IRS employees who review applications for exemption have a duty to ask follow-up questions of applicants, including groups affiliated with the tea party. In the current controversy, IRS reviewers wrongly singled out conservative groups for unusually exacting follow-up. In a number of these cases, they also asked inappropriate questions, such as the identity of donors.
Some media reports, however, imply that the IRS cannot and should not ask any questions of applicants for exemption, that any inquiry invades privacy and violates the First Amendment. That implication is wrong. An organization that seeks an IRS acknowledgment of its exempt status subjects itself to scrutiny — scrutiny designed to ensure that the group in fact qualifies for the benefit of tax exemption.
Twenty-nine categories of organization are exempt from income tax under section 501(c) of the Internal Revenue Code. A few of these categories require an application for recognition of exemption. For example, section 501(c)(3) exempts charities and entitles organizations satisfying its requirements to receive tax-deductible contributions. Most entities seeking to qualify as 501(c)(3) exempt charities must file an application. (Churches and very small organizations are not subject to the application requirement.)
For other categories, such as 501(c)(4) social welfare organizations, the category at the center of the current furor, filing an application is not required. A 501(c)(4) organization that makes a decision to file for recognition of exemption is also making a decision to subject itself to review by IRS employees to ensure that the group qualifies for the exemption it seeks.
Filing an application for exemption entails far more than checking a box on a single-page form. The application for exemption is detailed and lengthy. It asks questions about the applicant’s activities; the names, addresses and compensation of its officers, directors and trustees; and financial data, including a statement of revenue and expenses, as well as a balance sheet.
Even with all the information provided on the application, filing it is only the beginning of the process. IRS reviewers generally ask a number of follow-up questions. These questions aim to ensure that the applicant qualifies for exemption.
Questions might seek assurance that the entity is being operated for the benefit of the public and not, in fact, for the benefit of for-profit entities owned by the insiders running the tax-exempt applicant. There would be nothing untoward in asking for minutes of board meetings to ensure the organization is carrying out the activities it describes on the application.
In the case of 501(c)(4) social welfare organizations, reviewers must be satisfied that the organization is, as the applicable regulations require, “primarily engaged in promoting in some way the common good and general welfare of the community” and not primarily engaged in “direct or indirect participation or intervention in political campaigns on behalf of or in opposition to any candidate for public office.” The tax law nowhere defines “primarily” for this purpose and the tax definition for campaign intervention turns on a “facts and circumstances test” that depends on context and a variety of possible factors. The reviewers’ task is thus very difficult.
This inherently difficult task became even more so after the Supreme Court decided in Citizens United that corporations and unions had a constitutional right to participate in campaign intervention. Savvy advisers realized that they could create entities that could engage in considerable campaign intervention without having to disclose donor names by setting up these entities as 501(c)(4) organizations rather than as primarily political organizations subject to donor disclosure under either Federal Election Commission or IRS rules. After Citizens United, applications for 501(c)(4) status undoubtedly became more complex as well as more voluminous.
The duty of the IRS reviewers, however, did not change. They continued to have an obligation to ensure that the applicants qualified for recognition of exempt status under section 501(c)(4). While the reviewers and their supervisors blundered in how they went about their business for the applications at the heart of this controversy, we must not conclude from that behavior that IRS review is inherently wrong.
Such review is required to ensure organizations carry out the charitable, educational, civic and other activities that are so vital to our country and for which they are granted tax exemption.
Ellen P. Aprill is the John E. Anderson professor of tax law at Loyola Law School, Los Angeles, and is the organizer of the school’s annual Western Conference on Tax Exempt Organizations.