S. HRG. 109–207

CHARITIES AND CHARITABLE GIVING:

PROPOSALS FOR REFORM

HEARING

BEFORE THE

COMMITTEE ON FINANCE

UNITED STATES SENATE

ONE HUNDRED NINTH CONGRESS

FIRST SESSION

APRIL 5, 2005

(

Printed for the use of the Committee on Finance

CHARITIES AND CHARITABLE GIVING: PROPOSALS FOR REFORM

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20–838—PDF 2005

S. HRG. 109–207

CHARITIES AND CHARITABLE GIVING:

PROPOSALS FOR REFORM

HEARING

BEFORE THE

COMMITTEE ON FINANCE

UNITED STATES SENATE

ONE HUNDRED NINTH CONGRESS

FIRST SESSION

APRIL 5, 2005

(

Printed for the use of the Committee on Finance

COMMITTEE ON FINANCE

CHARLES E. GRASSLEY, Iowa, Chairman

ORRIN G. HATCH, Utah

TRENT LOTT, Mississippi

OLYMPIA J. SNOWE, Maine

JON KYL, Arizona

CRAIG THOMAS, Wyoming

RICK SANTORUM, Pennsylvania

BILL FRIST, Tennessee

GORDON SMITH, Oregon

JIM BUNNING, Kentucky

MIKE CRAPO, Idaho

MAX BAUCUS, Montana

JOHN D. ROCKEFELLER IV, West Virginia

KENT CONRAD, North Dakota

JAMES M. JEFFORDS (I), Vermont

JEFF BINGAMAN, New Mexico

JOHN F. KERRY, Massachusetts

BLANCHE L. LINCOLN, Arkansas

RON WYDEN, Oregon

CHARLES E. SCHUMER, New York

KOLAN DAVIS, Staff Director and Chief Counsel

RUSSELL SULLIVAN, Democratic Staff Director

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C O N T E N T S

OPENING STATEMENTS

Page

Grassley, Hon. Charles E., a U.S. Senator from Iowa, chairman, Committee

on Finance ............................................................................................................ 1

Rockefeller, Hon. John D., IV, a U.S. Senator from West Virginia ..................... 3

Santorum, Hon. Rick, a U.S. Senator from Pennsylvania ................................... 5

ADMINISTRATION WITNESS

Everson, Hon. Mark, Commissioner, Internal Revenue Service, Washington,

DC .......................................................................................................................... 7

CONGRESSIONAL WITNESSES

Yin, George K., Chief of Staff, Joint Committee on Taxation, Washington,

DC .......................................................................................................................... 9

Gravelle, Dr. Jane, Senior Specialist in Economic Policy, Congressional Research Service, Washington, DC ......................................................................... 33

PUBLIC WITNESSES

Panetta, Leon, director, Panetta Institute for Public Policy, California State

University, Seaside, CA ....................................................................................... 12

Hatch, Hon. Mike, Attorney General, State of Minnesota, St. Paul, MN ........... 14

Johnson, Richard, member, Waller Lansden Dortch and Davis, PLLC, Nashville, TN ................................................................................................................ 35

Kuo, David, former Special Assistant to the President and Deputy Director,

White House Office of Faith-Based and Community Initiatives, Alexandria,

VA .......................................................................................................................... 37

Gallagher, Brian, president, United Way of America, Alexandria, VA ............... 40

Aviv, Diana, president and CEO, Independent Sector, Washington, DC ........... 41

ALPHABETICAL LISTING AND APPENDIX MATERIAL

Aviv, Diana:

Testimony .......................................................................................................... 41

Prepared statement .......................................................................................... 53

Panel on the Nonprofit Sector, Interim Report presented to the Senate

Finance Committee, March 1, 2005 ............................................................. 85

Responses to questions from Senators Hatch and Rockefeller ..................... 155

Baucus, Hon. Max:

Prepared statement .......................................................................................... 158

Bunning, Hon. Jim:

Prepared statement .......................................................................................... 159

Everson, Hon. Mark:

Testimony .......................................................................................................... 7

Prepared statement .......................................................................................... 160

Responses to questions from Senators Hatch and Rockefeller ..................... 171

Gallagher, Brian:

Testimony .......................................................................................................... 40

Prepared statement .......................................................................................... 174

Grassley, Hon. Charles E.:

Opening statement ........................................................................................... 1

Letter from IRS Commissioner Mark Everson .............................................. 184

Page

IV

Gravelle, Dr. Jane:

Testimony .......................................................................................................... 33

Prepared statement .......................................................................................... 198

Response to a question from Senator Rockefeller .......................................... 219

Hatch, Hon. Mike:

Testimony .......................................................................................................... 14

Prepared statement .......................................................................................... 220

Johnson, Richard:

Testimony .......................................................................................................... 35

Prepared statement .......................................................................................... 228

Kuo, David:

Testimony .......................................................................................................... 37

Prepared statement .......................................................................................... 269

Lincoln, Hon. Blanche:

Statement of the Arkansas Community Foundation ..................................... 271

Panetta, Leon:

Testimony .......................................................................................................... 12

Prepared statement .......................................................................................... 274

Rockefeller, Hon. John D., IV:

Opening statement ........................................................................................... 3

Santorum, Hon. Rick:

Opening statement ........................................................................................... 5

Prepared statement .......................................................................................... 276

Trust Coalition, Executive Summary to Table of Cited Abuses ................... 279

Statement of the Alliance for Charitable Reform .......................................... 294

‘‘Death by Bureaucracy,’’ Wall Street Journal, April 4, 2005 editorial ........ 299

Letter from the National Volunteer Fire Council (NVFC) ............................ 302

Yin, George K.:

Testimony .......................................................................................................... 9

Prepared statement .......................................................................................... 302

Responses to questions from Senators Lincoln and Rockefeller ................... 306

COMMUNICATIONS

American Bankers Association ............................................................................... 309

Capital Area Literacy Coalition .............................................................................. 311

Capital Region Community Foundation ................................................................ 313

Center for Nonprofit Advancement ........................................................................ 315

Chapman Charitable Trusts ................................................................................... 319

Compton, Robert A. ................................................................................................. 329

William A. Cooke Foundation ................................................................................. 332

Council on Foundations ........................................................................................... 334

Electric Power Research Institute (EPRI) ............................................................. 344

Evangelical Council for Financial Accountability ................................................. 346

Harwell, Aubrey B., Jr. ........................................................................................... 366

The Humane Society of the United States ............................................................ 374

The Nature Conservancy ........................................................................................ 383

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CHARITIES AND CHARITABLE GIVING:

PROPOSALS FOR REFORM

TUESDAY, APRIL 5, 2005

U.S. SENATE,

COMMITTEE ON FINANCE,

Washington, DC.

The hearing was convened, pursuant to notice, at 10:06 a.m., in

room SD–628, Dirksen Senate Office Building, Hon. Charles E.

Grassley (chairman of the committee) presiding.

Also present: Senators Hatch, Snowe, Thomas, Santorum,

Bunning, Rockefeller, Jeffords, Lincoln, Wyden, and Schumer.

OPENING STATEMENT OF HON. CHARLES E. GRASSLEY, A U.S.

SENATOR FROM IOWA, CHAIRMAN, COMMITTEE ON FINANCE

The CHAIRMAN. Thanks to everybody for coming.

This hearing is on two very important subjects. The first is

strengthening the role of charities in this country. The second is

closing the tax gap that relates to charities and to charitable gifts.

Last week, the commissioner of the Internal Revenue Service

came out with the preliminary findings on the tax gap. The news

is not good. We continue to have a tax gap of well over $300 billion

a year. That is the difference between the amount of tax voluntarily paid and the amount of tax that should be paid.

Like a loaf of bread, the tax gap is made up of many slices. There

is not one specific problem or issue that makes up the whole. If we

are going to close the tax gap, then we are going to have to do so

one slice at a time.

In one particular area, we become familiar with the problem of

individuals taking big tax deductions based on estimates, often piein-the-sky estimates, for gifts of closely held stock, in addition to

the real and tangible property that is given to charity.

What we see too often is the charity receiving a very small

amount of support, at best, from this kind of gift. At the same time

the taxpayer gets a tremendous benefit from the tax deduction.

I have here a Spring Bok from South Africa. [Laughter.] Unfortunately, some people think that its name is really a ‘‘free buck.’’ The

Spring Bok is known for its ability to leap when startled. I was

surely startled myself when we learned of this new tax scam.

The story in this morning’s Washington Post makes me think

that many people think that the ‘‘tax’’ in taxidermy is meant to

allow them to write off safaris to Africa as tax deductions if they

give away the stuffed animal.

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This type of scam gives new meaning to the term ‘‘tax gaming.’’

I expect the Internal Revenue Service to be very active in big game

hunting when it comes to this particular type of tax shelter.

So, Mr. Commissioner, I would suggest the next head that needs

to be mounted—figuratively, of course—is the appraisers who have

been promoting this sort of scam. This taxidermy problem is just

one example of what we are seeing too often when it comes to certain tax deductions for gifts to charities. Similar problems with

valuation exist throughout the tax code. Finding solutions is part

of slicing away at the tax gap.

Now, the second aspect of today’s hearing is strengthening the

charitable sector. From the earliest days of European settlements,

charity has been central to our national character.

In his sermon to the Puritans sailing to the Massachusetts Bay

Colony, John Winthrop said that they would be ‘‘creating a city

upon a hill for all to see.’’ The Reverend Winthrop said that ‘‘to succeed in a new land, the Puritans needed to be a model of Christian

charity.’’

The years between then and now have proven the importance

and the value of the ethic of giving. Today’s tax code recognizes the

importance of charities and helping those in need. It provides taxexempt status to charitable organizations and tax deductions for

charitable giving.

Congress, the administration, and the charitable sector itself are

all obliged to make certain that these tax preferences are used as

intended. Congress has not taken on serious review of tax-exempt

organizations since 1969, and that is the year that man first

walked on the moon.

Today, I am submitting for the committee record a letter from

our good IRS commissioner Mark Everson. Mr. Everson’s letter to

Senator Baucus and me makes it clear that a lot has changed since

1969.

Congress must revisit the laws in this area to make sure that it

is charity that benefits from the laws rather than the private interests.

Last year, the Finance Committee had a hearing and a roundtable discussion on this subject. We considered a staff discussion

paper. Since then, we received the Joint Committee on Taxation’s

thoughtful proposal in this area, and the IRS commissioner’s detailed observations.

We have also engaged the charity sector, which is providing recommendations and reactions to the nonprofit panel. It is my hope

that, in the near future, the Finance Committee can move legislative reforms that will strengthen charitable governance and address this part of the tax gap.

Those revenues can offset the costs of what we know as the

CARE Act, which has been under the able leadership and advocacy

of Senator Santorum. I am confident we can consider a mark that

will take meaningful steps to address this part of the tax gap, help

see that charities act in the interest of their charitable purpose,

and, finally, engage in charitable giving. Today’s hearing gives

committee members an opportunity to explore these matters in detail.

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In the absence of Senator Baucus, who was necessarily delayed,

I call upon Senator Rockefeller for a statement for the Minority.

[The letter from Commissioner Everson appears in the appendix.]

OPENING STATEMENT OF HON. JOHN D. ROCKEFELLER IV,

A U.S. SENATOR FROM WEST VIRGINIA

Senator ROCKEFELLER. Thank you, Mr. Chairman. I am very

pleased that you have called this meeting. Just from listening to

your statement, as an average citizen, I would guess about 50 percent of foundations were cheating and 50 percent were doing good

work.

I find that most unfortunate, because there is no mention made,

or reference made, except for the second part of the discussion, how

to strengthen—and a good deal of John Winthrop—to make foundations stronger.

I know, from very personal experience, that foundations and

charities do a tremendous amount of good work. I hope that our

panelists, if they so feel, will reflect on that.

In a time when maybe one of the great scams of all time is the

enormous tax cuts which have been given to people without anything at all required in return, and now the effort to make them

permanent, forever, while we struggle with Social Security, Medicaid, and Medicare—that is kind of an interesting thing, too.

I also assume that when the chairman spoke about $300 billion

of shortfall, that he was not just referring to foundations, but he

was referring to the number of people in other groups that do not

pay taxes. It was not clear from his statement.

The CHAIRMAN. But you are right. It includes everything.

Senator ROCKEFELLER. Yes.

I have a lot of experience with foundations, a lot with my own

family. I have worked a lot with foundations. I am on a lot of foundation boards now that have to do with my State of West Virginia,

having to do with research on Alzheimer’s, having to do with economic development, having to do with a whole lot of different areas

of the State that need help that do not get, and will get much less,

help from the Federal Government in the coming years.

I find a lot of these organizations to be absolutely excellent and

to be doing things that others are not, and making possibilities for

people that the government will not, or chooses not to do.

For example, the Bennendom Foundation is an enormously powerful and wonderful foundation in West Virginia. They do untold

good. They are based in Pittsburgh, but, happily, Michael Bennendom was born in West Virginia and the greater part of that money

goes to West Virginia. Most of the private and public colleges and

universities in West Virginia could not operate without the

Bennendom Foundation and what they have done in the past.

The Greater Kennaw Valley Foundation, the Eastern West Virginia Community Foundation, the Nature Conservancy in West

Virginia all are doing excellent work in my home State.

In the past couple of years, we have seen reports of some indefensible abuses of the nonprofit sector for personal enrichment. I

take these problems very, very seriously. I would also like to take

them in perspective.

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I want to fix those problems, but I want to fix those problems in

a way which does not discourage foundations from continuing to

operate or individuals’ instincts, which are needed now more than

ever, both for public service in a non-financial way, and for public

service in a financial way for those who can afford to do that.

I am concerned that Congress may inhibit charities’ abilities to

fulfill their missions if we impose unreasonable—I think we have

to impose some very reasonable—strictures on hiring, compensation, administrative expenses, or reporting. For example, we must

take into consideration the vast differences between organizations,

some of which provide direct services and will naturally have higher administrative costs.

I also want to be careful not to discourage charitable gifts from

individual citizens. Indeed, this Congress has approved legislation

to try to encourage charitable giving, and I assume did so for a reason, and I do not think we should move unreasonably in the opposite direction now.

Many of the proposals that the committee is considering will dramatically improve the transparency of nonprofit organizations. I

happen to think that this is a very good way that we can guard

against abuse and fraud at foundations and charities, where they

exist, by requiring nonprofit entities to file more complete information with the Internal Revenue Service and by making more of this

information available to the public. The government also, and the

media also, and the donor community can provide valuable scrutiny

to ensure that organizations are truly fulfilling their charitable

missions according to all the laws.

I am very pleased that the representatives of nonprofit organizations with whom I have met have encouraged Congress to improve

disclosure requirements for the nonprofit community. I believe that

we can work together to do something reasonable and proper in

this respect.

As we have seen in the recent case of the Nature Conservancy,

when questionable behavior is brought to light, organizations can

act aggressively, and do act aggressively, to reform and protect

against abuses. In fact, I will go further.

The government standard now in place at the Nature Conservancy is considered the gold standard for nonprofit governance, and

I applaud them for their recent actions. They went through a bad

patch, but they did what they needed to do and they have come out

very well.

Concerning one of the most important consequences of greater

disclosure is the opportunity for the IRS to directly review whether

organizations’ actions are consistent with their missions.

I am interested in strengthening the enforcement abilities of the

IRS to make sure that it can provide effective oversight, and I will

have questions with respect to the people that you have to do that.

I am looking forward to today’s witnesses about how Congress

can help eliminate fraud and abuse conducted under the guise of

charity, where that exists. We must prevent nonprofit organizations from benefitting from abusive tax shelters. We also ought to

make certain that wealthy individuals are not able to game the

system by taking charitable deductions for schemes that provide

little or no real public benefit.

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I believe, in closing, Mr. Chairman, that we can take what I

would call prudent steps—I have always found that a comforting

phrase—to eliminate unethical practices in the nonprofit sector,

and we need to be reasonable, forceful, and accurate about those

prudent steps.

Then we will really be doing a favor to many, many high-quality

ethical organizations—they want this—that do so much good every

day, not just in my State, but all across the world. So, I look forward to this committee’s striking the right balance, and I thank

the Chairman.

The CHAIRMAN. Thank you.

Our first panel is going to provide us with an overview of the

problems and possible——

Senator SANTORUM. Mr. Chairman?

The CHAIRMAN. Senator?

Senator SANTORUM. Would it be appropriate if I just make a couple of brief comments?

The CHAIRMAN. Senator Santorum.

OPENING STATEMENT OF HON. RICK SANTORUM,

A U.S. SENATOR FROM PENNSYLVANIA

Senator SANTORUM. Thank you. I will ask that my full statement

be made a part of the record.

The CHAIRMAN. I suppose it is legitimate, since you are the sponsor of the CARE Act, and because of your leadership in this area.

Proceed.

Senator SANTORUM. Well, I thank you, Mr. Chairman. I am a

sponsor of the CARE Act, and I feel very, very strongly about the

role of nonprofits in our communities across America, and obviously

introduced the CARE Act because I would like to see more resources go to these very organizations which are out there meeting

educational, human services, and other needs to those who are less

fortunate in our society.

As I have spoken with the Chairman in the past, I have some

very serious concerns about some of the initiatives that are being

put forward by the committee. I just want to make mention of a

few that I have very serious concerns about.

The reason I have concerns is not because the committee has not

shown that there are some problems out in the nonprofit world.

There are problems everywhere. The question is, has there been

adequate enforcement? I think that is really what we should be focusing on.

I wrote a letter to Secretary Snow recently and asked him whether these problems, many of which have been raised in previous

hearings and the newspapers, could be handled simply through increased enforcement.

His response to me was, it is too soon to tell. That does not sound

like a ringing endorsement for moving forward on a broad array of

new proposals to potentially hamper the ability of nonprofits to be

able to meet their charitable missions.

So I think we really do need to look at enforcement. I got a letter

recently from an organization that looked at the 94 instances of

‘‘abuse’’ that were cited in the June 22, 2004 hearing.

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[The letter and other supporting materials appear in the appendix on p. 279.]

I am told that all but two, actually, are illegal under current law,

of these abuses that have been cited. So, is there a need for additional legislation here when what seems like the overwhelming

problem is inadequacy of enforcement by the IRS in this area?

Again, I am willing to sit down and look. I think there are many

in the nonprofit community and those who are concerned about this

who would like the opportunity to have some input. I just wanted

to put my marker down here that I do have some concerns.

I have concerns about taxation of fraternal organizations and

what that would mean to their ability to be able to do the good

works that they do. A lot of them are in my State and do a lot of

wonderful things for the community.

There are some concerns out there, and I appreciate the Chairman’s leadership in bringing some of those concerns to light. I can

tell you from the standpoint of having worked with a lot of nonprofits in my career here in the U.S. Senate, those nonprofits who

are out there doing the good work want this cleaned up too, because it hurts them. It hurts their ability to go out and fund-raise.

It hurts their ability to go out and meet their mission.

So, they want the bad actors cleaned out just as bad as, I think,

members of this committee would like to see it done. We want to

do so without hampering their ability to meet their charitable mission. I think that is what the Senator from West Virginia just said,

and I will look forward to working with him, as well as the Chairman, in making sure we have a nice, balanced approach here.

Thank you, Mr. Chairman.

The CHAIRMAN. Yes. I think if you get a chance to study the

Commissioner’s letter, you will find out that it is not just enforcement, but it is also the need of some change in legislation.

[The prepared statement of Senator Santorum appears in the appendix.]

The CHAIRMAN. Now to our panel.

We have Commissioner Everson. I particularly want to thank

you, Commissioner, because you and your staff have sent this very

thorough letter to Senator Baucus and me regarding these problems. I commend you for this letter and commend it to everybody

who is interested in this issue. I would say, without question, it is

one of the most thoughtful and thought-provoking letters that I

have received from an agency of the Federal Government.

We also have Mr. George Yin, Staff Director for the Joint Committee on Taxation. His organization, earlier this year, responded

to a request of Senator Baucus and me for proposals in dealing

with the tax gap.

His report and findings will be part of a more detailed hearing

focusing on that tax gap coming up April 15. However, today we

are asking Mr. Yin to comment on the extensive recommendations

made on improving tax compliance in the areas of charity and

charitable giving.

Then we have Mr. Leon Panetta, who has distinguished himself

as a member of Congress and as a member of the previous administration, and now is connected with the Panetta Institute in California, and also is associated with various nonprofit panels.

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Finally, we have the attorney general of the State of Minnesota,

Mike Hatch. It is important that the Finance Committee, as we

consider reforms, bear in mind the roles that States traditionally

have played in attending to charities carrying out their mission,

and also take this opportunity to learn from the States.

Unfortunately, there are only a handful of States that are active

in the area of charities. But we are pleased, today, to have you,

General Hatch, with us, because you have been a leader in this

area, and particularly in the area of tax-exempt foundations.

Now, we are going to depart a little bit from our usual 5 minutes

because Commissioner Everson and Mr. Yin both have been given

10 minutes because they have an extensive amount of material to

cover. We have asked them to be very thorough.

Then we will have the traditional 5 minutes for oral statements.

Everybody’s written statement, regardless of how long, will be incorporated into the record.

So, Mr. Everson?

STATEMENT OF HON. MARK EVERSON, COMMISSIONER,

INTERNAL REVENUE SERVICE, WASHINGTON, DC

Mr. EVERSON. Mr. Chairman, distinguished members of the committee, I do not think I will use all that time, but certainly we can

cover a lot of details in the questioning.

Thank you for inviting me here today. I am pleased to be a part

of this panel, particularly with Mr. Panetta. He demonstrates to

me that there is life after OMB, although I am not sure that there

is life after OMB and the IRS. [Laughter.] So, we will see.

I commend you for bringing attention to the need for reform

within the charitable sector. I share your admiration for the work

undertaken by this sector and believe that the overwhelming majority of charitable organizations do their utmost to comply fully

with the letter and spirit of the tax law.

But we are now at an important juncture. As I discussed with

you last spring, and as I discuss at length in my written testimony,

problems exist. Simply stated, there are increasing indications that

the twin cancers of technical manipulation and outright abuse that

we saw develop in the profit-making segments of the economy are

now spreading to pockets—pockets, I would say, Senator Rockefeller—of the nonprofit sector.

The government recognizes the challenges in this area and is

moving to address them. We welcome the Finance Committee’s

work and the work of the Joint Committee to determine what help

the IRS might need as we augment our efforts in the tax-exempt

arena.

Similarly, it is heartening to see leading members of the nonprofit community itself taking steps to address abuses. I congratulate the Panel on the Nonprofit Sector convened by the Independent Sector for delivering a constructive report calling for

strengthening the accountability of charities and foundations.

I wish the accounting, legal, and business communities had been

as enthusiastic about confronting abuses and the erosion of professional ethics when corporate governance problems and the proliferation of shoddy tax shelter promotions first became evident.

8

The extent of our concern is such that we have made determining abuse within tax-exempt and governmental entities, and

the misuse of such entities by third parties for tax avoidance or

other unintended purposes, one of our four service-wide enforcement priorities, and we are dedicating resources to this task.

Although the IRS budget for fiscal year 2005 increased by only

one-half percent, we have boosted our budget for exempt organization examinations by over 20 percent. The President’s 2006 budget requests an additional $14.5 million

to further step up our activities in the tax-exempt sector. Our focus

areas include those about which the committee has publicly raised

concerns: abusive tax avoidance transactions, supporting organizations, conservation easements, and the seemingly high level of compensation for officers and directors of charities and foundations, to

name a few.

We are beginning to see results. For example, in the area of credit counseling, we are on record that too many of these organizations are operating for the benefit of insiders who are improperly

in league with profit-making companies. We have responded aggressively and now have more than half the tax-exempt credit

counseling industry, in terms of revenues, under examination.

We have either revoked or proposed the revocation of tax-exempt

status for 20 percent of the industry, again, measured by revenues.

We are moving in the right direction, but I know that we are by

no means done and need to continue our work.

Before closing, I would like to raise three points for your consideration. First, while the nonprofit sector has grown and become

more complex, there has been little change in the law.

An overall review of the rules is timely. In particular, we need

to ask whether the IRS has the flexibility it needs to respond to

compliance problems. We are too frequently forced to choose between inconsequential penalties, on the one hand, or the nuclear

option, revocation of tax-exempt status, on the other. De minimis

penalties may have little impact on the troublesome behavior, and

revocation may not be in the public interest.

Second, we need to promote transparency through more electronic filing. The Interim Report of the Panel on the Nonprofit Sector supports mandated electronic filing for all 990 returns.

I must note, however, that at present the IRS does not have the

authority to mandate electronic filing for organizations that file

fewer than 250 returns annually. This severely reduces the number

of exempt organizations that can be required to file electronically.

The administration supports reducing the 250 return threshold. I

hope that this is part of any reform discussion.

I also believe there should be a discussion of sharing enforcement

information with other agencies, particularly State regulators. You

need only look at our recent work with the States on abusive tax

shelters to see how valuable an active partnership can be. I know

this committee has previously supported information sharing in

your CARE legislation. I hope that this is a topic in the coming review.

To put a finer point on information sharing, I return to credit

counseling organizations. It seems unconscionable to me that the

FTC and the State of Minnesota must do their important work in

9

this area without the full benefit of our audits and criminal investigations.

Moreover, as you listen to Mr. Johnson on the next panel, think

how we could work with the State of Tennessee as they tackle abusive cases like the one he describes.

Mr. Chairman, I admire the energy you, the committee, and your

staffs are bringing to this topic. If we do not act to assure the integrity of the nonprofit sector, there is a risk that Americans will

lose faith in charitable organizations. If that happens, they will

stop giving, and those who need will suffer.

Thank you.

The CHAIRMAN. Thank you, Mr. Everson.

[The prepared statement of Mr. Everson appears in the appendix.]

The CHAIRMAN. Now, Mr. Yin?

STATEMENT OF GEORGE K. YIN, CHIEF OF STAFF,

JOINT COMMITTEE ON TAXATION, WASHINGTON, DC

Mr. YIN. Thank you very much, Mr. Chairman and members of

the committee. It is a pleasure to testify today about the exempt

organization proposals in the recent Joint Committee on Taxation’s

staff report on options to improve tax compliance and reform tax

expenditures. As the Chairman indicated, the report was a response to a request of the Chairman and the Ranking Member.

As the Chairman asked, I will briefly highlight today the proposals dealing with charitable contributions, and then turn to those

concerning the operation of exempt organizations.

In the case of charitable contributions, the report focuses on the

most significant area of potential noncompliance, namely, the valuation of non-cash charitable gifts.

Under present law, taxpayers are entitled to deduct the fair market value of most charitable gifts of capital gain property to a public charity. When property value is uncertain, this rule presents

compliance burdens for the taxpayer, noncompliance opportunities,

and law enforcement difficulties.

As Commissioner Everson’s written testimony indicates, challenging taxpayer valuations is a very resource-intensive task for

the IRS. Even a preliminary determination that the amount of a

deduction may be questionable requires an up-front commitment of

resources. If a serious challenge is to be made, more resources are

needed to secure alternate appraisals and opinions.

Adding to the problem is the fact that the interests of the donor

and the donee are generally aligned, with each party therefore willing to give the donor’s claimed value the benefit of the doubt.

The staff report contains several options intended to improve

compliance for charitable contributions of property. The report does

not propose changing the current law rules with respect to cash

gifts or gifts of publicly traded securities which do not present valuation concerns.

First, in general, for contributions of appreciated property, the

report proposes that the tax deduction be equal to the taxpayer’s

basis in the property. This is the present law rule for gifts to most

private foundations, as well as gifts of certain property to public

charities.

10

In most cases, basis is a more certain amount than fair market

value and subject to easier proof by the taxpayer and verification

by the IRS. Thus, this option could be expected to improve compliance, reduce burdens and disputes, and lessen the amount of IRS

enforcement effort.

The general treatment of gifts of property just discussed would

not be helpful for gifts that have depreciated in value, such as

clothing and household items. In such cases, the deduction is limited to the value of the property. Thus, a determination of value

is still necessary.

The relatively small value of any item of clothing or household

good makes it unlikely that the IRS challenges many of these deductions, leaving taxpayers with significant flexibility in valuing

such gifts.

Moreover, taxpayers may have a natural tendency to over-value

such items due to their attachment to them. Because this situation

is vulnerable to error and noncompliance, the report proposes that,

at a minimum, the potential amount of error should be capped.

Thus, the report suggests limiting the deduction of gifts of clothing

and household goods to $500 per year.

In the case of conservation easements, a rule limiting the charitable deduction to the taxpayer’s basis in the easement is of no

help in easing the potential noncompliance problem. If a deduction

is to be allowed for such easements, a determination of value is

still necessary.

For several reasons, determining the value of conservation easements may be even more difficult than in the general case. First,

the value of the interest given away is a function of the contract

terms crafted by the donor and will vary from case to case. There

may be few, if any, comparables to help determine value.

Second, conservation easements constitute only a partial interest

in the property rights held by the taxpayer, meaning that valuation

must consider the taxpayer’s continuing interest in the property

after the gift.

Third, in many cases, taxpayers who make these contributions

are already subject to significant State and local restrictions on the

use of their property. Such restrictions vary considerably from jurisdiction to jurisdiction, and would have to be taken into account

in valuing the easement.

Because these valuation difficulties present the greatest challenge in the case of easements placed on property used by the taxpayer as a personal residence, the report proposes that no deduction be allowed for such contributions.

For other gifts of easements, the report proposes limiting the deduction to 33 percent of the value of the easement, or in the case

of historic structures, to the lesser of that amount, or 5 percent of

the value of the structure.

Moreover, the gift must be pursuant to some clearly articulated

Federal, State, or local government policy in favor of the conservation objective. The report also proposes heightened appraisal standards and requirements in the case of these contributions.

The second broad category of noncompliance in the exempt organization area is in the operation of the organization. An organizaVerDate 11-MAY-2000 17:15 Dec 19, 2005 Jkt 095484 PO 00000 Frm 00018 Fmt 6633 Sfmt 6633 20838.000 SFINANC2 PsN: SFINANC2
11

tion that is granted exemption from Federal income tax warrants

exemption not as a matter of right, but as one of privilege.

To maintain exemption on an ongoing basis, organizations are required always to conduct their operations in a manner that is consistent with the basis of the exemption.

Under present law, organizations are required to obtain a determination from the IRS that they are tax-exempt as a charity and,

thus, eligible to receive deductible contributions.

However, once charitable status is granted, it rarely is revoked.

There is no mechanism in present law requiring a periodic review

of the basis for an organization’s charitable status.

The report proposes to change this situation by requiring that

every 5 years charitable organizations other than churches file information that would enable the IRS to determine whether the organization continues to be organized and operated exclusively for

exempt purposes.

The proposal will apply to new organizations and those receiving

charitable status within 10 years of enactment of the proposal.

Related to the issue of an organization’s ongoing basis for tax-exemption is the effect of a public charity’s dissolution, or other termination, of exempt status. Federal tax law requires that, upon

dissolution, the charitable assets of the organization continue to be

dedicated to charitable purposes, yet there is no Federal enforcement mechanism of this requirement in the case of public charities.

In order to provide the Federal Government with a means to enforce the dedication to charity requirement, the report proposes a

termination tax on liquidation or conversions of a public charity.

The tax would also apply to private foundation terminations. The

tax could not be recovered against assets held by the charity for

charitable purposes.

The proposal also is designed to ensure that when insiders are

involved in the acquisition of a charitable organization, the acquisition is subject to the present law rules that tax abusive insider

transactions.

One of the primary compliance concerns in tax law today is abusive tax shelters. The increasing involvement of exempt organizations as accommodation parties in tax shelter transactions contributes to the erosion of the tax base by improperly extending the benefit of the tax exemption to non-exempt parties.

The report provides for an excise tax on the participation by any

exempt organization, not just charitable organizations, in listed or

certain reportable transactions.

Under the proposal, if an exempt organization participates in

such a transaction knowing, or with reason to know, that the

transaction is prohibited, the entity is subject to tax of 100 percent

of the entity’s net income attributable to the transaction.

If the exempt entity is eligible to receive deductible contributions,

the Treasury Department may suspend eligibility for 1 year. The

entity-level tax does not apply to certain pension plans and similar

tax-favored accounts.

An excise tax would also apply to the entity managers that approve the entity’s participation in the transaction. A lesser penalty

would apply in cases in which an exempt organization participates

12

in a transaction that is later determined by the Treasury Department to be a prohibited tax shelter transaction.

Mr. Chairman, I see my time is about up. I know you have a

number of witnesses. I appreciate very much the time you have

given to my testimony.

Let me just assure the committee that we will continue to examine potential areas in the exempt organization area, as well as

other areas, where noncompliance concerns may be present.

The CHAIRMAN. Thank you, Mr. Yin.

[The prepared statement of Mr. Yin appears in the appendix.]

The CHAIRMAN. Now, our former colleague, Mr. Panetta.

STATEMENT OF LEON PANETTA, DIRECTOR, PANETTA INSTITUTE FOR PUBLIC POLICY, CALIFORNIA STATE UNIVERSITY,

SEASIDE, CA

Mr. PANETTA. Mr. Chairman, thank you. It is a pleasure to be

back visiting with a number of my old friends on this panel.

I testify here in my capacity as a member of the Citizens Advisory Group to the Panel on the Nonprofit Sector. The panel was

convened at your encouragement and, as you know, issued this interim report which helps to, I think, identify some of the steps that

need to be taken in order to ensure that these organizations meet

higher ethical standards.

During the course of my career, I have had the opportunity, obviously, to work with and review the work of charities, foundations,

and nonprofits from the perspective as a member of Congress, Director of the Office of Management and Budget, Chief of Staff to

the President, and now as a co-director with my wife of a nonprofit

institute that tries to encourage young people to get into public

service.

Whether large or small, these organizations—and there are some

1.3 million charities, foundations, and religious congregations—I

think are absolutely crucial to fulfilling the needs of the Nation.

Alexis de Tocqueville recognized the unique role of citizens working together to care for one another, to build communities. Let me

quote from de Tocqueville: ‘‘Americans of all ages, all stations of

life, and all types of disposition are forever forming associations.

Where in France you would find the government, or in England,

some territorial magnate, in the United States you are sure to find

an association.’’ He recognized the importance of these groups to

our democracy.

It is true today. American people contribute $201 billion to these

organizations, largely because of their independence and their remarkable ability to innovate, to collaborate, to provide services in

nutrition, in health, in education, and other areas of social needs,

to test creative ideas, to build communities, and to support the

arts. They generally do it with less bureaucracy, less red tape,

fewer dollars, and bigger bang for the bucks than a government organization.

