The principle involved in the recent IRS scandal appears to be that every group with an interest in twisting the electoral process to its own advantage is exempted; only those groups that stand for disinterested good government are muzzled.
The IRS recently proposed rules to “provide guidance” to tax-exempt “social welfare” organizations concerning restrictions on their political activities. As Kimberly Strassel noted in the Wall Street Journal, this notice represents the IRS’s response to the revelations about its use of the tax laws to hamstring tea-party groups before the 2012 election.
The IRS rules might not survive legal scrutiny, but this is irrelevant. Once final, the rules would be applied retroactively, so the IRS can leave them in the “proposed” stage until after November 2014, which makes them unreviewable by a court even as they paralyze the citizen groups. The IRS could also start applying the new standards immediately by requiring that organizations requesting tax-exempt status promise to abide by them.
To understand how this perverse state of affairs came about, and to develop a strategy of resistance, one must start with the core principle that the Internal Revenue Code is supposed to be about government revenue. Therefore, it focuses on moneymaking commercial activities. However, tax law must also deal with the reality that millions of entities in U.S. civil society are not commercial, and indeed it has done so since 1913, in Title 26, Subtitle A, Chapter 1, Subchapter F, “Exempt Organizations.”
The core of Subchapter F is section 501, which has dozens of subparts listing various types of non-commercial groups. The list is eye-glazing, but it’s necessary to an understanding of the context of the current dispute, because it shows the breadth of Congress’s view of exempt activities:
Government corporations; Foundation[s] organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition; Civic leagues or organizations; Local associations of employees; Labor, agricultural, or horticultural organizations; Business leagues, chambers of commerce, real-estate boards, boards of trade, or professional football leagues; Fraternal beneficiary societies; Cemetery companies;
and so on through 29 subsections, plus numerous definitions and qualifications.
These entities are declared tax exempt in the sense that any excess of revenues over expenses, which is usually minimal or nonexistent, is not subjected to the income tax; and they file a special form designed for nonprofits instead of the standard corporate tax returns.
For the most part, individual taxpayers cannot deduct contributions to these groups from personal income taxes. That privilege is reserved for donations to the subset of organizations that qualify as charities or foundations under section 501(c)(3). These are more stringently regulated than other entities to prevent their being used as tax dodges, and 501(c)(3) contains explicit prohibitions on political activities by organizations claiming the benefits of the subsection.
This distinction between the 501(c)(3) charities and other exempt organizations is very important, but often ignored. None of the subsections describing other types of exempt groups contain anything like the prohibition on political activity that is found in 501(c)(3), except for a provision governing co-op health insurers that was added by Obamacare.
Despite the variety of descriptions of exempt organizations listed in section 501, none provides a direct fit for political activists. Logically, as a matter of textual analysis, the statute’s term “social welfare” — described in IRS regulations as “promoting the common good and general welfare of the community” — should include political activism, given that democratic politics is supposed to be about the common good and general welfare.
The key conclusion is that, under the statute, there is no basis for the IRS to exclude political activity from “social welfare,” and there is no need for it to do so to protect the public revenues.
However, the IRS took a different direction: It arrogated to itself the duty of deciding which groups deserve the benefit of tax-exempt status, and uses the Internal Revenue Code to micromanage the nonprofit sector.
In 1959, the agency revised its regulations to define “social welfare” as not including political activity. This caused a problem, because any group that is interested in a particular cause or issue must be interested in politics, given that the government snout intrudes into everything these days.
So the IRS backtracked on its definition in two ways. First, it rewrote the statute. 501(c)(4) says an exempt organization must be “exclusively” devoted to social-welfare activities, a test that became impossible if political activity was defined as out of bounds. So IRS decided that “exclusively” actually means “primarily,” with no certainty as to what this term means.
Second, the IRS made a series of rulings that political activity by social-welfare organizations is permissible if it is in furtherance of the group’s social-welfare mission. The same holds true for groups exempt under other subsections, such as unions and business associations. This was not totally voluntary on the part of the agency; in 1983, the Supreme Court indicated strongly that a social-welfare organization has a constitutional right to undertake political action in support of its mission.
As far as social-welfare and other exempt organizations were concerned, the result was a rough modus vivendi understood by the relevant players. These could engage in lobbying and politicking, as long as these activities were connected to their basic purposes and were not too extensive, in some undefined way. Substantive limits on what the organizations were allowed to do were supplied by the campaign-finance laws, not the revenue code. In D.C., (c)(4)s were set up to serve as lobbying arms for charitable (c)(3)s, without objection from the IRS.
The exact boundaries of allowable activities were determined case by case under an “all the facts and circumstances” test, and the IRS often imported decisions made about the limits on charities — which are covered by an explicit statute — to decisions on social-welfare organizations, which are not.
