IRS Audits of Grass-Roots Lobbying Expenses

Published by the Government Accountability Office on 1977-11-09.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                                         STATES GENERAL ACCOUNTING
                                              WASHINGTON,     DC.   20548


                                                                        November 9, 1977

             The Honorable Jerome Kurtz,           Commissioner
             Internal  Revenue Service
             Department of the Treasury

             Dear Mr. Kurtz:

                     As you know, the Subcommittee on Commerce, Consumer, and Monetary
             Affairs,     House Government *rations       Committee, plans to hold hearings
             on the proper accounting       for corporate   expenditures    made for political
             advertising.      While preparing   for these hearings,      we noted that the
             Internal     Revenue Service (IRS) has done little,        if anything,  to address
             apparent problems in this area which were surfaced as early as 3 years

                   In May and June 1974, the Senate Commerce Committee held hearings
             on the deductability      of political    lobbying expenses under section 162
             of the Internal     Revenue Code. Testimony presented indicated                that pub-
             lic utilities   as well as other energy related         industries     may be improp-
             erly treating   costs associated with certain         political     advertising     and
             that utilities    may be passing these costs along to consumers in the
             form of increased rates.        The testimony also pointed out that question-
             able tax deductions may be occurring          and that clarification         of both the
             Federal Power Commission (FPC) and IRS regulations              may be required.

                    After these hearings , we issued, at the request of Senator Stsxex                      .
            #.--y~ a report entitled,
            son,                           “Auditing     of Politicdl     AdvertisiFg-by      Electric
            Utilities      and Gas and Oil Companies” (END-76-2, July 16, 1976).                   The
            report,     released by the Senator on October 3, 1977, presented,                   in part,
            our concerns over the lack of clear criteria               for public utilities          and
            FPC auditors       to use in classifying      and auditing      political    advertising
            expenses.       The report also expressed our opinion that the instructions
            IRS has furnished       its auditors     contain little      guidance to aid them in
            making judgments about the political            nature of advertisements          claimed
            as deductions by corporations.

                       FPC agreed   to implement    our recommendations      to:

                       --Clarify   the description of advertising     transactions
                          to be recorded in its prescribed     accounts.
      --Furnish      its auditors     with additional       guidelines     on
         controversial       subjects relating       to plitical       adver-
         tising,     including    the identification        of certain     themes
         of such advertising         to help auditors make judgments on
         classif ications.

      --Revise     its examination     program    to expand
         audit   coverage.

      Conversely, IRS has taken little,   if any, action to improve its
guidance to taxpayers and its own auditors.     For example, the “Audit
Technique Handbook for Internal   Revenue Agents”” still merely advises
the auditor:

      ““Advertising   charges are relatively      simple to check.
      The principal    things for which an examiner should
      look are:     * * * Nondeductible     expenditures   claimed
      in connection with campaigns of political          candidates
      or for the promotion or defeat of legislation.”

       We reviewed several other IRS documents which instruct                auditors
regarding    the way possible grass-roots          lobbying expenses should be
detected and analyzed.         These documents included pertinent          regulations,
the ““Field Audit Case Nanaqers’ iiandbook,‘” basic revenue agent training
mater ial on lobbying expenses, and various audit technique handbooks
for specialized    industries.       In general,      the instructions    in these docu-
ments are no more specific        or helpful     to the auditor      than the instruc-
tions contained    in the revenue agent audit technique handbook.

         For example, the specialized       audit technique handbook for public
utilities     contains two sections which deal with determining         the proper
allocation      of advertising    expenses.     Those sections are appropriately
entitled,     ‘“Advertising    Expense, ” and “Lobbying Expense. ” Under the set-
tion dealing with advertising          expense the handbook says:

      “Certain    charges to advertising       expense are nondeductible
      under section 1.162(c)(l)       of the Regulations.          Ihis would
      relate to expenses such as certain outside advertising
      expenditures     which could be considered         as being of a propa-
      ganda or political      nature.     If the utility       is Federally
      regulated    and has followed     the Commission’s instructions
      (e.g. the Federal Power Commission),            a detail    of such
      questionable     items can generally      b-e found in the
      annual report.      * * * ”

      The section on lobbying expenses is a little     IIx3re detailed.  It
notes that in the course of auditing   utility   tax returns the auditor
should be aware of deductions  claimed for lobbying expenses involving

