The Internal Revenue Service said Thursday it would stop its examinations of donors to tax-exempt 501(c)(4) political organizations asking whether they had paid gift taxes, after the agency came under pressure from Republican lawmakers.

The IRS sent letters earlier this year to at least five political donors questioning their donations to tax-exempt 501(c)(4) organizations, which are named after a section of the Tax Code (see IRS May Tax Political Donations as Gifts). In the letters, the IRS wrote, “Donations to 501(c)(4) organizations are taxable gifts, and your contribution in 2008 should have been reported on your 2008 Federal Gift Tax Return (Form 709).”

The 501(c)(4) organizations have become an increasingly popular vehicle for soliciting political donations as the donors do not have to be named by the groups. Republican-leaning groups like Crossroads GPS and Americans for Prosperity played a particularly large role in the 2010 elections, and Democrats have also begun organizing their own 501(c)(4) organizations.

In response to reports about the IRS probe, Republican lawmakers began asking the IRS for information about the inquiry (see Senators Question IRS on Gift Tax Enforcement and Political Influence and Congress Demands Answers from IRS on Gift Tax Probe). In response, the IRS said Wednesday it would stop pursuing the examinations.

“Recently, questions have arisen regarding the applicability of the gift tax to contributions to 501(c)(4) organizations,” said the IRS on its Web site. “The Internal Revenue Service has little history to draw from in this area and the limited guidance we previously issued on this matter is almost thirty years old. While we review the need for additional guidance or legislation, we will not use resources to pursue examinations on this issue. Any future action we take will be prospective and after notice to the public. As we consider this issue, it is possible that Congress may choose to clearly articulate through legislation the applicability of the gift tax to contributions to 501(c)(4) organizations.”

House Ways and Means Committee Chairman Dave Camp, R-Mich., who was one of the lawmakers questioning the IRS probe, welcomed the IRS announcement, but said he still wanted to know why the IRS had begun the examinations.

“I am pleased that following my and other inquiries questioning the motives behind these investigations, the IRS has decided to immediately suspend all current gift tax examinations in this area and will not begin any new investigations before issuing public guidance,” he said in a statement. “However, I remain troubled that the IRS has failed to explain what prompted these audits in the first place. It has yet to adequately address why taxpayers were given no warning prior to the launching of these investigations. Furthermore, the IRS has failed to clarify that the gift tax will not apply to future political donations. Especially troubling is that the directive explicitly leaves open the possibility of future audits. Given the lack of transparency, I will continue my investigation until the complete story behind the actions of the IRS has been told.”

Sen. Orrin Hatch, R-Utah, who had also written to IRS Commissioner Doug Shulman asking why the agency was conducting the examinations, said he too wanted to know more about the origins of the probe.

“This decision today ensures that the IRS remains free from even the hint of undue political influence,” said Hatch. “It cannot be turned into an arm of political retribution or payback. It must remain independent. While I commend Commissioner Shulman for making this decision, there are many unanswered questions that still need to be answered. Namely, why did the IRS choose to enforce this in the first place? And did politics play a role in that decision?”

Ofer Lion, a tax lawyer with Mitchell Silberberg & Knupp in Los Angeles who brought the IRS enforcement initiative to light, was pleased with the IRS’s decision. “I think it’s the appropriate response,” he said in an interview. “Instead of sending out letters to just five different donors, they should have taken up some public discussion and debate and issued some public guidance. That’s what should have happened, and that’s what they say will be their path going forward.”

He thinks the IRS won't conduct any further examinations until after the 2012 elections.


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