Crumpled tax form. © Brian Hagiwara, Brand X, Corbis

The IRS Tea Party scandal plaguing the Obama administration has shed light on a murky and controversial area of the nation's excruciatingly complex tax code.

At the center of the scandal is the "501(c)(4)" tax designation, which is relatively little-known, even though it is used by many high-profile nonprofit groups including the National Rifle Association, AARP, the League of Women Voters, the National Right to Life Committee and the Sierra Club.

Groups approved for 501(c)(4) status are exempt from federal income taxes, due to the supposed service they provide in the nation's public life. But some say the tax-exempt status amounts to a subsidy paid for by the rest of us.

Some key things to know:

  • A group with the 501(c)(4) designation is supposed to be operated "exclusively for the promotion of social welfare," per the IRS. It's different from a 501(c)(3), which is the IRS tax code designation for a charity.
  • Unlike charities, these "social welfare organizations" can engage in unlimited lobbying and can even promote political candidates, although those activities aren't supposed to be their primary purpose -- a major issue of contention.
  • Unlike contributions to charities, contributions to these social welfare groups are not tax deductible. Contributions can, however, be anonymous -- unlike donations to purely political organizations, which by law are public information.

Image: Liz Weston

Liz Weston

The tax exemption for "social welfare" groups dates back a full century to the Revenue Act of 1913, according to the Wall Street Journal's Law Blog. The intent seems to have been to help civic and nonprofit groups that couldn't be classified as charities but still contributed to the public good.

Starting in the 1950s, the IRS gradually expanded the designation to allow for some political activity so long as that wasn't the organization's primary purpose.

Also in the 1950s, the Supreme Court reinforced the rule that 501(c)(4)s didn't have to reveal their donors. The top court ruled in NAACP v. Alabama that membership lists could be kept secret because of the constitutional right to freedom of association. The idea was that making the lists public could expose members to harassment.

It was another Supreme Court decision, in 2010, that set off a land rush for organizations scrambling to become 501(c)(4)s. The high court ruled in the Citizens United case that the federal government couldn't restrict political expenditures by corporations, labor unions or associations. That freed individuals, companies and organizations to give anonymously and without limits to social welfare organizations, effectively circumventing limits on straight political contributions.

Freed from spending rules and fueled by anonymous donors, these nonprofits spent more than so-called "super PACs" -- big political action committees -- in the 2010 election, according to a report by the Center for Public Integrity and the Center for Responsive Politics. The nonprofits' outlay more than tripled for the 2012 elections, comprising nearly a third of all dollars spent by "outside" interests.

Some of these spenders were big and well-known, such as Crossroads GPS and Priorities USA. Some were smaller groups derided as "pop up" nonprofits because they formed, spent money and disappeared before they could get much scrutiny.

Yet even as the line between politics and social welfare blurred, the IRS was still charged with deciding how much politicking was too much when granting 501(c)(4) status.

So now we come to the Tea Party scandal. As 501(c)(4) applications soared, an IRS office in Cincinnati made the infamous decision to single out applications by conservative groups for special scrutiny, demanding answers to long questionnaires and in some cases asking for lists of donors.

The IRS hasn't been in this much hot water since it was revealed that disgraced President Richard Nixon used the agency to audit and otherwise harass his political enemies.

And it's fair to surmise that a chastened IRS isn't going to be pushing back against abuse of social welfare status any time soon.

So what now? Do we leave things as they are and continue to let anonymous donations influence campaigns? Do we do away with tax-exempt status for social welfare groups, and tax them like businesses, which would spell big trouble for all manner of small nonprofit groups? Do we carve out an exception for social welfare groups that are primarily political, preserving their tax breaks but requiring disclosure of their donors? If so, what criteria should we use and who should be in charge of enforcing the rules?

When it comes to either taxes or politics, there often are no easy answers. Combine the two, and finding any answer will be tough.

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Liz Weston is the Web's most-read personal-finance writer. She is the author of several books, most recently "The 10 Commandments of Money: Survive and Thrive in the New Economy" (find it on Bing). Weston's award-winning columns appear every Monday and Thursday, exclusively on MSN Money. Join the conversation and send in your financial questions on Liz Weston's Facebook fan page.