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Donald B. Tobin shares his thoughts on political fundraising and nonprofits

April 5, 2012 | Faculty

What changes in the law have led political operatives to consider alternative structures when setting up campaign organizations?

The short answer is that organizations are improperly choosing alternative structures to avoid the campaign disclosure provisions in the Internal Rev­enue Code. But you did not really think there would be a short answer … did you?

The battle in the campaign finance area is generally about contribution/spend­ing limits and disclosure. During the 1980s and 1990s, there was a significant rise in election advertising by independent groups. Under the Federal Election Campaign Act, groups engaged in electioneering activity were supposed to disclose the con­tributions to the organizations and the organization’s expenditures. Candidates complied, but independent groups avoided the disclosure requirements by claim­ing that their ads were not electioneering ads but, instead, where “issue ads.” This interpretation subjected the electorate to aggressive ads denograting, demeaning, or even (rarely) praising candidates, but the ads avoided using “magic words” like “vote for,” “vote against,” or “defeat” that would clearly characterize the ads as electioneering activity.

In 2001, Congress tried to stop this abuse by amending Section 527 of the Internal Revenue Code, which is the section that governs political organizations, to require all political organizations to disclosure contributions and expenditures. The thought was that by subjecting the organizational form to regulation, political organizations could not avoid regulation by claiming that the political advertising was simply issue discussion. Because political organizations could no longer avoid disclosure by using “issue” advocacy, the organizations sought to avoid disclosure by choosing a different organization form.

How are political operatives using organizational form to avoid disclosure rules?

When groups organize, accept money, and pool resources, the government attempts to characterize these organizations so it can regulate the tax activities of those organizations. Section 527 of the code was created to regulate political organizations. Contributions to 527 organizations are not tax-deductible, but the organization itself is tax-exempt. Congress determined that as a condition of receiving tax-exempt status under Section 527, political organizations would be required to disclose their contributions and expenditures. If a Section 527 organization chooses not to disclose, it is subject to tax on its contributions and expenditures.

In order to avoid the disclosure provisions in Section 527, political operatives are seeking alternative organizations’ forms. The current form of choice is Social Welfare Organizations, which are defined by 501(c)(4) of the code. These organi­zations are allowed to engage in some political advocacy and lobbying, but social welfare must be the organization’s primary purpose. The regulations specifically provide that political activity is not a social welfare activity. By organizing as a Social Welfare Organization under Section 501(c)(4), these organizations can avoid the disclosure provisions in Section 527. The problem for many of these organizations is that they are not Social Welfare Organizations. These organiza­tions usually do not have as their primary purpose social welfare. Instead, they are political organizations masquerading as social welfare organizations.

What is the potential for abuse here?

In Citizens United, the Supreme Court of the United States ruled provi­sions that prohibited corporations from contributing to independent groups engaged in political advoacy are unconstitional. This decision, combined with other regulatory changes, signficantly increased the money that could be contributed to political organizations. In addition, although independent groups cannot coordinate with a candidate, as connected political operatives started op­erating “independent groups,” the independence of these groups has been called into question. The rise of large, anonymous, independent communications raise serious concerns about the intergrity of our elections.

The Supreme Court has generally recognized two justifications for campaign disclosure provisions. The first is corruption or the appearance of corruption, and the second is providing information to voters. The current system allows extremly large (in fact, unlimited) contributions to entities that, while legally do not coordinate with a candidate, are closely connected with candidates. This regulatory structure creates the worst of both worlds. A candidate will certainly learn of a large contribution to an organization that supports the candidate, and the donor certainly knows of the donation. But the greater public does not. Thus, the worst recipe for corruption exists. There is simply no check to make sure that the large contributions are not corrupting elected officials.

In addition, as independent expenditures become more and more a part of the overall amount spent on campaign advertising, it becomes increasingly impor­tant for voters to understand who is funding the communication. Organizations like “Pro Growth USA” (which is fictitious) sound great, but voters need more than a name to judge the information in the advertisement. Voters need to know the contributors to Pro Growth USA to evaluate how much weight to give its communications.

How do we solve this problem?

Campaign regulation is currently in a regulatory pingpong match. Al­though the Supreme Court recently has been very hostile toward campaign finance regulation, the court has consistently noted that disclosure is a consti­tutionally sound method of avoiding corruption and providing information to voters. The U.S. District Court for the District of Columbia just recently struck down regulations issued by the Federal Election Commission that weaken exist­ing disclosure provisions, and the IRS appears to be investigating some organiza­tions that are potentially abusing the code by claiming status as a Social Welfare Organization. There are some quick regulatory fixes that will help in this area, but comprehenisve statutory reform, especially with regard to disclosure, is necessary to stop the huge rise of undisclosed campaign adverisements. Large, undisclosed contributions to organizations primarily engaged in campaign ad­vocacy have serious negative consequences on our elections and our democratic institutions.

Donald B. Tobin, Virginia H. Bazler Designated Professor in Business Law and senior fellow at Election Law@Moritz, has quickly become one of the nation’s leading experts on the intersection of tax and campaign finance laws. Prior to joining Moritz, he worked on Capitol Hill and for the U.S. Department of Justice.