Following up on my previous post, Federal Judge Overturns IRS Rule To Shield Political Donor Identities: TaxProf Blog op-ed: Bullock v. IRS and the Future of Tax Administrative Law (Part I), by Daniel Hemel (Chicago):
The world of “dark money” became a bit less opaque at the end of last month when a federal district court in Montana struck down an IRS revenue procedure that had shielded section 501(c)(4) organizations from having to disclose large-dollar donors to tax authorities. The decision in the case—captioned Bullock v. IRS—is significant both because of its immediate implications for the oversight of section 501(c)(4) groups and other exempt organizations as well as its broader ramifications for judicial review of IRS actions. Tax law practitioners and professors—whether or not they focus on exempt organizations in their work, study, and teaching—should take note.
This is the first of two posts on Bullock v. IRS and its implications. Here, I’ll lay out the facts of the case and some thoughts on discrete legal issues that it raises. In the next post, I’ll try to situate Bullock within the wider debate over tax exceptionalism (and its alternative, which we might call “tax ordinaryism”). I’ll argue there that Bullock represents both a continuation of the trend toward tax ordinaryism and a novel twist.
I must acknowledge at the outset that my interest in this case is not entirely academic. In an informal and pro bono capacity, I advised lawyers for the lead plaintiff, Montana Governor Steve Bullock, in their preparation of the lawsuit and at the briefing stage, and I wrote an op-ed in Slate supporting the suit on the day the complaint was filed. I don’t think that disqualifies me to reflect on the case’s consequences, but please know that these are not the impressions of a neutral observer.
Bullock in Brief
Bullock arises against a statutory and regulatory backdrop that will be familiar to many readers and new to some. Section 6033(a)(1) of the Internal Revenue Code, which dates back to 1954, provides that every organization exempt from tax under section 501 must file an annual return including certain statutorily specified items as well as “such other information for the purpose of carrying out the internal revenue laws as the Secretary may by forms or regulations prescribe.” In 1969, Congress added a requirement that section 501(c)(3) organizations also report “the names and addresses of all substantial contributors” (i.e., donors who give $5000 or more in a taxable year). Then in 1970, the IRS—acting under its section 6033(a)(1) authority—promulgated a regulation extending the substantial contributor reporting requirement to other noncharitable tax-exempt entities, including but not limited to section 501(c)(4) “social welfare” organizations. (Note that the section 501(c)(4) category—while it encompasses politically active groups like the Koch brothers-backed Americans for Prosperity—also includes nonprofit health insurers, volunteer fire departments, veterans’ organizations, and community sports and recreation clubs, along with a wide range of other entities.)
Tax-exempt organizations subject to the substantial contributor reporting requirement transmit this information to the IRS on Schedule B of Form 990. Exempt organizations have never needed to disclose this information to the public—only to the IRS. On rare occasions, the IRS—by apparent accident—has leaked substantial contributor information, including when it posted the names and addresses of substantial contributors to the Republican Governors Association in 2013. But the general opacity of donors’ identities—combined with the political involvement of some section 501(c)(4) organizations—has given rise to the “dark money” moniker, which distinguishes these groups from section 527 political organizations that disclose their donors to the general public.
Until July 2018, “dark money” was not entirely dark, because the IRS (and as we shall soon see, some state tax authorities) had access to information about these groups’ donors. That month, though, the IRS published Revenue Procedure 2018-38, which purported to relieve exempt organizations other than section 501(c)(3) organizations from the substantial contributor reporting requirement. The IRS said that it didn’t need this information, that the reporting requirement increased compliance and administrative costs, and that reporting posed “a risk of inadvertent disclosure of information that is not open to public inspection.” Critics charged that the move would make it even harder for the IRS to ferret out abuses of tax-exempt status.
Revenue Procedure 2018-38 came with a flaw—and potentially a fatal one. The revenue procedure amended the requirements of a regulation, and the Administrative Procedure Act (specifically, 5 U.S.C. § 553) says that amendments to regulations—like the regulations themselves—must go through a process of notice and comment. The IRS, however, had skipped over that important procedural step.
The argument that the IRS had violated the notice-and-comment requirement was (as we’ll soon see) strong. But it wasn’t obvious that anyone could successfully challenge the agency’s action in court. That’s because plaintiffs in federal court must show that they have “standing,” which requires—among other criteria—that they have suffered an “injury in fact” that is “concrete and particularized.” If the IRS had relieved exempt organizations of public disclosure obligations, then individuals and firms who rely on that public information could plausibly claim an “informational injury.” But substantial contributor information is not public (except in the rare case that it is inadvertently released). So who could plausibly claim that the IRS’s action caused them an injury sufficient for constitutional standing?
