Paul L. Caron

Friday, May 27, 2011

Barone, Froomkin on the IRS's Use of the Gift Tax Against § 501(c)(4) Groups

Washington Examiner, Obama Skirts Rule of Law to Reward Pals, Punish Foes, by Michael Barone:

One basic principle of the rule of law is that laws apply to everybody. If the sign says "No Parking," you're not supposed to park there even if you're a pal of the alderman. Another principle of the rule of law is that government can't make up new rules to help its cronies and hurt its adversaries except through due process, such as getting a legislature to pass a new law.

The Obamacare waiver process appears to violate that first rule. Two other recent Obama administration actions appear to violate the second.  ...  The other example is the IRS's attempt to levy a gift tax on donors to certain 501(c)(4) organizations that just happen to have spent money to elect Republicans.

A gift tax is normally assessed on transfers to children and other heirs that are designed to avoid estate taxes. It has been applied to political donations "rarely, if ever," according to New York Times reporter Stephanie Strom. "The timing of the agency's moves, as the 2012 election cycle gets under way," continues Strom, "is prompting some tax law and campaign finance experts to question whether the IRS could be sending a signal in an effort to curtail big donations."

Huffington Post, IRS to Take on Karl Rove? Tax Laws Could Take a Bite Out of Secret Political Spending, by Dan Froomkin:

Top Republican political strategist Karl Rove's method of secretly funneling unlimited contributions from big donors was so hugely successful in the 2010 campaign that Democrats are now trying to copy it. But his model may yet end up backfiring spectacularly.

In one scenario, groups like Rove's Crossroads Grassroots Political Strategies could find themselves subject to massive fines, ranging as high as 35 to 70% of the money they received in secret donations.

In another scenario, their deep-pocket donors could be hit by a 35% tax on their contributions.

Rove may well have found a way around the nation's federal election laws. But now the key question is whether the IRS is willing to be assertive. Because if it is, then just like with Al Capone, it could be the IRS that gets him.

In Crossroads GPS's solicitations for money, the group describes itself as a tax-exempt 501(c)(4) organization, and due to a controversial loophole in federal campaign finance rules, the names of donors to those organizations do not have to be disclosed publicly.

But contrary to popular belief, Rove's group has not formally attained 501(c)(4) status. The group's application, requesting the IRS to classify it as a "social welfare" group, is still pending.

And while the designation is typically not much more than a formality -- organizations routinely call themselves (c)(4) groups before they've been formally approved -- tax and campaign finance experts contacted by The Huffington Post said the IRS could well deny Crossroads GPS's application. ...

"Lots and lots of things that would not be considered 'express advocacy' by the FEC, the IRS would consider intervention in a political campaign," said Donald Tobin, a tax and campaign finance law expert at the Moritz College of Law. ... "There's a good chance the IRS will deny the (c)(4) application," said Lloyd Mayer, who teaches tax law at the University of Notre Dame. ... Mayer described what he considers a likely scenario: The IRS denies Rove's group its (c)(4) status, but ends up letting him off with just a slap on the wrist. ... "That would be the easy way out," he added. Another possibility is that the IRS could just decide to let the issue drag out indefinitely, Mayer said. As it is, the earliest opportunity for decisive action may not be for almost another year.

(Hat Tip: Francine Lipman.)

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A couple of points

1. If donations to 501(c)(4) groups are political contributions, the groups are not 501(c)(4) groups.

2. Has there been any evidence whatsoever that the IRS is politically motivated or politically driven in its examination of gift tax implications for large contributions to 501(c)(4) groups. In the old days actual evidence of an action was usually required before making an accusation. Has that changed?

3. Everyone knows that the attempt here is to get around the disclosure laws so that anonomous contributions can be made to political campaigns. Why don't we just admit that and move on.

4. This is a tax law related blog. Can't someone do a brief legal analysis on whether or not the gift tax applies to 501(c)(4) organizations. Do I have to do everything?

Posted by: Sid (real one) | May 27, 2011 12:55:48 PM

Sid (real one):

This has been extensively covered on this blog:

Application of the Gift Tax to § 501(c)(4) Organizations (May 16, 2011)

Are Contributions to American Crossroads, Priorities USA & Other 501(c)(4) Groups Taxable Gifts? (May 11, 2011)

Are Contributions to 501(c)(4) Groups Subject to the Gift Tax? (Oct. 15, 2010)

Posted by: Paul Caron | May 27, 2011 1:09:00 PM


You are correct, this issue has been significantly covered on this Forum, and in fact it seems like it is the only Tax Forum I am aware of that is covering the issue extensively from a tax low perspective. My concern is not that the issue has not been extensively covered, but that a conclusion has not been reached on tax law and its application in this instance.

My point, (poorly made?), is that this is not a question of politics or the IRS playing politics. It is a question of tax law which should be answered one way or another. If contributions to 501(C)(4) are taxable gifts, so be it, and the IRS should be enforcing the law and even if they are politically motivated, that should not be an issue. If the contributions are not taxable gifts, let’s move on.

Instead we have the side show where people, mostly Republicans are accusing the IRS of political rather than revenue motivations in pursuing this. As far as I know the only evidence to suggest that this is politically motivated is the fact that a Democrat is in the White House and therefore it is implied the IRS is doing the Administration’s political will. That may be, but such an accusation should have something more than association as evidence or proof.

The most recent link ends with this conclusion.

“By seeking to use 501(c)(4) organizations as a campaign vehicle, individuals may be able to avoid the disclosure rules in §527. As a consequence of attempting to subvert these disclosure provisions, large donors may find that their large contributions to 501(c)(4) organizations are subject to the gift tax.”

