Posted: May 13, 2011
The Application of the Gift Tax Provisions in the Internal Revenue Code to § 501(c)(4) Organizations
Many political operatives are setting up 501(c)(4) social welfare organizations as a platform to engage in independent political campaign activities. Section 501(c)(4) organizations are attractive as campaign vehicles because contributions to 501(c)(4)s are generally not subject to disclosure, and therefore donors can keep their contributions anonymous. Traditionally, 501(c)(4)s are organizations created to promote social welfare, and, campaign intervention is not considered a social welfare activity. Social welfare organizations are, therefore, not designed to be the mechanism for significant campaign activities. However, since political organizations under section 527 of the Code are subject to disclosure provisions, there has been a significant movement toward the use of 501(c)(4) organizations as campaign vehicles.
Earlier in the year, I commented that those advocating the use of 501(c)(4) social welfare organizations as ideal campaign vehicles might not be as clever as they thought. I noted that one problem with using 501(c)(4)s is that contributions over $13,000 to (c)(4)s from individuals might be subject to gift tax. The New York Times and Politico are now reporting that some contributors to 501(c)(4) organizations have received letters from the IRS asking about the payment (or lack thereof) of gift tax on contributions to 501(c)(4)s. This commentary explains the gift tax rules, existing regulations, and the impact of these rules in the 501(c)(4) context.
Understanding the Tax Code
Section 2501 of the Internal Revenue Code provides that the donor of a gift must pay tax on gifts in excess of $13,000. Donors currently have a lifetime gift/estate tax exemption of $5,000,000, so a donor can either pay gift tax, or not pay gift tax and use up some of the lifetime gift-tax exemption amount. Since the amount of the gift tax and estate tax exemption are in flux, it is unlikely that most donors will want to use their gift tax exemption.
Section 527 organizations and section 501(c)(3) organizations are specifically exempted from the gift tax provisions. (See § 2501 (exempting 527 organizations), §2522(a)(2)(providing a credit against gift tax for charitable contributions)). Section 2522 also exempts associations operating under a lodge system but only “if such gifts are to be used exclusively for religious, charitable, scientific, literary, or educational purposes...”
The tax code, therefore, clearly sets out the contours of the tax. The donors of gifts are subject to gift tax unless those contributions are to 501(c)(3) or 527 organizations, or some other organizations but only to the extent those contributions are made for charitable type purposes. There is no exception in the Code for contributions to 501(c)(4) organizations.
The standard for determining whether a contribution is a gift for gift tax purposes is whether the transfer was made for “money or money’s worth.” See 2512(b). Section 2512(b) explains that gift tax is paid on the “amount by which the value of the property exceeded the value of the consideration . . .”
The IRS’ Position on Political Gifts
The IRS has consistently taken the position that payments to political or social welfare organizations are subject to gift tax absent a specific exemption in the code. As early as 1959, the IRS explained that individuals who make contributions to a political party or candidate in excess of the exemption amount were required to pay gift tax. Rev. Rul. 59-57. (This ruling may be why there is now a specific exemption in section 527). In 1972, following a case in the Fifth Circuit, discussed later, the Service restated its view that “political campaign contributions [are] taxable gifts.” Rev. Rul. 72-583. (See also, Rev. Rul. 72-355 “Since the enactment of the present gift tax in 1932, it has been the position of the Internal Revenue Service that contributions to a political campaign are taxable transfers for purposes of the gift tax.”)
The IRS more directly addressed the application of the gift tax to contributions to non-political organizations in 1982. In 1975, Congress amended the Code and provided that contributions to political organizations as defined by 527(e) would not be subject to the gift tax. The IRS then determined it would not contest the application of the gift tax to any contributions made to political organizations (even contributions made prior to the change in the law). In its explanation regarding non-enforcement of the gift tax for contributions to 527(e) organizations, the IRS specifically noted, “The Service continues to maintain 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.” The Service specifically noted as an example of such organizations, organizations “disqualified for exemption under section 501(c)(3) by reason of attempting to influence legislation and that do not participate in political campaigns.” Rev. Rul. 82-216.
