Conflicting Laws, Regulations Feed IRS Confusion

Article excerpt

Byline: Associated Press

WASHINGTON -- The uproar over the Internal Revenue Service's heavy-handed treatment of conservative groups seeking tax-exempt status can be traced partly to when New York University Law School went into the noodle business.

The 1947 episode -- more on that later -- helped produce conflicting laws about activities tax-exempt organizations may conduct. The IRS' attempt to enforce those laws with vague regulations has sown more confusion, tax lawyers, former agency officials and others agree.

"It's hard for groups to understand what the standards are, and different lawyers have different definitions of where to draw the line," said Abby Levine, who dispenses advice on nonprofit status to scores of groups as legal director of the liberal Alliance for Justice.

While no one interviewed by The Associated Press for this story defended the IRS' targeting of tea party and other conservative groups, no one disputed that the rules governing political activities by tax-exempt organizations are hard for everyone to follow, including the IRS. With one law saying some tax-exempt groups must engage "exclusively" in social welfare work, while a regulation changes the threshold to "primarily," President Barack Obama said last month that the result is "a bunch of ambiguity."

In the spotlight is a section of the tax code that has become increasingly attractive to many organizations in recent years, 501(c)(4), which grants tax-exempt status to so-called social welfare groups. Over the years, such groups have been allowed to participate in overt political activity as long as they focus mostly on social welfare work. While many of them engage in little or no political activity, for those involved in politics the designation offers a valuable feature: It lets donors remain anonymous.

After the Supreme Court in its 2010 Citizens United decision allowed unfettered political spending by companies and unions, campaign spending by social welfare groups exploded. Between the 2008 and 2012 elections it tripled, to $254 million, according to the nonpartisan Center for Responsive Politics, which tracks political expenditures.

The IRS received 3,357 applications for Section 501(c)(4) status last year, nearly double the number in 2010, according to the Treasury Department.

The story behind the confusion began a century ago, when Congress enacted legislation laying the groundwork for the modern income tax.

Exempted from the corporate income tax were nonprofits, including those "operated exclusively for the promotion of social welfare" -- the designation that many conservative groups have sought in the current controversy. An IRS history of tax-exempt organizations says it is assumed that provision in the 1913 law was requested by the U.S. Chamber of Commerce.

Fast forward to 1947, when wealthy graduates donated the C.F. Mueller Co., a pasta maker, to the NYU law school. That transaction, and a court ruling letting NYU keep its Mueller profits tax-free, helped call attention to the tax treatment of nonprofits.

NYU and other nonprofits had been fattening their coffers through ownership of factories, department store chains, cattle ranches, the Encyclopedia Britannica and other profitable businesses on which they were not paying taxes.

Urged on by President Harry Truman, Congress passed a law in 1950 allowing some nonprofits to keep unrelated businesses if they paid income tax on them.

But that left federal laws stating two things: a 1913 statute saying groups must operate "exclusively" for social welfare purposes and the 1950 law saying they could do unrelated things after all, as long as they paid taxes on the profits. …