IRS Hit for Slow Action in Reviewing Pulled Tax Exemptions

The Internal Revenue Service’s internal monitor sharply criticized the agency on Thursday for failing to add more resources to the “seriously understaffed” division that oversees nonprofits and to correct technical problems that led it to erroneously revoke the tax-exempt status of thousands of organizations.

The IRS now faces a backlog of about 66,000 applications from organizations seeking tax-exempt status or reinstatement of exemptions that were automatically pulled under an IRS drive to weed out groups that had not filed proper paperwork, the national taxpayer advocate, Nina E. Olson, said in her annual report to Congress.

That is four times the 2010 level and more than triple the 2011 level, the report said, noting that the IRS website tells organizations that applications requiring review by a specialist must wait 18 months just to be assigned.

Referring to nonprofits that deliver services to people in need, it said: “When charities lose funds because they cannot obtain timely recognition of their exempt status, or are erroneously treated as no longer exempt, these vulnerable populations suffer the consequences.”

Repeated Warnings

The IRS in 2010 began revoking exemptions from nonprofits that had not filed tax forms for three years under new reporting requirements imposed by Congress.

The agency has notified about 550,000 groups they are no longer tax-exempt, but about 9,000 of those were in error, the report said. Over the past three years, 50,000 nonprofits have asked the IRS to reinstate their automatic exemptions, adding to the already heavy workload of the exempt organizations division, it said.

The most common mistake happens when the IRS fails to recognize affiliate groups that are part of a parent organization’s tax return, it said.

IRS computers also start measuring the three-year reporting period from the time an organization obtains a federal employer identification number, instead of from when it starts operations, adding to the mistakes, it said.

The advocate said the IRS could avoid many errors by notifying organizations by letter when it plans to yank their tax exemptions and giving them 30 days to file proper paperwork and informing them they can request an administrative review if they believe the IRS made a mistake.

She said the agency had ignored repeated warnings that it lacked the staffing to handle the mounting influx of paperwork caused by the automatic revocations. The number of full-time IRS staff members handling tax-exempt applications, based in Cincinnati, fell from 206 in the 2011 fiscal year to 183 in the 2013 fiscal year, the report said.

The IRS as a whole does not receive adequate funding and should be treated differently from other agencies when Congress makes across-the-board spending cuts, the report said. “Federal budget rules treat the IRS the same way they treat all spending programs—with no credit given for the revenue it collects,” it said.

The IRS said in a statement that it would review the report, adding that it must “carefully balance limited resources to meet its dual mission of providing taxpayer service and enforcing the tax laws.”

It pointed to comments made by John Koskinen, the new IRS commissioner, earlier this week at a news conference. Mr. Koskinen said he was concerned about deep cuts to the agency’s budget, adding: “I hope that one of my legacies of my four years as IRS commissioner will be that we put the agency’s funding on a more solid basis.”