The IRS’ position is not ambiguous. The IRS has consistently indicated that contributions to non-charitable organizations similar to 501(c)(4) organizations are subject to the gift tax. Due to a general feeling that the Service was not enforcing the gift tax in the (c)(4) context, practitioners asked the IRS to provide more guidance on this issue. The IRS has not provided further guidance since the 1982 Revenue Ruling. The Service’s decision not to provide further guidance, however, is not an indication that the Service’s position is ambiguous.
Lower Courts Weigh in
Although there have been very few cases addressing the applicability of the gift tax to donations to (c)(4) organizations, the reported decisions uniformly hold the gift tax applies. In Blaine v. Commissioner, 22 T.C. 1195 (1954), the court determined that contributions to a social welfare organization were subject to gift tax. Similarly, in DuPont v. United States, 97 F. Supp. 944 (1951), the court upheld the applicability of the gift tax to payments by Lammot DuPont to the National Economic Council, an organization formed to promote certain economic policies.
Some have argued that contributions to political and social welfare organizations are not subject to the gift tax, and at least in the political organizations context, two courts have determined that payments to a political organization were not subject to gift tax. These two cases occurred before Congress amended the Code to provide an explicit exemption from the gift tax for 527 organizations.
Is the Contribution a “Gift?”
Arguments against the applicability of the gift tax are generally premised on the fact that the contributions to organizations are not subject to gift tax because they are arms-length transactions without donative intent. The assertion is that if a transaction is at arms-length and without donative intent the exchange must be for fair market value and therefore must be for “money or money’s worth.” Opponents argue that under Treasury Regulation §25.2512-8, a 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), will be considered as made for an adequate and full consideration in money or money’s worth” applies to contributions to (c)(4)s. Under this logic, the parenthetical (a transaction that is bona fide, at arm’s length, and free from any donative intent) after “course of business” defines what course of business must mean. Thus, they argue as long as they can show that the transaction is bona fide, at arm’s length, and free of donative intent, then the transaction is for money or money’s worth and there would be not be a gift.
This argument, however, stretches the ordinary course of business rule very far and is completely inconsistent with the rest of the language in the regulation. The purpose of the regulation is to explain that if something is given without receiving fair value in exchange, it should be a gift for gift tax purposes.
Treasury Regulation § 25.2512-8 provides guidance when a transfer is for insufficient consideration. The regulation is designed to expand the definition of gift, not limit it. It starts by noting that gifts are not confined to those transactions without valuable consideration, thus indicating that transfers without consideration are gifts. Thus a transaction which is bona fide, at arm’s length, and free from donative intent, but made without consideration, would still be a gift.
The regulation further explains that it is addressing transactions in which consideration exists but the consideration is for less than full value. (The regulation embraces “sales, exchanges, and other dispositions of property... “) It then notes that if a sale or exchange is in the ordinary course of business, it will be made for adequate consideration. This is clearly designed to avoid valuation questions when there are bona fide business transactions. The regulation clearly does not apply in a non-business context, or when there is not a sale, exchange or other disposition of property.
Finally, the regulation specifically notes that “consideration not reducible to a value in money or money’s worth, as love and affection, promise of marriage, etc., is to be wholly disregarded...” In addition, the Service has consistently held, with regard to charitable contributions, that the intangible benefits received by a donor do not make the gift a quid pro exchange and do not provide consideration. See I.R.S. Priv. Ltr. Rul. 6812121000A (Dec. 12, 1968)(using example of contributions to a cancer fund ok); Rev. Rul. 68-432 (1968)(privileges such as being associated with the organizations or being known as a benefactor do not have monetary value for purposes of determining whether payment was gift); Treas. Reg. 53.4941(d)-2(f)(2)(naming rights only an incidental or tenuous benefit for purposes of determining self-dealing in the private foundation context). Thus any intangible benefits a contributor receives for donating to a social welfare organization, like the benefit of promoting an issue or candidate, cannot provide consideration or money’s worth for the donation.
Application of Gift Tax in Other Settings
Two cases involving the applicability of the gift tax to contributions to political organizations provide some support for the notion that the gift tax might not apply to contributions to (c)(4) organizations. Both cases, however, apply in a very different situation, and should not be read to defeat the clear text in §2503 indicating that the contributions are gifts.
