S. HRG. 108–603

CHARITY OVERSIGHT AND REFORM: KEEPING

BAD THINGS FROM HAPPENING TO GOOD

CHARITIES

HEARING

BEFORE THE

COMMITTEE ON FINANCE

UNITED STATES SENATE

ONE HUNDRED EIGHTH CONGRESS

SECOND SESSION

JUNE 22, 2004

(

Printed for the use of the Committee on Finance

CHARITY OVERSIGHT AND REFORM: KEEPING BAD THINGS FROM HAPPENING TO GOOD CHARITIES

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95–482—PDF 2004

S. HRG. 108–603

CHARITY OVERSIGHT AND REFORM: KEEPING

BAD THINGS FROM HAPPENING TO GOOD

CHARITIES

HEARING

BEFORE THE

COMMITTEE ON FINANCE

UNITED STATES SENATE

ONE HUNDRED EIGHTH CONGRESS

SECOND SESSION

JUNE 22, 2004

(

Printed for the use of the Committee on Finance
COMMITTEE ON FINANCE

CHARLES E. GRASSLEY, Iowa, Chairman

ORRIN G. HATCH, Utah

DON NICKLES, Oklahoma

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

MAX BAUCUS, Montana

JOHN D. ROCKEFELLER IV, West Virginia

TOM DASCHLE, South Dakota

JOHN BREAUX, Louisiana

KENT CONRAD, North Dakota

BOB GRAHAM, Florida

JAMES M. JEFFORDS (I), Vermont

JEFF BINGAMAN, New Mexico

JOHN F. KERRY, Massachusetts

BLANCHE L. LINCOLN, Arkansas

KOLAN DAVIS, Staff Director and Chief Counsel

RUSSELL SULLIVAN, Democratic Staff Director

(II)
(III)

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

Baucus, Hon. Max, a U.S. Senator from Montana ................................................ 2

ADMINISTRATION WITNESSES

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

DC .......................................................................................................................... 4

WITNESSES

Josephson, William, assistant attorney general-in-charge, Charities Bureau,

New York State Department of Law, New York, NY ....................................... 7

Pacella, Mark, president, National Association of State Charity Officials, Harrisburg, PA ............................................................................................................ 8

MacNAB, J.J., CFP, CLU, QFP, owner/analyst, Insurance Barometer, LLC,

Bethesda, MD ....................................................................................................... 27

Adkisson, Jay D., editor of Quatloos.com, director, Private Client Services

Select Portfolio Management, Inc., Aliso Viejo, CA .......................................... 29

Mr. Car, a confidential witness to discuss fundraising ........................................ 31

Mr. House, a confidential witness to discuss exploitation of charitable assets

for private gain ..................................................................................................... 33

Aviv, Diana, president and CEO, Independent Sector, Washington, DC ........... 42

Bok, Derek, president emeritus, Harvard University, Cambridge, MA .............. 43

Boyd, Willard L., professor of law and professor emeritus, University of Iowa,

director, Iowa Nonprofit Resource Center and chair, The Iowa Governor’s

Task Force on the Role of Nonprofit Organizations in Iowa, Iowa City,

IA ........................................................................................................................... 46

Cohen, Rick, executive director, National Committee for Responsive Philanthropy, Washington, DC ...................................................................................... 48

Taylor, Art, president and CEO, BBB Wise Giving Alliance, Arlington, VA ..... 51

Ringling, Rock, managing director, Montana Land Reliance, Helena, MT ........ 52

ALPHABETICAL LISTING AND APPENDIX MATERIAL

Adkisson, Jay D.:

Testimony .......................................................................................................... 29

Prepared statement .......................................................................................... 61

Aviv, Diana:

Testimony .......................................................................................................... 42

Prepared statement .......................................................................................... 73

Baucus, Hon. Max:

Opening statement ........................................................................................... 2

Prepared statement .......................................................................................... 96

Bok, Derek:

Testimony .......................................................................................................... 43

Prepared statement .......................................................................................... 98

Boyd, Willard L.:

Testimony .......................................................................................................... 46

Prepared statement .......................................................................................... 101

Bunning, Hon. Jim:

Prepared statement .......................................................................................... 106
Page

IV

Cohen, Rick:

Testimony .......................................................................................................... 48

Prepared statement .......................................................................................... 109

Everson, Hon. Mark:

Testimony .......................................................................................................... 4

Prepared statement .......................................................................................... 128

Responses to questions from Senators Snowe, Santorum, and Daschle ...... 147

Grassley, Hon. Charles E.:

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

Prepared statement .......................................................................................... 154

Josephson, William:

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

Prepared statement .......................................................................................... 161

MacNAB, J.J.:

Testimony .......................................................................................................... 27

Prepared statement .......................................................................................... 194

Mr. Car:

Testimony .......................................................................................................... 31

Prepared statement .......................................................................................... 107

Mr. House:

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

Prepared statement .......................................................................................... 156

Pacella, Mark:

Testimony .......................................................................................................... 8

Prepared statement .......................................................................................... 214

Ringling, Rock:

Testimony .......................................................................................................... 52

Prepared statement .......................................................................................... 232

Santorum, Hon. Rick:

Prepared statement .......................................................................................... 235

Taylor, Herman Art:

Testimony .......................................................................................................... 51

Prepared statement .......................................................................................... 238

COMMUNICATIONS

American Association of Homes and Services for the Aging (AAHSA) ............... 249

American Association of Museums ......................................................................... 251

American Society of Association Executives (ASAE) ............................................ 254

Association of Art Museum Directors .................................................................... 260

Center for Science in the Public Interest (CSPI) .................................................. 263

Council on Foundations ........................................................................................... 265

Dickinson Wright PLLC .......................................................................................... 268

The Forum of Regional Associations of Grantmakers .......................................... 270

Foundation Source Philanthropic Services Inc. .................................................... 273

Free Speech Coalition, Inc. (FSC) .......................................................................... 276

Gilbert M. and Martha H. Hitchcock Foundation ................................................. 286

Goodwill Industries International, Inc. .................................................................. 296

Gregory F.W. Todd .................................................................................................. 301

GuideStar ................................................................................................................. 379

Innovation Network ................................................................................................. 390

International Association of Fish and Wildlife Agencies ...................................... 395

Land Trust Alliance (LTA) ...................................................................................... 397

National Community Foundation (NCF) ............................................................... 402

National Council of Nonprofit Associations ........................................................... 407

Nonprofits Insurance Alliance Group (NIA) .......................................................... 417

Nonprofit Coordinating Committee of New York .................................................. 418

The Philanthropy Roundtable ................................................................................. 420

Policy Development ................................................................................................. 423

Ruden, Stephen Y. ................................................................................................... 424

The Standards for Excellence Institute ................................................................. 427
(1)

CHARITY OVERSIGHT AND REFORM: KEEPING

BAD THINGS FROM HAPPENING TO GOOD

CHARITIES

TUESDAY, JUNE 22, 2004

U.S. SENATE,

COMMITTEE ON FINANCE,

Washington, DC.

The hearing was convened, pursuant to notice, at 10:00 a.m., in

room SG–50, Dirksen Senate Office Building, Hon. Charles E.

Grassley (chairman of the committee) presiding.

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

Bunning, Baucus, and Bingaman.

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

SENATOR FROM IOWA, CHAIRMAN, COMMITTEE ON FINANCE

The CHAIRMAN. I thank you all very much for your attendance,

particularly for witnesses that have gone to an awful lot of work

and come some distance to testify. We thank you for this.

I am going ahead with my opening statement. If we start the

first panel and Senator Baucus comes, it is always our practice to

have the Ranking Member have an opening statement as well, and

we will interrupt for him to make his opening statement.

Today, the Finance Committee considers a very serious matter,

ensuring that charities keep their trust with the American people.

We will hear testimony today that is troubling, very troubling, suggesting that far too many charities have broken the understood

covenant between the taxpayer and the nonprofits. That covenant

is that charities are to benefit the public good, not fill the pockets

of private individuals.

