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AFP Analysis: GAO report on IRS oversight of charities

See also:

  • Full text of GAO Report - "Tax-Exempt Organizations: Improvements Possible in Public, IRS, and State Oversight of Charities" (PDF file)

(July 10, 2002) As the charitable sector in the United States grows (there are now an estimated 750,000 501(c)(3) charities, according to the Internal Revenue Service), so does concern over how charities are allocating their funds. Congress, the media and the public were already questioning the amount of money charities were spending on fundraising even before the events of September 11. The call for greater charity accountability in this area has only increased over the last ten months.

In response to the public's concern, the General Accounting Office (GAO, the investigative arm of Congress) conducted a survey from June 2000 to March 2001 in which it analyzed the effectiveness of the IRS as a 'watchdog' over charitable organizations. GAO focused on the accuracy of the Form 990 (the annual filing form that most tax-exempt organizations are required to complete), the efficiency of IRS oversight of the charitable sector, and the ability of the IRS to share their findings with state governments. Coming as no surprise to the charitable sector, the results of the study concluded that the IRS is inadequately prepared to successfully monitor these organizations.

Form 990 is a 6-page form with a 45-page instruction booklet. The primary purpose of the complicated form is to document the funds that a charity spends on fulfilling its purpose. According to Form 990 data from 1994-1998, charities spent an average of 87% of their funds on charitable services. However, some question whether this figure accurately represents spending in the charitable sector. Some charities have been suspected of misreporting their spending to cover-up excessive spending in fundraising and administrative areas and to attract potential donors who might focus on how effectively a charity is using its funds.

Although it is the primary watchdog of tax-exempt charities, the IRS has not lived up to its duties. As the charitable sector in the U.S. has grown, the number of IRS staff designated to over-see tax-exempt organizations has dropped. Between 1998 and 2001, the number of applications for tax-exempt status increased by 9%, while the number of IRS oversight staffers dropped by 15%.

In addition, the IRS has been forced to focus primarily on processing the influx of new applications, abandoning in-depth examinations of many existing charities. In the past two years, examinations of charities have dropped to less than one half of one percent, with the current examination rate being the lowest in 6 years. The number of applications denied by the IRS has dropped from 73 in 1998 to 58 in 2001. The number of revocations of tax-exempt status have dropped too, from 24 in 1998 to 9 in 2001. These numbers indicate that the IRS is not capable of providing thorough examinations of charitable organizations.

The report concludes that with the charitable sector continuing to grow, it is unlikely that the IRS will ever be able to effectively monitor the entire charitable sector on its own, and that the IRS may need to turn to the states to share the job. However, under current rules, the IRS has no effective means of communicating with individual state governments and sharing readily the wide range of information about charities.

State officials are not routinely notified about charities whose tax-exempt status has been denied or revoked, nor are they able to obtain data regarding actions on state referrals, withdrawn applications or ongoing IRS examinations of charities. Although a limited amount of information is available to state governments, the process through which one obtains this information is arduous. It's such a difficult process that many state officials don't even know how to request the information.

The Charity Aid, Recovery and Empowerment (CARE) Act, currently under consideration by the Senate, contains provisions that would make it easier for state governments to obtain charity information from the IRS. If this bill passes, some of the information-sharing would be made easier.

The IRS has agreed that changes must be made in the way tax-exempt organizations are monitored. The agency plans to conduct market segment studies in order to obtain information about how donations are spent in the charitable sector. It will study 35 segments of the charitable sector to obtain insight on tax misreporting by nonprofits. It plans to research six organizations during 2002, but has estimated that their research will not be completed until 2008 due to 'resource limitations'. Other goals include improving compliance with tax laws by providing more guidance for charities and creating easier-to-understand instructions for Form 990.

In the report, the GAO commends the recent efforts of the IRS, but makes clear that their new plan is simply not specific enough. The study suggests that the IRS increase their staff, develop long-term strategies to improve their oversight, and develop a system with which to share a greater range of information with state governments on a regular basis.

The IRS has responded to the GAO report by indicating that it agrees with many of the report's conclusions, but that the issue of underfunding continues to confront the agency. It is not clear at this point what will become of the study or if its recommendations will be acted upon. Senator Charles Grassley (R-IA) of the Finance Committee requested the study, and he included a couple of the recommendations in the CARE Act. However, it was expected that wide-ranging limitations or new provisions regarding charities and their fundraising would also be proposed, perhaps as part of the CARE Act. Such provisions have yet to be proposed and, with the crowded Senate schedule, do not seem likely this year.

AFP will continue to monitor the impact of the report and any of its recommendations that become law or part of U.S. regulations.

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