Beyond Lerner: Fixing the IRS Interaction with Nonprofits

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Internal Revenue Services

September 5, 2014; USA TODAY

It is beyond debate that the controversy surrounding the Internal Revenue Service’s review of 501(c)(4) applications is missing the point. Last week’s report released by the Senate Permanent Subcommittee on Investigations found the IRS rent with mismanagement, poor communication, and inappropriate questioning of 501(c)(4) applicants. Contrary to the findings of the Treasury Inspector General for Tax Administration and contrary to the continuing focus of the House Committee on Oversight and Governmental Reform, the Senate report concluded that liberal groups often received the same inappropriate treatment by IRS reviews as conservative groups did, suggesting that the IRS looked for political triggers such as “ACORN,” “Occupy,” and “Progressive” like they looked for words such as “Tea Party,” “9/12,” and “Patriot.” Republicans countered in a dissenting report that more than four-fifths of the investigated groups were Tea Party and other conservative groups.

The tit-for-tat back and forth between Congressional Republicans and Democrats isn’t taking this controversy very far toward a productive end. If Lois Lerner and her colleagues were guilty of going rogue on reviews of 501(c)(4) applications, legal and administrative actions should be taken. But the personal culpability of Lerner and others is in some ways a complete side issue that is taking the attention of Congress and the American public away from the underlying core issues.

Potentially explaining the shoddy review and shortcuts of Lerner and her colleagues is a historically underfunded tax-exempt division at the IRS. This issue has finally been picked up recently by a number of outlets calling for increased funding for the tax exempt division of the IRS, but Nonprofit Quarterly has been raising this issue from long before the Lerner imbroglio—with specifics. The budget and staff levels for the tax-exempt unit have shrunk over the years while the nonprofit sector and the regulatory oversight challenges it presents have increased. Unbelievably, House Republicans have responded with efforts to punish the unit by further cutting its budget, though truth be told, there is generally little enthusiasm from either political party for putting money into the IRS in general, much less its tax-exempt division.

Our call has been to free the tax-exempt unit from being punished and starved by Congress by dedicating the private foundation excise tax, a funding source originally meant to pay for oversight of the sector, to the IRS’s tax-exempt unit, potentially even boosting the operations of state charity officers that oversee nonprofits at the state level as well. In fact, we made that point in Congressional testimony while other national organizations were either sidestepping the issue entirely or calling for the tax-exempt unit to be funded by imposing new fees on struggling nonprofits. Guaranteeing adequate funding for the tax-exempt unit at the IRS would not only help address the miscues and malfeasance that appear to have occurred in the reviews of the 501(c)(4) applications, but also shortcomings in the reviews and oversight of 501(c)(3)s and other 501(c) organizations that are within the tax-exempt unit’s purview.

Substantial funding goes into federal coffers through the private foundation excise tax, currently a two-tiered tax of 1 percent or 2 percent on private foundations’ net investment income. The amounts are far in excess of what the tax-exempt unit has been appropriated in the past—hundreds of millions of dollars, easily enough to put the tax-exempt division on the path toward sufficient resources and staffing for its mandated nonprofit oversight functions.

That still leaves out two important elements of a necessary fix for the tax-exempt unit. First is quality management. It is sad to say, but the Lerner imbroglio lays bare problems of management and oversight within the IRS. Whatever the pros and cons of the TIGTA report, one has to ask: Where was the Inspector General before Lerner’s acknowledgement (in response to a question at an American Bar Association meeting in May of 2013) that her unit had used names such as Tea Party, etc. to select 501(c)(4) applicants for special review, which she characterized as “wrong…[and] absolutely incorrect, insensitive, and inappropriate”? If this had been happening for a long time, it would appear that the IRS managers above Lerner and her colleagues, not to mention the IG, were missing in action. The tax- exempt unit deserves high quality management—because the nonprofit sector deserves high quality oversight from the Service.

The other missing element, of course, is clarification of the regulations that determine what is or isn’t a “political” nonprofit where electoral political activities outweigh their 501(c)(4) social welfare functions. The IRS has already tried and stumbled with an effort to generate clearer regulations and rules on political nonprofits, generating more public comments on a tax regulation than ever in history. Most of the comments were aimed at the IRS’s overly inclusive definitions, compelling the Service to rethink its framework. But the IRS should be encouraged to proceed and not be dissuaded by opponents that view any constraints on nonprofit political activity as wrong. The Bright Lines Project is just one of a number of groups that have generated thoughtful approaches to revised 501(c)(4) regulations worthy of review and adoption, clarifying what 501(c)(4)s should be permitted to do, but also protecting vital—and legal—501(c)(3) activities, such as political advocacy, lobbying, and nonpartisan voter registration and get-out-the-vote functions.

The answers are there for the IRS as an agency. Lois Lerner is just one person who, if she did something or directed other people to do things in contravention of the law, should be prosecuted—perhaps, as we have recommended in the past, by an independent counsel who would take this issue out of the hands of congressional committees. However, fixing the IRS itself requires more than congressional committees debating which political side received greater or lesser targeting by the review process acknowledged by Lerner in 2013. It requires adequate funding of the tax-exempt unit which has been starved for financial and staff resources over most of its history, ongoing quality management and oversight (including from the TIGTA), and clearer and stronger rules and regulations concerning the definitions and operations of 501(c)(4) social welfare organizations.—Rick Cohen