Too many well-meaning charities have fallen prey to the charlatan pitch about easy money. Some charities are blinded by their

own mission and the need for additional dollars. These charities

are willing to sign on to deals that provide dollars to promoters and

insiders, but only pennies to charity. Taxpayers are the losers.

In addition to well-meaning charities being led astray, we also

have a growing number of individuals who knowingly set up a

charity to evade taxes.

Finally, we have charities, even big-name charities, that seem to

just have had their wheels fall off. Often, problems at these charities can be traced back to poor governance or failure to abide by

best practices.

Since becoming Chairman of the Finance Committee, I have been

active in oversight in many areas, including charities. I have con-
2

* For more information on this subject, see also, Joint Committee on Taxation document,

‘‘Present Law Relating to Charitable and Other Exempt Organizations and Statistical Information Regarding Growth and Oversight of the Tax-Exempt Sector’’ (JCX–44–04), June 22, 2004.

ducted investigations into such organizations as United Way, Red

Cross, and Nature Conservancy. I am pleased that my oversight

has brought about good reforms at these organizations.

However, the Finance Committee is limited in its resources to

perform oversight. It is clear that we need to look at more general

reforms to address recurrent problems in the nonprofit sector.

The staff of the Finance Committee, on a bipartisan basis—and

I want to emphasize that, because we have had great cooperation,

particularly from Senator Baucus, the Ranking Democrat—have

produced a discussion draft. I want to mention and emphasize ‘‘discussion.’’

This draft serves as a very useful beginning point to consider

possible broad reforms. I welcome a dialogue about the best means

of achieving the ends that I hope we can all agree on, a vibrant

and engaged private sector that enjoys the confidence of the American people that charitable donations are being used to meet charitable needs, the obvious, in other words.

Reforms to that end will benefit all charities, particularly the

strong majority of charities that do their job and do their job well,

and play, as we all know, such a vital role in our country.

In view of these much-needed reforms as a partner to the important efforts by President Bush to encourage charitable giving in the

CARE Act, championed by Senators Santorum and Lieberman, I

continue to work to see that the CARE Act is brought to conference

and signed into law.

Just as I have worked with administrations on encouraging

greater contributions to charity, I hope the administration will

work with the Finance Committee to bring real reform to the nonprofit sector.*

We have the good fortune that Senator Baucus is here. I have

already said how he and his staff have cooperated very well with

getting this effort to this point and writing the draft discussion

paper that we have talked about, so at this point we will have the

opening statement by Senator Baucus.

OPENING STATEMENT OF HON. MAX BAUCUS, A U.S. SENATOR

FROM MONTANA

Senator BAUCUS. Well, thank you very much, Mr. Chairman.

Clearly, this is a very important hearing. Charities play a vital

role in our country. With many individuals still bearing the brunt

of this economic downturn and the unemployment rates still very

high, Americans rely very much on charities for help, and our charities have not let us down.

Charities rushed to the aid of those who were harmed by September 11, providing comfort, counseling, and financial assistance,

and they play a pivotal role aiding victims of natural disasters that

have paralyzed parts of the country during the past few years.

Charities helped rebuild homes and repair national parks from

fires in the west.

While these efforts show up on the front page of the paper, the

quiet work of so many goes unnoticed: the after-school program
3

that keeps a teenager on the path to college, the soup kitchen that

fees a senior citizen whom society has left behind, the conservation

group that preserves the remote streams so that our grandchildren

may enjoy nature.

In my home State of Montana, organizations like the YMCA in

Billings provides support to over 300 victims of sexual assault

every year. The Montana Boys and Girls Clubs provide after-school

outlets for over 100,000 children, and the Montana Food Bank Network serves more than 1.5 million meals every year.

But while charities are focused on doing good works and preserving the public trust, there have been a number of high-profile

examples of problems in this expanding sector: inflated salaries

paid to trustees and charity executives; insider deals with insufficient transparency; charities engaging in abusive tax shelters; and

charities serving as conduits to finance terrorist activities and operations.

This proliferation of sloppy, unethical, and criminal behavior is

unacceptable. It has led to a crisis in confidence among charities.

It has hurt fundraising by legitimate charities, and it overshadows

the good work done by the majority of civic-minded groups. Like

the recent corporate scandals, these events make Americans second-guess their faith in bedrock institutions.

Today we are privileged to hear from a host of witnesses who are

committed to addressing this crisis. Individuals who are set to testify today come to the table with insights built on years of experience in charities and public policy.

Our first panel includes two highly regarded state officials, Mr.

Josephson and Mr. Pacella, and the Commissioner of Internal Revenue, Mark Everson. His organization grants tax-exempt status to

almost 100,000 organizations every year and is responsible for ensuing compliance with Federal tax laws.

Two years ago, Senator Grassley and I had the General Accounting Office look into how the IRS could better perform oversight on

the charitable sector. GAO’s report included important recommendations on the collection of information from charities and

well thought out suggestions on improving coordination between

the IRS and State charity officials.

I am concerned that too little has been done to increase the level

of cooperation between the Federal Government and States in this

area, and look forward to hearing from the panel on what progress

has been made.

Our second panel includes witnesses who will tell firsthand accounts of abusive tactics and tax shelter involvement by some in

the charitable section.

Two of our witnesses on this panel are whistleblowers who fear

reprisal if their identities are made public, and I appreciate very

much their willingness to come forward.

One witness will discuss the ongoing problems in the car donation area. As previously highlighted by a GAO report that Senator

Grassley and I requested, this practice has been rife with abuse.

Often, charities receive pennies on the dollar for donated cars

that have fetched thousands of dollars in tax deductions. This witness’ testimony will shed light on the fraud perpetuated by car auctioneers and brokers who feed on innocent charities.
4

The second witness will detail a scam that involves cheating

American taxpayers to the tune of millions of dollars a year with

a down payment assistance charity.

I also look forward to hearing from Ms. MacNab and Mr.

Adkisson, who, by the way, 2 years ago previously testified before

this committee and we are very grateful for their reappearance.

They will discuss other abuses. This panel in particular should

serve as a wake-up call on how some charities are being used for

unethical, and potentially criminal, activities.

Finally, our third panel will address how we should fix these

problems. I want to make special mention of my friend Rock Ringling, the managing director of Montana Land Reliance.

Rock runs a tight ship. The Land Reliance serves as a model for

other conservation groups across the country, and Rock will offer

suggestions and best practices in the land donation area.

All of us, clearly, are very fortunate to have all of you as witnesses here, and we eagerly anticipate your testimony, and thank

you, too, for the opportunity to ask you questions. Let us go on and

try to make the most out of this hearing so that we are happy that

you did a good job.

Thank you.

The CHAIRMAN. I thank Senator Baucus for introducing the witnesses, so I am not going to repeat that introduction.

I would like to say, for this panel, as well as the other two panels, that without your asking, your entire statements, that probably

ought to be longer than five minutes, will be included in the record

as you submit them. Then we would ask you to summarize for five

minutes.

I would ask the members, we are going to take 5-minute rounds

of questioning. I do not think we will be able to have a second

round of questioning today, and I would ask if each, including the

chairman, would stay within their 5 minutes.

Then sometime within a half hour, or a little more than a half

hour, there will be votes. I did not discuss this with Senator Baucus, but if we could take turns going to vote, I would like to do that

so we could keep the hearing going, because we need to get done

around 12:30. So, if that is all right with you.

Senator BAUCUS. Fine.

The CHAIRMAN. Yes. So it may be a bad way to conduct a meeting, but there is no way we would ever have committee meetings

if we did not have them while the Senate is in session.

So, with those details, I think I have mentioned everything. We

will start with Mr. Everson, then go to Mr. Josephson, then Mr.

Pacella. Then we will ask questions when the whole panel is done.

Mr. Everson?

STATEMENT OF HON. MARK EVERSON, COMMISSIONER,

INTERNAL REVENUE SERVICE, WASHINGTON, DC

Commissioner EVERSON. Chairman Grassley, Ranking Member

Baucus, other members of the committee, thank you for the opportunity to testify this morning on the oversight of charitable organizations.