Today, I think these organizations, I might say, are perhaps

more important than ever, and more valuable than ever. At a time

of huge deficits, budget cuts, and diminished resources, they are

vital to meeting the basic human and social needs that are critical

to our democracy.

13

But to be effective, to justify the Federal and State incentives

that are provided to the donors, they must operate with integrity

and trust, particularly at a time when trust is being undermined

in a number of the basic institutions in our society.

Unfortunately, there have been, and there continue to be, abuses:

siphoning off of funds, misuse of dedicated contributions, self-dealing, scams for tax avoidance such as the non-cash contribution

scam that was reported in the Washington Post.

They represent a small percentage of those organizations, but as

always, because of what they do, they undermine trust in the work

of the entire nonprofit sector. I join with you in saying that these

abuses must be brought to an end.

I commend you for your vigilance and your commitment. I believe that your actions have already encouraged efforts to try to improve this sector. The challenge, as always—and I think all of you

understand this—is to find the right balance, the right balance between new laws and regulations, the balance for a need for stronger enforcement by the IRS, and in addition, the need for tougher

self-regulation by the nonprofit sector itself.

The panel’s interim report provides a framework for this action,

and I would commend it to you. Obviously, in terms of actions by

the Congress, you have heard suggestions.

I would agree that you have to require audits for organizations

over a certain level. You have to define and clarify rules for donoradvised funds, along with a number of other steps relating to conflicts and whistle-blower protections. Our institute has implemented a lot of these on the basis of best practices.

In IRS enforcement, you absolutely have to increase IRS funding.

We have been through this, as you know. In the budget negotiations, we always look to the IRS as one of the important factors to

try to find needed funds. They ought to be supported because they,

in fact, are crucial to the collection of fees and the enforcement of

penalties.

I would give them the software to enable electronic filing of the

990 series, as well as allow attorneys general to share in access to

the IRS information, with appropriate restrictions.

Lastly, on self-regulation, because in the end you cannot legislate

honesty, and all of the good will in the world is simply not enough,

to be credible and effective, standards must be enforced by the nonprofit sector. They must be given the authority to investigate, to

implement an administrative process, and to enforce penalties. I

would strongly recommend that the nonprofit sector establish a national council on nonprofit accreditation.

It would provide standards on governance, transparency, and accountability. It would make the appropriate adjustments so that

you meet the diverse needs of small, intermediate, and large organizations.

It would provide the necessary education and training that is so

sorely needed. I have to tell you, in this area, most nonprofits have

no understanding of the management requirements, the needs that

we are seeing with Sarbanes-Oxley.

The importance of self-regulation is that it would relieve the burden of the IRS, or help relieve their burden, it would preserve the

14

independence of the sector, and, most importantly, would place responsibility where it belongs.

These organizations do public good, they are important to our democracy, but they cannot do this without public trust. I hope you

will work with us in establishing that trust.

Thank you, Mr. Chairman.

The CHAIRMAN. We have appreciated the report that the private

sector has put out in regard to the nonprofits.

[The prepared statement of Mr. Panetta appears in the appendix.]

The CHAIRMAN. Thank you, Mr. Panetta.

Now, General Hatch?

STATEMENT OF HON. MIKE HATCH, ATTORNEY GENERAL,

STATE OF MINNESOTA, ST. PAUL, MN

Mr. HATCH. Mr. Chairman, members of the committee, I submitted a statement. I would like to make a few additional comments.

Nonprofits have changed. We have all changed over the years.

Not all of them, but many have. They have grown. They are huge.

Let me put it a different way. All the members of this committee

could easily be making more money somewhere else. You are here

for a reason. You are here because you are mission-driven. The

nonprofit area is the same way. It was started, it began, and it was

fostered because of mission-driven people.

But today, many of these nonprofit organizations are very large.

There has been lots of merging activity that has gone on. We have

now entered the era of the professional executive. That is fine, but

sometimes these professional executives lose the sense of mission.

The problem that has been created is that these large nonprofits

no longer have accountability tools in place for their stakeholders.

If we take a look at other organizations, like city councils, you have

accountability by election, by a State auditor, by Freedom of Information Act laws, and by open meeting laws. There are all sorts of

restrictions on the public official in terms of accountability, even

though I think most people go into politics or government because

of a mission-driven sense. It does not matter what political party,

they are mission-driven.

Public stock corporations also have accountability. The executives

are accountable to a board and, like it or not, there are institutional investors that have the stock that make the board accountable. Plus, in a public corporation, there is a pretty easy measurement gauge, namely profit. If you are not making a profit, you are

out. So, there is a pretty strong accountability standard in a forprofit company.

The hardest group in terms of accountability, however, are nonprofits. There are many stakeholders and many issues that are confronted by the nonprofit executive. But as nonprofits have evolved

over time and grown in size and use, for the professional, non-mission-driven executive, the first priority for that executive has now

become, what is in it for me? When my office conducted our nonprofit audits—and issued reports on them—we saw some remarkable abuses.

15

We have seen abuses in big nonprofits as well as small nonprofits. I do not want to cast a broad brush here over all charitable

organizations, but there are significant problems. The acts of a few

bad apples lose trust for all charitable organizations.

Self-regulation will not do it. The governing board of a nonprofit

is the directors. Most of those directors are selected by the executives themselves. They are indebted to the executives when they go

on that board. They are mission-driven in some cases. They are not

going to pay attention, however, to the finances of a multi-billion

or multi-million dollar nonprofit.

In some cases, the board members are community-driven activists who have a sense of mission but do not have the expertise to

read, digest, and discuss the financial statements of a charitable

organization that may have tens or hundreds of millions of dollars

in assets and/or revenue.

In other cases, board members may be executives who do have

that sophistication, but very frankly, they are concerned about the

mission, too. They know, if they are going to start pulling up rocks

on the administrative costs, they are not going to have the executives being friendly to what they want as the mission for that organization.

So, people on the board, when you are dealing with, in some

cases, a multi-billion-dollar organization, they simply do not have

the time, the ability, or the sophistication to be able to work

through the detail that is necessary to demand the accountability

from that professional executive.

The reforms you have proposed make sense. For instance, one

proposal relates to the conversion of nonprofits. I have seen many

occasions where not-for-profits have been converted to for-profits

with a huge loss of mission to the public. I have seen examples

where for-profits basically manipulate and run a not-for-profit organization.

The nonprofit becomes a virtual shell, paying out all their money

in administrative costs, which loses the mission of that organization. You see individual abuses by executives that simply should

not be tolerated.

These proposals, I do not think, harm the nonprofit industry,

they help it. They reform it. They allow it so that you, and I, and

everybody else can make contributions, knowing full well that the

best people are involved in that process.

I will leave the rest of my time.

The CHAIRMAN. Thank you very much.

[The prepared statement of Mr. Hatch appears in the appendix.]

The CHAIRMAN. Now we will take 5 minutes in the order people

are coming. First of all, me, as Chairman, then Senator Rockefeller,

then Senators Jeffords, Wyden, Bunning, and then Senator Hatch.

We will have 5-minute rounds.

I am going to start with you, Commissioner Everson, but I would

also ask General Hatch to join in.

I read with great interest your discussion in the March 30 letter

about compensation. The difficulty of enforcement in this area

seems to be great. I also read, Mr. Hatch, your thoughtful comments about high salaries.

16

There are too often cases of high salaries in the charitable sector

that the general public views as outrageous. However, the unfortunate reality is that the law limiting outlandish compensation is too

uncertain and difficult for the IRS to effectively administer.

So, could both of you give me your thoughts on this issue in general, as well as whether it would be beneficial for Congress to revisit the current laws if we are going to expect the IRS to be able

to effectively deal with the problems of compensation?

In particular, I would also like your views on the Joint Committee on Taxation proposal in this area, and if we should also require organizations to first consider nonprofit comparisons in terms

of determining salaries.

Mr. Everson, and then General Hatch.

Mr. EVERSON. Yes, sir. I would be happy to comment on that. We

are concerned about compensation. You may remember, last year

we actually initiated 2,000 contacts with different organizations on

this subject, asking them to explain to us what their compensation

policies were, how they reviewed compensation, to try to establish

a standard of comparability.

We are in the course of going through that information. So far,

we have completed about 500 of those inquiries and we see problems in this area, particularly with loans to people who work in the

organizations, and also with other perks. So, it is an issue.

I think the issue is a little bit broader than that, though, because

it extends to the dealings with related parties. It is not only compensation that is important here. Someone can have an interest, an

indirect interest, in other related parties, something we have seen

in the credit counseling organizations.

So, I would suggest that you not limit the scope of your inquiry

here or any policy changes to merely compensation. It is a basket

of areas. We do think comparability is an important launching

point.

I think the Joint Committee has talked about shifting the burden

of proof, if you will, on what is reasonable here. That could be

something that would be quite workable.

The CHAIRMAN. General Hatch?

Mr. HATCH. Mr. Chairman, the rebuttable presumption of reasonable standard needs to go. One of the problems, particularly in

the health care area, the nonprofits, is you have a whole industry

of consultants out there who are making money, and a large

amount of money, simply pushing up salaries.

Right now, the standard is, as long as you have an outside consultant saying what the salary ought to be, and as long as the

board of directors is independent in approving it, you are home

free. You have a nice safe harbor there.

The IRS and my office, and no other office, is going to contest it

because you have got this rebuttable presumption of reasonableness standard. That has got to go. I mean, the CEO of a for-profit

HMO in my State took home $111 million last year.

With that, in a for-profit, basically it is Katie-bar-the-door for

every other health care corporation in America, because all they

have to do is point to that and they can take all the money they

want, and the IRS and the AGO are going to have a tough time

dealing with it. That is what they point to.

17

A not-for-profit is different than a for-profit. They ought to be.

They are not acting any differently now, in the health care area.

When we audit these hospitals, we are finding they are not doing

any charity care. The charity care that they claimed was charity

was the bills that they could not collect. It was bad debt.

The for-profits have bad debt as well. They did not even have a

charitable list to offer to the people coming into the hospital. They

would offer, they would comply, with emergency room treatment

and offer it there, but they would hound them afterwards on the

collections. There was no charity care.

So, on the salary side of it, again, the nonprofit executive will

have a consultant for the board who will point to the salary of the

for-profits. But it should be a different standard. A not-for-profit

executive is not going to be thrown out if there is not a profit. The

not-for-profit executive stays on forever. It is his board. Very rarely

are you going to see that kind of a change.

Then you have these consultants going back and forth, displaying

the salary statistics of the ‘‘median’’ executive. And of course the

board of a nonprofit hospital feels that their hospital is better than

average. It is called the ‘‘Lake Wobegon’’ effect. Nobody is going to

go on a board who feels that it is below average.

So, as long as you have consultants to tell you that your hospital

is above average, and you believe that it is, you are going to award

your executives an above-average salary. The consultants then go

to the next hospital and point out that we have just got the salaries

up at that hospital, and we can get your salary up, too.

And so you have this ratcheting effect. You will see articles out

there pointing out that executive compensation in this area is accelerating the highest in the country.

I think it is the highest group in the country. The reason is because of this standard that is being applied. We have created a

whole industry of consultants going around increasing the salary.

The CHAIRMAN. Senator Rockefeller?

Senator ROCKEFELLER. General Hatch, that is actually a very interesting statement, and one which I am inclined to agree with.

I do not remember those consultant groups. Back when I was

serving on, frankly, some family foundations, it was done from

within. Is that a recent development? Because I agree with you.

In public service these days, I mean, all of our constituents think

that we are over-paid. It is just that some people cannot afford to

keep a home here in Washington and back in some other State that

they may be representing.

How long has that been going on?

Mr. HATCH. Mr. Chairman and Senator Rockefeller, I do not

know. I am not a historian on it. I can tell you, though, I gave a

speech to a group of people, and I made reference to the days of

the hospital bake sale. People under 40 did not know what I was

talking about. They did not understand that term.

So, something is going on. Something has changed. You will notice, and I suspect when the hospital bake sale went out, in came

the professional and in came the consultants.

The rebuttable presumption of reasonableness standard begs for

consultants to go out and make a career of getting executive salaVerDate 11-MAY-2000 17:15 Dec 19, 2005 Jkt 095484 PO 00000 Frm 00025 Fmt 6633 Sfmt 6633 20838.000 SFINANC2 PsN: SFINANC2
18

ries higher. It gives them a nice, safe haven. You use those consultants, and they can up the salary of the executive.

By the way, guess who retains them? Who is the first one to

interview these consultants? And who recommends them to the

board? Of course, it is the executives whose salaries are going to

be increased.

The CHAIRMAN. Just for information, my staff tells me—and I

will ask George for verification—but this was a change in the law

that came in 1987, Section 4958.

Mr. YIN. It was 1996, Mr. Chairman.

The CHAIRMAN. 1996?

Mr. YIN. And it was part of the intermediate sanctions rules that

came in 1996. In our report, we did recommend that that rule be

abolished.

The CHAIRMAN. All right.

Give Senator Rockefeller more time. Go ahead.

Senator ROCKEFELLER. Thank you, Mr. Chairman.

This would be to Commissioner Everson. You indicated that the

amount of the percentage or the number of people who will be

working on these problems—and we all recognize that there are

these problems—will be going up by 20 percent, even though, in a

sense, the more fundamental statement is that the half a percent

increase that you got, because that means that 20 percent, is coming from somewhere else, which is important.

Mr. EVERSON. Yes, sir.

Senator ROCKEFELLER. I will not ask you where it is coming

from, because you may not have decided yet.

There is an enormous amount of backlog. I think in Cincinnati

you have about a 6-month backlog there in trying to look for people

who are applying for tax-exempt status.

Sort of realistically, in the way of what we do in government, so

often what we say is, we will just triple the amount of people who

are working on that, and then it is not necessary that you get those

people or that those people are not siphoned off into other jobs because of priorities that then shoot their public profile up that you

have got to go after it.

What is your philosophy on that, and how certain are you that

you can get them as it relates to the 6-month backlog? What can

they do? I mean, this is a backlog of people applying.

Mr. EVERSON. Yes.

Senator ROCKEFELLER. We are also talking about trying to reduce abuses.

Mr. EVERSON. You are covering a lot of ground there. We start

from something that actually goes back to Director Panetta’s days

at the OMB, when GPRA, the Government Performance and Results Act, first came into play.

We have established a strategic plan that I made reference to before, where we have established these four mutually reinforcing enforcement priorities, one of which gets to the charitable sector and

governmental entities.

What that does is, it keeps us focused on the fact that we have

to allocate appropriate resources to that task. So as we go forward,

that guides our internal decision making within the agency.

19

When we look at things in this area, you are right. The initial

determination is an important task when we look at whether someone deserves this exemption when they come in with a proposal.

We get something like 90,000 requests a year for exemption. We

have to look at those carefully.

We have just updated the information we request in that context.

But we have to balance that work with audits, of course. I would

stress to you that audits in this sector are the lowest of anything

we do as a percentage.

They are lower than individual audits which, while we have recovered individual audits from 618,000 in the year 2000 to over a

million last year, that is still less than 1 percent.

In this sector, they are down less than half a percent. So, that

is what we are doing. We are trying to ramp up the audits as well

and get current on those determinations.

Senator ROCKEFELLER. Thank you very much.

Thank you, Mr. Chairman.

The CHAIRMAN. Now, Senator Jeffords?

Senator JEFFORDS. Mr. Everson, I appreciate the work you and

your organizations are doing to combat abuse in this area with the

limited resources that you have. I think there is a special outrage

of the scams involving charities because of the cynical portrayal of

public trust.

I realize a precise accounting is impossible, and I wonder if you

could give us at least some idea of the revenue impact, even if it

is only an educated guess. With the recent update of the tax gap

study, I think it would be helpful to get a sense of what share the

nonprofit sector might be contributing.

Mr. EVERSON. Yes, Senator. We are now refining the information

in the tax gap. What we announced last week, and which will be

the subject of the committee’s hearings next week, are really the

preliminary results that size the overall gap. We have provided a

range that we will work to refine as the year goes on.

Deductions are clearly a problem in here. Our information on deductions indicates that, out of the total gross tax gap—which is before the recoveries the IRS gets; we size it at $312 billion to $353

billion—that something in excess of $10 billion, about $15 to $18

billion, is overstatement of deductions by individuals.

Charitable contributions are in there. I would decline at this

stage to give you a specific accounting of that until our statisticians

have done more work. I have been cautioned many times by them

not to get out in front of the results. But this is a contributor to

the tax gap, just as the Chairman said.

Senator JEFFORDS. Mr. Yin, I recognize that there may be problems in setting values for real property donations, but I do not accept the notion that only cash in publicly traded securities should

receive full value for donations.

Simply put, a farmer donating his land or an easement on his

land deserves full value every bit as much as a donor of cash or

securities.

The government has no trouble taxing land-based appraisals, so

I do not think we can have it both ways. Can you expand on the

steps we take, and can take, to improve compliance while still

granting full value for such donations?

20

Mr. YIN. Senator, I would be happy to do that. Our proposal and

report was focused on the issue of noncompliance, but obviously we

are not oblivious to the policy implications of our recommendations

as well.

In the area of charitable contributions, I think the focus of the

committee should really be on two things. First, you need to get

some sense of, to what extent does the tax benefit actually induce

a higher level of giving? Presumably, the policy goal of the committee is to induce a greater amount of giving.

When you examine that, you need to differentiate between an actual permanent level of greater giving as opposed to simply giving

in a different form or at a different time, which may be of lesser

concern from the committee’s standpoint.

The second thing is to say, if we want to induce a certain amount

of giving and we want to induce a certain amount of increased permanent giving, what would be the best way to do that from the tax

side?

There you need to evaluate the relative efficiency of different

mechanisms to provide tax incentives to induce giving. If you provide a mechanism that is susceptible to noncompliance, essentially

the cost to the government of the noncompliance portion buys the

government nothing. That simply is a waste of taxpayer dollars.

So, if there is some alternative mechanism, either through the

tax system or outside of the tax system, that would provide the

same degree of additional giving in the charitable sector without

the degree of noncompliance, then it is a win-win situation. You

have the same degree of charitable giving that you are trying to induce. You have it at a lesser cost to the government, thereby saving the taxpayer’s dollar.

So, we are happy to work with you, Senator, and obviously with

the committee and your staffs, to see if we can come up with suggestions along those lines.

What we are trying to present here is that property gifts are susceptible to noncompliance, and therefore there is an element there

of wasted taxpayer money that buys nothing from the government

standpoint.

Senator JEFFORDS. Commissioner Everson, you indicate in your

testimony that the IRS is currently auditing 50 donors of conservation easements. Can you expand a bit on the types of transactions

that concern you most? Could you do the same for two other categories you mentioned, open space and facade easements?

Mr. EVERSON. I would say, generally, Senator, that we have piloted programs in this area in a couple of different locations, in a

couple of cities around the country. This is of concern to us. We are

trying to get at it when we make our audit selections for individuals, typically high-income individuals, where what we have done

is we have doubled the audits of high-income individuals over the

last 4 years. This is definitely in the mix.

Now, what we are also doing within our structure that looks at

the organizations is going to the organizations themselves and trying to see what they are doing to bring in this kind of activity.

Again, the general statement here would be that there are two

sides of this. One is the individual who is seeking to reduce tax.

The other is the organization that is seeking to bring in funds or

21

some benefit through fees, through these kinds of problems, or

other transactions where they are in the more typical tax shelter

area. So, we go after it from both sides in all these areas.

Senator JEFFORDS. Thank you, Mr. Chairman.

The CHAIRMAN. Yes.

Now, Senator Wyden?

Senator WYDEN. Thank you, Mr. Chairman.

Mr. Everson, to begin with you, it seems to me that responsible

charities are becoming the last strand in the social services safety

net. If you do not get this right, which I would define as drawing

a bright line between the abusers and the responsible, one of two

bad things is going to happen: more low-income people get hammered again or taxpayers get fleeced.

I want to ask you some questions with respect to drawing that

bright line. The first picks up on a suggestion my good friend, Leon

Panetta, and you both have touched on, and that is the question

of electronic filing.

Why not simply say that everything has to be online in one place

so that you all, prospective donors, everybody is in a position to see

who is a rip-off artist and who is responsible? Would that not make

sense and be a relatively low-cost exercise?

My understanding—and Leon, maybe you can correct me on

this—is that the responsible charities are willing to do this. We

have talked to them. They have said, put it all online. So if we are

going to do what you have suggested, have this electronic filing, let

us do it fast, let us put it all online in one place, and everybody

knows where we are.

Mr. EVERSON. Let me first say that I concur with your assessment, Senator, of what is at stake for our country. Those stakes are

very important.

Again, I do not want to say that we have already reached a point

of no return. Hardly the case. This committee, the Congress, and

the administration all have the ability to get on this before this

really gets bad, the way the tax shelters as a whole did, or corporate governance as a whole did. So, I applaud the sentiment you

are speaking to.

Transparency. This sector has transparency. The rules are different. Tax returns for corporations or individuals are not public information. There is a reason why the law provides this transparency, so that that scrutiny that washes out the bad apples, in

many instances, takes place. So, we do believe in increased transparency and we do believe in the mandatory electronic filing which

will get that information out there.

Senator WYDEN. Well, again, I want to go on. But you have

called for electronic filing. It is not that great to just have the filing

and then not put it in one place where everybody can be held accountable.

Now, let me ask you about something else. I am told that you

all collect these excise taxes from private foundations’ investment

earnings, and that only a small portion of that money is used for

oversight in this area. Somehow, $500 million, or thereabouts, gets

collected from excise taxes from private foundations’ investment

earnings, but only about $30 million is being used for enforcement

in the area.

22

Now, is that right? If not, why do we not use more than $400

million, again, to try to draw that bright line and separate out the

abusers and the non-abusers?

Mr. EVERSON. I am generally familiar with what you are speaking to. I do not know the precise amounts, and will certainly check

and get back to you on that. I do believe there is an opportunity

for us to use those fees, probably more effectively, to augment our

resources.

But I have to look at it. I have asked our people to look at it,

and also, of course, to talk to OMB and make sure that we are all

in accord with the proper policies here.

Senator WYDEN. I think we ought to get on with it. Again, both

of these areas, it seems to me, go to the heart of striking the balance I am interested in.

The last point. Mr. Yin, I want to be clear with respect to donated property, because many Oregonians have been coming to me,

and these are the pillars of our community, with questions about

this.

They want to make sure that people could deduct the fair market

value. Now, these are people, again, who have long histories in our

State. I gather that you say it is hard to do because we have got

all these problems making these calculations.

Well, how do we figure out a way to make sure we do not chase

away the legitimate donors because of some kind of bureaucratic

inconvenience? I would like your recommendations in that area.

Mr. YIN. Well, Senator, that is a very fair question. It is, of

course, similar to what Senator Jeffords was asking. I again would

just say that you need to think of the cost/benefit analysis. The

benefit that presumably the committee is striving for is to encourage a degree of charitable giving. That is the objective.

Then you need to look at the cost side to figure out, well, if it

is going to be a tax provision, what kind of a tax provision would

induce that? Let me give you an example. It generally is viewed

that cash gifts are less susceptible to noncompliance than property

gifts. I think most people would generally agree with that.

It would be possible for the committee to consider a rule, a

change, that would give even greater tax incentives to cash gifts

than is true currently, and conversely take away, reduce, eliminate

the tax incentives from property gifts.

With the proper mix, it might be possible to have little or no effect on the level of permanent charitable giving, and yet the benefit

to the government would be that, if in fact cash gifts have less noncompliance, there would be a lesser cost to the government to

produce that benefit of a given level of permanent charitable giving.

Senator WYDEN. My time is up. But it sounds to me like you are

interested in trying to build the monitoring costs so as to ensure,

again, that there are not abuses into the overall work that is done

with the tax code, and I think that is a step in the right direction.

Mr. Chairman, I thank you and look forward to working with

you.

The CHAIRMAN. Thank you.

Now, Senator Bunning?

Senator BUNNING. Thank you, Mr. Chairman.

23

Mr. Yin, I would like to follow up on what Senator Wyden was

just questioning. If you are having problems evaluating a piece of

property for a donation, or an easement, or whatever it might be,

for gift purposes, for the tax code, why is it that we do not use the

assessed value of that taxed property? That is what they are paying taxes on.

In other words, if I own a piece of property, or I want to give this

piece of property to a tax-exempt organization, I am paying taxes

on that piece of property. Why is that assessment that I have not

a fair value?

Mr. YIN. Well, that is a good question, Senator Bunning. Let me

try to give you a couple of responses.

Senator BUNNING. Do not tell me about the PVAs.

Mr. YIN. I do not know what PVAs are.

Senator BUNNING. Property value administrators.

Mr. YIN. Thank you, sir.

No. I was going to say two thoughts that come to me. One is that

of course not all of the property that is being given in a charitable

contribution is property that is subject to some kind of an assessment. Obviously, you can think of the household goods and items

like that.

Senator BUNNING. But you have put a value on household goods

in your suggestion.

Mr. YIN. That is correct. That is correct. But my general point

is, not all property that would be subject to the kind of charitable

contributions would be assessed, so there would not be an assessed

value.

The larger point, I suppose, is that the assessed value will vary

from jurisdiction to jurisdiction as to exactly what it is that they

are assessing and how the manner of assessment is.

Some jurisdictions will assess at 100 percent, some jurisdictions

will assess at less than that. Some jurisdictions are very current

in their assessments, some jurisdictions have assessments that

really have not been reviewed for years.

Senator BUNNING. Then why can you not have a formula built

in? If they are assessed at 60 percent, you have a formula that

would make it 100 percent. The same goes with those jurisdictions

that are supposed to be assessing value at 100 percent of property

value.

Mr. YIN. Again, I think some formulas and rules of thumb might

be developed, but there are going to be, certainly, any number of

instances where you simply do not have a current assessment or

one that you would consider to be reliable enough to base the tax

consequence upon.

Senator BUNNING. Well, there is a very, very fine line that you

are trying to draw, and it is almost impossible to draw it, as far

as what this piece of property is worth if I give it to a non-taxable

organization.

Mr. YIN. Well, Senator, I completely agree with that statement.

That is why what we are really trying to do is, we are asking, or

suggesting to the committee, that it might want to consider moving

away from that line which is under current law and moving to a

line which does not require that kind of an inquiry.

24

Because as you point out quite correctly, that is an extremely

fine and difficult line to figure out. It is very difficult for the taxpayer initially, very burdensome to the taxpayer, and very difficult

for the IRS to verify and enforce.

Senator BUNNING. Mr. Commissioner, in testimony that was submitted by the United Way for the second panel today that we will

be hearing, the suggestion was made that nonprofits be asked to

report concrete results annually that are tied directly to their mission and not just be asked to report on the level of activity that

they engage in. The suggestion was made that this type of reporting could be made on the annual form 990.

Could you comment on this suggestion? From a practical point of

view, how could such information be quantified and reported?

Mr. EVERSON. I have not studied the testimony in detail, but I

am intrigued by this idea, because it does go to the heart of the

idea that a charity should be operating for the public good. So, getting back to what you are doing that has advanced the public good

in a report to the public—because, again, this information does all

become public—that is the distinction here from other tax returns.

That seems to me that is something we ought to take a look at.

Again, if we can get all this stuff up online through the mandatory electronic filing, there will be a lot more transparency, and you

will be able to tinker with the reporting in just this kind of manner, or in other areas, to get the information that you and other

members of the Congress think is important to understanding what

is happening.

Senator BUNNING. Well, you can see why United Way would like

it that way, because they think they are pretty up front on the way

they handle their contributions, and they would like others to do

likewise, I believe.

Mr. EVERSON. Transparency is a very good thing in this area.

Senator BUNNING. Thank you.

The CHAIRMAN. Thank you.

Senator Lincoln, now.

Senator LINCOLN. Thank you, Mr. Chairman. Mr. Chairman, I

would like consent to have a statement from the Arkansas Community Foundation included in the record at the appropriate place.

The CHAIRMAN. Of course. We will receive that.

Senator LINCOLN. Thank you, Mr. Chairman.

[The prepared statement of the Arkansas Community Foundation appears in the appendix.]

Senator LINCOLN. Thank you to the panel here that has been

very helpful today. Just a couple of questions.

Mr. Yin, to the extent that abuse in the charitable world is leading to this tax gap in terms of missed revenue, which baseline is

the abuse affecting the most? Are most of the people seeking to

avoid estate taxes through trust arrangements or are they seeking

more income tax evasion? Do you have any estimates as to where

we are losing the money and the breakdown of how much we are

losing to each of those baselines?

Mr. YIN. I do not have that information. I can certainly try to

obtain the information for you. I would say, just as a general reaction, because the estate tax only applies to relatively few taxpayers,

whereas the income tax applies much more broadly, the breadth of

25

the tax gap concern would be presumably greater on the income

tax side than on the estate tax side.

On the other hand, of course, there are some very large gifts that

are being given at the time of death that would not typically occur

in an inter-vivos way. So, it may be that, looking at the two, there

would be some kind of trade-off between the two, but we could certainly try to get that information for you.

Senator LINCOLN. I would appreciate it. If you could help us decipher some of that information, that would be helpful.

[The information appears in the appendix.]

Senator LINCOLN. Mr. Everson, looking at, I guess, the

partnering that you mentioned, about partnering with the States

and the Federal Trade Commission, could you describe to us a little

bit more in detail about this Federal Investigation Unit that is now

under organization, as you have testified to be online, what will it

do? When will the specific plans be in place and on the drawing

board? Do we have time lines for that?

Mr. EVERSON. As we augment our enforcement efforts in this sector, we are doing a number of things. One of them is what you just

mentioned. We are looking at potentially criminal activities in this

area in a way that strengthens the link between our staffs internally who are doing exams, and then the criminal investigating

unit, which is a separate unit of the IRS. So, we are working on

that and pushing forward.

The broader point that you are making, though, gets to the protection of taxpayer privacy. We cannot share the specific results of

either our audits or our criminal investigations with regulators in

your, or other, States that look over these activities. That is the

rub. We can only sit down and say, here is what we are seeing generically.

But if a charitable organization is doing something bad in Minnesota and in Vermont, we cannot sit down and say, this is what

we are seeing with XYZ organization in Vermont, these are the real

facts, and then that regulator in Minnesota can marry that information up and reach a more informed conclusion of what is wrong.

Senator LINCOLN. So does that mean the transparency does not

help us as much if we cannot overcome that hurdle?

Mr. EVERSON. I think that is an absolute limitation on the effect

of transparency. Yes, it is, Senator.

Senator LINCOLN. The other thing you mentioned is shifting resources in order to be able to accomplish these things. Are there

any other areas that are going to become a problem if you shift resources over to the nonprofit away from those other areas? Do we

need to be alarmed about that?

Mr. EVERSON. I think that you are asking a question that gets

generally to the President’s budget request for 2006. I believe that

the request the administration made is a strong and balanced request. We are asking for an additional 8 percent in funding for enforcement activities.

This brings back direct revenues to the country. Our enforcement

revenues increased last year up to $43 billion. It is a great return.

There are indirect benefits when people do not play fast and loose

with their own return.

26

Now, having said that, we have been asked to do some belt-tightening on the service side of the organization. I am comfortable with

what has been requested. We have been asked to take a 1 percent

cut on the service side of the organization.

We have detailed plans that we are developing now. This level

of belt-tightening is consistent with what other domestic, nonhomeland, non-DoD agencies are being asked to do in this difficult

period, as you know.

Senator LINCOLN. Thank you.

Mr. Panetta, it is great to see you. Coming from a small, rural

State where we are very dependent on very small nonprofits in our

small communities to really take up a lot of slack, as we look at

other types of Federal reimbursements in the budget and the types

of cuts that we are looking at, particularly in terms of Medicaid

and others, as some of those reimbursements are being advocated

to go down in some areas where it will seem drastic, do you have

any ideas of what that impact might mean, when you have got a

State like mine where 76 percent of my nursing home residents are

covered by Medicaid and 50 percent of my births are? We talked

a little bit about health care and some of these other nonprofits

that take up some of that slack.

Mr. PANETTA. That is what I mentioned, that I cannot think of

a more important time to try to ensure that these organizations

continue to meet the needs of people, as you go through budget

cuts that are clearly going to impact service to people in need.

In California, if you combine the Medicaid cut with cuts at the

State level that are part of the State budget, you are going to have

a huge impact in terms of people that are going to need to have

services of one kind or another. The only place that that is going

to come from—it is not going to come from the county, it is not

going to come from other organizations—is from the nonprofit sector.

Senator LINCOLN. So it is essential we get it right.

Thank you, Mr. Chairman.

The CHAIRMAN. Thank you.

Senator Hatch, then Senator Schumer.

Senator HATCH. Well, thank you, Mr. Chairman. I welcome all of

you to the committee. Leon, it is great to see you again. I appreciate all of the service you have given, both during your service in

Congress, and afterwards as well.

Mr. Yin, like others, I am concerned about the staff of the Joint

Committee’s recommendations to eliminate the deduction of the

fair market value of donations of appreciated property.

Now, you mentioned in your testimony that changing the deduction to the basis of the property would improve compliance, reduce

burdens and disputes, and lessen the IRS enforcement effort. I

have no doubt that this is all true. However, I believe this change

would also result in fewer donations to charities.

Now, have you analyzed the potential effect on the amount of donations, or a change in the deductible amount from fair market

value to the basis the property might have, and are there other

ideas to reduce potential over-valuation abuse in the donations of

appreciated property that might not be part of reducing donations

to legitimate charities?

27

Mr. YIN. Well, Senator, again, our focus was on noncompliance.

But on the policy implications of the proposal, there certainly have

been various studies that have tried to measure the responsiveness

of taxpayers to the tax incentives. Roughly how much additional

charitable giving is stimulated by a dollar of revenue cost? How

much does that produce? There is a range.

I am not sure that the studies focus on the difference between

tax benefits in the form of cash contributions as opposed to property contributions. So in direct answer to your question, there

would be a degree of uncertainty as to what the effect would be.

I would just like to, again, reiterate the point I tried to make earlier, which is that there are a variety of ways in which the committee might try to induce a certain level of charitable giving, assuming that that is the committee’s objective.

Senator HATCH. I will look at your remarks.

Mr. YIN. And to the extent a mechanism can be designed which

is less susceptible to noncompliance, then you are able to accomplish your goals at a lower taxpayer cost.

Senator HATCH. All right.

General Hatch, I want to spend a few minutes with you because

you have raised some very important issues on nonprofit hospitals,

in particular. You indicated that some of these nonprofit hospitals

are over-paying executives, at least many believe that. They are

giving emergency care, but then dunning the people to such a degree that they never come back. They would not even think of coming back.

In addition, I have heard that some of them are secreting their

funds offshore instead of using them for truly charitable purposes,

which is to help people. On the other hand, I have heard the other

side of the coin too, where one of the leading hospital chains has

at least $800 million a year in uncompensated care.

