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Pro-Israel Organization Can Press Ahead with Politically Charged Tax Case.
(Parker Tax Publishing June 12, 2014)

A pro-Israel group can move forward with its complaint that the IRS violated the First Amendment when it implemented an internal review policy that subjected Israel-related organizations applying for tax-exempt status under Code Sec. 501(c)(3) to more rigorous review procedures than other organizations applying for that same status. Z Street, Inc. v. Koskinen, 2014 PTC 251 (D. D.C. 5/27/14).

Z Street is a non-profit corporation incorporated in Pennsylvania. It is dedicated to educating the public about various issues relating to Israel and the Middle East. Z Street filed an application with the IRS seeking to be recognized as a tax-exempt organization under Code Sec. 501(c)(3). In following up on the application, an IRS agent told Z Street's counsel that there were two major concerns about approving the application: first, that the organization engaged in advocacy activities that are not permitted under Code Sec. 501(c)(3); and second, that the IRS had special concerns about applications from organizations whose activities relate to Israel, and whose positions with respect to Israel contradict the current policies of the U.S. government. According to Z Street's counsel, the IRS agent said that the IRS carefully scrutinizes all Code Sec. 501(c)(3) applications that are connected with Israel, and that these cases are being sent to a special unit in the D.C. office to determine whether the organization's activities contradict the Administration's public policies.

Z Street filed a complaint alleging that the IRS violated the First Amendment when it implemented an internal review policy that subjected Israel-related organizations applying for tax-exempt status under Code Sec. 501(c)(3) to more rigorous review procedures than other organizations applying for that same status. Originally, Z Street filed the lawsuit in a Pennsylvania district court. However, that court concluded that Z Street's case was best construed as a controversy arising under Code Sec. 7428, which provides for declaratory judgments in suits related to the classification of organizations under Code Sec. 501(c)(3) and that only three courts have jurisdiction over such suits: the Tax Court, the Court of Federal Claims, and the District Court for the District of Columbia. While the Pennsylvania district court agreed with Z Street, it said it lacked jurisdiction and transferred the case to the D.C district court.

Before the D.C. district court, Z Street claimed that the IRS's Israel Special Policy constituted viewpoint discrimination in violation of the First Amendment and asked the court to declare that the policy is unconstitutional and issue an injunction ordering the IRS to disclose information about the policy and to bar the IRS from employing the policy when it rules on Z Street's Code Sec. 501(c)(3) application. The IRS characterized Z Street's claim as a complaint about tax liability and asked the court to dismiss the suit. The reasons the IRS gave for dismissing the suit were (1) both the Anti-Injunction Act (AIA) and the so-called tax exception of the Declaratory Judgment Act (DJA) barred the claim; (2) the D.C. district court lacked jurisdiction over the claim because the IRS had sovereign immunity; and (3) Z Street failed to state a claim upon which relief could be granted because it had an adequate remedy at law and thus injunctive relief was not available to it.

The district court held that the case could move forward. The court rejected the IRS's core argument that Z Street was seeking a determination of whether or not it is entitled to Code Sec. 501(c)(3) tax status. According to the court, there was nothing in the record to suggest that Z Street brought the action for the purpose of resolving the matter of its own tax liability because the amended complaint made crystal clear that Z Street was not asking the court to reach any conclusion regarding (or indeed, even to consider) the organization's qualifications for tax-exempt status under Code Sec. 501(c)(3). The court also rejected the IRS's assertions that the AIA, the DJA, or sovereign immunity barred Z Street's request for equitable relief and that it had an adequate remedy at law.

For a discussion of the criteria for becoming a Code Sec. 501(c)(3) organization, see Parker Tax ¶60,510. (Staff Editor Parker Tax Publishing)

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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