Common Cause Challenges American Legislative Exchange Council’s Tax-Exempt Status Using Whistleblower Provisions

May 4, 2012

Using the whistleblower provisions of the Internal Revenue Code of 1986 (Code or IRC), Common Cause has reported to the IRS what it states is “massive underreporting of lobbying by the American Legislative Exchange Council” (ALEC). Under the IRS’s procedures, an analyst in the Whistleblower Office must consider the information provided by Common Cause. Common Cause could receive between 15 and 30 percent of any taxes, penalties and interest collected, if certain requirements are met. Its motivation, however, is more likely the potential revocation of ALEC’s Section 501(c)(3) tax-exempt status than the award it might receive.

It is difficult for members of the public to challenge the tax-exempt status of a nonprofit organization. Courts generally have held that members of the public do not have “standing” to challenge a nonprofit organization’s federal tax-exempt status. Effectively, only the IRS can challenge a nonprofit organization’s federal tax-exempt status.

There are two processes the public can use to notify the IRS of perceived violations by tax-exempt organizations. The first, which has no specific statutory basis, is Form 13909, which the IRS released in 2007. It is an easy to complete one-page form (with instructions on the back) that allows members of the public to file a complaint about a tax-exempt organization. Forms 13909 are reviewed by the Exempt Organization (EO) function within the IRS and not the Whistleblower Office. EO uses a “reasonable belief” standard to evaluate the facts and to determine whether further action should be taken. It is completely within the discretion of the IRS to determine what, if any, action should be taken.

The second, a more formal process and one that is provided for by the whistleblower provisions of the Code (IRC § 7623), allows the public to apply for an award from the proceeds of amounts the IRS collects by reason of the information provided. Form 211 can be used for providing the information to the IRS and must be signed under penalties of perjury.

There are two types of awards under this process. One award is available if taxes, penalties, interest and other amounts in dispute as a result of the information provided exceed $2 million and if certain other requirements are met. Under this award, which was enacted in 2006 as part of the Tax Relief and Health Care Act of 2006 (IRC § 7623(b)), the IRS will pay 15 to 30 percent of the amount collected. If all the requirements are satisfied, the IRS must pay the award; that is, it is not discretionary, although the Whistleblower Office has discretion in determining the amount of the award within the statutory range. This is the award Common Cause is claiming.

The other award is available when the $2 million threshold is not met or the information provided relates to an individual taxpayer with gross income of less than $200,000. These awards are less, with a maximum award of 15 percent up to $10 million, and are at the complete discretion of the IRS.

Once a request for an award is filed (e.g., Form 211), the Whistleblower Office must analyze the information received and either investigate the matter itself or assign it to the appropriate IRS office for investigation. Thus, by filing a claim for an award under the whistleblower provisions, Common Cause is assured that the information it provided will be analyzed by the Whistleblower Office.

In its claim, which Common Cause refers to as a submission, it makes the following requests:

  • that the IRS investigate ALEC’s previous submissions to the IRS, in which it certifies that it does not spend any money on lobbying;
  • that the IRS should investigate whether ALEC operates in contravention of its Section 501(c)(3) status, because it does not operate “exclusively” for charitable and educational purposes, but instead operates to advance private business interests; and
  • that the IRS should disallow the tax deductions taken by ALEC’s for-profit corporate members, and collect taxes due from such members.

Historically, challenges to the tax-exempt status of a nonprofit organization generally were made by persons believing that the nonprofit organization was discriminating against them (e.g., a school that engaged in racial discrimination) or was receiving an economic benefit from its tax-exempt status even though it was engaged in a commercial activity (e.g., a for-profit fitness center competing with the YMCA). Recent developments, however, show that many challenges are coming from the political arena. For example, certain Democrats in Congress are requesting the IRS to investigate how Section 501(c)(4) organizations are being operated and funded. On the other side of the aisle, certain Republicans in Congress are accusing the IRS of being politically motivated in its investigation of the treatment of contributions to certain Section 501(c)(4) organizations and in delaying the approvals of applications for tax-exempt status filed by certain types of organizations.

The IRS protects the identity of a person filing a whistleblower claim to the fullest extent permitted by law and does not disclose claims it receives. This means (1) that Common Cause most likely voluntarily disclosed its whistleblower claim, and (2) that the IRS may have received a number of whistleblower claims from the public relating to the tax-exempt status of other nonprofit organizations.

Because a whistleblower claim must be submitted under penalties of perjury, the person making the claim must exercise a certain level of due diligence before the claim is made. This should act to temper the number of claims made and the accusations made in the claims.

Unlike nonpublicly traded for-profit entities, tax-exempt organizations are required to make publicly available much of their financial information. This allows whistleblowers to obtain the publicly available information with little effort. Nevertheless, it is clear from the claim filed by Common Cause that it spent considerable time obtaining information regarding ALEC’s organization and operations.

It is likely the public will never know what, if any, action the IRS takes as a result of the Common Cause claim. Whether the IRS acts or not, Common Cause’s disclosure of its claim demonstrates to the public and the IRS its commitment to changing the manner in which ALEC operates. This may be the beginning of a trend in which members of the public use the IRS whistleblower process to challenge the tax-exempt status of certain nonprofit organizations and make public their efforts to do so.