Donor reporting changes violate the Administrative Procedure Act

Editor: Sally P. Schreiber, J.D.

A district court held that the IRS must follow the Administrative Procedure Act’s (APA’s) notice-and-comment procedures if it wishes to alter the requirement in Regs. Sec. 1.6033-2(a)(2)(ii)(f) that tax-exempt organizations report certain information about their substantial financial donors (Bullock, No. CV-18-103 (D. Mont. 7/30/19)).

In 1970, the IRS promulgated Regs. Sec. 1.6033-2(a)(2)(ii)(f), which required most exempt organizations to report on Schedule B of Form 990 the “names and addresses of all persons who contributed . . . $5,000 or more” during the tax year. In Rev. Proc. 2018-38, the IRS eliminated this requirement for all Sec. 501(c) groups except public charities exempt under Sec. 501(c)(3).

Secs. 6103 and 6104 permit states and their tax agencies to collect and use federal return information gathered by the IRS. Montana and New Jersey, which had used the substantial-contributor information reported to the IRS under Regs. Sec. 1.6033-2(a)(2)(ii)(f) in enforcing their own laws regulating the activities of tax-exempt organizations, were not happy with the IRS’s decision to no longer collect the information. The states filed suit to set aside Rev. Proc. 2018-38, claiming that it was not validly promulgated because the IRS failed to follow the APA’s notice-and-comment procedure for rulemaking.

The district court agreed with the states that Rev. Proc. 2018-38 was invalidly adopted. The court explained that it was not assessing the revenue procedure’s underlying merits, just the process that the IRS followed. As the court saw it, the agency’s action appeared to be an attempt to “evade the time-consuming procedures” of the APA.

In the IRS’s view, Rev. Proc. 2018-38 was simply a rule of procedure or practice for which there was no need for a public notice-and-comment process. Disagreeing, the court examined case law regarding the difference between a legislative rule and an interpretative rule. It observed that, for one thing, “an interpretive rule remains consistent with the regulation that it seeks to interpret,” which was not true of the revenue procedure here.

The court therefore concluded that the IRS should have given the public and interested parties an opportunity to submit written data and opposing views or arguments.

Granting the states’ motion for summary judgment, the court set aside Rev. Proc. 2018-38 and held that the IRS “must follow the proper notice-and-comment procedures pursuant to the APA if it seeks to adopt a similar rule.”