As you know, I share your view that this is an important subject

and one of increasing concern. Several months ago, the IRS for-
5

mally articulated four enforcement priorities. These have now been

included in our recently issued strategic plan, which will govern

our operations from 2005 to 2009.

This committee is already quite familiar with IRS efforts to, (1)

address non-compliance by corporations, high-income individuals,

and other contributors to the tax gap, the centerpiece of which is

our battle against abusive shelters; (2) assure that tax practitioners

adhere to professional standards and follow the law; and (3) augment our investigations of tax and financial criminal activity.

I am appreciative of your support in each of these critical areas,

which are essential to our Nation’s system of tax administration.

Our fourth enforcement priority is equally crucial to the country.

It is to discourage and deter non-compliance within tax-exempt and

government entities, and the misuse of such entities by third parties for tax avoidance or other unintended purposes.

Non-compliance involving tax-exempt entities is especially disturbing because it involves organizations that are supposed to be

carrying out some special or beneficial public purpose.

While the vast majority of tax-exempt entities follow the law,

there are increasing indications of failures in governance and outright abuse within this sector. We have seen lavish compensation

packages for executives, inappropriate related-party transactions,

or in some cases operation of what is essentially a profit-making

entity, with no public purpose, in the guise of a charity to escape

the payment of taxes or regulatory oversight. For example, State

consumer protection laws.

The IRS is addressing non-compliance by tax-exempt entities on

a number of fronts. In one area of particular concern, credit counseling organizations, we have launched an unprecedented audit effort.

Fully one-half of the total revenues of the known filing universe

are either already under active audit or will be later this summer.

Thus far, we have issued a proposed revocation of exemption to one

entity. I expect there will be more in the not-too-distant future.

In the area of compensation, this summer we will begin contacting hundreds of organizations to assess their compensation

policies and procedures. Over time, we will adjust audit plans accordingly, to include associated issues like insider loans or sales to

executives and officers.

We are also initiating a broader review of foundations, to include

examinations of 400 entities, half of which will be somewhat akin

to our detailed National Research Program audits already under

way for individuals.

We are also enhancing our cooperative efforts with State charity

regulators, but here we are handicapped to a real extent by existing law. We can routinely share information with State tax authorities, but not with regulators of charities. Provisions in the

Senate version of the CARE Act would mitigate concerns in this

area.

Equally vital to effective regulation of charities is devotion of

greater resources to the tax-exempt sector. Historically, IRS regulates taxes. This chart shows an example of an organization which

was started in 1995, contrasting with IRS staffing over this period

and staffing adjusted per exempt organization filing.
6

After years of decline, we are augmenting our efforts. As you

know, the President has requested a 10.7 percent increase for IRS

enforcement efforts.

I am deeply appreciative of the efforts this committee has made

to secure that funding, and I want you to know that within that

request is a 17 percent increase for examinations in the tax-exempt

area.

Before closing, I would like to turn to the important subject of

misuse of tax-exempt and government entities by third parties for

tax avoidance or other unintended purposes.

The same floating consortium of unscrupulous attorneys and accountants who first brought us abusive shelters designed to escape

IRS detection through complex structures involving partnerships

and subchapter S corporations has now moved on to the use of taxexempt and government entities as combination parties for the generic tax products they develop and market.

As this chart indicates, almost half of the 31 types of transactions listed to date potentially involve tax-exempt entities. That

is the red, 14 out of the 31 of our listed transactions.

Viewed against the number of disclosures of listed transactions

that we have received, some 4,300, the number is even greater, almost 60 percent potentially involved. Again, I am not suggesting

that they all involve charities or other exempt entities, but they

can. That is the structure of the transaction.

More troubling is that this appears to be a growing trend. Five

of the eight transactions we have listed in fiscal year 2004 potentially use a tax-exempt entity.

Senator BAUCUS. I am sorry, Mr. Commissioner. You said it is

31 listed transactions?

Commissioner EVERSON. We list potentially abusive transactions.

What I am saying, Senator, is for a full 14, almost half of those,

the way they are structured, can involve a tax-exempt entity. Some

of these are municipalities, some of these are charities. In six of

these cases, they are specifically charities.

Senator BAUCUS. By ‘‘listed,’’ do you mean, in the Code, the listed

transactions that should be revealed and disclosed?

Commissioner EVERSON. These are the types of transactions that

we have put people on notice that we think they are potentially

abusive, and they are going to receive special scrutiny as we examine the returns.

Senator BAUCUS. And you are saying about half of them involve

tax-exempts.

Commissioner EVERSON. About half of them potentially involve,

can involve, tax-exempt entities. I am suggesting that six of them

are specifically structured for tax-exempt entities.

Senator BAUCUS. Thank you.

Commissioner EVERSON. This last chart is based on a real transaction that demonstrates how a charity can be used for an unintended purpose. In this case, the foreign currency options strategy,

generates a large paper gain to the charity, $1.5 million in this

case, and a loss to the taxpayer which reduces the taxpayers taxes

by half a million dollars. The charity does not feel any pain from

the gain, which is untaxed, but has received a cash payment of

$50,000 for its participation in this transaction.
7

I look forward to an ongoing dialogue with the committee on

these subjects. If we do not act to guarantee the integrity of our

charities, there is a risk Americans will lose faith in, and broadly

reduce their support of, charitable organizations, which are vital to

our social fabric. If Americans cannot trust their charities, they will

stop giving and those in need will suffer.

Thank you, Mr. Chairman.

The CHAIRMAN. I especially appreciate your concluding sentence

there. It is very important, and the basis for our interest in this,

because we want to continue a good thing going in America.

[The prepared statement of Commissioner Everson appears in

the appendix.]

The CHAIRMAN. Now, Mr. Josephson?

STATEMENT OF WILLIAM JOSEPHSON, ASSISTANT ATTORNEY

GENERAL-IN-CHARGE, CHARITIES, STATE OF NEW YORK, OFFICE OF ATTORNEY GENERAL, NEW YORK, NY

Mr. JOSEPHSON. Senator, I would like to express my appreciation

to you, to Senator Baucus, to Dean Zerbe of your staff, and Pat

Hecht of your staff for the wonderful cooperation we have had in

preparing for these hearings.

I have a statement, as you know. I submit it for the record. I

would just like to hit the highlights.

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

Mr. JOSEPHSON. One of the cases that I talk about in my statement involves a private foundation. This private foundation had assets of more than $11 million, when it came to our attention those

assets had declined to about $7 million.

Why? Because the board of that foundation, probably stimulated by its lawyer, took $3.4 million in compensation and pension benefits out of that private foundation. This was not a private foundation that did particularly complicated grants. This is what we call

a plain vanilla private foundation, grants to public charities, museums, the opera, and so forth.

We talk about board responsibilities. Too often, we see boards

that are inattentive or ill-informed. The Albany Urban League

went down the drain completely and stuck the taxpayers not only

with failed contributions, but with a half a million dollar tax lien

that could not be satisfied. And this was a board that was a distinguished board. It had high-level representatives on it of the Albany

community, who paid very little, if any, attention.

The IRS needs to pay much more attention to the application for

exemption process. We need to deal with governance issues in the

course of the review of the 1023. I give examples in my statement

of things that the 1023 should cover which it does not now cover.

The 990 needs to be reformed not only to make it user-friendly,

which it is not now, to make the information accessible to the

press, to members of the public, but also to enable us to track the

governance commitments that charities have made in their application form.

We very much need to be able to work with the Internal Revenue

Service. Commissioner Everson has already talked about the importance of enacting the amendments that are pending in H.R.
8

1528, as amended by the Senate, to enable the State charities officers and the IRS to talk to each other.

We need to be able to review exemptions. Exemptions should not

be permanent. We have done a study in New York of our 50,000

registrants have not filed for 2 years or more. The number have not

filed is 12,000.

On the basis of our examination to date, we estimate that 6,000

of the 12,000 will prove to be defunct. We need a plain, speedy, and

efficient way of dealing with these defunct organizations.

We have a situation in New York where we came across a private foundation that was deliberately paying the 4942 excise tax

rather than making the 5 percent distribution. For some reason,

the IRS has not picked that up. That is an example of the kind of

thing that we need to be able to work with the IRS on.

