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Campaign Reform Law: A Flawed Fix

BY Deirdre Davidson
by Deirdre Davidson on 7/24/00.

confounded by it, regulators are constantly under fire for failing to implement it, and Congress usually does everything it can to avoid it.

The new "527" legislation is the perfect example why.

The law, which Congress passed last month in hopes of eliminating a popular campaign finance loophole, may prove both more broad and less powerful than originally imagined.

With a scant week left before the law is fully implemented, election lawyers are already grousing about its breadth and stretching out loopholes to avoid its provisions.

Complicating matters, the Internal Revenue Service, which has been charged with enforcing the reforms, is going to find itself fighting in the politically charged realm of campaign finance law, as the Federal Elections Commission was left on the sidelines when Congress passed the measure.

"This bill was legislation at its worst. It was passed in a frenzy, without much time or care in what are certainly two of the most esoteric areas of the law-tax law and election law," says Mark Braden, a partner at Baker & Hostetler and former chief counsel for the Republican National Committee. " Why would anybody be surprised it doesn't work?"

Few thought the 527 legislation had a chance of getting through Capitol Hill. But it zoomed through in just a few weeks.

The bill is unique because it uses the tax code, not the Federal Election Campaign Act, to force disclosure on 527s, the popular moniker for groups registered as political organizations under '527 of the U.S. Tax Code. The benefit of 527 status is tax breaks: Donations are exempt from the gift tax, and a 527 does not pay taxes on any money it receives or spends.

Party committees-such as the Republican National Committee-are 527s, as are most PACs. Congress members frequently set up their "leadership PACs" under ' 527, as do trade groups, unions, and businesses that are politically active.

Most 527s disclose such things as expenditures and the names of officers and donors to the Federal Election Commission. But in the past few years, groups discovered that by registering as a 527 but working only to promote issues-not candidates-they avoided FEC disclosure, allowing the groups to operate virtually in secret.

Controversy over the issue-oriented 527s snowballed this year with allegations that consummate fund-raiser Sen. Tom DeLay (R-Texas) had stepped over the line in encouraging GOP supporters to pour money into the groups.

The new law attempts to wipe out the secrecy. Under the recently adopted reform, any group claiming 527 status must register with the IRS and file reports on the group's donations and expenditures. The law exempts groups that already report to the FEC from the IRS proscriptions.

Dual Account Issue

Enter problem 1: Some election lawyers are arguing that many accounts that don't currently report to the FEC are also exempt from IRS disclosure.

The possible loophole: Some PACs have two accounts. The first is a so- called federal account that collects money that can be used in support of a specific candidate or cause; this account is regulated by the FEC. The second is a nonfederal account, which can't be used to directly support a federal candidate for office. Money from this second type of account is not regulated by the FEC.

The lawyers argue that federal accounts and nonfederal accounts are both part of one political committee. Since one arm of the committee reports, the entire committee is exempted from IRS reporting, they argue.

"The unresolved question is: Are political committees with nonfederal accounts exempt from this 527 statute?" says election attorney Jan Baran, a partner at Wiley, Rein & Fielding who represents a number of Republican groups and 527s. "We don't have anything to go on except the statute and the
(registration) form, and both seem to say you are exempt."

That reasoning has appeal with federal lawmakers looking to keep some of their fund raising private. DeLay, in a speech last week at the Cato Institute, said he believed some of his fund-raising groups would not have to register with the IRS.

Here's how it would work under Baran's theory. A group sets up a political committee, with a federal and a nonfederal account. The group raises $ 1,000 with the federal account and donates it to a presidential campaign. With the nonfederal account, the group raises $ 5 million and spends it on ads trying to influence voters on certain issues pertinent to the election. Only the $ 1, 000 from the federal account would need to be reported.

