Editorial: New Rules For Nonprofits

The Connecticut Law Tribune

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On Nov. 29, the Internal Revenue Service published a Notice of Proposed Rulemaking in the Federal Register intended to provide new guidance regarding the nature and extent of political activities that may be conducted by tax-exempt 501(c)(4) social welfare organizations.

Depending on your perspective, the proposed new political activity rules reflect public dissatisfaction with the U.S. Supreme Court's 2010 Citizens United ruling or an extension of last year's IRS scandal targeting (mostly) conservative Tea Party organizations seeking tax-exempt status. The proposed new rules are either an attack on free speech and political theater to distract from the scandal, or they are an important step toward curbing the abuse that permits organizations engaged in partisan political campaigns and lobbying activity to operate with anonymous donors and nonprofit 501(c)(4) status.

To qualify for 501(c)(4) tax-exempt status under the Tax Code, an organization must be operated "exclusively for the promotion of social welfare" and, obviously, may not be organized or operated to make a profit. The current regulations for this section of the Tax Code, promulgated in 1959, permit social welfare organizations that are "primarily engaged in promoting in some way the common good and general welfare of the people" to satisfy the "exclusively for the promotion of social welfare" requirement.

These 501(c)(4) social welfare groups may not engage directly or indirectly in political campaigns—either in support of or opposition to—a candidate for public office. The organizations may engage in some political activity so long as it is not their "primary activity." The current test employed by IRS agents to determine an organization's "primary activity" is to consider all of the "facts and circumstances" of each case, thereby determining whether an organization's activities are in keeping with the Tax Code and regulations.

There are numerous revenue rulings, with illustrative examples of "facts and circumstances" to be considered by IRS agents when determining the "primary" activity of a group. In practice, it is a "we-know-it-when-we-see-it" standard. It seems clear that the current standard is overly broad, places great authority in the hands of IRS agents, and, in practice, is susceptible to abuse.

The report by the Treasury Inspector General for Tax Administration, issued on May 14, 2013, in response to the IRS-Tea Party scandal, did not address the "facts and circumstances" test. The same report determined the IRS "used inappropriate criteria that identified for review Tea Party and other organizations applying for tax-exempt status based on their names or policy positions instead of indications of potential political campaign intervention."

The proposed new guidance seeks more definitive rules regarding the type of conduct by 501(c)(4) organizations that does not promote social welfare and therefore will be considered inappropriate political campaign intervention—now to be known by the new term "candidate-related political activities."

Whether you agree with the proposed limitations or not, all can agree that more detailed definitions addressing the lack of objectivity in the current rules is a positive step. That said, there is little doubt that IRS agents will continue to employ the "facts and circumstances" test, albeit with the breadth of its authority somewhat reduced. The need to curtail broad and ambiguous "facts and circumstances" tests seem obvious to us.

And then there is the larger and perhaps more significant question that was put-off by the IRS in its Notice of Proposed Rulemaking. There is a glaring inconsistency between the Tax Code and the regulations that has existed since at least 1959. The Tax Code requires that an organization must be operated "exclusively for the promotion of social welfare" in order to achieve 501(c)(4) tax-exempt status. That language could not be clearer. But the regulation defines a group that is operated "exclusively for the promotion of social welfare" as one that is "primarily (emphasis added) engaged in promoting in some way the common good and general welfare of the people of the community." It's not hard to imagine the hours upon hours of discussions, and billable hours, by tax professionals and lawyers about the meaning of the "primarily" standard over the years and whether primarily simply means more than 50 percent.

To be fair, the Notice of Proposed Rulemaking does identify the questioned use of the "primarily" standard, but then dodges the issue by stating that the "Treasury Department and the IRS are considering" whether the current standard should be modified. Proposing new definitions, while failing to address this more fundamental inconsistency, is really putting the cart before the horse.

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