Democrat Party Letter to IRS RE SBAC Anti Brown Ad September 1 2010

8/8/2019 Democrat Party Letter to IRS RE SBAC Anti Brown Ad September 1 2010

http://slidepdf.com/reader/full/democrat-party-letter-to-irs-re-sbac-anti-brown-ad-september-1-2010 1/8

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BETSY BUCHALTER ADLE

GREGORY L. COLV

ROSEMARY E. FA:lADLER ROBERT A. WEXL

ERIK DRYBURG

INGRID MITTERMAI6 & ~ I & C O L V I N DAVID A. LEVI

STEPHANIE L. PETon

235 MONTGOMERY STREET. RUSS BUILDING, SUITE 1220 • SAN FRANCISCO, CALIFORNIA 941

TEL: 415.421.7555 • FAX: 415.421.0712 • WWW.ADLERCOLVIN.CO

September 1, 2010

VIA FEDERAL EXPRESS

Hon. Douglas Shulman

Commissioner

Internal Revenue Service

1111 Constitution Avenue, N.W.,

3000 IR

Washington, D.C. 20224

Dear Commissioner Shulman:

We represent the California Democratic Party. On its behalf, we are writing to

request that the Internal Revenue Service investigate the tax-exempt status of the Small Business

Action Committee ("SBAC"), which is currently recognized by the Service as a

Section 501 (c)(4) organization. SBAC's cunent primary purpose appears to be political activity

(within the meaning of Section 527 ofthe Internal Revenue Code ("Code")) and not social

welfare activity as required by Code Section 501(c)(4). If the Service's investigation reveals that

SBAC has indeed engaged in excessive political activity, we urge the Service to promptly take

appropriate action to prevent abuse of tax-exempt status, up to and including revoking SBAC's

status as a tax-exempt Section 501 (c)(4) organization and imposing taxes, penalties and interest,and retroactive donor disclosure requirements on SBAC should the Service determine that SBAC

is properly characterized as a political organization under Code Section 527.

It appears that SBAC intentionally has used its Section 501(c)(4) status to cloak

its donors in anonymity while engaging primarily in campaign intervention activities, in excess

of those permitted by a 501 (c)(4) organization. If so, SBAC's misappropriation of

Section 501 (c)(4) status frustrates the principles oftransparency fundamental to the disclosure

and reporting requirements Congress imposed on political organizations through Section 527.

We believe the Service has an obligation to enforce the federal tax laws

applicable to tax-exempt organizations engaging in political activity and to mitigate confusion-whether real or contrived - among state campaign advocates regarding their federal tax reporting

and disclosure obligations. This letter will explain why the California Democratic Party believes

that SBAC has exceeded the boundaries of its current tax status and provide an analysis of the

appropriate federal tax consequences of its activities.

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A-. ADLER'&'l, &COLVINA I..aw Co r p o r t l o

Hon. Douglas Schulman


September 1, 2010

PUBLICLY AVAILABLE FACTS

SBAC is a California nonprofit public benefit corporation currently recognized by

the Service as exempt from federal income tax under Code Section 501 (c)(4). According to the

California Secretary of State and the Service's Exempt Organizations Master List (as of

July 26,2010), SBAC has been incorporated and recognized as a Section 501 (c)(4) organization

since July 2003. For 2003 through 2008, SBAC reported annual total revenue and expenditures

on its Forms 990 as follows:

Year I Revenue Expenses

2003 $ 75,8001,751,400

$ 70,4831,443,749004

2005 1,368,590

734,365

280,133

850,450

1,618,017

731,962

225,129

866,501

2006

2007

2008

No more recent Forms 990 are publicly available at this time. SBAC has never filed Schedule C

ofthe Form 990, a Form 1120-POL, or a Form 8871 with the Service, indicating that SBAC

claims all reported expenses relate to social welfare activities. SBAC does not file campaign

finance reports with the California Secretary of State or the United States Federal Elections

Commission?

On August 16, the Sacramento Bee reported that SBAC had launched a new

television advertisement attacking California gubernatorial candidate Jerry Brown ("SBAC Anti

Brown Ad,,).3 The full voiceover script from the SBAC Anti-Brown Ad is as follows:

I SBAC's fiscal year ends on December 31.

