Federal court rejects change to substantial-donor reporting requirement

If the IRS wishes to no longer require tax-exempt organizations to report information about their substantial financial donors, it must follow a proper notice-and-comment process, a federal court in Montana held in a ruling issued Tuesday (Bullock, No. CV-18-103 (D. Mont. 7/30/19)).

U.S. District Judge Brian Morris concluded that the IRS should have allowed greater public input before altering the long-standing filing requirement because the action represented a legislative rule rather than an interpretive one.

The Service announced in Rev. Proc. 2018-38 that it would no longer require most tax-exempt organizations to report the names and addresses of substantial donors. The change did not apply to purely public charities exempt under Sec. 501(c)(3). Donor information is currently reported on Schedule B, Schedule of Contributors, of Form 990, Return of Organization Exempt From Income Tax; Form 990-EZ, Short Form Return of Organization Exempt From Income Tax; Form 990-PF, Return of Private Foundation; and Part IV, “Statement With Respect to Contributors, etc.,” of Form 990-BL, Information and Initial Excise Tax Return for Black Lung Benefit Trusts and Certain Related Persons.

Montana and New Jersey filed suit to challenge the rule change. The states highlighted that they use the substantial-contributor information in enforcing their own laws regulating the activities of tax-exempt organizations, because the federal data is shared with the states.

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 Administrative Procedure Act (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.

The judge also rejected the IRS’s other arguments, such as that Montana and New Jersey lacked legal standing to bring their lawsuit.

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.”

— Dave Strausfeld, J.D., (David.Strausfeld@aicpa-cima.com) is a Tax Adviser senior editor.