Friday, July 15, 2011

IRS Formally Ends Gift Tax Probe Of 501(C)(4) Contributors

On July 7, IRS announced on its website that it will no longer pursue the issue of whether the gift tax applies to contributions made to Code Sec. 501(c)(4) social welfare organizations. An accompanying memo from IRS's Deputy Commissioner for Services and Enforcement formalizes the decision with instructions to IRS personnel to stop pursuing the issue. IRS's decision to throw in the towel on the issue comes in the wake of withering criticism from Congressional Republicans that the gift tax probe was a reversal of long-standing policy and was politically motivated.

Background to the controversy. Earlier this year, it was reported that IRS was 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).

On May 18, six Republicans on the Senate Finance Committee (Orrin Hatch, Ranking Member, Jon Kyl (R-AZ), Pat Roberts (R-KS), John Cornyn (R-TX), John Thune (R-SD) and Richard Burr (R-NC)) wrote IRS Commissioner Shulman criticizing the reported probe of donors and asking him whether it was politically motivated.

In a May 31 reply to the Senate Republicans, IRS Commissioner Doug Shulman assured them that IRS's recent probe of donors who made transfers to Code Sec. 501(c)(4) organizations without paying a gift tax was not politically motivated and was limited in scope. Shulman categorically stated that no political appointee was involved in the initiation of the probe. He also said that the publicity over the issue arose from a single matter where an IRS employee followed up on an internal referral by sending letters to five taxpayers. Shulman told the Senators 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.”

Separately, House Ways and Means Committee Chair Dave Camp (R-MI) last month questioned the process leading up to IRS's probe and the level of involvement by the Obama Administration. “Every aspect of this tax investigation, from the timing to the sudden reversal of nearly thirty years of IRS practice, strongly suggests that the IRS is targeting constitutionally-protected political speech,” said Camp. A statement he released on June 15 said the gift tax has not generally been assessed on donations to 501(c)(4) entities, and that, while case law is unsettled on the matter, IRS “has refused to issue guidance on the matter in nearly thirty years—leading both donors and non-profits to believe gift taxes may not apply.”

IRS closes its inquiry. On its website, IRS acknowledged that: questions had arisen about whether the gift tax applies to contributions to Code Sec. 501(c)(4) organizations; IRS had little history to draw from in this area; and the limited guidance IRS previously issued on this question was almost thirty years old. As a result, IRS says that while it reviews the need for additional guidance or legislation, it will not use resources to pursue examinations on this issue, and that any future action it takes will be prospective and after notice to the public.

IRS suggests that it is possible that Congress may choose to “clearly articulate through legislation” whether the gift tax applies to contributions to Code Sec. 501(c)(4) organizations.

In a related memo, IRS's Deputy Commissioner for Services and Enforcement acknowledges the issue is “a difficult legal area with significant legal, administrative, and policy implications” where there's little enforcement history. It directs IRS personnel to close current exams on the issue and to not expend examination resources to referrals or develop audits on the subject. The memo says that the new directive “reaffirms and expands” the suspension on Mar. 23, 2011, of such examinations by IRS's SB/SE Estate and Gift division.

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