IRS resources are crucial. Crucial. Commissioner Everson has already talked about the inadequacies of the resources. The Securities and Exchange Commission, as I say in my statement, is funded

from registration fees. The Banking Department in New York is

funded from registration fees. We need to get something like that

to the IRS.

We need very much to have electronic filing. We need to support

the IRS’s State Registry Program so that we can get access to current data.

We need to deal with the extension problem. Too many extensions are routinely granted. The result of that, is that current data

is not available for nearly 2 years. Electronic filing, when it comes

in, should be required.

We need very, very much to deal with the string of abuses that

are detailed in my statement, including abuses that are compelled

by state law. I give you an example of how New York State law

permits trustees of charitable trusts to take two or more trustees’

commissions, plus the institutional trustee’s commission, and yet

the IRS, in a private letter ruling, approved this. We need to preempt that kind of state law largesse.

As the Committee staff has proposed, we need to make Section

4958 applicable to all private foundations, not just to public charities, because its provisions on excessive compensation and benefits

are much better than the self-dealing provisions in Section 4941.

The states need, as the committee staff has proposed in its white

paper, the ability to enforce those provisions, just like we can enforce the private foundation provisions.

I see I am over my time. There is much more I could say, but

I am grateful for the opportunity, please.

The CHAIRMAN. Thank you, Mr. Josephson.

Now, Mr. Pacella?

STATEMENT OF MARK PACELLA, PRESIDENT, NATIONAL ASSOCIATION OF STATE CHARITY OFFICIALS, HARRISBURG,

PA

Mr. PACELLA. Thank you, Mr. Chairman and members of the

committee. I am here today as the president of the National Association of State Charity Officials, or NASCO, as it is commonly

known.
9

NASCO is affiliated with the National Association of Attorneys

General, and it serves as a forum for State charity officials to exchange views and experiences relating to the regulation of public

charities, as well as to foster interstate cooperation regarding charitable enforcement initiatives and efforts.

On behalf of NASCO and its members, I would like to thank the

committee for the opportunity to participate in today’s important

proceedings, and also thank our members from New York for all of

their hard work over the past several years with the committee.

State charity officials serve as the primary regulators over public

charities that are most likely to pursue breaches of the fiduciary

duties of care, loyalty, and good faith that our State common law

and statutes impose on those charged with the responsibilities of

administering charitable assets.

Despite the broad authority that State charity officials have,

however, many States lack resources to effectively regulate the

charities that operate within their jurisdictions.

An example being, in the 50 States that we have, less than half

are able to be regular and active participants in NASCO’s annual

conference each year. Most States do not have personnel that are

dedicated exclusively to charitable enforcement. Very often, they

are tied into broader consumer protection responsibilities and circumstances like that.

NASCO wants to stress that, given the relative scarcity of our

enforcement resources, it is very important that we leverage the resources that we have and encourages the committee to make reforms in three general areas, the first being reporting and accountability, the second being information sharing and cooperation

among State and Federal regulators, and the third being exploiting

the opportunities we have in technology, particularly in the areas

of electronic filing and the Internet.

With regard to reporting and accountability, the committee has

already heard testimony, and I am sure has been privy to the fact

that the IRS is inadequately staffed and NASCO supports reforms

to strengthen the accuracy and the timeliness of the form 990. It

is the IRS form 990 that serves as the initial source of information

for both members of the public and regulators alike.

Unfortunately, those forms are often submitted by organizations

with many inaccuracies and incompletions, and it becomes difficult

to differentiate bad actors from the simply inept when you look at

these forms after a while.

Moreover, the forms are often filed one or more years after the

fiscal period for which they relate has passed, making it doubly difficult for regulators to be on top of, or pursue, enforcement actions

in a timely manner.

As part of the testimony that is being submitted in written form,

NASCO is offering a number of recommendations for specific

changes to the form, as well as the instructions.

One material recommendation that we ask the committee to consider is mandating that the IRS form be consistent with the financial statements of an organization. For large organizations that

have audited financial statements, that would subject the information in the 990’s to a set of third eyes, an independent auditor to

review the information that is set forth in those forms.
10

For most organizations, most of the smaller organizations, they

do not have audited financial statements and tight reporting requirements in the 990 that are required to be carried over into

their financial statements would serve to improve the accuracy and

consistency of those statements as well.

We do not believe that these recommendations require any

changes to generally accepted auditing or accounting principles,

and we look forward to the accounting profession working with

State and Federal regulators to improve the accuracy of these reports.

NASCO strongly supports the reforms contained in the Senate

version of H.R. 1528. It is very important, we believe, that State

and Federal regulators be able to share information and share it

effectively.

Ironically, State regulators are more apt to find out about IRS

activity through a target of our investigation than we are from the

IRS itself, the rules that have been imposed on them are that difficult to deal with.

The last point, being exploiting technology and the Internet. We

do think that it is very important that the IRS’s electronic filing

initiative be supported and that its State retrieval system be enacted or brought into fruition as soon as possible. That could serve

as a single point filing system for all State regulators and the Federal Government as well.

Right now, the paper is, itself, practically impossible to deal with

and oftentimes regulators’ attentions are only drawn to those public filings now when circumstances, for whatever reason, bring

them to our attention.

Having that information available in electronic format is an important thing, but being able to do something with it is even more

important. We want the committee to know that NASCO is working with GuideStar in a project, funded by a Technologies Opportunity Program Grant through the Commerce Department, it is a

$1.3 million grant.

If NASCO NET, as the project is known, is successful, it will enable the efficient posting of documents and information about enforcement activities that State regulators and Federal regulators

could share.

The information would be available to the public and it would

also extend state-of-the-art information technologies and regulatory

tools to jurisdictions that lack those resources and the expertise to

put that together on their own.

We do not have a sustainability model to fund this. NASCO very

much supports the proposal in the white paper to recommit the 2

percent excise tax to charities enforcement and hope that State regulators will be able to share in some of those revenues to help support this sort of initiative, and others.

Again, thanks very much to the committee for allowing us to participate in today’s proceedings. Thank you.

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

The CHAIRMAN. All right.

I announced five minute rounds of questioning, so it would be in

this order, first come: Grassley, Baucus, Thomas, Bingaman,

Bunning, Nickles, and Santorum.
11

To any or all of you on the panel, some of my questions will be

directed to specific people, but anybody that wants to help with

this one, I read with interest the Commissioner’s written testimony

about efforts to improve governance at nonprofits.

What are the panel’s views on this issue? How important is it to

get governance and best practices right to prevent problems, and

particularly examples from enforcement that would highlight this?

Commissioner EVERSON. Perhaps I will start, Mr. Chairman. We

do think this is a central issue. The comparison was made between

these issues and the corporate scandals.

The Congress and the administration did respond in the case of

the corporate issues, Sarbanes-Oxley, and the President’s Corporate Fraud Task Force. I believe that some of the abuses here

do go right back to governance.

The term was used, maybe lackadaisical or asleep at the switch.

There is some of that. We need to have clear conflicts of interest

policies within these organizations. They need to be looking at compensation. Internal auditing for larger organizations is another

best practice.

I think, as we go forward, we will be issuing a publication of best

practices. As you probably know, we do not have any direct authority in that area. It is not as if we oversee the governance mechanism within these organizations. But we will do everything we can

to set up what we think are the right basic bedrock principles.

The CHAIRMAN. Do either of the other members want to comment?

Mr. JOSEPHSON. Governance, Senator Grassley, is the most crucial issue. I hope that when Derek Bok speaks before the Committee later he will talk about his Nature Conservancy experience,

because in his talk at Harvard on this issue a few weeks ago he

really did a wonderful job of analyzing the contradictions that are

inherent in a board governance staff model.

I have referred already to what happened to the Albany Urban

League. We see all the time the too-large, or inattentive, or ill-informed, or not diligent board. It is not limited to the board. As the

staff well knows and the white paper discusses, other lines of defense, the accountants, the paid preparers, are not doing their job.

