Hobbled IRS can’t stem ‘dark money’ flow

Introduction

When federal election lawyers decided the nonprofit Crossroads Grassroots Policy Strategies likely violated political spending limits, campaign finance watchdogs were certain the Internal Revenue Service would take action.

After all, lawyers for the Federal Election Commission argued that Crossroads GPS, co-founded by Republican operatives Karl Rove and Ed Gillespie, spent more on politics than anything else leading up to the 2010 election.

Then the IRS tea party scandal exploded.

Republicans in Congress began waylaying the IRS over what they said was the systematic and inexcusable targeting of tea party and conservative groups. And the Treasury Inspector General for Tax Administration declared that the agency had employed “inappropriate criteria” in heavily scrutinizing some groups’ tax-exemption applications.

The scandal has persisted with the recent revelation over missing agency emails, which the IRS has blamed on a computer hard drive crash in 2011.

The IRS’ nonprofit division, grappling with a decimated staff and limited resources, effectively lost whatever nerve it had left. Notably, it came to a near standstill on deciding whether it should grant “social welfare” nonprofit status to Crossroads GPS and other conservative groups. It likewise balked at denying or revoking nonprofit status for a growing constellation of politically driven, big-spending liberal nonprofits such as Patriot Majority USA and Priorities USA.

The IRS knew that many of these groups were highly political. But “nobody wanted to say ‘no, you’re not exempt,’” said an IRS exempt organizations division staffer who asked not to be identified for fear of losing his job.

“We stalled so we wouldn’t have to say no,” he added.

The paralysis allowed organizations waiting for IRS approval to continue to spend freely on elections while keeping the names of their donors secret.

The tea party scandal, combined with Congress systematically stripping the IRS of resources and clout over decades, has led to an exempt organizations division that has all but quit regulating politically active nonprofits in any consistent, demonstrable way, a six-month Center for Public Integrity investigation reveals.

The investigation, which involved a review of thousands of pages of IRS documents and interviews with more than two dozen current and former IRS employees and administrators, finds the agency’s nonprofit regulation division has:

• Bled 14 percent of its staff positions during the past two decades while the number of nonprofits it regulates has grown by more than 40 percent.
• Scaled back inquiries, as the number of nonprofit group tax returns investigated recently fell by 10 percent, from 11,699 in 2011 to 10,575 last year. Applications for “social welfare” nonprofit status jumped 27 percent from 1,777 to 2,253 during the same time.
• Reduced the number of denials for exempt status for social welfare nonprofits from nearly 4 percent during the early 1980s to less than a quarter-percent in 2013.
• Softened, tabled or reversed course on at least a dozen proposed policy positions or enforcement plans after criticism from politicians and lobbyists.

How IRS’ nonprofit division fared in 5 charts

Investigations of nonprofits, rulings on unclear issues, denials of groups seeking tax-exempt “social welfare” status and staffing have all generally declined over time for the IRS’ nonprofit division. But its workload has increased, as has spending by social welfare nonprofits that aren’t required to publicly disclose their donors.

Sources: Internal Revenue Service documents and Center for Responsive Politics data.
Note: Data used from IRS documents vary slightly from year to year in some cases. For instance, some data is presented in fiscal years while other data is in calendar years. Election spending is calculated by two-year election cycle.

IRS Commissioner John Koskinen says the agency he’s led since December is in peril.

“We don’t have enough employees anywhere,” he told the Center for Public Integrity when asked about its ability to regulate nonprofit groups. “I think the whole agency is at risk at the level of underfunding we have.”

‘Social welfare’ explained

“Social welfare” nonprofits, also known as 501(c)(4) organizations, today play a key role in many federal political elections.

But they began their existence as entirely different — and unassuming — kinds of creatures.

A federal law passed in 1913 created them as a “catch all” for nonprofit groups that weren’t necessarily educational or charitable but provided a public service and operated “exclusively for the promotion of social welfare.”

Thank a macaroni factory run by the nonprofit New York University Law School for their evolution.

Responding to business complaints about the arrangement, Congress in 1950 passed a law levying taxes on nonprofits’ “unrelated business income.” If nonprofits — 501(c)(3)s like hospitals, charities and universities and 501(c)(4)s — could run a side business, it meant they weren’t operating “exclusively” for their exempt purpose.

