Five Years on From Scandal, Tax-Exempt Enforcement In Decline

The 501(c)(4) controversy rocked the IRS, and its aftermath continues to drag down parts of the agency.

Former IRS official Lois Lerner
AP Photo/J. Scott Applewhite
Casey Wooten
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Casey Wooten
April 16, 2018, 8 p.m.

It’s been five years since the IRS grappled with one of its biggest scandals in decades, in which it admitted to targeting certain political groups applying for tax-exempt status. And the fallout from that incident lingers, especially at the agency’s Exempt Organizations division, experts say.

The 2013 scandal put the agency on its heels both financially and administratively. Now, years of funding crunches and staff shortages have led to the agency’s inability to properly enforce rules surrounding 501(c)(4) organizations, the tax-exempt groups at the center of the scandal, said Marcus Owens, a tax lawyer who headed the IRS Exempt Organizations division from 1990 to 1999.

“The IRS seems to have lost the resources to enforce existing law, and it doesn’t really matter which side of the political spectrum it is,” Owens said.

On May 10, 2013, Lois Lerner, then-director of the Exempt Organizations division, told a group gathered at an American Bar Association conference that certain organizations applying for 501(c)(4) status were targeted for additional scrutiny, calling it “incorrect,” “insensitive,” and “inappropriate.”

The revelation broke open a massive firestorm, with conservative groups accusing President Obama’s administration of putting its thumb on the scale against them in the run-up to the 2012 elections. Shortly afterward, the agency’s watchdog, the Treasury Inspector General for Tax Administration, released a report finding that the IRS used “inappropriate criteria” when reviewing tea-party and other groups applying for tax-exempt status based on their names and policy positions, instead of their level of political activity.

The scandal ultimately forced Lerner, acting IRS Commissioner Steven Miller, and others to resign their posts and led to years of GOP animus on Capitol Hill toward the agency. John Koskinen, the IRS commissioner brought in shortly after the scandal broke, became a regular fixture in front of lawmakers investigating every facet of the targeting issue.

President Trump’s choice to replace Koskinen, Charles Rettig, awaits Senate confirmation. House Ways and Means Chairman Kevin Brady told reporters last week that he hopes the new IRS head will have an opportunity to put safeguards in place to prevent future targeting scandals.

But the scandal’s effects remain at the agency and on Capitol Hill. Diminished funding and the managerial exit at the Exempt Organizations division left enforcement of 501(c)(4) groups on the wane, and that’s reflected in the number of audits conducted on tax-exempt groups.

According to annual data from the IRS, there were 15,397 audits of all tax-exempt returns, including from 501(c)(4) organizations, in the 2017 tax year. That’s down from 26,576 returns in 2012, before the scandal broke.

The issue came to the forefront again this month when the Center for Responsive Politics published a report finding that Secure America Now—a 501(c)(4) group backed by hedge-fund billionaire Robert Mercer—reported more than $1 million in political spending to the Federal Election Commission in 2016, while reporting only $124,192 in political spending to the IRS. The discrepancy would likely go unexamined because of the agency’s vague rules and spotty enforcement, the report said.

In speaking to current IRS employees, Owens said that resource-strapped auditors struggle to enforce rules for the 80,000-plus 501(c)(4) groups and other tax-exempt entities such as the more common 501(c)(3) groups, which are charity, religious, educational or similar groups.

“What I hear at some point is, ‘We have no support, we have no clear path for resolving questions that are clearly covered by existing rules, we are forced to close cases at breakneck speed,’” Owens said.

501(c)(4)s are classified as “social-welfare” organizations, and are typically innocuous groups such as volunteer fire departments and civic associations. They may engage in some political activity, though it must not be the group’s primary purpose. The definition of “political activity,” however, is vague, and 501(c)(4) groups generally don’t have to disclose donors.

That’s led groups from across the political spectrum to organize as tax-exempt social-welfare groups—particularly just before election season—to push out “issue ads,” political advertisements that advocate one side of an issue, but may not explicitly endorse a political candidate.

The IRS has tried to clarify its rules surrounding permissible political activity for 501(c)(4) groups in the past. In 2013, the Treasury Department proposed rules that would have created a more detailed definition of candidate-related political activities for social-welfare groups. The proposal was divisive, though, with some non-profit groups like the Council on Foundations saying that it would chill civic-engagement efforts for the charities they represent. Other public-advocacy groups backed the draft rule, which stemmed from the inspector general’s report into the scandal earlier that year.

Republican lawmakers, unhappy with the draft-rule’s language, have inserted provisions into subsequent funding bills that bar the Treasury from advancing the regulation, including the most recent omnibus legislation in March.

And that’s where efforts to rework IRS social-welfare enforcement have stayed, in a legislative limbo with the vast majority of nonprofits simply wanting to follow clear rules, but afraid of stepping over undefined lines, said Emily Peterson-Cassin, coordinator at the Bright Lines Project team at the consumer-rights advocacy group Public Citizen.

Peterson-Cassin pushes for a system of bright-line rules on permissible political activity, as well as safe-harbor provisions for entities trying to conduct basic political activity like voter-registration drives.

“Then you are in a situation where you can know what you can and can’t do, but also a lot of the secret-money type of activity that really is electioneering gets declared as electioneering and pushed into disclosable entities,” said Peterson-Cassin. “You’re supposed to know who’s doing that spending and because of these vague rules right now, we can’t know that.”

Lawmakers are working on a broad, bipartisan bill to restructure the IRS, but it does not address tax-exempt-entity enforcement.

Owens said it may take another crisis to spur Congress into action.

“I think where we are now is, from a standpoint of tax administration, we are just waiting for a huge scandal that will trigger Congress to act to create an efficient oversight mechanism,” Owens said.

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