Treasury and IRS Issue Guidance for 501(c)(4) Tax-Exempt Social Welfare Organizations

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The Treasury Department and the Internal Revenue Service said Tuesday they are issuing initial guidance regarding qualification requirements for tax-exemption as a social welfare organization under Section 501(c)(4) of the Tax Code after a scandal erupted earlier this year over claims that the IRS was targeting Tea Party groups applying for tax-exempt status. 

The proposed guidance defines the term “candidate-related political activity,” and would amend the current regulations by indicating that the promotion of social welfare does not include this type of activity.  The proposed guidance also seeks initial comments on other aspects of the qualification requirements, including what proportion of a 501(c)(4) organization’s activities must promote social welfare.

The Treasury is issuing the guidance in response to a recommendation in a report from the Treasury Inspector General for Tax Administration on how the IRS selected inappropriate criteria for screening applications from tax-exempt status from various groups. Ahead of the release of the TIGTA report. Lois Lerner, the former head of the IRS’s Exempt Organizations, touched off a firestorm of criticism of the IRS after she disclosed in May that the agency was using terms such as “Tea Party,” “Patriot” and “9/12” to filter through applications for 501(c)(4) tax-exempt status from conservative organizations. It later emerged that the IRS was also using terms like “progressive” and “Occupy” to filter out applications from liberal groups. Lerner was eventually forced out of the agency along with other officials such as former acting commissioner Steven T. Miller.

His replacement, the current IRS acting commissioner Danny Werfel, has pledged to stop using so-called “BOLO,” or “Be on the Lookout,” lists, and to enable streamlined processes for tax-exempt status including allowing 501(c)4 organizations to self-certify themselves as tax-exempt until their applications have been examined. Meanwhile Congress has been grilling IRS officials at a contentious series of hearings and introducing legislation as recently as last week to reform the process further (see Congress Introduces Bill to Change IRS Reviews of Tax-Exempt Organizations).

The TIGTA report recommended that the Treasury Department and the IRS chief counsel develop guidance on how to measure the primary activity of 501(c)4 social welfare organizations.

The IRS and the Treasury acknowledged that there are a number of steps in the regulatory process that must be taken before any final guidance for the tax-exempt groups can be issued.  Given the significant public interest in these and related issues, the Treasury and the IRS said they expect to receive a large number of comments.  The Treasury and the IRS stressed that they are committed to carefully and comprehensively considering all of the comments received before issuing additional proposed guidance or final rules.

“This proposed guidance is a first critical step toward creating clear-cut definitions of political activity by tax-exempt social welfare organizations,” said Treasury Assistant Secretary for Tax Policy Mark J. Mazur in a statement.  “We are committed to getting this right before issuing final guidance that may affect a broad group of organizations. It will take time to work through the regulatory process and carefully consider all public feedback as we strive to ensure that the standards for tax-exemption are clear and can be applied consistently.” 

“This is part of ongoing efforts within the IRS that are improving our work in the tax-exempt area,” said Werfel. “Once final, this proposed guidance will continue moving us forward and provide clarity for this important segment of exempt organizations.”

Organizations may apply for tax-exempt status under section 501(c)(4) of the Tax Code if they operate to promote social welfare, the IRS pointed out. The IRS currently applies a “facts and circumstances” test to determine whether an organization is engaged in political campaign activities that do not promote social welfare. Tuesday's proposed guidance would reduce the need to conduct fact-intensive inquiries by replacing this test with more definitive rules.

Senate Finance Committee chairman Max Baucus, D-Mont., who has called for clarification of the rules, welcomed the new guidance. “Unfortunately, groups on both ends of the political spectrum have tried to take advantage of the ambiguity in the law when it comes to the tax treatment of 501(c)4s," he said in a statement Tuesday. "We need to ensure clear standards and equal footing for the treatment of tax exempt social welfare organizations. Today’s action by the IRS is an important step towards that goal.”

