IRS to Issue 501(c)(4) Rules, but Observers Say Cure May Be Worse Than the Problem

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By Diane Freda

Jan. 27 --This could be the year the Internal Revenue Service finally issues guidance on how much political activity social welfare organizations can do without risking their tax-exempt status--a development that many political observers and watchdog groups have long awaited.

The IRS has taken the first step by issuing proposed rules. The reception has been largely cool due to a perception that the rules are overly broad, but the conversation has at least started and many commenters are expected to weigh in.

The Tea Party scandal, which consumed the agency in 2013, is expected to have many spillover effects in 2014, not the least of which is that all types of applications for tax exemption--not just the problematic tax code Section 501(c)(4) ones--will be processed slower, practitioners said.

“We have certainly experienced a standstill since May, when Lois [Lerner] gave her speech, until late 2013,” LaVerne Woods, a partner with Davis Wright Tremaine LLP, told Bloomberg BNA Jan. 7. “While we always have a large number of applications pending at any one time, we were getting nothing coming back out. Things are starting to move now.”

Lerner, the former IRS director of exempt organizations, rocked the exempt world when she announced in May that the agency had inappropriately handled Tea Party and other conservative groups' applications for tax-exempt status beginning in 2012.

Her public apology, extended congressional hearings in both the House and Senate, and the media blitz of the scandal were a long and painful chapter in the agency's history from which practitioners said the IRS is now beginning to emerge.

Practitioners told Bloomberg BNA that new management at the top is expected to help.

New Management

The IRS's selection to succeed Lerner, Tamera Ripperda, industry director of Global High Wealth in the agency's Large Business and International Division, is a mystery to several practitioners interviewed by Bloomberg BNA.

But whatever her style of governing will be, practitioners said they are glad to have someone permanent in place. “We haven't known who to ask any questions of,” Woods said.

They found comfort that Sunita Lough, a former tax law specialist in the Exempt Organizations division, a somewhat known figure, will be taking over the position of commissioner of the Tax Exempt and Government Entities Division. Lough has held several other positions in the IRS, including director of the Office of Federal, State, and Local Governments.

Little is known about Ripperda, but her background in tax law enforcement has been duly noted. In her Global High Wealth position, she oversaw the examination activities of high-wealth individuals with global holdings and interests. Prior to that, she was director of abusive transactions and technical issues in the Small Business/Self-Employed Division where she was responsible for Service-wide policy and guidance in the identification and investigation of abusive transactions. Ripperda didn't respond to a Bloomberg BNA request to be interviewed.

“If you're going to have to pick a background other than familiarity with tax-exempt organizations, that's probably not a bad one to pick,” Marc Owens, a member of Caplin & Drysdale, and a former IRS director of exempt organizations, said March 2. “It suggests she is familiar with tax law enforcement.”

Lloyd Mayer, a professor at Notre Dame Law School, said Jan. 16 that the new TE/GE managers will have two goals as they assume their posts--avoiding anything controversial and learning the part of the Internal Revenue Code that pertains to exempts.

New TE/GE managers will have two goals--avoiding anything controversial and learning the part of the Internal Revenue Code that pertains to exempts, said Lloyd Mayer of Notre Dame Law School.


That means that controversial guidance projects--such as one on the current guidance priority list of finalizing proposed rules on beginning church tax inquiries, pending since 2009--aren't likely to get done any time soon, Mayer said.

Coordination With FEC

As for the proposed Section 501(c)(4) rules on politicking (REG-134417-13) that the IRS released in November 2013, Owens said they are flawed in that they insert terminology from election law--such as “clearly identified candidate” and “express advocacy”--into tax law. IRS agents will be applying those terms and creating a body of tax precedent defining them, he said.

“But because there's no way for the IRS to coordinate the application of those terms with the Federal Election Commission, a revenue agent who is doing an audit and trying to figure out if there is a clearly identified candidate, or not, won't be able to call the FEC and ask what they think,” Owens said. “He will have to come up with his definition independent of what the FEC is doing.”

Over time, the definitions of those terms will begin to differ, he said, which means that ultimately it will provide a way for those who want to avoid the FEC rules or the IRS tax rules to play the definitions off against each other. “Those terms aren't even definite in the FEC world,” he said. “They are still being debated.”

In addition, as stakeholders on both sides of the political aisle have pointed out, another big problem with the proposed rules is that certain activity that was deemed to be appropriate if conducted in a nonpartisan fashion before would now be deemed political, even if conducted in a nonpartisan way. This would include voter registration, get-out-the-vote drives and voter guides.