So, tell me about that. Tell me what we should do about this.

Mr. HATCH. There are a number of issues that are raised in your

question.

Senator HATCH. I mean, cousin to cousin, I am throwing you a

real softball here.

Mr. HATCH. You are. [Laughter.] That is a tough one, actually.

We are talking, number one, about cost shifting. You see health

care premiums going up double digits. One reason is for uncompensated care. Somebody is going to have to pay it. We know that

there have been cutbacks in various funding programs, the end result being there is going to be higher levels of charity care. We

know there are more uninsured in this system.

The health care system, in and of itself, has no accountability.

There are about 15 transactions between the time that an employer

and an employee pay a premium to the time that a provider is providing treatment to the patient. Those 15 transactions are a huge

bureaucracy. Over 40 percent of our health care right now is just

spent on administrative costs.

Senator HATCH. Part of that is our fault here, too.

Mr. HATCH. Well, it is our system.

Senator HATCH. That is right.

Mr. HATCH. It is a system that needs to be radically changed.

Senator HATCH. I agree with you.

28

Mr. HATCH. Because employers cannot afford this any more, and

we cannot afford it any more.

Senator HATCH. Am I right that a lot of these nonprofits are

shipping their funds overseas so they do not have to use them

charitably?

Mr. HATCH. That, I am not aware of. We did not find that. It

could have happened and we just did not see it, but I am not aware

of that.

There are two issues that come up that I think are not being discussed here. One, is criminal, but one is more regulatory. A lot of

the issues I raised in my statement are more regulatory. For instance, the HMO executive takes a $35,000 trade mission to Brazil,

even though the HMO can only do business in Minnesota. I would

not call that criminal, but I would say it is an awful lavish waste

of money. Or spending $10,000 to go to Australia to attend a seminar that is entitled, ‘‘Are We Pricing the Consumer out of the Cost

of Health Care?’’

Or the Alina executives that went on a wine retreat in Napa Valley, spending about $40,000 on hot air balloons. They came back

and they said the purpose of the trip was to ‘‘find their moral center.’’

When the accountant asked them, is this really a business purpose for Alina and the guy says, well, we do not think the media

will catch on. In other words, what was significant to the executive

was not whether the attorney general would catch on or the IRS,

it was whether the media would catch on.

These are not criminal, but they are just awfully stupid, and

they are things that ought not occur. We do need better oversight.

These are very large institutions. It is very hard to ask executives,

civic organizers, community activists to sit on the board of a billion

dollar company and effectively know what is going on. It is just too

hard.

Mr. PANETTA. Could I comment, too?

Senator HATCH. Sure. Then I would like Mr. Everson to comment

on my totality of questions here, what is happening to these funds

and are they being treated fairly.

Mr. PANETTA. Senator, if I could just comment. It goes back to

Senator Rockefeller’s concern about establishing compensation. We

have seen this in the private sector. I have served on private

boards, I have served on nonprofit boards.

On private boards, you could make the same accusations about

boards of directors that you are making with regards to nonprofit

boards. I mean, boards of directors generally went there, did the

golf tournament, signed off on most of the things that were done.

That has changed.

I mean, the boards I am on now, the boards of directors are taking much more interest in what goes on in the organization. You

have got to place larger responsibility on these boards of directors.

Yes, they are from the community. I serve on a board for a community hospital in my area.

I have to tell you, that board is, today, a lot more vigilant about

what is going on in terms of compensation, in terms of these other

requirements because of the pressure that has been brought to

29

bear because of some of the scandals that have taken place in the

corporate world.

Senator HATCH. Mr. Everson, I would like your comments on all

of this.

Mr. EVERSON. A couple of comments. First, Senator, we have not

yet seen significant indications of funds going overseas. Now, I will

follow up to see whether there is anything that I am not aware of,

but that has not been brought to my attention.

Generally, talking about hospitals or other issues of like kinds of

organizations, my concern here would be that you are seeing a slow

melding, an indistinguishable difference, if you will, between profit

making and nonprofit entities.

So, those that are nonprofit are paying the same high salaries,

perks, benefits and everything to individuals associated with the

organization, and it is increasingly difficult to draw a distinction

between what they are doing for reasons that you are talking about

of providing, say, charitable care, and what our profit-making entity is doing.

So the real stake here is that, over time, not just with people inflating their deductions for grandma’s painting, but that more and

more of the supposedly taxed economic activity of the country will

end up in this sector that is not taxed because it is easier to organize there. There is less scrutiny and people can live well with less

accountability.

So, we think this is something that needs to be looked at. A lot

of it comes back to adequate enforcement by us. The bright lines

here are difficult to draw. It relies, in fact, on the good judgment

of our career examiners, sir.

Senator HATCH. Thank you. Thank you very much.

The CHAIRMAN. Senator Schumer?

Senator SCHUMER. Thank you, Mr. Chairman.

I want to thank all of our witnesses, and particularly welcome

my former roommate of 10 years, Leon Panetta, who lived in our

little house on D Street until he was asked by President Clinton

to be OMB chair, and his wife came to Washington, and he preferred her to us. I do not blame him. [Laughter.] She was a lot

neater, too.

In any case, I want to thank the Chairman and Ranking Member

for holding this hearing. It is a subject I have a great deal of interest in, and I am sorry I could not be here all morning. We had the

Patriot Act hearing in the Judiciary Committee.

I would like to work more closely with you and your staff as we

look at the process of reforming tax-exempt organizations. I have

a few questions, but first I want to make a few brief comments.

First, while charities and nonprofits play an important role in all

our States, they play an integral role in New York. They are part

of the fabric that makes New York a great and special place. In no

other State represented on the committee do tax-exempt organizations play such an essential role.

In fact, the New York metropolitan area contains the largest concentration of philanthropic capital in the world. We have, in New

York City, more than 27,000 nonprofit organizations that employ

528,000 people. There is an annual payroll of $22 billion, and they

serve more than 2.2 million city residents, most of them poor, most

30

of them indigent. So it is immensely important to both the economy

and the provision of social service in my State that the nonprofit

sector be healthy. While people may immediately think of large organizations like the Ford Foundation, the truth is, most of these

tax-exempt organizations are actually very small. Nationally, of

65,000 private foundations, the vast majority have assets under

$50 million. Of 1.4 million public charities, 98 percent have revenues under $5 million.

So as the commission ponders necessary reforms, I urge them to

consider what Derrick Box said at last June’s hearing, namely that

crafting new, one-size-fits-all rules for all tax-exempt groups, regardless of size, may be unduly burdensome for many of the smaller organizations that support or directly provide important social

services.

Second, I was stunned to learn about Commissioner Everson’s

new report on the tax gap. According to the IRS, $300 billion in tax

revenue goes uncollected every year due to tax avoidance and evasion.

I have heard that the gap could be closed with better enforcement of existing laws, not passing new laws. In my view, Congress

has to provide the IRS, your organization, with the resources it

needs to do the job.

But I would argue that the same is true in large part for taxexempt organizations, because my constituents tell me many reforms sought by the committee could be better accomplished with

greater enforcement of the laws on the books.

I urge the committee to consider which areas truly require new

laws, such as regulating donor-advised funds and supporting organizations, and which abuses would be better reduced with the

threat of better tax enforcement.

Finally, I know the panel on the nonprofit sector was formed at

the urging of the Chairman and the Ranking Member. It has produced an excellent interim report. Hundreds of dedicated people

committed thousands of hours to the panel’s work. I think we owe

it to those who have worked so hard to craft the panel’s recommendations to wait until the final report is presented before the

committee considers specific legislation.

Now, two questions. First, for Mr. Yin. One of the Joint Tax

Committee’s recommendations involves requiring a taxpayer who

donates appreciated property, other than publicly traded stock, to

take a deduction for their basis in property rather than the fair

market value. I understand there have been abuses here. I know

Senator Hatch mentioned this.

But there are many successful entrepreneurs who donate to charity by giving shares of restricted stock in their company. I know

you, Commissioner, mentioned, well, let us look at ways they can

give cash. These folks do not have cash. They have the stock and

not much else.

So, if we were to greatly restrict this, you would end up with

fewer charitable contributions, not a switch from stock to cash. The

anecdotal evidence I have received from my constituents is that

such a change would be devastating. I was wondering if the Joint

Committee has done any analysis as to how limiting these deducVerDate 11-MAY-2000 17:15 Dec 19, 2005 Jkt 095484 PO 00000 Frm 00038 Fmt 6633 Sfmt 6633 20838.000 SFINANC2 PsN: SFINANC2
31

tions to one’s basis in the property might reduce charitable giving

by the entrepreneurial sector.

Mr. YIN. Thank you, Senator. In the case of closely held stock,

certainly there may be situations where the donor would have a

limited amount of liquid resources. On the other hand, there are

often situations where, for example, there is an ample amount of

liquid resources within the company itself. In fact, one of the standard tax planning devices that is often used to attract donations of

stock of that sort is to have the donor donate the stock of a closely

held company to a charity, and then to have that stock be redeemed by the company through a cash payment to the charity.

After all, if in fact there really is little or no market for this

stock, the stock is of little value to the charity as well. So, the charity, in the end, would like to get some cash. By carrying out the

transaction in that way, the effect, really, is simply to do nothing

more than to allow the donor to avoid paying capital gains taxes

or dividend taxes on that cash coming out of the company.

Senator SCHUMER. But are there not a lot of companies that

would not want to do the process that you suggested?

Mr. YIN. I think, on the contrary, for most closely held companies, that is exactly the way they would prefer to carry out the

transaction because they are not interested in having somebody

other than themselves or somebody very close to them own stock

in the company. They are interested, however, in avoiding paying

some taxes and this is, again, a fairly standard way in which they

can accomplish that end.

Senator SCHUMER. All right. Well, I will certainly look at that.

But from what I have heard, it may not do the job.

Can I ask one more question, Mr. Chairman? Are we running

late?

The CHAIRMAN. Yes.

Senator SCHUMER. All right.

The CHAIRMAN. But I do have to go to the Ranking Democrat

here to ask one additional question that he wanted, then I am

going to go to the second panel.

Senator ROCKEFELLER. Thank you, Mr. Chairman.

First of all, the Ranking Member is Max Baucus.

The CHAIRMAN. But you are now the Ranking Member.

Senator ROCKEFELLER. I know.

The CHAIRMAN. How does this sound: the next Ranking Member?

Senator ROCKEFELLER. I want to ask unanimous consent that his

statement be included in the record. He asked me to do that, so I

am obliged to do that.

The CHAIRMAN. I do not know whether he can do that or not.

[Laughter.]

Senator ROCKEFELLER. Will you contemplate that then?

The CHAIRMAN. Yes. We will do that.

Senator ROCKEFELLER. Thank you, Mr. Chairman.

[The prepared statement of Senator Baucus appears in the appendix.]

Senator ROCKEFELLER. I want to ask a somewhat deliberately

provocative question of you, Mr. Everson.

The CHAIRMAN. I thought it was a little question.

32

Senator ROCKEFELLER. The statement was made earlier that

about $16 to $18 billion—I am not even sure that I heard it correctly—has to do with tax evasion, et cetera. I am quite sure that

not all of it has to do with foundations.

Two questions. Number one. I am just asking you, do you know

of any studies that have been made of the percentage of foundations that exist in this country that do for large States like Senator

Schumer’s and small States like mine what we think they do, and

they are important, how many of them are, in a sense, cheating or

abusing? That fellow who raised his salary so he could get his

daughter married, which is an all-time disgusting example.

But those things catch attention and they raise an issue enor- mously. But then on the other hand, we went to the $350 billion

or $320 billion of individuals or corporations that are not paying

their taxes.

In a proportionality sense, when you say you are going to raise

by 20 percent the number of people who are focused on foundations, I wonder what happens.

Are you doing an equal thing with respect to corporations and individuals who are not paying their taxes? Because those folks are

probably not helping with Medicaid in New York or West Virginia

hospitals.

Mr. EVERSON. Certainly. The budget request we put forward for fiscal year 2006 requests about $265 million of new enforcement

monies. As I indicated at the top of the hour, about $14.5 million

of that, or 5 percent, goes to the tax-exempt government entities.

The measures that I took, in 2005, to try to increase this funding

for tax-exempts by 20 percent were unsuccessful, frankly, despite

the good efforts of this committee to help the IRS receive the President’s request. The monies that I was given were fairly meager

compared to what the President had requested. He had asked for

about $500 million, we got $48 million.

So, I have sort of said, what am I going to do with the little bit

of money we got? I decided to try to move the needle in this area

because the stakes were so great. Does this go after the tax gap,

per se, that augmentation I spoke of on the exempt organizations?

No, but it goes to Senator Schumer’s point.

We cannot only attack the tax gap. The IRS’s responsibilities are

many. They extend beyond the taxable segment of the economy. We

have been given the responsibility to ensure the integrity of taxexempt organizations, so that is what we are doing in this instance.

Senator ROCKEFELLER. Thank you.

Thank you, Mr. Chairman.

The CHAIRMAN. I thank this panel. I am glad it took a long time,

because you all have good information for us, and I think we will

make good use of that information. Thanks to all of you.

Now we go to the panel of Dr. Jane Gravelle from CRS, a very

detailed, independent analysis in three areas of concern to our committee: donor-advised funds, supporting organizations, and donation of property. Dr. Gravelle’s report will be included in the

record. I strongly encourage anyone interested in these matters to

read this report that is very nonpartisan and look at it closely. It

is an eye-opener in terms of problems that we face in these three

areas.

33

Let me add that I think it is an example of the type of analysis

that we need more of, but do not get nearly enough of, be it from

government, academia, or think tanks.

This analysis from CRS looks at specific tax code sections, as

well as organizations that are created by tax code regulations, and

holds them up to a hard light of analysis to see what is actually

happening in the everyday life of nonprofits. It is too rare, if we

ever get this. I thank Dr. Gravelle. Thank you very much for your

efforts.

The second person is an attorney from Tennessee, Mr. Richard

Johnson, who will let us have a first-hand experience of his efforts

to deal with a private foundation where the wheels came off.

Then Mr. David Kuo, who was, until recently, at the White

House, where he was a senior advisor to the President’s FaithBased and Community Initiatives.

Then we go to Brian Gallagher, president of United Way. He

knows first-hand the problems that confront charities and will

speak to United Way’s efforts to bring reform internally, as well as

comment on proposals for reform.

Finally, Ms. Diana Aviv, whom we had a news conference with,

who is president of the Independent Sector, an umbrella group of

many of our Nation’s charities, and is spearheading this effort of

the Nonprofit Panel that was formed in response to a letter from

Senator Baucus and me to the Independent Sector asking them to

provide input from the charitable sector. That preliminary report

was aforementioned to the first panel.

We will go just the way I introduced you. So, Dr. Gravelle?

STATEMENT OF DR. JANE GRAVELLE, SENIOR SPECIALIST IN

ECONOMIC POLICY, CONGRESSIONAL RESEARCH SERVICE,

WASHINGTON, DC

Dr. GRAVELLE. Mr. Chairman, members of the committee, thank

you. I am Jane Gravelle, Senior Specialist in Economic Policy at

the Congressional Research Service, and I thank you for the opportunity to appear here today.

I discuss two types of entities that allow individuals to deduct

contributions before the gift is actually made to a charity: donoradvised funds and supporting organizations.

Payments to donor advised funds are treated as completed gifts

for tax purposes and the fund is legally controlled, but the donor

effectively makes the choice. I also discuss gifts of appreciated

property, and I relate this discussion to the Senate staff discussion

proposals and the Joint Tax Committee proposals.

My main findings may be summarized as follows. Donor-advised

funds and supporting organizations allow the tax-free accumulation

of assets intended for charitable purposes, as is the case of a private foundation, whether or not subject to private foundation rules.

They are, therefore, uniquely tax-favored.

Both donor funds and supporting organizations have grown rapidly and are a significant part of the mix of charitable assets. Distributions from large donor funds and supporting organizations are

a third the size of distributions from private foundations, which in

turn account for 10 percent of all giving. Assets and large donor

34

funds grew at an average annual rate of 25 percent from 1995 to

2003, increasing 5-fold over that period.

There are two issues. First, do these organizational structures increase giving or do they harm charities by deferring giving? Second, are these organizational forums used for private benefits rather than charitable purposes?

Concerns that funds may not be paid out to charities appear justified. A survey of several community donor funds found that 19

percent of donors made no distributions during the year. Data on

large supporting organizations showed that 25 percent made no

distributions, and two-thirds distributed less than 5 percent.

While tax subsidies should increase giving, econometric studies

of charitable giving suggest that the response of donors to timing

is much, much more powerful than aggregate giving responses.

A well-known study found that the effects encouraging delay are

3 to 28 times the size of effects encouraging giving. This analysis

also showed that a dollar of tax revenue lost encourages from 8

cents to 51 cents of additional permanent giving, and much more,

of course, in shifting.

When giving is funneled through these special organizations, it

may also be reduced by management fees. In addition, emerging

econometric evidence and economic research on the effects of default roles is relevant to the effect of these forms of tax-preferred

giving.

These studies suggest that individuals disproportionately choose

options that require no action. After making contributions to donor

funds and receiving the tax deduction, individuals may simply

leave them there.

While there are no data to quantify abuses, there is considerable

indication of their existence from witness testimony, practitioner

websites, and from supporting organizations’ data on loans made

back to the donors. Among the abuses is a practice called round

tripping, where donor-advised funds donate to foundations and the

foundations then donate to donor-advised funds.

Type III supporting organizations may be particularly vulnerable

to abuse because the supported charity does not have control of the

organization. Although even where the supported charity does have

control, there is certainly pressure to take into account the preferences of the donor.

Gifts of appreciated property that account for 25 percent of giving by tax itemizers rises to 50 percent at the highest income levels. Again, statistical evidence suggests that tax benefits for appreciated property gifts are much more likely to shift the form of giving rather than the level.

Data also suggest that there may be problems in valuing a significant fraction of these gifts because they are not publicly traded.

Options for revision include eliminating the additional tax benefit

for donor-advised funds and supporting organizations or applying

all of the private foundation rules.

The Senate staff discussion proposals are actually much more

modest than these approaches. They suggest applying self-dealing

to all charities, eliminating Type III supporting organizations, and

applying a minimum distribution requirement to donor funds. Let

35

me say, a minimum distribution requirement for donors funds is

much less restrictive than a per-account minimum distribution.

Gifts of appreciated property to donor funds would be sold within

a year or disallowed as gifts altogether. Donor funds could not

make grants to foundations or to individuals, and foundations could

not give to donor funds.

Donor funds cannot be used for grant selection. Such a provision

would prevent, for example, the fund paying for the donor and family to snorkel the reefs of Cozumel to ascertain the degree of reef

damage before providing a grant for reef damage reduction. I think

we have heard today many other instances of this kind of use of

funds.

For appreciated property that is not publicly traded, the Joint

Tax Committee would restrict the deduction to basis for all donations. The Senate staff proposal is much more limited. It would

subject valuation disputes to final offer arbitration, which should

induce more realistic valuations and a greater willingness to reach

a negotiated agreement with the IRS.

Thank you.

The CHAIRMAN. Thank you.

[The prepared statement of Dr. Gravelle appears in the appendix.]

The CHAIRMAN. Now, Mr. Johnson?

STATEMENT OF RICHARD JOHNSON, MEMBER, WALLER

LANSDEN DORTCH AND DAVIS, PLLC, NASHVILLE, TN

Mr. JOHNSON. Thank you, Mr. Chairman and distinguished

members of this committee, for allowing my law partner, Joseph

Woodruff, who is standing over there, and myself the opportunity

to provide you with our assessment as to how this committee’s proposed reforms may have affected the situation in the Maddox Foundation and the regulatory efforts to correct that situation we are

currently litigating.

Also, due to the unselfish efforts of our client, Ms. Tommye Maddox Working, who is also here with us today, these problems are

now in the process of being rectified by the District Attorney General of metropolitan Davidson County, Tennessee, Hon. Victor S.

Johnson, III, in a private, relator-type civil action.

Our written testimony details the history and the purpose of the

Maddox Foundation, the assumption of control by its current director, Ms. Robin Costa after the Maddox’s death, and the removal of

the foundation from its intended home in Tennessee.

Likewise, our written testimony details the many allegations of

breaches of fiduciary duties that have occurred since the Maddox’s

death, and how the proposed reforms might have prevented the

problems we are now facing.

For the sake of brevity, please allow me to focus the committee’s

attention on only three of what we consider the most significant

abuses: purchase of professional sports teams, director compensation, and excessive administration expenses, and three of the most

significant areas of proposed reform: governance, compensation of

disqualified persons, and enhanced enforcement.

As we detail in our written testimony, Ms. Costa has used what

we estimate as over $8 million of foundation assets, first, to purVerDate 11-MAY-2000 17:15 Dec 19, 2005 Jkt 095484 PO 00000 Frm 00043 Fmt 6633 Sfmt 6633 20838.000 SFINANC2 PsN: SFINANC2
36

chase and then to operate, two minor league professional sports

teams. In 1 year alone, in 2003, Ms. Costa spent more than $4 million of foundation money to operate these for-profit sports teams.

In documents filed with the court, Ms. Costa admits that the

foundation entered into a contract with a casino for purposes of the

foundation providing lodging to visiting hockey team players, as

well as players coming to try out for the hockey team. All of these

expenditures are claimed on the foundation’s tax returns to be

charitable contributions.

Ms. Costa attempts to justify this characterization by claiming

that the sports teams are program-related investments. She even

has attempted to obtain the endorsement of the Internal Revenue

Service on this characterization by filing, more than a year after

the fact, a request for a private letter ruling. Now, that private letter ruling request is still pending.

The characterization, we submit, is totally inappropriate, for a

number of reasons, not the least of which would be that these

sports teams are jeopardy investments, and Ms. Costa is holding

herself out to the public as their owner and president.

In fact, when the purchase of the teams was announced, the

hockey team issued a press release which quoted Ms. Costa saying

that she ‘‘fell in love with hockey and with the River Kings,’’ and

‘‘as a new owner, you’ll see a lot of me.’’

Since moving the foundation out of Tennessee, Mrs. Costa has

been able to operate the foundation without independent oversight.

She alone decides how the foundation money is used.

Her compensation is not reviewed and approved by an outside

board. Consequently, she has paid herself annual compensation

from the foundation calculated on what was represented to be the

total value of the foundation’s assets, although the foundation did

not own all the assets at the time.

Plus, she paid herself compensation out of a wholly owned company that comprises one of these foundation assets. This double

dip, however, is not the end of the compensation story. She also

paid to herself, without prior court approval, executor and trustee’s

fees, again calculated on the Maddox’s assets. The total through

2003 of this triple dipping is in excess of $3.2 million. We do not

yet know the whole story.

Until last November when the probate court in Nashville ordered

an accounting of the foundation, Ms. Costa had never opened the

books and records to an independent audit. We have prepared two

charts graphically to demonstrate the magnitude of disparity between the Maddox Foundation expenses and the genuine charitable

contributions.

Mr. Chairman, as you can see, in total, out of $16 million of foundation funds spent, $5.4 million went directly to charities. Or if you

will look at our pie chart, 66 cents out of every dollar went to overhead, compensation, and operation of sports teams, as well as to

payments to third parties.

We have also provided examples in our written testimony of the

harmful impact the manipulation of the Maddox Foundation has

had on charities in our State, and we can reach no other conclusion

than that the charities are the victims.

37

Establishing national standards for governance, oversight and financial accounting as proposed would help prevent these types of

excesses. Requiring that independent directors set and approve

compensation paid to disqualified persons would help to avoid circumstances where a foundation director holds a compensation committee meeting by merely looking in the mirror.

Providing funding to States to prosecute claims, including claims

based on the violation of the Internal Revenue Code, and expanding the jurisdiction of the public’s access to the U.S. Tax Court will

greatly enhance the tool box available to regulators. Common-sense

reforms such as those under consideration by this committee could

have preserved Dan and Margaret Maddox’s legacy for their intended beneficiaries, the charities of Middle Tennessee.

Thank you, Mr. Chairman.

The CHAIRMAN. Thank you.

[The prepared statement of Mr. Johnson appears in the appendix.]

The CHAIRMAN. Mr. Kuo?

STATEMENT OF DAVID KUO, FORMER SPECIAL ASSISTANT TO

THE PRESIDENT AND DEPUTY DIRECTOR, WHITE HOUSE OFFICE OF FAITH-BASED AND COMMUNITY INITIATIVES, ALEXANDRIA, VA

Mr. KUO. Chairman Grassley and members of the committee, I

am David Kuo. For 21⁄2 years, I served as Special Assistant to the

President and Deputy Director of the Office of Faith-Based and

Community Initiatives at the White House under President George

W. Bush.

My perspective on the topics we discuss this morning is informed

by various vantage points on the charitable sector I have had during the past 15 years.

I have worked in senior positions here in the U.S. Senate, in advocacy organizations, and in the White House. I founded, and for

3 years built, a charitable organization to objectively determine the

efficacy and the efficiency of social service organizations.

I was even recruited by a dotcom company with the promise that

I would be able to manage what was going to be a remarkably huge

foundation. They were going to give away 1 percent of gross revenue to charity. Since they would be making hundreds of billions

of dollars annually, that meant a lot of money for charity. Suffice

it to say, things did not turn out quite as promised.

I also approach this from a certain philosophical perspective. I

believe in government’s inviolable duty to help the poor. This is not

just a political philosophy for me, it is also theology.

I believe that Jesus’s command to care for the least among us

means that we have to bring to social problems every available resource and every best effort. It is in that spirit that I want to speak

today to government, to the nonprofit sector, and to us as individuals.

I believe in President Bush’s compassionate, conservative philosophy as articulated at the start of his 2000 campaign: ‘‘It is not

enough for conservatives like me to praise charitable efforts. Without more support and resources, both public and private, we are

asking charities to make bricks without straw.’’

38

His proposals for $8 billion per year in new spending and charitable tax incentives for non-itemizers and IRA roll-overs were important policies that sent the unmistakable message to the public

that charity, compassion, and care for the poor were to be cornerstones of his domestic policy.

Four years later, these tax incentives and other spending programs have not yet been enacted. The White House certainly could

have done more. That has already been said. However, were it not

for the President’s interest in these issues, we probably would not

be here today.

But what about Congress? Save for the tireless action of this

committee that has repeatedly pushed for charitable tax incentives,

I have been astounded by the lack of interest in these matters by

your colleagues.

The CARE Act is a perfect example. For the last 4 years, the

CARE Act has had overwhelming bipartisan support and has gone

nowhere. Why? In large part, it is because of widespread Congressional apathy and a desire for political gamesmanship on all sides.

The White House does know how to get what it wants, but just

as certainly, Congress knows how to get what Congress wants.

Why has Congress not been a passionate advocate on behalf of

charities and the poor in the midst of an economic crisis, a downturn in charitable giving, and an upturn in social service needs?

As members of the U.S. Senate, you are called and pulled in

every different direction. Every problem, every constituency demands more from you, and of you. But I can think of no other area

in American politics so ignored by American political leaders than

matters of charity, of care for the poor, and of substantive debate

and discussion on matters of civil society.

No, America’s poor do not have a powerful voice. They are not

likely to flood your office with calls, e-mails, or letters. Yet, there

are more poor Americans today than ever before. It is always easy

politics to blame either the other party or the White House, but I

just wonder why these matters have been such a low priority for

the U.S. Congress.

It is not, however, just Congress that has ignored these charities.

Without any doubt, the charity abuse stories that we hear today

are the result of a lack of IRS enforcement of existing laws.

Having had my own 501(c)(3) organization that examined other

groups, I saw first-hand cases of willful misuse of funds. That kind

of stuff was hardly a secret in the charitable world.

Yet, where is IRS enforcement of these existing laws? It has been

AWOL. But now we are to believe that new laws are the answer?

By themselves, they are not. They may serve the appetite of a public that wants action, because nothing spells action louder than a

new bill. But without dramatic enforcement enhancements, we will

all be back having the same debate years from now.

Make no mistake, however. I am not some shiny, happy charity

cheerleader. If we do not face the fact that loopholes need to be

closed, reforms made, and accountability had, we will have failed

just as much as if we had done nothing.

The IRS cannot enforce laws that make no sense or that provide

loopholes for the wealthy in the name of charity. Clearly, more

stringent rules need to be put in place regarding the use of donorVerDate 11-MAY-2000 17:15 Dec 19, 2005 Jkt 095484 PO 00000 Frm 00046 Fmt 6633 Sfmt 6633 20838.000 SFINANC2 PsN: SFINANC2
39

advised funds, and it hardly seems a stretch to require accounts to

pay out a certain amount annually to charities.

More publicly disclosed information about charities also seems to

be a no-brainer. Charities are, by their very definition, here to

serve the public interest. The public deserves to know what they

are doing.

I would like to add one more thing. We need to begin looking at

information in different ways. To date, charities tend to be judged

by how well their accountants make their books look like all the

money is going to serve targeted populations.

Why? Because that is how ‘‘efficient’’ charities are judged and

have been ranked by media, like U.S. News & World Report. Unfortunately, this mind-set has prevented us from asking a more important question: how well?

Efficacy is a far more important and relevant gauge than efficiency. We need to begin asking charities to tangibly measure how

well they are doing their jobs, not just how efficiently.

Charitable abuses are real and offensive. They must be eliminated. Serious fines must be imposed. Violators need to be exposed.

But we must be careful amidst these reports not to allow these

abuses to create new laws that punish the overwhelming majority

of donors, organizations, and the recipients of nonprofit services. I

am concerned about changes in non-cash deductions—in clothing

deductions, for instance—that may be examples of disproportionate

use, given the problems.

Finally, the United States faces record budget deficits, not because of abuses in the charitable sector, but because of choices and

priorities that our government has made.

Much of the rhetoric around charity that we have been hearing

lately seems to suggest that the charitable sector is just a great

target for raising more funds to ensure the continuity of our existing ways of government waste. Does that not strike the committee

as a bid odd, perhaps even a bit perverse?

Everything we are discussing today is about the culture of charity that we are creating. The culture of charity is hurt by a lack

of enforcement. It is hurt by loopholes and exemptions and tricks

that benefit the rich in the name of the poor.

It is also hurt by laws that inadvertently discourage charitable

giving. Nowhere is that clearer than in the estate tax. Congress

will be revisiting this matter in the coming months.

As it does so, I hope that it, and this committee, will bear in

mind the huge consequences that matter has to the charitable community. Conservative estimates show that a total repeal of the tax

would cost the charitable sector more than $10 billion per year.

That is a lot of money, and it certainly discourages the culture of

charity.

I want to close by again thanking you, Senator Grassley, and

thanking the committee and the exceptional staff, for pushing this.

We are having a vigorous debate this morning about charity, about

giving, and about helping others. Everyone here should be excited

about that debate, because this sector will emerge stronger and

more powerful in the end.

Thank you.

The CHAIRMAN. Thank you.

40

[The prepared statement of Mr. Kuo appears in the appendix.]

The CHAIRMAN. Mr. Gallagher?

STATEMENT OF BRIAN GALLAGHER, PRESIDENT,

UNITED WAY OF AMERICA, ALEXANDRIA, VA

Mr. GALLAGHER. Thank you, Mr. Chairman, Senator Rockefeller,

distinguished members of the committee. I appreciate the opportunity to speak to you today about issues of governance, accountability, and performance in the nonprofit sector.

As president of United Way of America, I am here today representing my organization, but also 1,348 local United Ways

around the country.

When I first came to United Way of America 3 years ago, my

goal was to rally local United Ways around our true mission, which

is to improve lives by mobilizing individuals and organizations into

collective action.

But traumatic world events interceded. There were the attacks

of 9/11 and the response of the charitable community to that event.

There were a series of corporate scandals: Enron, WorldCom, Tyco,

and after that, a scandal closer to home for us, the United Way of

the National Capital Area. This was now my local United Way, and

it made me sick.

When the Washington Post story came out, I received a letter

from Chairman Grassley asking how United Way of America monitors the work of local United Ways and what changes we would

make to improve those operations across the system, and the sector

as a whole.

Across the Nation, United Ways were operating ethically and

doing great work. It does not matter if the vast majority of United

Ways are operating at the highest level, however, if one, or two, or

three are not. It erodes confidence in all of us. I knew I needed to

focus on accountability first so that we could get on to the real

work, which is mission. Change needed to happen fast.

In a front-page Washington Post article, I made it clear that the

volunteer board and the CEO at the National Capital Area United

Way had to go, and they did. New volunteer and professional leaders enacted real reform, and since then have rebuilt trust and confidence.

Next, United Way of America rewrote all of our membership

standards. I personally reviewed those new standards with Senator

Grassley before they were implemented within our system.

Working with Senator Grassley’s office was one of the reasons

that these stronger standards were adopted overwhelmingly by our

members in less than a full year. The new standards have successfully raised the bar on our operations, and we have instituted

third-party review and oversight over all local operations.

We disaffiliated more than 50 local United Ways that failed to

meet one or more of our new membership requirements, and for

the rest of us, this was a reaffirmation of the values of transparency, accountability, and disclosure.

United Way action was necessary, and now the entire sector

needs to wake up on this issue. We all must ensure and promote

greater accountability. If we cannot, then there should be legislation that makes meaningful and common-sense reforms.

41

Last summer, the staff of the Senate Finance Committee circulated a white paper containing a number of options for improving

accountability in the nonprofit sector. For the record, we agree with

much of what is in this paper. In fact, some of the language used

in the paper, especially related to the IRS Form 990, was taken

from United Way’s new membership requirements.

Specifically, we agree with the proposals around responsibility,

disclosure, and effective operations, including that the chief executive officer, not just the chief financial officer of a nonprofit, should

be required to sign and be responsible for the information on the

Form 990. There should also be a certification that the volunteer

board has reviewed the annual Form 990 and all audits.

Second, that the IRS should review every nonprofit’s tax-exempt

status every 5 years to ensure that they continue to operate exclusively for charitable purposes.

Finally, Congress should increase funding for IRS enforcement.

We support this increase, even if funding must be provided through

increases in fees assessed on our own sector, as long as we can be

certain that the new fees will be used for their intended purpose.

Finally, if I ended my remarks now after addressing financial

and legal accountability only, I would be doing our sector a huge

disservice. Research shows that, while trust in nonprofits is alarmingly low, more regulation is not what people are looking for. Financial accountability is just table stakes. Yes, we do need to get

that right first, but ultimately the American public should hold our

sector accountable for delivering on our missions.

In fact, the number one reason that people do not have faith or

trust in the nonprofit sector, is that donors do not know how charities spend their money. The American public does not give us

money just because our operations are clean. They really give us

money because they want to make a difference, they want to improve people’s lives.

