Rooting Out Errors on Charity Tax Forms

IRS weighs new penalties on nonprofit groups after salary investigation turns up pattern of mistakes

Now that it has completed its two-year investigation of executive compensation at nonprofit organizations, the Internal Revenue Service is weighing whether to impose new penalties on charities and foundations that fail to provide complete and accurate information about the salary and benefits paid to top officials.

In addition, the IRS says it will continue to examine nonprofit pay closely because its investigation showed what it considered to be a troubling number of errors by nonprofit organizations.

The study, which examined the informational tax returns of 1,826 charities and foundations, found that almost half of them had made mistakes.

Nearly 400 did such a poor job of filling out their forms that they had to file amended returns. The IRS sent written warnings to 115 organizations that it said engaged in improper practices, and imposed $21-million in penalties on officials at 25 groups it said had substantially overcompensated their leaders.

Under federal law, people who receive overly high pay, and those who approve such compensation — including board members of nonprofit organizations — are assessed penalties.

More penalties could be imposed, said IRS officials, who are still working on 77 audits related to the investigation.

The tax agency said that fewer than 15 percent of the charities and foundations with improper compensation practices tried to fix their problems before the IRS caught up with them, even though the law that governs excessive pay and benefits rewards officials who correct problems themselves by charging them much lower penalty fees than they would normally owe.

“What we saw was that there wasn’t a lot of self-reporting or fixing of excessive amounts,” said Ronald J. Schultz, senior technical adviser for the IRS’s tax-exempt and government-entities division. “If self-reporting is nonexistent, you have to have some kind of enforcement for the system to work.”

‘Inexcusable’ Lack of Disclosure

For many charities, the most serious outcome of the salary investigation may be a decision by Congress or the IRS to impose new penalties on organizations that submit incomplete or incorrect information on their tax returns. Some lawmakers lambasted nonprofit groups for their mistakes after the results of the investigation were released, saying that the informational tax return, known as Form 990, is supposed to be a window into a charity’s finances and operations for both regulators and the public.

Max Baucus, a Montana Democrat who chairs the Senate Finance Committee, said he was “deeply concerned” about the errors. The committee’s leading Republican, Sen. Charles E. Grassley of Iowa, said: “The lack of transparency is inexcusable.”

One lawyer who represents charities says that many of the errors are made by the accountants whom charities hire to assemble their returns.

Charles M. Watkins, a Washington lawyer, said he has found mistakes in a number of the forms he has been asked to review for clients.

“The errors I’m seeing are ones that I think a reasonable accountant ought not to make,” he said.

Some charity officials disputed some of the report’s conclusions, including Diana Aviv, president of Independent Sector, a coalition of charities and foundations in Washington that is leading an effort to develop principles to help nonprofit groups stomp out abuses on their own, rather than through government regulation.

Ms. Aviv pointed out that at least 85 percent of the charities and foundations the IRS surveyed reported compensation properly on their Form 990 returns, although many made other mistakes on those and other tax forms. That statistic, she said, shows that although some bad actors may try to beat the system, the vast majority of groups do not.

“A lot of this is about good practice,” she said. “If the sector develops standards, it provides organizations with an opportunity to do the right thing.”

Protesting Penalties

Many charity lawyers said the last word has yet to be written on the IRS investigation. The people the IRS penalized are likely to challenge the tax agency, they said, and the penalties could be reduced or even eliminated entirely.

Nancy Ortmeyer Kuhn, a Washington lawyer, said she represents some organizations that are fighting the revenue service over compensation issues. “I predict we’ll win,” she said.

The salary investigation — the largest such effort carried out to date by the IRS — was a learning experience for the tax agency as it sought to apply a law enacted in 1996 that gives the agency the authority to fine charity officials for receiving salaries and other benefits that are deemed excessive, as well as to penalize trustees who approve the compensation. It is known as the intermediate-sanctions law because it gives officials an alternative to revoking a charity’s tax-exempt status.

In part because of the salary investigation, the IRS has now rewritten the Form 990 to require more details about compensation and to spell out the reporting requirements more clearly. It will revisit the section on compensation when it issues a fully revised Form 990 this summer, Mr. Schultz said.

Among the other findings of the investigation:

A pattern of mistakes. The IRS said that each of the 50 groups it contacted that paid more than $250,000 in compensation had made exactly the same mistake: failing to include a schedule that showed who received the compensation and how much money each person was paid.

Mr. Schultz said the IRS did not try to determine whether the errors on the returns were deliberate, but said it is considering whether to impose relatively high penalties in the future for improper reporting, based on the importance of the missing information.

“We have to ask, when you have significant errors on the 990, what should the consequence be?” he said.

Excessive benefits. Serious problems at organizations weren’t limited to excessive pay or bonuses, the revenue service said, but included payments for vacation homes, cars, legal fees, personal meals, and gifts that were not reported as compensation. In at least one case, the IRS said, a charity paid more to a business owned by one of the charity’s top officials than its services were worth.

Loans. The IRS said one of the most significant problems it found was improper loans by charities and foundations to their top executives. Of the groups that made loans, 53 percent offered terms that were lower than commercial rates, and 31 percent of officials failed to repay their loans as promised.

The IRS is following up with a new investigation into loans made by 250 organizations.

High — but legal — pay. Many charities paid executives or trustees salaries or benefits that the public might consider excessive, but because those groups complied with the law, the IRS took no actions against them, Mr. Schultz said.

The intermediate-sanctions law allows charities to pay top officials based on what other similar organizations are paying their leaders. When it passed the 1996 law, Congress directed the IRS to let charities compare their compensation to that of for-profit businesses, a decision that has been hotly debated ever since.

A copy of the report on the investigation is available online under the heading “EO Executive Compensation Project Report.”