Proposals for Strengthening Charity Oversight

While the number of charities has risen exponentially since the 1990s, to almost 1.1 million last year, nonprofit experts say the Internal Revenue Service division charged with monitoring them remains understaffed and underfinanced. Its 868 employees, who are also responsible for reviewing tens of thousands of applications for tax-exempt status each year, are able to audit only a tiny percentage of charities annually.

When Congress introduced an excise tax on foundation investment income in 1969, it agreed the revenue should help pay for IRS oversight of tax-exempt organizations. However, it has never been used for that purpose. Unlike other IRS activities, monitoring charities for wrongdoing does not raise much money for government coffers—and lawmakers who are under heavy pressure to cut the deficit are unlikely to give it priority.

The Pension Protection Act of 2006 allowed the IRS to share more information from charity tax records with state officials so they could investigate possible violations of state law. But it established such strict controls over how it could be used that only three states have signed information-sharing agreements with the agency. For example, state officials who contact a charity may not say their inquiry was prompted by details obtained from the IRS. More than 40 attorneys general have asked Congress to relax the rules, saying confidentiality protections designed to benefit taxpayers should not apply to organizations that must file publicly available tax forms and “operate with the public subsidy of tax-exempt status.”

The attorneys general made their proposal in a letter last year to senior members of the Senate Finance Committee. No action has been taken.

It doesn’t make sense for the IRS, whose primary purpose is to collect taxes, to oversee groups that are tax exempt. Nonprofit experts have proposed creating a new body that is given proper tools to investigate alleged wrongdoing and penalize problem charities. Ideas have included setting up a new division in the Treasury Department or other federal agency or setting up an independent agency along the lines of the Securities and Exchange Commission, the Federal Trade Commission, or Britain’s Charity Commission. Marcus Owens, former head of the IRS’s nonprofit unit, proposed creating a public-private organization similar to the Financial Industry Regulatory Authority, which regulates securities firms and is overseen by the SEC.

Nonprofit experts are divided over whether a new body is a good idea. Some fear a new layer of bureaucracy, and others prefer working with the IRS because it is relatively shielded from political pressures. Creating a new agency could be a hard sell in today’s small-government political environment.

States are on the front lines of the effort to prevent charity fraud and bad governance, responding to consumer complaints and requiring charities and professional fundraisers to register and file financial information. Like the IRS, with limited budgets, they are struggling to keep up with an expanding number of charities—a situation that has been aggravated by the economic downturn. Some nonprofit and policy experts have proposed that the federal government provide money to help the states, usually the attorney general’s office, expand or create charity-oversight offices.

Concerns about the federal budget deficit—and more pressing needs in states that have faced deep budget cuts in recent years—make this a hard sell.

Regulators and the public now have trouble getting centralized information about charities that operate across state lines, including financial data from the 40 states that require charities to register. Several groups are working to set up a central Web site that would allow organizations to register electronically in multiple states at once, with the information posted online. That would make it easier for the public to learn about charity solicitation campaigns nationwide and allow state officials to focus more on fraud prevention than on registration activities

Nine states are participating in a three-year pilot project, “Singlepoint,” to set up such a unified registration system. It was crafted by the National Association of State Charity Officials, the Urban Institute, and Columbia Law School’s National State Attorneys General Program. “Because of the wealth of information that will be instantly available and accessible, it will be easier to spot trends around the country for charities that are cheating,” says George Jepsen, Connecticut’s attorney general, whose state is helping to design the effort. The project needs about $3-million to get started and is planning to seek foundation money.