To that end, I respectfully suggest that the ‘‘results’’ section of

the annual Form 990 be expanded and strengthened. Nonprofit organizations should be asked to report concrete results annually

that are tied directly to their missions, not just on the level of their

activity.

This section should be moved from Part III of the annual form

to Part I, reflecting its importance. We owe it to the public to demonstrate that their investments are making a difference and getting real results.

Thank you for your time, your commitment, and your consideration.

[The prepared statement of Mr. Gallagher appears in the appendix.]

The CHAIRMAN. Now, Ms. Aviv?

STATEMENT OF DIANA AVIV, PRESIDENT AND CEO,

INDEPENDENT SECTOR, WASHINGTON, DC

Ms. AVIV. Chairman Grassley, Senator Rockefeller, and distinguished members of the committee, I come before you as the president and CEO of Independent Sector, a national coalition of charities and foundations and corporate philanthropy programs that

42

collectively represents tens of thousands of nonprofit organizations

across the country.

I am also here as the executive director of the Panel on the Nonprofit Sector, convened last October by Independent Sector.

We welcomed your encouragement to form the panel because we

recognize how important it is for our sector to operate according to

the highest possible ethical standards.

We know that the wrongdoing of even a few can damage the

public’s trust in all organizations, even though the vast majority of

organizations operate legally and ethically. Therefore, our goal is to

eliminate abuse.

This commitment to higher ethical standards is shared across

the sector by the 24 distinguished leaders who comprise the panel,

by the 150 experts who are participating in the panel’s work and

advisory groups, and by thousands of people who have joined our

conference calls, submitted comments, and are now attending our

field hearings across the country.

These people are all volunteering their time because they understand the importance of this work. On March 1, the panel released

its interim report, and I ask that it be submitted for the record.

[The interim report appears in the appendix on p. 85.]

Ms. AVIV. Maintaining public trust in charitable organizations

requires a balance between a viable system of self-regulation and

effective government oversight.

The panel’s report recommends actions to be taken by charitable

organizations, by the IRS and State charity oversight officials, and

by Congress. Together, these create a comprehensive package of reforms in which no single action stands alone. I will highlight a

handful of these recommendations.

First, penalties should be increased on managers and board

members of foundations who, at the expense of the organization,

receive or approve improper financial benefits.

Second, making reliable and timely information about charitable

organizations easily accessible to all interested parties will go a

long way toward deterring unethical behavior.

We encourage the IRS to mandate electronic filing of all Forms

990, with adjustments to be made to accommodate the relevant attachments. We will offer recommendations in June on how the

forms themselves can be improved to ensure consistency, reliability

and accuracy.

Third, we believe that organizations whose annual receipts fall

below $25,000 should file an annual notice with the IRS providing

some basic information. Additionally, organizations with annual

revenues of more than $2 million should be required to have an

audit, and those above $500,000 should be required to have an

auditor review their financial statements.

Fourth, Congress should remove the barriers that prevent the

IRS from sharing information about ongoing investigations with

State charity regulators, something it now does with State revenue

officers.

Fifth, more needs to be done so that taxpayers do not over-value

property that they donate to support charities. However, we have

deep concerns about the proposals that would discourage donors

from giving appreciated property to charitable organizations.

43

We do not want to see these programs damaged by solutions that

throw out the baby with the bath water. We will be getting back

to you on this with specific recommendations on how to address the

problem without hurting the program.

Sixth, although donor-advised funds are an important channel

for stimulating philanthropy, gaps in current law have allowed improper use by some of these charitable assets. We need explicit

rules that prohibit improper benefits to the donor. Our report contains a number of recommendations in this regard.

Seventh, the panel strongly believes that effective law enforcement is integral to eliminating harmful behavior. We want to build

on the good work of Commissioner Everson to ensure that there are

adequate resources for oversight and education. We urge you to

work with your colleagues to see that additional funds are earmarked for this purpose.

Finally, the key to meeting our goal of no abuse is the actions

of the sector itself. We have recommended a series of steps that are

vital for charitable organizations themselves to take, such as the

establishment and dissemination of conflict of interest policies, the

inclusion of financially literate people on their boards of directors,

and the creation of independent audit committees.

The panel is just halfway through its work. Our final report is

due to this committee in June, and we intend to make recommendations on such issues as board composition, compensation,

and governance. While we understand the desire to begin moving

forward now, we believe that you will be well-served by considering

the recommendations in our final report as well.

I want to extend special thanks to you, Chairman Grassley, and

to Senator Baucus, for your leadership in this area, which already

has had a significant impact on our sector’s practices and procedures.

As I travel around the country, I am constantly asked for more

information on the issues and guidelines for action, which I believe

are as a result of your calling attention to these issues.

You all know about the invaluable work charitable organizations

undertake in your respective States and in your communities. The

nonprofit sector must remain a vital component of American life.

It must maintain its independence and its creativity. It must always be responsible and transparent.

Governments should provide vigorous oversight of the sector

without discouraging legitimate charitable activity; but at the heart

of this effort to improve ethics and operations must be the actions

of the sector itself.

Mr. Chairman, Senator Rockefeller, members of the committee,

I would be happy to answer any questions.

[The prepared statement of Ms. Aviv appears in the appendix.]

The CHAIRMAN. All right. If it is all right with Senator Rockefeller, here is what I would like to do. I would ask four questions,

myself, and then I will give you whatever time you need to ask

questions. Then I have a closing statement, even though it might

take a little bit longer than 5 minutes.

Senator ROCKEFELLER. All right.

The CHAIRMAN. Before I ask the first question, for Mr. Kuo, you

raised the point about the frustration with the CARE Act not being

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passed. I said at the start of the hearing, we intend to work with

Senator Santorum to enact a package of CARE Act reforms.

As you know, last Congress the Senate did act. Unfortunately,

we had objections from going to conference. Hopefully, we will not

encounter that this particular year, and we will be able to move

that through the Senate and to conference.

I am going to start with Dr. Gravelle. I was very interested in

your comments about the impact of beneficial tax treatment of gifts

and appreciated property on cash, and then, of course, on the other

side of it, non-cash giving.

You spoke about tighter rules on gifts of appreciated property,

that you do not anticipate a real decline in charitable giving, but

that individuals will look at then giving cash instead, if we would

have these reforms to determine a more reasonable value for gifts.

Would you comment on that, please?

Dr. GRAVELLE. Well, on the econometric study, the statistical

study that I cite in my report, which tried to look at this issue of

substitutability between our gifts of appreciated property and cash,

what they found was there was a very, very high degree of substitution.

This is much like the timing effect, an order of magnitude of the

timing effect I talked about, which, as I indicate, was about 3 to

28 times. Twenty-eight is for very high income donors. So, that statistical evidence, which is all the evidence that we have right now,

suggests that there is a big substitution effect, but not a very large

permanent effect.

That would suggest, if people found the tax benefits for gifts of

property to be reduced, they would most likely give cash instead.

Cash, of course, I think in most cases, is much more valuable for

the charities.

In fact, if you look on the Internet, you will find charities discussing the problems they face with peculiar gifts of property and

how difficult sometimes it is to cash them in or to use them.

The CHAIRMAN. All right.

Mr. Johnson, you indicated in your testimony that Ms. Working,

the Maddox’s step-granddaughter, I believe it is, is funding the litigation with her own personal funds. Now, that does not happen

very often, and it surprises me.

Would you explain her motives? I would also like to ask you to

comment on the importance of the authority Ms. Working has

under the relator statute to bring this action to address these

issues.

Mr. JOHNSON. Thank you, Mr. Chairman, for the question. In the

18 years that I have been practicing law, I have not worked with

a client as unselfish as Ms. Working.

What I attribute it to is, I find that she has a deep desire, or she

almost feels there is an obligation on her part, to make sure that

her grandfather’s charitable intentions are carried out. She sees

those charitable intentions being frustrated. I will give you several

examples.

First, for example, Mr. and Mrs. Maddox attended Covenant

Presbyterian Church there in Nashville. The minister there has

filed an affidavit in our case. What had happened was the Maddox’s wanted to have a new sanctuary built. After their untimely

45

deaths, the foundation had made a commitment to pay $2 to $4

million to the church for building that sanctuary.

Well, after the foundation moved to Mississippi, Ms. Costa told

the minister, well, we cannot fulfill that commitment, that the

foundation does not have the assets to do that, and instead gave

the minister $5,000 for the church.

Now, there is testimony from a witness who has stated that Ms.

Costa referred to those types of gifts as gag gifts, go away gifts. In

addition, there was, for example, the administrative expenses and

travel expenses.

Mr. Maddox was a supporter of Belmont University. If you would look on the 2002 990 PF, it would show that there was a $5,150

charitable contribution to Belmont University. Well, $500 of it was

cash and $4,650 of it was for expenses for charter trips by Ms.

Costa back and forth to Nashville.

Then the administrative expenses. I will be brief, Mr. Chairman.

The foundation had credit cards. Ms. Costa charged to the foundation meals for the hockey players, gas, florists, pet store charges. There was an $8,000 charge to a casino, approximately $4,000 to a LaCosta Resort & Spa, approximately $13,000 for statuary from

the Colleton Gallery in La Jolla, California. So, these are the reasons why she feels like she needs to pursue it.

As to your second question, the private relator action, as a practical matter, we saw that this was, in Tennessee, the only mechanism we had to pursue this foundation. The District Attorney’s resources are very slim.

With your proposed reform, adding a Federal alternative would

have been something that we would have seriously looked at, because as I read it, either the Internal Revenue Service is carrying

the ball, or at least we are sharing the ball. And I can tell you, Ms.

Working has spent a lot of money pursuing this.

The CHAIRMAN. That brings up a short question, and the last

question for you. Do you know what, if anything, the IRS is doing

about this situation at the foundation?

Mr. JOHNSON. Ms. Costa, in her answer in the litigation, attached a letter from the IRS that in effect said that the 2001 tax

year was clean. There were no changes to the 990 PF. Now, we believe that what they will argue is, they are going to use this letter

to suggest that the IRS has blessed the way the foundation is being

administered. We are skeptical of that claim.

However, if you adopt some of the reforms that you have suggested, and I would ask Mr. Woodruff to show this, it is easy to

show you, if you will look at 2001, there is $450,000 of compensation to the director, Ms. Costa.

Now, with your reforms, the disclosure of affiliated entity compensation, the disclosure of how you justify and rationalize the

compensation, you would find that, in addition to what was shown

on the 990 PF, which was $275,000 of compensation, that was,

based on the testimony of the consultant, on $180 million of assets

rather than $49 million of assets.

You would also see that $125,000 was also paid to her from a wholly owned company that the foundation now owns, plus $50,000

from trusts that the Maddox’s assets went through to the foundation.

46

So, your proposed reforms would provide greater disclosure,

greater transparency, and may make the IRS’s job a little easier.

We do not know what the IRS looked at to make that determination.

The CHAIRMAN. All right.

Now, Ms. Aviv, my last question. We, like you, have looked at

some organizations assisting Native American communities, particularly in education, and find that little money is going to help

those in need. I know you are familiar with those things.

This is similar to a situation that our Finance Committee has investigated with the attorney general of Pennsylvania of an organization cashing in on public support for the Make-A-Wish Foundation by raising money for a similarly named organization.

I understand from your recent field hearings you conducted that

you have come across similar concerns. Could you mention those

for the benefit of the committee?

Ms. AVIV. Sure, Senator Grassley. I was in Denver about 2 weeks

ago, and we had a field hearing in which the charities and foundations from around the Denver area joined Senator Worth and Senator Brown and me at these field hearings. There was an individual who stood up by the name of Rick Williams from the American Indian College Fund who attended the field hearing, and he

indicated that there are a number of problems within the American

Indian community with respect to fraudulent charities attempting

to raise money on the backs of poverty issues within those particular communities, and that it simply was not going to those folks

who needed the money most.

So the problem is in two categories. The first is fraudulent claims

in direct-mail letters about crises in communities in order to raise

considerable sums of money that do not go to the tribes.

The second is scams allowing businesses to donate large quantities of goods that are, in essence, useless and dumping them in

American Indian communities. Now, both of these practices are illegal, although they say that they are continuing and that they are

not getting the kind of relief they need, so their view is that they

need this prosecuted.

They have sent to me just yesterday about a foot and a half of

material supporting all of this, which I am happy to share with you

and your staff, on the background of this. The specifics of the case,

I am not as familiar with as to what he said.

But he also issued a warning to everybody in the room who was

listening to this. Do not assume that because people raise funds in

the name of charity that we should automatically assume that they

are honorable. We really need to do our homework ourselves to see

that the funds do go for charitable purposes.

The CHAIRMAN. Yes.

Senator Rockefeller?

Senator ROCKEFELLER. Thank you, Mr. Chairman. I will not ask

a question. I will just make a very brief statement. I think this has

been a superb panel. Both of them are that way.

I should point out to the panel that our Chairman has an unbelievable knack for raising questions that cause all kinds of concepts

that have not been carefully reviewed before, or budget priorities,

or things, and it always ends up in doing good. If the private secVerDate 11-MAY-2000 17:15 Dec 19, 2005 Jkt 095484 PO 00000 Frm 00054 Fmt 6633 Sfmt 6633 20838.000 SFINANC2 PsN: SFINANC2
47

tor, the foundation sector, is concerned, you ought to try the folks

at the Department of Defense. They live in terror of Chairman

Grassley.

The next thing I would like to say is, I was very moved by what

everybody said. David Kuo, I was profoundly moved by what you

said, the way in which you said it, and the terms that you used

to, in essence, voice what I was feeling all weekend as I watched

nonstop the death of the pope and the reaction of the people. And

they were all young people. They were all young people, at least

where the television reached.

I think that that was because, not so much they knew him or

they agreed with everything that he had ever said, or they honored

his historical courage, but I think it was for this very simple question that you raise, and that is, people reaching out to the dispossessed and poor.

He went to 139 countries, which I still cannot absorb into my

thinking, and he did it when there was no enormous reason for him

to do it, except, I think, to say, we care everywhere about every

person who is hurting and is in trouble and does not have representation, and I will represent them, he said.

I am not a Catholic, but I found myself just extraordinarily

moved by that weekend. I found it very much in consort with the

spirit of what you said, very much in consort.

That leads me to my final statement, Mr. Chairman. I use the

example of, somebody raised their salary so their daughter could

get married. I abhor abuse in the foundation sector, the third sector, whatever you want to call it.

I abhor it. I abhor it because of the damage it does to others because people grab onto it, the media grabs onto it, it becomes an

enormous factor, and then people generalize and assume everything is that way. I know it is not. I know it is not, because I have

just seen enough that are trying to do the right thing.

I also felt, Mr. Chairman, in this hearing, from both sides of the

dais here, that there is, I think, a very workable approach to solving these problems. A lot will come, as some have said, from within.

I think a very good example of that is the Nature Conservancy,

who have done a superb job in reforming themselves and were

shocked by what they went through, and then set about to make

themselves, as I indicated, kind of a gold standard.

But I think there is a real desire to make this work right without

affecting the inherent beauty of the American people which de

Toqueville referred to, not in them and their organizations, but in

their desire to give of themselves to others.

That is religious in its derivation, and it is also that America was

formed in a very different way. People moved out west in the middle of the 19th century, they got their land, they put up white

fences, and worried about educating their children. But it has always been in the American spirit, partly because of religion, this

desire to help other people.

I will extend it to say that I can remember when I was Governor,

we had terrible floods in West Virginia, where only 4 percent of the

land is flat, and 96 percent is one shape or another of a mountain.

48

So, the water gathers very quickly and places are ruined easily.

Virtually every time in the 8 years I was Governor I would open

up National Guard armories, and nobody would come.

The reason they did not come is because their neighbors were

taking them in. It was a sense of family. I think it is tremendously

important that that not be destroyed in what we are doing here,

that foundations are needed more than ever, that the American

spirit is needed more than ever to contribute to foundations, for

people to get on boards of foundations, and to do much more disciplined work, which perhaps they are now doing, where some

foundations are so staff-driven, that boards become almost rubber

stamps. It is a terrible thing when that happens, and it does.

But I think when you look at transparency, governance, oversight, I think we can do things here. We can pass legislation that

will be effective, together with what is being done already within

the foundation community.

I think the foundation community has been rocked by this. They

have been rocked at least two other times I can think of in the 20

years that I have been here. But they survived because that is the

American spirit, that is the American way of contribution. People

want to do it.

One little caveat, just as a warning, on proving what you have

done each year. I tend to think that is a good idea, on balance. I

think one has to be careful, however, when one is dealing with, for

instance, agricultural sciences.

I know one foundation that was trying to figure out how to take

a grain of rice and quadruple what it produced, and it did, but it

took a long time. I doubt the reports during all of those years

would have been very easy to write, and were certainly very boring

to read. Also, in medical science, where you are talking about the

cure of extraordinary diseases.

On the other hand, all things being said, I think people should

do that. Now, I worry about, will they have the resources in some

smaller foundations to be able to do that? Because that is a very

hard task to be looked at by the Commissioner, and all the rest of

it.

But on balance, I think, Mr. Chairman, we are on our way here

because of your good work in your classic Iowa manner in which

you identify a problem with ferocity, and yet love, and then we all

react to it. I see solutions coming, and I feel good for the future

of foundations, provided we act prudently, which I think we will.

Thank you, Mr. Chairman.

The CHAIRMAN. I think, Senator Rockefeller, your statement says

better than I have ever said the motivation behind making sure

that the tax exemption is used wisely by charitable organizations,

because we do, as you suggest, want to promote greater use of

charitable giving and foundations and organizations, and you have

expressed it very well, and I would associate myself with your remarks. I would say, in summation, that that is the purpose of the

work that we have been doing for the last year.

I would just like to summarize a little bit for myself, in about 2

or 3 minutes.

The testimony today has made it clear that there is a need for

reform, and particularly reforms that deal with this part of the tax

49

gap. We have heard good suggestions that will allow us to address

the problems.

Balancing these efforts, I want to make certain of the vitality of

nonprofits, in the same vein as Senator Rockefeller just expressed.

Particularly, though, I want to make sure that, in keeping that vitality, in anything we do, as far as normal charities and churches

are concerned, that they are not unduly burdened by government’s

reforms.

I want to note the work of the Nonprofit Panel which has been

well represented here today by Ms. Aviv, Mr. Gallagher, and Mr.

Panetta. So as you do your work in the next few months, consider

that today we have heard extensive and thoughtful comments of

problems in the nonprofit sector. These comments need to be

passed on and made clear to the charitable sector as you conduct

your discussions and meetings.

Too often, as charities across the country consider proposals for

reform, they do so in an atmosphere that does not reflect the unfortunate realities that are coming out in a hearing like this.

I strongly encourage the Nonprofit Panel that their work must

be one not only of dialogue with charities, but informed dialogue

that starts with serious and significant education of the problem

before it. Without education, it is only natural that some charities

will respond as if the sky is falling.

It is, unfortunately, those who turn a blind eye to the problems

of the charitable sector or seek only a fig leaf of reform who are

potentially causing real long-term damage for nonprofits. Those

who are seeking real reforms to address the issues raised by the

Commissioner and others today will help ensure continued public

confidence and support for nonprofits. By doing so, they act in the

true interests of their charities.

Given the limited time frame, I encourage the Nonprofit Panel

to concentrate its work, first, on the area of governance. It is particularly vital that the panel provide us serious proposals that the

IRS can efficiently administer in the areas of self-dealing, governance, and payment of benefits.

The Finance Committee has taken a rare step of reaching out extensively. It is my hope that this experiment is not only a success

in terms of trying to bring change to charities, but it also may be

something we can build on in other areas in the work of this committee. It is an experiment where I hope we will see serious proposals, and see them quickly. Thank you.

Do you have one question you want to do?

Senator LINCOLN. I do.

The CHAIRMAN. How long is it going to take? I have a meeting.

Could you adjourn the meeting?

Senator LINCOLN. Sure. Absolutely.

The CHAIRMAN. I trust her. [Laughter.] Here is what I would like

to do, though, before she goes. Obviously, you have been around

here for 3 hours now, and have presented your testimony. I thank

you very much and look forward to working with you, particularly

if you continue your panel work. Thank you very much.

I will turn it over to you. When you are done, then the hearing

automatically is adjourned.

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Senator LINCOLN. Absolutely. And thank you, Mr. Chairman, for

putting such detail into a very important issue, and all of these

groups that do a tremendous amount, the good actors, deserve that.

So, thank you, Mr. Chairman.

I guess I have been a little bit concerned, and I wanted to get

your response here, about what looks to be some of the illegal integration of politics in some of the nonprofits and not-secular industries. I guess my specific alarm came from recent reports that show

that obviously there are politicians who have been able to raise

money for lobbying and funnel that money to people who can arrange broadcasting and advertising for nonprofits, particularly on

religious radio and TV stations. The stations then broadcast information, propaganda, what have you, supporting those politicians,

the positions of the lobbyists and their clients.

So much of all that we know, oftentimes—until we get to this

point where we have testimony and witnesses—is what we read in

the news, read in the papers.

But from your standpoint, being so involved with a lot of those

different groups when you were in the Office of Faith-Based Initiatives, were you aware of any of the nonprofit religious-based media

organizations that were willing to participate in that political strategy or messaging in exchange for dollars, exchange for money?

Mr. KUO. No, Senator. I am not aware of any sort of quid pro

quo, so to speak, where there was any explicit, implicit, or any

other ‘‘plicit’’ acknowledgement.

I think behind your question is the question, was there sort of

a pay or play, play for play sort of thing, were religious groups

given money in exchange for support, or vice versa? I am not aware

of anything remotely resembling that, no.

Senator LINCOLN. Again, some of the accounts that we hear in

the reports indicate that, again, all of what we are investigating is

making sure that those who are in the nonprofit arena and those

that are taking that political status through the tax code are doing

the things that they are designated to do, but not going forward,

and a lot of that.

So if you did not see any or were not aware of any of that kind

of activity that occurred——

Mr. KUO. And I am specifically speaking in terms of government

grants. I assume that was what was behind your question, were

groups brought in for support in exchange for government grants.

That is what I understood your question to be.

Senator LINCOLN. Well, not necessarily just grants. I mean, we

are talking about, certainly, the political arena—the whole political

arena, not just government dollars that come through—but certainly in terms of the context of what nonprofits are there to do,

whether or not they were working on behalf of politicians in return

for what lobbyists were doing and what political support was going

on in the direction for those politicians.

Mr. KUO. Again, I do not know of anything specific along those

lines.

Senator LINCOLN. Did you see any of the reports or see any of

the articles that were concerning the casino gambling, particularly,

on the nonprofit radio?

51

Mr. KUO. No, none at all. But again, I left the White House in

December of 2003.

Senator LINCOLN. Those are just accounts in the media.

Mr. KUO. No. I am not aware of any of those.

Senator LINCOLN. All right.

Well, thank you all so much for your help. I appreciate it, and

I know the Chairman does. We are looking forward to coming up

with some of the solutions that we can. Thank you.

The committee is adjourned.

[Whereupon, at 12:55 p.m., the hearing was concluded.]

(53)

A P P E N D I X

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

PREPARED STATEMENT OF DIANA AVIV

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RESPONSES TO QUESTIONS FROM SENATOR HATCH

Question: Ms. Aviv, I want to start by commending Independent Sector for convening the Panel on the Nonprofit Sector and for yours and the panel’s hard work

in producing the interim report. It is my understanding that the Finance Staff’s initial discussion draft last summer called for the repeal of the exemption for Type III

supporting organizations. The Interim Report of the Panel on the Nonprofit Sector

acknowledges that there have been some Type III supporting organization abuses,

but recommends targeted anti-abuse rules, accompanied by appropriate penalties to

eliminate the abuses, instead of repeal of the exemption. Is this correct?

Answer: Thank you, Senator Hatch, for your commendation of the work of Independent Sector and the Panel on the Nonprofit Sector. The panel is continuing its

work examining problem areas within the sector and carefully considering specific

remedies that would deter abuse and punish willful wrongdoing. Our final report

will be ready in June with additional recommendations for action. You are correct

156

in stating that the Senate Finance Committee’s discussion draft called for the elimination of Type III supporting organizations, while the Panel on the Nonprofit Sector

supports preserving Type III organizations. The panel does acknowledge in its interim report that there have been inappropriate uses of Type III supporting organizations, but we also believe there is a legitimate and unique charitable purpose

served by Type III supporting organizations, and that most of these organizations

provide real benefit to the charities they support. The panel recommends targeted

anti-abuse rules and increased penalties for misconduct. We are currently reviewing

specific recommendations regarding the nature of anti-abuse rules and specific penalties, including a number of the suggestions made to the committee by Mr. John

Dedon. The panel’s recommendations will be included in the final report.

Question: Can you describe to the committee the benefits to the community provided by Type III supporting organizations and how you would stop the acknowledged abuses short of repealing the exemption for these organizations?

Answer: A Type III supporting organization is a public charity organized and operated exclusively for the benefit of one or more other public charities. As with other

types of supporting organizations there must be a close and continuous relationship

between the Type III and the supported organization. The uniqueness of a Type III

supporting organization is that legal control of a Type III lies neither with the supported organization nor with the contributor or his/her family. Instead, the rules for

Type III supporting organizations allow for independent ownership and management of assets that are exclusively dedicated to the benefit of one or more supported

charities.

Communities benefit from Type III supporting organizations in a variety of ways,

depending on the kind of charitable institutions receiving support through them. In

general, the flexibility currently allowed in the use of Type III supporting organizations provides a way for charitable organizations to receive valuable assets for public purposes that might otherwise be retained for the private benefit of the donors

and their families. In our review of Type III supporting organizations, the panel

identified a number of instances in which Type IIIs were uniquely suited to meet

the needs of the charity, the donor, and, in some cases, governmental entities. Some

examples are: • A donor wishing to ensure that a gifted collection is exhibited by a museum and

not sold to support other activities could contribute the collection to a Type III

supporting organization which would provide it to the museum but retain independent legal control. Without such an entity to ensure that the collection is

both displayed and retained, the donor might well keep it in private hands. • Type III supporting organizations have proved useful to governmental entities

in advancing their public purposes. In one instance, agreement on the conversion of a nonprofit hospital was reached when the parties agreed to place the

sale proceeds in a supporting organization to the community foundation. A Type

III supporting organization was created at the insistence of the State attorney

general, because it would give the new entity a strong separate identity from

the community foundation.

• Public colleges and universities often have Type III supporting organizations

that independently hold and manage important assets, such as technology assets, that might otherwise become subject to control and potential appropriation

by State governments for other, unrelated State programs.

• Type III supporting organizations are also useful when a donor wishes to support a number of charities with differing short- and long-term needs. The independent management of Type IIIs allows for more effective balancing of charities’ competing goals.

The panel has found that the flexibility that makes Type III supporting organizations uniquely suited to meeting the needs of donors and charities also provides

room for abuse by some. There are cases where donors have inappropriately maintained de facto control over assets, creating the functional equivalent of a private

foundation, while avoiding the rules that apply to private foundations. The panel

believes that clarification of current guidelines and regulations is needed along with

new, targeted anti-abuse rules and appropriate penalties. Specific recommendations

for anti-abuse rules will be included in the panel’s final report.

Question: Ms. Aviv, it appears we have a real problem with tax abuse by a few

bad apples in the non-profit sector. How can we best prevent these abuses without

harming or discouraging those whose only intent is to do good?

Answer: The vast majority of America’s 1.3 million nonprofit organizations are

now, and have always been, responsible, ethical and accountable in the conduct of

their programs and the management of their funds. But, yes, there are bad apples

who have called into question the work of all charitable organizations. Independent

Sector and the Panel on the Nonprofit Sector are determined to assure the public

157

and the Congress that we are serious about preventing and punishing misconduct

in the nonprofit sector and equally serious about preserving an environment in

which the hundreds of thousands of lawful, ethical and accountable nonprofit organizations can continue to serve and enrich our communities, our Nation and the

world.

Maintaining the public trust in charitable organizations requires a balance between a self-regulatory system, including a viable system of management and governance standards and proactive educational programs, and vigorous governmental

oversight and enforcement. In our interim report, the panel recommended actions

for the charitable sector and charitable organizations, actions that might be taken

by the IRS, and legislative actions to improve governance and oversight of the sector. The panel is currently looking at complex and difficult issues, such as the valuation of non-cash gifts, rules for board compensation and the board’s role in setting

executive compensation, prudent investment rules, regulation of international

grantmaking and charitable organizations. Recommendations on these and other

issues will be contained in the final report along with more specific language to

strengthen the general recommendations contained in the interim report. For instance, where the interim report stated that there should be a legal definition of

donor-advised funds, the final report will suggest what that definition should be.

As in any aspect of life, those who set out to deceive others or violate laws will

likely find a way to do so. The nonprofit sector is no exception. The panel is determined, however, to make it as difficult as possible to break the rules for exempt organizations and to make it as certain as possible that those who willfully abuse nonprofit status will be detected and punished. We are working from within the sector

on codes of ethics and accountability, models of transparency and good governance.

We are working with the IRS on designing better forms that provide the type of information needed for good law enforcement, but also for more informed philanthropic decisions by the public. And we will continue to work with Congress to help

shape the most effective laws to target abusive behavior. At the same time, we are

also hoping that Congress will continue to encourage charitable giving and seek to

assure the American public that most charities are worthy of their support.

Question: Ms. Aviv, do you see any significant difference between the donation of

a facade easement and the donation of a conservation easement? Is there a difference in the level of abuse in these two areas? Should there be different rules governing the deduction of such donations?

Answer: Current law provides several distinct, and often complex, rules for donations of land and real property for conservation and historic preservation purposes.

Generally, no deduction is available if the use of the property is inconsistent with

the conservation or historic preservation purposes of the gift or for transfers that

have no material effect on the value of the property or that enhance, rather than

reduce, the value of the property for the donor.

The panel is currently studying areas in the current laws and regulations governing such donations to make recommendations in its final report. Specifically, we

have identified some gaps in the standards for appraisers and the penalties that can

be imposed on appraisers that provide gross misstatements of a property’s value for

taxpayers to use in claiming income tax deductions. We are also looking at steps

that the IRS is undertaking to address some of the alleged abuses reported in recent

press stories. Finally, the panel is studying steps that charitable organizations can

take to more effectively monitor how the property is used following the original donation and to assist efforts to ensure that the valuations claimed by taxpayers for

these important charitable contributions are fair and accurate. We expect to provide

detailed recommendations in the near future.

RESPONSE TO A QUESTION FROM SENATOR ROCKEFELLER

Question: Adam Meyerson, the president of the Philanthropy Roundtable, has

raised some concerns about the possibility of the IRS reviewing the tax-exempt status of organizations every 5 years.

He expressed concern that inviting the IRS to review nonprofits every year could

lead to politically motivated interference. Specifically, he worried that the IRS could

impose enormous administrative burdens on organizations as part of a review process, and that, under some circumstances, the IRS may be acting to sideline an organization the administration does not support.

Does this concern ring true to you? How can Congress protect against politically

motivated enforcement actions while we encourage the IRS to take a more active

role in overseeing tax-exempt entities?

Answer: Charitable organizations are stewards of the public’s generosity, serve a

public purpose and should be open to public scrutiny. If the information collected

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on a 5-year review would add significantly to the transparency needed by donors

to make good philanthropic decisions, then there might be merit to warrant the additional paperwork. It is important to weigh any gain in transparency, however,

with the additional costs that would be incurred by the charitable organizations and

by the IRS, which would have to review all the reports.

The panel is currently reviewing this proposal and other opportunities for increasing transparency and accountability. Two new subgroups are currently looking into

possible revisions of the annually filed forms 990 and 990–PF to see if including additional information on these forms would meet the same need as a new 5-year report. We have not yet drawn a conclusion on the usefulness of a 5-year review

versus filing expanded 990s annually.

It seems to me that whether or not the IRS should review the tax-exempt status

of charitable organizations every 5 years is a separate question from how to prevent

politically motivated enforcement actions. Even without a 5-year review process in

place, I get calls from nonprofit organizations who believe that Federal and/or State

charity regulators are investigating them for political reasons. It is not only the IRS

that has the power to audit or harass a charity, but virtually any public agency with

which charities contract or participate in grant programs. Because we live in a democracy with elected officials and political appointees, some very partisan, in positions of power, there is always the possibility that someone will overstep the line

and engage in politically motivated actions. Fortunately, most public servants know

where the line is and respect the rule of law.

Abuse of power is a subject Congress, executive branch agencies, State agencies

and nonprofit organizations must guard against all the time. The solution to halting

bad practices in the public sector is the same as the solution to halting bad practices

in the charitable sector: clear rules, tough penalties, and sufficient training to assure that office holders—elected and appointed—understand their responsibilities. I

would also add that the Panel on the Nonprofit Sector has made a recommendation

that charitable organizations should have policies and procedures to protect whistleblowers with credible information about wrongdoing. Federal and State government

agencies already have such policies, but employees may not know about them or the

laws may not be adequately enforced. A review of such procedures for new employees might help, as would a reminder to supervisors to take reports of wrong-doing

seriously.

PREPARED STATEMENT OF HON. MAX BAUCUS

Thank you, Mr. Chairman.

Winston Churchill once said, ‘‘We make a living by what we get. We make a life

by what we give.’’ We are here today to discuss how Congress can encourage more

giving, while preventing abuse by bad actors.

We are lucky to live in a country where people give of both their riches and their

energy to make a better world. In my home State of Montana, small charities with

few resources provide many essential services.

The Flathead Foodbank in Kalispell prepared over 11,000 boxes of food and

served almost 8,000 people just last year. This group makes sure that the sick, elderly, and poor in Northwest Montana have someone to depend on.

At the Montana Job Training Partnership, over three-quarters of folks who walk

through their door are able to find good stable jobs. This group helps Montanans

build a better future for themselves and their families.

And if you hike among the pristine wilderness of the Elkhorn Mountains, you can

thank the 3-person team at the Prickly Pear Land Trust for protecting over 1,500

acres of wildlife, trails, open space, streams and productive agricultural land in central Montana.

These charities, while limited in the funds they employ, provide a powerful benefit

to Montana. They add to my State’s quality of life, making Montana a compassionate and environmentally attractive place.

When I consider the reforms that we are here to discuss today, I am going to keep

groups like the Flathead Food Bank, the Montana Job Training Partnership, and

the Prickly Pear Land Trust in mind. I recognize that any reform effort needs to

be a balance between cracking down on the bad guys, and not unduly burdening

the good guys.

That said, I am serious about working together with Senator Grassley to root out

abuse where it exists. Today we’ll hear from IRS Commissioner Everson and others

about charities that are used to foster personal wealth rather than good deeds.

