutional, and that no citizen should be morally or legally bound by them unless and until they are upheld by the courts.

Such a resolution would be legal and political terra incognita, and its formal impact would be subject to rancorous dispute.  But it might do some good as a legal matter, and it would certainly stiffen the will to resist the IRS over-reaching.

A House resolution would also highlight the biggest elephant in the room – the crisis of political legitimacy that is undermining the foundations of the Republic.  A government that does not regard itself as bound by law cannot complain if its citizens reciprocate in kind.

James V DeLong lives in Red Lodge, MT.  His career history includes a tour as research director of the Administrative Conference of the United States, and his formal comments on the IRS proposal are here.  He is the author of Ending ‘Big SIS’ (The Special Interest State) & Renewing the American Republic.

As the scandal over the proposed IRS rules attacking citizen activists grows, the administration digs in.  It is a good bet that the rules will be finalized soon, though perhaps the IRS will rethink some of the most blatantly unconstitutional sections, such as those forbidding all mention of the names of candidates.  Even if the House voted to delay the rules, the double-whammy of Senate inaction and a presidential veto would kill the effort, so the Democratic grandees have no reason to bend.  

The prospect of quick action raises an interesting question: should citizen activists pay any attention to rules?  Why not just ignore them?

Most of the commentary accepts the progressive narrative that the rules would indeed shut down citizen-activists.

To reach this conclusion requires two assumptions:

(1) that a citizen activist organization must obtain advance IRS approval of its tax-exempt status; and

(2) that obtaining tax-exempt status matters.

The first of these is wrong, and the second is dubious.  After consultation with good tax lawyers, any activist group might well conclude that it can damn the torpedoes and go full speed ahead.

First, the approval issue.

A basic division in the non-profit world concerns the ability of donors to deduct contributions from their personal income taxes.  Foundations, charities, churches, and schools are called “(c)(3)s” because their exempt status is contained in section 501(c)(3) of the Internal Revenue Code.  Anyone who gives to a (c)(3) can deduct the gift.  501(c)(3) explicitly forbids (c)(3)s to engage in politics – including lobbying, grassroots organizing, and electoral activity.

In addition, section 508(a) says that a (c)(3) must file an application with the IRS.  If the agency approves, the tax-exempt status is retroactive, but the approval must be obtained.

Citizen-activist groups are “social welfare” organizations, called “(c)(4)s” because they are covered by section 501(c)(4).  Contributions to (c)(4)s are not deductible by the donor; “tax-exempt” means only that the group pays no taxes on its own income (assuming it has any).

Two other important differences between (c)(4)s and (c)(3)s exist.

First, the prohibitions on political activity contained in 501(c)(3) do not apply to (c)(4)s.

The latter are allowed to lobby and engage in grassroots organizing.  However, in a series of weird ipse dixits dating back to 1959, the IRS declared that electoral activity is not within the meaning of the term “social welfare,” but that a (c)(4) can still engage in such politicking as long as it is connected to the main mission and does not constitute too great a proportion of the group’s activities.  (The pending proposal is the latest in this series.) 

The second big distinction between (c)(3)s and (c)(4)s is that the requirement that the IRS approve an application for exemption does not apply to (c)(4)s.

This distinction derives from the minutiae of the Internal Revenue Code.  Subsection 501(a) says that organizations described in subsection 501(c), including all its subsections, “shall be exempt.”  Then, section 508(a) says that an organization seeking exemption under 501(c)(3) must file an application – but 508(a) does not refer to (c)(4)s.

Within the tax trade, the fact that the statute refers to (c)(3)s and does not mention (c)(4)s  means that a (c)(4) is not required obtain IRS approval of its exemption.  Various IRS documents confirm this, as in a 2012 IRS letter to Sen. Orrin Hatch: “The law allows section 501 (c)(4) organizations to self-declare and hold themselves out as tax-exempt.”

The IRS does not like to call attention to this reality, so its language is usually opaque, but the point is well-established in the legal literature on non-profits.

Thus it is open to a social welfare group to create a non-profit corporate entity under state law without filing anything with the IRS.  (Thereafter, it must file annual Form 990 tax returns.)

Indeed, there are sound reasons to follow this course.  If the organization files for approval, then the IRS can ask for promises about the group’s proposed activities.  These can be more restrictive than the law requires, but if the organization agrees, it will have signed under penalty of perjury.

In the opinion of many lawyers, the proposed rules exceed the agency’s authority, violate the First Amendment, and are unlikely to survive judicial review.  (See the materials collected by the Center for Competitive Politics.)  So an activist organization could make its own judgment as to what the law requires, and fight over the issue some years down the road if the IRS disputes its future annual returns.  (Over 93,000 social welfare organizations file 990s.) 

The second question is, what happens if a social welfare organization is not tax-exempt?  For a (c)(3), which needs to assure donors that they can take a deduction, denial of exempt status is a disaster.  But this is not so for (c)(4)s, which are funded with after-tax dollars.  The organization would be subject to a tax on its income, but most activist organizations do not have any, and donations would not be income under some previous IRS rulings.  So it is hard to see serious tax consequences if a group operates without the benefit of (c)(4) status.

Some difficulties might arise under yet another section of the code, section 527, which covers political organizations created to collect and spend money for candidates.  Under 527, a (c)(4) that engages in electoral activities might be taxed on the lesser of the expenditure or its investment income, but what citizen-activist group has investment income?   

On the whole, many conservative spokesmen are doing the cause no favors by fear-mongering.  Their emphasis on mobilizing to stop the IRS from crippling citizen-activists leaves the false impression that if rules are not stopped, then the Tea Party organizations will indeed be crippled. 

This is not the case, and the spokesmen should be explaining the situation, not sowing panic.  Granted, all tax rules are tricky, careful legal advice is needed, and compliance with the campaign finance laws creates a separate set of important issues.  But the IRS rules need not inhibit the citizen-activist movement.

The citizens should demand one thing of Congress, though.  While no law is possible, the Republicans should be pressured to pass a sense-of-the-House resolution that the IRS rules are illegitimate, illegal, and unconstitutional, and that no citizen should be morally or legally bound by them unless and until they are upheld by the courts.

Such a resolution would be legal and political terra incognita, and its formal impact would be subject to rancorous dispute.  But it might do some good as a legal matter, and it would certainly stiffen the will to resist the IRS over-reaching.

A House resolution would also highlight the biggest elephant in the room – the crisis of political legitimacy that is undermining the foundations of the Republic.  A government that does not regard itself as bound by law cannot complain if its citizens reciprocate in kind.

James V DeLong lives in Red Lodge, MT.  His career history includes a tour as research director of the Administrative Conference of the United States, and his formal comments on the IRS proposal are here.  He is the author of Ending ‘Big SIS’ (The Special Interest State) & Renewing the American Republic.

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