That’s where Montana and its governor, Steve Bullock, came in. While ordinary citizens can’t view an exempt organization’s substantial contributor list, state officials can. Section 6103(d) of the Code allows states to inspect those lists insofar as it’s necessary to enforce their own tax laws. (Yes, that’s the same section 6103 that’s at issue in the House Ways and Means Committee’s attempt to obtain President Trump’s tax returns.) And so Bullock and the Montana Department of Revenue could argue what an ordinary citizen could not: that they suffer an informational injury as a result of the IRS’s action.
In late July of last year, Governor Bullock and the Montana Department of Revenue filed a lawsuit against the IRS in federal district court in Montana. In March of this year, New Jersey joined Montana’s lawsuit as a co-plaintiff. On July 30 of this year, District Judge Brian Morris granted summary judgment to the states.
Judge Morris’s opinion addresses four main issues and sides with the states on all four:
— Standing. The court’s analysis of Montana’s standing is rather straightforward. Montana has said that substantial contributor information can help it enforce state tax laws. Revenue Procedure 2018-38 means that Montana no longer can obtain that information from the IRS. That’s a clear informational injury—the IRS has made it harder for the state to access information that it needs.
The opinion doesn’t delve into the details of when exactly substantial contributor information would be relevant to a tax authority, though the states’ filings do a nice job of providing examples. Here’s a particularly clear one: A business deducts—as an ordinary and necessary business expense—a $10,000 contribution that it says it made to a tax-exempt trade association. Whether the business does or doesn’t appear as a substantial contributor on the trade association’s Schedule B would be very useful to know in a state income tax audit. If the business doesn’t appear on the trade association’s Schedule B, then that should be a bright red flag.
The same standing argument applies to New Jersey, but so does another. New Jersey law requires certain organizations (including a number of 501(c)(4)s) that fundraise in the state to file a “complete copy” of their most recent federal tax returns, including “[a]ll schedules,” with the state attorney general’s Division of Consumer Affairs. That means that if the IRS frees noncharitable exempt organizations from the substantial contributor reporting requirement, New Jersey—unless it changes state law—will no longer receive information that these organizations previously would have reported to the state when they provided copies of their Form 990 filings with Schedule B attached. In response, the New Jersey Division of Consumer Affairs has proposed regulations that would require tax-exempt organizations to supply the state with information that it previously obtained via Schedule B. This regulatory process, according to the court, “has diverted state resources” that could have been directed to other ends if not for the IRS’s revenue procedure. That diversion of resources, the court says, is an additional “injury in fact” justifying New Jersey’s standing to sue.
— Zone of Interests. The court next addresses the zone-of-interests test (formerly known as “prudential standing”), which requires a plaintiff to show that her interest in the case is at least related to the interests that the relevant statute seeks to protect. The test is, as the Supreme Court has acknowledged, “not meant to be especially demanding,” and the district court makes relatively quick work of it. According to longstanding court of appeals precedent, a plaintiff “within the zone of interests of any substantive authority generally will be within the zone of interests of any procedural requirement governing exercise of that authority.” And Montana and New Jersey, the district court concludes, fall well within the zone of interests of section 6103, which “facilitates a century-long policy of information sharing between the IRS and state tax officials.” (A subtle point that administrative law professors and students may appreciate: The court looks to the zone of interests around section 6103 even though the substantive authority invoked by the IRS is section 6033. The court appears to be treating the entire Internal Revenue Code—rather than section 6033 specifically—as the statute that’s relevant to the zone-of-interests analysis. That’s a sensible position, and it helps that both section 6103 and section 6033 were part of the same 1954 statutory enactment. The Supreme Court has given little guidance on this issue. This is a good example of an instance in which the issue matters.)
— Agency Discretion. The district court goes on to consider whether the reporting requirements for exempt organizations are “committed to agency discretion by law,” in which case the Administrative Procedure Act would not provide for judicial review. The court agrees with the IRS that “the substance of its ultimate decision” to require or not require substantial contributor information is “subject to the Commissioner’s discretion.” But the court still may review whether the commissioner “followed whatever legal restrictions applied to his decision-making process.”
— Notice and Comment. Finally, the court comes to the merits of the states’ notice-and-comment claim. The Administrative Procedure Act requires agencies to go through notice and comment before promulgating “legislative” rules, but not before announcing “interpretative rules,” “general statements of policy,” or “rules of agency organization, procedure, or practice.” The court addresses only the first of these exceptions and concludes that it does not apply. The IRS had argued that the revenue procedure “interprets and clarifies” the term “other information” in section 6033. The argument is untenable and the court recognizes it as such. Revenue Procedure 2018-38 does not seek to divine the meaning of ambiguous words in section 6033. It alters the substance of the information that exempt organizations must report.