The IRS tells us that 25 percent of all 990’s are either filed incomplete or inconsistent on their face. We know that 4720’s that

disclose the existence of self-dealing and other prohibited transactions are rarely filed.

I give you an example in my statement of a private foundation

that has made illegal political contributions. It did not file the 1120

POL. This story could go on and on.

I do not want to leave out lawyers. I told the committee earlier

that a lawyer masterminded this scheme in which $3.4 million was

taken from the Grand Marnier Foundation. We have lawyers who

tell their clients they have filed the 990’s when they have not.

We have lawyers who are executives of private foundations and

members of law firms who bill their charities for their work as

their executives, inflating the law firm’s bill, inflating their take in

the law firm, and depriving the charity of money.

Mr. PACELLA. I would confirm Mr. Josephson’s comment. I think

that boards should be viewed as the public’s very first line of over-
12

sight over the affairs of public charities. They have the most immediate and direct opportunity to regulate what goes on in their organization.

Two quick examples, I believe the Chairman had asked for. In

Pennsylvania, we have been reviewing hospital transactions, conversions, mergers, sales of assets. We do that by trying to ensure

that the board has exercised due diligence in coming to whatever

their decision is, whether it is a merger or a sale.

In one particular community hospital sale, the board submitted

paperwork to us that suggested that they wanted to sell the hospital for a consideration of $19 million. Our review questioned

whether they had publicly offered the asset for sale. They had not.

We asked them if they would consider that. They did.

When they went back and offered it publicly, they ultimately got approximately $38 million. That was an increase of nearly 100 percent, about another $19 million that now serves health care issues

in the community.

In another case involving the Allegheny Health Education and

Research Foundation, a bankruptcy in 1998, the board was not attentive to the ongoing affairs of the organization.

By the time the situation got bad enough and there was a finan- cial collapse, there had been some $80 million in restricted charitable endowments that had been misapplied to support the bankrupt system’s operations in the months leading up to the bankruptcy. We succeeding in getting about $26 million of that back,

but obviously we are way short of a full recovery.

The CHAIRMAN. Senator Baucus?

Senator BAUCUS. Thank you, Mr. Chairman.

My first question is, how big a problem is this? I mean, in terms

of dollars, what amounts are we talking about here annually? Either amounts of scam, insider trading or whatnot, or lost Federal

revenue because taxes or excise taxes are not collected? Do we have

a sense of how big this problem is? Anybody? Mr. Everson, do you

have an idea?

Commissioner EVERSON. I do not have precise indications. Let

me simply say, Senator, the very fact that we have elevated this

to make it one of our four service-wide enforcement priorities indicates how serious we think this problem is. As I indicated, I think

it is one that is growing.

Clearly, there are many billions of dollars that are lost each year

through the shelters that I have spoken about, which you are well

familiar with. So, that is clearly one indication.

But as I have indicated, I believe that the longer term issue here,

and the more important one, is respect for charitable organizations,

and the consequences if that is not corrected.

Senator BAUCUS. If you were tasked to figure out how big a problem it is, what would you do? How could you find out?

Commissioner EVERSON. In the foundation area we are going to

be doing some more detailed examinations that are akin to the National Research Program that you are already familiar with for individuals.

We will learn quite a bit as we do these examinations. We will

be able to adjust our programs, and I suspect that we will develop

better data regarding the size and scope of the problem.
13

Senator BAUCUS. Do you have a timeline on that project?

Commissioner EVERSON. We are launching in coming months,

and I suspect over the next 6 to 12 months we will start to get

some pretty good information.

Senator BAUCUS. So at least a year from now you will have a

much better handle on the size and magnitude of the problem.

Commissioner EVERSON. I believe that is a fair statement.

Senator BAUCUS. And also by then starting to know more precisely what it is you have to do to get at them.

Commissioner EVERSON. I think that is correct. Again, to make

a pitch for the budget, if we secure the resources we will have more

people to be doing those kinds of examinations, because as you dig

into this, as I said, this is an area where the audit coverage has

been the lowest because it has been viewed as a compliant area.

Because tax-exempt organizations do not generate revenue, it has

sort of been left off on the side. But we cannot afford to do that

now.

Senator BAUCUS. Could you all expand a little more on the federal/State sharing? I understand what some of the impediments

are, and the CARE Act helps that a bit. But could you expand on

the degree to which you are heeded now, and what is really needed

here?

Commissioner EVERSON. Certainly. I would be delighted to, Senator.

Mr. JOSEPHSON. I would like to talk very briefly about fundraising abuse, which may not rise to the senatorial level, but it is

a common problem.

Senator BAUCUS. Well, we are interested in fundraising. [Laughter.]

Mr. JOSEPHSON. Professional fundraising. Professional fundraisers who, themselves, create charities that they then raise

money for and give precious little to charity. We see that over and

over again. Attention needs to be paid to the currently ineffective

Code Section 6113, which does not regulate that.

I would like to give you an example, a particularly gross example. We are looking at the kinds of charities I have just described,

charities that appear to be arms of professional fundraisers.

One of these did not smell right to me, so I asked our accountants to take a look at why its assets jumped from $100,000 to $2

million in a year. And this gets into another area that I know the

Committee is concerned about.

Our accountants discovered that this charity, this two-bit charity, received in 1 year an Ingstrom helicopter, a Lescom plane, a

Boeing Steeraman, a Tiara Pursuit 25-foot boat, an

Aerocommander, another Aerocommander, a Merlin 3B, and Easterly sloop.

Is this charity liquidating? No. These assets were held for at

least a year. Do any of these assets have anything to do with the

charitable purpose of this charity? No.

Is the charity spending any money on maintenance or storage of

these? No. We suspect—and this is another issue that the IRS

Commissioner and we have to be able to work together on—that

these were phony donations and that the contributors are still
14

using this property. I would like formally to refer that matter to

Commissioner Everson right here and now.

Commissioner EVERSON. Well, I would like to refer it back, but

I cannot do that under the law. [Laughter.]

Mr. JOSEPHSON. Exactly correct. This was not a set-up, but, as

I said, we cannot talk to each other.

Senator BAUCUS. I was going to say, that is a great set-up.

Mr. JOSEPHSON. And we have to be able to.

Senator BAUCUS. All right.

So, again, you are agreed on what the changes in the law should

be so you can share.

Mr. JOSEPHSON. Yes, sir. Yes.

Senator BAUCUS. Now, would any civil rights groups or groups

interested in privacy raise a fit over this?

Mr. PACELLA. Really, I think that historically the confidentiality

rules have simply carried over from the private taxpayer side to

the public charity side.

I do not believe that any of the dynamics or any of the public policy considerations that weigh in favor of confidentiality for any of

our individual tax returns or that of monied commercial corporations are in any way applicable to public charities. These are public

monies that are being privately administered. If anything, they

should be subject to more public scrutiny.

Senator BAUCUS. One quick question, Mr. Chairman.

Mr. Josephson, you mentioned Mr. Bok’s testimony and a speech

he apparently gave a couple, 3 weeks ago about the Nature Conservancy.

I read his testimony and was a bit struck where he said that the

review that the Nature Conservancy performed revealed that Sarbanes-Oxley types of regulations should apply, but only on a voluntary basis. That is, they do the best they can.

I was a little surprised that he did not go a little further and say

we should have some mandatory, appropriate, whatever they might

be, selective provisions from Sarbanes-Oxley that would apply to

charities. I am just curious what your reaction to that might be.

Mr. JOSEPHSON. We are all in favor of that. Attorney General

Spitzer himself proposed State legislation this year that would incorporate into State law many of the Sarbanes-Oxley provisions

that we think are relevant.

We applaud the staff’s proposal that requires the chief executive

officer of charities to sign the 990 or the 990 PF. We think that

the staff’s proposals for severe penalties on paid preparers who do

not do their jobs are entirely appropriate.

Senator BAUCUS. Would you change the staff proposal in any

way, any of the three of you?

Mr. JOSEPHSON. Yes, I would. I agree with the staff’s proposal

that the accountant audit responsibility should be rotated. That is

going to be difficult, perhaps, for the small charities in less-populated areas. Perhaps there needs to be an exception for that. But

for the major charities, absolutely.

