The real IRS scandal

It’s strange how “scandal” gets defined these days in Washington. At the moment, everyone is screaming about the “scandal” of the Internal Revenue Service scrutinizing conservative nonprofits before granting them tax-exempt status.

Here are the genuine scandals in this affair: Political organizations are being allowed to masquerade as charities to avoid taxes and keep their donors secret, and the IRS has allowed them to do this for years.

The bottom line first: The IRS hasn’t done nearly enough over the years to rein in the subversion of the tax law by political groups claiming a tax exemption that is not legally permitted for campaign activity. Nor has it enforced rules requiring that donors to those groups pay gift tax on their donations.

The organizations at issue are known as 501(c)4 groups (call them C4s for short) after the section of the tax code that applies to them. They’re nonprofit “social welfare” organizations that by law must be devoted primarily to programs broadly serving their communities, not private groups. IRS forms reveal what the agency considers to be mainstream C4s: religious groups; cultural, educational and veterans organizations, homeowners associations, volunteer fire departments. In recent years, however, overtly political groups have been claiming C4 status, which allows them to keep their donor lists secret and to avoid paying taxes on certain income.

Our lunatic campaign finance system is what turned the typical C4 from a volunteer fire department into a conduit of anonymous political cash. Big donors were given the green light to spend freely on elections by the Supreme Court’s 2010 Citizens United decision. That wasn’t good enough for some; they wanted to distribute their largess secretly.

C4s were there for the exploitation, and the result has been a wholesale decline of donor disclosure on the national level: As recently as 1998, nearly 100% of all donors to federal campaigns were publicly identified, according to the Center for Responsive Politics, a campaign finance watchdog group. By the 2012 presidential election, that was down to 40%.

The beneficiaries of the C4 tax break, understandably, will employ any subterfuge to keep it. That’s what’s behind the current firestorm over disclosures that in 2010 and 2011, IRS personnel screened requests for C4 status by applicant organizations with “tea party,” “patriot” or “9/12” in their names.

Those weren’t the only groups whose applications were selected for extra scrutiny on the reasoning that they might be devoted to more than “social welfare.” According to an IRS Inspector General report made public this week, they represented only about a third of the 298 applications selected. That was certainly too coarse a screen, and by January 2012 the IRS had scrapped those definitions. It had substituted a screen designed to capture “political action type organizations involved in limiting/expanding government, educating on the constitution and bill of rights, [and] social economic reform/movement.”

Conservatives contend that this is still an anti-conservative screen. It sounds perfectly neutral to me, unless someone knows of a conservative organization devoted to “expanding government,” or unless right-wing groups are supposed to have a monopoly on “social economic reform.” In any case, the inspector general found that most of the 298 selected applications indeed showed indications of “significant” political activity that might have made them ineligible for the tax exemption.

It’s about time the IRS subjected all of these outfits to scrutiny. The agency’s inaction has served the purposes of donors and political organizations on both sides of the aisle, and contributed to the explosive infection of the electoral process by big money from individuals and corporations.

Nor is Congress innocent. The lawmakers have dodged their responsibility to make the rules crystal clear. On the rare occasions when the IRS has tried gingerly to impose regulatory order, members of Congress have forced the agency to back off. There should be a rule in Washington that if you give regulators deliberately vague guidelines, you’re not allowed to protest when they try to figure out where the lines are.

Thanks to ambiguity about what it means to be “primarily” concerned with “social welfare,” political activists have reaped a bonanza for years while the IRS ignored their chicanery. And once again, now that the agency has tried to regulate, the regulated parties have blown its efforts up into a “scandal.” It’s amusing to reflect that some politicians making hay over this are the same people who contend that we don’t need more regulations, we just need to enforce the ones we have. (Examples: gun control and banking regulation.) Here’s a case where the IRS is trying to enforce regulations that Congress enacted, and it’s still somehow doing the wrong thing.

