Last of a three-part series.

Interviews with current and former IRS officials outline a roadmap of the tax laws the agency would use in deciding whether to pull the nonprofit Media Matters tax-exempt status for stepping beyond its charitable mission of educating the public on conservative misinformation.

In a formal petition filed with the IRS on July 27, President George H.W. Bushs former White House counsel, C. Boyden Gray, has asked the IRS to revoke the nonprofits tax-exempt status because its "unlawful conduct"  is in violation of U.S. tax law, due to its moves to sabotage the commercial interests of FOX News and News Corp., its parent, among other things.

(The full petition can be read below.)

Such activities are not found in the scope of nonprofit tax law, former IRS officials and tax lawyers tell FOX Business, which is the sister network of FOX News.

Media Matters did not respond to repeated phone calls and emails over a month-long period asking for comment. Gray tells FOX Business he filed the request "pro bono" and is not on News Corp.'s payroll.

Marcus Owens, the IRSs former head of its exempt organizations division, also says the website Politico gave an incomplete and jumbled description of his explanation of how a part of the tax law protects Media Matters activities. Media Matters has been reportedly using Owens comments to defend its activities.

Gray notes in his IRS petition the nonprofits campaign to get advertisers to "Drop FOX -- words billboarded on its website along with "NewsCorpwatch" that link viewers to form letters to send to advertisers to get them to stop advertising on the network.

Because it is a nonprofit, the U.S. government is also effectively supporting the website's attempt to disrupt News Corp's purchase of BSkyB, a satellite broadcaster; its demands to Congress to investigate News Corp. and its head, Rupert Murdoch; its efforts to get disgruntled ex-employees to file suit against FOX News; and its pressuring investors to divest their holdings in the company.

The nonprofit failed to report all of these activities to the IRS on its tax returns, a review of its filings show.

The nonprofit, which launched in May 2004, has also operated a boot camp aimed at training progressive media pundits; has engaged in partisanship during presidential races; and has advocated in favor of legislation, among other things.

Also, Media Matters has been a profligate spender of its backers donations. The nonprofit spent an eye-popping $18.5 million on office costs, salaries, travel, entertainment and other undisclosed items for 2008 and 2009, causing it to report $3.5 million in losses to the IRS for the period. Its founder and chief executive David Brock pays himself a handsome salary, about $300,000 annually, which includes a $20,100 "bonus," according to his nonprofit's 2009 tax returns.

The New York Times also reports that Brock has launched a political action committee, American Bridge, in which fund-raising consultants can raise money for Democratic-oriented media efforts not just through American Bridge but also via one of the nonprofit organizations Mr. Brock currently runs, Media Matters Action Network, which does not disclose its donors.

Owens, the former IRS official says: Nonprofits cannot be used in any way for political fundraising. That is an improper use of the charity.

Politico says Owens explained to it that nothing in the tax law prohibits tax-exempt educational nonprofits from attacking specific companies, as long as there is no private benefit to that companys competitor.

But Owens says: Thats a jumbled description of the point I was trying to make and it is just one test in the law of what nonprofits are allowed to do. The IRS has had a long-standing position that organizations that monitor and evaluate the accuracy of media, and then communicate on their findings, are entitled to their exempt status as educational organizations. The concept of private benefit doesnt enter into that calculation unless a private benefit is being furthered by the charitable organization. The concept of benefiting a competitor is just part of the law. Tax law indicates if such statements benefit a companys competitor or private interests, including those who donate to Media Matters for political purposes, then that is problematic. A charity cannot act as a stalking horse for private interests. Nonprofits have to be very careful to be constructed to avoid benefiting non-charitable donors.

Owens continued: For example, an organization formed to support a classical music station applied for tax-exempt status. The IRS said no dice, because classical music supporters would get a private benefit. Again, this is just one test of the law, though, there are many other standards nonprofits must meet.

So, what will the IRS turn to if it had to decide whether to bring a lawsuit to revoke Media Matters tax-exempt status?

The IRS gave FOX Business the history of tax law and case law covering nonprofits.

The IRS says it has a long and colorful history battling abusive nonprofits on both sides of the political aisle that dates back to the early part of the 20th century.

Nonprofits over the decades have pushed the envelope of the law with tortured readings of a well-tortured law, to the point where the IRS quotes Pontius Pilate in one background document: What is truth? (John 18:38).

As far back as before World War I, when the federal income tax was enshrined in the law, charities by law were supposed to serve the publics interest, not private interests, in their charitable and educational activities.

Joseph DeTrane, an expert on nonprofit tax law and a partner with Grant Thornton, says: With political issues, the IRS draws the line on education and advocacy of an issue. It tends to err on the side of education.

As of 1919 the U.S. Treasury has had on its books a regulation that says: Associations formed to disseminate controversial or partisan propaganda are not educational within the meaning of the statute, and are in violation of U.S. tax law.

Later, in 1920, the Solicitor of the IRS ruled that, for nonprofits, the prime purpose of education is to benefit the individual, including the fair and balanced dissemination of information.

