Parting the dark money sea: exposing politically active tax-exempt groups through FEC-IRS hybrid enforcement.

• Author: Miller, Carrie E.

TABLE OF CONTENTS INTRODUCTION I. TAX LAW AND ELECTION LAW FOUNDATIONS A. Internal Revenue Code Provisions 1. Section 501(c)(4) Social Welfare Organizations 2. Section 527 Political Organizations B. Campaign Finance Doctrinal Framework 1. Statutory Basis and Underlying Values 2. Evolving Case Law II. ESCALATING POLITICAL ACTIVITY OF TAX-EXEMPT SOCIAL WELFARE ORGANIZATIONS: WHERE TAX LAW AND ELECTION LAW INTERSECT A. IRS Treatment of Political Activity 1. Conflicting Threshold Standards 2. Vague Definitional Problem B. Section 501(c)(4) Organizations Have Emerged as the Preferred Campaign Finance Vehicle 1. Increased Independent Expenditures 2. Relaxed Reporting Provisions 3. The Coordination Problem C. Deregulation's Impact on Values that Support Campaign Finance Restrictions III. PROPOSAL: FEC-IRS HYBRID ENFORCEMENT, ENHANCED BY INTERNAL AGENCY REFORMS A. Internal Agency Reforms 1. Filing Requirements 2. Earmarked Funds 3. Combatting the Daisy Chain Effect 342 WILLIAM & MARY LAW REVIEW [Vol. 57:341 B. Cooperative Regulation: Pooling Together Tax and Election Enforcement Powers CONCLUSION INTRODUCTION

The Internal Revenue Service (IRS) grants tax exemptions to nonprofit entities organized under [section] 501(c)(4), and in exchange, restricts these groups to a "social welfare" purpose. (1) Such a restriction limits how much political activity [section] 501(c)(4) organizations can fund. (2) Engaging in political action necessarily involves the Federal Election Commission (FEC), the Agency founded to enforce the federal election laws (campaign finance restrictions in particular), (3) and so there is an unavoidable intersection of tax law and election law when these tax-exempt groups participate in partisan activity. This Note aims to improve the system designed to regulate this overlapping area of the law by pooling the respective powers of the IRS and the FEC. The collaborative framework proposed herein presents an opportunity for an enhanced regulatory landscape, in which the two Agencies work better together than either can alone.

Consider the following examples of the murky campaign finance world, where funding sources are obscured and the true messages of campaigns are confused. In the 2010 election, the [section] 501(c)(4) organization Commission on Hope, Growth, and Opportunity ran a series of television advertisements with cartoon depictions of prominent Democrats, including President Obama and Representative Nancy Pelosi, dancing in a conga line and "living it up" in Washington. (4) The ads called on viewers to "join" the Republicans, whom the Commission presumably viewed as more viable candidates. (5) This message likely appeared partisan for many viewers--a call to action for Republican voters--but the Commission did not register as a political committee or report any political spending to the FEC. The group also declared no political spending to the IRS, despite listing on its tax return that 96 percent of its total expenditures ($4.6 million) were on advertisements like the one described. (6)

In the 2014 North Carolina Senate race, the Iowa-based [section] 501(c)(4) American Future Fund (AFF) launched a series of online advertisements endorsing libertarian candidate Sean Haugh and praising him for supporting marijuana legalization. (7) AFF did report the expenditures to the FEC, (8) but more significant here is the confusion such an advertisement creates. AFF actually supported Republican candidate Thom Tillis, but the point of the ad was to portray Haugh as the best choice for "progressive values"--a preferable alternative, then, to Democrat incumbent Kay Hagan. The ads also provided a new slogan for Haugh--"More weed, less war"--which his campaign did not approve. (9) To the average North Carolina voter, it may have appeared that Haugh, or a group supporting Haugh, paid for or approved of the advertising. The true story, however, reveals that without stricter guidelines, independent political spending can and does skew campaign messaging.