In January, I sent a letter with Senator Grassley to the IRS asking them to look

at the most significant compliance issues that they could identify within the taxVerDate 11-MAY-2000 17:15 Dec 19, 2005 Jkt 095484 PO 00000 Frm 00166 Fmt 6601 Sfmt 6621 20838.000 SFINANC2 PsN: SFINANC2
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exempt sector. I appreciate the IRS’s prompt and thorough response. IRS cited some

troubling practices by individuals who use charities to engage in tax shelters.

We must forcefully address incidents of deliberate cheating among tax-exempt organizations. Failure to do so undermines the public’s confidence in the charitable

sector and the tax system in general.

We will also hear from the Independent Sector—the charitable community’s nationwide representatives—and their distinguished representative, Leon Panetta.

Welcome back, Leon. I am glad to hear that Independent Sector brought you on

board to help with their Panel on the Nonprofit Sector. The panel has done a good

job recognizing the need for reforms in the charitable sector to promote transparency, best practices and good governance.

When Senator Grassley and I sent a letter to Independent Sector last September,

we asked them to provide guidance to us in a timely fashion. They have done so.

Their response provides an excellent starting point to begin the discussion on reforms. I look forward to your testimony.

George Yin, from the Joint Committee on Taxation, will also testify today about

proposals the Joint Committee on Taxation has developed to address abuses in the

nonprofit sector. I commend the hard work of the staff at the Joint Committee in

this area, even if I cannot endorse every proposal they have put forward.

In particular, I am concerned that their proposal on land conservation may have

gone too far. While I want to make sure that scams in the land preservation field

are addressed, I also want to ensure that farmers and ranchers in Montana can continue to get a fair deduction for donating easements that protect valuable open

space.

The Joint Committee proposal would eliminate the deduction for charitable contributions of conservation easements that include a principal residence. This would

prevent many working farmers and ranchers from claiming a deduction for donations of easements.

One of Montana’s greatest resources is its open space. I want to make sure that

generations of future Montanan’s can appreciate the clean streams, rolling fields,

and rugged mountains as I did growing up. I intend to work to ensure that farmers

and ranchers continue to play a key role in preserving Montana’s open space.

I am eager to hear from the other witnesses scheduled to testify today. Brian Gallagher has done a terrific job turning the United Way around, and Diana Aviv is

a tireless and effective advocate for charities at the Independent Sector. I am glad

that they are here today to share their thoughts about reform.

I am also pleased to welcome Attorney General Hatch. States play an important

role in regulating charities, and I am eager to hear about the successful steps he

has taken in Minnesota to ensure a vibrant charitable sector.

Finally, I am glad to welcome the rest of our witnesses—David Kuo, Jane

Gravelle, and Richard Johnson. Thank you for appearing here today and contributing to this important conversation.

PREPARED STATEMENT OF HON. JIM BUNNING

Thank you, Mr. Chairman.

I am pleased that the committee is examining charitable institutions today. There

have been many recent press reports about abuses in the charitable arena, and

these reports have had a negative impact on the reputations of charitable organizations everywhere. It has become obvious there are certainly some bad actors taking

advantage of the charitable community, but I think it is important that we don’t

lose sight of the millions of souls who are doing good everyday through charity

work. In order to ensure that the above-board organizations are able to continue to

raise the funds and gather the volunteers that they need to continue to make the

important—and in some instances life-saving—contributions to our society, we need

to work to make sure that public confidence is not eroded.

I support the efforts that this committee is undertaking to ensure that charitable

contributions go toward the charitable purposes which the donor intended and

which the public expects of those organizations to which we grant special privileges

through our tax laws. I look forward to working closely with Chairman Grassley and

Senator Baucus on these issues in the coming months in order to achieve the goal

of shutting down abusive practices. As we examine proposals, however, I plan to

work to make sure that, while we go after bad actors, we do not impede the millions

of individuals who are providing necessary services to our country and its citizens.

I look forward to hearing today’s testimony. Thank you.

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PREPARED STATEMENT OF HON. MARK EVERSON

Mr. Chairman, Senator Baucus, distinguished members of the committee, thank

you for the opportunity to discuss a number of issues relating to tax-exempt organizations. The country rightfully takes pride in its tax-exempt sector. It is composed

of millions of dedicated volunteers and staff who faithfully and impressively carry

out critically important work. On them, many within the United States and

throughout the world rely.

My remarks will focus on problems with abuse that we are encountering in the

tax-exempt area. In making these observations, I am not talking about the inspiring

work that the charitable community does day-in and day-out. Nor am I overlooking

that the overwhelming majority of these organizations try hard to comply fully with

the letter and spirit of the tax law.

But we must recognize that we are now at an important juncture. We can see that

abuse is increasingly present in our sector, and we must work to address it. We will

act vigorously, for to do otherwise is to risk the loss of the faith and support that

the public has always given to the charitable community. And if that is lost, the

bountiful vitality of the American charitable sector will wither.

The administration strongly encourages and supports donations to our charities.

But you and I share the same concern. Some entities now use their privileged status

to achieve ends that Congress never imagined when it conferred tax exemption.

They are wantonly abusing the generosity and faith of the public. I therefore appreciate your efforts, and those of the Joint Committee on Taxation, to consider

changes that will make our oversight of this area stronger, our ability to remediate

abuse swifter, and the strength of the charitable sector more secure.

As I begin, let me also extend my appreciative congratulations to the Panel on

the Nonprofit Sector, convened by Independent Sector, for its fine interim report.

I have read it from cover to cover. It represents an impressive effort to move the

tax-exempt community to a better place. The IRS strongly supports the Eight Guiding Principles of accountability and governance, and commends Independent Sector

and the Panel on the Nonprofit Sector for their role in encouraging adherence to

these standards of excellence.

Good governance and accountability are important, given the size and impact of

the tax-exempt sector in our economy. Although our exempt organization masterfile data is imprecise, the IRS lists 1.8 million tax-exempt entities, and the number

is constantly growing. More than 300,000 entities have been added to our rolls since

2000. Total assets of these organizations approximated $2.5 trillion in 2002, with

revenues of $1.25 trillion. Collectively these organizations file more than 800,000

annual returns.

The IRS Strategic Plan for 2005–2009 recognizes the significance of this sector for

tax administration. The Strategic Plan sets out four key objectives designed to enhance tax law enforcement over the next 5 years. One of these objectives directly

addresses the charitable sector. That objective is to ‘‘Deter abuse within tax-exempt

and governmental entities and misuse of such entities by third parties for tax avoidance and other unintended purposes.’’

Despite the importance of this sector, until recently our enforcement budget was

not keeping up with its growth. From 1995 through 2003, there was an increase of

over 40 percent in the number of exempt organization returns filed, yet IRS staffing

of the exempt organizations function steadily declined.

The chart below shows how we are turning this around. Using 1995 as a benchmark, the chart shows the percentage increase in exempt organization returns filed,

together with the percentage changes in staffing and staffing per exempt organization, on a year-by-year basis. Although our staffing devoted to exempt organizations

has declined, we have begun to reverse this trend.

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Although I will discuss this at greater length later, let me say here that by September we will see a 30-percent increase in enforcement personnel for Exempt Organizations over September 2003 levels.

I will divide my testimony today into four parts. First, we outline external factors

currently impacting this sector. Second, we outline our findings regarding compliance issues facing this sector and specific steps we have taken. Third, we outline

our broader response to these compliance problems. Finally, we identify unresolved

policy issues that should be part of any discussion on reform.

EXTERNAL FACTORS IMPACTING THE SECTOR—A LESS COMPLIANT ENVIRONMENT

A number of factors are impacting compliance in the tax-exempt area. As might

be expected, these factors do not necessarily operate independently of one another.

Taken together, however, they add up to a culture that has become more casual

about compliance and less resistant to non-compliance. These are attitudes that we

must work together to change.

Increase in size and complexity of the tax-exempt sector. This sector has grown rapidly over the past decade, and this growth has impacted the manner in which organizations do business. The number of exempt entities on our master-file has increased by almost 500,000 since 1995, to 1.8 million today. In fiscal year 2002, the

reported value of the assets of these organizations was approximately $2.5 trillion.

Further, most recent figures show reported annual revenues for Internal Revenue

Code (Code) section 501(c)(3) organizations at $897 billion. This growth impacts our

ability to regulate and creates other pressures within the sector. For example, competition for donations has increased, and with that pressure we have seen changes

in fundraising practices and reporting. We have seen many organizations that might

be considered inefficient when considering the ratio of fundraising expenses to charitable outlays. In addition, as individual organizations grew, the skyline changed,

with more organizations entertaining complex business structures and transactions.

The prime example in this area is the transformation of health care providers and

the increased merger activity in the health care sector that we saw in the 1980s

and 1990s.

The lack of an adequate enforcement presence in recent years. In the Tax Exempt

and Government Entities Division (TE/GE), as in the rest of the IRS, our enforcement presence faded in the late 1990s. A number of factors contributed to this decline. In the area of exempt organizations, we were, and continue to be, struggling

with yearly increases in the number of applications for tax exemption. In TE/GE’s

Exempt Organizations (EO) function, overall staffing declined and fewer and fewer

employees were deployed to do traditional enforcement work.

This decline in enforcement presence, combined with the significant growth of the

tax-exempt sector noted above, created opportunities for noncompliance. We simply

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did not do enough ‘‘policing’’ in the area to support the good actors in their quest

to voluntarily comply with the rules.

Lax attitudes towards governance. An independent, empowered and active board

of directors is the key to ensuring that a tax-exempt organization serves public purposes, and does not misuse or squander the resources in its trust. Unfortunately,

the nonprofit community has not been immune from recent trends toward bad corporate practices. Like their for-profit brethren, many charitable boards appear to be

lax in certain areas. Many of the situations in which we have found otherwise lawabiding organizations to be off-track stem from the failure of fiduciaries to appropriately manage the organization. For example, as we will discuss below, we have

found issues relating to how executive compensation is set and reported by nonprofits. Similarly, issues exist as to whether sufficient due diligence and care is

taken in filing tax and information returns.

The rise of abusive transactions: tax shelters and artifices to pay personal expenses.

As in the governance area—and arising in part from the same lax practices—some

parts of the regulated community have become involved in abusive transactions.

In the tax shelter area, abusive programs often require a ‘‘tax-indifferent party’’

to make the scheme work. Tax-exempt organizations are natural candidates. We are

concerned that tax-exempt entities are being used as accommodation parties to enable abusive tax shelters. Of the 31 categories of listed transactions, nearly half may

involve tax-indifferent parties either as accommodation parties or as active participants.

We believe that the tax-exempt organization that participates or allows itself to

be used in an abusive transaction may be inappropriately trading on its privileged

tax-exempt status. Some shelter promoters use tax-exempt organizations to create

abusive shelters where, for a fee, the tax-exempt entity lets the promoter exploit its

tax-free status.

Other abusive transactions involving charities are less complex, but just as corrosive to the credibility of the tax system and to the public’s faith in our charitable

sector. These transactions often share the same guiding principle: a donor receives

a deduction for a charitable contribution while maintaining control over the contributed assets, often using them for personal gain. We list several examples below, including abusive donor-advised funds and supporting organizations.

The terrorist acts of September 11, 2001. One of the most disconcerting revelations

since the horrors of September 11 has been that certain terrorist organizations have

used charities to raise and move funds or otherwise support terrorist activity. Especially troubling is the fact that the 40 charitable organizations designated as financing terrorist activity include six U.S.-based charities. Although those represent a

minuscule part of the charitable sector, curtailing possible corruption and abuse is

a critical element in how we now regulate the charitable sector. September 11 has

had an impact on the way we design, process, and review forms and the business

processes by which we recognize exemption and review continued operational compliance.

Improved transparency in the tax-exempt sector. A positive development in recent

years is the improvement in ‘‘transparency’’ within the tax-exempt sector. ‘‘Transparency’’ refers to the ability of outsiders—donors, the press, interested members of

the public—to review data concerning the finances and operations of a tax-exempt

organization. By creating a means by which the public may review and monitor the

activities of tax-exempt organizations, we promote compliance, help preserve the integrity of the tax system, and help maintain public confidence in the charitable sector. To achieve these goals, we began in the mid- to late-1990s to image Forms 990,

the annual information returns filed by many tax-exempt organizations. We put this

information on CDs and provide it to members of the public, including a number

of watchdog groups that monitor charitable organizations. These groups put the information up on their websites, where it is available to the press and to the public.

This process has resulted in increased press and public scrutiny of the tax-exempt

sector, which we believe is highly desirable. It has also increased the ability of the

IRS and State regulators to access Form 990 data, because they are more readily

available.

CURRENT COMPLIANCE PROBLEMS IN THE CHARITABLE SECTOR—

ABUSES AND MISUSES OF EXEMPT ORGANIZATIONS

Now I want to turn to some of the specific reasons why our emphasis on the taxexempt sector is required. Each year the IRS publishes a list of its ‘‘Dirty Dozen,’’

the schemes that have the dubious honor of sinking to the lowest level of tax abuse.

This year, for the first time, abuses involving exempt organizations have a significant representation on the list, occupying four spots.

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One can divide these abuses into two broad categories. The first group involves

charities that abuse their tax-exempt status. The second group involves charities

that are misused by third parties. Both of these groups are targets of the strategic

objective I mentioned a moment ago: to deter abuse within tax-exempt and governmental entities, and also to deter the misuse of tax-exempt and governmental entities by third parties.

Charities that abuse their status

One group of organizations that abuse their status is charities established to benefit their donors. Generally, the abuses share the same theme: a donor receives a

charitable contribution deduction while maintaining control over the contributed assets, often using them for personal gain. I will list several examples.

Abusive donor-advised fund arrangements. A donor-advised fund typically is a

separate fund or account established and maintained by a public charity to receive

contributions from a single donor or a group of donors. These funds can offer a convenient way for a donor to make charitable gifts. However, for the payment to a

donor-advised account maintained by the charity to qualify as a completed gift to

the charity, the charity must have ultimate authority over how the assets in each

account are invested and distributed in furtherance of its exempt purposes. Although the donor may recommend charitable distributions from the account, the

charity must be free to accept or reject the donor’s recommendations.

We have found that certain promoters encourage individuals to establish purported donor-advised fund arrangements that are used for a taxpayer’s personal

benefit, and some of the charities that sponsor these funds may be complicit in the

abuse. The promoters inappropriately claim that payments to these organizations

are deductible under section 170 of the Code. Also, they often claim that the assets

transferred in the funds can grow tax-free and later be used to benefit the donor

in the form of compensation for purported charitable projects, to reimburse them for

their expenses, or to fund their children’s educations.

We have a compliance team that is vigorously addressing abuses of these funds.

Currently, we are examining the returns of over 200 donors, and have several organizational examinations underway, with more planned. We have denied the exemption application of one organization that is now challenging our action in court, and

have proposed revocation of tax-exempt status in another case.

Section 509(a)(3) supporting organizations established to provide benefits to founders. Supporting organizations are public charities that, in carrying out their exempt

purposes, support another exempt organization, usually another public charity. The

category can cover many types of entities, including university endowment funds

and organizations that provide essential services for hospital systems. The classification is important because it is one way a charity can avoid classification as a

private foundation, a status that is subject to a much more restrictive regulatory

regime. There are three types of these organizations, depending upon the relationship between the supporting organization and the organizations it supports. Briefly,

Type I supporting organizations are controlled by the supported organization in a

manner comparable to a parent and its subsidiary. Type II supporting organizations

share common supervision and control with the supported organizations. Most problems we are finding are in Type III organizations, where the relationship is least

formalized. We have found some issues with the Type I organizations as well, where

the supported organization may be controlled by the promoter.

Some promoters in this area have encouraged individuals to establish and operate

supporting organizations purportedly described in section 509(a)(3) that they can

control for their own benefit. There are a variety of methods of abuse, but a common

theme is a ‘‘charitable’’ donation of an amount to the supporting organization, and

a return of the donated amount to the donor, often in the form of a purported loan

that may never be repaid.

For example, we have seen contributed amounts that have ultimately been returned and then used by the donor to purchase residential property. To disguise the

abuse, the transaction may be routed through one or more intermediary organizations controlled by the promoter, some of which may be offshore.

We are aggressively combating this abuse. An IRS compliance team has obtained

the client lists of several promoters. We have approximately 100 examinations underway, with more planned. We have revoked the exempt status of one supporting

organization, which is challenging our determination in Tax Court. Two cases involving individuals who claimed charitable contribution deductions to supporting organizations are currently docketed in Tax Court. Fifteen individuals are under examination for promoter penalties, and three cases involving supporting organizations are being considered for criminal investigation.

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Corporation sole abuses. Corporations sole are a repeat entry on our dirty dozen

list. A corporation sole is an entity authorized under certain State laws to allow religious leaders to hold property and conduct business for the benefit of a religious entity. The leader can incorporate under State law in his capacity as a religious official. A corporation sole may own property and enter into contracts as a natural person, but only for the purposes of the religious entity. Title in property that vests

in the officeholder as a corporation sole passes to the successors in office, and not

to the officeholder’s heirs. The purpose of a corporation sole is to ensure continuity

of ownership of property dedicated to the use of a religious organization.

The corporation sole form of organization serves a valid function for legitimate religious entities. However, some promoters are urging use of corporation sole statutes

for tax evasion. Individuals incorporate under the pretext of being a ‘‘bishop’’ of a

religious organization or society. The idea promoted is that the arrangement entitles

the individual to exemption from Federal income taxes as a nonprofit, religious organization as described in section 501(c)(3).

The position is without merit. In Rev. Rul. 2004–27, 2004–12 I.R.B. 625, the IRS

announced that persons relying on this scheme to avoid Federal income tax could

be subject to civil and criminal penalties. Similar sanctions will be applied to the

promoters of this abuse. We have almost 50 promoter investigations underway involving corporation sole abuses, and the Department of Justice has obtained permanent injunctions against seven promoters. Three persons have been indicted in connection with corporation sole scams. In addition, almost 250 returns have been identified as having links to abusive corporation sole arrangements and have been

placed in the examination process. Of these, 90 returns are under active examination and several are under consideration for the application of fraud penalties.

Charitable trust problems and abuses. Some promoters have set up purported

charitable or split-interest trusts that can be used for the taxpayer’s personal benefit. There are a variety of schemes, without legal merit, designed to allow individuals to deduct amounts that ultimately will be used for their personal expenses. The

charitable trust typically is a nonexempt charitable trust that serves as a holding

entity of the individual’s assets. Individuals retrieve these assets at will, generally

through loan transactions, gifts, or by having the trust pay for expenses directly.

We have also seen a variety of abusive promotions involving charitable remainder

trusts, which have both charitable and non-charitable elements. These trusts are

typically funded with highly appreciated property. One marketed scheme attempts

to abuse the tax rules governing the character of distributions from the trust to the

transferor by timing distributions in a year when the trust has little or no ordinary

income or capital gain. The claim is that the transferor thus avoids any significant

tax liability from the sale of the trust’s appreciated property. This type of abuse is

specifically prohibited by Treasury regulations, and this transaction and other similar transactions have been designated as listed transactions.

There are other variations on this theme, and we are still investigating the extent

to which these schemes have been sold. In sum, trusts that are designed for charitable purposes are being manipulated for tax avoidance by their creators. We have

over 40 charitable remainder trust examinations underway involving variants of the

above abuse in which the total amounts sheltered exceed $1 billion.

Abusive credit counseling organizations. Certain credit counseling organizations

are abusing their tax-exempt status, albeit in a much different manner. Increasingly, it appears that some credit counseling organizations have moved from their

original purposes, that is, to counsel and educate troubled debtors, to inappropriately enrolling debtors in proprietary debt-management plans and credit-repair

schemes for a fee. These activities may be disadvantageous to the debtors and are

not consistent with the requirements for tax exemption. Further, a number of these

organizations appear to be rewarding their insiders by negotiating service contracts

with for-profit entities owned by related parties. Many newer organizations appear

to have been created as a result of promoter activity.

We are taking strong actions to eliminate the abuses. To date, we have identified

60 credit counseling organizations for examination. Of those, almost 50 examinations have begun, accounting for over 50 percent of the industry by gross receipts.

We have revoked or proposed revocation of tax-exempt status for credit counseling

organizations representing over 20 percent of the industry’s gross receipts. We are

using the knowledge we have gained from examining industry abuse to screen new

applications more effectively.

To help our credit counseling compliance activities, our recent revision of Form

1023, the application for recognition of tax exemption filed by charities, now asks

questions to help identify applicant organizations that have close ties to service organizations owned by insiders. On the Form 990, the annual information return

filed by exempt organizations, we now ask whether organizations provide credit

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counseling, debt management, credit repair, or debt negotiation services to help us

identify organizations that have shifted to or added credit counseling activities after

having established tax-exempt status as a different kind of charitable organization.

Finally, we are partnering with the States and the Federal Trade Commission

(FTC) to leverage our resources. We are developing strategies to address consumer

concerns, coordinate our enforcement actions, and share information.

Organizations recognized by the IRS as described in section 501(c)(3) often are excluded from coverage under FTC rules, as well as State and local consumer protection laws. We remain very concerned that the potent combination of exemption from

income tax and from consumer protection laws is encouraging those who are motivated by profit rather than charity to seek tax exemption. Our vigilance on credit

counseling is even more important given that the bankruptcy legislation that recently passed the Senate includes a provision mandating credit counseling for many

debtors. If this legislation is enacted into law, it is imperative that we ensure that

those individuals in bankruptcy receive the required counseling from legitimate organizations.

Misuse of charities by third parties

I have discussed charities that abuse their tax-exempt status. Others charities are

misused by third parties, often unknowingly, but sometimes with the charity’s

knowledge and consent.

Overstated deductions. A common problem occurs when a taxpayer takes an improper or overstated charitable contribution deduction. This happens most frequently when the donation is of something other than cash or readily marketable

securities. Last year, when I appeared before this committee, I listed several specific

concerns in this area, and I would like to take this opportunity to thank the Congress for the provisions in the American Jobs Creation Act of 2004 that will reduce

compliance problems with donations of vehicles and intellectual property. Let me

discuss some problems that remain.

Conservation easements. In recognition of the need to preserve our heritage, Congress allowed an income tax deduction for owners of significant property who give

up certain rights of ownership to preserve their land or buildings for future generations.

The IRS has seen abuses of this tax provision that compromise the policy the Congress intended to promote. We have seen taxpayers, often encouraged by promoters

and armed with questionable appraisals, take inappropriately large deductions for

easements. In some cases, taxpayers claim deductions when they are not entitled

to any deduction at all (for example, when taxpayers fail to comply with the law

and regulations governing deductions for contributions of conservation easements).

Further, the conservation easement rules place the charity in a watchdog role. In

a number of cases, however, the charity has not monitored the easements, or has

allowed property owners to modify the easement or develop the land in a manner

inconsistent with the easement’s restrictions.

Another problem arises in connection with historic easements, particularly facade

easements. Here again, some taxpayers are taking improperly large deductions.

They agree not to modify the facade of their historic house and they give an easement to this effect to a charity. However, if the facade was already subject to restrictions under local zoning ordinances, the taxpayers may, in fact, be giving up nothing, or very little. A taxpayer cannot give up a right that he or she does not have.

Last year, we published Notice 2004–41, 2004–28 I.R.B. 31, which describes another abuse. A charitable organization purchases property and places a conservation

easement on the property. The charity then sells the property subject to the easement for a price that is substantially less than the price paid by the charity for the

property. As part of the sale, the buyer makes a second payment designated as a

charitable contribution to the charity. The total of the payments fully reimburses

the charity for its cost. In some cases, the second payment is really part of the negotiated purchase price of the property and therefore is not a contribution.

Now let me explain what we are doing about these problems. Notice 2004–41 describes a specific abuse, but it also provides a warning. The IRS will look at the

substance, rather than the form, of abusive transactions, and will impose appropriate penalties against the abusers.

We are modifying our tax forms to aid in the identification of abuse. We added

new questions to Form 1023, the application for recognition of tax exemption filed

by charities, that will help us identify organizations with conservation donation programs. We are considering changes for our next revision of Form 990, the annual

information return filed by exempt organizations, that will allow the IRS and the

public to better identify organizations that take easements and to understand what

they do with them. We also will revise Form 8283, the form the donor files to supVerDate 11-MAY-2000 17:15 Dec 19, 2005 Jkt 095484 PO 00000 Frm 00173 Fmt 6601 Sfmt 6621 20838.000 SFINANC2 PsN: SFINANC2
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port a non-cash charitable contribution, to clarify what is permissible and to disclose

better information on the type of property donated.

While this will enable us to better target our enforcement efforts in the future,

we have an active enforcement program now as well. We are currently looking at

the activities of more than a dozen promoters. We are examining charities that we

believe may have been involved in particular abuses and those charity officials who

may have unduly profited from their positions with a charity. We are currently examining 48 easement donors and also are reviewing deductions taken for nearly 400

open-space easements, to be followed with a review of over 700 facade easements.

We will use all civil and criminal tools at our disposal to combat abuses.

Other non-cash charitable contributions. We also have persistent problems in taxpayers’ valuation of deductions taken for non-cash charitable contributions. Valuation issues are often difficult. Overvaluations may arise from taxpayer error or

abuse, as well as from aggressive taxpayer positions. Additional enforcement concerns are whether consideration has been received in return, and whether only a

partial interest has been transferred.

I have read with much interest the Joint Committee on Taxation’s description of

problems in the area of clothing, household items, and other contributions of property, and I agree that these are resource-intensive for us to audit. Overvaluations

are difficult to identify, substantiate, and litigate. Further, donors and the recipient

charities do not have adverse interests that would help establish a correct valuation.

As I mentioned, the Congress addressed two major abuses with legislation that

targets vehicle donations and patent and other intellectual property donations. This

has greatly helped us administer this area of the tax law, but problems remain with

respect to the valuation of other property.

Abusive tax shelters involving tax-exempt accommodation parties. An ‘‘accommodation party’’ is a term generally used to describe a tax-indifferent party’s involvement

in a transaction that does not necessarily affect the entity’s primary function, but

is designed to provide tax benefits to a taxable third party. We have seen an increased use of various tax-exempt entities, including charities and other tax-exempt

organizations, private and government retirement plans, Indian tribal governments,

and municipal governments, to achieve abusive results.

In one listed transaction, Notice 2003–81, involving tax-avoidance using offsetting

foreign currency option contracts, we have found both otherwise-legitimate and suspect charities to have been involved.

Disclosure is an important way for the IRS to identify participants in abusive

transactions. The IRS requires participants to disclose their participation in listed

and other reportable transactions on Form 8886, which must be filed with the organization’s annual return. We have begun to name accommodation parties as participants in listed transactions (see Notice 2004–30). However, not all potential accommodation parties have a return-filing requirement. Those that do not file returns include churches, small exempt organizations, State and local governments, State and

local government retirement plans, and Indian tribal governments. Thus, even

where we specifically designate accommodation parties as participants, these entities are not required to disclose their participation in these transactions. As I reported to you last year, we have worked around this problem to some degree by revising Form 8886 to require the other participants to identify the tax-exempt parties

in a listed transaction.

Increased disclosure to the IRS will help in this area, even without a sanction.

However, it is as yet unclear whether disclosure to the IRS will prove a meaningful

deterrent to exempt entities engaging in this behavior. We welcome a discussion of

the issues raised by this committee and the Joint Committee on Taxation staff, as

well as the Panel on the Nonprofit Sector.

Compensation issues. There has been much publicity about high salaries and generous compensation at some charities and foundations. An exempt organization is

entitled to pay reasonable compensation for the services it receives. Moreover, what

some may consider excessive levels of compensation may meet the requirements of

current law in this area. High compensation is not necessarily an abuse under the

law if it is warranted based on the value of services performed for the exempt organization. The key to this determination is whether the compensation is comparable

to that paid by similar organizations for similar work. The organizations being used

for comparison may be nonprofit and for-profit organizations, but it is not always

clear that the comparison actually used in a particular case is appropriate for the

particular position. In addition, there is a major risk that organizations that effectively allow key executives too great a voice in determining their own compensation

will not end up with objective and reasonable compensation levels.

Excess compensation by an exempt organization is not permissible. An organization that overcompensates its officers and directors risks revocation of its tax-exVerDate 11-MAY-2000 17:15 Dec 19, 2005 Jkt 095484 PO 00000 Frm 00174 Fmt 6601 Sfmt 6621 20838.000 SFINANC2 PsN: SFINANC2
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empt status. In the case of charities and social welfare organizations, the IRS also

can impose an excise tax on certain individuals who receive more than their due.

Last year, we began a comprehensive enforcement project to explore the seemingly high compensation paid to individuals associated with some exempt organizations. This is an aggressive program that includes both traditional examinations and

correspondence compliance checks. Its purpose is to enhance compliance by identifying practices organizations use to set compensation, learning how organizations

report compensation to the IRS and the public, and creating positive tension for organizations as they decide on compensation arrangements. This project also has an

educational component.

We are contacting a broad spectrum of nearly 2000 public charities and private

foundations and asking for detailed information and supporting documents on their

compensation practices and procedures, and specifically how they set and report

compensation for specific executives. We also are asking organizations for details

concerning the independence of the governing body that approved the compensation,

and for details concerning the duties and responsibilities of these executives. We

also are looking at organizations that failed to supply, or did not fully complete,

compensation information on Form 990. We are requiring them to file amended returns immediately to supply information missing on any part of the Form 990.

We have completed our review of over 500 of these contacts. It is too early to state

any findings definitively, but we are seeing issues in the reporting of loans and deferred compensation, as well as whether all ‘‘perks’’ are being appropriately reported. There may also be an issue of spreading compensation among several affiliated organizations, which decreases transparency.

Terrorist financing. We want to ensure that U.S. charities have no role in financing terrorist activity, and we continue to assist in the fight against terrorism and

those who fund it. On the criminal side, we have ongoing investigations concerning

potential terrorist financing. Efforts by special agents in our Criminal Investigation

function have played an important part in designations of several entities as terrorist organizations by Treasury’s Office of Foreign Assets Control. Since 2001, in

conjunction with other agencies, our actions have contributed to the sentencing of

44 individuals in terrorism-related cases, 32 of them for money-laundering.

We have created a Lead Development Center to pilot a counter-terrorism project,

including a focus on the abuse of charities. It uses advanced analytical technology

and subject matter experts to support ongoing investigations and proactively identify potential patterns and lawbreakers. The center is staffed with personnel from

both our criminal and civil functions, and it integrates its work with the larger Federal law enforcement community, chiefly through our participation in the Joint Terrorism Task Forces led by the FBI. Using data from tax-related information that

is protected by disclosure laws, the center can analyze information not available to

other law-enforcement agencies. By combining that data with public-source information and with data gathered by other law-enforcement agencies, the center can perform a complete analysis of all financial information relating to specific investigations.

On the civil side, the tax-exempt status of six entities has been suspended automatically by operation of section 501(p). We are also exercising due diligence to ensure that individuals designated as terrorists have no place in U.S. charities. Applications for tax-exempt status are screened for terrorist names. We have adopted

procedures and are developing the electronic capability to review filed Forms 990

and 990–PF for terrorist names. Name matches are coordinated with the appropriate office for verification or further action.

We are seeking better information about U.S. charities with international activities. Our recent revision of Form 1023 asks for more specific information on foreign

activities, and we expect that our forthcoming revision of Form 990 will have similar

questions. We also are seeking better baseline information about the practices of organizations that make grants to foreign entities, and the level of oversight the organizations exercise over the use of the funds abroad. For this purpose we are examining over 100 charities that make grants or have operations overseas. Depending

upon what we find, we will institute new compliance programs or issue new guidance or educational material, as appropriate.

In addition, we asked for public comments on international grant-making. Among

other things, we are interested in the practices that charities find work best for

them to ensure that their assets are used only for their intended charitable purposes. The IRS intends to issue a publication that discusses some of the methods

used by charities with international operations.

Political activity of non-profits. Section 501(c)(3) organizations are statutorily prohibited from intervening in political campaigns. Each election cycle we become involved with significant allegations of wrongdoing, and this problem shows no indicaVerDate 11-MAY-2000 17:15 Dec 19, 2005 Jkt 095484 PO 00000 Frm 00175 Fmt 6601 Sfmt 6621 20838.000 SFINANC2 PsN: SFINANC2
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tion of abating. In 2002, a mid-term election year, our records indicate that we received approximately 70 complaints alleging campaign activity by charities. In 2004,

a presidential election year, that number was over 200. These are difficult cases,

and our actions often trigger questions and concerns from the public and the Congress.

In the 2004 election cycle, we took a more active stance than we have in the past

in an attempt to reduce the number of violations. Early in the campaign year we

issued a news release, as well as a mailing to political parties explaining the prohibition against campaign intervention. During this past summer, we began a project

designed to respond to reports of campaign intervention on an expedited basis. We

also pursued other educational avenues, including the sponsorship of seminars and

the distribution of plain-language publications that explained the rules. Our objectives were to ensure that charities understood the rules and the need to avoid political campaign activity, without chilling the ability of charities to speak out on important issues of public policy.

A committee of experienced career employees selected about 130 organizations for

examination by our revenue agents. The selected organizations represented all segments of the political spectrum. We intend to repeat this project in future election

cycles, with modifications that include, among other things, an earlier starting date

in the election year and greater up-front publicity.

IRS RESPONSE: REVITALIZING AND REFOCUSING EXEMPT SECTOR ENFORCEMENT

AND ENHANCEMENTS TO TRANSPARENCY

Revitalization—recent budget increases

Because of the priority we have given to the charitable sector, as expressed in the

key objective in the Strategic Plan to deter abuse and misuse of tax-exempt entities,

the budget for our EO function increased significantly in fiscal year 2004 and fiscal

year 2005. Although the IRS budget increased only one-half of one percent in fiscal

year 2005, the TE/GE budget increased 9 percent, the EO budget increased 13.8 percent, and the EO examinations budget increased 21 percent. In EO examinations,

this increase will translate, by September, into a 30-percent increase in staffing over

September 2003.

We have translated the increase in funding into concrete results. In fiscal year

2004, we added 70 new agents to conduct exempt organizations examinations, and

additional employees for our new EO Compliance Unit, which reviews Forms 990.

This year, the fiscsal year 2005 budget supports the creation of the EO Financial

Investigations Unit, and I have reallocated resources to EO to hire 69 additional

compliance employees.

For next fiscal year, fiscal year 2006, the administration has requested a 4.3-percent increase in the IRS budget, with nearly an 8-percent increase in enforcement.

If the Congress approves the request, the amount we plan to dedicate to the taxexempt area would be used to combat abusive promotions involving tax-exempt entities, to start examinations quickly when we detect a risk, to give agents better information for their first contact with taxpayers, and to increase vigilance against the

misdirection of exempt organizations’ assets for illegal activities or private gain.