The U.S. Department of the Treasury, the IRS’ parent agency, ultimately issued new regulations interpreting “exclusively” as “primarily.” In other words, social welfare nonprofits could engage in other kinds of activities so long as they operated primarily for the common good.

By 1981, the IRS further relaxed the rules by saying social welfare nonprofits could “carry on lawful political activities” as long as their work primarily benefited society’s welfare.

It wasn’t until the Supreme Court’s Citizens United v. Federal Election Commission decision in 2010, however, that politically active nonprofits — social welfare groups as well as 501(c)(5) labor unions and 501(c)(6) trade groups — became a major force in political elections, all while receiving a de facto tax subsidy.

The decision allowed corporations, unions and certain nonprofit groups to spend unlimited amounts of cash supporting or opposing political candidates so long as they didn’t coordinate with candidates or their committees.

Social welfare and other nonprofit groups galloped into the post-Citizens United era with an inherent advantage over overtly political groups: They could hide the source of their funding, regardless of whether those sources were corporations, individuals or other special interests. And they’re only required tell the FEC the names of donors who give money to help produce specific ads — something that rarely happens.

Social welfare groups’ political spending, specifically, ballooned to $256 million during the 2012 election cycle from next to nothing only a few years before, according to the Center for Responsive Politics.

Aghast, watchdog groups and politicos filed numerous complaints with the IRS in hope the agency’s exempt organizations division would intervene, since it’s supposed to ensure 501(c) nonprofit organizations don’t become more political than the law allows.

Meanwhile at the FEC, efforts by the commission’s three Democratic appointees to rein in the nonprofits were stymied by the three Republicans on the commission, who were ideologically opposed to stifling what they consider the free expression of political views.

Weeks turned to months and months into years, and the IRS showed few outward signs that nonprofit groups’ politicking and electioneering was of any particular concern.

While IRS officials declined to say how many social welfare groups have been rejected for tax-exempt status on the grounds that they were too political, the Center for Public Integrity and other media organizations have identified 10 groups since the Citizens United decision.

Six were chapters of Emerge America, a group that trains Democratic women who want to run for office, and one engaged in politics abroad. Another — Arkansans for Common Sense — spent about $1 million during 2010 supporting the failed re-election bid of Democratic Sen. Blanche Lincoln.

At least several other groups had their tax-exempt status denied for benefiting private groups such as political parties instead of the common good.

‘Always being second-guessed’

Nonprofit regulation is “the most explosive, difficult and challenging area of the IRS,” said Larry Gibbs, a former IRS commissioner who served under presidents Ronald Reagan and George H. W. Bush. “It touches on issues that every voter in the country not only can understand, but they’re also issues voters have very strong feelings about.”

Both the IRS and its nonprofit division are prone to criticism, IRS Exempt Organizations Director Tamera Ripperda told the Center for Public Integrity.

“We’re always being second-guessed,” she said, adding that the division is obligated to consider external feedback.

Most of the two dozen former and current IRS employees interviewed — spanning five decades at the agency — could recall moments the nonprofit regulation division succumbed to outside pressure by retreating from or killing proposed actions.

In part because of this pressure, and in part because of what it considered its limited resources, the exempt organizations division deprioritized full-blown examinations in favor of audits done by mail and bare-boned “reviews” done by phone.

The division’s “assembly line approach to deal with the volume” of work likely led to shortcuts, like searching for questionably named groups, and contributed to the tea party debacle, said Jim Buttonow, who worked for the IRS for nearly two decades until 2006 and managed large investigations of nonprofits.

“What you end up doing is delegating and empowering people at the lowest levels,” he said.

In late 2002, to grapple with new priorities and a smaller workforce, the nonprofit division officially reassigned about 100 employees from its investigations unit to the area that processes applications for tax-exempt status, said Steve Miller, who led the division then, in a speech published in the trade journal Tax Analysts.

“Examination workforces have greatly diminished and hence the number of examinations we are able to do,” added Miller, who was fired as acting IRS commissioner in May 2013 amid questions about tea party targeting.

The nonprofit regulation division’s investigations of all nonprofits — politically active ones and otherwise — have fallen during recent decades and also the post-Citizens United years. For instance, the division audited fewer than seven tax returns per every 1,000 nonprofits last year. Early in Ronald Reagan’s presidency, the IRS audited such groups at nearly four times that rate.

