Reforming §501(c)(4) organizations

Sep 26, 2022

Using one guiding principle, here are two proposed reforms to improve the permissions, restrictions, and tax advantages around 501(c)4s.

Two recent major gifts to § 501(c)(4) social-welfare organizations, one by Barre Seid and the other by Yvon Chouinard, have generated serious discussion about entities of this sort and how they are funded. Much of the commentary about these donations was ideological, with some hailing both men as heroes and others equating them to the denizens of hell. However, a few thoughtful writers looked at both cases and concluded that the funding and regulatory structure of (c)(4) groups is broken and needs to be fixed. Here is an initial contribution to what I hope will be a robust discussion about these very political nonprofit entities.

Section 501(c)(4)s are nonprofits that can engage in election-related and lobbying activities far more extensively than §501(c)(3) public charities. However, as a result of (c)(4)s’ ability to influence politics and policymaking, contributors to them do not receive a tax deduction for their donations. Donors can give assets, like stock and property, to both (c)(4) and (c)(3) groups and, in doing so, avoid paying capital-gains tax—which, for very wealthy, high-income donors could be as much as 23.8% of the difference between the original cost of the asset and its current value. In addition, private foundations, donor-advised funds (DAFs), and other (c)(3)s can transfer financial resources to a (c)(4) if the activities funded at the recipient (c)(4) are in line with the mission of the (c)(3) donor. Through these routes, a donor can donate assets to a (c)(3), avoid the capital-gains tax, receive a charitable deduction, and support the political and lobbying activities of the (c)(4). 

Finally, a (c)(4) can also contribute to §527 organizations, political-action committees that are not coordinated with a specific candidate. These entities are used to support issue campaigns as well as political campaigns. While 527s are required by the Federal Election Commission to reveal their donors, a gift passed through a (c)(4) is unlikely to name the original donor. As a result, a charitable contribution with all of the attendant tax advantages and benefits could end up supporting an explicitly political venture.

The last wrinkle in the (c)(4) story is control. A donor can give assets to a (c)(3) foundation or DAF, yet still have complete control over the disbursement of those resources. Many family foundations are just that—entities controlled by the donor and his family. For DAFs, the control issue is even simpler. You don’t need the façade of a malleable board. You simply tell the sponsor of the DAF, like Fidelity or Schwab, to transfer money to a specific entity. While the big financial institutions may be chary to make grants to a (c)(4), many of the ideological sponsors of DAFs do not have the same aversion. Now, it gets interesting. There is limited disclosure about the control of (c)(4) entities. There are certainly (c)(4)s created and largely controlled by their major donors. In these cases, a very wealthy person can reap enormous tax benefits, enhance his or her giving by avoiding capital gains, and maintain complete control over the money right up to the final, politically motivated (c)(4) recipient.

In the case of Seid, he contributed 100% of his shares in his electronics company, $1.6 billion, to the Marble Freedom Trust, a (c)(4) with strong conservative leanings. He did not ask to be on the board of the recipient and, as far as we know, he does not have any direct control over how the money is used beyond the promises of the receiving party. The Chouinard case is more complicated. He and his family gave some voting stock in Patagonia, the company they founded, to a trust that one can assume has the family members and close family associates on the governing board. The remaining stock, representing 98% of the $3 billion value of the company, went to a (c)(4) devoted to fighting climate change. While the governance of the Holdfast Collective is not transparent, there are indications that the donors have a significant say in the activities of this group. Neither Seid nor Chouinard tried to harvest charitable tax benefits. Both avoided capital gains. But Chouinard kept control of his company and may have control over the (c)(4) that now owns 98% of Patagonia. Both gifts may be signals that the system is broken, and the Chouinard donation shows how a broken system can be stretched to the limits in order to the benefit of the donor.

There are many ways this mess could be cleaned up. Some, like simply ending all tax benefits related to charitable organizations, are politically impossible. Other constraints, like restricting the activities of (c)(4) organizations, might be unconstitutional by violating First Amendment guarantees. One principle that should guide any reform efforts is straightforward: gifts to (c)(4)s should not accrue direct or passive tax benefits. Avoiding capital-gains taxes may not be a direct benefit, but it does enhance the size of the gift and potentially the influence of the donor. Using this principle as a guide, here are two proposed reforms to (c)(4) institutions.

The first is simple: contributions to (c)(4)s have to be in cash. Assets, like stocks and real estate, would have to be sold and taxed, and only then could the proceeds go to the (c)(4). Under this proposal, the American taxpayer is not being asked to subsidize, directly or indirectly, the political causes or policy fetishes of the very wealthy. Technically, at least 51% of a (c)(4)’s work must be devoted to social welfare, as opposed to politics and lobbying. Some may argue that it should be okay to give appreciated assets to a (c)(4) if the donation is limited to those “good” activities. However, the definition of “social welfare” has become so distorted that all sorts of issue-oriented “education” and “mobilization” can be conducted under its broad rubric. Given the poorly defined constraints on (c)(4) activities, it seems safest to simply prohibit all transfers of stocks and other non-cash assets to these entities.

The second is to preclude contributions from private foundations, DAFs, and other (c)(3) groups to (c)(4)s. Some activists will wail that this prohibition would prevent these entities from pursuing their legitimate charitable missions. If the activities are legitimate and warrant various considerations under the tax code, then they should be done through (c)(3) groups that are able to engage in electoral-adjacent and lobbying activities only within limits. If you want to go all in on your political agenda and policy passions, then do so without a subsidy from the middle-class taxpayer.

These two reforms would also have the effect of making the control of (c)(4) organizations moot. If Chouinard is paying cash into a (c)(4) controlled by him and his family, there’s no problem with that. If he is enhancing his gift by avoiding capital gains or reaping charitable deductions by using DAFs or other vehicles, then his control is another matter because he is asking all taxpayers to subsidize his partisan interests.

These proposals will not be popular with the left or right in America. A thick network of advisers, (c)(4)s, and friendly DAF sponsors have emerged over the past two decades for the sole purpose of finding ways to subvert the restrictions placed on the charitable system in 1969 and later. Now, it is time to begin addressing these subversions and making the charitable sector truly charitable.