High-Stakes Word Search: Ensuring Fair and Effective IRS Centralization in Tax Exemption

• Author: Heath C. DeJean
• Pages: 258-301

Louisiana Law Review Volume 75 | Number 1 Fall 2014 High-Stakes Word Search: Ensuring Fair and Effective IRS Centralization in Tax Exemption Heath C. DeJean Repository Citation Heath C. DeJean, High-Stakes Word Search: Ensuring Fair and Effective IRS Centralization in Tax Exemption , 75 La. L. Rev. (2014) Available at: http://digitalcommons.law.lsu.edu/lalrev/vol75/iss1/12 This Comment is brought to you for free and open access by the Law Reviews and Journals at DigitalCommons @ LSU Law Center. It has been accepted for inclusion in Louisiana Law Review by an authorized administrator of DigitalCommons @ LSU Law Center. For more information, please contact sarah.buras@law.lsu.edu . High-Stakes Word Search: Ensuring Fair and Effective IRS Centralization in Tax Exemption TABLE OF CONTENTS Introduction ......................................................................... 260 I. Background: The Determinations Process and IRS Targeting ............................................................................. 263 A. The Tax-Exempt Determinations Process..................... 266 1. Interpretation Issues in the Determinations Process .................................................................... 269 2. Social Welfare Organizations in the Wake of Citizens United ........................................................ 272 3. Benefits of Centralization ....................................... 274 B. Examples of Acceptable Exempt Organization Targeting ....................................................................... 275 1. Credit Counseling Organizations ............................ 276 2. Donor-Advised Funds ............................................. 278 II. The Tea Party Scandal ........................................................ 280 A. Justification for Targeting by the IRS ........................... 283 B. Propriety of Tea Party Targeting .................................. 284 1. The Section 501/527 Gray Area.............................. 285 2. The Structure of the Tea Party ................................ 287 III. Curative Approaches to the Political Spending Problem .... 289 A. The IRS’s Stopgap Solution .......................................... 290 B. Avoiding Inappropriate Criteria .................................... 293 C. An Argument for IRS Targeting Through the Audit Process .......................................................................... 294 1. Open-Door Determinations and Targeting Through Auditing .................................................... 295 2. Organizational Compliance .................................... 297 a. Promoting Compliance Through Third Parties ....................................... 298 b. Strategic Publicity ............................................. 299 Conclusion .......................................................................... 301 260 LOUISIANA LAW REVIEW [Vol. 75 INTRODUCTION On May 10, 2013, Lois Lerner, then director of the Internal Revenue Service (IRS) Exempt Organizations unit, gave a speech revealing that the IRS had recently decided to review some organizations’ applications for tax exemption with heightened scrutiny. 1 Lerner admitted that certain organizations were chosen for “centralization”—a process of assigning applications to a specialist who is better able to handle issues raised in the application—based on the presence of certain identifying terms in their applications, including “Tea Party” and “Patriots.” 2 The purpose of centralization was to treat these applications consistently, but the process brought added delay in reaching a decision and introduced heightened scrutiny into the operations of these organizations. 3 In her speech, “Ms. Lerner defended the practice of centralization, but admitted that referring cases for centralization based on their names and perceived political affiliations was wrong.” 4 Many in the political world shared Lerner’s belief that the process, as applied in the context of Tea Party applications, was improper. 5 Although the Acting Commissioner of the IRS claimed Copyright 2014, by HEATH C. DEJEAN. 1. Lerner, in response to a request for updated information on the IRS’s review of Tea Party organizations, admitted that “many [organizations] indicated that they were going to be involved in advocacy work.” Transcript of the May 10, 2013, ABA Tax Section’s Exempt Organizations Committee Meeting , THE EXEMPT ORG. TAX REV., Aug. 2013, at 119, 126 [hereinafter ABA Transcript ]. Lerner continued by noting that the IRS’s “line people in Cincinnati that handle the applications did what we call centralization of these cases. They centralized work on these in one particular group.” Id. Steven Miller, the acting IRS commissioner, admitted that the question asked of Lerner was planted, “which gave Lerner the leeway to put the scandal into the public domain before the release of the TIGTA Report.” Washington Alert—Part I , 59 FED. TAXES WEEKLY ALERT, May 23, 2013, art. 19. See also TREASURY INSPECTOR GENERAL FOR TAX ADMIN., INAPPROPRIATE CRITERIA WERE USED TO IDENTIFY TAX-EXEMPT APPLICATIONS FOR REVIEW 2 (May 14, 2013) [hereinafter TIGTA Report]. 