During the post-Citizens United years, audited returns fell from 11,449 in 2010 to 10,575 in 2013, agency records indicate. During the same time, applications for 501(c)(4) social welfare status jumped to 2,253 — up from 1,741 in 2010. The Citizens United decision made it easier for these groups to involve themselves in elections.

In addition, last year and this year, the nonprofit regulation division temporarily shifted some employees from investigative work to help process the backlog of nonprofit applications. The backlog is a major concern of Republicans and conservatives upset with the IRS.

“Everybody is all hands on deck” to tackle that problem, said Ripperda, who replaced Lois Lerner, a central figure in the tea party controversy.

It’s not that there’s a dearth of complaints about nonprofits. Eve Borenstein, a Minneapolis attorney, said she was told by Lerner a few years ago that there were tens of thousands of them.

The retreat on investigations gives nonprofit groups the impression they can bend the IRS’ rules, which may not be clear in the first place, Borenstein said.

When Borenstein advises her nonprofit clients against doing something that may violate IRS rules, she says they sometimes tell her: “There are six others who do that.”

Fewer resources, less enforcement

For an agency whose primary responsibility is to collect tax dollars, the IRS itself is receiving fewer and fewer of them from Congress.

The IRS’ approved budget for the 2014 fiscal year is $11.3 billion. That’s $855 million, or 7 percent, less than its 2010 budget.

During the same period, the IRS lost more than 10,000 staff positions — an 11 percent reduction. Meanwhile, it collected 22 percent more in taxes through fiscal year 2011, an indication that its workload has increased.

Congress is proposing another $341 million cut to the agency’s budget for fiscal year 2015.

The Center for Public Integrity is still waiting for a response to a Freedom of Information Act request filed in December that seeks a variety of basic information about the IRS’ exempt organization operations, such as a staff position roster and enforcement actions against politically active nonprofits.

But interviews and IRS documents show the division has, of late, been hit particularly hard.

Since the Citizens United decision in 2010, the exempt organization division’s budget has shrunk 6 percent, from $101.2 million to $95.4 million during 2013.

Staffing in the division dropped more than 8 percent, from 900 in 2010 to 824 in 2013. Ninety-eight division employees left the IRS from Jan. 1, 2012 to May 17, 2014, according to a list of former employees obtained from the IRS through a FOIA request to the federal Office of Personnel Management.

Viewed over decades, the staffing declines become more pronounced.

For example, exempt organization division staffing decreased 14 percent from the early 1990s to last year.

Unlike other IRS divisions, the nonprofit regulation unit’s main job isn’t raising revenue by collecting taxes — making it an easy target in times of budget cuts.

The exempt organizations division has also faced several waves of retirements, thereby losing expertise and institutional knowledge, former employees there say.

The “brain drain” has been exacerbated since the early 2000s by the agency filling key roles with people with management know-how but lacking nonprofit regulation experience.

The budget for training exempt organizations staffers was also slashed from 2009 to 2013 — from more than $7 million to less than $500,000 thanks to “budget cuts and sequestration,” records show.

The IRS has also recently decided, in a bid to save time and money, that it will no longer screen most applications for 501(c)(3) charitable status. Some IRS watchdogs worry politically motivated organizations will attempt to exploit this decision.

Scandal, then paralysis

Since the tea party dispute erupted, more than half a dozen key agency employees have left the agency. They include Miller, acting commissioner at the time, and Lois Lerner, director of the exempt organizations division.

The tea party affair has directed attention away from what many IRS workers say is the much larger problem — regulating the activities of politically charged nonprofits.

The issue is “too hot to handle” for Congress in part because members may benefit from the groups, said Alex Reid, a former U.S. Treasury fellow who was also a staffer for the Joint Committee on Taxation.

“Money in politics is such a divisive and politically sensitive issue that Congress hasn’t been able to” do anything, he said. “It has fallen to the IRS …. It’s working to sweep up after the parade​.”

Still, employees and retirees say the tea party brouhaha, triggered by the IRS delaying some conservative nonprofits’ tax-exempt applications and asking them invasive questions based on their names, could have been averted.

Regulators, for example, could have denied exemptions on the grounds that some social welfare nonprofits appeared too political or they could have approved the groups and flagged some for future audits.

