Tuesday, June 21, 2011

The IRS is Pursuing 501(c)(4)s

The 2011 Workplan of the IRS Exempt Organizations Division states:

"[i]n recent years, our examination program has concentrated on section 501(c)(3) organizations. Beginning in FY 2011, we are increasing our focus on section 501(c)(4), (5) and (6) organizations."

The (c)(3) is the classic charity – Muscular Dystrophy or March of Dimes, for example. The purpose of a (c)(4) is to pursue a near-endless range of public policy goals through action and advocacy. Many of these entities are barred from (c)(3) status because they express their advocacy through political activity. It is quite common to couple a (c)(3) with a (c)(4). You already know some of the big (c)(4) players, organizations such as AARP and the National Rifle Association.

Now let’s carve-out the meaning of “political activities”:

* Promoting legislation germane to the (c)(4)s purpose is considered a permissible social welfare purpose. Therefore an organization can qualify as tax-exempt under( c)(4) even if the organization’s only activity is lobbying, as long as the lobbying is related to its exempt purpose.
* A social welfare purpose does not include participating in an election in order to advance or defeat a given candidate. Candidate-related activity cannot be the (c)(4)s primary activity. The IRS does not tell us what “primary” means, and advisors differ. Some advisors s feel comfortable with electioneering approaching (but always remaining below) 50% of the organization’s total activities. It is unclear how to even measure activities. What is the measure: dollars spent, time spent by staff and volunteers, a percentage of fixed expenses (such as rent)?

So lobbying is acceptable but electioneering is not.

Donations to (c)(4)s are not afforded the same protection as a (c)(3), and the IRS has held its powder for almost 30 years on whether it would consider (c)(4) donations to be subject to the gift tax.

That has changed.

How would the IRS know who donated to a (c)(4)? A (c)(4) has to disclose to the IRS on its 990 filing contributors who donated $5,000 or more. This list however does not have to be publicly disclosed. Therefore, you and I might not know, but the IRS would. It would not be a difficult task for the IRS to identify donors for audit.

And they have. The IRS has recently sent letters that read as follows:

"Your 2008 gift tax return (Form 709) has been assigned to me for examination. The Internal Revenue Service has received information that you donated cash to [REDACTED], an IRC Section 501(c)(4) organization. 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 federal gift tax applies to a gratuitous transfer of property by an individual. The gift tax is separate from the individual income tax. Not all gratuitous transfers are subject to the gift tax. Transfers between spouses are not considered gifts, for example. An individual can give away $13,000 per year to anyone for any reason without involving the gift tax. Donations to (c)(3)s are not considered gifts, irrespective of the amount. Donations to a 527 organization (that is, a PAC) are not considered gifts. Donations to a (c)(4) are considered gifts.

At least they are considered gifts by the IRS. The IRS pulled out almost 30 years ago, and the limited guidance and cases in this area leaves doubt that the IRS is correct. If one focuses in on the political nature of the contribution, then one has to consider Stern and Carson, for example. In Stern (CA-5, 1971), the IRS lost its argument that campaign contributions were taxable gifts. In Carson (CA-10, 1981) the Tax Court held that Congress did not intend for gift tax to apply to campaign contributions, and the Tenth Circuit affirmed on this point.

We almost undoubtedly will see this matter litigated.

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