2 However, SBAC is related to two organizations engaged in political and lobbying activities: The first is the Small

Business Action Committee PAC, a general purpose committee for California campaign finance purposes, with nofederal tax filings; it appears to focus on ballot measures and other legislative lobbying. The second organization is

the Small Business Action Committee Newsletter, formed in November 2009, which is a "slate mailer organization"

for Califomia campaign finance purposes and a Section 527 political organization for federal tax purposes. The

SBAC Newsletter files Forms 8872 on a regular basis. On its Form 8871, filed in November 2009, the SBAC

Newsletter organization indicated that it is connected to SBAC.

3 See Torey Van Oot, Group Backing Whitman Launches 'Issue' Ad Attacking Brown, THE SACRAMENTO BEE,

available at http://blogs.sacbee.comJcapitolalertlatest/20 10108/csba.html (last visited August 30, 20 10).

{00276455.DOC; 5)



A .... ADLER"&'L &COLVIN

Hon. Douglas SchulmanInternal Revenue ServiceSeptember 1, 2010

Two million Californians out ofwork, andAttorney General Jerry Brown makes it

harder to create jobs, saying he has 1,100 attorneys ready to sue over government

regulations. As a forty-year politician, he doesn't "get" what it takes to create

jobs. As governor, he grew spending, turned a surplus into a deficit, and left office

with 11 % unemployment. And Brown's solution to California's deficit? More

debt, which will kill jobs. Tell Jerry Brown we need more jobs. 4

The Bee article stated that political blog CalBuzz5

had reported on August 15 thatthe cost of running the SBAC Anti-Brown Ad was approximately $1.6 million, although otherknowledgeable sources have subsequently reported to our client that the purchaselprice of the air

time alone (which is likely to continue to increase from the date of this letter) has alreadyexceeded $3.1 million, a figure that does not include any of the costs of creating 2dr producing theadvertisement, which are likely to be substantial. When asked to comment on the nature of theSBAC Anti-Brown Ad for California campaign finance law purposes, both SBA I 's President,Joel Fox, and a spokesperson for SBAC, Jennifer Dudikoff, characterized the advhtisement as"issue advocacy" and stated that SBAC had complied with all reporting requirembnts for issueadvocacy, which do not include reporting its donors.6

In its August 15 piece, CalBuzz suggested that the SBAC Anti-Brqwn Ad wasmasquerading as issue advocacy so that SBAC could attack Attorney General Brown'sgubernatorial candidacy while hiding the identity of its donors. In apparent confitmation of thisview, KQED, the San Francisco Bay Area's National Public Radio affiliate, reported on thecontroversy on August 30,7 quoting Joel Fox, President of SBAC, who stated that SBAC'sdonors prefer not to disclose their identities.8

4 See id. for a link to a full video of the advertisement.

5 See "Small Biz Group Attacks Brown in Phony 'Issues' Ad," available at http://www.calbuzz.com/20IOI08/small-

biz-group-attacks-brown-in-phony-issues-adl (last visited August 30, 2010).

6 California campaign finance law differentiates between "issue advocacy" and "express advocacy" by focusing on

the presence or absence of certain "magic words," such as language explicitly asking the viewer to vote for oragainst the candidate supported or opposed. Express advocacy requires a higher level of disclosure, including donordisclosure, than does issue advocacy.

7 See John Myers, "Advocate or Educate? The 'Magic Words' of Campaign Ads," available at

http://blogs.kqed.org/capitalnotes/20 I0108/30/advocate-or-educate-the-magic-words-of-campaign-adsl (last visitedAugust 30, 2010).

8 Fox cited donor concerns about possible retribution by the Attorney General if such donors' opposition to Brownwere made public, but our client and others view that argument as specious. In the same article, the Chair of

California's state campaign finance enforcement agency, the Fair Political Practices Commission ("FPPC"), DanSchnur, a former Republican strategist and political communications expert, discounted Mr. Fox's claims that fears

of retribution justif); hiding the identity of political donors; Chair Schnur stated, "I have a much greater concern

{00276455.DOC; 5}



~ .... ADLERi&"l. &COLVINA Law Co r p o r a t f o

Hon. Douglas SchulmanInternal Revenue ServiceSeptember 1,2010

RELEVANT FEDERAL TAX LAW

While there may be debate about whether the SBAC Anti-Brown Ad does in factqualify as issue advocacy under California campaign finance disclosure laws,9 its categorizationunder California law is not relevant to its characterization under federal tax law. For federal taxpurposes, applying Revenue Ruling 2004-6,10 the SBAC Anti-Brown Ad is "exempt function"

political activity within the meaning of that term under Code Section 527. Since SBAC hasnever expended more than $1.62 million on social welfare activities in any prior year, I I unlessSBAC engages in unprecedented amounts of social welfare activity in 2010, SBAC no longerqualifies as a Code Section 501 (c)(4) organization.