The first case, Stern v. United States, 436 F.2d 1327 (5th Cir. 1971), follows the logic discussed above. The court read Treasury Regulation §25.2512-8 broadly and determined it could apply to contributions to political organizations. The case, however, concerned contributions to a political organization, which would be a section 527 organization, and involved a situation where the contributor maintained control over the contributions. In addition, the court noted that the transactions were “permeated with commercial and economic factors” and that “the contributions were motivated by appellee’s desire to promote a slate of candidates that would protect and advance her personal and property interests.” The court also noted that to insure that actions were consistent with her goals, the donors retained “control over the disbursement of their contributions.” Id at 1330. The court basically concluded that Stern received something, political ads advocating for her concerns, in exchange for her contribution.
In addition, Stern is a very fact-intensive case that relied on a type of contribution that does not exist in the current context. Moreover, in Stern the Service stipulated that the contributions were made without donative intent. Ms. Stern had a colorable argument in that regard because she maintained control of, and directed the contributions. The level of control she exercised strongly indicated a lack of donative intent.
This logic, however, does not apply in the (c)(4) context. Contributors to (c)(4)s do not maintain control over the contributions. In fact, if the donor maintained control, or indicated that the donation had to be spent on a certain campaign expenditures, the donation would likely be subject to disclosure obligations. Thus, the more control and quid pro quo the contributor asserts, the more chance that the contributions will need to be disclosed. Here you have donations to organizations that are organized with both a social welfare and campaign purpose. Once contributions are made to the organization, the organization, not the donor, controls how the funds are spent. Funds are not returned to the donor after the campaign, nor are they generally designated to a specific candidate or commercial.
The second case dealing with whether the gift tax applies to contributions to political organizations is Carson v. Commissioner, 641 F.2d 864 (1981). The court in Carson took a different approach. It declined to rest its holding on the grounds that the contributor received adequate consideration. Instead, the court held that campaign contributions “when considered in light of the history and purpose of the gift tax, are simply not ‘gifts’ within the meaning of the gift tax law.” Id. at 866.
The Carson holding completely ignores the relevant law and merely holds that campaign contributions are not gifts. In light of the broad language in the Code regarding the gift tax, and Congress’s specific determination that taxpayers would not be subject to gift tax for contributions to section 527 and 501(c)(3) organizations, it is unlikely that a current court would apply the approach taken in Carson to 501(c)(4) organizations. If Congress did not believe that contributions to (c)(4) organizations should be subject to gift tax, it could clearly have said so, as it did with regard to section 527 and 501(c)(3) organizations.
We have seen a significant growth in the use of 501(c)(4) organizations in political campaigns. Fueling this growth, are large anonymous contributions to (c)(4) organizations. Had these large donations been made to section 527 political organizations, the contributions would not be subject to gift tax, but they would be subject to the disclosure rules in 527. By seeking to use 501(c)(4) organizations as a campaign vehicle, individuals may be able to avoid the disclosure rules in §527. As a consequence of attempting to subvert these disclosure provisions, large donors may find that their large contributions to 501(c)(4) organizations are subject to the gift tax.
 For an excellent analysis of the applicability of the gift tax to (c)(4) organizations See Barbara K. Rhomberg, The Law Remains Unsettled on Gift Taxation of Section 501(c)(4) Contributions, 15 Tax’n of Exempts 62, 65 (Sept.-Oct. 2003)(Rhomberg does not ultimately reach a conclusion regarding whether the gift tax would apply to (c)(4) organization but instead thoroughly explores the arguments on both sides.)
 See 11 C.F.R. § 104.20(c) (9)(“ If the disbursements were made by a corporation or labor organization pursuant to 11 CFR 114.15, the name and address of each person who made a donation aggregating $1,000 or more to the corporation or labor organization, aggregating since the first day of the preceding calendar year, which was made for the purpose of furthering electioneering communications.”)
Donald Tobin is an expert on the intersection of tax and campaign finance laws. He served on Capitol Hill and in the U.S. Department of Justice before arriving at the Moritz College of Law in 2001. His two articles on the relationship of tax and campaign finance laws concerning the regulation of political groups having tax-exempt status under section 527 of the Internal Revenue Code, his work on charities and their involvement in political campaigns, as well as his co-authored work with EL@M Director Edward B. Foley, have been widely recognized as leading publications on this topic. View Complete Profile