Democracy 21 and the Campaign Legal Center sent a letter today to the Internal Revenue Service (IRS) challenging the eligibility of four organizations engaged in campaign activity to be treated as 501(c)(4) tax exempt organizations. Democracy 21 took the lead in preparing the IRS letter.

The letter to the IRS called for prompt investigations and action by the IRS. The four organizations include Crossroads GPS, Priorities USA, American Action Network and Americans Elect.

According to Fred Wertheimer, President of Democracy 21:

Section 501(c)(4) organizations are given tax exempt status to promote “social welfare.” The idea that these organizations are social welfare groups is nonsense. The  overriding purpose of these groups is to participate in and influence elections, which makes them ineligible for tax exempt status. The groups have sought tax-exempt status under section 501(c)(4) in order to keep secret from the American people the donors financing their campaign expenditures.

These groups are misusing and abusing the tax laws at the expense of the American people. It is clear  that these groups have little, if anything, to do with promoting “social welfare” and everything to do with electing and defeating candidates. It is incumbent on the IRS to put a stop to this charade and to act promptly to protect the integrity and credibility of the tax laws and the interests of the American people.

Secret money in American elections leads to scandal and corruption. Absent quick and effective action by the IRS to stop these abuses of the tax laws, secret money in our elections will grow dramatically and it will become commonplace for campaign operatives to establish 501(c)(4) organizations to launder secret contributions into elections. Scandal and corruption will invariably follow.

These four groups should be operating as 527 political organizations and disclosing their donors, instead of disingenuously posing as “social welfare” organizations to hide big money campaign givers. Appropriate penalties should be imposed by the IRS for violations the agency finds. The penalties need to take into account the need for strong deterrence to stop similar violations from occurring in the future.  

According to J. Gerald Hebert, Executive Director of the Campaign Legal Center:

The abuses of the tax code by these shadow campaign operations have mushroomed since the last election cycle with both Democrats and Republicans now in on the act and not even bothering to maintain a facade that they have any real purpose other than to elect members of their respective parties. To maintain that these groups are "social welfare" organizations is simply laughable. 

Spending millions of dollars running attack ads against vulnerable incumbents in non-election years does not constitute the “promotion of social welfare” that their tax status – and thus their ability to hide the identities of their funders – is dependent upon.  But until the laws on the books are enforced these groups will continue to flourish to the extreme detriment to the health of our democracy.

According to the letter sent to the IRS today by Democracy 21 and the Campaign Legal Center:

 Under the IRC, IRS regulations and court decisions interpreting the IRC, section 501(c)(4) organizations are required to primarily engage in the promotion of social welfare in order to obtain tax exempt status.  Court decisions have established that in order to meet this requirement, section 501(c)(4) organizations cannot engage in more than an insubstantial amount of any non-social welfare  activity, such as directly or indirectly participating or intervening in elections.  

Thus, the claim made by some political operatives and their lawyers that section 501(c)(4) organizations can spend up to 49 percent of their total expenditures on campaign activity and maintain their tax exempt status has no legal basis in the IRC and is contrary to court decisions regarding eligibility for tax-exempt status under section 501(c)(4).  An expenditure of 49 percent of a group’s total spending on campaign activity is obviously far more than an insubstantial amount of non-social welfare activity.

The IRS applies the “primarily engaged” test on the basis of the “facts and circumstances” of an organization’s formation and operations.  Here, we believe, the “facts and circumstances” show that each organization has engaged in far more than an insubstantial amount of participation or intervention in elections and that the overriding purpose of each organization is to influence elections.

Thus, under the IRC and court decisions interpreting the IRC, these organizations are not eligible to receive section 501(c)(4) tax exempt status.

The IRS letter further states:

In a 2008 Letter Ruling, the IRS stated that a group is not eligible for tax exempt status under section 501(c)(4) where the facts and circumstances show that the  group’s “first and primary emphasis” is to get candidates elected to public office.  

This standard is different than, and in conflict with, the standard applied by the courts. But even under this standard, we believe the “facts and circumstances” relating to the formation and activities of the four organizations discussed in this letter show that each group was organized and is operated for the overriding purpose of participating or intervening in elections.  

