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Did the IRS Just Buy Off the Tea-Party?

You may have missed the small item in the tax press describing the latest embarrassment for the Service arising out of the agency’s handling of applications for tax exempt status submitted by “tea party” organizations. The taxpayers, their supporters in the press, and many in Congress have long contended that the IRS action was politically motivated and evidence of an agency running amok. Meanwhile, the Service bungled its response, adding fuel to the fire. While public discussion of the scandal has subsided in recent months, we learned last week that the Government had settled a class action brought by the Tea-Party organizations with a $3.5 million payment from the Treasury. NorCal Tea Party Patriots v. Internal Revenue Service, No. 13-cv-00341 (Order of April 4, 2018).

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For any of you who do not know remember the back story, the underlying dispute began nearly a decade ago with filing of a spate of applications for tax-exempt status by organizations with political agendas, including many organizations associated with the Tea Party movement. The applications attempted to skirt the prohibition against political activities by tax-exempt organizations, although the political focus of the applicants was readily apparent. The exempt organizations specialists within the Service’s National Office, headed by Lois Lerner, eventually transferred the applications to a small office in the Cincinnati Service Center, where they largely languished in inaction. The motive for the Service’s action is a subject of dispute—many have contended that the Service was implementing the political agenda of the Obama administration. The official explanation of what happened provided by senior Service officials kept changing, Ms. Lerner refused to testify at Congressional hearings, the Service “lost” the data from Ms. Lerner’s computer, and IRS Commissioner Koskinen’s appearances before congressional committees only added to fears of political wrongdoing. Years later, several senior Service officials have left office with their reputations damaged, the public standing of the Service has declined even further following congressional hearings, and many of the complaining organizations have quietly received tax-exempt status.

Naturally, the scandal generated a substantial amount of litigation, little of which has gone well for the Government. The Nor-Cal case was brought as a class-action by one of the disappointed applicants for tax-exempt status. According to the plaintiffs, the Service gave increased scrutiny to applications submitted by the taxpayer and other politically conservative groups, delayed action on some of the applications and, in some cases, requested additional and unnecessary information from the applicants to delay review of their applications. Substantively, the plaintiffs’ legal claims asserted violations of the First Amendment and the Section 6103 prohibition against disclosure of taxpayer return information.

For several years, the Government vigorously (and unsuccessfully) defended the case. It objected to certification of the case as a class action and vehemently resisted discovery of documentation from the Service’s files. The courts rejected the Government’s technical legal arguments, certified the case as a class action involving any disappointed applicant for tax-exempt status, and required very broad production of Service documents regarding the processing of applications for exempt status submitted by taxpayers who were not parties to the case. Overall, the courts made it quite clear that they did not approve of the Service’s conduct of the whole affair and might well rule for the taxpayers on the merits.

The recent settlement of the Nor-Cal case almost went unnoticed, although the Government agreed to pay damages of $3.5 million to members of the class. (The bland settlement agreement filed in court did not mention the amount of damages, but subsequent reporting disclosed the payment.) While other cases brought by similar taxpayers had previously had been settled, this appears to be the first case resulting in a payment of damages by the government.

The settlement is remarkable in part because the taxpayers’ claims appear to have had massive legal and factual holes, even accepting the taxpayers’ allegations regarding the Service’s mis-handling of their exemption applications. Some of those holes include—

  • Given the uncertainty regarding the bounds between permissible educational advocacy and impermissible political activity, had the taxpayers established that they would have been entitled to tax-exempt status absent the alleged misconduct?
  • Was there any specific evidence that the Service had violated Section 6103 by improperly disclosing any taxpayer’s tax return information to anyone—the only conduct barred by Section 6103?
  • Assuming that the Service had delayed approval of the taxpayers’ applications for tax exemption because of their politics, is that conduct sufficient to establish a constitutional violation actionable under Bivens, particularly given the extensive authority rejecting Bivens claims under outrageous factual circumstances?
  • Recognizing that the taxpayers were asserting that the Service had delayed (not rejected) their applications, when does delay in processing a request for a ruling become a constitutional violation, particularly recognizing that the wheels of government bureaucracy (and especially the IRS ruling process) often grinds slowly?
  • What damages could the taxpayers establish resulted from an improper delay in granting tax-exempt status?
  • Given the case law drastically limiting the availability of class actions in cases involving taxation, why weren’t the varying facts regarding the applications of various class members an insurmountable barrier to class certification?
  • These issues do not appear to have been fully litigated (at least not at the appellate level).

Under the circumstances, the Government’s willingness to settle the case by paying damages to the class is remarkable. This blogger’s experience has been that the procedures employed by the Government for reviewing settlement proposals of tax cases involving multi-million dollar payouts from the Treasury would have required formal written review by several officials in the Justice Department’s Tax Division, including the Acting Assistant General. Several Service employees would also have reviewed the proposal, with formal written approval given by someone acting on behalf of the current Acting Chief Counsel. Depending upon application of some nuances in the procedures governing settlements, a review by the Congressional Joint Committee on Taxation may have been required under Section 6405.

So, this blogger asks: What induced these officials to approve the settlement and the multi-million dollar payout? Did the Government’s evaluation of the litigating hazards (likelihood of success multiplied by potential damage award) justify a payment of $3.5 million to the class? Or, was the payment justified by other considerations (e.g., a desire to buy a quiet resolution to embarrassing litigation)? And, if so, is that a proper reason for the government to pay litigants? As much of that process was conducted internally within the government and is privileged, we will all be left to ponder the possibilities.

Did the IRS Just Buy Off the Tea-Party?