IRS Apologizes For Targeting Tax-Exempt Applications By Conservative Groups

This has been a difficult few weeks for the IRS.

In March Rep. Charles Boustany (R-La.), chairman of the House Ways and Means oversight subcommittee chastised the agency upon discovering a series of IRS training videos that parodied “Star Trek” and “Gilligan’s Island.” The videos cost the IRS approximately $60,000. The IRS initially refused to make the videos public. They later did after mounting criticism.

In April the American Civil Liberties Union released documents obtained under the Freedom of Information Act showing that the IRS criminal tax division believed the agency could access e-mails and text messages without obtaining a warrant. Rep. Charles Boustany demanded the IRS present its policies for when search warrants are needed to review private e-mails and communications.

Last week the IRS announced that it was changing its policy to require search warrants both for criminal and civil tax proceedings.

Last week we found out that an IRS employee at the Covington campus had been charged with destroying at least 800 fiduciary income tax returns. “Fiduciary” is a fancy term for a trust, and the term includes an estate which receives income and has to pay income tax. The employee – Brady James – is only 30 years old, and he could be facing a maximum prison term of 20 years.

One has to wonder what Brady James was thinking.

Last Friday an IRS employee – Lois Lerner, head of the IRS tax-exempt division – responded to a question concerning tax-exempt applications by conservative groups at an American Bar Association conference. A firestorm ignited, and the IRS quickly scheduled a media conference call for the same day.

She apologized for “inappropriate” targeting of conservative political groups during the 2012 election. IRS employees in Cincinnati singled out approximately 75 organizations using “patriot” or “tea party” in their name. The IRS was trying to get ahead of an AP news report, as well as an expected report by the Treasury Inspector General for Tax Administration.

Why Cincinnati? The IRS breaks up its work functions into units, and these units are located throughout the country. The unit under discussion handles the review of applications for tax-exempt status, and that unit is located in Cincinnati.

The number of organizations filing for tax-exempt status has more than doubled since 2010. To handle the volume, the IRS centralized its review of the applications in Cincinnati. Makes sense, as it allows the development of expertise within the unit and consistency in the process.

Until it goes wrong. Terribly wrong.

The IRS for example responded to the Richmond (VA) Tea Party’s application by requiring additional documentation on 17 different matters. When it did so, the IRS responded by requiring documentation on 53 additional matters. Oh, and the Richmond Tea Party had two weeks to respond.

 “We made some mistakes,” said Lois Lerner. “Some people didn’t use good judgment. For that we are apologetic.”

Heartfelt apology, isn’t it?

Lerner went on to explain that low-level employees initiated the IRS practice. It was not motivated by bias, she said.

COMMENT: Who would even think of bias? Do not pay attention to the fact that groups with words like “progressive” in their name did not receive the same scrutiny.

"It's the line people that did it without talking to managers," Lerner continued. "They're IRS workers, they're revenue agents."

COMMENT: Are there no supervisors in Cincinnati? She makes it sound like her revenue agents are doing whatever they want, without review and apparently without accountability.  I am throwing the B.S. flag on Ms. Lerner.

Lerner told the AP that no high-level IRS officials knew about the practice.

COMMENT: This means some non high-level will take the fall, of course. Hey, there are perks to being a high-level.

Friday was not Lerner’s best moment. At one point she said, "I'm not good at math." Granted, she is an attorney and not an accountant, but still.  That is not a comforting comment from an IRS high-level.

Good grief.

Senators Question IRS Gift Tax Enforcement

You may have read that the IRS has decided to pursue Section 501(c)(4) organizations. This beggars the question: what is a 501((c)(4) organization?

The (c)(4) is a tax-exempt. That is not saying much, as there are over two dozen types of tax-exempts in the Internal Revenue Code. So what is different about this flavor of tax exempt?

The( c)(4) must not be organized for profit and must be operated exclusively for the promotion of social welfare. Examples of (c)(4)s are AARP and the National Association for the Advancement of Colored People. You may also remember MoveOn.org and America Coming Together.

A (c)(4) may further its social welfare purposes through lobbying without jeopardizing its exempt status as long as it is consistent with the organization’s purpose. It cannot however be the organization’s primary activity. If it is, then one should consider a Section 527 organization.

Are donations to a (c)(4) deductible? That depends. Donations to 501(c)(4)s that are public entities (such as a volunteer fire station) are deductible. Donations to other (c)(4)s are not deductible.

So what has happened to draw the IRS’ attention? Tax advisors such as me have known for a long time that donations to a (c)(4) are not deductible, and we make adjustments when a client includes these amounts in a list of contributions. The IRS has now decided to pursue the (c)(4)s with the argument that contributions are taxable gifts by the donors.

A taxable gift? This is a new issue to me, and I have been at this for a while.

It has caught the Senate’s attention. Six senators from the Finance Committee recently wrote a letter to IRS Commissioner Shulman. The Finance Committee writes tax law in conjunction with the House Ways and Means Committee. The Senators wrote (in part):

The applicability of gift taxes to 501(c)(4) contributions is ambiguous. Historically, the IRS has deliberately opted against vigorous enforcement of the gift tax on 501(c)(4) contributions. There are good reasons for this. First, it is unclear if contributions to these organizations are eligible for the gift tax given their gratuitous nature, and the fact that the donations are made with the expectation that the organization will work to advance the donor’s policy views. Moreover, these contributions are clearly not designed for tax planning purposes or to avoid the estate tax. Most importantly, however, enforcement of gift taxes on contributions to 501(c)(4) organizations engaged in public policy debate runs an unacceptable risk of chilling political speech, which receives the highest level of constitutional protection under the First Amendment

This pattern of nonenforcement over a period of nearly three decades, coupled with the troubling issues regarding the adverse impact that enforcement might have on the exercise of constitutionally protected rights, raises important questions regarding the timing of the decision to enforce the gift tax on these contributions. Retroactive enforcement of the gift tax in this highly politicized environment raises legitimate concerns and demands further explanation."

The statement by IRS spokeswoman Michelle Eldridge did not assuage these concerns and left us with only more questions. According to Eldridge, “[a]ll of the decisions involving these cases were made by career civil servants without any influence from anyone outside the IRS.” We would expect that decisions regarding particular enforcement actions would be made by career civil servants. The more pressing question, not answered to date, is whether political appointees inside or outside the IRS were involved in any way in the decision to prioritize this category of cases."

I understand that (c)(4)s are not supposed to be piggybanks, but are there really enough tax dollars here for the IRS to prioritize this issue?

I was too young, but I have understood that President Nixon used the IRS as a political weapon against his opponents. In a country where half the population does not trust the current President to do the right thing, it is unfortunate to have the IRS call its neutrality into question. You can accept or hate the IRS, but it is imperative that the IRS act and be perceived as a neutral entity.

One can argue that perhaps there is no good time for this type of action, but the observation remains that this is not a good time.

I will come back in a separate post with more detail on the tax issues raised by (c)(4)s.