House Ways and Means Committee ranking Democratic member Sander Levin, D-Mich., also was encouraged by the proposed guidance for tax-exempt social welfare organizations issued by the Treasury Department and the IRS. “The work of 501 (c) (4) organizations is vital in communities across the country and it is important that there be clear guidelines between promoting social welfare and engaging in political activity for organizations seeking this tax exemption," said Levin. "As we plainly saw in the investigations into the failings within the IRS tax-exempt division, the lack of clear guidance on defining and measuring political activities under current law led to mismanagement and delays in the processing of exemption applications from progressive and conservative organizations. The proposal for a ‘candidate-related political activity’ is a reasonable starting place, but the details will be important, for example in an area as critical as voter registration drives. This is a good first step to engage the public and one clearly that must be taken so that we remove the ambiguity from the current system. This proposal is part of an overall effort that has been underway for months at the IRS to ensure that those mistakes—which included gross mismanagement of the tax-exempt division—are not repeated. After dozens of interviews and the review of hundreds of thousands of pages of documents, there is absolutely no evidence of any political motivation or outside involvement, contrary to what Republicans have alleged from the beginning.”

Congressional Republicans were more skeptical, however. "There continues to be an ongoing investigation, with many documents yet to be uncovered, into how the IRS systematically targeted and abused conservative leaning groups," said House Ways and Means Committee chairman Dave Camp, R-Mich., in a statement. "Before rushing forward with new rules, especially ones that appear to make it harder to engage in public debate, I would hope Treasury would let all the facts come out first—something they could achieve by fully cooperating with Congress in the investigation. This smacks of the Administration trying to shut down potential critics. Given how they have handled the ObamaCare rollout, one can understand why they may take that approach, but it doesn't make it right."

"There is much in these proposed rules to scrutinize. Any change should be carefully considered in a fair, equitable and non-partisan manner," said Senate Finance Committee ranking Republican member Orrin Hatch, R-Utah. "Given the IRS' recent track record, I pledge to thoroughly oversee this process to ensure politics aren't brought to bear. However, I find it unfortunate that the Administration decided to move ahead with these new rules before the Finance Committee could conclude its bipartisan investigation into the targeting of those applying for tax-exempt status.  Waiting would have been wiser and would have offered some critical guidance that would have benefited this process. Furthermore, the uptick in applications over recent years was not just isolated to 501(c)(4)s, but to union tax-exempt 501(c)(5) organizations as well. I hope the Administration understands that what's good for the goose is good for the gander and looks at these union groups moving forward."

In defining the new term, “candidate-related political activity,” the Treasury and the IRS said they drew upon existing definitions of political activity under federal and state campaign finance laws, other IRS provisions, as well as suggestions made in unsolicited public comments.

Under the proposed guidelines, candidate-related political activity includes:

1.    Communications

•    Communications that expressly advocate for a clearly identified political candidate or candidates of a political party.

•    Communications that are made within 60 days of a general election (or within 30 days of a primary election) and clearly identify a candidate or political party.

•    Communications expenditures that must be reported to the Federal Election Commission.

2.    Grants and Contributions

•    Any contribution that is recognized under campaign finance law as a reportable contribution.

•    Grants to section 527 political organizations and other tax-exempt organizations that conduct candidate-related political activities (note that a grantor can rely on a written certification from a grantee stating that it does not engage in, and will not use grant funds for, candidate-related political activity).

3.    Activities Closely Related to Elections or Candidates

•    Voter registration drives and “get-out-the-vote” drives.

•    Distribution of any material prepared by or on behalf of a candidate or by a section 527 political organization.

•    Preparation or distribution of voter guides that refer to candidates (or, in a general election, to political parties).

•    Holding an event within 60 days of a general election (or within 30 days of a primary election) at which a candidate appears as part of the program.

The proposed rules are supposed to reduce the need to conduct fact-intensive inquiries, including inquiries into whether activities or communications are neutral and unbiased.

The Treasury and the IRS said they plan to issue additional guidance that will address other issues relating to the standards for tax exemption under Section 501(c)(4).  In particular, they noted, there has been considerable public focus regarding the proportion of a Section 501(c)(4) organization’s activities that must promote social welfare.  Due to the importance of this aspect of the regulation, the proposed guidance requests initial comments on this issue. 

The proposed guidance also seeks comments regarding whether standards similar to those proposed Tuesday should be adopted to define the political activities that do not further the tax-exempt purposes of other tax-exempt organizations and to promote consistent definitions across the tax-exempt sector.

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