Code Section 501 (c)(4) describes "civic leagues or organizations not organizedfor profit but operated exclusively for promotion of social welfare. .. [provided] no part of the netearnings of such entity inures to the benefit of any private shareholder or individual."J2 TheTreasury Regulations ("Regulations") promulgated thereunder provide that "a civic league ororganization may be exempt as an organization described in [Code Section] 501 (c)(4) if (i) it is

not organized or operated for profit; and (ii) it is operated exclusively for the promotion of socialwelfare."l3 The Regulations clarify that "exclusively" means "primarily": "an organization is

operated exclusively for the promotion of social welfare if it is primarily engaged in promoting

about the individual who gives a hundred dollars or who puts a sign in his store front window than someone who

spends hundreds of thousands or millions of dollars in television commercials." Chair Schnur went on to stress that

the FPPC favors transparency and the right of the public to know the identities of the funders ofmedia promoting or

opposing candidates: "Every voter, every citizen, every union, every corporation has a right to communicate and to

pay good money to communicate its message on television and radio advertising. But what we believe just as

strongly is the voters need to know who's paying for that ad." In fact, Chair Schnur has indicated that the FPPC

intends to tighten the applicable regulations immediately after the November election, which would, if adopted,

effectively bring within the definition of express advocacy communications like the SBAC Anti-Brown Ad,

reducing the size of the current state regulatory loophole and increasing transparency.

9 FPPC Chair Schnur's remarks indicate that he agrees that though the SBAC Anti-Brown Ad did not meet the

definition of "express advocacy" under current California law, the purpose of the advertisement was plainly to

oppose Brown's candidacy as governor and influence the California gubernatorial election.

102004-4 I.R.B. 328.

II That is, in any prior year for which SBAC's Forms 990 are currently publicly available.

121.R.C. §501(c)(4).

13 Treas. Regs. §1.501(c)(4)-1(a)(I).

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'.6\. .... ADLER"&\, &COLVINA l aw Co r p o r a t i o



September 1, 2010

in some way the common good and general welfare of the people of the community.,,14

Furthermore, the Regulations explicitly state that "the promotion of social welfare does not

include direct or indirect participation or intervention in political campaigns on behalf of or in

opposit ion to any candidate for public office.,,15 As articulated in Revenue Ruling 81-95,16 a

Section 50 1(c)(4) organization's political activity must be "less than primary" or the organization

will be disqualified from tax-exempt status under Code Section 501 (c)(4). In other words, in

order to be properly classified as a tax-exempt Section 501 (c)(4) organization, the social welfare

activities of the organization, however measured, must be greater than all of its non-social

welfare activities combined. The political campaign intervention activities of a

Section 501(c)(4) organization cannot in any year exceed its social welfare activities.

ApPLICATION OF FEDERAL TAX LAW TO SBAC ANTI-BROWN AD

Revenue Ruling 2004-6 provides a list of factors to be used by Code Section

501(c)(4), (5), and (6) organizations to determine whether their expenditures for certain kinds of

advocacy communications should be categorized as political activity under Code Section 527,

and therefore subject to taxation under Section 527(f). The Revenue Ruling provides a list of six

factors that tend to show that an advocacy communication is political activity and five factors

that tend to show that an advocacy communication is not political activity.

We believe that the SBAC Anti-Brown Ad is a classic political advocacy communication

intended to discourage voting for Mr. Brown in the upcoming November elections in Californiaand therefore is political activity under Code Section 527. The table on the following page

analyzes the SBAC Anti-Brown Ad under each of the eleven factors, 17 confirming our view. As

illustrated by the table, each of the positive and negative factors provided in Revenue Ruling

2004-6 weighs in favor of characterizing the SBAC Anti-Brown Ad as political activity

described in Code Section 527(e)(2).

14 Treas. Regs. §1.501(c)(4)-1(a)(2)(i).

15 Treas. Regs. §1.50 I(c)(4)-1(a)(2)(ii).

16 1981_1 C.B. 332.