2. See Lily Kahng, The IRS Tea Party Controversy and Administrative Discretion , 99 CORNELL L. REV. ONLINE 41, 49 (2013); see also Questions and Answers on 501(c) Organizations , INTERNAL REVENUE SERV. (May 15, 2013), http://www.irs.gov/uac/Newsroom/Questions-and-Answers-on-501(c)-Organizations, archived at http://perma.cc/6L48-HP9X. 3. See ABA Transcript , supra note 1, at 119. 4. More Details Emerge on IRS’s Targeting of Conservative Groups Applying for Exempt Status , 59 FED. TAXES WEEKLY ALERT, May 16, 2013, art. 2 [hereinafter More Details Emerge on IRS’s Targeting ]. 5. Donald Tobin explained: 2014] COMMENT 261 that the agency’s actions “were in no way due to any political or partisan motivation,” 6 many began to suspect that this was not true. 7 Senate Finance Committee Chairman Max Baucus voiced his intention to subject the IRS to a full investigation, and Attorney General Eric Holder called for a criminal investigation by the FBI. 8 On May 14—a mere four days after Lerner’s speech—the Treasury Inspector General for Tax Administration released its report on the scandal, finding that the IRS had used “inappropriate criteria” in selecting certain applications for centralization. 9 This Comment examines the methods employed by the IRS in selecting tax-exemption applications for centralized review. 10 The IRS’s resources are limited, 11 and in the pursuit of efficiency and Some tax-exempt groups and politicians argued that the IRS improperly targeted conservative, politically active tax-exempt organizations for scrutiny, while others argued that the IRS had failed to enforce restrictions in the IRC regulating the political activity of tax-exempt organizations. The IRS’s attempt—and some say ineptitude—in enforcing the code’s political campaign restrictions caused a political crisis that rocked America’s trust in the nonpartisan enforcement of the tax laws. Donald B. Tobin, The 2013 IRS Crisis: Where Do We Go From Here? , 142 TAX NOTES 1120, 1120 (Mar. 10, 2014). 6. More Details Emerge on IRS’s Targeting , supra note 4 (quoting Steven T. Miller, IRS: We Should Have Done a Better Job , USA TODAY (May 13, 2013, 9:13 PM), http://www.usatoday.com/story/opinion/2013/05/13/irs-exempt-organ izations-editorials-debates/2156991/, archived at http://perma.cc/KEZ3-WKB5). 7. Kahng, supra note 2, at 42 (“A media firestorm ensued with fevered speculation about a hidden political agenda extending all the way to the White House.”). 8. Id. The FBI investigation has since ended, with a finding that no laws were broken by the IRS. Steve Benen, So Long, IRS ‘Scandal’ , MSNBC (Jan. 14, 2014, 6:40 PM), http://www.msnbc.com/rachel-maddow-show/so-long-irs-scandal, archived at http://perma.cc/667N-HR7Y. 9. See TIGTA Report, supra note 1, at 43. The TIGTA report “has been criticized as sloppy and incomplete. It has since come to light that the IRS targeted conservative political groups, liberal political groups, and a variety of other groups for heightened scrutiny, although the TIGTA Report omitted these facts.” Kahng, supra note 2, at 43. 10. Applications seeking recognition of exemption for social welfare organizations are a narrow subset of the work the IRS does and must be distinguished from the determinations and audit process that many readers are familiar with through the individual tax return system, which in many ways is quite different. See infra Part III.C. 11. The National Taxpayer Advocate, in its 2012 Annual Report to Congress, argued: The significant and chronic underfunding of the IRS poses one of the most significant long-term risks to tax administration today. Because of funding shortages, the IRS is unable to answer millions of taxpayer 262 LOUISIANA LAW REVIEW [Vol. 75 consistency, the IRS sometimes filters out applications that present a need for greater scrutiny. 12 However, the selection of specific applications for heightened scrutiny review brings with it the risk that the public will take issue with the selection methods used. This risk becomes even greater when the IRS examines social welfare organizations for impermissible levels of political campaign intervention. 13 Any suggestion that the IRS is acting with political bias not only goes against its mission, 14 but also threatens the public’s trust. 15 If it is proper for the IRS to target for centralized review similar organizations’ tax exemption applications, it must do so in a way that minimizes the risk that the public will view it as acting with partisan motives. 16 These risks can be reduced if the IRS adopts an open-door determinations process, allowing organizations to self-certify that they qualify for exemption, and moves its centralization practices exclusively to the audit process. 17 telephone calls or timely process letters; the tax gap ( i.e., the amount of tax due but...