Keep that in mind when you hear politicians — and they’re not exclusively Republicans — grandstanding about how the IRS actions are “chilling” or “un-American.” It turns out that none of the “targeted” groups actually was denied C4 status. Nevertheless, says Sheila Krumholz, director of the Center for Responsive Politics. “There’s a sense of discomfort that the IRS was doing much of anything.”

The IRS wasn’t actually doing much. The biggest C4s, including one founded by GOP operative Karl Rove and another run by ex-Obama campaign staffers, got their C4 status routinely. The little guys got questionnaires.

C4s are curious creatures in the tax code. They’re allowed to engage in lobbying, but not (“primarily”) in campaign activity. Their donors don’t get a tax deduction, but the organizations are tax-exempt. For example, they don’t have to pay taxes on income they earn by investing donated funds. But what makes C4s especially attractive to people who want to funnel money into politics is this: They don’t have to identify their donors.

Remember the mysterious $11-million donation to the campaign for California’s anti-union Proposition 32 last November? When the state Fair Political Practices Commission punctured its anonymity, it found not one, but two 501(c)4 organizations behind it. The FPPC, which is still investigating, has already called this a case of “campaign money laundering.”

As of September last year, the center found, some $254 million, or 20%, of all outside spending came through C4s. The biggest C4 in the electoral arena was Crossroads GPS, an affiliate of American Crossroads, a campaign organization founded by Rove. The Obama camp’s C4 was known as Priorities USA.

The IRS was swamped by the wave. The number of groups seeking C4 status from the agency rose from 1,500 in 2010 to 3,400 last year. Meanwhile, the agency was being pulled in two directions. In February last year, seven Democratic senators complained that the IRS was too “permissive” with its rules, which judged a C4 not to be engaged “primarily” in electioneering as long as no more than 49% of its spending went to such activities. In August, 10 GOP senators warned the agency to deep-six any efforts to tighten the rules on C4s.

Already in 2011, an IRS disclosure that it was auditing five big donors to determine whether they owed gift taxes for donations to C4s had caused a political uproar. (The gift tax can be up to 35% of a donation in excess of $14,000 per recipient and a $5.25-million lifetime exemption, paid by the donor.) GOP lawmakers accused the IRS of “targeting constitutionally protected political speech.” As Ellen Aprill, a tax law expert at Loyola Law School, observed later that year, “at that point, the IRS threw in the towel” — even though there was little doubt that the tax levy was proper and plainly constitutional.

The danger inherent in the latest faux controversy is that the IRS will have its wings clipped before its investigation of C4s is fully fledged. Politicos and pundits are in a lather over the questions the agency put to targeted organizations to determine their social welfare bona fides — things like the identity of their board members and the amount of time and money spent on “electoral issues,” and endorsements of candidates. These facts would be pretty fundamental to determining whether an organization is political, wouldn’t you say?

The IRS also asked some groups for the identity of their donors. The inspector general contends that request was inappropriate. Still, if the IRS discovered that a major donor to a C4 was, say, the politically active billionaire Sheldon Adelson, wouldn’t that suggest that the group might not be a plain vanilla “homeowners association”? By the same token, when the pro-Obama C4 Priorities USA disclosed that it had five anonymous donors, one of whom contributed $1.9 million, or 84% of the total, wouldn’t it help an investigator to know who that person is?

Let’s remember that a tax exemption handed over to any group costs all of us money. It’s proper for the IRS to scrutinize applicants. The biggest laugh line uttered in this affair is that the IRS is somehow “harassing” these public-spirited organizations by asking them to justify their status. Here’s a good rule of thumb: You don’t want to get harassed by the IRS? Then don’t claim a tax exemption you may not deserve.

Michael Hiltzik’s column appears Sundays and Wednesdays. Reach him at [email protected], read past columns at latimes.com/hiltzik, check out facebook.com/hiltzik and follow @latimeshiltzik on Twitter.