Various proposed means of campaign finance reform, such as broader disclosure requirements (10) and more nuanced contribution restrictions, (11) may, in the long term, correct the problems illustrated above. The grave lack of enforcement in this area, though, allows current abuses of both the tax and electoral systems to continue. Despite the Supreme Court's recent stripping away of campaign finance restrictions, this Note operates under the presumption that some regulation of tax-exempt organizations' political speech is constitutionally permissible under the First Amendment (12)--regulation which is indispensable to fulfilling Congress's wish for robust and fair elections. (13) A more immediately powerful solution, and what this Note proposes, is to ramp up enforcement by empowering both the IRS and the FEC to make internal changes and then cooperate to hold politically active social welfare organizations responsible when they violate the tax and election laws. Only if both Agencies work together will they be able to fulfill their respective obligations and prevent corruption and exploitation of the electoral and tax systems.

This Note proceeds in three parts. Part I compares and contrasts the tax code provisions that apply to politically active tax-exempt groups. It also traces the recent evolution of the Supreme Court's First Amendment election law jurisprudence. Citizens United v. FEC is the hallmark case, but other doctrinal decisions have also added to the enormous influx of undisclosed independent spending, referred to as "dark money." Part II explains how social welfare organizations have been pushed to the forefront of the campaign finance debate and addresses weaknesses in the tax code that allow for abuse. Because political activity that [section] 501(c)(4) groups engage in is treated more leniently than that which [section] 527 groups engage in, [section] 501(c)(4)s have become an ideal, and indeed preferred, mouthpiece for wealthy donors with special interests.

Part III proposes a way forward: administrative alterations that can facilitate effective enforcement of current regulations. Providing for stricter enforcement by enabling the FEC and IRS to work together would cut through some of the debilitating FEC gridlock and truly empower the IRS to hold organizations responsible for abusing the tax code. There is no stopping money from entering politics, but rigorous enforcement can help control its effects in future elections.

1. TAX LAW AND ELECTION LAW FOUNDATIONS

   Incorporated entities face graduated tax rates under the current regime, ranging from 15 percent to 35 percent depending on annual income. (14) In order to encourage certain social-minded activities, though, Congress has exempted from the corporate tax scheme organizations that make no profit and exist for the public good. (15) With some exceptions, [section] 501 of the Internal Revenue Code (I.R.C.) captures the full range of exempted conduct, which includes charitable pursuits like churches and schools, (16) as well as labor unions, (17) trade associations, (18) and social welfare groups. (19) This Note focuses on activity by social welfare groups, [section] 501(c)(4) organizations, because they have become the corporate form of choice for entities wishing to participate in political speech. (20) This Part first describes the incongruent provisions that apply to politically active tax-exempt entities and then traces recent election law developments in this area.

   1. Internal Revenue Code Provisions

      A basic understanding of the differing rules that apply to tax-exempt entities helps reveal why [section] 501(c)(4) organizations have become "the keys to the political kingdom." (21) The I.R.C. includes a separate, express provision, [section] 527, for organizations that engage in partisan political activity. (22) Despite Congress's intention that political groups organize themselves under [section] 527, (23) [section] 501(c)(4) groups have become the political speech vehicle of choice. (24) Most importantly, although entities organized under both sections engage in "political activity," [section] 527 political groups and [section] 501(c)(4) social welfare groups are held to drastically different definitions and standards. (25)

      1. Section 501(c)(4) Social Welfare Organizations

         Section 501(c)(4) groups get their moniker directly from the text of the I.R.C., which states that these organizations should be "operated exclusively for the promotion of social welfare ... the net earnings of which are devoted exclusively to [these] purposes." (26) Social welfare groups are designed to be issue advocacy groups focused on a particular policy area, and are permitted to conduct unlimited lobbying efforts in support of their public-minded missions. Increasingly, though, these organizations have become involved in elections, participating in partisan political activity, which does not honor their exempt purpose. (27)

         Social welfare groups face few functional and procedural requirements. Unlike some tax-exempt organizations, [section] 501(c)(4)s do not have to notify the IRS of their formation, nor are they required to apply for exempt status. (28) There is but one filing requirement: social welfare organizations must provide an informational tax return (Form 990) to the IRS, which lists some donor information and expenditures, as well as donations to other tax-exempt groups. (29)

         Of course, even this requirement is not without a loophole. The Form 990 is due by the fifth month following the end of the tax year, so depending on their date of formation, social welfare groups may take advantage of an eighteen-month delay in filing. (30) Augmenting this already prolonged interval, organizations can request extensions, pushing the filing deadline past twenty-two months after formation. (31) Because these groups are not required to file anything when they organize, the IRS may not even know a...