Group Challenges 501(c)(4) Tax Break at Center of IRS Rhubarb

WASHINGTON (CN) - In a response to the Tea Party tax brouhaha, a watchdog group claims a loophole in the Tax Code and IRS regulations creates a gaping funnel through which groups pour millions of dollars to political candidates with anonymity.

Citizens for Responsibility and Ethics in Washington (CREW) sued the IRS and its Acting Commissioner Daniel Werfel in Federal Court, claiming that the agency's denial of its petition to fix the loophole violates the Administrative Procedure Act.

The lawsuit, filed Tuesday, is evidently a response to Tea Party groups' complaints that the IRS singled them out for scrutiny. A Northern California Tea Party group sued the IRS for this on Monday in Cincinnati.

In its own complaint, CREW claims the IRS plays extremely loosely with so-called "social welfare" organizations, allowing de facto political campaign committees to waltz through the loophole bearing millions of dollars, while hiding the contributors, as required by weakly enforced campaign laws.

The Tax Code provides a tax exemption for organizations not organized for profit but "operated exclusively for the promotion of social welfare," and IRS regulation § 1.501(c)(4)-1(a)(1) exempts groups that are "operated primarily for the purpose of bringing about civic betterments and social improvements," CREW says in its complaint.

The slight difference in language gives anonymity to individual donors who contribute millions of dollars to politic groups under the guise of being apolitical nonprofits, according to the complaint.

It's also responsible for political pundits' widely reported arguments about the tremendous difference between a group that allegedly spends 49 percent of its money on politics, as opposed to 51 percent of it. The former would qualify for tax-exempt status as "social welfare" groups, the 51 percenters would not.

"CREW is hindered in carrying out its core programmatic activities when those individuals and entities that attempt to influence elections and elected officials are able keep their identities hidden," the complaint states. "This problem was exacerbated in the 2012 election cycle, when tax exempt § 501(c)(4) organizations, relying on an IRS regulation requiring that they only be 'primarily' engaged in promoting charitable work, were able to pour vast amounts of anonymous money into the political system. As a result, CREW was deprived of information critical to advancing its ongoing mission of educating the public to ensure the public continues to have a vital voice in government decisions."

CREW says the discrepancy gives a weapon to "pay-to-play" schemers who can push their agendas through Congress while keeping their identities secret.

"The discrepancy between the 'operated exclusively' standard of the statute and the 'primarily engaged' language of the regulations was a cause of controversy at the IRS both during the drafting of the regulations and for two decades after they were promulgated in 1959," the complaint states. "In 1962, the chief counsel for the IRS twice rejected recommendations to deny tax-exempt status under § 501(c)(4) to organizations engaged in some amount of non-social welfare activity. In one case, the organization was conducting political activity, and although the chief counsel noted the difference between the statute and the regulations, he construed the regulations to 'in effect deny exemption only to organizations that are primarily engaged in' political activity.'"

In another case, CREW says, the IRS claimed that question of which definition to follow is a "policy decision."

CREW claims this discrepancy has created alarming results, allowing 501(c)(4) spending to increase from $92 million in the 2010 election cycle to $255 million two years later.

"CREW's rulemaking petition also advised the IRS that four § 501(c)(4) organizations dominated outside spending in the 2012 election cycle: Crossroads GPS, founded by Karl Rove; Americans for Prosperity, founded by the Koch brothers; Americans for Tax Reform, founded by Grover Norquist; and the American Future Fund, founded by Nick Ryan, a longtime political adviser to former Republican Iowa Congressman Jim Nussle," the complaint states.

"As set forth in the petition, according to the Center for Responsive Politics, in the 2012 election cycle, Crossroad GPS spent $70,968,744 in independent expenditures; Americans for Prosperity spent $33,542,051 in independent expenditures; American Future Fun spent $24,599,533 in independent expenditures; and Americans for Tax Reform spent $15,794,552 in independent expenditures. [For a total of $144.9 million.]

"Further, CREW's petition provided the IRS with spending information on specific 2012 Senate and House races. In the Virginia Senate race, for example, § 501(c)(4) organizations spent approximately $15 million, or nearly 29 percent of all outside spending. Similarly, in the 2012 Nevada Senate race, § 501(c)(4) organizations spent over $12 million, or 43.26 percent of all outside spending."

Also, 501(c)(4) groups accounted for 20 percent of outside spending ($9 million) in Wisconsin's 2012 Senate race, and 22 percent of outside spending ($8 million) in Ohio's Senate race that year.

CREW adds that American Action Network, a 501(c)(4) group, spent $1.5 million on a Republican congressional candidate in Illinois, causing the defeat of Democrat Dr. David Gill.

"In the final weeks of that campaign, AAN spent over $1 million on political advertisements that included demonstrably false statements," CREW claims. "Dr. Gill lost his race by 1,002 votes, or three-tenths of 1 percent of the votes cast, even though nearly every reputable poll showed Dr. Gill leading his opponent, Rodney Davis, by margins ranging from 1 to 9 percent."

CREW claims the IRS has illegally failed to act on its petition for a rule change that would close the loophole.

It seeks a court order forcing the IRS to reform its regulations to comply with the Tax Code.

CREW is represented by staff attorney Anne Weismann.

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