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Loophole in 527s Shields Donors

As Congress debates what to do about 527 groups, the independent political organizations that spent almost a half-billion dollars to influence the 2004 elections, an underlying assumption has been that while the groups raised unregulated soft money, at least their donor lists were public.

But a review of disclosure forms required by the Internal Revenue Service reveals that contributors to 527s are able to withhold their names through a virtually unnoticed loophole. By simply writing “withheld” in the space where the donor’s name was supposed to go, 527s appear to have an IRS-sanctioned way around the disclosure requirements.

The loophole has a price, however: a 35 percent penalty that the group must pay for not following the rules. But for wealthy donors who want to play the political-influence game anonymously, 35 percent may be a small price to pay for privacy.

Under the widely cited part of the 2000 law, 527s must disclose the name, address and occupation of each contributor who gives more than $200. But what is rarely mentioned is a provision stipulating that failure to disclose such information results in a penalty equal to the highest corporate tax rate “on the amount to which the failure rates.”

Although it’s unclear just how many 527 groups — if any — have paid the penalty to avoid disclosure, independent political organizations are increasingly wising up to the option, legal and campaign finance experts say.

“Sooner or later, it’s bound to become an important mechanism for the funding of the political activity of our large donors,” said Greg Colvin of Silk, Adler and Colvin, a San Francisco law firm that advises nonprofits.

The reason, Colvin said, is the gift tax. The other avenue for large, anonymous political contributions is donating to 501(c) organizations — nonprofits, like 527s, that are named after the portion of the tax code they operate under. But donations to 501(c)(4)s, (5)s and (6)s are taxed at nearly 50 percent, making it a less efficacious route for political money. By comparison, the 35 percent penalty paid by donating anonymously to a 527 is a bargain, Colvin said.

In addition to the gift tax, 501(c) groups also may not have as their primary purpose influencing federal elections. Many election lawyers have interpreted this requirement to mean that less than 50 percent of the funds can be spent on political activity, furthering the inefficiency for large donors to give to 501(c)s in order to influence the electoral process.

Colvin said in an interview that he has advised clients, both donors and nonprofit groups, of this little-noticed provision, but added that he’s unsure how many groups have actually used it.

At the request of Roll Call, Political Money Line searched documents submitted to the IRS by 527 groups listing “withheld” in place of a donor name for the 2004 election cycle. The query yielded 38 instances submitted by 19 different organizations. A separate search done by the Center for Responsive Politics garnered similar results. Political Money Line and CRP are private, nonpartisan groups that track money in politics. Tallying such surveys is an inexact science, however, as the IRS’ Web site does not allow searches by contributor name and groups often fill out forms inconsistently. So an accurate tally could be far higher.

The contribution amounts for receipts labeled “withheld” ranged from $6 to $189,041, and totaled just under half a million dollars. But it’s not clear which donations, if any, were from individuals or organizations who gave to 527s wishing to remain anonymous. For instance, three of three organizations contacted by Roll Call indicated that the amounts listed as “withheld” were simply aggregates of small contributions that the IRS doesn’t require to be itemized.

Independent political groups that organize under Section 527 are required to report to the IRS and itemize all contributions of more than $200. Contributions under that amount do not have to be reported. It seems that these groups erred on the side of too much disclosure by telling the IRS how much they raised from small donors giving $200 or less.

The group with far and away the largest number of contributions “withheld” was the National Federation of Republican Women. But the organization’s president, Dianne Thompson, said the more than $175,000 listed as “withheld” on the organizations 2003 and 2004 filings represented the sum of small donations.

“We follow the letter of the law and do not look for loopholes,” Thompson said in a statement.

Scott Shires, who runs the Senate Majority Fund LLC in Colorado, said his organization reported its small contributions the same way. As for whether larger, anonymous contributions could be reported that way, Shires said he’s heard it discussed among directors of other 527s but that “it has never been a policy of our organization.”

Frances Hill of the Campaign Legal Center isn’t surprised that organizations would make an honest mistake in recording their aggregate unitemized contributions as “withheld” donors. “The instructions, I think, are confusing,” she said, adding, “the IRS is extraordinary unwilling [and] reluctant to offer guidance in the entire area of campaign activity.”

Hill also believes that the whole concept of withholding the names of donors to deliberately skirt the disclosure requirements is completely inconsistent with the 2000 law. In August 2004, the Campaign Legal Center — a nonpartisan, nonprofit organization that supports tighter campaign finance restrictions and enforcement — urged the IRS to rein in the practice.

The group cited a 2003 decision by the 11th U.S. Circuit Court of Appeals that, in its view, determined that disclosure is a condition for 527s to remain tax-exempt.

Hill, CLC’s tax program director and a professor of law at the University of Miami, told the IRS in a letter that certain 527s were taking the position that they may choose to pay the penalty while retaining their exempt status. That misunderstanding, Hill wrote, is furthered by erroneous guidance the IRS gave on its instructions accompanying 527 disclosure forms.

“The Campaign Legal Center urges you to issue public guidance making it clear that this practice is not consistent with exemption under section 527,” Hill wrote.

In an interview, Hill said she never heard back from the IRS after a perfunctory letter thanking the organization for its input.

The IRS has since updated its 527 disclosure form, but the section to which Hill referred remained untouched.

The IRS did not respond to requests for comment by press time.

Fred Wertheimer, president of Democracy 21 and advocate for campaign finance reform, had a slightly different take.

“There is a problem, and we solve it if we get these guys to register as political committees,” Wertheimer said.

Legislation now before both chambers would require 527s to report their activities to the Federal Election Commission and bring them under the same contribution restrictions as the national parties and individual lawmakers’ campaign committees.

The Senate Rules and Administration Committee is set to mark up the bill today. It is not without significant opposition, however, as many independent groups believe it impinges on their First Amendment rights and would stifle political debate.

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