Did the IRS illegally target the Tea Party? Seven questions answered.

The IRS is under investigation for illegally targeting the Tea Party and other conservative groups. Steuerle offers answers to seven basic questions about the IRS Tea Party scandal.

To help clarify  whether IRS incorrectly, unfairly, or illegally targeted the Tea Party and other conservative groups, here are the  answers to a few basic questions.

1. Is it improper for IRS to target specific groups? 

   Almost every contact the IRS makes with select taxpayers derives from targeting. Because  its  resources are constrained, the IRS conducts only limited audits, examinations, or requests for information. For instance, if you give more than the average amount to charity, you’re more likely to be audited since there is more money at stake. If you run a small business, you have a greater ability to cheat than someone whose income is reported to IRS on a W-2 form. The only way  the IRS can  enforce compliance at a reasonable administrative cost is by targeting.

   This is especially true for the tax-exempt arena. Because audits yield little or no revenue, the IRS tax-exempt division examines very few organizations. Therefore, the IRS  must use some criteria to “target” which tax-exempt organizations to approach. 

2. Does the IRS discriminate?

   Picking out which organizations or taxpayers to examine meets the definition of statistical discrimination. Firms do this when they consider only college graduates for jobs; political parties do this when they offer selective access to their supporters. Discrimination is wrong when it implies unequal treatment under the law, such as when unequal punishment is meted out for the same crime, or when people of color have less access to the mortgage market.

3. Why then did IRS say it erred in targeting Tea Party and other organizations?

   We don’t have all the data yet but organizations with a strong political orientation have a higher probability of pushing the borderline for what the law allows. The groups at the center of this controversy  generally applied for exemption under IRS section 501 (c)(4) which requires, among other things, that its primary purpose cannot be election-related and cannot overtly support political candidates.

   However, the IRS could have  identified  election-related activity as a  practice  worthy of extra attention without  specifying  “tea party” or similar labels to identify such organizations. Had it done so, it might not be facing  a problem now.

   IRS apparently initially thought it was just using these labels as a shortcut for such an identification. Had it been engaged early on, the national office might have been quicker to warn against this practice since it would tend to identify more Republican organizations than Democratic groups with similar motives. Who decided what when is still under investigation.

   Remember  IRS was under pressure  to  examine those c(4) organizations after applications grew rapidly in the wake of the  Supreme Court’s 2010 Citizens United decision. If IRS waits until after an election, it’s generally too late to make any difference.

4. Why did IRS start with the exemption process rather than wait and see how the organizations behaved?

   Because  IRS audits so few tax-exempt organizations,  noncompliance is a major problem.  But often noncompliance is inadvertent. Organizations trying to do “good” fail to understand legal technicalities or why IRS should be worried about them at all. If the IRS can get these organizations to comply with the rules from the start, it has a better chance of minimizing future problems.

5. Well, then, why the heck is IRS even in this game in the first place?

   A question asked by many. Unlike some other nations with charities’ bureaus or other government regulatory agencies, tax-exempt organizations in the U.S. are monitored mainly by IRS at the national level and the state attorneys general at the state level. The IRS efforts generally derive from the Congressional requirement that charitable dollars (for which there are deductions and exemptions) go mainly for charitable purposes and not others such as electioneering.

6. But c (4) or social welfare organizations don’t benefit from the charitable deduction, so why don’t those with political orientation just operate without tax exemption or c(4) status?

   They could, but the tax exemption  provides several benefits. The least important may be non-taxation of income from assets since many of these organizations don’t have that much in the way of assets to begin with. However, many contributors interpret (often incorrectly) tax exemption to mean that the organization has satisfied  legal hurdles, thus making it easier to raise money. Some c(4) organizations are closely connected to charities or c(3) organizations that can accept charitable contributions, and sometimes there’s a synergy between the two. My colleague Howard Gleckman reminds us that c(4)s quickly became favored over an alternative “527” tax-exempt political designation because the former does not need to reveal its donors. Finally, tax exemption provides an easy way  to insure that any temporary build-up of donations in excess of payouts is not interpreted as  taxable income to the organization or its  contributors.

7. What will be the end result of this flap?    

   Success at agencies like IRS is often measured by their ability to stay out of the news rather than on how well they  do their job.  I’m guessing this episode will only will increase the bunker-like incentives within the organization. It would be good if Congress used this as an opportunity to  figure out how better to monitor tax-exempt organizations, or whether IRS has the capability under existing laws, but that isn’t likely to happen.