Bullock is an unusually rich case that could easily consume a day of discussion in an administrative law course. I’ll focus here on the standing and notice-and-comment questions, which I think have the clearest implications for tax.
— Standing. The implications of the court’s standing analysis are potentially broad. Section 6103(d) provides an avenue for states to access a wide range of federal return information—not only information related to exempt organizations. By the court’s logic, states would seem to have standing to challenge any IRS action that meaningfully limits the information that would be available to the states via section 6103(d). In other words, any deregulatory change to reporting requirements would seem to be the subject of a potential suit by a state.
The implications of the district court’s other holding on standing are potentially even broader. According to the court, New Jersey has standing to challenge Revenue Procedure 2018-38 because New Jersey’s own reporting requirements explicitly incorporate federal law, and so when federal law changes, the state has to change its own laws in order to obtain the same information as before. If this argument applies to the collection of information, then it would seem to apply to many other revenue-related actions. As Ruth Mason has noted, most states import the federal definitions of adjusted gross income or taxable income into their state tax laws. This means that any IRS action that reduces taxpayers’ federal AGI or federal taxable income will generally reduce states tax collections. If so, then by the Bullock court’s logic, states would seem to have standing to sue.
That the court’s ruling is broad does not mean that it’s wrong. David Kamin and I make a similar standing argument in our article, “The False Promise of Presidential Indexation,” in which we contend that states would have standing to challenge a potential Trump administration rule indexing capital gains for inflation. But if that’s right (and we think it is), then it opens the door for many more state challenges to IRS actions that reduce revenue collections.
— Notice and Comment. The court effectively deals with the IRS’s dubious claim that Revenue Procedure 2018-38 merely “interprets” section 6033 and is thus exempt from notice and comment. The court doesn’t, though, address the agency’s potentially stronger claim that Revenue Procedure 2018-38 is exempt from notice and comment under the “procedural rule” exception. That turns out to be a difficult question (and a likely focus of an IRS appeal).
The Supreme Court has shed little light on the scope of the “procedural rule” exception. Court of appeals case law on the subject is more extensive. “The critical feature of a procedural rule,” then-Judge Brett Kavanaugh wrote in a 2014 opinion, “is that it covers agency actions that do not themselves alter the rights or interests of parties, although it may alter the manner in which the parties present themselves or their viewpoints to the agency.”
The rescission of the substantial contributor reporting requirement seems to affect the rights and interests of parties. Whether an organization’s option to keep the identities of its donors private is a “right” or an “interest,” it looks like it’s at least one or the other. To be sure, the requirement also alters the manner by which organizations present themselves to the IRS, though that doesn’t seem to be outcome-determinative under Judge Kavanaugh’s “critical feature” test. If an agency action alters the rights or interests of parties and alters the manner in which they present themselves to an agency, then the rule is legislative, not procedural.
Judge Kavanaugh’s “critical feature” formulation is just one among several ways of stating the “procedural rule” test. And rather remarkably, whether tax information reporting requirements are legislative rules or procedural rules is not a question that the courts have yet resolved. The IRS sometimes takes the prudent approach of soliciting comments on proposed changes to the information reporting rules even though courts (before this case) had not told the agency that it needed to. In other cases, like this one, the IRS is not so cautious.
Ultimately, the distinction between legislative and procedural rules is—per the D.C. Circuit—“one of degree,” and “[t]he exception for procedural rules is narrowly construed.” That narrow-construction approach favors the states here, since they are the ones trying to cabin the procedural rule exception’s ambit. But this is almost certainly not the last case that will raise the question of whether tax information reporting requirements must go through notice and comment. (Speaking of notice and comments: 2Ls choosing topics for law review notes and comments might consider this subject as one to pursue.)
Bullock is the most we have heard from any federal court on two important questions in the administrative law of tax: (1) whether a state has standing to challenge the IRS’s relaxation of information reporting requirements, and (2) whether an IRS information reporting requirement is a “legislative rule” that must go through notice and comment. The court’s resolution of these two questions—while not definitive—is at least indicative of how other federal courts might resolve similar issues in similar cases.
Caveats aplenty. The district court’s order—unless it is overturned on appeal—binds the IRS as to this revenue procedure, but it does not create binding precedent for future cases. A different judge with a different jurisprudential orientation might come out a different way on similar issues. (Judge Morris is an Obama appointee, though somewhat atypically for an Obama appointee, he clerked for the not-at-all liberal late Chief Justice William Rehnquist.) Bullock nonetheless points to a potential pathway for states to influence federal tax policy through administrative law litigation. The next post will consider where that path might lead.