Social Welfare or Political Advocacy? The Confusion Over 501(c)(4) Companies

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The divisive climate during election season always seems to create hardline opinions on a variety of subjects. Entering the fray this cycle is an interesting debate, which seemingly benefits both major political parties in terms of campaign spending. At the center of this controversy is an Internal Revenue Services’ classification for companies designed to empower local communities. What’s at stake isn’t just politics as usual.

The Current Climate

Every election year guarantees a plethora of political advertisements flooding the airwaves. According to Kantar Media’s Campaign Media Analysis Group, President Obama entered this summer with $97.5 million in campaign funding, running more than 35,000 television ads during the first half of July alone. The president’s opponent, Governor Mitt Romney, began the same time period with $22.5 million in campaign funding and aired less than half the commercials during that timeframe. The month of July alone proves that both campaigns will be spending millions of dollars in campaign-funded ads, yet the sources of these funds may be unclear to constituents.

Although political ads disclose the monetary source for funding at the end of commercials, most viewers are not clear as to what type of organization is actually paying the bill. Recently, some political financiers discovered a federal tax provision that, they argue, allows 501(c)(4) organizations to purchase television commercials, much to the chagrin of some analysts, researchers and even other politicians.

What is a 501(c)(4)?

The IRS provides an exemption under Section 501(c)(4) of the Internal Revenue Code for social welfare organizations (called 501(c)(4) organizations), that are nonprofit in nature and operate exclusively for the promotion of the common good and welfare of a community. These local associations of employees must provide net earnings exclusively for the purpose of charitable, educational or recreational goals. The NAACP and AARP are examples of 501(c)(4) organizations that are classified as groups promoting social welfare primarily for the common good and welfare of a community.

Even though the IRS stipulated organizations that primarily benefit a private group of citizens cannot qualify for 501(c)(4) exempt status, the IRS distinction has a controversial past since the 501(c)(4) exemption has been used by groups funding political advertisements. For example, in 2010, a 501(c)(4) organization named Crossroads GPS and advised by former George W. Bush strategist Karl Rove, spent $65 million to defeat Democratic Senator Harry Reid from Nebraska. Because the group was not required to disclose the money’s sources, democrats tried and failed to pass a bill imposing disclosure requirements on 501(c)(4) organizations.

The Center for Responsive Politics and the Center for Public Integrity reported that 501(c)(4) organizations outspent super PACs in the 2010 election $95 million to $65 million, respectively. Only $8 million of this $95 million came from groups that partially disclosed who the donors were, unlike super PACs, which are required by law to disclose their donors. Because the IRS cannot examine the 501(c)(4) groups until after they file tax returns, which occur after the elections are over, this poses problems for the IRS’s ability to crackdown on any potential wrongdoing that may occur during an election cycle.

Social Welfare vs. Political Activism?

A 501(c)(4) group can technically fund political advertisements as long as the ad isn’t the primary purpose of the group beyond the social welfare it provides to a community. However, the “social welfare” activity of many of these groups is under suspicion by both political analysts and the IRS. An example of a 501(c)(4) that’s been questioned is the American Action Network, which was formed in 2010 by former Republican Senator Norm Coleman from Minnesota, and Rob Collins, the former chief of staff to Republican House Minority Whip Eric Cantor. A self-proclaimed “action tank,” the nonprofit organization purchased attack ads against Democratic candidates and ads that supported Republican candidates.  

Under its 501(c)(4) status, the American Action Network is not required to disclose its donors, although its board of directors includes chief GOP fundraisers, including New York venture capitalist and cofounder of Home Depot, Kenneth Langone, and former cochairman of Senator John McCain’s 2008 fundraising committee, Fred Malek. The Washington Post reported that the group spent about $25 million during the 2010 elections. That same year, the Supreme Court ruled 5-4 not to ban political spending by corporations, with proponents stating the federal government should not be curbing political free speech.

Both sides of the political spectrum have been guilty of failing to disclose where their donor money came from to fund political ads. In 2006, the Obama campaign ran advertising that did not disclose its main donor, a public utility called Commonwealth Edison, since state law did not require the disclosure. President Obama’s former deputy press secretary, Bill Burton, also created the nonprofit group, Priorities USA Action, to help raise money for democratic candidates.

IRS Consequences?

The New York Times reported in 2011 that the IRS planned a crackdown on five nonprofit advocacy groups that contributed heavily to political campaigns. The communication from the IRS has stated that these organizations may be subject to a gift tax if the donations exceed certain limits under tax law.

Whatever the end result might be with the IRS investigation, these 501(c)(4) organizations surely will remain a hot-button topic during this election cycle. Whether the IRS and ultimately the courts determine that these nonprofit organizations are primarily supporting political candidates or contributing to the common good of the community remains to be seen. However, if more measured limits on spending are not imposed, it’s doubtful that the consensus view of politicians and their ilk will change any time soon.