Refocusing of efforts—pursuing the right cases

We also are refocusing the way we approach exempt organizations. We are expanding our presence in the community, and making data about exempt organizations more accessible to our agents and to the public.

To enhance compliance, we are interacting with a greater number of exempt organizations. We established two new offices to help us do this. First, our new EO Compliance Unit is designed to review Forms 990 and correspond with organizations on

inconsistencies, errors, and other matters that do not require an examination. For

example, the EO Compliance Unit may correspond with a non-filer to solicit a Form

990 when we know from other sources, such as a State bingo regulatory agency,

that the organization has gross receipts that exceed the $25,000 filing threshold.

The Compliance Unit has also sent educational letters to charities that report the

receipt of substantial contributions that, coupled with low fundraising expenses,

could indicate a reporting problem. Our letters provide instruction on the proper reporting of fundraising income and expenses. We will monitor future returns of these

organizations to see if their behavior has changed. This unit has also played a key

role in our compensation initiative.

At the tougher end of the compliance spectrum is our Financial Investigations

Unit, which we are now organizing. This unit will specialize in our most difficult

and significant cases in the civil context, including fraud and terrorism, and will

serve as a strike force when we need to move quickly.

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These new units will be aided by two new groups. The Data Analysis Unit, which

became operational in 2004, will use innovative data capture to better select cases

for examination. The comparison of State bingo databases to our master-file is an

innovative example of the type of work this unit will perform. A separate, newly

funded group will identify and follow up with selected Form 990 filers in the first

years of their operations, bridging the gap between what an applicant organization

tells us when it applies for exemption and how it actually operates.

We have also refocused our staff to work the most troublesome areas. EO is devoting approximately one-third of its examination staffing to EO’s priority compliance

areas this year, all of which are among the issues I have referred to earlier, up from

a much lower percentage in fiscal year 2004.

Enhancements to transparency

Transparency is a lynchpin of compliance within the sector. Therefore, part of our

work is to improve exempt organization transparency, including better data quality

and better data availability. With our e-filing initiatives, planned changes to Form

990, expanded imaging of returns, and changes to the application process and the

Form 1023, we expect substantial progress toward this goal.

All exempt organizations can now file their annual returns electronically. Electronic filing was available for Form 990 and 990EZ filers in 2004, and is now available this year for private foundations, which file Form 990–PF. We want to encourage e-filing because it reduces taxpayer errors and omissions and allows us, and ultimately the public, to have ready access to the information on the return. For this

reason, we have required e-filing in certain cases. Under proposed and temporary

regulations, by 2007 we will require electronic filing for larger public charities and

all private foundations. Due to statutory restrictions, discussed below, at this time

we can only do so for organizations that file at least 250 returns with us annually.

We are also working on improving the Form 990. The current form is not particularly ‘‘user-friendly,’’ and does not give us all the information IRS agents need to

do their jobs; the public is similarly constrained. We are at work revising the form.

We anticipate that the revised form will have specific questions or even separate

schedules that focus on certain problem areas. For example, filers should not be surprised to find specific schedules or detailed questions relating to credit counseling

activities, supporting organizations, compensation practices, and organizational governance. The timing of the revision of the Form 990 is somewhat dependent on our

partners, including the States, 37 of which use the Form 990 as a State filing, and

software developers.

We are also expanding our Form 990 imaging capabilities. We already image the

returns of public charities and private foundations. This month, for the first time,

we are imaging the returns of our many categories of exempt organizations that are

not section 501(c)(3) organizations. This will allow our agents immediate access to

these returns, and will allow us to respond quickly to public requests for returns.

While important at this time, it is our hope that imaging will become a relic of the

past as electronic filing becomes the norm.

In November, 2004, we revised Form 1023, the form that charities file when they

apply for tax exemption. This was a comprehensive redesign. We ask many new

questions that focus on potential problem areas, and others that are designed to reduce the need for our personnel to request more information from the applicant. We

also ask questions that we hope will lead our charity applicants to focus on selfgovernance issues and organizational best practices.

As we move forward, we will increase compliance efficiency by making closed application files more accessible. As budget permits, we intend to replace our antiquated microfiche storage system by imaging the application files so that they can

be readily viewed by our compliance personnel and the public.

IRS FOCUS AREAS FOR DISCUSSION OF REFORMS—UNRESOLVED ISSUES

Notwithstanding our revitalized and refocused program, we believe there are several areas that should be included as part of any discussion of reform in the taxexempt area. The first such question is whether there are additional bright-line

tests that are available to aid the public in complying with, and the IRS in administering, the law. A debate on reform also should include the following questions,

identified below.

Have changes in practice or industry created gaps in the statutory or regulatory

framework? There has been huge growth in the tax-exempt sector, but much less

change in the law governing those organizations that qualify for tax-exempt status.

Since 1969 there has been only limited review of the rules relating to tax-exempt

organizations. Some within the community have argued that it is time for a more

thorough review, and we welcome that.

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As we regulate various parts of the TE/GE community, compliance in some areas

becomes difficult to administer, where industry practice, or the industry itself,

changes, but the rules remain constant decade after decade. An example we noted

above is the credit counseling area. This industry grew up in a different time, under

different rules, but now has evolved into something substantially different from

what it was. There also have been great changes in technology that should be considered. One important issue, for example, is how rules that are several decades old

apply in an Internet, often virtual, environment.

Does the IRS have the flexibility to respond appropriately to compliance issues? We

believe a discussion about reform should address whether we have the proper range

of tools to enforce compliance in a measured way, where appropriate. In many areas

of our jurisdiction, our remedial tools are not effective. Often our only recourse is

revocation of tax exemption, a ‘‘remedy’’ that may work a disproportionate hardship

on innocent charitable beneficiaries. Moreover, even where we have an intermediate

sanction, it may not work as intended.

Similar discussions may be worthwhile with respect to the rules on political intervention in campaigns by exempt organizations and the reporting requirements for

political action committees.

With regard to abusive tax shelter transactions, the accuracy-related penalties imposed by the Code are not sufficient to deter a tax-exempt accommodation party,

which has no taxable income to understate. Likewise, IRS’s compliance sanctions for

exempt organizations do not fit these situations. Participating in a transaction as

an accommodation party rarely affects the tax status of a charity or other tax-exempt entity.

In some areas, activities of exempt organizations have transformed greatly in recent decades, but the rules governing tax exemption have not, leaving the IRS with

difficult and fact-intensive administrative challenges. An example is health care, an

evolving industry that has changed dramatically over the last few decades. Some

tax-exempt health care providers may not differ markedly from for-profit providers

in their operations, their attention to the benefit of the community, or their levels

of charity care. Further, some exempt providers have entered into joint ventures

with for-profit organizations, sometimes placing their entire health care operation

in the venture and transforming themselves into what is effectively a tax-exempt

holding company with a charitable grant-making function. Although this is not impermissible, we insist that the charitable entity ensure that the charitable purposes

of the venture are not sacrificed for the sake of maximizing profits. However, it can

be difficult for the IRS and the courts to wrestle with fact-intensive cases.

Finally, in our attempts to ensure that exempt organization funds are not diverted to improper purposes, including terrorism, we do not have tools comparable

to those applicable to private foundations to sanction public charities that fail to

monitor their grants. For those organizations that need not file for exempt status

and do not file annual returns, such as small organizations that normally receive

not more than $5,000 annually and churches, the problem is compounded because

we have little ability to monitor their operations against diversion of assets.

Should more be done to promote transparency? Transparency is a lynchpin of

compliance within the tax-exempt sector. However, there are legitimate questions

about whether to enhance transparency, and if so, how to proceed. As I noted to

you last June, limitations on our ability to communicate with State charity officials

prevent us from fully leveraging the relationship and jurisdiction we share with

them. Further, there are segments of the TE/GE community that we are unable to

track, including several categories of legal non-filers (for example, those exempt organizations that are not required to file a Form 990, such as churches and organizations with less than $25,000 in gross receipts). Our master-file is replete with errors

concerning these organizations.

Finally, one of our key transparency initiatives is the establishment of electronic

filing for Forms 990 and 990–PF. The recent report by the Panel on the Nonprofit

Sector, referenced above, supports mandatory electronic filing for all returns for

nonprofits, and we have issued temporary regulations requiring such filing for certain groups. While this will markedly advance the ability of the Service, the States,

and the public to access Form 990 data in real time, our ability to mandate e-filing

is limited at this time by statutory restrictions that prevent us from mandating electronic filing for any organization that files fewer than 250 returns with us. The administration’s 2006 budget proposal echoes this concern. The administration’s proposal would lower the current 250-return minimum for mandatory electronic filing,

but would maintain the minimum at a level high enough to avoid imposing undue

burden on taxpayers.

Does the IRS have the resources it needs to do the job? While this is a topic worthy

of discussion, I have outlined what we have done to expand our resources in the

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tax-exempt area. I believe we have done a credible job of recognizing the task before

us and preparing to meet that challenge. To continue this work, I would ask the

committee to support the administration’s 2006 budget proposal, which calls for an

8 percent increase in our enforcement budget.

CONCLUSION

To conclude, let me briefly outline where I believe the IRS must head in the next

5 years if it is to be successful in reining in abuse and appropriately regulating the

tax-exempt sector.

First, while we must continue to maintain a high level of quality service to the

sector, we also must continue to strengthen our enforcement activities. To do this

we need to concentrate on the following tasks. We need to improve our business

processes. We need to develop and increase partnerships with other regulatory agencies, such as the FTC, the Federal Election Commission, and State charity officials,

so that we can better leverage resources. We need to increase our ability to identify

potentially problematic areas and high-risk cases. We need to continue to ensure a

fair allocation of resources to exempt organization examinations to increase our

audit presence in the community. And we need to improve our case-building ability

through better access to researchable data.

Second, we need to increase electronic submissions. This is not only with respect

to Form 990 and 990–PF, for which we now have the capability to accept e-filing,

but also Form 1023 and other forms as well. This will increase the amount of data

accessible to IRS employees, other regulatory agencies and the public, and will allow

us to focus on problem areas faster.

Finally, we need to further tailor our compliance efforts by focusing on specific

segments of the EO community. This will allow us to target our resources, including

educational resources, to those areas where they will have the greatest impact.

I thank the committee for its attention. I am pleased to respond to your questions.

RESPONSES TO QUESTIONS FROM SENATOR HATCH

Question: Commissioner Everson, I think your testimony today was excellent. I

share your concern that we must ensure that abuse in the charitable sector is kept

to a minimum. However, I believe it is very important that we do not allow the pendulum to swing too far in the other direction to the point where we are discouraging

citizens and businesses to donate to charitable causes. How can we make sure we

do not, in our efforts to crack down on abuses, also create roadblocks to charitable

giving?

Answer: We are aware of the vital role that charities have in our communities.

Without the funding that comes from donors, our charities simply cannot continue

to provide the services so many Americans, and people throughout the world, rely

on. It would indeed be unfortunate if well-intentioned efforts to stem abuses in some

organizations were to result in diminished giving to our many, many well-run charities. I would hope that whatever remedies the Congress adopts to curtail the bad

apples are not so broad in scope as to reduce the flow of much-needed funds to good

charities.

In our view, a vigorous enforcement program that is appropriately targeted will

bolster, not damage, the culture of charitable giving. We also believe that a more

knowledgeable public will be better able to discern the most worthy organizations.

Many of our efforts will improve the information available to donors. These include

our efforts with Form 990, such as imaging the form, making it publicly available,

establishing and promoting electronic filing, and reviewing the form and corresponding with organizations on questionable entries.

I also believe that the charitable sector can provide much assistance to us as well

as to the committee in our endeavors to ensure that any reforms are good reforms.

I applaud the good work that the Independent Sector and the Panel on the Nonprofit Sector are doing to promote stronger governance and oversight of charities,

and I have every confidence that these and other voices in the charitable community

will continue to offer excellent advice to Congress and guidance to their members.

Question: Mr. Commissioner, I have been told that the area of charitable hospitals

is rife with abuse. Has the IRS examined tax-exempt hospitals and, if so, what recommendations do you have for legislative or regulatory reform in this area?

Answer: Hospitals have been a substantial part of the IRS Exempt Organizations

Compliance Program for at least a decade. Our examinations during that timeframe

have covered in excess of 1,500 hospital or hospital-related entities. The examinations involved a wide range of tax issues, including unrelated business income,

inurement, taxable subsidiaries, joint ventures, physician recruitment programs, excise tax, excess funded pensions, the tax status of health maintenance organizations,

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employment tax, fundraising and several other issues. In addition, we also have a

compliance project regarding the issue of whether medical residents are eligible for

the student exception to FICA that now encompasses some 365 health organizations

and 1,950 residents.

As mentioned in my testimony, this area is of concern because of its size, complexity and increasing difficulty in the ability to determine the difference between

for-profit and tax-exempt hospitals. In an effort to better measure the compliance

levels within the hospital area of the exempt community, we began a market segment study of hospitals in 2003, reviewing our work to date in this area. We are

scheduled to conclude this study this summer. This study is a considerable undertaking, because examinations of hospitals are extremely complex and fact-intensive,

requiring large teams of examiners to handle each case. We expect the final study

to include recommendations as to how to improve the compliance level within the

health field and will be working with the Office of Tax Policy at the Department

of the Treasury and with committee staff on needed reforms. Of course, we will be

more than happy to discuss our findings as we move forward.

Question: Mr. Commissioner, do you believe the Service has the resources it needs

to go after abuses in the tax-exempt area in general and specifically where known

abuses occur, whether in tax shelter accommodation, overvaluation, tax-exempt hospitals, or wherever the specific problems are?

Answer: One of our strategic objectives is to deter abuse of tax-exempt entities

and misuse of such entities by third parties. As stated in my testimony, I have increased the resources we are devoting to our Tax Exempt and Government Entities

Division (TE/GE), which oversees the tax-exempt area. In fiscal year 2005, our budget for TE/GE’s Exempt Organizations (EO) function increased 13.8 percent, and our

compliance staffing will increase dramatically in this area. It is vitally important

that the Congress approve the administration’s request for a 4.3-percent increase in

the fiscal year 2006 IRS budget, which includes a nearly 8-percent increase in enforcement. If the Congress approves the request, the amount we plan to dedicate

to the tax-exempt area would be used to combat abusive promotions involving taxexempt entities, to start examinations quickly when we detect a risk, to give agents

better information for their first contact with taxpayers, and to increase vigilance

against the misdirection of exempt organizations’ assets for illegal activities or private gain.

Question: The number and size of tax-exempt entities appear to have grown very

significantly in the past few years. Is there any indication that this growth rate will

slow? How will the IRS keep up with this sector, especially as some who would

abuse the rules become more sophisticated and their improper actions become harder to detect?

Answer: We have no reason to believe that current growth trends will not continue, though in the last 2 years the growth in applications for exempt status has

slowed.

In our efforts to improve our front-end determination process, we have revised

Form 1023, the application form for charitable status, which now asks for more information. We hope this will reduce the need for our staff to correspond with applicants. We also have introduced a program to identify cases that may involve abusive

transactions early in the determination process, and to ensure consistent application

of the law. Ultimately, we will pursue electronic filing of the Form 1023.

To better identify and select problem organizations for examination, we are pursuing improved data in both quality and quantity available. Electronic filing will

help in this regard.

To administer tax law in an increasingly large and complex environment, we are

becoming more innovative and proactive in the ways we do business. We have established a Data Analysis Unit to provide trend research and analysis to improve workload selection for our EO examination function. It will support EO compliance activities through identification of trends, support improved examination case selection,

and identify potential compliance issues through use of the Internet and various

IRS and non-IRS databases.

We are also establishing a new office in EO to combat fraud and suspect financial

transactions in the tax-exempt area. This Financial Investigations Unit will address

complex fraud and tax avoidance cases. The unit’s staffing will include revenue

agents, forensic accountants, and data miners, and it will serve as a strike force

when we need to move quickly in a specific case.

Question: I have been told that the current-law 2-percent excise tax on the net

investment income of private foundations was intended to fund IRS enforcement operations? Is this true, and is that what the money raised from this tax is used for?

Answer: When the tax on the net investment income of private foundations (section 4940 of the Internal Revenue Code) was adopted in 1969, a rationale for the

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tax was that private foundations should share the burden of the cost of more rigorous enforcement of tax laws relating to exempt organizations. See Staff of Joint

Committee on Taxation, 91st Cong., 2nd Sess., General Explanation of the Tax Reform Act of 1969, 29 (Joint Comm. Print 1970). This excise tax was originally set

at 4 percent, but was lowered to 2 percent in 1978.

In 1974, the Congress established the Office of Assistant Commissioner for Employee Plans and Exempt Organizations (EP/EO) and authorized the use of the section 4940 tax to carry out the functions of EP/EO in former section 7802(b) of the

Code. Notwithstanding the authorization, the excise tax revenues have never been

appropriated for IRS use, and have always represented a part of general revenues.

The authorization to use these tax revenues for EP/EO was repealed in 1998, as was

the establishment of EP/EO itself, when the IRS was restructured pursuant to the

Internal Revenue Service Restructuring and Reform Act.

RESPONSES TO QUESTIONS FROM SENATOR ROCKEFELLER

Question: I understand that a large number of IRS agents hired during implementation of the 1969 Tax Act are becoming eligible for retirement. What impact will

this have on the EO division’s ability to continue its current work and, potentially,

to take on additional duties? What are your plans for ensuring sufficient staff resources to ensure a smooth transition during this time?

Answer: We do not anticipate that near-term retirements will disproportionately

affect our existing workforce of EO revenue agents. However, we do expect it to be

necessary to replace many of our EO managers and technical staff. We have developed a hiring plan that foresees the need to replace EO employees lost through attrition, but we expect a challenge in finding and developing interested and capable

management candidates in some areas. Our efforts in replacing staff will be assisted

by hiring in 2004 and 2005. In fact, by September 2005, we will have a 30-percent

increase in EO Examinations staffing over September 2003.

Question: I understand that there is about a 6-month backlog in the Cincinnati

office for consideration of exempt status for new organizations. If this is true, how

will the EO division be able to handle additional work?

Answer: By way of background, EO has two major arms: EO Examinations is

headquartered in Dallas and examines exempt organizations to ensure they remain

in compliance with the requirements of law. EO Rulings and Agreements is

headquartered in Washington, DC, and has jurisdiction over the Cincinnati office

that handles new applications. Each arm has its own agents. To handle processing

of an increasing number of applications, prior to 2003 EO used many examination

agents to assist in processing the increasing volume of applications. As a result, the

number of EO examinations seriously declined. Since that time, EO has maintained

a strict policy of dedicating specific personnel to each function. Today, an increase

in workload or change in staff levels in one arm should not ordinarily affect the operations of the other. Because the number of applications has normally increased

each year, we have fallen behind in processing them. This was necessary to restore

our enforcement presence in the community. We are taking steps to alleviate the

backlog.

We are improving the ability of the Cincinnati office to process its workload

through a combination of increased staffing and efficiencies in the workplace. As

part of my redirection of resources to EO, we will hire new determinations specialists to complement its existing staff. In November, 2004, we introduced a completely

redesigned application form for charitable status (Form 1023), which asks for more

information. We hope this will reduce the need for our staff to correspond with applicants. We are also developing a ‘‘cyber-assistant’’ for applicants that should reduce errors and omissions in the application process and thereby reduce staff time

devoted to corrections. We expect this Internet application to be available in 2007.

Ultimately, electronic filing of applications is the answer, and the ‘‘cyber-assistant’’

is a step in that direction.

Question: If the proposal requiring a 5-year review for every exempt organization

gets enacted, how will the IRS handle review of 1⁄5 of filings every year? How many

exempt organizations are currently examined every year? How will the IRS increase

its capacity to examine a greater number of organizations? How many revenue

agents are dedicated to oversight and review of exempt organizations? Has the number increased or decreased over the past 2 years? Past 5 years?

Answer: The 5-year review proposal represents a challenge if the expectation is

a review of each filing. The Joint Committee version, as proposed, is for newer exempt organizations to file every 5 years (older organizations are exempted), with no

mandated requirement that IRS review those filings. Even this effort would require

diversion of existing staff resources or an increase in staffing.

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We recognize the need for follow-up after exemption. This year we are establishing an office that will review filings from ‘‘at risk’’ organizations, including a portion of those that have been in operation only 3 years.

EO examined 5,754 entities in fiscal year 2003 and 5,800 in fiscal year 2004. In

addition, EO’s new Compliance Unit began operations in fiscal year 2004 with 1,475

correspondence compliance contacts. These numbers should increase with the infusion of new staffing. As I mentioned in testimony, we hired 70 new EO examinations agents last year and expect to hire additional agents by the end of fiscal year

2005. By September, 2005, I expect our EO examinations staffing level to be around

531 employees, up from 395 in September, 2003.

Question: Anecdotal information and media reports indicate wrongdoing and questionable activities of a few organizations. How widespread do you believe these problems to be? Do you know of any credible studies assessing exempt organization compliance? How can Congress determine the size and scope of the noncompliance problem in the area?

Answer: We have seen problems in the areas I mentioned in my testimony, but

it is impossible to say with certainty how great the problems are. What I can say

is that, at least in those areas I have discussed, we need to act quickly to counter

a perception of corruption that derives, quite naturally, from continued press reports

of scandals.

The universe of tax-exempt organizations has many different segments with very

diverse purposes and activities. In the long run we will be looking at many parts,

if not all, of the tax-exempt community. We are performing market segment studies,

which seek to profile particular sectors of the tax-exempt community by using sampling techniques to determine whether, and to what extent, compliance issues are

present. Generally, these initiatives and studies rely on taxpayer contacts and field

examinations to obtain information. When we complete these studies, we will be in

a better position to provide information on specific potential compliance problems,

or the particular market segments we have reviewed.

Question: Congress enacted the excise tax on private foundation income to fund

the cost of IRS oversight of exempt organizations, but I don’t believe that the revenue generated has ever been used for this purpose. In 2001, the Joint Committee

on Taxation recommended elimination of the excise tax as part of their plan to simplify the tax code. In his fiscal year 2006 budget, President Bush called for a flat

1 percent excise tax. How much money is raised annually from the excise tax? How

much of that is used for enforcement? Should this tax be eliminated, or at least flattened?

Answer: You are correct that the revenue from the section 4940 excise tax is not

used to fund the cost of IRS oversight of exempt organizations. It is part of general

Federal revenues and is not appropriated for enforcement. In 1974, the Congress established the Office of Assistant Commissioner for Employee Plans and Exempt Organizations (EP/EO) and authorized the use of the section 4940 tax to carry out the

functions of EP/EO in former section 7802(b) of the Code. Notwithstanding the authorization, the excise tax revenues have never been appropriated for IRS use, and

have always represented a part of general revenues. The authorization to use these

tax revenues for EP/EO was repealed in 1998, as was the establishment of EP/EO

itself, when the IRS was restructured pursuant to the Internal Revenue Service Restructuring and Reform Act.

The amount raised from the tax has varied widely in recent years. Receipts of

about $503 million in fiscal year 2000 increased to $720 million in 2001, declined

to $490 million in 2002, $290 million in 2003, and $240 million in 2004. The administration has proposed simplifying the tax. Under the current two-tier structure of

the tax, a foundation may be discouraged from significantly increasing grant-making

in a particular year because doing so makes it more difficult for the foundation to

qualify for the reduced 1-percent excise tax rate in subsequent years.

PREPARED STATEMENT OF BRIAN GALLAGHER

Thank you, Mr. Chairman, Senator Baucus, and distinguished members of this

committee. I welcome the opportunity to speak to you today about issues of governance, accountability and performance in the nonprofit sector.

I am Brian Gallagher, President of United Way of America. I am here today representing my organization and 1,348 local, independent United Ways across the

country that are working hard to improve people’s lives and have a measurable,

positive impact in communities across America.

When I first came to United Way 4 years ago, I was hired to change the organization’s mission—to get United Way to focus on work that would show results. But

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traumatic world events interceded. We had the attacks on 9–11 and the response

of the charitable community to that event. There were corporate scandals at Enron,

WorldCom, and Tyco. And then a scandal erupted here, right in our own backyard,

at United Way of the National Capital Area.

I was embarrassed by that scandal, and it made me sick. Soon after it broke in

the Washington Post, we got a letter from Chairman Grassley asking how we monitor our local United Ways and what changes we would recommend to improve the

way nonprofit organizations work.

It became clear to me that no matter how many United Ways operate ethically

and do great work, a handful can make us all look bad and erode the confidence

people have in us. I realized that if I didn’t focus on accountability first we would

never get to our real work around mission.

So I took advantage of the opportunity this request from Chairman Grassley gave

us to accelerate changes within United Way. First, I put pressure on the National

Capital Area United Way to make significant changes—and they did. United Way

of the National Capital Area has taken the necessary steps since then to institute

real reform.

Next, I called for a review and an overhaul of our existing membership standards,

which was adopted overwhelmingly by our members in less than a year. We moved

fast and aggressively. The revised standards (see Attachment 1) have successfully

brought other United Ways into line, and, as a result, we disaffiliated over 50

United Ways for failure to meet one or more of our new membership requirements.

But for every United Way that remained in the system, we reaffirmed the values

of transparency, accountability, and disclosure through compliance with these new,

higher standards.

We at United Way needed a wake-up call and have taken the necessary steps to

restore trust, but the entire non-profit sector also needs to wake up on this issue.

If we in the sector can’t make meaningful, common-sense reforms that will promote

greater accountability, then there should be legislation—because changes in nonprofit accountability must be made in order to restore trust.

Last summer the staff of the Senate Finance Committee circulated a White Paper

containing a number of options for improving accountability in the nonprofit sector.

For the record, we agree with the overall thrust of this paper. In fact, some of the

language used in the paper, especially related to the IRS Form 990 reforms, was

taken verbatim from United Way’s new membership requirements. I had personally

reviewed these requirements with Chairman Grassley before they were implemented within our system.

Specifically, we agree with the proposals around responsibility, disclosure and effective operations—key elements of trust—including: • That the Chief Executive Officer—not just the Chief Financial Officer—of a

nonprofit should be required to sign and be responsible for the information on

the IRS Form 990.

• That the IRS should review every nonprofit’s tax-exempt status every 5 years

to ensure that they continue to operate exclusively for charitable purposes.

• That Congress should increase funding for IRS enforcement—and we support

this increase even if funding must be provided through increases in fees assessed on our sector, as long as we can be certain that the new fees will be used

for their intended purpose.

But we don’t agree with everything included in the White Paper. For example,

we disagree:

• That the size of nonprofit boards of directors should be limited by Federal law.

• That there should be government-mandated accreditation for nonprofits. Government regulation should focus on whether operations are legal, accountable,

and transparent, not on micromanagement.

But while we disagree on some of the details, we agree overall. We need to look

seriously at fundamental changes if we plan to change the operation and culture

of our sector. This is a great opportunity to address the trust issues that are facing

us.

Finally, if I ended my remarks now—after addressing financial and legal accountability only—I’d be doing our sector a huge disservice.

In a recent Internet poll conducted by United Way, we found that, while trust in

nonprofits is low, regulation isn’t what people are looking for. Only 35 percent of

respondents said that they thought there should be more regulation of charities by

the Federal Government.

The number one reason that people don’t have faith or trust in the non-profit sector is that donors don’t know how charities spend their money. It’s overwhelming—

71 percent of respondents who don’t trust charities said that their trust in non-profits would be greater if they knew how the money was spent.

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Financial accountability is just table stakes. You have to get that right first. But

ultimately, the American public should hold our sector accountable for delivering on

our missions. Unlike the business world, we don’t have market forces in play that

directly reward the creation of value or punish the lack thereof.

To address that concern, I respectfully suggest that nonprofit organizations be

asked to report concrete results annually that are tied directly to their missions, not

just the level of activity. Perhaps a results section such as that can be added to the

annual Form 990.

We should be asked to report concrete results that are tied directly to our missions, not just the level of activity we produce. When you’re asking people to contribute, you’re asking for an investment in your mission. And like a for-profit business, you are then accountable to your investors, not just for keeping good books,

but for creating value and offering a concrete return.

For those of us in human development, that means efforts that lead to measurable

improvements in people’s lives ought to be the ones rewarded with public or private

investment. In other words, the organizations that produce the greatest results

should grow and be rewarded. Those that do not should be forced to change or go

out of business.

Producing results has become the major focus for United Way—we’re looking at

the conditions that exist in the world today and we’re transforming our business—

what we do, how we do it and, most importantly, how we define success.

Why should we change? Because our helping systems were built for a different

economic time and a different set of social conditions. In the U.S. we have evolved

from an agrarian economy to an industrial economy, to a service economy, and finally an information and technology economy. And we are now in a global marketplace which changes how money is earned and how wealth and income are accumulated and distributed. It is why, during one of the longest macroeconomic expansions

in our history during the 1990s, we did not make real progress on some of our most

difficult social issues. Our systems were built for a time when economic good times

would lift all boats. It just doesn’t work that way anymore. So unless we get a laser

beam-like focus on real results, our health systems, education systems, child protection systems, and United Way systems will not create different strategies, work

with different partners, invest our resources differently, use the right metrics of success, and therefore make progress which will satisfy donor and taxpayer aspirations,

and thereby earn their trust and confidence.

Getting results is a huge part of rebuilding and maintaining trust. We know from

our research that, when people see their local United Way as a leader in getting

results in the community, their trust is significantly higher than our national average. In addition, these local United Ways also outperform our system averages in

the amount of money they raise. I believe that if we applied the same logic to the

entire nonprofit sector, we’d find the same thing.

The American public doesn’t give us money just because our operations are clean.

They expect that they are clean, and they should have every right to do so. Why

they really give us money, however, is because they want to make a difference. They

want to improve lives. And we—at United Way and throughout the sector—owe it

to them to be able to demonstrate that their money, invested through us, is indeed

making a difference and getting results.

Thank you for your time and consideration. I would be happy to answer any questions that you may have.

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LETTER FROM IRS COMMISSIONER MARK EVERSON

SUBMITTED BY SENATOR GRASSLEY

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RESPONSE TO A QUESTION FROM SENATOR ROCKEFELLER

Question: Anecdotal information and media reports indicate wrongdoing and questionable activities of a few organizations. How widespread do you believe these problems to be? Do you know of any credible studies assessing exempt organization compliance? How can Congress determine the size and scope of the noncompliance problem in this sector?

Answer: There are no data to my knowledge that could indicate how widespread

are abuses, questionable activities, or lack of compliance. To fully measure the incidence of such behavior, in addition to defining it, one would wish to take a random

sample of organizations and then audit them to determine the frequency of the activity in question. Such a study would need to be carried out by the Internal Revenue Service. The IRS has made such a compliance study in the past of individual

returns.

Absent such a study, only data that are largely anecdotal, data on examinations

reported by the IRS (as in Commissioner Everson’s testimony), or data that have

been gathered from returns are available. With respect to the issues I addressed in

my testimony, I cited a study reported in the Chronicle of Philanthropy that

searched a database to determine the number of supporting organizations with large

loans to officers and directors. The Form 990 returns of tax-exempt organizations

are public and have been put into a searchable database on the Internet by

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1 Harvey Lipman and Grant Williams, ‘‘Donors Set Up Grant-Making Groups, Then Borrow

Back Their Gifts,’’ Chronicle of Philanthropy, vol. 16, Issue 8. 2 Harvey Lipman and Grant Williams, ‘‘Assets on Loan,’’ Chronicle of Philanthropy, vol. 16,

Issue 8.

GuideStar, at www.guidestar.org. The Chronicle article reported 18 cases of sup- porting organizations with loans above $100,000.1

Considering charitable organizations and loans more generally, another article in

the same issue of the Chronicle indicated that 10,700 organizations showed loans

of some size (out of a population of 264,000 organizations).2 This is a rate of about

4 percent. Of the 10,700 organizations, 2,278 said they were owed at least $10,000;

4,756 did not report the amount of loans.

Making loans to officers and directors by charities is not prohibited by Federal

law, so that this practice may be considered questionable but would not constitute

non-compliance with Federal tax law. The article indicated that 19 States and the

District of Columbia prohibit or limit these loans, but there were 221 organizations

reporting loans in these jurisdictions. This finding suggests a higher rate of loans

among those States that do not prohibit these loans than for those States that do

prohibit such loans.

Note, however, that this type of analysis can detect practices by organizations

that report the required information, but not by organizations that fail to report,

and presumably organizations in States that prohibit lending are more likely to conceal such activities. Only a sample and audit approach can detect unreported activities, and even audits may not detect well-concealed behavior. Thus, it is reasonable

to expect a greater rate than 4 percent, perhaps significantly greater, but it is difficult to say how much.

One can use other types of data to try to estimate the magnitude of a problem,

as I discussed in my testimony. Tax return data on large supporting organizations

did show that two-thirds distributed less than the minimum amounts required by

private foundations, and if one considers delayed giving a problem, such data are

suggestive. More limited evidence from a private survey seemed to suggest similar

problems for donor-advised funds. As I discussed in my testimony, there are aggregate data from individual and estate tax returns that indicate a potentially significant problem with gifts of property that are difficult to value, but no way of knowing

the extent of overvaluation.

As noted above, the best approach, the sample and audit approach, can only be

done by IRS. For the 990 returns that are publicly available, analysis of the data

could be made by any group. Other tax returns, such as individual returns, are confidential, and to analyze data on these returns, committees and agencies with access

would need to do the analysis. Although certain congressional entities have access

to confidential tax return data, IRS may still need to provide specialized samples.

PREPARED STATEMENT OF HON. MIKE HATCH

I. INTRODUCTION

Mr. Chairman, members of the committee, it is a privilege to appear before you

to discuss the regulation of nonprofit and charitable organizations. I applaud the

Senate Finance Committee for conducting these hearings and considering improvements to foster increased accountability of such organizations. I also applaud the

many excellent suggestions for reform contained in the Senate Finance Committee

staff discussion draft and the report prepared by the staff of the Joint Committee

on Taxation.

Charitable organizations receive very generous local, State, and Federal tax exemptions in exchange for performing their charitable missions. Nonprofit and charitable organizations play an important role in our communities and in bettering the

lives of our fellow citizens. Most are dedicated to fulfilling their charitable missions

and perform a genuine public service worthy of the tax exemptions they receive. Unfortunately, a surprising number of charitable organizations encounter governance

problems that threaten the proper stewardship of charitable assets. There are also

bad actors within the sector who personally profit at the expense of the charitable

organization and its mission.