Senator BAUCUS. But would you change the staff proposal in any

way?

Mr. JOSEPHSON. Yes.

Senator BAUCUS. And the way would be to do what?
15

Mr. JOSEPHSON. The way would be to require smaller boards,

committees, audit committees, compensation committees, independence on the part of board members. All of the staff proposals that

analogize to Sarbanes-Oxley are absolutely appropriate in the charitable sector.

Senator BAUCUS. Mr. Pacella, Mr. Everson, any comment on the

staff proposal?

Commissioner EVERSON. I do not have a detailed comment. I

think that the white paper raises a lot of very important issues and

needs to be looked at carefully and addressed, and we are going to

do that.

Senator BAUCUS. All right.

Mr. Pacella?

Mr. PACELLA. We would agree, with the proviso of building some

safeguards in for the small organizations, the small, locally-based

organizations.

Senator BAUCUS. Thank you, Mr. Chairman. Thank you very

much.

The CHAIRMAN. Thank you.

Senator Thomas?

Senator THOMAS. Thank you, Mr. Chairman.

Let me ask some kind of broader questions. You all go into great

detail, and I understand that, but there is great reason to be a

charitable group, to obtain the status, and so on.

What is the definition of a charitable group and how do they become charitable unless you agree that they are?

Commissioner EVERSON. Well, they make an application to us

and they have to have a broader public purpose that they are serving. Let me talk about credit counseling just as an example, because I did mention that.

Credit counseling was an industry or a subsector that existed for

a long time, and it educated and counseled families or couples or

individuals that got into financial difficulty. These were organizations, small and large alike, that did this work and they did it carefully.

But what has happened here that is disturbing, is that now some

entities, newer entities, have gotten involved. They are funneling

debt service packages to related parties.

Senator THOMAS. But my question is, is there not a definition?

If it does not apply to them, why do you allow them to be in that

category?

Commissioner EVERSON. Well, because, as I indicated before, this

is an area where I do not think we have provided adequate attention. We have upped our resources to address this very problem.

It was mentioned earlier, we are devoting a lot more focus on the

determination process, the front end when they make an initial application. But sometimes they will say one thing on the application

and then act differently as they go down the road. The only way

you are going to get after that is through an audit process, and our

audit coverage here is quite low. It is less than half a percent.

Senator THOMAS. I see. But that is the way you handle everyone

else in the tax situation, is if it does not appear right, you audit

it. Right?
16

Commissioner EVERSON. That is correct. So what I am suggesting is, and why we have asked, Senator, for all of the additional resources is that this was a sector that was more compliant,

and now we are seeing a deterioration in behavior so we need to

adjust our plans accordingly.

Senator THOMAS. But you all asked about more money. Now,

would changing this bring in more money to offset the costs that

you all are talking about?

Commissioner EVERSON. I think that you need to do three things.

You need to start with the President’s proposal, which, as I indicated, would provide 17 percent increased spending and examination in this area.

We need to address this sharing issue that has just been discussed. That is terribly, terribly important, because if you look at

abusive tax shelters, right now we are sharing with 46 different

States information, and they are pursuing some cases and we are

pursuing others. We cannot do that with these gentlemen. We need

to be able to do that so we leverage cooperative efforts.

The third, is we need to jointly assess all of the issues that surfaced in the white paper, and some of the things that are in my

testimony as well.

Senator THOMAS. Now, the States are interested in it because of

State tax. Is that correct?

Mr. JOSEPHSON. That is correct.

Senator THOMAS. Not all States are involved in it then.

Mr. JOSEPHSON. I would like to emphasize the importance of the

exemption granting and the exemption review process. Exemption

is a privilege, it is not a right. Charities that receive the exemption

ought to periodically justify that they are doing the job they said

they would do when they applied, and they ought to justify their

governance practices.

Senator THOMAS. Do you have a definition of what is proper?

What is the characteristic that you would measure against?

Mr. JOSEPHSON. We try to evaluate the extent to which any charity uses charitable funds for its charitable purposes.

Senator THOMAS. What is a charitable purpose?

Mr. JOSEPHSON. To the extent that we have data, we look at the

ratio between administrative expenses and program expenses.

Senator THOMAS. All right. But do not go on any further. What

is charitable? You have said they have used it for something different, but it still qualifies.

Mr. JOSEPHSON. Yes.

Senator THOMAS. Do you define charitable?

Mr. JOSEPHSON. I think that this charity that I referred to earlier that has become a donation vehicle is not using its assets for

charitable purposes.

Senator THOMAS. Clearly. But do you define that?

Mr. JOSEPHSON. You find a lot of that, yes.

Senator THOMAS. No. Do you define it? How do you determine

that? You determine most other taxes fairly clearly. You act here

like charitable is, oh, maybe it is this, maybe it is that.

Mr. JOSEPHSON. This particular charity is a health care charity.

That is a traditional area for charities.
17

Senator THOMAS. Well, you are still not answering my question.

Would you answer my question, please, sir? Do you have a definition of charity?

Mr. JOSEPHSON. Yes, we do. We have the traditional definition

that is dated from the 16th century: health care, education, social

service. The definition of charity has not changed in 400 years.

Senator THOMAS. It has not been, in the tax law, defined, has it?

Mr. JOSEPHSON. Yes, it has.

Senator THOMAS. All right. Then that is what I am asking you.

Mr. JOSEPHSON. That is the traditional definition which is in the

Internal Revenue Code.

Senator THOMAS. Do not talk to me about the 1600’s. That is not

the issue. We are talking about today, so that you can look at it

and say, this charity is one that qualifies for charity.

Mr. JOSEPHSON. Yes. In New York, we have a series of charitable

definitions. The most pertinent to traditional charity is what we

call a Type B charity, and that is what we measure charitable performance by.

Senator THOMAS. That is my question. I hope it is very clear.

Thank you.

The CHAIRMAN. Senator Bingaman?

Senator BINGAMAN. Thank you very much.

Commissioner Everson, let me ask about the overall budget level

for the IRS this coming year. The IRS Oversight Board has said—

and this is reading from their latest report in March—’’the Board

believes the administration’s 2005 budget cannot achieve its stated

goals to add almost 2,000 personnel to bolster the IRS enforcement

efforts, and will threaten hard-earned improvements in customer

service.

This year’s request will lead to a $230 million shortfall in the

IRS budget because it fails to budget adequately for the anticipated

$130 million of Congressionally mandated civilian pay raises, rent

increases, and at least $100 million of unfunded expenses.

In fact, fiscal year 2005 is the fourth year in a row in which the

administration has called for IRS staff increases, while not covering pay raises or required expenses.’’

Do you agree with that?

Commissioner EVERSON. I do not agree with the board assessment in this area. I support, down the line, the President’s request.

The President has provided a request for the IRS that is 10 times—

10 times—the average request for a non-Homeland, non-DoD agency. The overall request is 5 percent, in contrast to 0.5 percent.

What I do ask the Congress to do, is to fully fund that request.

There are some indications already that the marks going back to

the appropriators are less than would provide for that. It is critically important that the request be funded.

If there are things like the civilian pay increase, an additional

2 percent is provided, that would cost us about $100 million. We

can find a way to absorb that. It is a $10 billion-plus organization,

and as the Chairman and others have said, we have got to be more

efficient.

We are searching for ways to be more efficient. We can do some

things to close some of those gaps, but we cannot do that if, instead
18

of the $10.7 million the President has asked, only $10.3 million or

$10.4 million is provided.

Senator BINGAMAN. Let me ask about the abusive tax shelters.

Did you say there were 31 that you identified?

Commissioner EVERSON. What we do, sir, is on an ongoing basis

is issue guidance and a list of transactions that we consider potentially abusive so that they get special scrutiny if they show up on

a return. As of now, there are 31 that have been listed as having

those characteristics.

Senator BINGAMAN. And these are tax abuses that are, in your

view, illegal, contrary to current law, and ones which, under current law, you can prevent it. To the extent you can identify them,

you can take them to court and stop that. Is that right?

