WASHINGTON -- As the Internal Revenue Service began to use broad search terms like "tea party," "patriot" and "9/12" to target groups seeking tax-exempt status in March 2010, the agency was already facing a major crush of applications for exemption under section 501(c)(4) of the tax code.
As Lois Lerner, director of the IRS' exempt organizations division, explained to a Washington crowd of tax lawyers on May 10 during her initial apology for inappropriately focusing on conservative groups, "[B]etween 2010 and 2012, we started seeing a very big uptick in the number of 501(c)(4) applications we were receiving." The number, she said, "more than doubled -- about 1,500 in 2010 and over 3,400 in 2012."
This increase came after two major Supreme Court decisions -- Federal Election Commission v. Wisconsin Right to Life in 2007 and Citizens United v. FEC in 2010 -- opened the door for 501(c)(4) groups to engage in increasing amounts of political activity.
"There's a pretty direct link between the Citizens United line of cases and why the IRS is put in this position," said Rick Hasen, an election law professor at the University of California-Irvine, "although it does nothing to explain how the IRS decided to deal with this problem."
The Supreme Court rulings undid a string of campaign finance regulations and opened up loopholes for groups to avoid disclosure. The tax-exempt 501(c)(4) nonprofit, which can accept unlimited contributions from any source and whose donors can be kept secret, became the primary vehicle for operatives looking to engage in politics with "dark" money. The number of applications for 501(c)(4) status spiked, thrusting the IRS into a precarious position of overseeing partisan politics in a way that it had never done before.
"It's just another example of just the inability of the IRS to really enforce what are really political election campaign regulations," said Ofer Lion, a lawyer who works with tax-exempt organizations at Hunton & Williams. "These are career civil servants down in the IRS basement somewhere without adult supervision trying to deal with problems they don't know how to deal with."
The main problem is the need for the IRS to review partisan political activity, which has been strictly limited for tax-exempt organizations since 1954. While 501(c)(4) groups are allowed to engage in some political activity, including running partisan advertising, it cannot be their primary purpose. In its review process, the IRS examines whether a group is seeking tax exemption for inappropriate reasons like personal gain or, the current concern, improperly engaging in politics.
Ever since the Citizens United decision, IRS officials in Washington have been under pressure from both Congress and campaign finance reform groups to step up their regulation of 501(c)(4) groups. Nonprofit groups spent more than $100 million on political activities in the 2010 election and more than $300 million in the 2012 election, according to the Center for Responsive Politics.
Democratic lawmakers sent letters demanding action from the IRS in reviewing groups like Crossroads GPS, a 501(c)(4) nonprofit founded by Karl Rove that engages in a large amount of political activity, including running so-called issue ads that it claims are not electoral advocacy. Campaign finance reform groups asked the IRS to reject the 501(c)(4) applications of Crossroads GPS, the Democratic group Priorities USA and the independent Americans Elect. The agency's review of these larger organizations appears to be ongoing.
The IRS dealt with the bulge in 501(c)(4) applications by deploying a number of routine tools it uses for issues that it deems worth more attention. Reviews were centralized in one office, increasing efficiency and allowing the agency to give the groups broader scrutiny. This practice has been used for other entities seeking tax exemption, Lion noted, including charter schools and carbon tax credit trading associations.
The IRS also used search terms to quickly identify applications that appeared to come from the type of organization that might be inappropriately political in nature. Such shortcuts are a common agency practice to sweep up groups for review where a large number of them might not meet an exemption test. The best-known use of shortcuts came when the IRS used broad search terms to identify credit and mortgage counseling nonprofits that were potentially fronts for banks.
The problem appears to be in how those tools were deployed to get a handle on the flood of applications for 501(c)(4) status.
"Lois Lerner left me with the impression that the agency, at least at the lower staff level, was at least overwhelmed by the number of applications that they had to process, and they came up with some shortcuts to handle the processing of these applications and made some pretty big mistakes in how they developed those shortcuts," said Paul S. Ryan, a lawyer at the Campaign Legal Center, a campaign finance watchdog group.
"They can be very useful tools, but they're only tools and they're not perfect tools," Charles Watkins, a tax lawyer at Webster, Chamberlain & Bean, said. "But more to the point, in this particular context, it was an unfortunate choice of terms because it suggests that the IRS was only looking for a certain kind of conservative organizations, even though it was pretty clear to everyone that there are liberal organizations that seem to be doing pretty much the same thing."
What is not immediately clear is the reason the IRS used search terms like "tea party" and later changed its search to groups advocating for "limiting/expanding government" and "social economic reform/movement." Were these groups targeted for explicitly political reasons, or was this political tone-deafness from an agency thrust into policing electoral activity?
"If that was political tone-deafness downstairs, people upstairs should have been acutely aware of that," Lion said.
Now, campaign finance watchdogs are worried that outrage over how the IRS handled past reviews of groups applying for 501(c)(4) status could stymie any further review of those improperly seeking or acting under 501(c)(4) status.
"The politics of this incident will seemingly make it more difficult for the IRS to do that job, and that is truly unfortunate," Ryan said.
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