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Activists at IRS facility in Mountainside, New Jersey, on May 21, 2013, protesting IRS targeting of partisan groups. (PHOTO: JAMES M. BENNETT/WIKIMEDIA COMMONS)

The IRS’s Tea Party Tax Row: How ‘Exclusively’ Became ‘Primarily’

• June 07, 2013 • 8:00 AM

Activists at IRS facility in Mountainside, New Jersey, on May 21, 2013, protesting IRS targeting of partisan groups. (PHOTO: JAMES M. BENNETT/WIKIMEDIA COMMONS)

Tax-exemption guru Ellen Aprill delves into the language behind some of the IRS’s activities and finds that cracking the “macaroni monopoly” set the table for today’s Tea Party tax scandal.

In the wake of the current controversy regarding the treatment of applications for exempt status from conservative groups, much has been made in the press and congressional hearings that while the statute governing Section 501(c)(4) organizations says it must be operated “exclusively” for the promotion of social welfare, the regulations governing these groups state that “exclusively” means “primarily” engaged in promoting social welfare.

In a June 4 hearing by the House Ways and Means Committee, for example, Congressman Lloyd Doggett, a Texas Democrat, stated that Congress was very clear that section 501(c)(4) organizations “must be operated exclusively for the promotion of social welfare” and the IRS was wrong to promulgate a later regulation that “seems to conflict direct with the clear wording of the statute” in order to give the IRS “discretion to explore organizations” like those that are the subject of the current scrutiny.

The implication is that Treasury and the IRS somehow acted nefariously to undermine congressional intent.

“The macaroni monopoly will be in the hands of the university … and eventually all the noodles produced in this country will be produced by corporations held or created by universities.”

Nothing could be further from the truth. IRS-issued regulations interpreting “exclusively” to mean “primarily” exist not only for Section 501(c)(4) social welfare organizations that range from the Sierra Club and League of Women Voters to these conservative advocacy groups, but also—in 1959 and under Dwight D. Eisenhower—for Section 501(c)(3) charities. These regulations were needed after Congress changed how tax-exempt organizations were treated, a change that still applies today.

In 1950, Congress enacted a set of rules known as the unrelated business income tax, or UBIT. Pre-UBIT, tax exemption depended on the destination, not the source, of the income. Famously, the New York University Law School owned Mueller Macaroni, which operated free of tax because its profits supported the school’s exempt activities. In one congressional hearing, a congressman warned that unless action was taken, “the macaroni monopoly will be in the hands of the university … and eventually all the noodles produced in this country will be produced by corporations held or created by universities.”

Spurred by such concerns over unfair competition and lost revenue, Congress enacted the UBIT. It taxed any trade or business regularly carried on by Section 501(c) organizations if the activity is not related—aside from the need for funding—to the organization’s exempt purpose. For example, a recent IRS College and University Compliance Project reported that these institutions were subject to UBIT on golf courses and sports camps that were open to the public and charged fees comparable to for-profit endeavors.

The UBIT rules acknowledged and accepted that exempt organizations could engage in activities that did not carry out their exempt purpose. Thus, the earlier statutory language requiring that section 501(c)(3) and 501(c)(4) organizations operate “exclusively” for their exempt purposes no longer accurately described the applicable law. Treasury regulations then reinterpreted “exclusively” as “primarily.” (These IRS regulations were not issued until 1959, but they applied retroactively to 1953.)

Critics of the “primarily” language in the regulations often point to language in a 1945 Supreme Court opinion, Better Business Bureau, that the presence of any substantial non-exempt purpose will destroy exemption. “Purpose,” however, is not the same as “activity,” and the regulations focus on the nature of the exempt organization’s operations and activities, not their purpose. Moreover, Better Business Bureau predated the UBIT regime and thus could not consider the impact of unrelated activities on exemption.

I agree with those arguing that clarification of the amount and kind of campaign intervention permitted for Section 501(c)(4) organizations is needed. But formulating appropriate rules is not an easy task. We would need to make allowances for activities subject to UBIT, such as advertising income, university travel tours without educational content, use of museum facilities for private events, or pharmacy sales to the general public. We must decide how to regulate organizations engaged in substantial campaign intervention—but still not primarily engaged in campaign intervention as required for “political organizations” subject to Section 527 of the Internal Revenue Code.

Our problems regarding excessive campaign intervention by these kinds of organizations will not be solved, at a penstroke, by simply returning to the statutory requirement that these groups be “operated exclusively for the promotion of social welfare.”

Ellen P. Aprill
Ellen P. Aprill is the John E. Anderson Professor of Tax Law at Loyola Law School, Los Angeles, and the organizer of the school’s annual Western Conference on Tax Exempt Organizations.

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