Armanino Blog

IRS Controversy Continues

by Tom Schulte
June 17, 2013

In three short weeks of intense scrutiny by Congress, the President and the 24-hour media, there has been an ouster of the acting IRS Commissioner and an attempted ouster of the IRS director of exempt organizations.

There have been no less than four congressional hearings, condemning and suggestive sound bites by both parties as to “conservative targeting” and lawsuits filed by conservative groups against the IRS and top Obama officials. And we can be certain new “villains” will be identified in the future as Congress and the media have shown no desire to slow the momentum of this story. Let’s face it—there are few people who don’t get some satisfaction in watching the IRS suffer.

So what has created all this havoc? Unlikely enough, at the center of this controversy are social welfare organizations–nonprofit organizations that are exempt from taxation under section 501(c)(4) of the Internal Revenue Code.

So how could such a benign group of organizations that promote such a worthy cause create such a ruckus?

The issue began quietly in early 2010 when the IRS began taking special notice of 501(c)(4) applicants that had politically-themed names, specifically those that might be associated with the Tea Party or other conservative causes.

Traditionally 501(c)(4) organizations have long been used by many well–known organizations like the NAACP, AARP and the NRA to engage in political advocacy, but there were limits in amounts that could be raised and what they could do with their funds. They could engage in politics but politics was not allowed to be the primary purpose of the organizations. As long as donors gave dollars that were not earmarked for political advocacy they could be assured of privacy. But in early 2010, the “Citizen’s United” Supreme Court decision (ironically, named after the conservative organization that brought the case) allowed for a new use of the traditional 501(c)(4) organization and a new title was born—SuperPAC.

These newly-titled SuperPACs have no legal limit as to the amount of funds they can raise from individuals, corporations or unions and can use the funds in ways they see fit as long as they remain independent of and non-consultative with the campaigns they support. And as long as the SuperPAC is within a 501(c)(4) the identity of the initial donor has been effectively shielded from public scrutiny, resulting in a new use of a 501(c)(4) organization.

Politicos immediately seized upon this new tactic to raise unlimited funds anonymously, and applications for new 501(c)(4) organizations skyrocketed. The IRS began to question whether these new 501(c)(4) applications were for bona fide social welfare exempt purposes, or were being formed primarily in order to skirt traditional PAC donor disclosure requirements.

Initially the IRS method of dealing with these unknown organizations was to sit on the applications, and that is exactly what they did. It became commonplace for exemption applications of organizations with political– sounding names or missions, most of which had a conservative bent, to sit untouched for up to 13 months.

When the outcry from this approach became too much, the field office went to a Plan B–follow–up letters. Follow-up letters are not unusual but these letters, which were initially sent in January 2012, set off alarm bells at the organizations due to the inappropriate nature of the queries and because it seemed that these letters were being concentrated on applicants with conservative-sounding names.

There are two schools of thought as to why the IRS decided to take this unfortunate approach to the issue: the “waving the cape at the charging bull” theory and the “too much work, too little capacity” theory. Let’s start with the “waving the cape” theory.

The newly created Super PACs took off and were very effective in raising funds. The Center for Responsive Politics reported that by August 2012, there were 797 Super PACs that had raised $350 million—from a mere 100 donors. And they were everywhere. Many of the commercials that bombarded us this last Presidential campaign were funded not by the candidates, but by the Super PACs that supported them.

Super PACs became the story of the election with the media criticizing them and the candidates expressing frustration as to their inability to curb offensive commercials financed by the Super PACs. The system was ripe for abuse and also ripe for ridicule as Stephen Colbert demonstrated quite well by publicly setting up his own SuperPAC, “Americans for a Better Tomorrow, Tomorrow” in various segments of his show. Colbert, along with a former Federal Election Committee chairman, gave the nation a tutorial as to how to set up a tax-exempt entity that could raise unlimited funds from unlimited sources to be used for loosely regulated ends. So what happens when you wave a red cape at a bull? It charges.

Now let’s consider the less notorious “too much work, too little capacity” explanation. The IRS tax exempt division is based in a field office in Ohio. At this office, 140 employees comprise the “determinations unit” and review the 60,000 applications from organizations from across the United States who wish to be classified as tax-exempt.

The Citizens United decision gave life to a whole new wave of applicants that overwhelmed an already overwhelmed determinations unit. It also provided an additional level of complexity to the application granting process they had not experienced before and were not prepared to address. And, as the Inspector General’s report highlighted, the determinations unit had an adversity to reaching out to Washington, D.C. for direction due to the overly technical legal advice they would receive. So, they sought their own practical solution- they sat on the applications.

While sitting on the applications of groups that appeared to have conservative agendas may not have been the most ideal practical solution, it was certainly better than the follow-up letter “Plan B” solution that began being practiced in January 2012.

The continuing Congressional and media interest will not be focused on this lone Ohio field office, but rather on “who knew what and when did they know it.” While that topic is interesting, it is more appropriate for this article to ponder how this series of events may affect exempt organizations in the future.

In the immediate future, I would anticipate that any follow-up letters will have been vetted and re-vetted at high levels and will concentrate on appropriate areas of interest that should be considered in the exempt application process. The spotlight shone on the meager resources in the IRS Tax Exempt/Government Entities Division should result in an increase in forces with stronger guidance and more attention from Washington D.C.

I would also hope that the dismal turnaround time that all exempt statuses were experiencing will improve. In the longer term future, don’t expect to see the abolishment of the IRS as some are taking the opportunity to propose. But there may be more of an overhaul in the entire exempt application process to be more in line with the Supreme Court decisions.

Who said the nonprofit industry is dull?

June 17, 2013

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