TaxProf Blog

Editor: Paul L. Caron
Pepperdine University School of Law

Tuesday, January 3, 2017

The IRS Scandal, Day 1335:  Politics, Disclosure, And State Law Solutions For 501(c)(4) Organizations

IRS Logo 2Linda Sugin (Fordham), Politics, Disclosure, and State Law Solutions for 501(c)(4) Organizations, 91 Chi.-Kent. L. Rev. 895 (2016):

In 2013, the Internal Revenue Service (IRS) suffered its worst scandal in a generation over its treatment of tea-party related organizations. Some of the facts are undisputed: Following the Supreme Court's 2010 Citizens United decision, people rushed to organize section 501(c)(4) organizations that would be active in politics. The IRS was overwhelmed by applications, and the regulatory standard provided little guidance. The agents, who were not lawyers, used a shorthand to identify organizations that might not meet the standard of being “operated exclusively for the promotion of social welfare.” The Treasury watchdog found that “[t]he IRS used inappropriate criteria that identified for review Tea Party and other organizations applying for tax-exempt status based upon their names or policy positions.” Instead of identifying possible ineligible organizations by their names (including “Patriots” and “9/12”), the IRS should have determined eligibility for exemption by analyzing whether the organizations satisfied the regulatory requirements concerning political activity. Since that time, the IRS has been paralyzed in this area, and the Federal Election Commission has been deadlocked.

The post-Citizens United explosion of (c)(4) political activity—and the federal government's dysfunction—did not go unnoticed by the states. While the federal government was at an impasse, some states attempted to bridge the gap. Federal law determines tax exemption, but state law defines charitable and noncharitable nonprofit organizations and regulates their governance. If nonprofit organizations are operated to the detriment of the public interest, state attorneys general have the power to investigate and discipline them. New York and California have both attempted to address the same concerns about secret money in politics that led to the IRS scandal and proposed regulations.

This article asks whether the states can (and should) use state nonprofits law to solve the problem of dark money spent by nonprofit non-charitable organizations. Since the problem of (c)(4) politicking is not a revenue issue, the Internal Revenue Service is clearly not the ideal regulator. Dark money may be solely an election law problem, in which case it would be exclusively in the domain of the FEC and state election regulators, and not in the purview of state nonprofits law. However, if there are concerns about nonprofit organizations in politics that implicate the policies relating to nonprofits, there might be something beyond election law at issue that state nonprofit law might address. There are three reasons why state charity regulators might intervene in this area: (1) to protect charities, (2) to protect voters, and (3) to protect donors to nonprofit organizations. If dark money is damaging the reputation and integrity of the nonprofit sector as a whole, states may legitimately regulate noncharitable nonprofits to protect charities from negative consequences. The general public seems to confuse 501(c)(3) with 501(c)(4) organizations, failing to appreciate their legal distinction. Consequently, states have an interest in preventing reputational damage to charitable organizations on account of bad behavior by noncharitable nonprofit organizations. In addition, states may be justified in regulating politicking nonprofits to protect the public itself, either as donors or as voter. Much of state nonprofit law is designed to protect donors, so if regulating political speech is designed to protect donors who might unwittingly support political activity, then state nonprofits regulators are in a familiar institutional role. Donor confusion is understandable since 501(c)(4) organizations are categorized as “social welfare” organizations; donors may reasonably expect that their donations support social welfare activities, rather than politicking.

The final state policy, protecting the public as voters, veers away from nonprofits law into clear election law territory. Nevertheless, state attorneys general have an interest in preventing the public from being misled. State nonprofits law is already concerned with preventing fraud perpetrated by bogus charities and unscrupulous solicitors. If it is fraudulent to pretend to be someone else or to speak anonymously in a political communication, then nonprofit regulators might approach the problem as analogous to charitable solicitation. Both political campaign activity and charitable solicitations raise First Amendment issues. The Supreme Court has repeatedly struck down statutory limits on charitable solicitation under the First Amendment, but it has allowed states to prosecute charitable fundraisers for misleading potential donors.

This article proceeds as follows: The next Part provides a brief background to the current situation and explains why federal tax law is not the appropriate locus of regulation. After that, I describe the steps that California and New York have taken to reduce the influence of dark money in their elections. Both states were motivated by specific incidents involving out-of-state interests, and both states faced substantial pressures from constituencies opposed to regulation. Part IV considers possible state law policies for regulating dark money, and Part V considers the regulatory solutions that correspond to those policies. Part VI steps back to assess the desirability of state nonprofit law regulation, considering the legal and practical problems with states undertaking this regulation. Although the states can achieve some important goals, the conclusion in Part VII expresses skepticism at the states' ability to solve the (c)(4) politicking mess.

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