'Lawyer Gamesmanship'

"If you exempt the nonfederal accounts, you create this huge potential for nondisclosure," says Kenneth Gross, an election law specialist and partner in the D.C. office of New York's Skadden, Arps, Slate, Meagher & Flom who " totally disagrees" with Baran's interpretation. "The legal theory they are basing it on is totally invalid."

Gross, who frequently represents corporate clients as well as lawmakers from both sides of the aisle, finds it particularly galling that some are arguing for this exemption because of how broad the law is in other respects.

For example, the legislation calls for all state PACs, including those of candidates for state legislature, attorney general, or governor, to register with the IRS if they spend more than $ 25,000. Many of the state PACs, namely those of businesses and trade associations, will also have to report their contributions and expenditures no matter how extensive their in-state reporting.

Public Citizen, a campaign reform advocacy group, sent a letter to the IRS last week asking the agency to issue guidelines stating that nonfederal accounts must report. Campaign reformers are outraged that some 527s are already seeking loopholes.

"I think that is an interpretation that completely undermines the intent, if not the language of the law," says Don Simon, general counsel for Common Cause. "I think this is lawyer gamesmanship to twist the meaning of the bill."

Congressional staffers who worked on the legislation say they believe that those groups should have to file, but that it is now up to the IRS to make that determination.

"From the standpoint of congressional intent, they should be covered," said one staffer. An IRS spokeswoman said the agency is studying the legislation and hopes to set guidelines for compliance in the coming weeks.

Even if this loophole doesn't materialize, there are other ways to avoid the 527 requirements. Among the options: buy your own issue advertising; incorporate as a private corporation; or change your tax status to a 501(c)4, a nonprofit entity that can lobby. All of these options have some drawbacks- namely, fewer tax benefits- but they offer more anonymity.

Already, the nonprofit option is emerging as the most attractive.

Over the years, many groups have used it effectively. In fact, many of the 527s operating today were once nonprofits, but changed status to get the benefit of the gift tax exemption for their donors. And although nonprofits have to make some information, such as their total income, publicly available, they do not have to reveal their donors. Many 527s, such as industry- sponsored groups Citizens for Better Medicare and Citizens for a Sound Economy, are considering the nonprofit option, according to spokespersons.

Those who do remain as 527s will be taking their cues from the IRS, which has been plunged into the middle of the debate thanks to Congress' decision to put it in charge of administering the reform.

"I think the IRS is going to be very unhappy about getting involved in the sticky election law issues involved in administering this law," Gross says.

Can IRS Enforce Properly?

The IRS has never made its reputation in the disclosure business. And as the FEC has learned, campaigns often need a little enforcement from regulators in order to stay in line. The bill, however, provides no additional resources to the IRS. With all the time that the agency already spends processing tax returns, some question whether it will be able to effectively police the political field.

"With this legislation, the IRS is talking about turn-around time that is measured in days," says Marcus Owens, a partner at D.C.'s Caplin & Drysdale. " It's the kind of enforcement they may not be able to do on the IRS enforcement timetable."

Some reform advocates are hopeful the IRS will prove less hamstrung than the FEC. It was the IRS, after all, that refused to grant the Christian Coalition nonprofit tax status on the grounds that the organization was overtly political. The coalition is fighting the ruling in court.

Advocates hope the agency will be as aggressive with those groups that try to skirt the new 527 reforms.

"I have more faith that the IRS is going to say no to them than the FEC would," says Steve Weissman, a lobbyist for Public Citizen. "The FEC is paralyzed."

Deirdre Davidson is a reporter at Legal Times. Her e-mail address is>

Photo cutlines/credits

Is anybody happy?: Marcus Owens (above)

of D.C.'s Caplin & Drysdale says the IRS

is ill-suited for enforcing the new campaign reform law, which has come under attack from some election lawyers. Skadden, Arps' Kenneth Gross calls " totally invalid" the claim by many attorneys that loopholes exempt their clients from the new reporting and disclosure requirements./photos by Patrice Gilbert