Making Oversight a Priority

Federal report nudges IRS toward review of charity rules

The Internal Revenue Service has failed to ensure that charities report accurate financial information to it,

undermining its ability to oversee how nonprofit groups raise and spend their money, a new government report concludes.

The report, which was written by the General Accounting Office, says that the IRS lacks the resources to keep pace with the explosive growth that has occurred in recent years in the nonprofit world.

The number of charities filing Form 990 informational tax returns with the IRS rose 25 percent from 1996 through 2001, from 228,013 to 285,733, the report notes. But, it says, the number of IRS staff members reviewing applications for tax-exempt status and examining Forms 990 fell by 10 percent, from 609 to 546, over the same period.

The GAO produced the report at the behest of Sen. Charles E. Grassley of Iowa, the senior Republican on the Senate Finance Committee, which oversees the IRS. Mr. Grassley, whose office did not respond to requests by The Chronicle for an interview, said in a press release that he disagreed with the notion that the IRS lacks adequate resources to oversee charities properly.

“I’ve heard that before from the IRS in other areas,” Mr. Grassley said. “I disagree. The IRS should do a better job of using the resources it has.”

Study to Be Completed in 2008

The GAO report points to studies by nongovernment groups showing that charities frequently fill out the Form 900 improperly, making it difficult to monitor fund raising and other activities. In addition, the GAO notes, both IRS rules and the accounting profession’s standards allow nonprofit groups to use a variety of methods to calculate fund-raising costs, making it virtually impossible to compare the expenses reported by different charities.

In addition, the report states that the IRS has only recently begun an effort to study how well nonprofit organizations comply with reporting requirements — and will not complete that review until 2008.

The GAO also concludes that IRS regulations and federal law interfere with state charity regulators’ ability to oversee nonprofit groups by preventing the IRS from sharing information with state officials.

Partly as a result of the report, the Senate Finance Committee is expected to endorse proposed legislation giving state regulators more access to IRS data, according to a key aide to Senator Grassley who spoke on condition of anonymity.

In addition, the aide said, Mr. Grassley will probably place language in the legislative message accompanying one of two bills now before the committee making it clear that Congress considers improvement of the IRS’s information-collecting process a priority.

That language, which would be added upon the Finance Committee’s approval of one of the bills, would be attached to either the Charities Aid, Recovery and Empowerment (CARE) Act, or a different bill dealing with federal tax law. The CARE Act includes a number of changes in federal law regarding nonprofit organizations, including allowing taxpayers who do not itemize deductions to get a tax break for charitable donations and making it easier for faith-based groups to receive federal money.

‘Rotten Apples’

Mr. Grassley asked for the GAO report as part of his effort to investigate nonprofit groups that he says abuse their tax-exempt status, in some cases fraudulently raising money with no intention of using it for charitable purposes. The senator said in his press release that, “like any other industry,” charities include some “really rotten apples,” and that the IRS should “help the public identify whether charities are spending donors’ money on lavish salaries, expensive vacations, or other inappropriate items.”

The senator’s aide said the IRS “should expect Senator Grassley to follow up” on whether it is carrying out the GAO recommendation that it develop ways to improve its collection of financial data on nonprofit groups. Mr. Grassley will personally stay in touch with the tax agency and request detailed information on how it is doing so, the aide said.

In a response attached to the GAO report, IRS Commissioner Charles O. Rossotti wrote that the tax service is taking steps to improve its oversight.

“The IRS has established a task force that will develop and implement projects intended to improve data collection and compliance in the fund-raising area,” Mr. Rossotti stated. “The IRS has a long-term plan to determine and address compliance levels,” he added, beginning with its planned six-year review of nonprofit organizations.

Under the IRS plan, the tax agency has divided the nonprofit world — including charities and other types of tax-exempt organizations — into 35 categories, such as hospitals, labor unions, social-service groups, and religious organizations. It will collect demographic and other data on six of these groupings annually, completing its analysis in 2008, and then use that information to identify situations in which nonprofit groups are not complying with federal tax law.

