Over the last week, commentators have expressed great outrage over the handling by the IRS of applications by Tea Party groups and others for 501(c)(4) status. In the haste to trigger the next administration-crippling “gate,” these analyses have largely ignored one of the most surprising aspects of this entire episode—that the IRS was actually trying to do its job.
A little context is warranted. There are more than 1.5 million nonprofit organizations in this country, a number that reliably grows by more than 50,000 each year. It’s an incredibly important sector of our economy—not just because it represents more than $1.5 trillion in annual revenues and close to 15 percent of the American workforce, but also because nonprofits dominate critical fields such as education, health care, social services, arts, and, yes, politics. Yet, despite the critical nature of these organizations and their services, the Exempt Organizations Division, the group within the IRS charged with regulating the field, plays only the most passive of roles with respect to the nonprofit sector.
How passive? The approval rate for applications to form public charities (and charities account for more than two thirds of the nonprofit sector) stands in excess of 99.8 percent. It takes little more than a reasonable facility with government forms, a small check, and the patience to wait a few months to start a federally approved charity. And the problem has only grown worse in recent years, as the IRS budget and staffing have been repeatedly pruned (by more than $1 billion) and the number of applications for nonprofit status has continued to surge. The IRS’s role in the review process is almost entirely ministerial: a quick review of forms, a flurry of stamps and signatures, and a letter of endorsement.
That has led to some truly astonishing results: charitable status has been granted to the Renegade Rollergirls in Bend, Oregon; the All Colorado Beer Festival; and the Sugar Bowl, just to mention a few. The issue is of significant dimensions. The tax-privileged status of nonprofits, including the enormously profitable $650 billion-a-year charitable hospital industry, costs federal, state, and local government tens of billions of dollars annually in lost income from charitable deductions, income-tax exemptions, and property-tax abatements.
It is thus a rather extraordinary development that the IRS roused itself to carefully scrutinize a significant number of applications for 501(c)(4) status.
And it had good reason for doing so. As it has now been widely reported, the definition of “social welfare” organizations has historically meant civic leagues, employee organizations, or issue groups such as the Sierra Club, groups that have little in common with the plainly political and electoral goals of the Tea Party Movement and Karl Rove’s Crossroads GPS. Congress long ago created a category for politically oriented groups under code provision 527. Just as with 501(c)(4) groups, political groups organized under Section 527 are tax-exempt, but unlike 501(c)(4) nonprofits, these groups have significant transparency and disclosure requirements. The Citizens United decision engendered a land rush for these groups seeking nonprofit status as 501(c)(4) organizations, with the sole purpose of avoiding the congressionally mandated donor-disclosure requirements of Section 527.
Though 501(c)(4) organizations are barred from a certain scope of political activity, it is quite possible that many of these groups would qualify due to the very restricted definition of political activity imposed by the courts—though it strains credibility to think that any Karl Rove (or Jim Messina, for that matter) organization would be properly thought of as nonpolitical. Nonetheless, it is a critical responsibility of the IRS to make sure that politically motivated groups seeking to avoid the congressionally created disclosure requirements (really the last piece of federal campaign-finance rules to survive Citizens United) meet all the tests of 501(c)(4) status. The fact that IRS staffers were willing to do more than look behind simple paper applications and test the veracity of claims is nothing more than government doing its job.
So good for the IRS for rousing itself from its long slumber.
Yes, they screwed up badly, maybe because their investigative skill set is so rusty from disuse. Their failure was not that they scrutinized too hard or too many, but that they scrutinized too few. If the IRS had more evenhandedly and more widely reviewed applications for 501(c)(4) status, this would have been a singularly worthwhile effort. Instead it has been a disaster for the IRS and the Obama administration. And there are implications here that extend beyond this specific case and beyond partisan politics.
In the best of all possible worlds, the congressional hearings, the very public resignations, and the ritual floggings on Meet the Press would encourage the IRS to continue to investigate thoroughly, but just in a more evenhanded fashion. It won’t work that way. The tax bureaucracy will become even more cautious, more reluctant to stick its neck out, more likely to rubber-stamp ever more applications—legitimate or not. That may be good for someone, but it will be bad for anyone who wants a well-regulated nonprofit field not pockmarked and diminished by fraudulent, miscategorized, and ineffective organizations.