Earlier this month, the Internal Revenue Service took a major step to make the world of political “dark money” even darker. Now, the state of Montana is working to turn the lights back on, filing a lawsuit seeking to reinstate a rule that requires dark-money groups to report their largest donors to tax authorities.
Dark-money groups are entities that can receive unlimited contributions from corporations and individuals and that are not required to disclose their donors’ identities to the public. Among these are Section 501(c)(4) “social welfare” organizations such as the Koch brothers’ Americans for Prosperity and the Trump-connected America First Policies. Election-related expenditures by these groups exploded after a 2007 Supreme Court decision struck down a provision of the bipartisan McCain–Feingold Act that had limited dark-money spending.
Although dark-money groups are not required to disclose their donors to the public, a federal regulation dating back to 1971 requires all organizations that are exempt from taxes under Section 501—including 501(c)(4) groups—to report the names and addresses of their “substantial contributors” to the IRS each year. A “substantial contributor” includes any individual or corporation that gives more than $5,000 to the organization. By law, this information is open to inspection by state tax authorities for the purpose of administering state tax laws.
But in a sharp break from past practice, the IRS announced on July 16 that 501(c)(4) groups—and most other tax-exempt organizations aside from 501(c)(3) charities—will no longer be required to report the names and addresses of their substantial contributors to the service.
That’s where the state of Montana has stepped in. Montana, perhaps more than any other state, has witnessed the pernicious effects of unregulated political spending. Gilded Age mining baron W.A. Clark won one of the state’s U.S. Senate seats by spending hundreds of thousands of dollars bribing state lawmakers. (In his own defense, Clark famously said, “I never bought a man who wasn’t for sale.”) The Anaconda Copper Mining Company, a firm affiliated with the Rockefeller family, dominated the state Legislature throughout the first half of the 20th century. In light of its history, Montana has an especially strong interest in protecting the few remaining limits on money in politics.
On Tuesday, Montana Gov. Steve Bullock, a Democrat, announced that he and the state’s tax agency are suing the IRS in federal court to block the new policy (called a revenue procedure) from taking effect. (Full disclosure: I served as an informal adviser to Montana in its preparation of the lawsuit.) According to the complaint, the state’s tax agency relies on information collected by the IRS when making its own tax-exemption determinations, and the revenue procedure will therefore make it harder for the state to verify the representations of organizations seeking tax-exempt status. (Indeed, reporting by ProPublica indicates that a conservative 501(c)(4) group that is active in Montana politics may have misled tax authorities about the identity of its major donor when it sought tax-exempt status.) The lack of contributor information will also make it harder for Montana tax authorities to learn whether tax-exempt organizations are being used by major donors as piggy banks in order to avoid state income tax obligations.
The revenue procedure of the IRS, moreover, is legally flawed in at least two ways. First, a 1946 federal law, the Administrative Procedure Act, requires agencies to give the public an opportunity to comment before promulgating, modifying, or repealing a “substantive” rule—such as a rule that imposes binding legal obligations on private parties. The new IRS policy should qualify as a substantive rule under that provision of the APA.
The 1971 regulation imposed a binding legal obligation on 501(c)(4) groups and other tax-exempt entities to furnish the IRS with a list of their substantial contributors’ names and addresses. That means that this month’s revenue procedure—which effectively amends the 1971 regulation by exempting tens of thousands of organizations from the substantial-contributor-reporting requirement—is a substantive rule subject to the Administrative Procedure Act’s notice and comment provisions. The IRS did not follow that process when it issued the revenue procedure.
Second, the Supreme Court has held that an agency “must supply a reasoned analysis” before it promulgates, modifies, or repeals a substantive rule. This requirement—known as the State Farm doctrine—stems from the Administrative Procedure Act’s prohibition on “arbitrary” and “capricious” agency action. The agency’s “reasoned analysis” must demonstrate that its decision “was based on a consideration of the relevant factors” and that the agency has not “entirely failed to consider an important aspect of the problem.”
The IRS revenue procedure flunks that standard too. For starters, the IRS gave no consideration at all to the interests of state tax authorities who might need access to name and address information in order to administer their own state laws. It also gave no evident thought to the interests of other federal authorities—including the Justice Department and the Federal Election Commission—that are responsible for enforcing the ban on election-related contributions by foreign nationals.
Perhaps the IRS will answer that it was justified in its laserlike focus on the enforcement of federal tax laws, to the exclusion of state tax laws and other federal laws. But that answer would be less than persuasive. For example, the IRS says in the revenue procedure that it “does not need personally identifiable information of donors … in order to carry out its responsibilities.” But one of the agency’s statutory responsibilities is to ensure that the activities of 501(c)(4) organizations serve the interests of the community rather than the interests of the individuals who run and fund those groups. To that end, federal law imposes sanctions on so-called disqualified persons who derive an “excess benefit” from their transactions with 501(c)(4) organizations, and whether or not someone is a “substantial contributor” to a 501(c)(4) group is one of the factors that determines if she is a disqualified person. How can the IRS enforce the excess-benefit rule if it doesn’t know whom the rule covers?
So why did the IRS act so hastily to eviscerate a rule that had applied to 501(c)(4) groups for nearly a half-century? For one thing, it faced heavy pressure from conservative activists: The Koch brothers’ Americans for Prosperity group, among others, had urged President Trump and Treasury Secretary Steven Mnuchin to make the change. And because the IRS moved quickly through a revenue procedure instead of waiting for public comments, its new policy can take effect for tax year 2018—which means that millions of dollars can pour into midterm races without the names and addresses of donors being reported.
The federal district court in Great Falls, Montana, which now has the state’s lawsuit, should set aside the IRS revenue procedure and send the agency back to the drawing board. To be sure, a comprehensive solution to the dark-money phenomenon requires legislation, and the Senate so far has declined to take up a bipartisan proposal that would mandate that 501(c)(4) organizations disclose their significant donors if they intervene in electoral campaigns. In the meantime, Montana’s lawsuit is one of the few efforts that can stop the world of dark money from going pitch-black.
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