Starting in and around 1954, the IRS issued regulations that made it clear that a nonprofit actually can advocate a particular position or viewpoint, but so long as it presents a sufficiently full and fair exposition of the pertinent facts so as to permit an individual or the public to form an independent opinion or conclusion.

IRS regulations also note: An organization is not educational if its principal function is the mere presentation of unsupported opinion.

The IRS has also ruled a nonprofit will lose its tax-exempt status if, among other things, a significant portion of its communications consist of viewpoints or positions unsupported by facts; if the facts the nonprofit uses to support its positions or viewpoints are distorted; and if the nonprofit makes substantial use of inflammatory and disparaging terms and expresses conclusions more on the basis of strong emotional feelings than of objective evaluations (IRS revenue procedure 86-43).

The IRS pulled the tax-exempt status of an unnamed nonprofit for these very reasons (revenue ruling 68-263).

The nonprofit was formed to promote the education of the public on the dangers of an extreme, unnamed political doctrine, and had distributed materials that attacked individuals and institutions based on unsupported facts.

The IRS noted in pulling the groups tax-exempt status that these attacks were not supported by a sufficiently full and fair exposition of the pertinent facts to permit the public to form opinions or judgments independent of those presented.

Since then, numerous nonprofits have asserted their First Amendment free speech rights, and have beaten back IRS lawsuits alleging they were attempting to influence legislation or were advocating the adoption or rejection of legislation as a substantial part of their activities, among other things, says a former IRS official.

Former IRS official Owens notes the Big Mama Rag tax case in 1980 established a free-speech precedent for nonprofits.

Big Mama Rag was a nonprofit that refused to publish in its newspaper material damaging to the womens movement. A U.S. circuit court upheld its tax-exempt status on free speech grounds, even though it was found to also be publishing unsupported opinion, innuendo and was using inflammatory disparaging language.

Since the Big Mama Rag case, the IRS has hauled in nonprofits that violated the educational section of the nonprofit tax law, because the agency found they really werent educational, but instead had engaged in partisan advocacy.

An outfit called the American Campaign Academy did not get tax-exempt status in 1989, IRS documents show, because it wanted to run a boot camp school similar to what Media Matters has funded and ran.

In his petition with the IRS asking it to yank Media Matters tax-exempt status, former White House Counsel C. Boyden Gray cites the American Campaign Academy case to back up his complaint.

He says the IRS had concluded that a purportedly nonpartisan institution serving as a de facto supporter of a political party cannot maintain its tax exemption. In this instance, Gray is saying Media Matters is a de facto supporter of the Democratic Party.

The Academy ran a school that trained men and woman wanting to work as campaign professionals, the majority of whom ended up working at campaigns for Republican candidates.
Additionally, the IRS found that the Academy had modeled its program after one designed by the Republican National Committee; that Republican officials sat on its governing board; and that GOP donors funded its operation.

But Owens says not so fast. He says Media Matters training camp for people who want to be liberal pundits is like a liberal college, and doesnt threaten Media Matters tax-exempt status. Media Matters also reportedly says it is not training pundits for campaigns, only for media. Gray questions whether those individuals will actually end up in Democratic campaigns.

Separate from this, Media Matters new charitable mission involves a Drop FOX campaign, and a strategy of guerilla warfare and sabotage of FOX News and News Corp., which means it is turning its charity into an action group that taxpayers effectively subsidize.

And that means another famous tax case could come into play here if the nonprofit ever gets hauled on the carpet.

Less than ten years after the American Campaign Academy decision, a federal district court judge upheld the IRSs decision to reject the tax-exempt application for another group, the Fund for the Study of Economic Growth and Tax Reform, headed by the late Republican Congressman Jack Kemp.

The IRS nixed the Funds application, ruling it was an action group that existed solely to advance a particular agenda in violation of the law, meaning, the reform or repeal of the U.S. tax system, and the establishment of a flat tax.

Is Media Matters acting as an agent for the Democratic Party, as former White House counsel Gray says in his complaint to the IRS?

The IRS might look here to yet another test set down in a case dating back to 1934, the World League Against Alcoholism, formed in part by prohibition groups. This nonprofit almost lost its tax-exempt status because the IRS ruled it operated as an agent to its members, serving their prohibition or anti-prohibition causes.

But the Fourth Circuit reversed the ruling, because this nonprofit had adequately disseminated information showing both sides of the prohibition debate.

Again, there is a broader policy issue at stake.

Swap out the words FOX News with the words MSNBC, CNN, CSpan, PBS, National Public Radio, or the New York Times.

Should the U.S. government let a nonprofit operate on your nickel, tax-free, by running an organization that has engaged in partisan activity and that exists to sabotage and disrupt the commercial interests of a tax-paying business?

Gray's Petition to IRS

Elizabeth MacDonald joined FOX Business Network (FBN) as stocks editor in September 2007.
Follow Elizabeth MacDonald on Twitter @LizMacDonaldFOX.