“The NAACP has been doing voter registration and get-out-the-vote drives in places like Mississippi and Alabama for 100 years, and this rule would make it impossible for them to continue,” Owens said.

One-Year Delay

Meanwhile, House Ways and Means Committee Chairman Dave Camp (R-Mich.) announced Jan. 16 that he will holding hearings on the proposed rules and introduced legislation that would halt the rules process for one year.

Mayer said the proposed rules aren't likely to be finalized until after the election anyway. “It would avoid the appearance that the Treasury and IRS are acting for the administration in some way,” he said.

Mayer also said he has concerns with the breadth of the definition of candidate-related political activity. The rules would prevent Section 501(c)(4) groups from doing clearly nonpartisan activity, and there should be no difference in the definitions for 501(c)(4)s and 501(c)(3)s, he said.

While Owens dismissed the Tea Party scandal as one in which conservative groups suffered nothing more than being subjected to “silly questions,” and Woods described the Tea Party scandal as “a tempest in a teapot,” one practitioner who thinks the situation was much more serious is Cleta Mitchell, a Foley& Lardner LLP partner. Mitchell represents many of the conservative groups whose applications for tax-exempt status were held up for years, as the IRS applied extra scrutiny to them based solely on the names of organizations that may have had political connotations.

Many 501(c)(4)s will be spending the first part of the year trying to stop the IRS rules as proposed, Mitchell said. “We'll be trying to focus attention on how draconian they are. They've taken everything that 501(c)(4) organizations do in the normal course of business and proposed to convert that all to candidate-related activity, even if a candidate is never mentioned.”

Mitchell said congressional hearings are needed on the proposed rules and if all else fails, legal action may be required. The proposed rules won't pass constitutional muster, she said.

“They are both over-broad and under-inclusive,” she said, subjecting 501(c)(4) organizations to provisions of law that wouldn't be similarly applied to other types of nonprofit organizations.

Mitchell predicted that groups and individuals would cross political lines to oppose the proposed rules.

Moreover, she has filed a Freedom of Information Act request to try to get all the documents and records pertaining to the rulemaking process.

Mitchell said the timing of the proposed rules' release--just before the Thanksgiving holiday--was designed by the IRS to eliminate five weeks of a 90-day comment period.

She said she thinks IRS officials are trying to codify their treatment of conservative organizations in order to build a record that will protect the agency from litigation, and to influence the next election by stifling the same conservative speech that caused the IRS controversy in the first place.

“That's why the proposed rules were rushed through,” Mitchell said. “The objective is to get the rules in place before the 2014 election.”

Missing Work Plan

While business appears to be getting back to normal in the Exempt Organizations unit at the IRS, Owens said there are lingering concerns. One of them is the approach that will be taken toward tax administration going forward.

“What we are missing is the annual work plan,” he said. That document traditionally outlines the exempt unit's plans for guidance and enforcement projects for the upcoming year.

Nothing has been forthcoming from the acting managers on how the laws are to be enforced for tax exempts, Owens said. All the pronouncements to date have addressed the Section 501(c)(4) applications, with the exception of several revenue procedures.

“People will be watching to see what signals the newcomers send on what they are going to do,” he said.

Donor-Advised Funds

In other areas, Woods said the rules she is most anxious to see completed are those relating to donor-advised funds.

Donor-advised funds, tax code Section 501(c)(3)s, allow the donor to advise the sponsoring organization where the money should go. The IRS has expressed concerns that some donor-advised funds may be used to create questionable charitable deductions, as well as impermissible tax-sheltered investment income for donors and their families.

Donor-advised funds are a growing part of the exempt organizations landscape, Woods said, with $45 billion in assets. “Some of the biggest charities in America are donor-advised fund sponsors and we had quite sweeping statutory change in the area in 2006, yet we still do not even have proposed regulations,” she said.

According to Treasury Department officials, these rules will be a long time coming, as other projects bump them aside.

The project that is new on the priority guidance plan for 2014 is guidance under Section 4941 on private foundations investing in partnerships in situations where disqualified persons are also investors. This is an increasingly common fact pattern, Woods said, where families, and sometimes corporations, are investing in the same hedge fund with private foundations. Woods said there are inconsistent rulings on when that is a self-dealing transaction, and more guidance is needed.

To contact the reporter on this story: Diane Freda in Washington at

To contact the editor responsible for this story: Cheryl Saenz at

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