17 For a more detailed discussion of the factors, please see Revenue Ruling 2004-6.

{00276455.DOC; 5}



TIADLER'&t:1&COLVIN

Revenue Ruling 2004-6 Analysis

Factors indicating political activity

Communication identifies a candidate for public office?YES

SBAC ad features name and photo ofMr. Brown, Democratic

candidate for governor of California

Communication timing coincides with an electoral campaign?YES

SBAC ad will run within 9 weeks of election day, during

period when candidates are actively campaigning

Communication targets voters in a particular election?YES

SBAC ad will run in California, targeting California voters fo

governor in the November 2010 election

Communication identifies candidate's position on the public policy issue that is SBAC ad describes Mr. Brown's alleged position onthe subject of the communication? YES government regulation, the California budget deficit, and job

creation

Candidate's position on the public policy issue has been raised as distinguishing

the candidate from others in the campaign?YES

Jobs and the status of the California economy are already

pivotal issues in the campaign. See below for press coverage

Communication is not part of an ongoing series of substantially similar advocacy

communications by the organization on the same issue?YES

We are not aware of similar communications by SBAC on the

jobs issue, certainly not on the scale of the SBAC ad

Factors indicat ing NOTpolitical activity

Absence of factors above? NO All factors indicating political activity are present

Communication identifies specific legislation or a specific event outside the

control of the organi iation that the organization hopes to influence?NO

SBAC ad does not specify any legislation or event that SBAC

hopes to influence

Communication's timing coincides with a specific event outside the control of the SBAC ad timing does not coincide with any specific event

organization that the organization hopes to influence? NO that SBAC hopes to influence, as no such event is specified;SBAC ad urges public to contact Mr. Brown on jobs, but

Attorney General position has no role injobs creation

Communication identifies the candidate solely as a government official who is in

a position to act on the public policy issue in connection with the specific event?NO

SBAC ad identifies Mr. Brown as Attorney General, but does

not specify any event with respect to which he can act

Communication identifies the candidate solely in the list of key or principal

sponsors of subject legislation?NO

SBAC ad does not refer to any specific pending legislation

For press coverage of jobs as campaign issue, please see: Maeve Reston & Seema Mehta, Firorina, Whitman, Court Central Valley Voters, Los ANGELES TIMES, Aug 13,2

available at http://www.latimes.com/news/local/la-me-central-valley-20100813,0,200083.story (last visited August 31, 201O);Marc Lifsher, Jobs Data Show Growth During Je

Brown Years, Los ANGELES TIMES, Aug. 11, 2010, available at http://latimesblogs.latimes.com/money_co/2010/08/jobs-data-show-strong-growth-during-jerry-brown-years.ht

(last visited August 31, 2010); Steven Harmon, Reality Check: Meg Whitman's Latest Anti-Brown Ad Doesn't Quite Hold Up, SAN JOSE MERCURY NEWS, July 18,2010, avail

at http://www.mercurynews.com/elections/ci_15527387?nclick_check=1 (last visited August 31, 2010); andAd Watch: Whitman Attack on Brown Plays Loose with Facts, TH

SACRAMENTO BEE, June 26, 2010, at A3, available at http://www.sacbee.com/201O/06/26/2850427/ad-watch-whitman-attack-on-brown.html (las t visited August 31, 2010).

-6



A_ ADLER.&\" &COLVINA Law corporatio

Hon. Douglas SchulmanInternal Revenue ServiceSeptember 1, 20 10

CONSEQUENCES OF CLASSIFICATION OF SBAC ANTI-BROWN AD

AS "POLITICAL ACTIVITY"

Because the SBAC Anti-Brown Ad is exempt function activity under Section 527,and based upon both comments by the SBAC leadership and a comparison of the cost of theSBAC Anti-Brown Ad and SBAC's comparatively low historic annual social welfareexpenditures,J8 it is likely that the CUlTent primary purpose of SBAC is political activity, andSBAC should be reclassified as a Section 527 organization that has failed to report itsexpenditures or its contributors as required by the Code and Regulations.