The GAO, however, says the plan fails to “define the overall results the IRS hopes to achieve.” The plan “does not, for instance, provide goals for improving compliance levels of tax-exempt organizations,” the report says.

“What the IRS seems to be doing is saying, ‘We’re just going to go out and study a bunch of stuff until 2008 and see if what we come up with results in something we can do anything with,’” said Michael Wyland, a financial consultant in Sioux City, S.D., who frequently works with nonprofit groups.

The IRS study will take so long, he added, that “it has the effect of postponing any meaningful use of the Form 990 for charities regulation until at least the next decade.”

Other experts on nonprofit organizations, however, said the problem is not with the IRS or the tax form, but rather with the lack of direction and support Congress has provided to the tax agency.

“Congress doesn’t know what it wants to do” in terms of regulating nonprofit groups, said Putnam Barber, president of the Evergreen State Society, in Seattle, which works on efforts to improve charities. The only clear command Congress has given the IRS, Mr. Barber added, is to make sure that tax-exempt organizations do not violate federal tax laws.

“If Congress wants the IRS to exercise effective oversight of exempt organizations, it’s going to have to give the IRS a clearer mandate of what effective oversight means. And it’s going to have to pay for it.”

Technology Solutions

Some problems facing the IRS can be fixed inexpensively through the use of technology, some observers maintain. For example, many nonprofit groups make mistakes in filling out their Forms 990, and those mistakes could be caught if the IRS required the returns to be filed electronically, said Peter Swords, a lawyer in New York who for years has worked to improve the quality of the data reported on the form. “That would mean that software programs can be developed to audit these forms without any personnel cost to the IRS.”

Such software could prevent charities from entering incomplete information by requiring that all relevant sections of a return be completed. Having the Form 990 in an electronic database, Mr. Swords added, would also allow the IRS to write computer programs to improve its analysis of the information.

Collaborating With States

Still, while technology might improve the accuracy of information in Forms 990, the GAO identifies what may be an even greater obstacle to the effective oversight of charities. It says the IRS does a poor job of sharing information with state regulators — partly because of bureaucratic inefficiency and partly because federal law prevents the tax service from revealing many kinds of information.

Although federal law allows certain information to be shared with state regulatory officials — such as whether the IRS has denied a group’s application for tax-exempt status or revoked an organization’s tax exemption — the IRS has no procedure in place for passing that information to the states.

For one thing, state officials must request the information before the IRS will even consider sending it, the GAO notes.

“Such requests used to be sent to the IRS district office director,” the report states. However, as part of a recent reorganization of many of the IRS’s divisions, the tax agency “abolished this position and the IRS has not developed a new process” for states to follow, the GAO says. IRS officials say they are working on a new procedure that they hope they will be ready to discuss with the states this year.

In addition to the fact that states must ask the IRS for any information they seek, federal law limits what the IRS can disclose. It cannot, for example, tell a state whether it is following up on cases referred to the federal agency by state regulators. Nor can it provide state law-enforcement agencies with information gathered as part of an IRS audit of tax-exempt organizations. The U.S. Treasury Department, the IRS’s parent agency, is supporting legislation to lift some of those restrictions.

Those changes are “crucial to law enforcement,” said Karin Kunstler Goldman, president of the National Association of State Charity Officials. Enforcement resources can be wasted because state regulators, unaware of whether the IRS is conducting an investigation, may open duplicate inquiries, said Ms. Goldman, who heads the Charities Bureau in the New York Attorney General’s office.

She added that even when the IRS turns up violations of state law that the federal government cannot act on, it is often barred from passing that information to state regulators.

“There are other situations where joint prosecutorial efforts might be appropriate,” Ms. Goldman said.

The IRS should be eager to cooperate with the states, she added, because local authorities are likely to know more about the people behind an organization than are federal officials in Washington.

“We’re the ones on the ground,” Ms. Goldman said. “We know the organizations.”

The General Accounting Office report is available free online at http://www.gao.gov/new.items/d02526.pdf

FEDERAL OVERSIGHT OF CHARITIES