The board of directors is responsible for the proper governance of a nonprofit organization. Unlike private corporations, nonprofit organizations do not have shareholders to serve as a check to ensure that the board of directors exercises proper

stewardship. Nonprofit boards are essentially self-perpetuating. Strong State and

Federal Government regulatory oversight of the nonprofit sector is imperative to

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protect charitable assets, preserve the public’s trust, and ensure that tax exemptions

are well-deserved.

II. NONPROFIT HEALTH SYSTEM COMPLIANCE REVIEWS

A. Introduction

In Minnesota, there are over 25,000 nonprofit organizations, 2,500 charitable

trusts, 6,500 charitable soliciting organizations, and 250 professional fundraisers.

The Minnesota Attorney General is responsible for regulating these organizations.

This is a role attorneys general have played at common law dating back to 17-century England, where it was recognized that the community has an interest in the

enforcement of charitable organizations, and the attorney general was responsible

to represent this community interest. Today, our office exercises its regulatory oversight pursuant to both statutory and common law. Unfortunately, we only have a

staff of eight engaged in such activity. We have no financial auditors. We have no

compliance auditors. As with most States, we rely on the Internal Revenue Service

(‘‘IRS’’) to determine if a 501(c)(3) organization is engaging in charitable activity

that meets the standards of the Internal Revenue Code.

We are frequently required to take action involving nonprofit and charitable organizations when the boards of directors make or allow the improvident use of charitable assets in a manner inconsistent with the mission of the organization and the

tax exemptions those organizations enjoy. Today I would like to focus specifically on

our findings involving nonprofit health care organizations, which amply make the

case why self-regulation is not the right approach, and why strong government regulation of this sector is needed.

B. The Allina compliance review

In Minnesota, like the rest of the country, our health care system is in crisis.

Health care premiums have increased at double-digit levels year after year. Employers are getting squeezed by these costs, making it increasingly difficult for them to

offer health insurance to their employees. Health care also is prohibitively expensive

for many self-employed, retired, and uninsured citizens. In this climate, nonprofit

health care organizations owe a heightened duty to show proper stewardship over

nonprofit assets.

In 2000, the Office of the Inspector General (‘‘OIG’’) for the Health Care Financing

Administration completed a review of the spending practices of nine managed-care

organizations around the country that performed services for the Medicare program.

The OIG concluded that a number of these organizations had incurred expenses for

a variety of luxury items, such as Waterford crystal, season sporting tickets, and

travel.

Medica Health Plans (‘‘Medica’’) was one of the nine managed-care organizations

whose expenditures were reviewed by the OIG. Medica is a large, Minnesota-based

nonprofit health maintenance organization. The Medica president publicly announced that none of the expenditures uncovered by the OIG were billed to the

Medicare program, but instead were purchased with ‘‘private,’’ nonprofit, assets. Accordingly, members of the Minnesota State senate asked our office to commence an

investigation to determine the extent to which nonprofit assets were wasted on such

expenditures.

In 2000, we began a compliance review of Medica and its parent organization,

Allina Health Systems (‘‘Allina’’). Allina is registered with our office as a charitable

organization with tax-exempt status under section 501(c)(3) of the Internal Revenue

Code. It solicits funds from donors and operates numerous hospitals and clinics in

Minnesota. The purpose of the compliance review was to determine whether Allina

was exercising proper stewardship over its charitable assets.

The Allina compliance review required the commitment of a tremendous amount

of resources of the Attorney General’s Office over a 11⁄2-year period. Allina was a

$2.6 billion organization which controlled over 50 separate legal entities. These entities included nonprofit tax-exempt organizations, taxable nonprofit organizations,

for-profit organizations, joint ventures, trusts, partnerships, limited liability companies, and numerous operating units and divisions, both with and without separate

boards of directors. Allina refused to cooperate with the compliance review, and we

were forced to obtain a court order requiring it to produce records. The records it

ultimately produced documented a serious breach of accountability on the part of

both Allina executives and the board of directors.

Allina paid for employee travel to destinations such as Aruba, London, Paris, Venice, Grand Cayman, Athens, Cancun, Pago Pago, and Los Cabos. It paid for its

president and his wife to travel to Grand Cayman Island, including four nights at

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a 5-star oceanfront resort costing over $600 per night. It paid for over 30 trips to

the Hawaiian Islands.

Allina paid $89,000 for its board members and executives, and their spouses, to

travel to the Phoenician Inn in Arizona. The Phoenician Inn boasts a $25 million

art collection, marble from the same Italian quarry that Michelangelo used for the

Pieta, chocolate for ‘‘tuck in’’ service flown in from Belgium 3 times per week, and

a 22,000 square-foot spa. Allina spent over $14,000 on food and alcohol and over

$4,500 on golf, tennis, and spas. One dinner alone cost over $5,000. Executives

charged the organization for $100 floral arrangements to decorate their $855 per

night suites. When we asked Allina to explain its ‘‘business purpose’’ for the trip,

it stated that the trip was designed to inspire discussions about ‘‘health care reform.’’

Allina similarly paid $42,500 to send executives and their spouses to the

LaQuinta Resort in California, which promotes itself as ‘‘one of the most coveted golf

resort destinations anywhere in the world.’’ They spent over $16,000 on golf, including over $2,000 in golf lessons, $1,700 in spa charges, and $2,400 for a jeep tour.

On another occasion, Allina paid for its executives and spouses to take a 3-day

wine tour of Napa Valley, complete with private limousines and hot air balloon

rides. On yet another occasion, it sent executives to Monterey, California, where

they traveled in limousines and expensed thousands of dollars in meals at the area’s

most exclusive restaurant. Allina stated that the trip was designed to teach executives how to run a health care system with a ‘‘moral center.’’ The hospital administrator ordered an accounts payable clerk who questioned the propriety of the expenses to pay the bills, noting that he doubted there was a ‘‘high exposure’’ of the

media learning about the junket.

Allina paid for private memberships for ten of its top executives in the Twin Cities’ most prestigious golf clubs. It reimbursed one executive $1,400 to analyze his

handicap, polish his golf clubs, and otherwise tend to similar needs.

Allina also spent thousands of dollars on executives’ season and playoff tickets to

the Minnesota Timberwolves, Minnesota Vikings, and Minnesota Twins.

Executives were reimbursed for lavish gifts to other executives and board members, including $3,000 bronze sculptures, $1,300 golf clubs, and $600 Waterford crystal.

Executives were handsomely paid. Allina offered executives approximately ten different incentive and bonus plans to augment 6-figure executive salaries by up to 150

percent. For instance, it compensated its executives with management incentive

plans, defined benefit plans, 401(k) plans, long-term incentive plans, supplemental

retirement plans, and mutual fund acquisition plans. The CEO in 1998 received

compensation of over $900,000 per year.

Allina manipulated its bonus plans to guarantee that executives would qualify for

bonuses. For instance, Allina’s management incentive plan required that it reach 80

percent of its budgeted annual net income for bonuses to be paid. When it became

clear that Allina would not meet that target as the end of the year approached,

Allina simply lowered the figure to 60 percent and paid $2.6 million in bonuses for

which executives were ineligible.

Allina paid long-time executives over $1 million as ‘‘retention bonuses’’ for simply

remaining employees of Allina. The president, for instance, was promised a ‘‘signing

bonus’’ of $100,000 when he moved from one Allina affiliate to another and an additional $200,000 if he remained an executive of Allina 2 years later. Allina then paid

the executive the $200,000 1 year early.

Allina also spent tens of millions of dollars on consultants who failed to document

their time or expenses.

Allina paid nearly $1 million per year for a part-time consultant to act as its chief

operating officer. Allina also paid for her $855 per month luxury sport utility vehicle, luxury lakefront condominium, and first-class air travel. It paid for her

incidentals of daily living, such as her cable TV bill, utility bills, valet parking, maid

service, and even her shower curtains.

Allina paid $1.9 million to another consultant (who promoted herself as an ‘‘advisor’’ to movie stars) to serve as the personal confidant of the COO. The confidant

billed $300,000 in expenses with no documentation. Another consultant was paid

over $150,000 to help groom the image of top executives. Allina paid $15,000 for a

sleepover retreat for senior executives in which they watched the movie 12 O’clock

High. It paid $37,000 to a consultant to organize the retreat. At these sleepover retreats, which occurred on a regular basis, executives were forced to sit in each other’s laps to ‘‘build trust’’ and play ‘‘ring toss’’ to find their ‘‘inner selves.’’

Allina’s ‘‘independent’’ auditor was paid over $35 million, mostly for acting as a

consultant. No detail was provided to justify the accounting firm’s professional fees,

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nor was supporting detail provided for over $4 million in expenses. The auditor repeatedly issued unqualified audits.

The organization was rife with conflicts of interest.

The Allina board of directors not only failed to prevent the above abuses, but actively participated in them.

C. The HealthPartners compliance review

After completing the compliance review of Allina in 2001, we commenced a compliance review of HealthPartners, another large nonprofit HMO and hospital system

in Minnesota. HealthPartners was registered with our office as a charitable trust.

It has over $1 billion in revenue and operates over 19 nonprofit and for-profit subsidiaries. The HealthPartners compliance review also took about a year and a half

to complete. As with Allina, the compliance review documented a lack of accountability and proper stewardship.

HealthPartners paid for over 100 flights to over 30 international destinations, in- cluding every continent but Antarctica. It paid over $17,000 for its CEO’s ‘‘trade

mission retreats’’ to Brazil, Chile, and Ireland, though the organization only operates in Minnesota and western Wisconsin. It paid $9,000 for its CEO to travel to

Australia to find out: ‘‘Are we pricing consumers out of health care?’’ HealthPartners paid over $30,000 per year for its CEO and board members to

travel to 4-star Florida resorts, where they golfed, dined, and entertained themselves at the nonprofit’s expense. HealthPartners paid almost $250,000 for its executives’ membership in and use of country and golf clubs. It paid over $50,000 for its

CEO’s season tickets to the Minnesota Vikings.

HealthPartners paid for executives and board members to give each other expensive gifts, including golf clubs, kayaks, crystal, and spa services. It paid for its

CEO’s living expenses, which it attempted to conceal in expense reports. For instance, a Garrison Keillor satire and book on Harley Davidson motorcycles were

billed as ‘‘business strategies research.’’ Items such as the CEO’s lean cuisine dinners were billed as ‘‘supplies.’’

Executives received generous savings and retirement plans, such as ‘‘split dollar’’

life insurance plans, retention bonuses, mutual fund option purchase plans, capital

accumulation plans, and supplemental executive retirement plans. HealthPartners

took steps to conceal the payments by mislabeling them, and it improperly omitted

executives’ deferred compensation from the IRS Form 990.

After HealthPartners began to pay for massages at board meetings, masseuses

were implored to ‘‘bring more oil’’ to the next meeting. Ironically, the HMO refused

to cover massage therapy for victims of Parkinson’s Disease.

Once again, the HealthPartners board of directors not only failed to prevent these

abuses, but actively participated in them.

III. NONPROFIT HOSPITAL CHARITY CARE AND DEBT COLLECTION PRACTICES

Another important area I would like to address is our experience concerning the

billing, debt collection, and charity care practices of nonprofit hospitals. These issues

relate to whether nonprofit hospitals are appropriately fulfilling their missions in

a manner that justifies their tax-exempt status.

We should not in this country have a health care system that bankrupts patients

because they get sick. The very poor typically have access to government programs

such as Medicaid to help them with their medical bills. The middle class and working poor do not. With skyrocketing premiums, many employers are unable to offer

health insurance coverage for their employees, and many individuals are unable to

afford to pay for coverage. The reality is that even a short hospital stay can bankrupt a middle-class or low-income family who is uninsured or under-insured. Indeed,

Harvard University recently reported that approximately 50 percent of all bankruptcies are caused in part by medical bills.

Medical providers are among the creditors most likely to refer debt to collection

agencies. Patients subjected to aggressive medical debt collection practices are more

likely to resort to financially unsound methods, such as credit cards and home equity loans, to pay off the debt. This sinks them even deeper into debt.

Medical debt also has serious health consequences. Over 50 percent of patients

with medical debt reported in one study that they delayed getting necessary treatment because of their unpaid medical bills. These patients were uncomfortable seeking additional treatment because they owed money, they were asked to pay cash up

front, or they were denied care because of the unpaid bills. Patients who postpone

medical care often resort to seeking more expensive and less effective care later on,

such as in the emergency room.

Many hospitals today are under pressure to absorb the cost of treating the uninsured. For instance, in my State, an additional 40,000 Minnesotans were recently

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cut from MinnesotaCare to balance the State’s budget. Since 1992, MinnesotaCare

had offered modest health coverage benefits for the working poor in exchange for

affordable premium payments. These cuts place increasing financial pressure on

hospitals.

Nevertheless, until the health care system is changed, nonprofit hospitals must

do their part not to bankrupt the uninsured. Nonprofit hospitals benefit from generous tax exemptions at the local, State, and Federal levels. As a result of these

exemptions and their nonprofit status, they owe the community a duty to treat the

uninsured in a fair and humane fashion. To do this, hospitals must take several actions.

First, hospitals must end brutal and inhumane debt collection practices. Some

nonprofit hospitals hire debt collectors to sue impoverished patients, to garnish their

meager bank accounts, hound them with harassing calls, or even to threaten them

with arrest. One disabled woman in rural Minnesota was so hounded by a hospital’s

debt collectors after incurring $75,000 in cancer treatment that she wrote to us that

she felt she had no options to satisfy her debt ‘‘short of killing myself.’’ We have

discovered debt collection lawyers who lie about serving summonses, who sue patients because hospitals bill insurers over a year late and are therefore barred from

collecting from the insurers, and at least one female patient who received treatment

for a fractured elbow and was billed for two penile implants. These types of debt

collection practices are not consistent with a nonprofit mission and subject the hospital to litigation.

Second, hospitals and clinics charge substantially more to uninsured patients than

they charge to HMOs, insurance companies, or the government for the exact same

treatment. Third-party payors and the government use their market power to extract steep discounts from the retail, or ‘‘sticker’’ price, of hospital and clinic bills.

As hospitals and clinics seek to generate more revenue, they raise their retail price

for services, prompting insurers to demand even steeper discounts the next time

both sides negotiate. The result is that uninsured patients are billed an artificial

retail price that may be 50 percent or more than the cost an insurance company

or the government pays for the same services. In other words, nobody pays the retail price but the hapless uninsured, who are usually poor.

The practice through which hospitals and clinics charge an inflated rate—which

nobody else pays—to the uninsured must end. These pricing inequities are inconsistent with a nonprofit mission. They also constitute consumer fraud.

Last Friday, Fairview Health Services (‘‘Fairview’’), one of the largest hospital

systems in Minnesota, took steps to give discounts of 40 to 100 percent to uninsured

Minnesotans with household income of up to 450 percent of the Federal poverty

level (i.e., a single person with household income of $43,065 or a family of four with

household income of $87,075). Persons with those incomes will also have their total

liability capped at $5,981 and $12,095, respectively. Fairview also entered into an

agreement with our office to improve the manner in which medical debt is collected

from patients.

Fairview’s leadership is a step in the right direction. One hospital, however, cannot act alone for long, lest it become a dumping ground for the uninsured by other

hospitals. All hospitals must reform their retail prices so as not to gouge the uninsured with phony, artificially high rates that nobody else pays. For those Minnesota

hospitals that do not, we intend to examine their charity care and billing practices

and, where necessary, file lawsuits to correct them.

Third, hospitals must deliver a fair level of charity care. Many nonprofit hospitals

deliver charity care at paltry levels, far less than the need of their patients or that

their revenue, assets, or fundraising would allow. Hospitals also sometimes try to

inflate their supposed charity care through numerous devices. They may label as

‘‘charity care’’ the fact that they treat Medicare and Medicaid patients at the discounted rates the government reimburses for treatment rendered to those patients.

They may label as ‘‘charity care’’ bad debt they write off. Or they may label as

‘‘charity care’’ various ‘‘educational’’ expenses that appear designed less to deliver

health care to the patient than to increase the hospital’s market share.

Finally, many nonprofit hospitals tout their benevolent good works to donors

when they solicit tax-deductible donations. A hospital that does this, while at the

same time billing the uninsured a phony retail price, not providing fair levels of

charity care, and hounding patients through unfair debt collection practices, engages

in the fraudulent solicitation of charitable donations.

I call on Congress to exercise leadership in helping to reform nonprofit hospital

billing, collection, and charity care practices. I also call on the IRS to crack down

on nonprofit hospitals that do not reform their practices.

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IV. NONPROFIT ORGANIZATIONS MUST BE REGULATED TO ACHIEVE ACCOUNTABILITY

Nonprofit organizations should establish internal standards for proper conduct

and strive to hold themselves accountable. Self-regulation, however, is no replacement for strong government regulation. Nonprofit directors and executives sometimes suffer from a ‘‘halo effect’’ in which they believe that because their mission

is pure, their actions are above reproach. Indeed, during our health care compliance

reviews, executives expressed surprise that we would dare to question whether their

trips or country club memberships constituted proper stewardship. of nonprofit assets, when ‘‘everyone else in the industry was doing it too.’’ When the board and

executives assume such an attitude, there are no shareholders to question their conduct; there is only the government to fulfill a role it has played for centuries.

Self-regulation alone also is not the answer because boards or trustees often actively participate in the abuses. We found this to be true in our health care compliance reviews. It happens in other areas as well. We recently discovered that the assets of an elderly woman’s charitable trust had been depleted by her trustee, who

was also her financial advisor. Through the purchase of annuities and life insurance

that named him as the beneficiary, the trustee transferred millions of dollars to

himself and his family, creating an estate tax liability that siphoned off the remainder of the trust’s funds, leaving no money for the intended charitable beneficiaries.

I would like to offer several additional observations gleaned from our experiences

with nonprofit health care organizations, as well as our experiences gained from

regulatory oversight of other types of charities.

First, the board of directors of a nonprofit organization is responsible to set the

tone and culture for the organization and ensure proper stewardship. Yet, we frequently encounter directors of nonprofits who take a subordinate role to the paid

executives of the organization. Nonprofit boards are sometimes composed of good

people who are well-meaning but, for one reason or another, may not fill their role

in ensuring stewardship by the organization. This may occur because board members are volunteers who are not appropriately engaged in the governance of the organization or are on the board primarily to lend credibility or fundraising prowess.

Our office is called upon on a regular basis to reform nonprofits which fail to follow

sound governance principles. We would support legislative efforts, such as those contained in the committee staff paper, to prompt boards to follow prudent, basic governance standards—such as to establish, review and approve basic organizational

policies and procedures.

Second, in some cases, nonprofit boards are too heavily comprised of directors who

are compensated by the organization. This leads to a ‘‘tail wagging the dog’’ effect,

where the board is led by the staff, rather than the other way around. In other

cases, the CEO hand-picks directors who are then awarded lucrative legal, insurance, supplier, or other contracts by the organization. For example, we recently investigated a mental health organization with an important mission of serving certain hard-to-reach communities. Several ‘‘interested’’ board members were also employed by the organization, and they deadlocked with the independent directors on

the board. During the ensuing power struggle, the organization’s finances became

imperiled. Congress should limit the number of board members who may be compensated by the organization and require conflict of interest policies to be adopted.

Third, far too many nonprofit organizations operate in this country for regulators

to catch all abuses. Congress should pass legislation to help increase the likelihood

that the most glaring abuses will be detected, including steps to ensure that bad

actors cannot carry out their wrongdoing through inertia. These reforms should require independent auditing firms to be replaced on a regular basis and require nonprofit organizations to justify their tax-exempt status to the IRS on a periodic basis.

I also understand that Congress is considering a proposal to target Federal dollars

to States for their charitable regulatory enforcement efforts. Any efforts by Congress

to provide funds to State agencies would be welcome, particularly in an era of

strained State resources.

Fourth, the selection criteria for undertaking an investigation may differ widely

among regulators. A case that is ‘‘too small’’ for the Federal Government may be

taken by a State regulator because of its local impact. A case that is too spread out

for any one State to take a parochial interest in may catch the attention of the Federal Government. A State may lack the resources to take a particular case. Other

cases may simply escape detection by various regulators for unknown reasons. For

instance, Minnesota was recently the first State in the country to take action

against the National School Fitness Foundation (‘‘NSFF’’), a Utah nonprofit which

operated on a national level and had tax-exempt status under section 501(c)(3) of

the Internal Revenue Code. NSFF purported to offer free physical education equipment to school districts nationwide. It did this by getting school districts to pay its

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for-profit affiliate for equipment on the promise that districts would later be repaid

by NSFF with charitable donations it received. Instead, NSFF simply operated one

of the largest ponzi schemes in history, in which school districts had their ‘‘free’’

equipment paid for by newer districts entering the program. Over 600 cash-strapped

school districts entered into these arrangements at a cost of over $77 million. In

July, 2004, the president of NSFF’s affiliated for-profit company pled guilty to Federal criminal charges.

Congress should vest more regulators with more authority. The IRS should be

permitted to share data with State attorneys general. State attorneys general are

hampered in their enforcement efforts because the IRS cannot share data with

them. In the case involving the NSFF ponzi scheme, for example, while we were

able to provide information to the IRS, Federal law prohibited it from sharing information with us. Further, State attorneys general should be allowed in their charities oversight role to enforce Federal tax laws. This is an approach that has worked

well between the Federal Trade Commission and State attorneys general, where attorneys general are permitted to enforce Federal laws such as the Telemarketing

Sales Rule and Fair Credit Reporting Act. Similarly, the IRS and tax courts should

have the authority that State attorneys general have to seek the removal of board

members, officers, or employees who have engaged in improper conduct.

Fifth, executives and directors of nonprofits have no financial skin in the game.

They do not place their own money at risk, nor is their own money being spent.

We have frequently seen nonprofits spend money—particularly on travel and entertainment expenses—in a manner more copious than many private corporations. We

certainly saw this in our health care compliance reviews. For example, we uncovered dozens of private country club memberships paid for by nonprofit health care

organizations. Many for-profit corporations we interviewed noted that such expenses

are not deductible under IRS regulations and stated that they would not pay for

them in any event. Nonprofit organizations sometimes attempt to rationalize such

expenses on the basis that the executives earn less than they would in the private

sector. My response is that while this may be the case, those executives are free

to go work in the private sector. Congress should limit the amount that nonprofits

may spend for travel, meals, and accommodations to the rate the U.S. government

would pay for those items. There is absolutely no reason that a nonprofit that receives tax breaks from the government needs to spend more than the government

for travel and entertainment.

Sixth, particular reforms are also needed in the area of executive compensation.

The compensation of executives in some nonprofits, particularly the health care organizations discussed above, is grossly excessive. The IRS intermediate sanction regulations created procedures (i.e., board review, market comparability studies, etc.)

designed to ensure a substantively appropriate result. The regulations further provided that, if these procedures were followed, there would be a rebuttable presumption that the compensation was reasonable. The thought was that if the proper procedural steps were followed, the proper result would be reached. This has not occurred. Indeed, the sanctions have had an opposite effect with Minnesota health

care organizations. These organizations feel empowered to pay excessive salaries because they believe it will be difficult for regulators to question the substance of the

transaction if the required procedural steps were taken. The problem is that it is

far too easy to manipulate the procedural steps to obtain the desired result.

At the outset, executives of the health care companies we examined retained the

compensation consultant hired to provide the market comparison figures. The consultant is then beholden to the executive who hired him and, wanting to please that

executive so as to be retained again in the future, will help justify the executive’s

salary. Next, the market comparisons relied on to justify health care executives’

compensation are those of other overly-paid health care executives. Then, because

no board of directors wants to hire a ‘‘below average’’ executive, boards typically pay

their executives a compensation package that is ‘‘above average’’ in the market to

reflect the board’s good judgment in hiring an above-average executive. This leads

to a ‘‘Lake Wobegon’’ effect, in which all health care executives are above average.

The problem is magnified during succeeding review periods.

For these reasons, I concur with the suggestion in the report by the staff of the

Joint Committee on Taxation to repeal the ‘‘rebuttable presumption of reasonableness’’ under the intermediate sanctions test. Under that standard, a salary is presumed reasonable as long as the right procedural steps are followed. In this way,

regulators would become more liberated to question the substance of the transaction

for reasonableness, not just the procedures employed. Congress should also embrace

the staff suggestion that compensation consultants be retained and supervised by

the board so as to ensure a proper level of independence.

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Seventh, we regularly advise donors to use the Form 990 as a tool to make informed decisions. Yet, Form 990s often are not particularly useful, especially where

they are incomplete, inaccurate, or late. I agree with the recommendations in the

Senate Finance Committee staff discussion paper that Form 990s should be signed

by the CEO, that penalties be increased for failure to file a Form 990, and that the

Form 990 more fully disclose the filing organization’s relationships with affiliated

tax-exempt and nonexempt organizations. The nonprofit health care organizations

we have examined are enormously complex entities, and it is far too easy for them

to masquerade their finances by steering money to other affiliates in the organization, including for-profit affiliates. Greater transparency is needed.

Eighth, Congress should tighten up the standards for nonprofit credit counseling

organizations, particularly in the face of the mandatory credit counseling provisions

of the Federal bankruptcy bill. I was one of the State attorneys general who filed

a lawsuit against AmeriDebt, Inc., together with the Federal Trade Commission.

AmeriDebt aggressively marketed Minnesotans, touting its status as a 501(c)(3) to

bait vulnerable consumers into credit counseling. Instead of assisting consumers to

pay down their debts, AmeriDebt exacerbated their situation, charging large monthly and up-front fees which it then siphoned off to for-profit companies. For example,

one rural Minnesota consumer named in our complaint turned to AmeriDebt for

help paying her bills in the face of health problems. She believed that AmeriDebt,

as a nonprofit, would provide her free services. In fact, AmeriDebt took a $200 origination fee and $25 from each monthly payment that she thought would go to creditors. Because the creditors were not paid, they started assessing the consumer late

charges. This woman, along with thousands of others, was in a far worse financial

position after turning to AmeriDebt for help.

V. CONCLUSION

A solemn trust with the public is created when an organization receives tax-exempt status. That trust includes a duty to make provident use of the organization’s

assets to further the mission of the organization and better the community. When

one organization engages in the types of abuses described above, confidence in the

entire sector is degraded. Congress should take decisive action to promote more effective regulation of charitable organizations at both the State and Federal levels.

I thank you for the opportunity to appear before you today.

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PREPARED STATEMENT OF RICHARD JOHNSON

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PREPARED STATEMENT OF DAVID KUO

Chairman Grassley, Senator Baucus, and distinguished members of the committee, I am David Kuo, contributing editor to Beliefnet.com, the leading multi-faith

religion and spirituality website. For 21⁄2 years I was also Special Assistant to the

President and Deputy Director of the Office of Faith-Based and Community Initiatives at the White House under President George W. Bush.

My perspective on the topics we discuss this morning is informed by various vantage points on the charitable sector I’ve had during the past 15 years. I’ve worked

in senior positions here in the United States Senate, in advocacy organizations and

in the White House. For 3 years I founded and tried to create a charitable organization to objectively determine the efficacy and efficiency of social service organizations. I was even recruited to a dot-com company with the promise that I’d be able

to manage what promised to be a huge foundation—they were going to give away

1 percent of gross revenues to charity, and, since they’d be making hundreds of billions of dollars every year, that meant a lot of money for charitable giving. Suffice

it to say that things didn’t turn out quite as planned.

I also approach it from a certain philosophical perspective. I believe in government’s inviolable duty to help serve the poor. This isn’t just philosophy for me, it

is also theology. I believe that Jesus’s commands to care for the least among us

mean that we have to bring to social problems every available resource and every

best effort. I reject some conservative notions that suggest the government is the

enemy and must step out of the way and let the private sector take over. I similarly

reject some liberal notions that suggest the answer to every problem is another government program and more government money. Both of these noxious notions are

born of either ignorance or indifference. It doesn’t really matter which. My passion

isn’t for politics per se but for what politics can bring to bear on these matters. It

is in that spirit that I want to speak to government, to the non-profit sector, and

to us as individuals.

I believe in President Bush’s compassionate conservative philosophy as articulated

at the start of his 2000 campaign. ‘‘It is not enough for conservatives like me to

praise [charitable efforts]. It is not enough to call for volunteerism. Without more

support and resources, both private and public, we are asking them to make bricks

without straw.’’ His proposals for $8 billion per year in new spending and charitable

tax incentives for non-itemizers and IRA rollovers were important policies, but they

were something more—they were an unmistakable public signal that charity, compassion, and care for the poor were to be cornerstones of his domestic policy.

Four years later, these tax incentives and other spending programs haven’t yet

been enacted. The White House could certainly have done more. That’s already been

said. However, were it not for the President’s interest in these issues, we wouldn’t

be here today. That brings me to Congress. Save for the tireless action of this committee that has repeatedly pushed for charitable tax incentives, I have been astonished by the lack of interest in these matters by your colleagues. The CARE Act

is a perfect example. For the last few years, the CARE Act has had overwhelming

bipartisan support, and has gone nowhere. Why? In large part it is because of widespread congressional apathy and a desire for political gamesmanship on all sides.

I have been quoted as saying that the White House knows how to get what it really

wants to get. That is true. But, just as certainly, Congress knows how to get what

Congress wants. Why hasn’t Congress been a passionate advocate on behalf of charities and the poor in the midst of economic crisis, a downturn in charitable giving

and an upturn in social service needs?

As Members of the United States Senate, you are called and pulled in every different direction. Every problem, every constituency demands more from you and of

you. But I can think of no other area in American politics so ignored by political

leaders than matters of charity, of care for the poor, of substantive debate and discussion on matters of civil society. No, America’s poor do not have a powerful voice.

They aren’t combined into the power of the AARP. They aren’t likely to flood your

office with calls, e-mails, or letters, and yet there are more poor Americans today

than there were 4 years ago. It is always easy politics to blame either the other

party or the White House, but I just wonder why these matters are such a low priority for the United States Congress?

It isn’t just Congress that has ignored charities. Without any doubt, the charity

abuse stories that we hear are the result of a lack of IRS enforcement of existing

laws. Having had my own 501(c)(3) organization that looked into the efficacy and

efficiency of other organizations, I saw firsthand cases of willful misuse of funds.

That kind of stuff was hardly a secret. And yet where is IRS enforcement of these

existing laws? It has been AWOL, and now we are to believe that new laws are the

answer?

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By themselves they are not. They may serve the appetite of a public that wants

action, because nothing spells action more than a new law. But, without dramatic

enforcement enhancements, we’ll all be back having the same debate 5 years from

now.

Make no mistake, however, I am not a shiny, happy charity cheerleader. If we

don’t face the facts that loopholes need to be closed, reforms made, and accountability had, we will have failed just as much as if we did nothing. The IRS cannot

enforce laws that make no sense or that provide loopholes for the wealthy in the

name of charity. Clearly, more stringent rules need to be put in place regarding the

use of donor-advised funds. It hardly seems a stretch to require accounts to pay out

a certain basement requirement annually. More publicly disclosed information about

charities also seems to be a no-brainer. Charities are by their very definition here

to serve the public interest. The public has a right to know a lot more than they

currently do about how these organizations operate, how much money individuals

are making, and how the money is being spent. Donors’ private information should

remain private, but charities need to see daylight.

I’d like to add one more thing. We need to begin looking at information in different ways. To date, charities tend to be judged by how well their accountants

make their books look like all the money is going to serve targeted populations.

Why? Because that is how ‘‘efficient’’ charities have been ranked by media like U.S.

News & World Report. Unfortunately, this mindset has prevented us from asking

a more important question. ‘‘How well?’’ Efficacy is a far more important and relevant gauge than efficiency. We need to begin asking charities to tangibly measure

how well they are doing their jobs, not just how efficiently.

Charitable abuses are real and they are offensive. They must be eliminated, serious fines must be imposed, and violators need to be exposed. But we must be careful

amidst these reports not to allow these abuses to create new laws that punish the

overwhelming majority of donors or the recipients of non-profit services—the poor,

the addicted, those seeking education, those in need of health care or those who simply love art. I am concerned about changes in non-cash deductions and clothing deductions; that may be using disproportionate force given the problems.

Finally, the United States faces record budget deficits, not because of abuses in

the charitable sector but because of choices and priorities that our government has

made. Much of the rhetoric around charity that I have been hearing lately seems

to suggest that the charitable sector is a great target for raising more funds to ensure the continuity of our existing way of government waste. Doesn’t that strike the

committee as a bit odd, perhaps even a bit perverse?

Everything we’re discussing today is about the culture of charity that we are creating. The culture of charity is hurt by a lack of enforcement. It is hurt by loopholes

and exceptions and tricks that benefit the rich in the name of the poor. It is also

hurt by laws that inadvertently discourage charitable giving. Nowhere is that clearer than in the estate tax. Congress will be revisiting this matter in the coming

months. As it does so I hope that it, and this committee, will bear in mind the huge

consequences that matter has on the charitable community. Conservative estimates

show that a total repeal of the tax would cost the charitable sector more than $10

billion per year. That is a lot of money and discourages the culture of charity.

I want to close by again thanking Senator Grassley, Senator Baucus and their exceptional staffs. We are having a vigorous debate this morning about charity, about

giving, and about helping others. Everyone here should be excited about the debate,

because the debate will lead to important changes, new understanding, and a

stronger charitable sector benefiting America.

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STATEMENT OF THE ARKANSAS COMMUNITY FOUNDATION

SUBMITTED BY HON. BLANCHE LINCOLN

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PREPARED STATEMENT OF LEON PANETTA

Mr. Chairman, members of the committee, I am pleased to be here in my capacity

as a member of the Citizens Advisory Group to the Panel on the Nonprofit Sector.

As most of you know, I have been in the public sector and the private sector and

I now serve as the director of the Panetta Institute, a nonprofit, non-partisan center

for the study of public policy located at California State University, Monterey Bay.

When I was in government, I was privileged to serve as a Member in the House

of Representatives, and as Director of the U.S. Office of Management and Budget,

and as Chief of Staff in the White House.

From those different vantage points I learned a great deal about the role of charities and foundations in this country and came to appreciate, far more than I had

before, how essential to our communities and our Nation these organizations are to

serving the needs of a nation. Whether large or small, these organizations focus on

a wide range of services from helping the homeless or bringing opera to the schools,

cleaning the oceans or researching a cure for AIDS. Their ability to innovate, collaborate and tailor services to meet an immediate need, test a creative idea or build

a museum for the arts is something government officials support and applaud. Their

work in many ways represents the essence of our democracy.

The human as well as financial resources these organizations tap is inspirational.

We saw it most recently and most overwhelmingly following the tsunami crisis,

when the best of what we are capable of being came to the fore as millions of individuals and organizations contributed more than a billion dollars to help the victims

of this immense tragedy.

