By Donald B. Tobin
According to some, 501(c)(4)s are the perfect advocacy organization for independent third parties seeking to influence elections; they can take unlimited donations and do not have to disclose the names of donors. If (c)(4)s can operate this way, they become a perfect mechanism for corporate influence in campaigns and also fundamentally destroy the few checks that are left on the corruptive influence of large contributions in political campaigns.
Even before Citizen’s United we saw a significant increase in the use of 501(c)(4) tax-exempt “Social Welfare Organizations” as vehicles for advocacy in election campaigns. In a recent article in The New York Times, Michael Luo and Stephanie Strom examine the use of 501(c)(4) organizations in political advocacy. They note the attractiveness of these organizations for large contributors because in most cases these organizations do not have to disclose donations to the organizations. According to proponents of the use of (c)(4)s, they are the perfect advocacy organization for independent third parties seeking to influence elections; they can take unlimited donations and do not have to disclose the names of donors. If proponents are correct that (c)(4)s can operate this way, (c)(4)s become a perfect mechanism for corporate influence in campaigns and also fundamentally destroy the few checks that are left on the corruptive influence of large contributions in political campaigns.
What is important to distinguish, however, is whether the proponents are in fact correct. In most cases, the (c)(4)s formed to engage in independent advocacy are not complying with the law. As Luo and Strom explain in their article, enforcement in this area is difficult, and the IRS is both underfunded and unequipped to handle large-scale regulation in this area. The question, however, is not whether (c)(4)s can get away with this behavior in the short run, but whether their interpretations are in fact correct and whether their actions are legal. If their actions are illegal, then there are actions that can be taken to rein in large-scale abuse.
Prior to highlighting methods of reining in the abuse of (c)(4)s, it is important to understand the requirements for different tax-exempt organizations. In general, organizations seek some type of organizational structure with which to conduct their activities. Since Citizens United, organizations can engage in campaign activities through a for-profit corporation. There are also tax-exempt organizations that can be used to engage in political discourse. Section 501(c)(3) organizations are what we think of as typical non-profit organizations. These are religious institutions, charities, educational institutions, etc. Contributions to these organizations are deductible and income related to the organization’s exempt purpose is not taxed. These organizations, however, may not intervene in an election campaign for or against a candidate for public office. Some (c)(3) organizations push the envelope, but for the most part, these organizations stay out of large scale campaign advocacy. (For more on the use of (c)(3)s in political campaigns see Campaigning by Churches and Charities).
Section 501(c)(4) organizations are “social welfare organizations” and donations to these organizations are not tax deductible (and are likely subject to gift tax), but income generated by the organization related to its exempt-purpose is not taxed. Social welfare organizations must be organized primarily (although the statute says exclusively) for a social welfare purpose and political campaign advocacy is not a social welfare purpose. The regulations governing (c)(4) organizations provide that an organization qualifies as a (c)(4) if “it is primarily engaged in promoting in some way the common good and general welfare of the people of the community.” The regulations further provide that “the promotion of social welfare does not include direct or indirect participation or intervention in political campaigns on behalf of or in opposition to any candidate for public office.” See Treas. Reg. 1.501(c)(4)-1(a)(2)(i) and (ii). Intervention in a political campaign has been defined broadly by the IRS, and it is the IRS’s definition, not the FEC’s definition that applies in this instance.
Finally, section 527 of the Code was created for political organizations. Section 527 organizations are organizations whose primary purpose is to influence the “selection, nomination, election, or appointment of any individual to any federal, state or local public office.” Section 527 organizations are not subject to tax on its exempt function income, contributions to 527 organizations are not deductible, but contributions to 527s are not subject to gift tax. Section 527 organizations, however, are subject to a disclosure regime that requires disclosure of contributions and expenditures. If organizations do not disclose, they are subject to tax on non-disclosed contributions and expenditures.
So in short, 501(c)(4) organizations are supposed to be primarily engaged in social welfare, are not subject to tax on income, and may engage in a limited amount of intervention in a political campaign. Section 527 organizations are designed for political advocacy. Contributions to the organizations are not income, but the organizations are required to disclose contributions and expenditures or face additional tax.
Current advocates of using (c)(4)s as campaign advocacy vehicles are distorting the law and often are mischaracterizing their activities. If they are truly lobbying to promote their social welfare purpose, then they are properly (c)(4) organizations. But if they are engaged in intervention in a political campaign, and they are trying to cloak their activities as lobbying, they are violating both the spirit and the substance of the statute. Under campaign finance jurisprudence, they may be able to use such trickery, but it is usually not accepted in tax jurisprudence.