We recognize that the obvious consequence of failure to meet the requirements of

Code Section 501 (c)(4) is the reclassification of an organization as a taxable corporation. 19

However, where an organization engages in political activity substantial enough to disqualify theorganization from Section 501(c)(4) status, and does so with the apparent intention of improperlyshielding its donors from public disclosure of their identities otherwise required by law, webelieve that it is appropriate to evaluate the organization under Section 527 and, if the Servicedetermines that the organization's activities are primarily political, require the organization toprovide Forms 8871, 8872 (including retroactive contributor disclosure), and 1120-POL for theperiods in which it failed to qualify as a Section 50 1(c)(4) organization.

CONCLUSION

The most recent report from the Treasury Inspector General for TaxAdministration ("TIGTA Report"i

O expressly urges management in the Service's Exempt

18 Because we do not have access to SBAC's financial records for the current tax year, it is conceivable that SBAC's

2010 Form 990 will reflect expenditures substantially exceeding its historical levels. Nonetheless, it appears that at

minimum, SBAC should report the SBAC Anti-Brown Ad as political activity on Schedule C of its 2010 Form 990and file a Form I 120-POL for 20 10. In the event that SBAC reports social welfare activities for 2010 that appear to

be its primary activities, we urge the Service to closely examine SBAC's Form 990 and its classification of itsactivities. We note that in the Forms 990 and 990-EZ available for public inspection, SBAC reported as "Other

Expenses" the following expenditures. While such activity may have had a lobbying or otherwise social welfarepurpose, it may also have supported Section 527 political activity.

YearDescription

from Form 990-EZ, Part I, Line 16 or Form 990, Part II, Line 43Amount

% of TotaJExpenses

2004 "Tax & Govemment Issues Research"

(differentiated from "Ballot Initiative Support Cost" of$680,394)

$ 129,091 8.9%

2004 "PoJling & Focus Group Research" 127,424 8.8%

2005 "Tax & Govemment Issues Research"(differentiated from "Ballot Initiative Support Cost" of $865,000)

285,180 17.6 %

2008 "Tax & Government Issues Research" 362,030 41.8 %

2008 "Polling & Focus Group Research" 80,250 9.3 %

19 We also note that if SBAC were reclassified as a taxable corporation, its expenditures for political purposes wouldnot be deductible, as provided by Code Section 162(e).20 Michael R. Phillips, Deputy Inspector General for Audit, "Improvements Have Been Made, but AdditionalActions Could Ensure that Section 527 Political Organizations More Fully Disclose Financial Information"(Feb. 4, 2010).

{00276455.DOC; 5}



11_ ADLER.&\.. &COLVINA Law corpor3tlo



September 1, 20 10

Organizations division to continue to focus its enforcement efforts on noncompliant political

organizations. As the TIGTA Report notes, full and accurate disclosure of political

organizations' financial information "will help the public gain an accurate understanding of

political organizations' activities." While the TIGTA Report concerns organizations that have

identified themselves as Section 527 political organizations, the fundamental principle

underlying Treasury's concerns - that public transparency for donors to political organizations

promotes the proper functioning of democracy - urges even stricter enforcement action where

organizations are intentionally avoiding identifying themselves as Section 527 organizations and

thereby escaping altogether the Congressionally mandated disclosure regime.

While SBAC may be justified in narrowly construing California's campaignfinance disclosure laws to avoid reporting its donors to state regulators, it is not permitted to rely

on such laws to avoid its disclosure obligations as a tax-exempt organization under federal tax

law. The Service has repeatedly stated that it will apply federal tax law precedents in

determining what constitutes political activity under Code Section 527, without regard to the

concept of express advocacy under FECA or similar state statutes. The Service is also charged

with ensuring that organizations continue to qualify for the privilege of tax-exemption under the

applicable rules for their putative status, and with enforcing reporting requirements imposed by

that status. Excessive political activity is inconsistent with SBAC's continued exemption under

Code Section 501 (c)(4); organizations whose primary activity is political must seek exemption

under Section 527. Improper use of Section 501 (c)(4) status to avoid Section 527 disclosure

requirements is an abuse.

To remedy both this specific abuse of federal tax-exempt status, and to discourage

similar abuses by other organizations, we urge the Service to act quickly and decisively in

investigating SBAC.

~ ( £ U t ~ osemary E. Fe(;J

REF:NEM:mmg

cc: Lois Lerner, Director of Exempt Organizations Division

John Burton, Chairman, California Democratic Party

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Democrat Party Letter to IRS RE SBAC Anti Brown Ad September 1 2010

Documents

Transcript of Democrat Party Letter to IRS RE SBAC Anti Brown Ad September 1 2010