What I am looking for is for someone to change out the word “may” above to either “will” or “will not”, and hopefully additional posts will serve to clarify the issue. The argument that the donations are “political contributions” and political contributions are not subject to the gift tax is fine, but that opens the issue of whether or not the groups are legitimate 5501(C)(4) entities. The issue needs to be put into the context of tax law where it belongs, there are no political considerations here.

Thanks for the opportunity you give all of us to express these opinions.

Posted by: Sid (real one) | May 27, 2011 3:03:55 PM

Sid (real one):

As a tax person (I have seen you post a lot), you know as well as anyone else in the tax community that the IRS/Treasury does not come up with answers lickety split. At a minimum, someone on the line has to research the issue and write something about it. then there are who knows how many levels of review, and at any level the issue can be pushed back down for further development as a who or in part or to address an issue not covered. and on top of all the review, it has to be cross shared with every division in the IRS to make sure they have no problems with it. Then Treasury gets involved (maybe sooner) and Treasury can do the same exact thing (pushed back down for further development as a who or in part or to address an issue not covered).

then, after all this review, a decision has to be made on how to release it and how much to release. is it guidance (if so, what kind)? is it a reg project? is it an announcement?

even then, the may still may be a may and not a will or will not if it is based on facts and circumstances. some things are inherently ambiguous (although this does not seem to be one of them).

The only quick answer is going to come from the private sector, and you can guess what that answer will be. And the ABA may get a position paper out faster than the IRS, but not that much faster.

Thoughtful analysis is not instantaneous. In an instant gratification society, Congress and the media want an answer yesterday for one that might take the IRS, Treasury, or the courts years to decide. There is nothing wrong with taking your time to get it right. Perhaps everyone should back off a little (at least on the real substantive issue) and let people think deliberately about the issue and come to a reasoned conclusion. Politicians scream fire because it rallies the based or sets the other side on fire. That tactic does not answer complex tax questions well. Rush an answer on this question and you will get the answer that you paid for (a rushed job).

Posted by: tax guy | May 28, 2011 7:10:00 AM

Tax Guy

All of your points are good ones but my problem is this and I will use a hypothetical example.

Suppose the situation is that I provide tax planning, tax strategy and tax advice to privately held companies and high net worth/high income individuals (ok, that part is true) and a client comes to me with the following issue. The client has already made taxable gifts in his/her lifetime of more than $10 million in prior years, and will not make any taxable gifts this year. This year the client made a donation of $100,000 to a 501(C)(4) group to support its activity of running political ads. The client wants me to tell him/her whether or not a gift tax return will have to filed, and whether or not a gift tax will have to be paid. My choice of answers is the following.

A. No, you have made a political contribution and political contributions are not considered gifts and are exempted from the gift tax. You do not have to file a return and you do not need to pay a gift tax.

B. Yes, even though you call your donation a political contribution, Sec. 501(C )(4) organizations are not political organizations and do not engage in political activity. Therefore even though you call your donation a political contribution, the fact that you made it to a 501(C )(4) organization means it is not a political contribution. You will have to file a gift tax return and pay a gift tax on the donation.

C. Recent articles on the subject say you may or may not have to file the return and pay the tax.

D. I have not the slightest idea at this time.

Well, you see the problem.

Now at this time answers C and D are the correct answers, but I cannot give the client either answer D or answer C because the client expects an answer and either answer A or answer B is what I should be saying because I am supposed to know these things.

It is nice to be able to say let’s wait, but clients (and students if you are teaching tax law) expect a correct response when they post the question, because after all, we are supposed to be experts and know what the law and regulations not only say but mean, and the client has to know whether or not to file a return. An IRS position is only one position, and we may or may not agree with it; their position is not law.

Incidentally, the answer to the client is E.

E. Tax law is not settled on this issue. I recommend you file a gift tax return, declare the $100,000 donation, provide a statement that it is a political contribution and therefore not subject to a gift tax and do not pay a gift tax. You should also be aware that taking this position my cause the organization to lose its 501(C )(4) designation. I cannot give any guidance on the consequences of that happening but I doubt it will be beneficial for any of the involved parties.

Not satisfactory, but about the best I can do at this time. Hopefully Forums like this one and others will (along with my personal research on the topic as needed) will clarify things.

Posted by: Sid (real one) | May 28, 2011 5:25:44 PM

How about F, G, H, I,J -- all opinion letters:

F: reasonable basis
G: realistic possibility (1/3)
H: there is substantial authority
J: should

Clients are used to receiving opinion letters, and I think that is what they will get on this issue. I doubt anyone would give a should opinion on this one. If they do, power to them. I do not know about a MTLN. I really haven't done the research so I don't know what % of lawyers would be likely to give a MLTN, but this is probably what the client wants. I bet many lawyers would be willing to give a realistic possibility or a substantial authority letter because of "C" (which if they are good articles should contain the types of citations that allow you to get to the substantial authority standard). I think probably a lot of clients would be satisfied with this, to protect them from penalties, and then could to "E" with a measure of comfort. I don't know if F would satisfy clients.

I do not see why attorneys cannot and will not be giving clients opinion letters - especially G & H, and possibly I. Clients, of course, want Papal blessings but they will have to be satisfied with the fact that there is uncertainty in the law. An attorney's job, in part, is to convince their clients to be satisfied with the type of opinion letter that the attorney is willing to give them (although MLTN probably won't take much convincing). It probably will be harder to convince them to file a Form 8275 as part of option "F" but without disclosure proceeding with option "F" is walking into the lion's den (it has to be a red flag item for the IRS, so why not disclose it to at a minimum prevent penalties?)

Posted by: tax guy | May 30, 2011 6:21:57 AM