Lessons from the IRS Firestorm on 501(c)(4) Political Organizations
The recent Internal Revenue Service scandal concerning the Agency’s handling of applications for certain tax exempt organizations has created a media frenzy and a forum for daily congressional mud-slinging. The issue first came to light in May 2013 when Lois Learner, the Director of IRS’ Exempt Organizations (EO) Division, acknowledged that IRS had inappropriately categorized and scrutinized “Tea Party” applications for tax-exempt status. This Client Alert provides insight into the failures of the Agency that led to the scandal, what the IRS is doing to fix the problems, and how these recent changes may impact organizations applying to the IRS for tax exempt status or that have applications pending.
Highlights of the Controversy
The controversy surrounds work in the IRS Cincinnati Office which processes roughly 70,000 applications for exempt status each year. Of these annual applications, relatively few are from groups engaged in electoral or political activities. However, starting in 2010, the Office was overwhelmed with applications for exemption under Section 501(c)(4) which regulates “social welfare” organizations. Some of the applicants used group names that included terms such as “Tea Party,” “Patriot,” and other political or election-related names. This sent up red flags in the Cincinnati Office because 501(c)(4) groups can engage in election-related activities but only as a secondary, not a primary activity. According to the IRS, the pending 501(c)(4) applications were grouped together for efficiency’s sake, and were put on hold while the Cincinnati Office obtained guidance from IRS DC Headquarters on how much political activity was too much. Unfortunately, but not unexpectedly, the IRS wheels turned slowly at producing guidance to help process these applications, and the (c)(4) applications began to stack up.
IRS’ Response & How it Affects Section 501(c)(4) Organizations
During the firestorm of accusations, the first order of business was for the IRS to clean house in its DC and Cincinnati offices. New leadership was installed at all five levels of the IRS senior executive managerial chain that have responsibility over exempt organization activities. In addition, the IRS suspended the controversial “BOLO” (“Be on the Lookout”) and “TAG” (“Touch and Go”) labels which ostensibly helped agents determine which groups deserved additional screening. It also suspended lists used by the IRS to review applications with “emerging issues for more consistent treatment of similarly situated taxpayers,” aka (c)(4) political organizations.
Second, in response to a May 2013 Report by the Treasury Inspector General for Tax Administration, the IRS issued its own report “Charting a Path Forward at the IRS: Initial Assessment and Plan” on June 25, 2013. The IRS admitted that the Agency had indeed used inappropriate criteria to screen applications for 501(c)(4) tax exempt status within the IRS. The Report also specifically described what happened, how the IRS would investigate the causes of the events and implement corrective measures, and how the Agency planned to ensure accountability for mismanagement or wrongdoing.
Third, the IRS also announced a new initiative to reduce the backlog of 501(c)(4) exemption applications (those pending 120 days or more as of May 28, 2013) by accelerating the IRS review period for the applications. This new “streamlined, safe-harbor option” will allow certain organizations to obtain an IRS determination letter within two weeks if the following conditions are satisfied:
- The Application for 501(c)(4) status does not indicate any private inurnment concerns.
- The Applicant provides representations under penalty of perjury regarding the organization’s past, current and anticipated future political campaign intervention and social welfare activities.
- The Applicant self-certifies that no more than 40% of the organization’s expenditures and voluntary person-hours will go toward political campaign intervention activities, and at least 60% of the organization’s expenditures and voluntary person-hours will go toward promoting social welfare.
Such a fast-track determination is virtually unheard of at the IRS. However, (c)(4) applicants who choose not to take advantage of this streamlined process will have their applications transferred and subject to the review of not only the IRS’ EO Technical Group, but also IRS Chief Counsel attorneys, and in some cases the newly-formed “Advocacy Application Review Committee.” All-in-all, a time-consuming and uncertain process.
More broadly, the IRS has initiated an end-to-end overhaul of its business processes for EO applications, and has added technical and programmatic experts to assist the EO staff with the review of applications for tax exempt status. This is good news for not only 501(c)(4) organizations, but also for other charitable organizations such as 501(c)(3) organizations that seek tax exempt status from the IRS. However, despite these changes and new initiatives, there has been and will continue to be significant turnover of IRS management and line staff in both the Cincinnati and DC offices. This is sure to have a significant impact on the pace at which the IRS can process applications and incorporate the many changes ahead for the Agency.