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How is the IRS supposed to vet 501(c)(4) groups, anyway?

The Internal Revenue Service has come in for widespread criticism after an internal probe revealed that the agency had been applying heavy scrutiny to conservative organizations and Tea Party groups that were applying for tax-exempt status.

So how unusual was this scrutiny? It's worth taking a closer look at what the IRS was actually doing — and compare it with how the agency is supposed to vet organizations that apply for tax-exempt status under Section 501(c)(4) of the Internal Revenue Code. This designation allows the groups to keep their donors anonymous.

What is the IRS supposed to do? Let's start with what the rules say. The IRS should, in theory, draw a distinction between political groups and "social welfare" groups across the spectrum. Any tax-exempt group that is organized under Section 501(c)(4) must fall into the latter category. That is, the group has to be "primarily engaged in promoting in some way the common good and general welfare of the community."

That can include anything from a corporation set up to renovate a stadium to an animal-rights groups to an organization lobbying for abortion restrictions. These groups can even participate in some political actions.* But they shouldn't be primarily engaged in partisan politics or electioneering. (Again, that's the theory, though some larger 501(c)(4) groups like Priorities USA and Crossroads GPS seem to be extremely political.)

In practice, that's a tricky line to draw. A 1995 agency memo laying out the guidelines opens by noting that "politics is not an exact science." When the agency scrutinizes 501(c)(4)s, it needs to weigh a variety of factors:

Whether an organization is "primarily engaged" in promoting social welfare is a "facts and circumstances" determination.
Relevant factors include the amount of funds received from and devoted to particular activities; other resources used in conducting such activities, such as buildings and equipment; the time devoted to activities (by volunteers as well as employees); the manner in which the organization's activities are conducted; and the purposes furthered by various activities.

And there's no clear limit on what the IRS can ask to make this distinction, says Richard Schmalbeck, a Duke University law professor.  "The IRS has an obligation to determine whether these are political or social welfare groups," he says. "Any question that you can ask where you can imagine an answer would help determine that is legitimate to ask."

So how was the IRS treating conservative groups? Various conservative and Tea Party groups, however, say that the questions and scrutiny they received in applying for tax-exempt status were unusually aggressive.

Dan Backer is a Washington-based lawyer who helped six smaller conservative groups apply for 501(c)(4) status, including and the Combat Veterans Training Group. A year ago — well before this IRS scandal broke — he wrote a white paper alleging that  the IRS was "harassing" his clients with excessive questions.

Take "This organization was formed to help engage Americans in the Tea Party movement, people who think our society is headed in the wrong direction, who think we're taxed too much, who think excessive debt is bad," Backer told me. "The group doesn't give independent expenditures, they don't want to get people elected, they just want to do education and outreach, to share traditional conservative American values." applied for tax-exempt status three years ago and is still waiting approval. On Feb. 9, 2012, the IRS sent the group a list of 16 further questions it needed answered, including information about its voter education drives, its fundraising activities and — what caught Backer's eye — detailed information about the group's donors. (You can read the IRS questions here.)

"The demand that groups identify donors is the most shocking part of this inquiry," Backer wrote. "Not only does it have no bearing on an organization’s qualification for tax-exempt status, reporting donor information has a chilling effect on free speech." He told me that refused this request.

Two other groups — the Richmond Tea Party and Combat Veterans Training Group — were also asked about donors, according to Backer.

Was that extra scrutiny proper? The Inspector General's report argued that many of the questions directed toward conservative groups were indeed "unnecessary and burdensome" — including the request for "lists of past and future donors."

Schmalbeck, the Duke law professor, says that an IRS question about donors might, in theory, be legitimate. "It's potentially relevant," he says. "If your donors consist exclusively of other political organizations, then that raises a sense that you are more likely to be a political organization that involved in promoting social welfare."

However, adds Schmalbeck, a big potential problem here is that all of the IRS questions and answers are supposed to be made publicly available once the organization is approved. The law is vague on whether organizations who go through this process could ask to keep their list of donors secret. And yet part of the point of 501(c)(4)s is that they're supposed to allow donors to stay anonymous. (The IG report states that, according to IRS officials, donor information "was later destroyed.")

Another issue is whether the IRS was delaying or holding up applications for these smaller conservative groups in some way. The IG report agreed that conservative applicants were facing "substantial delays." Backer says his application for has taken more than three years. By contrast, he had helped a non-conservative educational organization apply for a 501(c)(3) and finished in just 68 days.

"I understand there's a backlog," Backer said. "The number of applications doubled [after the Citizens United decision]. But that doesn't excuse this conduct. So far, I haven't done any [501(c)(4) filings] for groups whose focus tends to be conservative where the process has gone smoothly."

All told in 2012, some 2,774 groups of all types applied for 501(c)(4) status. Of those, 2,324 were approved, eight were denied, and 442 were held in limbo, neither approved nor denied. A number of conservative groups found themselves in this last category.

Why did conservative groups get singled out for this treatment? That's the biggest and most contentious question here. According to the Treasury Department's Inspector General, the IRS developed "inappropriate criteria" to flag groups with “tea party,” “patriot” or “9/12” in their names in order to subject them to review.

The fact that Tea Party groups — especially smaller organizations — appear to have been specially singled out for scrutiny is what most troubles many experts here. Not least because larger, politically oriented groups like Crossroads GPS and Priorities USA were able to form 501(c)(4) organizations with little trouble.

“It’s part of [the IRS's] job to look for organizations that may be more likely to have too much campaign intervention,” Loyola law professor Ellen Aprill told my colleagues. “But it is important to try to make these criteria as politically neutral as possible.”

"The targeting aspect of this is god-awful," agreed Douglas N. Varley, a Washington-based lawyer with Caplin & Drysdale who deals with tax-exempt organizations. He adds that the agency's special focus on conservative groups is a much bigger deal than the sheer number of questions that were posed to groups seeking 501(c)(4) exemption, which isn't by itself unusual.

Post updated with additional citations from the IRS Inspector General report.

* Correction: An earlier version of this post said that the Club for Growth, a 501(c)(4), endorses candidates. That's incorrect. A separate organization, the Club for Growth PAC, which is a registered political group, endorses candidates.

Related: Everything you need to know about the IRS scandal, in one FAQ.