Win for Democracy – Federal Court Rejects Change to Substantial Contributor Reporting Requirement

The Service announced in Rev. Proc. 2018-38 that it would no longer require most tax-exempt organizations to disclose the names and addresses of substantial contributors on Form 990. The change did not apply to purely public charities exempt under Sec. 501(c)(3). Substantial contributor information is currently reported on Schedule B, Schedule of Contributors, of Form 990, Form 990-EZ, Form 990-PF and Form 990-BL. The ruling reduced transparency with respect to substantial contributors and was widely seen as a boon to dark-money forces seeking to influence our elections.

The new Revenue Procedure was swiftly challenged in court. Montana and New Jersey filed suit to challenge the rule change on the basis that the federal data is shared with the states and they rely on the substantial-contributor information in enforcing their own laws. On July 30, 2019, a federal district court in Montana ruled that the IRS violated federal law when it adopted Revenue Procedure 2018-38.

The court’s ruling is not based on whether the IRS has the authority to change the substantial contributor disclosure procedures. Rather, it is based on flaws in the rule-making process that the IRS followed in adopting the new procedure.  The court noted that the agency’s action appeared to be an attempt to “evade the time-consuming procedures” of the Administrative Procedure Act (APA). The IRS treated the rule change as a change of procedure or practice for which there was no need for a public notice-and-comment process. The court disagreed. In reaching its conclusion, the court examined case law regarding the difference between a legislative rule and an interpretative rule. It reasoned that “an interpretive rule remains consistent with the regulation that it seeks to interpret,” which was not the case of the revenue procedure at issue. The court therefore determined that the IRS should have given the public and interested parties fair notice and an opportunity to comment on the proposed change.

Granting the states’ motion for summary judgment, the court set aside Rev. Proc. 2018-38 and held that the IRS “must follow the proper notice-and-comment procedures pursuant to the APA if it seeks to adopt a similar rule.” New Jersey Attorney General Gurbir S. Grewal applauded the ruling, stating:

“This decision is a big win for democracy and for the rule of law. Not only did the IRS try to make it easier for dark money groups to hide their funding sources, it did so behind closed doors, without seeking public input. By setting the IRS’s decision aside, the court has ensured that the IRS will be held accountable for its actions – and dark money groups can be held accountable for theirs.”

It is possible that the IRS will attempt to re-introduce the rule as a legislative rule change. Opponents of the rule change should be prepared to weigh in on any further attempt to shield donors of dark money groups from disclosure.

Ellis Carter is a nonprofit lawyer with Caritas Law Group, PC. To contact Ellis, call 602-456-0071 or email us at info@caritaslawgroup.com.

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