Tobin: 501(c)(4) Groups Funding Political Ads Are Violating the Tax Law

Donald B. Tobin (Ohio State), The Rise of 501(c)(4)s in Campaign Activity: Are They as Clever as They Think?:

Even before Citizen’s United we saw a significant increase in the use of 501(c)(4) tax-exempt “Social Welfare Organizations” [e.g., Crossroads Grassroots Political Strategies, Americans for Prosperity, MoveOn.org Civic Action] as vehicles for advocacy in election campaigns. In a recent article in The New York Times, Michael Luo and Stephanie Strom examine the use of 501(c)(4) organizations in political advocacy. They note the attractiveness of these organizations for large contributors because in most cases these organizations do not have to disclose donations to the organizations. According to proponents of the use of (c)(4)s, they are the perfect advocacy organization for independent third parties seeking to influence elections; they can take unlimited donations and do not have to disclose the names of donors. If proponents are correct that (c)(4)s can operate this way, (c)(4)s become a perfect mechanism for corporate influence in campaigns and also fundamentally destroy the few checks that are left on the corruptive influence of large contributions in political campaigns. ...

In most cases, the (c)(4)s formed to engage in independent advocacy are not complying with the law. ...

501(c)(4) organizations are supposed to be primarily engaged in social welfare, are not subject to tax on income, and may engage in a limited amount of intervention in a political campaign. Section 527 organizations are designed for political advocacy. Contributions to the organizations are not income, but the organizations are required to disclose contributions and expenditures or face additional tax.

Current advocates of using (c)(4)s as campaign advocacy vehicles are distorting the law and often are mischaracterizing their activities. If they are truly lobbying to promote their social welfare purpose, then they are properly (c)(4) organizations. But if they are engaged in intervention in a political campaign, and they are trying to cloak their activities as lobbying, they are violating both the spirit and the substance of the statute. Under campaign finance jurisprudence, they may be able to use such trickery, but it is usually not accepted in tax jurisprudence. ...

The question really is what type of enforcement mechanism exists to constrain entities that are improperly characterizing themselves as (c)(4)s. It is one thing to say that these entities can get away with organizing as a (c)(4) and another thing to say that it is legal. The fact that enforcement is lacking does not make the action legal. ... [H]ere are some proscriptive solutions for limiting the abuse of (c)(4)s.

First, the IRS could take stronger action against such organizations. In many cases, these organizations are violating the law. If procedural mechanisms are not in place to properly regulate these organizations (like the fact that they do not necessarily file tax forms when they are created so the IRS may not know who they are), the IRS has the power to change those regulations.

Second, the IRS can reclassify these organizations as 527 organizations and assess tax based on the organizations’ failure to disclose contributions and expenditures. ...

Third, ... Congress could create disclosure provisions in (c)(4) for those organizations who rely on “lobbying” as their primary social welfare purpose. ...

Fourth, ... lawyers who are setting up these organizations have an ethical responsibility under our Professional Responsibility rules not to assist others in engaging in illegal activities. ... Lawyers are not allowed to counsel people to cheat on their taxes even though there is little chance they will get caught, and they are not allowed to counsel people to create (c)(4) organizations when they are not (c)(4) organizations. ...

Fifth, the IRS could start assessing gift tax on donations to (c)(4) organizations. While there is a statutory exemption from the gift tax for contributions to (c)(3) and 527 organizations, there is no such exemption for (c)(4)s. If large donors were subject to gift tax on their contributions, (c)(4)s would be a lot less attractive as a campaign vehicle.

So are proponents of 501(c)(4)s as smart as they think? Probably, if smarts are measured by what they can get away with in the short run. But if their point is that they have found a legal way to engage in secret campaign advocacy, they are wrong, on both moral and legal grounds. The question is not whether the IRS, Congress, or local bars have the power to limit this abuse, they certainly do. The question is whether we are going to be serious about disclosure in a post-Citizens United campaign finance system. If (c)(4)s can be used as independent campaign advocacy organizations with no disclosure requirements, then there will be no check on the corruptive influence of large campaign contribution and our democracy will surely suffer.