All of this confusion was compounded by the spate of campaign-finance-reform laws passed in the 1970s, which tried to impose substantive limits on what organizations, including social-welfare organizations, could do. The result has been a series of hairsplitting cases that interact with the IRS determinations. Also, in 1975, a new section of the Internal Revenue Code gave a tax exemption to political organizations that collect money and run campaigns.
The result of all this history was a confused mess of uncertainty. Basically, exempt organizations (other than charities, which get tax-deductible contributions) were allowed to lobby and politick as long as they could connect it to some more general purpose, and as long as a fig leaf of respectability was maintained. Unions have probably been the biggest beneficiaries of this outcome.
Into this confusion wandered the tea-party groups. They are clearly social-welfare organizations, under the IRS definition of “promoting the common good and general welfare of the community.” Compared with other exempt organizations, such as unions or business associations, the tea-party groups are uniquely selfless in that they do not seek advantages for themselves. They must be politically active, because their function is to educate the public and to encourage elected officials and candidates who embrace tea-party values, such as limited government and the rule of law.
These public-advocacy and electoral-influence functions are inextricably linked, and the IRS could have decided that this, in itself, legitimated tea-party political activities; IRS rulings and Supreme Court cases could serve as precedent.
But tea-party political activity is offensive to the IRS — so the current notice classifies any references to candidates, even in voter guides or open forums, as political. Then, to nail the door shut, the proposal contemplates eliminating the “primary purpose” test and forbidding social-welfare organizations from engaging in any political activity. (Repeat: This proposal does not apply to unions, business associations, or other organizations exempt under other subsections.)
Obviously, this proposal has nothing to do with protecting tax revenues. The idea that a tea-party group, run on a shoestring and the energy of volunteers, threatens the collection of the nation’s taxes is a joke.
At one point in its notice, the agency recognizes the thinness of the legal ice it’s skating on: It says that while it “is draw[ing] key concepts from the federal election campaign laws,” it is making “appropriate modifications” to reflect that the purpose of the proposal is tax law and not campaign-finance regulation.
This bow to legal rectitude is blatantly untrue. The proposal has nothing to do with revenue protection, and should be held by a court to be ultra vires. Why is it within either the mission or the institutional competence of the IRS to decide that a particular political activity should be squelched? As long as an organization is not being used for tax evasion or avoidance schemes, the IRS has no legitimate interest.
Besides, as a matter of constitutional protection of free speech and association, how can one possibly justify a system of whimsical determination of who is allowed to speak, governed by an administrative agency applying a standard of “all the facts and circumstances”?
As noted earlier, the discrimination of this proposal is blatant. Tea-party groups and other 501(c)(4)s are hit, but not the myriad organizations granted exemptions by other subsections of 501, such as unions, trade associations, cooperatives, and business groups. Even charities, which are supposed to be more stringently regulated, escape the proposal.
How should the tea-party groups respond? It is clear that the IRS should be challenged legally. Its statutory authority is thin and probably nonexistent and the unconstitutional nature of the overall system is blatant.
(For administrative-law geeks: Yes, there is an issue of Chevron deference to an agency’s interpretation of its governing statute, but Chevron is not a license for an agency to ignore all limits. Compare the different language of subsections (c)(3) and (c)(4) and then try to argue that the same standards of political activity apply under both of them. The argument runs afoul of the most basic tenets of statutory interpretation. And yes, there is also an argument that Congress ratified the IRS rules by failing to change them, especially when it passed section 527 in 1975. But ratification should be implied very sparingly, and not when all experience shows that the original decision was a mistake. The better argument is that 527 rejected the IRS’s approach but was incomplete.)
Beyond this general advice to resist, one must tread carefully so as not to give legal advice to strangers, especially in an area as legally complicated as this one.
The tea-party groups should talk with their lawyers about the consequences of ignoring the proposed rules. Even if the rule becomes final, the penalty for losing exempt status is that the organization would be subject to corporate taxation, but tea-party groups have little income; what there is goes out for overhead. What is there to tax? The cost of the politically related activity might be subject to tax, but the amounts involved would be small.
The tougher question concerns applications of new groups for recognition of tax-exempt status: What if the IRS refuses to grant it unless the applicant promises to engage in no activity covered by the current rules? Here, good legal advice is essential, but the possibility of simply proceeding on the theory that the proposed political activity is legitimate needs to be analyzed. Waiting for formal legal confirmation of this fact will hand victory to those who want to suppress the Tea Party.
It should be noted that an organization can go active before it receives approval of an application of exemption, and even before it files the form. As long as the form is filed within 27 months, the exempt status is retroactive. So a group that wants to become active for 2014 can proceed now, file later, and trust in Providence that the mess will be sorted out within 27 months, and calculate that, if it loses, the taxes imposed will be small, precisely because the tea-party groups are shoestring operations.
Again, this is a topic that requires good, careful legal advice.
– James V. DeLong is a former research director of the Administrative Conference of the United States, and the author of Ending ‘Big SIS’ (The Special Interest State) and Renewing the American Republic. He cautions that he is an administrative lawyer, not a tax specialist.