The IRS is under increasing scrutiny in the wake of a lawsuit filed by a conservative Jewish organization accusing the federal agency of discriminating against groups whose policies are not aligned with the Obama administration.
Z Street, a Pennsylvania-based group, claims the Internal Revenue Service stalled its application for tax-exempt status because of its support for Israel.
But in an affidavit obtained by FoxNews.com, the IRS says the application was delayed because of concerns that the group may be providing resources to organizations within Israel, one of many Middle Eastern countries that the agency says has a higher risk of terrorism.
"This is unbelievable. It is astounding," Lori Lowenthal Marcus, president of Z Street, told FoxNews.com. "It's treating an entity that supports Israel as if it's supporting terrorism." She added that the government is equating Israel to a country like Yemen. "That's still a constitutional violation."
The group, which was founded in November 2009, filed its application in January and the lawsuit in August.
The IRS declined to comment on the lawsuit.
"Our privacy laws do not allow us to comment on a particular taxpayer," the agency said in a written statement.
In the lawsuit, the group says it was notified in July by an IRS agent that its application was "at least delayed, and may be denied because of a special IRS policy in place regarding organizations in any way connected with Israel."
The agent also said that the applications of many pro-Israel groups had been assigned to a "special unit in the D.C. office to determine whether the organization's activities contradict the administration's public policies," the lawsuit says.
According to the complaint, the agent questioned whether the group's activities were "educational as described under Section 501(c) (3) of the code, but instead might be lobbying, or that Z Street might be an action organization, which is the case when the only way to accomplish the purpose of the organization is through legislation."
The group later revealed a letter from a different IRS agent to an unidentified group asking whether it supports the existence of Israel and what the group's religious beliefs are toward the Jewish nation state.
"There is something very serious, and very wrong, in the process the IRS is using to allocate tax exempt determinations, and Z Street is committed to exposing and righting that wrong," Marcus said.
Now, Citizens for Responsibility and Ethics in Washington, or CREW, is seeking answers. The watchdog sent a Freedom of Information Act request to the IRS seeking records documenting the agency's efforts to obtain information about the policy positions of tax exempt groups or groups seeking the status.
"We haven't reached any conclusions about the lawful or unlawfulness about those questions," Anne Weismann, chief counsel for CREW, told FoxNews.com.
"I certainly think it is the case that government agencies cannot ask questions that implicate First Amendment rights without legitimate purpose," she said. "We want to make sure what the IRS is doing is legal and the policy is being applied in an even-handed manner."
Marcus applauded CREW's FOIA request.
"We are gratified that CREW is trying to get to the bottom of the use by the IRS of its legitimate investigative power to engage in illegitimate and apparently politically motivated questioning," she said in a statement to FoxNews.com. "Can you imagine the media explosions if the government expended resources looking into an organization's views on abortion or homosexuality?"
The government is seeking to dismiss the case now. In the affidavit, the IRS says applications are flagged when they indicate resources may be provided to groups in a country with a higher risk of terrorism.
But the agency added that a delay in the application process doesn't mean the group supports terrorism, "only that further development is necessary to ensure that the organization will put procedures in place to prevent resources from being used to support terrorism."
Marcus said she's "absolutely in shock" that the government has revealed this policy -- one that she described as casting suspicion on "anything you do in Israel might be supporting terrorism because terrorism happens in Israel."
Some law experts aren't convinced that the IRS did anything illegal.
"All you have are allegation and a complaint. I don't know what they can prove," said Douglas Laycock, a law professor at the University of Virginia who reviewed the complaint. "The allegations might be true, but not plausible. This is an agency with strong incentives to be apolitical, and since the Watergate scandal they have a pretty good record of being apolitical."
Laycock added that the agency's claim that it is investigating whether the group is supporting terrorists in Israel is "legitimate"
"Israel is our ally but not everyone in Israel is our ally," he said. "So what the IRS is saying is not inherently implausible. Israel is in the Middle East and a lot of that stuff happens over there. If that's what they're genuinely worried about, they can hold up the application."
Mark Stern, an attorney for the American Jewish Committee, a passionate supporter of Israel, told FoxNews.com that the U.S. sometimes groups Israel with other Middle Eastern countries to avoid suggesting Arab states are the only ones held in "special suspicion."
Stern, who said he doesn't endorse the practice, said previous administrations have done it too.
He also said Z Street is unlikely to win its case against the IRS.
"If they think they're going to win a constitutional violation claim, they have a lesson coming to them," he said, arguing that the courts are not going to second-guess the IRS judgments. "There's no constitutional right to a tax-exempt status."
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