How Congress Could Have Prevented the IRS Scandal
Business + Economy

How Congress Could Have Prevented the IRS Scandal


House Speaker John Boehner, R-Ohio, said heads should roll and others should go to jail for the scandal over the IRS’s targeting of conservative and Tea Party groups seeking tax-exempt status.  Now, from the looks of things, a shakeup is well underway. 

President Obama on Thursday appointed senior budget adviser Daniel Werfel as the acting commissioner of the IRS after forcing out Steven Miller. And Joseph Grant, commissioner of the Tax Exempt/Government Entities Division, announced his plans to retire, according to an IRS statement.

But if Boehner and other lawmakers want a more permanent solution to the problems IRS oversight of tax-exempt groups, they might consider mounting the most important reform of the federal tax code by rewriting the rules for so-called 501(c)(4)s.  

For decades these tax-exempt groups have avoided paying corporate taxes on surplus income by asserting that the majority of their activities promote “social welfare.” The groups have ranged from the liberal, which was created in 1998 in response to the Republican House impeachment of President Bill Clinton, to Republican strategist Karl Rove’s mega American Crossroads GPS during the 2012 presidential election campaign.

The Supreme Court’s Citizens United ruling in 2010 triggered a surge in the number of these groups and the amounts they were spending by declaring that outside groups could now spend unlimited amounts of money to influence elections, as long as they were independent of candidates.

Yet groups of this sort have frequently violated an implicit IRS rule that no more than 49 percent of a given group’s funds and resources can be used for political purposes, according to campaign finance experts.

Sheila Krumholz, executive director of the Center for Responsive Politics, said yesterday that while the IRS’s targeting of conservative groups as detailed in an inspector general’s report this week was “absurd and scary,” some Tea Party groups that were improperly challenged may well have been skirting a requirement that the majority of their work must be devoted to “social welfare” efforts.

While some IRS officials rightly should be fired or punished for misconduct, she said, some targeted groups may have been illegally spending a majority of their resources on political activities while manipulating the tax code to hide donors and evade taxes.

“We would not be at this point – this would not have happened – were the IRS to have interpreted the law more strictly, instead of creating this netherworld of, ‘Is it political or isn’t it?’ and not be clear about what the bright lines are,” she said. 

Lawmakers, however, have refused to create a checklist, a set of criteria, or a minimum set of standards an organization must meet to be designated a 501(c)(4) – leaving it instead to IRS officials to essentially make it up as they go along.

“It’s done on an ad hoc basis and under very vague standards, and that’s part of the problem,” Jan Baran, a prominent Republican campaigns and election lawyer at the D.C. –based Wiley Rein firm, told The Fiscal Times. 

These conditions allowed IRS employees to target GOP groups with names that included Tea Party, patriots, and 9/12 for 18 months, according to the report this week.  But it’s Republicans who have pushed back against changing regulations that would force additional disclosure by non-profits, arguing among other things that it would be an abridgement of free speech .

Marcus Brown, an attorney and former chief of the IRS division overseeing nonprofits, says that many groups with interest on both sides of the political aisle frequently blur the distinction between advocacy and raw politics – and deserve increased scrutiny. 

“Many start out with the intention of trying to walk the line carefully, being [as] politically active as they can while taking up issue advocacy to a degree that they can safely operate,” Brown told The Fiscal Times. “If you have an interest in who wins, there is the temptation to put more money into a politically aggressive message until it is inevitable” that the balance tips toward politics, he said.

Groups like the Sierra Club, the National Rifle Association, the NAACP, and the AARP are all organized as 501(c)(4)s. But the game changed when became a powerful political force as a 501c4. Republicans followed suit and now, even President Obama’s devotees have jumped on board.  “Organizing for Action will raise and spend money from corporations and other special interests to support his policy agenda,” according to the Huffington Post. 

The roots of the IRS scandal date back a century, when 501(c)(4)s were created by Congress. The category of social welfare organization first appeared in the Tariff Act of 1913.  Before the 1950s, these groups were engaged only in social welfare activities. But in 1959, lawmakers created a loophole – changing the language of the regulation governing these organizations from “exclusively” to “primarily.”

While opening the door to political activities for these groups, Congress was vague on what actually qualified as a 501(c)(4). It did not create a specific set of criteria or a minimum standard an organization had to meet, according to Baran. 

In practice, a group is eligible for 501(c)(4) status if it spends 51 percent of its funds on social welfare programs. It’s free to participate in political advocacy with the other 49 percent. This has led to the creation of a strange mixture of organizations – from the very political American Crossroads and Americans for Prosperity, to “issues groups” that include the Sierra Club, the NRA and others.

According to current rules, groups granted tax-exempt status have carte blanche to raise and spend money without telling the IRS their sources of revenue and without paying taxes on that money. The Treasury and Congress have no way of gauging how much this policy costs the government in foregone revenues, because 501(c)(4)s are not viewed as or treated like the scores of other tax loopholes and deductions in the  code that are costing the Treasury an estimated $1 trillion a year

While the number of these groups has ebbed and flowed in recent decades, applications for 501(c)(4) status virtually doubled after the Citizens United ruling. The applications went from 1,751 in 2009 to 3,357 by the 2012 presidential election campaign, according to this week’s inspector general’s report on the IRS controversy.

“There was a sense across the board that many of these organizations were newly empowered by the Citizens United decision, and understood they had great latitude to have their cake and eat it too – to raise money from anonymous sources and spend a fair amount of it on political activities,” Krumholz said. “There seems to be quite a bit of confusion, if not deceit.”

Throughout the 2012 election campaign, 138  groups raised and spent $308.5 million, according to the Center for Responsive Politics. None were required to disclose the sources of the contributions. 

The center’s analysis says that 85 percent of those funds were raised by conservative 501(c)(4) groups and 11 percent by liberal groups. Krumholz characterized this sudden massive infusion of “dark money” into the political system as a “bipartisan scandal.”

“With the surge of dark money into politics, we need to ensure that the IRS is capable of rigorously enforcing the law in a nonpartisan, but more effective, way,” Krumholz said.

Twice so far this week Obama has urged Congress to look at the law and regulations that he said have created ambiguities and confusion for the IRS and find ways to “make sure tax laws are being enforced evenly and fairly.” But given the toxic political environment right now, tax reform is unlikely to happen any time soon. Yet the issue over what happened at the IRS is certain to linger.

David French, senior counsel at the American Center for Law and Justice and the attorney representing 27 of the Tea Party groups targeted by the IRS,  said he has long believed his clients were targeted. But he did not realize the scope of it until the scandal broke. “It was hard for us to believe it was localized in the Cincinnati office,” he said. “The abuse was more widespread, more severe, than we ever knew. The way they were targeted was unconstitutional.”

“Litigation is coming,” he warned. “This [has] cost hundreds and hundreds of hours of time. The damages that [my clients have] suffered are very considerable.”