Nonprofit Accounting Basics

501(c)(4) Organizations and the IRS: A Little Background on the Controversy

Note: Articles published before January 1, 2017 may be out of date. We are in the process of updating this content.

The IRS Exempt Organizations group (EO) has admitted to at least some inappropriate targeting of politically-conservative Section 501(c)(4) organizations in the exemption application process. We have already seen the resignation of the IRS Acting Commissioner, and the head of EO being placed on administrative leave and pleading the 5th before Congress. In this article, we will discuss why the IRS is so interested in 501(c)(4)’s with political agendas.

501(c)(4) organizations are defined in the Internal Revenue Code as “civic leagues or organizations not organized for profit but operated exclusively for the promotion of social welfare.” This is a fairly broad definition and has been used by a wide variety of organizations with a very wide range of agendas for “social welfare.” The primary differences between these organizations and charitable organizations are important: (1) Donations to 501(c)(4) organizations are not deductible as charitable organizations; (2) 501(c)(4)’s can engage in unlimited lobbying activities (charities are limited); and (3) 501(c)(4) organizations may engage in political activity as long as it is not their primary purpose. 501(c)(3)’s, on the other hand, are strictly prohibited from any level of political activity.

In 2010, the Supreme Court, in its decision in Citizens United v. Federal Election Commission, struck down provisions of the McCain-Feingold Act which prohibited corporations (including nonprofit corporations) from making independent expenditures and electioneering communications. It was quickly realized that 501(c)(4) organizations would be ideal vehicles for politically-motivated groups to utilize for fundraising and to engage in a variety of political activity including political advertising in print and on television. This activity is not regulated by the Federal Election Commission, an agency with many rules and public disclosure requirements for traditional political organizations such as political parties, election committees, and Political Action Committees (PACs). A key disclosure avoided by 501(c)(4)’s is any public disclosure of donor identities. Although these organizations have to list donors on their Form 990s, these lists are redacted on public disclosure copies. Corporations and individuals can give unlimited amounts to these organizations without being identified as supporters.

So, it did not take long for hundreds of new 501(c)(4) organizations to sprout up. These entities came from across the political spectrum – from extremely conservative to extremely liberal. It appears significant political expenditures were made by these organizations in subsequent national, state, and local campaigns.

These new 501(c)(4)’s caused a lot of concern at the IRS. A couple of obvious issues were the basis of this concern: (1) Was political activity the primary purpose of these organizations? (2) Were they organized to primarily benefit a private party (such as a candidate or committee), something which is prohibited for 501(c)(4) organizations?

The IRS, in several announcements and speeches by EO leadership, expressed these concerns and said it would be taking a hard look at exemption applications by these organizations as well as examining a number of them through the audit process. The Form 1024 exemption application filed by non-charitable organizations requires a significant amount of information about the organization including programs and activities, lobbying and political activity, officers, board members and key employees, sources of support, and prospective financial information.

Thus, it should have been no surprise that exemption applications from politically-connected 501(c)(4) organizations received a significant amount of scrutiny from IRS reviewers. It is not uncommon for any exemption application to be delayed by the IRS until the government has gotten enough information from the organization to be assured the organization does indeed qualify for exempt status. Since the IRS had expressed concerns about these organizations, significant correspondence from the IRS about the applications should have been expected.

However, if conservative organizations were targeted with increased scrutiny and liberal organizations were not, then an obvious bias was being shown by the IRS. If there was a bias, it is unclear as to where the bias was originating. Congress will be digging into this with a series of hearings and some answers should be forthcoming.

We will have to wait and see what emerges from testimony at the hearings. One thing is certain: this has caused a serious shake-up with the IRS EO group. How it comes out of the situation will be interesting to see. It is likely more oversight will be forthcoming in the exemption application process and an already lengthy process will take even longer.

Stay tuned!