Commissioner EVERSON. We can do that. It is going to depend on

the facts and circumstances of the individual transaction. What we

do, is we talk about the general transaction, and sometimes the

facts and circumstances are different.

Some are more egregious than others. You may be familiar with

a transaction called Son of Boss. We have a settlement offer out on

that. That is a very abusive transaction, one of the worst.

Senator BINGAMAN. Some of the later witnesses here, in their

testimony, cite what they consider to be abuses. J.J. MacNab has

some examples in the testimony that has been filed. One of them

is this Life Heritage Plan, LIFE.

The testimony says the charity sets up a trust which sells either

fixed income shares or dead instruments to the insurance company.

Using the money raised, the trust purchases 10,000 life insurance

policies totalling $2 billion from a different insurance company on

the lives of the charity’s donors.

The charity receives the first million in death benefits each year

for 30 years. The remaining pool, which is about $2 billion, goes to

the insurance company or the investor. Each donor receives a small

death benefit, $10,000, as an entitlement to have the policy purchased on his or her life.

So, the charity gets $30 million, but that is nothing more than

rent for the insurable interest that is transferred to the trust for

the use of the institutional investors who benefit substantially

more.

Now, that is not one of the tax abuses you are talking about, because that is perfectly legal, as I understand the current state of

the law. Am I right about that?

Commissioner EVERSON. I would hesitate to comment. You covered a lot of ground there. I understand there are issues with insurance and the interaction with charities at this point that we are

carefully looking at, but have not yet reached final conclusions. So,

that would cause us concern. We are looking at these kinds of

issues.

But I would say, stepping back for a minute, it buttresses the

broader comment that I have made that we are seeing more and

more structured transactions not through a traditional gift of cash

or securities, but to interacting with these charities, again, created

by the attorneys and the accountants trying to create something of

mutual benefit that I think is oftentimes at variance with what the
19

expectation has been about how these organizations will govern

themselves.

Senator BINGAMAN. Can Mr. Josephson also comment on that?

Mr. JOSEPHSON. May I comment on that?

Senator BINGAMAN. Please.

The CHAIRMAN. Yes. Go ahead.

Mr. JOSEPHSON. The New York State Insurance Department

issued a ruling recently that would prohibit exactly the kind of

scheme that you are talking about. I am sorry to say that one of

your former colleagues is lobbying the New York State legislature

to overturn that ruling.

Senator BINGAMAN. Thank you.

The CHAIRMAN. Senator Bunning?

Senator BUNNING. Thank you, Mr. Chairman.

Mr. Commissioner, many of the financial violations of charitable

organizations arise from directors and officers obtaining unjustified

compensation from their organization.

Can you comment on how it may be determined what is and

what is not excessive or unjustifiable compensation?

Commissioner EVERSON. Certainly, sir. This is a facts and circumstances test. You have got to look at the nature of the institution, what are comparable practices in other organizations, size has

something to do with it, and technical expertise.

There are a range of issues, but you can spot some pretty clear

problems as you look at some of these organizations. But it depends on the individual examination of our career professionals

who will take a look, and they need to render a judgment.

Senator BUNNING. Should it be subjective or should you have

some type of statute that would fix compensation within a reasonable parameter?

Commissioner EVERSON. I think it is about right where it is now.

You rely on the audit process to look at it. I would be hesitant to

develop a cookie-cutter, or more mechanical, approach. I do not

think that is consistent with a good regulatory scheme, because

there are differences in circumstances.

Senator BUNNING. In your testimony, a number of current law

penalties may be imposed in situations where salaries in excess of

reasonable compensation are paid. Can you comment on how often

these penalties are imposed?

In addition, could you comment on the differences between the

penalties that are available to be imposed in situations of abuse in

the public charity content, such as the tax on excessive benefit

transactions, and the penalties that are available in the private

foundation context, such as the tax on self-dealing and taxable expenditures, and the effectiveness of each? Do you think it would

have an impact to expand the private foundation’s self-dealing

rules to the public charities?

Commissioner EVERSON. I would like to take that in two parts.

Senator BUNNING. All right.

Commissioner EVERSON. My understanding of the potential penalties, is that you can assess sort of a surtax. If an individual has

paid too much, then you can subject the individual, not just the

charity, to a 25 percent, I believe it is, penalty.
20

That has not been used as often as it ought to be. We are going

to start to increase the use of it as we go along here, particularly

these credit counseling organizations that I mentioned where we

are focusing more attention.

But we have not done much of this. My inquiries have indicated,

perhaps, it is a handful each year. So, we need to do more of that,

absolutely. I think we should carefully consider whether there are

other areas where there are abuses.

But, again, I would suggest not on a cookie-cutter or mechanical

approach, but using the judgment of the the independent experts

that we have, as to whether things or reasonable or not. Yes, other

penalties might be a good idea.

Senator BUNNING. Other than the anecdotal information that we

have on abuses, the IRS has not really dug into this in depth. Is

that correct?

Commissioner EVERSON. I am not sure that I agree with that assessment. We have looked at this enough, and we have seen

enough changes in certain segments of this sector, that, again, we

have elevated this to one of our four service-wide priorities. We

have requested significant additional funding. We have launched

the four or five different initiatives that I mentioned earlier.

Now, beyond that, I would agree with my colleagues on the panel

who have indicated that we have other work to do. We need to revise the reporting in this area. We have launched electronic filing.

That will give us a better capability to analyze the data. So, there

are a lot of things that are happening.

But yes, if you are saying that we have been slow to get at this,

probably it is fair to say that this problem has crept up over time,

and our response has lagged.

Senator BUNNING. Well, for us to look at increasing, as requested, the amount of dollars being spent on this specific area,

there has to be some justification.

Commissioner EVERSON. Yes.

Senator BUNNING. So, the justification would be if the audits of

those entities would reveal a lot of abuse, and therefore return to

the Treasury the money that we are expending to actually capture

that money back for the abuses.

Commissioner EVERSON. Yes.

Senator BUNNING. So, unless we can be convinced of that, I do

not know how you can expect us to justify the expenditure of the

additional dollars.

Commissioner EVERSON. Senator, of the $300 million in additional funding that the IRS has requested for enforcement, we conservatively estimate overall a 5:1 direct return. Beyond that, there

is an indirect return, a change in behavior that takes place when

people are held accountable.

Senator BUNNING. Do we not have the laws on the books now?

Commissioner EVERSON. We have, largely, the laws on the books

now. But I think what the white paper is indicating that there

needs to be a discussion on certain additional steps, so we get consistency in this sector with some of the other approaches that are

taken in a regulatory scheme.

Senator BUNNING. Thank you.

The CHAIRMAN. Thank you, Senator Bunning.
21

Now, Senator Nickles?

Senator NICKLES. Mr. Chairman, thank you very much, and

Commissioner Everson, and to other panelists. Thank you for participating in this.

Mr. Chairman, I compliment you and Senator Baucus. I think

this is a very interesting hearing and one that hopefully will help

make some changes.

Commissioner Everson, you mentioned two or three things. One,

there are about 3 million tax-exempt entities today?

Commissioner EVERSON. Yes, sir. There are about a million charities and a comparable number of pension plans. This whole sector

includes Indian tribes, governmental entities. We have four different sorts of organizations in the IRS. Our smallest is the one

that deals with this whole basket of tax-exempt and government

entities.

Senator NICKLES. And in the charities, you would include all the

education groups?

Commissioner EVERSON. Those organizations would be included

in the charitable group. Right.

Senator NICKLES. I appreciate that.

Well, just a couple, three comments. One—and some of you alluded to this. Mr. Josephson, I think, did—that a lot of charities—

not all charities. Most charities do most great, and my compliments

to them. Some charities do great fundraising and very little goes

to the recipients, or to the intended people. That irks the heck out

of me.

I do not want to contribute, nor do I want somebody else to contribute, $100 or $1,000 to a group and find out that 90 some percent of it went to fundraising expenses, and very little bit of it went

to the beneficiaries.

Mr. JOSEPHSON. And it deals with revenue loss, as my colleague

said.

