Democrats keep exemption.

In the waning days of the Bush administration, the government ended its long-running effort to retroactively revoke the tax-exempt status of a Democratic Party-affiliated organization that it claimed had improperly promoted the party's candidates.

In 1985, prominent members of the Democratic Party including then-Gov. Bill Clinton formed the Democratic Leadership Council (DLC) to promote social welfare and to bring about "civil betterments and social improvements." The DLC applied for tax-exempt status as a social welfare organization, explaining that it was organized by Individuals concerned about national policy and the direction of policy debate within the Democratic Party. The DLC intended to create task forces, contract for studies and host fundraising events. It would also hold town meetings, issue forums and policy meetings. It said it would not intervene In campaigns or seek to influence voter perceptions. The IRS granted the DLC tax-exempt status under IRC [section] 501 (c)(4). Courts have allowed 501(c)(4) organizations to engage In political activities if they operate primarily to bring about social improvements.

During 1997, 1998 and 1999, the DLC hosted prominent Democratic elected officials at conferences and held events attended exclusively by Democrats. The president of the DLC stated that its activities were efforts to shift the Democratic Party's policies closer to its own policies, which could help Democrats at the polls.

In 2002, the IRS issued a proposed adverse action letter revoking the DLC's tax-exempt status for 1997 and 1998 because, it said, the DLC was primarily benefiting a private group--newly elected Democrat officials and the Democratic Party--rather than the community. In 2003, the IRS proposed to revoke the DLCs exempt status for 1999. The DLC paid approximately $20,000 In taxes under protest and filed suit for a refund of the amount in the District Court for the District of Columbia, which ruled in its favor in April 2008. The government appealed to the D.C. Circuit but agreed to a dismissal on Dec. 16, 2008.

The DLC argued that it qualified as a 501(c)(4) organization during the years at issue and that the IRS improperly revoked the exempt status retroactively In violation of Treas. Reg. [section] 601.201(n)(6). Although the IRS may prospectively revoke an organization's tax-exempt status if the organization no longer qualifies for an exempt purpose, the IRS is subject to restrictions when it attempts to revoke tax-exempt status retroactively. The IRS may retroactively revoke an organization's exempt status only if the organization omits or misstates a material fact or operates In a manner materially different from that originally presented.

The IRS claimed the DLCs later operations did substantially differ from its originally stated purposes. The application did not state that the DLC would attempt to reclaim centrist national policies from Republicans or to help elect a Democrat president, both of which its leaders subsequently stated as goals, the IRS chimed. Also, the government said, there was no evidence that the DLC held town meetings or issue forums or contracted for policy studies.

The court recognized the IRS' primary argument that the elected officials were dominant in the creation, control and policies of the DLC but concluded that the IRS did not provide evidence of material changes In the DLC's operations. Regardless of whether the DLC held town meetings and other Intended activities, there was no evidence that it operated In a materially different manner than it had proposed, the court said. The court noted that an IRS agent who investigated the DLC's operations testified that it was operating within the terms of its exempt ruling.

The court said the DLC may have been unworthy of exempt status under 501(c)(4), but the revocation was a clear abuse of discretion, and the DLC was entitled to a refund.

* Democratic Leadership Council Inc. v. U.S., 101 AFTR2d 2008-1597, appeal dismissed docket no. 08-5193 (D.C. Cir. 2008)

By Jennifer Haynes, tax associate, KPMG, and Allen Ford, the Larry D. Horner/KPMG Professor of Accounting at the University of Kansas, Lawrence, Karl