Paul Streckfus, who worked in the division for six years and now runs a trade publication called EO Tax Journal, said Miller and Lerner had reputations for being very cautious.

“It’s sort of ironic they got into trouble. She … should have denied the groups off the bat. But she kept them, kept looking at them, and the rest is history,” Streckfus said.

Miller and Lerner declined to comment on the record.

A current IRS exempt organization division attorney, who didn’t want to be identified for fear of losing his job, said denials were warranted in some cases.

“The groups were coming in saying, ‘No, we’re just trying to exercise free speech.’ But that doesn’t mean you should do that as a tax exempt organization,” he said. “We should have just let them go to court. A judge will tell us if we’re right or wrong.”

Gibbs, the former IRS commissioner appointed by Reagan who now works at the Miller & Chevalier law firm, echoed the sentiment, saying the social welfare designation isn’t intended for highly political nonprofits.

“No ma’am, it’s just not,” he said. “That’s why 527 was put in the code.”

Political “527 groups” are tax exempt like 501(c)(4) groups, but unlike them, they must disclose their donors.

U.S. Rep. Tony Cárdenas, D-Calif., said additional delays with applications can be blamed on congressional hearings that began in earnest during 2013.

“When you see employees of the federal government getting badgered by members of Congress … that’s got to have a really detrimental effect on the psyche of any worker [who is] thinking, ‘Wow, if I take action or not, I might be called in front of Congress and I might be badgered like that in front of the whole country.'”

IRS officials have estimated the scandal has so far cost the agency at least $16 million as it limps from U.S. House investigation to investigation.

Groups like the Richmond Tea Party, one of 41 conservative groups suing the IRS, was not denied tax-exempt status. But delays and extra paperwork cost it time and money.

Organizations can initially operate as tax-exempt social welfare nonprofits without receiving formal approval from the IRS.

But Bruce Jaggard, chairman of the board of the Richmond Tea Party, said it took the agency two-and-a-half years, until July 2012, to approve his group’s application to be a social welfare group in part because it sent the group two more rounds of questions in addition to those asked in the application.

“If you have to do something two and three times, there’s no question you’re going to get into a backlog,” Jaggard said. “Our application we had sent to them was complete with all the information they requested. So make a determination, a thumbs up or thumbs down. They made work for us, and they made work for themselves.”

That, he added, is reason enough to believe the agency doesn’t need more money.

Red alert

Republican congressional members leading efforts to investigate the IRS said the only inappropriate pressure exerted on the agency was by President Barack Obama and Senate Democrats, who repeatedly criticized political spending by social welfare nonprofits.

IRS employees “were intimidated by their own [colleagues’] politics,” said Rep. Darrell Issa, R-Calif., chairman of the U.S. House Committee on Oversight & Government Reform.

Rep. Charles Boustany, R-La., added that the IRS wastes money, as evidenced by reports about its spending on a conference and a “Star Trek”-themed video in 2010.

“If they think congressional oversight is intimidation, well, they have more coming,” Boustany said.

In addition to the political pressure, the rules regarding activities of nonprofits aren’t very clear.

“I can’t blame [social welfare nonprofits] because the law was not clear on what is political activity and how much is allowed,” said Marv Friedlander, a 41-year veteran of the IRS who retired in 2009 as chief of the exempt organization division’s technical branch.

Without easy-to-understand rules, regulators’ jobs became harder, and “they were stuck,” Friedlander said.

Late last year, the IRS attempted to tackle the unclear rules by defining “political activity” for social welfare groups. But it scrapped the proposal earlier this year after receiving about 169,000 comments — many critical.

Members of Congress from both sides of the aisle criticized the rules, noted Rep. Elijah Cummings, D-Md.

“At some point, we have to let people do their jobs,” he said of IRS exempt organizations division employees.

Koskinen, the new IRS commissioner, said the IRS is working on new rules that will not only create a definition, but say how much political activity is allowed.

“We’d be much better off if we had clearer definitions and a clearer roadmap,” he said.

The IRS’ new proposal isn’t expected until early next year — after the mid-term elections — at which point the IRS will hold hearings and ask for more public comments.

‘Dark money’ proliferates

Nonprofits have spent $26 million on 2014 elections as of July 2 — more than double what they had spent at this point in the 2012 election cycle, a presidential election year, according to data from the Center for Responsive Politics.