       ’ Q-137762
.. I

            attempts to influence      legislation     or aid political       candidates.       It
            further   notes that these nondeductible           expenditures    may be found in
            various   utility  accounts.       The section also defines properly            deduct-
            ible expenses-- institutional         or good will advertising--as          those which
            keep the company’s name before the public,               such as sponsoring      news
            and weather reports or encouraging           contributions      to charitable     organ-

                   It goes on to point out that after tax year 1362 the companies
            may deduct expenses involved       in the submission of information         to and
            appearances before the legislature       of Federal, State, and local govern-
            ments.     It also provides   a broad explanation      that certain    other expen-
            ses pertaining     to the general area of lobbying which are not deductible
            include political     campaigns at all levels,     influencing      the public to
            supprt    or reject a measure in referendum or law, and supprt              or defeat
            of legislation.

                    These definitions   are no more specific    than the regulations    defin-
             ing section 162 of the Internal     Revenue Code. They do not provide any
             specific    guidance to the auditor  as to how he or she should exercise
             judgment in determining     whether or not advertising     is for grass-roots
             lobbying purposes and therefore     nondeductible.

                   Except for a limited         survey done to prepare for the pending hear-
             ings, 1% has not systematically             reviewed the advertising            or grass-roots
            lobbying practices        of various     industries,      identified     any potential         poc-
            kets of noncompliance         that may exist regarding            the classification         of
            related expenditures , and determined what, if any, appropriate                         audit’
            action is needed.         Moreover I IRS apparently          has not researched the prob-
            lem sufficiently      to determine why taxpayers might improperly                    classify
            advert is ing expenses and I conseguently f not developed the information
            needed to rewrite       regulations      or instructions        to make more accurate
            the taxpayers’    initial      determinations        regarding     the allowability       of
            deducting certain       advertising      expenses.       We believe    that IRS should
            do so.

                   To insure the continued success of one of the basic principles
            underlying    our tax system# self-assessment,     it is essential     that IRS
            make the regulations    which the taxpayers must follow as clear as pas-
            sible.     It is also essential  that IRS auditors    have definitive      criteria
            for measuring the extent to which proper self-assessment            is being

                   We recognize that there are many specific  corporate    accounts.
            Given IRS’ primary mission of protecting   the revenues,    it would seem
            natural   for the Service to focus on those accounts that have the most

ptential   for tax adjustment.     Thus, in the absence of specific National
Office instructions,     it would not be surprising to find that auditors
devote relatively    less effort to accounts that, although important from
a public policy standpoint, lack significant       adjustment potential.
      The extent to which public policy concerns about possible areas
of noncompliant, 0 should override cost/benefit    concerns in determining
the emphasis IRS should give to auditing accounts that may not generate
substantial   tax adjustments is a decision which should be made at the
national level.    A recent example of a National Office determination
that a public policy concern was overriding      is the issuance of detailed
audit instructions    to be followed and specific compliance checks to be
performed in detecting corporate slush funds.
       We see nothing to indicate that similar IRS action is not warranted
to clarify   for taxpayers and its own auditors the provisions of Code
section 162 as they relate to political     advertising.  FPC acted to cor-
rect the related confusionl misunderstanding and noncompliance which
existed within its own jurisdiction     and it seems that IRS should take
similar action.
     Acccordingly,   we recommend that IRS:
     --Clarify     existing   regulations  in the area of political
        advertising      and grass-roots lobbying to provide
        taxpayers and auditors with better definitions         for
        classifying      such expenses for income tax purposes.
     --Systematically   test the practices followed by
        various industry groups in the area of advertising
        and lobbying expenses to determine the extent of
        noncompliance that exists and what corrective   action,
        if any, is warranted.
     --Provide more specific audit criteria     for IRS agents
        to follow in deciding whether to select corporate
        accounts relating to political  advertising   and lobby-
        ing expenses for examination.
     --Develop additional   guidance, such as a listing
        of advertising  themes, for auditors to follow
        in separating grass-roots lobbying and advertising
        expenses from allowable deductions in computing
        taxable income.


“, *.
   . .,B-137762

                  We would appreciate  your comments on these recommendations by
           December 9, 1977. If you or your staff want to discuss these matters
           further,   feel free to call me on 566-6503.

                                               Sincerely     yours,

                                               Richard     L. Fogel
                                               Associate     Director