Watch out, you may be subject to gift tax.
The Internal Revenue Service (“IRS”) is paying significant attention to certain tax-exempt entities organized under Sec. 501(c) of the Internal Revenue Code (“Code”) and the donors who contribute to these tax-exempt organizations. The recent Supreme Court case, Citizen United v. Federal Election Commission, 558 U.S. 50 (2010), invalidated long-standing prohibitions in federal campaign finance law on corporate and labor union campaign spending. As a result, Code Sec. 501(c)(4) tax-exempt organizations (commonly referred to as “social welfare organizations”) have seen an increase their level of political involvement, and current expectations are for this trend to continue in the upcoming election cycle. However, the recent trend toward increased political activity by these social welfare organizations has not gone unnoticed.
The IRS is currently investigating five donors who made contributions to social welfare organizations without reporting such transfers as taxable gifts on their gift tax returns.
What is a social welfare organization?
A social welfare organization, as defined under Code Sec. 501(c)(4), includes any civic league, non-profit organization operating exclusively for the promotion of social welfare. The Treasury Regulations under Code Sec. 501(c)(4) clarify that “[a]n organization is operat[ing] exclusively for the promotion of social welfare if it is primarily engaged in promoting in some way the common good and general welfare of the people of the community.” Treas. Reg. § 1.501(c)(4)-1(a)(2). Social welfare organizations, like Code Sec. 501(c)(3) organizations (commonly referred to as “public charities”), are exempt from income taxation, as long as certain requirements under the Code are met; however, unlike public charities, social welfare organizations may engage in political campaign activities on behalf of, or in opposition to, candidates for public office, as long as the campaign activity is not the organization’s primary activity. In addition, social welfare organizations may engage in an unlimited amount of lobbying (i.e. the influence of legislation) provided that the lobbying is related to the organization’s exempt purpose.
Finally, while contributions to political organizations must be publicly disclosed, social welfare organizations are not required to publicly disclose their donors. As evident by the expansive definition and broad scope of use, social welfare organizations provide those individuals and entities having a political agenda with a tax-exempt platform.
Gift Tax on Contributions to Social Welfare Organization
Generally, a gift tax is imposed on the transfer of money or other property by gift under Code Sec. 2501(a). The gift tax exemption is now $5,000,000. However, pursuant to Code Sec. 2501(a)(4), there is no gift tax on a transfer to a political organization organized under Code Sec. 527(e)(1) (“political organization”). Further, under Code Sec. 2522(a)(2), gifts made to public charities are deductible for gift tax purposes, subject to certain restrictions under the Code.
While gifts to such political organizations and public charities are generally not subject to gift tax, the IRS has taken the position that gifts to social welfare organizations (Code Sec. 501(c)(4) organizations) do not qualify for the political organization exclusion under Code Sec. 2501(a)(4) or the charitable gift deduction under Code Sec. 2522. In Rev. Rul. 82-216, 1982-2, the IRS stated that “gratuitous transfers to persons other than organizations described in section 527(e) of the Code are subject to gift tax absent any specific statute to the contrary, even though the transfers may be motivated by a desire to advance the donor’s own social, political or charitable goals.” The IRS further cites Code Sec. 2522(a), which “limits the charitable gift tax deduction otherwise available for transfers to charitable organizations to only those organizations that have not been disqualified for exemption under section 501(c)(3) by reason of attempting to influence legislation and that do not participate in political campaign.”
While some practitioners have acknowledged the IRS view that contributions to social welfare organizations are subject to gift tax, they argue that enforcement in this area, until recently, has been lax, if not nonexistent. Accordingly, on May 18, 2011, six Republicans on the Senate Finance Committee wrote IRS Commissioner Shulman and asked him to explain the IRS’s reported examination of donors who made transfers to social welfare organizations without paying a gift tax.
Their letter proclaims that, “[h]istorically, the IRS has deliberately opted against vigorous enforcement of the gift tax” on contributions to social welfare organizations. In addition, the letter questions whether the IRS’s reported enforcement initiative is politically motivated and characterizes the applicability of gift taxes to such contributions as “ambiguous.” The letter states that “enforcement of gift taxes on contributions to 501(c)(4) organizations engaged in public policy debate runs an unacceptable risk of chilling political speech, which receives the highest level of constitutional protection under the First Amendment,” and requests Commissioner Shulman to release names of individuals inside and outside of the IRS involved in the decision to pursue the issue and related correspondence. Click here to view a copy of the letter.
What does this mean for you?
Some practitioners argue that taxing such transfers to social welfare organizations fails to pass muster, because of: (1) the free speech issues involved, and (ii) equal protection and due process arguments that it is unfair for the IRS to retroactively and selectively tax contributions to Code Sec. 501(c)(4) organizations after a prolonged period of non-enforcement. However, provided that transfers to social welfare organizations are neither statutorily excludable (like political organizations), nor deductible (like public charities), there is a strong argument that such transfers are subject to gift taxes.
While the IRS has acknowledged that it is examining some donors, it has not released their names. Perhaps the IRS will restate its position in clearer terms in light of the recent letter. In the meantime, donors to social welfare organizations should be prepared to pay gift tax or consider alternative transfers or simply keep annual transfers below $13,000, the gift tax annual exclusion amount.