It has been reported that IRS is examining five donors who made transfers to Code Sec. 501(c)(4) social welfare organizations without reporting them as taxable gifts. Such transfers have proliferated in the wake of the 2010 Supreme Court decision in Citizens United v. Federal Election Commission (FEC). This article examines IRS's apparent position that such transfers are indeed taxable gifts and possible escape hatches from gift treatment.
Social welfare organizations. Under Code Sec. 501(c)(4), civic leagues or organizations not organized for profit but operated exclusively for the promotion of social welfare are exempt from income taxation if no part of their earnings inures to the benefit of any private shareholder or individual and no substantial part of the organization's activities consists of providing commercial-type insurance. These organizations may engage in political campaign activities on behalf of or in opposition to candidates for public office. However, in order to retain its tax-exempt status, an organization must ensure that its political campaign activities do not constitute its primary activity. In general, Code Sec. 501(c)(4) organizations may engage in an unlimited amount of lobbying (i.e., attempting to influence legislation), provided that the lobbying is related to the organization's exempt purpose. (IRS Publication 4221-NC, Compliance Guide for Tax Exempt Organizations (other than 501(c)(3) Public Charities and Private Foundations))
A 2010 Congressional Research Service (CRS) report examined the subject of the political campaign activities of social welfare organizations. (R40183) Under federal law, such groups are allowed to engage in campaign activity subject to regulation under the Code and the Federal Election Campaign Act (FECA). The role of Code Sec. 501(c)(4) organizations was in the spotlight during the 2010 elections given the Supreme Court's decision in Citizens United v. FEC, which invalidated FECA's prohibitions on corporations and labor unions from using their general treasury funds to make independent expenditures for electioneering communications or for advocating the election or defeat of a candidate. In the 2010 election cycle, the Citizens United decision enabled Code Sec. 501(c)(4) organizations to operate with less restriction, CRS said. "At the same time, it is important to realize that Code Sec. 501(c)(4) social welfare organizations are still subject to regulation under FECA and the Code," CRS noted. For example, under FECA, incorporated Code Sec. 501(c)(4) organizations cannot make political contributions and must create a political action committee for that purpose. Also, the Code requires that the organization must have the promotion of social welfare as its primary activity.
Gift tax. The gift tax is imposed on the transfer of money or other property by gift. (Code Sec. 2501(a))
The gift tax applies whether the transfer is in trust or otherwise, whether the gift is direct or indirect, and whether the property is real or personal, tangible or intangible. (Code Sec. 2511) If a gift is made in property, the property's value at the date of the gift is the amount of the gift. Where property is transferred for less than an adequate and full consideration in money or money's worth, then the amount by which the value of the property transferred exceeds the value of the consideration received is considered a gift. (Code Sec. 2512)
The first $13,000 of gifts of a present interest made by a donor to each donee in is excluded from the amount of the donor's taxable gifts. (Code Sec. 2503(b))
For gifts made in 2010, the gift tax is imposed if the sum of taxable gifts for that year and taxable gifts for prior years is more than $1 million. For gifts made and decedents dying after 2010, the gift tax is integrated with the estate tax under a "unified" rate schedule that imposes a single tax on transfers during life and at death which effectively imposes no tax on gifts unless the total amount of taxable gifts for any such year and all prior years exceeds $5 million (indexed for inflation after 2011). For gifts made after 2012, the amount exempted from the gift tax will be $1 million. (Code Sec. 2505)
The gift tax must be paid by the donor. (Code Sec. 2501(a)) If the donor fails to pay the tax when due, the donee is also liable for the tax to the extent of the value of his gift. (Code Sec. 6324(b))
Transfer to political organizations. There's no gift tax on a transfer to a political organization within the meaning of Code Sec. 527(e)(1). (Code Sec. 2501(a)(4)) Under Code Sec. 527(e)(1), "political organization" means a party, committee, association, fund, or other organization (whether or not incorporated) organized and operated primarily for the purpose of directly or indirectly accepting contributions or making expenditures, or both, for an exempt function.
Observation: Contributors to Code Sec. 527 organizations generally must be publicly disclosed. On the other hand, Code Sec. 501(c)(4) organizations are not required to publicly disclose their donors.
Charitable gifts. Charitable gifts and certain similar gifts are deducted in arriving at taxable gifts for the calendar year. (Code Sec. 2522) Gifts are deductible for gift tax purposes if made to or for the use of any corporation, trust, community chest, fund or foundation organized and operated exclusively for religious, charitable, scientific, literary or educational purposes, including the encouragement of art, or to foster national or international amateur sports competition (but only if no part of the organization's activities involve the provision of athletic facilities or equipment, except for a "qualified amateur sports organization," or for the prevention of cruelty to children or animals, subject to the requirement that the organization must comply with certain restrictions. (Code Sec. 2522(a)(2))
Gifts to social welfare organizations. Gifts to social welfare organizations do not qualify for the exclusion for political organizations under Code Sec. 2501(a)(4) or the deduction for charitable gifts under Code Sec. 2522. Thus, it can be argued that since they don't qualify for the specific exclusion or deduction that applies for gifts to other types of organizations, they are subject to gift tax. Indeed, this seems to be IRS's position. In Rev Rul 82-216, 1982-2 CB 220, IRS stated that "gratuitous transfers to persons other than organizations described in section 527(e) of the Code are subject to the 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." As an example, IRS cited Code Sec. 2522(a), which it said "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 campaigns."
Observation: Some practitioners acknowledge that the IRS view appears to be that contributions to Code Sec. 501(c)(4) organizations are subject to gift tax, but note that enforcement in this area has been lax if not nonexistent. Thus, according to them, there is a question of fairness if IRS were to retroactively impose gift taxes on contributions to such organizations, which were fairly large in the 2010 election cycle. With IRS's admission that it is examining some donors, perhaps it will restate its position in clearer terms. In the meantime, donors to Code Sec. 501(c)(4) organizations must be mindful that gift taxes may be owed on annual transfers in excess of $13,000.
Possible escape hatches. It is possible that a donation to a Code Sec. 501(c)(4) organization will not be subject to gift tax if:
... A court find such transfers to be outside of the reach of the gift tax, which historically has been aimed at transferring wealth to family members and other loved ones. Indeed, before enactment of Code Sec. 2501(a)(4) (originally in Code Sec. 2501(a)(5)), a few courts had held that the gift tax did not apply to political contributions. (See Rev Rul 82-216.) Whether courts would do so now in the face of the specific statutory exclusion for political contributions, which is limited in scope, remains to be seen.
... The transferor is found to have received full and adequate consideration for the transfer. Under Reg. §25.2512-8, a sale, exchange, or other transfer of property made in the ordinary course of business (a transaction which is bona fide, at arm's length, and free from any donative intent), is considered as made for adequate and full consideration in money or money's worth. This exception, however, may be tough to meet in the context of a donation to a social welfare organization.
... Taxing the transfer fails to pass constitutional muster either because of the free speech issues involved or because of equal protection and due process arguments that it is unfair for IRS to retroactively and selectively tax contributions to Code Sec. 501(c)(4) organizations after a prolonged period of nonenforcement.
Bottom line. The fact that certain transfers are statutorily excludable or deductible provides a sound argument for finding that transfers to Code Sec. 501(c)(4) organizations are subject to gift tax. While there may be escape hatches, they are by no means certain and donors would have to incur costs to advocate for their applicability should IRS seek to tax the transfers. Thus, donors should be prepared to pay gift tax or consider alternative transfers that qualify for the exclusion or deduction. Another approach would be to keep annual transfers below the gift tax annual exclusion amount (currently $13,000).