Are there abuses in the nonprofit field? Yes, sadly, there are. In the midst of incomprehensible human suffering and need in southeast Asia, there were a few scam

artists attempting to siphon off funds for their personal use, funds that would otherwise have gone to help rebuild the devastated communities in Sri Lanka, India and

Thailand. There are a few charitable organizations that have not been good stewards of the public trust, that have spent charitable dollars for purposes other than

those for which they were contributed.

I join you in saying that these abuses must end. I feel very strongly that charitable institutions must be above reproach, because they are so essential to every aspect of community life. The only way to guarantee their continuation is to ensure

an even higher level of public confidence and trust in the way they do business. We

cannot allow the small number of those who deliberately abuse the public trust to

hurt the good name of thousands of organizations that operate in good faith and

serve the public good with distinction.

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Having spent some time lately reviewing current laws and IRS regulations as well

as the Finance Committee’s staff discussion paper and the Joint Committee on Taxation’s Options paper, I believe that collectively you have done an excellent job of

clearly identifying problem areas. I want to commend you for your vigilance and

your commitment to protecting what is best about this magnificent voluntary sector.

Already your attention to this area has stimulated many to look at their programs

and practices with an eye towards improvement.

The fundamental issue you confront today is how do you balance the need for new

laws and regulations with the need for stronger enforcement of existing laws with

the need for tougher self-regulation?

There may be some new laws or clarifying rules needed in certain areas of charitable activity, but we also need greater attention paid to adequate enforcement of

current law. Many of the stories I’ve seen describing excessive compensation and

self-dealing (where insiders benefit not the charitable cause) appear to be violations

of existing law. In those instances, the problems would not be solved by simply raising the bar, but by going after the violators.

The vast majority of abuses are already illegal, and the solution lies more in improving—greatly improving—enforcement of the laws and regulations already on the

books than in creating more laws and regulations that increase the burdens on the

IRS. I say this having served in the public sector and being keenly aware of the

shortage of financial resources to achieve this important goal. I begin, therefore, by

encouraging serious consideration of increased funding for the IRS to allow for additional audits, collection of fees, and development and installation of software that

will enable mandatory electronic filing of all of the forms in the 990 series, including

attachments, and Form 1023, the application for 501(c)(3) status.

I believe that a good blueprint for action is provided in the recommendations included in the Panel on the Nonprofit Sector’s Interim Report. As a member of the

Citizens Advisory Group, I had the opportunity to review the work of the Panel and

the well-considered advice it received from so many fine experts and organizations.

I believe it has achieved the important balance between adequate oversight and accountability and the ability of charitable organizations to fulfill their missions.

Among the recommendations that I call to your attention are: • Requiring audits for organizations with annual revenues over $2 million, and

mandating an independent public accountant’s review of financial statements

for those with budgets of $500,000 to $2 million (p. 23). • Defining and clarifying the rules for donor-advised funds (p. 36). • Increasing penalties for violations of the self-dealing rules (p. 40). • Allowing better cooperation between State and Federal regulators (p. 47). • Encouraging the IRS to move forward with mandatory electronic filing for the

Form 990 series (p. 21).

The Panel on the Nonprofit Sector is now preparing its recommendations on other

critical issues, and will release a final report in late spring. I encourage you to hear

the full scope of its recommendations before you take any formal action.

Even with improved regulations and the significant infusion of funds, there is a

limit to what can be achieved through new legislation and improved enforcement.

Without the collective will within the voluntary sector to uphold good standards of

ethical practice, we will not achieve the outcome we all wish for.

I have had the opportunity to meet many leaders of charitable endeavors. Their

purpose is to make life better in some way, and they try their best to live up to

their obligations. Too many of them don’t know as much as they would like about

board governance, management of organizations, audit processes, self-dealing and so

on. For them a good program of education would do wonders. I hope that this committee will favorably consider putting some meaningful resources behind a nationwide education system undertaken by the charitable sector itself. But I also encourage the sector itself to invest in this effort. A comprehensive education initiative will

take both public and charitable sectors coming together to achieve these outcomes.

Let me offer some thoughts that go beyond where the panel is at this time. I fervently believe the best way to prevent abuse and raise the standards of the charitable sector is for the sector to demand of itself greater accountability. And I understand that this is beginning to happen. Numerous organizations have held conferences, workshops, seminars and other training sessions on the fiduciary responsibilities of boards of directors, chief executive officers and others. Many of the sector’s leaders have begun to better educate themselves and their directors about the

law and filing requirements. And there are a host of organizations—national, regional and local—devoted to standard setting and improving the practices of their

affiliates and those associated with them. I am aware that some fields of practice

require compliance and meeting of certain standards in order for the organization

and professionals to operate. Other standards are entirely voluntary.

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It is a good start, but it is far from sufficient. Self-regulation, to be credible and

effective, must have a structure, must demand high standards, and must have the

authority to investigate allegations of wrongdoing and enforce penalties. Without

such a structure, self-regulation is just an aspiration.

It is my view that the charitable sector needs a formal structure, a National

Council on Nonprofit Accreditation, that brings together all of the accrediting bodies

of the sub-sectors under one umbrella. They ought to have common standards regarding governance, transparency and accountability, allowing for the diverse needs

of small, intermediate and large organizations. Although the charitable purposes of

public interest groups, family service agencies, health systems and research centers

are significantly different, there are standards of operation that they must surely

share.

A National Council of some sort could write clear guidelines requiring that any

nonprofit institution seeking accreditation from any cooperating accrediting body

must meet the guidelines for board composition, audits, public disclosure of financial

information, and compliance with all laws and regulations governing exempt organizations. These guidelines would be in addition to the sub-sector requirements for

curriculum development, physician certification or whatever is relevant in each subsector to obtain accreditation today. Violations of governance and ethical standards

would be cause for suspension and finally revocation of accreditation, just as failure

to meet academic, health or safety standards.

An additional function of a National Council on Nonprofit Accreditation would be

education and training. I have been truly surprised to find that many, many people

working in charitable organizations or serving on boards or as trustees do not know

the laws and regulations that apply to their tax-exempt status, IRS filings, fiduciary

responsibilities and public disclosure requirements. While not denying that there is

abuse of tax laws that is knowing and purposeful, there are a great many errors

of omission and commission that are due to ignorance of the law or its application

to the specific organization. Examples are failure to file a Form 990, failure to receipt gifts over $250 or providing excess benefits to executives or trustees.

At the end of the day, relying on this type of self-regulation has three main advantages. It lightens the burden on the IRS and other regulatory agencies, all of

whom are already struggling to meet their responsibilities with limited resources;

it preserves the independence of the sector, which has been crucial to its ability to

address the needs and aspirations of Americans; and it places the responsibility

where it should be: on the organizations across the country that know that they will

maintain the support of the public only if they operate according to the highest possible ethical standards.

The charitable sector is indispensable to American life as we know it. Americans

value volunteer service to their communities, and they trust and rely on nonprofit

institutions that serve them. We send our children to religious schools or community

centers to learn the values in which we believe. People from all over the world come

to the United States for higher educations in some of the finest colleges and universities ever established. It is impossible to enumerate the myriad services charitable

organizations make available to families that would be unable to afford them in the

private marketplace—from shelters for the homeless to job training, cancer

screenings to literacy programs.

The charitable sector serves the public good. But it must do more. It must serve

well, and to do that there must be more accountability and transparency. The trust

placed in these organizations is more important than the dollars contributed to

them. The good work needs funds; the donors need trust. They are inseparable.

So I urge you to please keep the pressure on. Demand better enforcement of current laws from the IRS and give them the means to do it. Demand passage of new

laws and promulgation of new regulations to curb abuse and increase penalties, but

do so cautiously and only where absolutely necessary.

And finally, demand that the charitable sector do a better job of self-regulation.

Those of us involved in the sector will make demands on ourselves as well: for higher standards of ethics and governance, for better training of professionals and volunteers about their duties and responsibilities, and for holding organizations accountable for meeting those standards.

Together we have an obligation to give the public the trust they need to ensure

that they give to the Nation.

PREPARED STATEMENT OF HON. RICK SANTORUM

Mr. Chairman and members of the committee, I want to take this opportunity to

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out to transform the lives of individuals, families, and communities. I believe strongly that the philanthropic, generous nature of Americans is a big part of what makes

America a great nation. Neighbors helping neighbors, those blessed with financial

resources and talents walking alongside and learning from the least of these in our

communities.

I recently introduced S. Con. Res. 15, which encourages Americans to increase

their charitable giving. I have been working for several years with Senator Joe

Lieberman and this committee on a broad package of incentives to encourage charitable giving through the Charity Aid, Recovery, and Empowerment Act (CARE Act).

The CARE Act includes incentives for non-itemizers, IRA charitable rollovers, food

donation incentives, and corporate giving incentives. The CARE Act passed the Senate on April 9, 2003, by a vote of 95–5. The House of Representatives passed companion legislation, the Charitable Giving Act, H.R. 7, on September 17, 2003, by a

vote of 408–13. Tragically for those in need, the bill was chosen as the first bill to

not be allowed to go to conference after passage by both chambers and thus prevented from becoming law in the last Congress.

The CARE Act is currently included in S. 6 in the 109th Congress. The recently

passed Senate budget included an amendment which I offered to reflect our ongoing

support for completing this important package. I look forward to passage of a similar bill by the House and its consideration by this committee again and by the full

Senate.

Unfortunately, what brings us here today is not incentives for charitable giving

but a series of proposals which would collectively require the charitable community

and charitable donors to bear a significant burden for dubious public benefit. Of

course we want to discourage inappropriate behavior by those who may seek to

abuse the public’s trust. Included in the CARE Act—with the help of the Chairman

and this committee—are several key provisions which encourage transparency, disclosure, accountability, and better coordination between State and Federal authorities tasked with charitable oversight responsibilities. These proposals are the next

logical step, combined with appropriate enforcement efforts of existing laws. I also

appreciate the work of the Independent Sector in their interim report and the Alliance for Charitable Reform in developing proposals that meet the goals of the committee without unnecessarily burdening the important work of legitimate charities.

Some of the committee staff proposals and relevant Joint Committee on Taxation

tax proposals target problem areas which are limited in scope and in nearly all

cases inappropriate under current laws. As one illustration, in the initial hearing

that the Finance Committee had last summer on June 22, 2004, concerning areas

of abuse, one private group went through the transcript and found approximately

94 cited references to ‘‘abuses’’ in the charitable sector in the testimonies and written statements. All but two are addressed in current laws and regulations.

Troubling for all aspects of the charitable community from social service organizations to volunteer firefighting departments are prescriptive proposals of charitable

governance. These include everything from the size of one’s board to Sarbanes-Oxley

corporate-style self-dealing rules. The reality is that a ‘‘one size fits all’’ approach

is not appropriate for the vast and diverse charitable sector in this country. There

are more than 1.2 million charities in this country. Most charities are small, focus

primarily on their mission, struggle with resources, and would find these requirements a distraction and burden imposed from Washington, DC. Many do not know

anything about these proposals and would not likely know much until after their

adoption—they are too busy feeding the hungry, mentoring children, helping the

disabled, restoring ex-felons, rehabilitating drug addicts, teaching kids how to read,

and serving the elderly. Clearly we should be capable in collaboration with the Executive Branch of more artful responses to these areas of concern, if necessary, rather

than proposing elimination of legitimate incentives altogether.

I recently asked Secretary Snow in a written question following a hearing whether it is necessary to consider sweeping changes in charitable governance, and what

evidence we have that this is a problem area which cannot be adequately addressed

by effective oversight and existing laws. In his response he mentioned the IRS’s current review of compensation practices and procedures of 2000 charities and said,

‘‘Although the results of the IRS audit initiatives may indicate the need for particular governance reforms, it is simply too soon to tell.’’

Another problematic proposal is the elimination of fair market value deductions

for the contribution of land to charities. The JCT report recommends that any donor

receive only the basis for such a contribution. While I understand that their can be

legitimate concern over excessive evaluations in some cases, clearly we don’t have

to effectively throw out this incentive altogether. This is no longer a reform but a

tax increase and a barrier to charitable giving. We should instead be seeking narVerDate 11-MAY-2000 17:15 Dec 19, 2005 Jkt 095484 PO 00000 Frm 00285 Fmt 6601 Sfmt 6621 20838.000 SFINANC2 PsN: SFINANC2
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rowly targeted solutions for clearly demonstrated problems once the government has

established that enforcement of current law alone is inadequate.

Another proposal limits deductions of clothing and household items to an aggregate annual total of $500 per taxpayer. This appears to be an arbitrary number apparently intended to minimize inappropriate deductions. Yet the proposed solution

would eliminate legitimate in-kind contributions without providing any assessment

of its impact on charitable giving and its impact on organizations which do great

work—like the Salvation Army and Goodwill—but receive many of these in-kind

contributions.

As a final example, while a different category of charities—apparently because of

a misunderstanding about the charitable nature of their activities and some limited

abuses—I must add that I am deeply troubled by the Joint Tax Committee’s proposal to impose taxes on fraternal benefit societies, reviving a proposal that was

considered in the mid-1980s and rejected. These organizations are a major source

for good in the United States, with 10 million members nationwide that devote

themselves to fraternal, charitable, religious, and patriotic activities. The Joint

Committee’s proposal would extinguish these organizations and the good that they

do at the very time that our society needs the private sector to step in and support

our communities. As I mentioned recently in the Congressional Record, this is a proposal that clearly should be rejected once again.

I appreciate the Chairman’s commitment to ensuring the public trust and protecting the charitable community from abuse, but we need to tread carefully before

we would impose an added layer of burden on the social entrepreneurs helping those

in need around the country. We also need to think twice before we send the message

that those blessed with significant resources would be safer spending their money

on yachts rather than helping improve their communities. Unintended consequences

in this arena will have real world consequences in the lives of those in need.

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1 Joint Committee on Taxation, Options to Improve Tax Compliance and Reform Tax Expenditures (JCS–02–05), January 27, 2005.

PREPARED STATEMENT OF GEORGE K. YIN

Mr. Chairman, Ranking Member Baucus, members of the committee, I am pleased

to testify today about the exempt organization proposals in the recent Joint Committee on Taxation staff report on ‘‘Options to Improve Tax Compliance and Reform

Tax Expenditures.’’ 1 As you know, the report was in response to a request of the

Chairman and Ranking Member.

In the report, the staff offered a range of proposals to address many potential

causes of noncompliance in the tax system. In my testimony today, I will describe

only the proposals involving the tax-exempt sector, particularly the charitable sector. I will first discuss proposals dealing with charitable contributions and then turn

to those concerning the operation of exempt organizations.

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NONCOMPLIANCE IN CHARITABLE CONTRIBUTIONS

In the case of charitable contributions, the report focuses on the most significant

area of potential noncompliance, namely the valuation of noncash charitable contributions.

Under present law, taxpayers are entitled to deduct the fair market value of most

charitable contributions of capital gain property to a public charity. When property

value is uncertain, this rule presents compliance burdens for the taxpayer, noncompliance opportunities, and law enforcement difficulties. Challenging taxpayer

valuations is a very resource-intensive task for the IRS. Even a preliminary determination that the amount of a deduction may be questionable requires an up-front

commitment of resources. If a serious challenge is to be made, more resources are

needed to secure alternate appraisals and expert opinions. The less likely the threat

of enforcement, the more likely is the possibility of overvaluation and noncompliance. Adding to the problem is the fact that the interests of the donor and donee

are generally aligned because each wants to see the gift completed. Thus, each party

has a reason to give the value claimed by the donor the benefit of the doubt.

The staff report contains several options intended to improve compliance for charitable contributions of property. The report does not propose changing the current

law rules with respect to cash gifts or gifts of publicly traded securities, which do

not present valuation concerns.

General treatment of contributions of appreciated property

First, in general, for contributions of appreciated property, the report proposes

that the charitable deduction be equal to the taxpayer’s basis in the property. This

is the present-law rule for contributions to most private foundations as well as contributions of certain property to public charities. In most cases, basis is a more certain amount than fair market value and subject to easier proof by the taxpayer and

verification by the IRS. Thus, this option could be expected to improve compliance,

reduce burdens and disputes, and lessen the amount of IRS enforcement effort. It

would also eliminate the greater tax preference under current law provided to these

types of property gifts than to contributions of cash.

As an alternative, the report suggests that a basis deduction might apply only to

taxpayers contributing property unrelated to the charity’s exempt function. Under

this alternative, for example, a taxpayer could still deduct the fair market value of

an appreciated gemstone given to a natural history museum, but could deduct only

the basis of appreciated closely held company stock or real estate contributed to the

museum.

Used clothing and household items

The general treatment of gifts of property just discussed would not be helpful for

gifts that have depreciated in value, such as used clothing and household items. In

such cases, the deduction is limited to the value of the property. Thus, a determination of value is still necessary.

Congress faced this same challenge last year in adopting rules for the donation

of vehicles. Before the new rules, vehicles, like clothing and household items, were

deductible at their fair market value at the time of the gift. Under the new rules,

a taxpayer generally is not allowed any deduction for a contribution of a vehicle

until the item is sold by the charity, at which point the sales price provides an indication of the proper amount of deduction. However, this solution obviously would

not be feasible for the many thousands of items of used clothing and other household goods given to charities each year.

The relatively small value of any item of clothing or household goods makes it

unlikely that the IRS challenges many of these deductions, leaving taxpayers with

significant flexibility in valuing such gifts. Moreover, taxpayers may have a natural

tendency to overvalue such items due to the attachment they have to the item.

Because this situation is vulnerable to error and noncompliance, the report proposes that at a minimum, the potential amount of error should be capped. Thus,

the report suggests limiting the deduction for gifts of clothing and household goods

to $500. This option has sometimes been mischaracterized as granting taxpayers an

automatic $500 deduction with no questions asked. In fact, all of the current-law

substantiation requirements would continue to apply in order for the deduction to

be available; the proposal simply limits the deduction to no more than $500 each

year.

Conservation easements

Unlike clothing and household items, the value of a conservation easement generally exceeds the taxpayer’s basis in the easement. Yet a rule limiting the charitable deduction to the taxpayer’s basis in the easement is of no help in easing the

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potential noncompliance problem because in most cases, the taxpayer’s basis in the

easement will depend upon a determination of the fair market value of the property

interest. Thus, if a deduction is to be allowed for conservation easements, a determination of value is again necessary.

For several reasons, determining the value of conservation easements may be

even more difficult than in the general case. First, the value of the interest given

away is a function of the contract terms crafted by the donor, and will vary from

case to case. There may be few, if any, comparables to help determine value. Second,

conservation easements constitute only a partial interest in the property rights held

by the taxpayer. As difficult as it may be to determine if I have correctly valued

the old shirt I give to a charity, at least the charity owns it and I do not. How much

more difficult would the value determination be if I retained substantial rights to

the shirt after contributing it to the charity? Third, in many cases, taxpayers who

make these contributions are already subject to significant State and local restrictions on the use of their property. Such restrictions vary considerably from jurisdiction to jurisdiction and would have to be taken into account in valuing the easement.

Because these valuation difficulties present the greatest challenge in the case of

conservation easements placed on property used by the taxpayer as a personal residence, the report proposes that no deduction be allowed for such contributions. For

gifts of easements placed on other historic structures, the report proposes a deduction equal to the lesser of 5 percent of the fair market value of the structure or 33

percent of the value of the easement. For all other gifts of conservation easements,

the deduction would be limited to 33 percent of the value of the easement. Moreover,

the gift must be pursuant to some clearly articulated Federal, State, or local government policy in favor of the conservation objective. The report also proposes heightened appraisal standards and requirements in the case of these contributions.

NONCOMPLIANCE IN EXEMPT ORGANIZATION OPERATIONS

The second broad category of noncompliance in the exempt organization area is

in the operation of the organization. An organization that is granted exemption from

Federal income tax warrants exemption not as a matter of right but as one of privilege. To maintain exemption on an ongoing basis, organizations are required always

to conduct their operations in a manner that is consistent with the basis for exemption. To the extent an organization deviates from its mission, there is noncompliance.

Five-year review

Under present law, charitable organizations are required to obtain a determination from the IRS that they are tax-exempt as a charitable organization, and thus

eligible to receive deductible contributions. Typically, organizations apply for charitable status shortly after they are formed, and the IRS generally must make its determination of such status based on statements of intent by the organization. However, once charitable status is granted, it rarely is revoked. Yet organizations may

change and grow significantly over time, sometimes in ways inconsistent with their

exemption. There is no mechanism in present law requiring a periodic review of the

basis for an organization’s charitable status.

The report proposes that, every 5 years, charitable organizations (other than

churches) file with the IRS information that would enable the IRS to determine

whether the organization continues to be organized and operated exclusively for exempt purposes. The proposal applies to new organizations and organizations receiving charitable status within 10 years of enactment of the proposal. The filing would

be done electronically, perhaps as a schedule to the current information return, and

be made publicly available to encourage improved oversight of the sector by both

the public and by State officials. The IRS would not be required to take action or

make any determination with respect to a 5-year review filing, but would have the

discretion to review any filing and could revoke tax-exempt status retroactively or

prospectively, as warranted by the facts and circumstances.

As described in more detail in the report, the information to be filed as part of

a 5-year review filing would include a narrative about the organization’s prior, current, and contemplated operations and practices; a description of the prior, current,

and contemplated trade or business activities of the organization and whether and

how such activities are related to the organization’s exempt purposes; a summary

of the organization’s compensation of management and senior employees for the previous 5-year period; a description of related-party transactions over the previous 5-

year period; a description of the organization’s material changes during the prior 5-

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erating foundations would be required to show how much of the foundation’s required payout was made up of administrative expenses.

Termination tax on public charities

Related to the issue of an organization’s ongoing basis for tax exemption is the

effect of a public charity’s dissolution, acquisition by a for-profit company, and other

change of ownership or control. Federal tax law requires that, upon dissolution, the

charitable assets of the organization continue to be dedicated to charitable purposes.

Yet there is no Federal enforcement mechanism of this requirement in the case of

public charities. In contrast, upon their termination, private foundations generally

are subject to a tax equal to the amount of the aggregate tax benefit received by

the foundation over time (not to exceed the net asset value of the foundation), unless their assets are dedicated to charitable purposes.

As an example of this issue, a charitable nonprofit hospital may be acquired by

a for-profit hospital, thus terminating the nonprofit hospital’s charitable status. In

this case, the ‘‘dedication to charity’’ requirement of present law means that the

Federal Government has an interest in ensuring that a fair price is paid for the nonprofit hospital, and that the proceeds from the transaction be dedicated to charitable

purposes.

In order to provide the Federal Government with a means to enforce the ‘‘dedication to charity’’ requirement, the report proposes a termination tax on liquidations

or conversions of a public charity. The tax would also apply to private foundation

terminations, and differs from the present-law termination tax principally in that

the tax would be based on the net asset value of the charity and not on the aggregate tax benefit. The tax could not be recovered against assets held by the charity

for charitable purposes. The proposal also would impose the present-law excess benefit transaction rules to conversions of a public charity if, after the conversion, insiders of the public charity are also insiders of the newly converted entity. This is intended to ensure that, when insiders are involved in the acquisition of a charitable

organization, the acquisition is subject to the present-law rules that tax abusive insider transactions.

Exempt organization involvement in tax shelters

One of the primary compliance concerns in tax law today is abusive tax shelters.

The increasing involvement of exempt organizations as accommodation parties in

tax shelter transactions is a growing concern. Such transactions contribute to the

erosion of the tax base by improperly extending the benefit of tax exemption to nonexempt persons. Tax shelters involving exempt organizations also raise questions

about whether the facilitation of tax avoidance by an exempt organization can be

consistent with the basis for tax exemption. Although recent legislation addressed

many tax shelter abuses, such legislation does not prevent certain abuses that

might be perpetrated using exempt organizations.

The report provides for an excise tax on the participation by any exempt organization (not just charitable organizations) in a transaction that the Treasury Department determines is a listed transaction, or a reportable transaction that is a confidential transaction or one with contractual protection. Under the proposal, if an

exempt organization participates in such a transaction, knowing or with reason to

know that the transaction is ‘‘prohibited,’’ the entity is subject to a tax of 100 percent of the entity’s net income attributable to the transaction. If the exempt entity

is eligible to receive deductible contributions, the Treasury Department may suspend eligibility for 1 year. The entity-level tax does not apply to certain pension

plans and similar tax-favored accounts. An excise tax would also apply to the entity

managers that approved the entity’s participation in the transaction.

The proposal also addresses the case in which an exempt organization participates

in a transaction that is later determined by the Treasury Department to be a prohibited tax shelter transaction. Because the exempt entity did not know at the time

it entered into the transaction that it would later be prohibited, taxing all of the

entity’s net income attributable to the transaction may not be appropriate. However,

the proposal would impose an excise tax at the UBIT rate on the exempt organization’s net income from the transaction after it has learned that the transaction is

prohibited. There also are obligations to disclose involvement in such transactions.

OTHER PROPOSALS

I will briefly touch on the other exempt organization proposals in the report.

Private foundation excise tax rates.—As you know, private foundations are subject

to a special set of restrictions and excise taxes that do not apply to public charities.

The excise taxes apply to acts of self-dealing, failure to meet the mandated payout,

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tures. The tax rates on the initial taxes have not been revisited since their enactment in 1969. The report proposes a doubling of the present law initial rates of tax.

Intermediate sanctions.—Public charities are subject to excise taxes on so-called

‘‘excess benefit transactions’’ between the organization and an insider of the organization. This regime was enacted to provide a sanction short of revocation of exemption for abusive self-dealing transactions by public charities. The report concludes

that the sanction would be more effective if certain changes are made. For example,

present law provides organization insiders with a presumption that a transaction

is reasonable if certain steps are taken. The report recommends eliminating the presumption of reasonableness because it unnecessarily gives the taxpayer a procedural

advantage on a matter that already is difficult to enforce. The report also suggests

modifying the ‘‘initial contract exception’’ so that the sanctions apply to a contract

by an organization with a person who is contracting for a position of substantial influence within the organization.

Form 990–T.—The report suggests that the Form 990–T, which exempt organizations file to report unrelated business taxable income, be made public, so as to provide the public with a better picture of an organization’s business activities. The report also proposes that large exempt organizations obtain a certification from an

independent auditor or counsel regarding the organization’s reporting of the unrelated business income tax.

Other proposals.—The report contains proposals that (1) require small charitable

organizations to file short annual returns, (2) expand the base of the tax on the net

investment income of private foundations, (3) limit the tax-exempt status of fraternal beneficiary societies that provide commercial type insurance, and (4) establish additional exemption standards for credit counseling organizations.

We will continue to examine compliance issues in the exempt organizations area

and give consideration to possible additional proposals beyond those contained in

the report.

Thank you very much for this opportunity to testify.

RESPONSE TO A QUESTION FROM SENATOR LINCOLN

Question: Mr. Yin, to the extent that abuse in the charitable world is leading to

this tax gap in terms of missed revenue, which baseline is the abuse affecting the

most? Are most of the people seeking to avoid estate taxes through trust arrangements or are they seeking more income tax evasion? Do you have any estimates as

to where we are losing the money and the breakdown of how much we are losing

to each of those baselines?

Answer: The ‘‘tax gap,’’ i.e., the difference between what taxpayers owe and what

taxpayers voluntarily pay on a timely basis, is comprised of three components:

(1) underreporting of taxes; (2) underpayment of taxes; and (3) non-filing of returns.

Underreporting of taxes is the largest component of the tax gap, accounting for more

than 80 percent of the total. Underreporting of income by individuals is the largest

subcomponent of underreporting, representing approximately half of the total tax

gap. Such understatement by individuals results not only from excluding income

from a return or underreporting income on a return, but also from taking improper

deductions (including charitable deductions), overstating business expenses, and erroneously claiming credits.

In my testimony, I stated that valuation of contributed assets is the most significant area of potential noncompliance in charitable contributions. I believe that

misstatements of value in claiming income tax charitable deductions have a far

greater effect on the tax gap than misstatements of value in claiming estate tax

charitable deductions. Where a taxpayer overstates the value of a donated asset in

claiming an income tax charitable deduction, such overstatement generally results

in an understatement of the taxpayer’s tax liability by reducing the taxable income

reported on the taxpayer’s return. An overstatement of the income tax charitable

deduction could occur, for example, in the context of an outright transfer of an asset

(other than cash) to charity or through a transfer of such an asset to a split-interest

trust. In contrast, if the value of an asset is misstated for purposes of claiming an

estate tax charitable deduction, the misstatement generally will not affect the estate

tax liability. This is because the effect of the estate tax charitable deduction generally is to offset the entire value of the contributed asset, thereby removing the

asset from the taxable estate. However, where an estate tax charitable deduction

is claimed improperly, the improper deduction could increase the tax gap. For example, in the case of a transfer to a defective charitable trust, an estate might claim

a charitable deduction to which it is not entitled, resulting in an understatement

of estate tax liability.

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IRS estimates of the tax gap support a conclusion that abuse in claiming estate

tax charitable deductions accounts for only a small portion of the total tax gap. Indeed, such estimates show that all underreporting of estate taxes—not limited to

underreporting relating to charitable contributions—accounts for less than 1 percent

of the total tax gap.

Although we believe that abuses in claiming income tax charitable deductions account for a greater portion of the tax gap than abuses in claiming estate tax charitable deductions, we do not have estimates of the portion of the total tax gap attributable to such abuses. The IRS estimates that the portion of the tax gap attributable to individual income tax deductions is between $15 billion and $18 billion.

Commissioner Everson testified that income tax charitable deductions account for

a portion of this $15 billion to $18 billion estimate, but he stated that more specific

figures will not be available until the IRS conducts additional statistical analysis.

RESPONSES TO QUESTIONS FROM SENATOR ROCKEFELLER

Question: Anecdotal information and media reports indicate wrongdoing and questionable activities of a few organizations. How widespread do you believe these problems to be?

Answer: In general, the proposals in the Joint Committee on Taxation staff report

are directed toward two types of noncompliance in the exempt organization area:

noncompliance with exempt status rules and noncompliance with charitable contribution deduction rules.

With respect to the first type, noncompliance occurs when an exempt organization

acts in a manner that is inconsistent with the basis for the organization’s exemption

from Federal income tax. This type of noncompliance can occur in a variety of ways,

and may implicate rules regarding revocation of tax-exempt status (due, for example, to operation for a nonexempt purpose, private inurement, private benefit, substantial lobbying activity, or political activity), the unrelated business income tax,

intermediate sanctions, or any of the specific rules applicable to private foundations.

The second type of noncompliance occurs in the context of a charitable contribution

of property for which a fair market value deduction is available, if the amount of

deduction claimed by the taxpayer is not in fact the fair market value. Several recent investigations and reports have identified both types of compliance problems

associated with certain activities and organizations (see answer to next question for

references).

The Joint Committee staff has not conducted an independent assessment of how

widespread particular forms of noncompliance in the exempt organization sector

may be. Rather, the staff proposals in this area primarily derived from an analysis

of the noncompliance opportunities created by present law. It general, noncompliance is exacerbated by legal tests that rely upon difficult factual determinations.

Thus, for example, ensuring compliance in the context of charitable contributions of

certain types of property is difficult because enforcing the law requires the Internl

Revenue Service (‘‘IRS’’) to make a factual determination about the value of a specific item of property. Whenever enforcement of the law depends upon such determinations, there are significant opportunities for noncompliance.

The staff proposals also took account of the limited amount of enforcement resources available to the IRS. For example, the staff concluded that the current annual information return does not provide information sufficient for the IRS to make

a determination that a charitable organization continues to be operated exclusively

for a charitable purpose, and that a procedure should exist that requires organizations to file every 5 years information with the IRS that is explicitly directed to the

organization’s continuing basis for tax exemption. By providing more useful and current information to the IRS, the proposals should improve compliance levels even

without any change in IRS resources committed to that effort.

Question: Do you know of any credible studies assessing exempt organization compliance?

Answer: We have not found a comprehensive study assessing compliance by all

types of exempt organizations There are a number of reports on particular abuses

or practices within the sector. See, for example, Marion R. Fremont-Smith and

Andras Kosaras, ‘‘Wrongdoing by Officers and Directors of Charities: A Survey of

Press Reports 1995–2002,’’ The Exempt Organization Tax Review 25 (October 2003);

Marion R. Fremont-Smith, ‘‘Pillaging of Charitable Assets: Embezzlement and

Fraud,’’ 2004 Tax Notes Today, 247–29 (December 23, 2004); Christine Ahn, Pablo

Eisenberg and Channapha Khamvongsa, ‘‘Foundation Trustee Fees: Use and Abuse,

The Center for Public and Nonprofit Leadership,’’ Georgetown Public Policy Institute (September 2003). In April 2002, the General Accounting Office prepared a report: ‘‘Tax Exempt Organizations: Improvements Possible in Public, IRS, and State

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Oversight of Charities,’’ (GAO–02–526), which provides a helpful overview of some

compliance issues. The Exempt Organization (‘‘EO’’) function within the IRS established in 2004 an EO Compliance Unit that you may want to contact about compliance information within the sector. The Treasury Inspector General for Tax Administration released an audit report in December 2004 titled ‘‘The Exempt Organizations Function’s Market Segement Approach Needs Further Development’’ (2005–

10–020), which may provide some insight to how the IRS is addressing compliance

issues.

Question: How can Congress determine the size and scope of the noncompliance

problem in this sector?

Answer: In general, a systematic audit program for exempt organizations would

be the best means of assessing the extent of compliance within the sector, provided

results of the audits are maintained in a centralized database. To assess compliance

with respect to donations for charitable giving, this effort would ideally include the

linking of data on property received and sold by exempt organizations to the corresponding individual donor’s tax return. The EO compliance unit established in

2004 is a crucial first step in such a study. Providing for additional funding to include a research component for this initiative within the IRS, and a significant increase in audits, could result in a better overall assessment of compliance within

the exempt organization sector.

Measures that foster and impove disclosure of information about exempt organizations would aid Congress, the States, and the general public in assessing the

amount of noncompliance, and improve enforcement of the law. For example, encouraging increased electronic filing of information returns and substantial revisions

to the principal information return (Form 990) should result in more accurate and

accessible information about exempt organizations. In addition, the Joint Committee

staff report proposed the public disclosure of the tax return filed by exempt organizations to report their unrelated business income (Form 990–T) , which would provide the public with a clearer picture of an organization’s business activities that

are not related to exempt purposes. The staff report also proposed that certain small

organizations not currently required to file information returns with the IRS file

each year a short form that confirms the organization’s existence and provides contact information, so that the IRS and the public have updated information about

small organizations. The staff proposal (mentioned above) to require section

501(c)(3) organizations to disclose additional information every 5 years with the IRS

also is directed to improving the quality of information about charitable organizations for compliance purposes.

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