501(c)(4) Donations: So Bad They Tax Them Twice
As Mike Riggs noted the other day, the IRS is investigating at least five donors to 501(c)(4) organizations, asking whether their contributions were subject to the gift tax. The New York Times made this development its lead story today, emphasizing the possible impact on political spending during the 2012 election season (and including the obligatory reference to Citizens United):
Big donors like David H. Koch and George Soros could owe taxes on their millions of dollars in contributions to nonprofit advocacy groups that are playing an increasing role in American politics….
The timing of the agency's moves, as the 2012 election cycle gets under way, is prompting some tax law and campaign finance experts to question whether the I.R.S. could be sending a signal in an effort to curtail big donations.
But the Times never addresses a question that must have been on the minds of at least some readers: What the hell is a gift tax? Does the IRS, having taxed someone's income once, really expect him to hand over another chunk of it simply because he chooses to give it to someone instead of spending it on a new car, a home theater system, or a European vacation? Yes, officially it does. In practice, only wealthy people end up owing gift taxes, which are aimed at preventing them from avoiding estate taxes (another form of double taxation) by giving away their property before they die. But many people of more modest means are theoretically required to report gifts so the IRS can keep track of them.
What counts as a "gift"? Per the IRS, "any transfer to an individual, either directly or indirectly, where full consideration (measured in money or money's worth) is not received in return." That includes not only cash but "any property" that is given away or sold for less than its "fair market value" as well as interest-free or reduced-interest loans. When is a gift taxable? "The general rule is that any gift is a taxable gift," the IRS says. "However, there are many exceptions to this rule." It notes that "the laws on Estate and Gift Taxes are considered to be some of the most complicated in the Internal Revenue Code."
If you give to a qualified charity, the donation is not subject to the gift tax. (In fact, it is tax-deductible, reducing your taxable income.) Gifts to spouses, payments for another person's tuition or medical expenses, and "gifts to a political organization for its use" are "generally" not subject to the gift tax. In most other cases, gifts, including gifts to your children or grandchildren, are subject to an annual limit per recipient, currently $13,000. Above that threshold, they are taxable. But there is also a "lifetime exclusion" of $5 million, meaning you can rack up that amount in taxable gifts before you actually have to pay taxes on them. That's why only the rich need to worry about paying the tax, although everyone is supposed to be reporting gifts that count toward the lifetime limit.
The exclusion for "political organizations" includes 527 groups, which Congress specifically exempted in 2000, but not 501(c)(4) "social welfare organizations," which are tax-exempt but permitted to engage in lobbying and political campaigning, as long as the latter is not their primary focus. Unlike donations to 501(c)(3) organizations, whose political activity is subject to stricter limits, donations to 501(c)(4) groups are not tax deductible. In fact, assuming the IRS is serious about enforcing the gift tax, contributions to these organizations could be taxed twice. That's assuming the contribution exceeds $13,000 and the donor has hit his $5 million lifetime limit, which will probably be the case for anyone with a decent-sized fortune who is trying to minimize the taxes on his estate.
Addendum: In the comments, Alan Vanneman says the gift tax is not double taxation, because "if someone gives you money, dude, that's income," "so you pay tax on it." The gift tax is incurred by the donor, not the recipient. If George Soros gives $100,000 to Priorities USA, say, he's the one who owes any applicable gift tax.
