IRS Suspends Gift Tax Audits for Contributions to 501(c)(4) Organizations

Last Thursday, the U.S. Internal Revenue Service announced that it has suspended its controversial gift tax audits of certain contributors to Section 501(c)(4) organizations. See IRS Statement on applicability of gift tax on 501(c)(4) organization contributions (July 7, 2011).

Section 501(c)(4) organizations most prominently include “[c]ivic leagues or organizations not organized for profit but operated exclusively for the promotion of social welfare.” 501(c)(4) organizations are exempt from federal income taxation. However, unlike contributions to charities which are exempt under Section 501(c)(3), donations to 501(c)(4) organizations are not deductible from the income of the contributor for purposes of computing the contributor’s federal income tax.

Subject to a $13,000 per donee exclusion, the U.S. federal gift tax applies to any transfer by gift of real or personal property, whether tangible or intangible, made directly or indirectly, in trust, or by any other means to a donee. There is no express exclusion for gift tax purposes of contributions to 501(c)(4) organizations. Nevertheless, the IRS has very seldom attempted to collect gift taxes on such contributions.

Since 2008, a number of advocacy organizations formed as 501(c)(4) organizations have made substantial interventions in political election campaigns. The use of anonymous contributions by such organizations has led critics and public servants to call for investigation of whether politically-oriented 501(c)(4) organizations serve an exempt purpose or improperly confer private benefits. See, e.g., U.S. Senate Committee on Finance, Baucus Calls on IRS to Investigate Use of Tax-Exempt Groups for Political Activity (Sept. 29, 2010).

On May 13, 2011, the IRS announced that it had commenced audits of five contributors to 501(c)(4) organizations to determine whether their contributions were taxable gifts and whether the contributors should have filed gift tax returns. U.S. House of Representatives Ways and Means Chairman Dave Camp (R-MI) wrote to the IRS Commissioner, expressing the view that in light of the long history of non-collection of gift taxes in such circumstances, the IRS’s action was deeply troubling, and appeared to constitute the “selective target[ing of] certain taxpayers who are engaged in political speech.”See June 4, 2011 Letter from Rep. Camp to IRS Commissioner Douglas H. Schulman. A group of Republican senators on the U.S. Senate Finance Committee directed a similar letter to the commissioner. See Senators to IRS: Questions Raised by Agency’s Recent Actions into Gift Tax Enforcement; Concern about Political Influence (May 18, 2011).

The IRS Commissioner responded in a letter dated May 31, 2011, in which he denied that any political appointee was involved in the decision to commence the gift tax audits. Instead, he wrote that, “This activity was conducted as part of ongoing work that focuses broadly on gift tax non-compliance and is not part of any broader effort to look at donations to 501(c)(4) organizations.” According to the Commissioner, the IRS commenced the audits in reaction to specific, “internal referral[s].”

In a statement posted on its website on July 7, 2011, the IRS announced that it was suspending the gift tax audits. In its entirety, the statement reads as follows:

Recently, questions have arisen regarding the applicability of the gift tax to contributions to 501(c)(4) organizations. The Internal Revenue Service has little history to draw from in this area and the limited guidance we previously issued on this matter is almost thirty years old.

While we review the need for additional guidance or legislation, we will not use resources to pursue examinations on this issue.  Any future action we take will be prospective and after notice to the public.

As we consider this issue, it is possible that Congress may choose to clearly articulate through legislation the applicability of the gift tax to contributions to 501(c)(4) organizations.

Also on June 7, 2011, Representative Camp issued a statement expressing satisfaction with the suspension of the audits but adding —

I remain troubled that the IRS has failed to explain what prompted these audits in the first place.  It has yet to adequately address why taxpayers were given no warning prior to the launching of these investigations.  Furthermore, the IRS has failed to clarify that the gift tax will not apply to future political donations.  Especially troubling is that the directive explicitly leaves open the possibility of future audits.  Given the lack of transparency, I will continue my investigation until the complete story behind the actions of the IRS has been told.

Press Release, Camp: IRS Suspends Gift Tax Examination – IRS Announcement Leaves Questions Unanswered, Camp Investigation Continues (July 7, 2011).

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