Neither Death Nor Certainty for the 501(c)(4) Gift Tax
Anyone keeping tabs on the efforts of the Internal Revenue Service (IRS) to assess gift taxes on major donations to 501(c)(4) organizations should be wondering if the old adage regarding the certainty of death and taxes needs to be updated in the post-Citizens United era.
In February, the IRS warned five major donors to 501(c)(4) organizations that they might owe gift taxes on their contributions. These examinations had raised interest in both legal and political communities – both for their nearly unprecedented nature and for their potential implications for the 2012 elections.
On July 7, the IRS announced that it would drop the examinations until it had determined "whether there is a need for further guidance" regarding whether the gift tax can be applied to large contributions to 501(c)(4) organizations. Deputy Commissioner for Services and Enforcement Steven T. Miller cited the "significant legal, administrative, and policy implications with respect to which we have little enforcement history" as the reason behind the decision.
501(c)(4) organizations are often called "social welfare organizations" because the tax code says they may be "[c]ivic leagues or organizations not organized for profit but operated exclusively for the promotion of social welfare." While nonprofits organized under section 501(c)(4) must have a "primary purpose" that does not relate to elections, they are nevertheless free to collect unlimited contributions from donors who may remain anonymous. After Citizens United enabled for-profit and nonprofit corporations to make independent expenditures to advocate for or against particular candidates, major political donors began looking to 501(c)(4) organizations as a way to influence the political process.
It is an understatement to say that "[t]he use of undisclosed funds has skyrocketed." In 2010, a total of $4 billion, or $45 for every vote cast, was spent. Outside groups trying to influence federal elections spent $266.4 million, with at least $135 million coming from groups that do not publicly disclose their donors.
Even before voters went to the polls in 2010, it was clear that the role of 501(c)(4) organizations in our electoral system was changing and deserved serious examination. On Sept. 29, 2010, Senate Finance Committee Chairman Max Baucus (D-MT) sent the IRS a letter requesting an investigation into whether 501(c)(4) organizations' "political activities reach a primary purpose level" and "whether they are acting as conduits for major donors advancing their own private interests regarding legislation or political campaigns, or are providing major donors with excess benefits."
By May, five donors had been notified by the IRS that they were being audited with an eye toward determining whether they owed gift taxes on their contributions. The gift tax is currently assessed at 35 percent of gifts over $13,000 – except for certain protected transactions, including donations to 501(c)(3) and 527 organizations. Since 1982, the IRS has maintained that contributions to 501(c)(4) organizations are different and could be subject to the tax. Nevertheless, news reports and practitioners' anecdotes suggest that the IRS has generally not sought to enforce this position. In fact, even the one publicly available letter to a donor under investigation suggests only that an examination is beginning – not that the donor owes any back taxes or penalties.
Even though the IRS insisted that the investigations were being managed by career civil servants and that they were not part of a larger review of the activity of 501(c)(4)s, the investigations still drew vociferous critiques. In a letter dated May 18, Republicans on the Senate Finance Committee accused the IRS of targeting conservative political activists. The announcement that the examinations had been suspended did little to quell the controversy because it left potential donors with no guidance as to what the IRS might do about future contributions to 501(c)(4) organizations.
While some practitioners assert that "tax lawyers as a whole have not changed their views" about whether contributions to 501(c)(4)s are subject to the gift tax, others are advising both donors and 501(c)(4) organizations themselves to "consider carefully the possible gift tax implications of contributions."
Perhaps even more concerning than tax uncertainty, however, is the appearance of political interference. "The clear implication left by the I.R.S. action on July 7 is that I.R.S. enforcement activity can be curtailed by intervention from a handful of members of Congress, whatever their party affiliation, when political contributions are at risk," Marc Owens, a lawyer who used to head the division of the IRS which oversees nonprofits, wrote in a letter on behalf of four clients.
If such political interference has, in fact, caused the IRS to suspend its investigations into large donors to 501(c)(4) organizations, Americans are left with little to be certain about as the 2012 elections approach. Will groups without a true social welfare purpose continue to be allowed to spend unlimited, undisclosed amounts of money to influence elections with no tax implications for the organizations or their donors, or will the IRS move beyond congressional complaints and other criticisms to ensure that 501(c)(4) organizations are following the law while engaging in electoral politics?