The distinction is important here. It is not by mistake that (c)(4)s do not have to disclose while 527 political organizations do. Social welfare organizations were not designed to be vehicles for promoting candidates; they were designed to promote social welfare. The promotion of social welfare may include lobbying on issues related to the organization’s social purpose. There is an argument that these types of activities do not pose the same concerns with regard to the corruptive influence of money in political campaigns that is present when organizations intervene in political campaigns. A statutory scheme that requires disclosure for campaign intervention but not for lobbying and the promotion of social welfare therefore makes sense. If organizations are able to mask campaign intervention as lobbying, then the check on corruption present in the current statutory scheme will be subverted.
The question really is what type of enforcement mechanism exists to constrain entities that are improperly characterizing themselves as (c)(4)s. It is one thing to say that these entities can get away with organizing as a (c)(4) and another thing to say that it is legal. The fact that enforcement is lacking does not make the action legal.
Why does it matter? If it is illegal but the illegality is unenforced, won’t the action continue? The answer is maybe, but at some point, there are consequences to people who subvert the law and are too clever. So here are some proscriptive solutions for limiting the abuse of (c)(4)s.
First, the IRS could take stronger action against such organizations. In many cases, these organizations are violating the law. If procedural mechanisms are not in place to properly regulate these organizations (like the fact that they do not necessarily file tax forms when they are created so the IRS may not know who they are), the IRS has the power to change those regulations.
Second, the IRS can reclassify these organizations as 527 organizations and assess tax based on the organizations’ failure to disclose contributions and expenditures. An organization is not a 501(c)(4) organization simply because it says so. Section 527 specifically defines organizations that are 527 organizations. There is no opt-out provision. So even if an organization says it is a 501(c)(4) organization, it may actually be a 527 organization and thus subject to disclosure requirements of a 527 organization.
Third, when disclosure provisions were enacted as part of section 527 it was a compromise between no disclosure and an earlier bill that would have required disclosure of 501(c)(4) and 527 organizations. If 501(c)(4)s continue to be used to subvert the disclosure provisions in section 527, Congress could create disclosure provisions in (c)(4) for those organizations who rely on “lobbying” as their primary social welfare purpose. (As an aside, § 501(c)(4) could be amended as part of budget reconciliation and therefore could be modified with only 51 votes, thus potentially avoiding concerns that modifications could be easily filibustered).
Fourth, The New York Times article states that one of the problems is that these organizations may disappear as soon as the election is over. In this instance, lawyers who are setting up these organizations have an ethical responsibility under our Professional Responsibility rules not to assist others in engaging in illegal activities. If these are campaign advocacy organizations masquerading as social welfare organizations, lawyers cannot participate in setting up or advising these organizations. Lawyers are prohibited from assisting a client in engaging in an illegal activity. Lawyers cannot assist in such an activity even if there is lax enforcement, and the lawyer believes the client can get away with it. It is this type of attitude that brought us Worldcom, Enron, and some of the downfall in the financial industry. Lawyers are not allowed to counsel people to cheat on their taxes even though there is little chance they will get caught, and they are not allowed to counsel people to create (c)(4) organizations when they are not (c)(4) organizations. Moreover, the Treasury has implemented specific ethical rules under Circular 230, which governs practice before the IRS. Those rules are often stricter than state bar rules and the rules under circular 230 would likely apply in this instance.
Fifth, the IRS could start assessing gift tax on donations to (c)(4) organizations. While there is a statutory exemption from the gift tax for contributions to (c)(3) and 527 organizations, there is no such exemption for (c)(4)s. If large donors were subject to gift tax on their contributions, (c)(4)s would be a lot less attractive as a campaign vehicle.
So are proponents of 501(c)(4)s as smart as they think? Probably, if smarts are measured by what they can get away with in the short run. But if their point is that they have found a legal way to engage in secret campaign advocacy, they are wrong, on both moral and legal grounds. The question is not whether the IRS, Congress, or local bars have the power to limit this abuse, they certainly do. The question is whether we are going to be serious about disclosure in a post-Citizens United campaign finance system. If (c)(4)s can be used as independent campaign advocacy organizations with no disclosure requirements, then there will be no check on the corruptive influence of large campaign contribution and our democracy will surely suffer.