IRS Controversy: What is a 501(c)(4) anyway?

Allegations of inappropriate IRS investigations of the tax status of “tea party” groups have put so-called 501(c)(4) groups in the headlines. Section 501 of the U.S. Internal Revenue Code (i.e. Title 26 of the U.S. Code) identifies many types of organizations exempt from most federal income taxation (with exceptions provided by certain other sections of this sub-chapter of the Code). Sub-section 501(c) lists out the types of exempted organizations. 501(c)(3) is the most well-known of these, and covers non-profit corporations including many charitable, religious, and educational institutions. Until recently 501(c)(4) has received far less public, political, or non-specialist legal attention. 501(c)(4) exempts “civic leagues or organizations not organized for profit but operated exclusively for the promotion of social welfare” or certain kinds of local employee organizations.

Part of the background to the controversy is that there was an increase in groups seeking such taxpayer status during the relevant period. The Supreme Court, in Citizens United v. Federal Election Commission, 558 U.S. 310, had ruled that corporate entities could not constitutionally be prohibited from using unlimited amounts of general funds to pay for political speech (i.e. advertising and organizational efforts). While the Citizen’s United Court indicated that disclaimer and disclosure requirements could pass constitutional muster, as could caps on funds given directly to candidates, it invalidated spending restrictions as impermissible restraints on corporate political speech.

But why 501(c)(4)?

In the wake of Citizens United, a large number of new fund-raising entities were formed. Many were so-called “super PACs” organized under Section 527 of the tax code, which provides the tax rules for explicitly-defined political organizations. Others (as is Citizens United itself) were 501(c)(4) “social welfare” organizations. Both are tax exempt organizations, but 501(c)(4) groups do not have the same requirement as 527 groups to disclose donations. Note that Citizens United did not change the fact that some types of non-profit organizations (such as those organized under 501(c)(3)) could endanger their tax-exempt status by participating directly in political advocacy. But although the literal statutory language says that 501(c)(4) groups are to be devoted “exclusively” to social welfare, they have long been permitted to engage in some level of political activity. In combination with the absence of 527-like disclosure requirements, this makes them a potentially appealing conduit for political spending.

501(c)(4)s are also not allowed to be primarily engaged directly in electoral politics, but they may educate the public about issues with political dimensions. IRS rulings and interpretations have long allowed 501(c)(4) “social welfare” organizations to engage in some level of political activity while retaining tax-exempt status. Arguably, the rise in 501(c)(4) groups reflects a combination of a looser regulatory bar on explicitly-political activities than is applied to 501(c)(3) organizations and a looser standard for disclosure than applies to 527 groups. Given that the tax liabilities avoided by most groups may be fairly small, there is a widespread sense that avoiding disclosure is a key feature of these organizations.

Primary Sources

Title 26 of the United States Code comprises the Internal Revenue Code.

26 USC 501, subsections (c) and (d), describes types of organizations that are tax exempt except as provided under §§ 502 and 503. 26 USC 527 defines political organizations and also includes provisions regarding the taxability of political activities of § 501(c) organizations.

Regulations adopted by T.D. 6391 and amended in 1990 by T.D. 8308 (55 FR 35588) permit political “action” organizations to be organized as 501(c)(4) organizations, even while reiterating that their tax-exempt social welfare purpose does not include “direct participation in political campaigns.” Treas. Reg. §1.501(c)(4)-1 (26 CFR 1.501(c)(4)-1)). Treas. Reg. §1.501(c)(3)-1(c)(3)(ii) (26 CFR 1.501(c)(3)-1(c)(3)(ii)) defines such “action” organizations and bars them from 501(c)(3) status.

Selected Recent Articles of Interest

Disclosure Issues

Lloyd Hitoshi Mayer, Nonprofits, Politics, and Privacy, 62 Case W. Res. L. Rev. 801 (2012).
Outlines the intersection of different disclosure regimes from general tax law, the law of tax-exempt organizations, and election law.
Andrew C. Byrnes and Cortlin H. Lannin, I Went Down to the Crossroads: Lifting the Blindfold About the Origin of 501(c)(4) Political Advertisements,” 46 U.S.F L. Rev. 481 (2011).
Seeks to clarify the working of these entities through an evaluation of the relationship between American Crossroads (a 527) and Crossroads GPS (the affiliated 501(c)(4)).
Donald B. Tobin, Campaign Disclosure and Tax-Exempt Entities: A Quick Repair to the Regulatory Plumbing, 10 Election L. J. 427 (2011). Also available as a working paper from the Center for Interdisciplinary Law and Policy Studies, Moritz College of Law, http://ssrn.com/abstract=1920269 (2011).
Argues for clarifying regulation and new procedural requirements for 501(c)(4)s. In particular, the article seems to anticipate the current scandal regarding IRS scrutiny of these groups.
Richard Briffault, Nonprofits and Disclosure in the Wake of Citizens United, 10 Election L. J. 337 (2011).
Anticipates the widespread use of 501(c)(4) and 501(c)(6) intermediaries by business corporations interested in electoral activity.