Millions of dollars more have been spent by social welfare nonprofits on politically charged “issue ads” that don’t directly advocate for or against candidates, and therefore, aren’t reported to the FEC.

Said Robert Maguire, a political nonprofit investigator at the Center for Responsive Politics: “The amount of ‘dark money’ this cycle will far eclipse what we saw in the last midterms and probably even the totals we saw in the last presidential elections.”

Meanwhile, the exempt organizations division is in limbo, and employees fear doing anything controversial as congressional hearings into the tea party issue continue.

“While we have a duty to oversee, it can very well have a chilling effect,” Cummings said.

As part of a reorganization of the nonprofit regulation division, about 45 employees will be shifted to the chief counsel’s office, IRS spokesman Grant Williams said.

There are no guarantees the attorneys being moved will continue working exclusively on nonprofit issues, Ripperda, the exempt organizations director, said in a recent interview. “The counsel is still in the process of structuring that. We don’t know that yet.”

The changes will happen by year-end.

What’s clear is that written opinions on nonprofit regulation issues will now be drafted by the IRS chief counsel, a political appointee.

“If you wanted to take politics out of the thing, you just put the politics in there completely,” said Debra Kawecki, a former senior attorney for the nonprofit regulation division.

Marc Owens, the exempt organizations division director from 1990 to 2000, put it this way: “They are setting the stage for an even more cataclysmic situation.”

With the reorganization under way, congressional scrutiny continuing and pressure to do more work with fewer resources, employees say morale is at an all-time low.

“We spend all our time processing applications, doing some auditing, and nothing is left over,” said a current IRS exempt organizations employee familiar with this work.

Kawecki, who left seven years ago, said even then the Cincinnati office, which processes most of the applications, was overwhelmed trying to keep pace: “The last year when I was there, we took cases from them and did them in the national office [in D.C.] because they were just swamped.”

Commissioner bites back

Some employees are encouraged by Koskinen, a turnaround expert with experience in the private and public sectors who has shown himself to be a bulldog at times.

At a recent hearing in which members of Congress grilled him about the tea party scandal, with one accusing him of lying under oath, Koskinen stood firm. He refused to apologize when asked and corrected his questioners on several occasions when he believed they were making misleading statements.

In addition to his recent announcement of bigger plans for the IRS’ new rules on political activity for social welfare groups, he has said the agency recently restarted audits of social welfare groups that were suspended last year — despite the heat it’s getting from Congress about the issue.

“We tend to look at it a lot from the political side. The real question is also what are your social welfare activities? Primarily, are all your activities, are they social welfare? So we will look at that as well as the other side of the coin,” Koskinen said in an interview.

IRS officials declined to comment on the record beyond what Koskinen said, citing several reasons: regulations the agency is drafting on nonprofit political activity, lawsuits filed against the agency and ongoing investigations by congressional committees, the Department of Justice and the U.S. Treasury’s inspector general.

“Accordingly, it is inappropriate for the IRS to comment at this time on these matters,” IRS spokesman Bruce Friedland said.

The U.S. Treasury provided a brief statement that in part reads: “The IRS and Treasury work together to implement the tax code in a manner that is effective and fair​.” The White House did not respond to requests for comment.

Meanwhile, others worry Congress won’t budge on funding and won’t let the IRS do its job.

“Congress has made it clear that nobody is to stick their neck out” to regulate nonprofit political activity, said Cheryl Chasin, who retired from the IRS about three years ago and whose email on politicized social welfare groups was referenced in a congressional report.

A recent IRS manager familiar with exempt organization issues places the blame squarely on Congress.

“It’s them. They write the rules. … They have ruined people’s lives,” said the former employee, who asked not to be identified for fear of reprisal. “If this is what happens [when you regulate,] who is going to ever want to do it?”

For its part, Crossroads GPS has spent tens of millions of dollars on political candidate advertisements since its inception, although none yet in 2014. Dozens of other 501(c)(4) nonprofit groups also are spending big on candidate advocacy. The IRS largely remains idle.

Crossroads GPS maintains its activities comply with federal law, and that its primary purpose isn’t political. Representatives from the organization did not return requests for comment.

With no foreseeable action by regulators, the nonprofit spending trend is expected to continue into the midterm elections this fall unabated, and the donors to these groups still largely a mystery.