There was quite a stir in the media this past week surrounding so-called “social welfare” organizations that are exempt from federal income tax under Section 501(c)(4) of the Internal Revenue Code.
Unlike the better-known 501(c)(3) organizations, which are prohibited from engaging in political activities, 501(c)(4) organizations are expressly permitted to take part in lobbying and spending money on electioneering.
In the past, donors to 501(c)(4) social welfare organizations that were engaged in political activities were able to make contributions to the organizations without fear of having the Internal Revenue Service come calling, asking for them to pay gift taxes on their contributions. That may be changing.
There were reports in several media sources last week, including the New York Times, that the IRS has recently sent letters to five individuals who had made donations to 501(c)(4) organizations and who had not filed gift tax returns with respect to their donations.
At present, federal tax law imposes a federal gift tax of up to 35% on taxable gifts, which are generally gifts in excess of $13,000 per year per gift recipient. So, for example, if a wealthy political donor makes a gift of, say, $1 million to a social welfare organization that has the same political leanings as the donor in order to permit the organization to fund political advertisements, the donor might well find himself receiving a tax bill for hundreds of thousands of dollars as the price for his political involvement and largesse.
From a politically minded donor’s perspective, 501(c)(4) organizations have offered significant advantages–donations to 501(c)(3) organizations cannot lawfully be used in political activities, but donations to 501(c)(4) organizations can be so used, and the donor can make his contribution with anonymity as a 501(c)(4) organization is not required to disclose who it donors are. Up until now, the IRS has not sought to impose gift tax liability on contributions to 501(c)(4) organizations, but the recent attempt by the IRS to do so may very well significantly chill large donations to social welfare organizations, just as the 2012 presidential campaign is getting set to ramp up in a big way.
The IRS, in a statement last Thursday, denied that any outside influence was involved in the decision to undertake the gift tax enforcement action being taken, indicating that the action was merely part of its obligation to enforce compliance with federal tax law requiring the filing of gift tax returns when taxable gifts had been made.
Larry M. Elkin of the Palisades Hudson Financial Group, LLC, in a posting today (http://palisadeshudson.com/2011/05/irs-rattles-a-gift-tax-saber/) on that group’s blog, makes the point that it may not be a slam-dunk for the IRS in this instance. Whether donations to 501(c)(4) organizations are even gifts in the first place, or whether there are constitutional or policy grounds that a court might find to turn aside the IRS’s attempt to impose a gift tax on such donations are questions that only lengthy and presumably hotly contested litigation would be able to resolve. The Catch-22 conumdrum for the wealthy political donor is this: should he pay the tax and retain his anonymity, or should he fight the government in court and gift up his status as a secret donor.
In the big picture, although the donors who are under scrutiny by the IRS at present are certainly not going to be happy to be the target of the IRS’s new enforcement action in this arena, the bigger story is certainly going to be the impact on those who would have given money to 501(c)(4) organizations but choose not to do so because of the risk of getting a not-so-friendly letter from the IRS.