Therefore, none of the four groups meets the standard for tax exempt status under section 501(c)(4) because they are not primarily engaged in “the promotion of social welfare.”

By claiming tax-exempt status under section 501(c)(4), these groups allow their donors to evade the public disclosure requirements that would apply if the organizations were registered under section 527 as “political organizations.”  In fact, it appears that avoiding disclosure of their donors is the basic reason that these groups organized under section 501(c)(4).

Absent timely and appropriate action by the IRS, widespread abuses of the tax code by  groups organized under section 501(c)(4) are likely to become commonplace in the 2012 presidential and congressional races. These abuses will come at the expense of the integrity and credibility of the tax laws and of the right of the American people to know the identity of the donors providing money to influence elections.

Accordingly, we request that the IRS promptly investigate the groups discussed in this letter and take appropriate enforcement action and impose appropriate penalties for any violations of section 501(c)(4) that the agency may find.

The letter states that under IRS rules, communications are not required to contain express advocacy or the functional equivalent of express advocacy in order to constitute campaign activity.

Campaign activity is defined under IRS rules as “direct or indirect participation or intervention in political campaigns on behalf of or in opposition to any candidate for public office.”

According to the letter:

IRS regulations make clear that “direct or indirect participation or intervention in political campaigns on behalf of or in opposition to any candidate for public office” is not limited to activities or communications which contain express advocacy or the functional equivalent of express advocacy.  Thus, so-called “issue ads” that promote, attack, support or oppose a candidate fall with the meaning of direct or indirect participation or intervention in political campaigns.

The letter states:

Revenue Ruling 2004-6 explains that, because section 501(c)(4) public policy advocacy “may involve discussion of the positions of public officials who are candidates for public office, a public policy advocacy communication may constitute an exempt function (a political activity) within the meaning of 527(e)(2).”  Rev. Rul. 2004-6 at 1.  The Ruling states:

All the facts and circumstances must be considered to determine whether an expenditure for an advocacy communication relating to a public policy issue is for an exempt function under 527(e)(2). When an advocacy communication explicitly advocates the election or defeat of an individual to public office, the expenditure clearly is for an exempt function under 527(e)(2). However, when an advocacy communication relating to a public policy issue does not explicitly advocate the election or defeat of a candidate, all the facts and circumstances need to be considered to determine whether the expenditure is for an exempt function under 527(e)(2).   (emphasis added)

Thus, even if an ad discussing an issue does not express advocacy, it may nonetheless be treated as “exempt function” electioneering activity under IRS regulations, depending on the “facts and circumstances.”  Therefore, even where an ad discusses an “issue,” and where the ad does not contain express advocacy or the functional equivalent of express advocacy, it can still be treated as “direct or indirect participation or intervention in political campaigns” under IRS standards for purposes of determining whether a 501(c)(4) organization is “primarily engaged” in the promotion of social welfare.

The letter to the IRS concludes:

In the 2010 congressional races, section 501(c) organizations spent more than $135 million on campaign activities that were financed by secret contributions.  The bulk of these expenditures were made by section 501(c)(4) organizations.  The amount of secret contributions funding campaign expenditures by section 501(c)(4) organizations is expected to grow dramatically in the 2012 presidential and congressional races.

Crossroads GPS, Priorities USA, American Action Network and Americans Elect are each organized under section 501(c)(4) of the Internal Revenue Code.  Based on the information about each organization set forth above, the IRS should conduct an investigation of whether each such organization has engaged in more than an insubstantial amount of non-exempt activity by participating or intervening in political campaigns and accordingly is not primarily engaged in the promotion of social welfare. The IRS should also conduct an investigation of whether each organization’s primary activity is campaign activity and is accordingly not primarily engaged in the promotion of social welfare.

If the IRS investigation determines that the facts and circumstances show that the organizations discussed above are not primarily engaged in “the promotion of social welfare,” because they have engaged in more than an insubstantial amount of campaign activity or because the organization’s primary activity is campaign activity, the organizations should be denied or should lose tax-exempt status. In addition, appropriate penalties should be imposed by the IRS for violations the agency finds. The penalties should take into account the need for strong deterrence to stop similar violations from occurring in the future.