Senator NICKLES. Absolutely. I look at this from both sides. If

you are talking about big sums—Mr. Everson, do you have a figure,

what the total amount of charitable contributions that people claim

on their returns? Do you happen to have that?

Commissioner EVERSON. I do not have that with me, sir, but we

could certainly give you the data on that.

Senator NICKLES. If you would give that to us, and what that

meant, if you have an estimate of loss in revenue.

Commissioner EVERSON. In 2002, on 40,399,695 returns,

$140,571,365 in charitable contributions was claimed.

Senator NICKLES. I am not saying we should take away that deduction, but conversely, if you looked at—let us just use a large figure. If it had $100 billion in charitable deductions, and let us say

it cost the government—were you wanting to add something, Mr.

Josephson?

Mr. JOSEPHSON. I think I can provide that information. Marian

Freemont-Smith’s new book, Governing Nonprofit Organizations,

estimates an annual contribution total of $241 billion.

Senator NICKLES. All right. Well, I was going to use $100 billion for simplification. If it is $241 billion, let us say it is an $80 billion

average tax rate, or whatever that figure would be. Or maybe I will

make it smaller.
22

If a person is making a $100 contribution and they deduct $100, but only $5 or $10 goes to the recipient, the Federal Government,

if that person is in a 30 percent tax bracket——

Mr. JOSEPHSON. That is what our recommended amendments to

6113 would deal with. That is an extremely abusive situation and

it is very difficult to deal with on an individual case, because I cannot justify the allocation of my scarce resources to deal with lots

of $100 or smaller contributions.

Senator NICKLES. I have not looked at your recommendations

that closely, Mr. Josephson, but I am happy to look at it. I am just

trying to get a little bit of a grasp on the figure.

But I happen to think there are a lot of charities, particularly a

lot of the ones that are using phone and mail. You can burn a lot

of money on phone solicitation and mail solicitation and generate

very little net for the purpose.

Mr. JOSEPHSON. Probably the biggest volume of complaints that

we get on the State level are from people who feel they have been

abused by professional fundraisers.

Senator NICKLES. All right.

If we did a better job, or is there some disclosure that if charities

had to disclose the percentage of their dollars raised, their fundraising expense, or maybe reverse that, the percentage of money

that actually goes to the beneficiaries, should that figure be required if they are going to contribute?

Here is your United Way list of beneficiaries, and some are very

efficient, and maybe 90 percent of the money raised goes to the intended purpose, and others might be less efficient, and maybe 3

percent of the money goes to the beneficiaries. Is there one place

where people could find that?

Mr. JOSEPHSON. We need to work with the committee on that

issue. There are three 1980 Supreme Court cases that inhibit the

ability of the States to require that kind of point-of-solicitation disclosure.

Now, the recent Madigan case gives us an opening in situations

where there is fraud. I think we can construct a Code provision

that will get exactly at what you are worried about, Senator Nickles. I would be happy to work with the committee staff on that.

Senator NICKLES. All right. I appreciate that.

Mr. Everson, do you have any comment on that?

Commissioner EVERSON. I think that I view that as a consumer

protection issue and not necessarily a tax issue.

Senator NICKLES. Well, they are both. Charities can be a very efficient, much better method, frankly, than government as far as

providing assistance to those people who really need it. They can

be better in many respects.

Conversely, if you have a charitable organization that is taking

a lot of tax-exempt money and using very little of it for beneficiaries, the taxpayer is getting ripped off and the beneficiaries are

getting very little for a lot of money expended.

Commissioner EVERSON. Fair enough.

Senator NICKLES. So, there are tax consequences, too.

Commissioner EVERSON. Clearly, our predisposition is to disclosure, that disclosure is helpful. I think that is really what you are

arguing for.
23

Senator NICKLES. I think sunshine disclosure would be very healing in the process. I think it would be an embarrassment to a lot

of charities if people knew the percentage of money, or the small

percentage of money, in some cases, that goes to the actual beneficiaries. Maybe that would change donating behavior, so it might

fix itself.

I am also very concerned about some of the scams. I think,

whether there are some insurance things that may be legal—but

if you look at the total dollars, again, that people may be contributing and the amount of money that goes to the school, or whoever,

is putting that together, I think some of it looks pretty questionable and it needs to be reviewed. I guess you have mentioned you

are in the process of reviewing that, so I appreciate that.

Thank you, Mr. Chairman.

The CHAIRMAN. Mr. Pacella, did you have something to say?

Mr. PACELLA. Yes. I did want to offer a response.

Senator Nickles, the Supreme Court cases that Mr. Josephson

referenced made clear that the States cannot constitutionally compel a point-of-solicitation disclosure as to how much is going to go

to a particular charitable cause.

What the Supreme Court has told us, is that we can require the

registration and reporting of a charity’s finances and the constitutional way to get this information out is for States to disseminate

this information.

There are approximately 38, 39 States that have registration reporting requirements on the books. Pennsylvania is one of those.

But this ties back in a critical way to the accuracy of these 990 reports that you have all heard us mention earlier.

That old adage about ‘‘garbage in, garbage out,’’ the battlefield

has really concentrated now on the accuracy of the financial information that these organizations report.

Even donors that have the presence of mind to make inquiries

and check with their State registration offices, Better Business Bureaus, or whatever, to find out what information they can glean

about what an organization’s finances have been, are oftentimes

frustrated, if not completely circumvented, because of the inaccuracies of these 990’s that get filed, the wiggle room that exists in reporting requirements, the fact that sometimes the most timely information available may, honestly, now, be 3 years old, that does

not really give donors much insight into how much of the $100 they

are considering today for the benefit of the local food bank, or

whatever, is actually going to get there.

So, disclosure is something that has been very well litigated, and

I think that question has been answered for us. It is critical that

we tighten the reporting requirements so that States can disseminate accurate and timely information.

Senator NICKLES. Thank you.

The CHAIRMAN. Senator Santorum?

Senator SANTORUM. Thank you, Mr. Chairman.

Commissioner, how widespread is this problem? I mean, what

percentage of charities are involved in activities that you would

consider to be problematic?

Commissioner EVERSON. I do not think we have a precise answer

at this time, Senator. This was a sector of the country that was
24

pretty compliant. And, as I have indicated, we have seen two

things that are happening here, and that is why we have articulated the enforcement priority the way we have.

The first, is we have seen abuses within the sector that we have

been talking about this morning, governance abuses, insider dealing, dealing of related parties where you are really just funneling

money to profit-making entities.

Then the second thing we have seen, which is particularly of concern to this committee in terms of the abusive shelters, is the use

of these organizations as accommodation parties for tax avoidance

schemes. I do not know if you had come in yet during my opening

statement, but this chart is a transaction.

This is based on a real transaction where a product is marketed

by the attorneys and accountants. It involves foreign currency. It

is pretty complicated, with offsetting options.

What happens is the taxpayer gets a half a million lower tax bill, the charity gets a paper gain of $1.5 million, which of course does

not cause any pain to the charity because they do not pay any

taxes, but they get $50,000 in cash by having these offsetting arrangements.

Those kinds of things, that is not what was happening 10 or 20

years ago. But because we have tightened up on some of the other

shelters, now people are finding these channels, and that is very

disturbing to us.

Senator SANTORUM. Is this legal?

Commissioner EVERSON. We have listed that as an abusive transaction and we are stopping that kind of thing. But you have to stop

it through the disclosure and regulations that we issue, and then

you have to follow through with the audits.

But, here you have got a couple of different issues that I would

say are tough. We have been talking a lot about charities here. The

charities issue these annual reports that we have been talking

about.

Some of these—not this scheme, but others—go through municipal organizations which are also not regulated at all by the IRS,

so it is very difficult for us to pick up all the participation in these

kinds of tax shelter transactions.

Senator SANTORUM. I would maybe just come back to my initial

question again. You said you have gotten records of abuses and anecdotal evidence. My question comes then, how widespread is this?

Commissioner EVERSON. Well, this goes into the billions of dollars.

Senator SANTORUM. I understand. But that is a particular

scheme, if you will. We have got hundreds of thousands of charities

out there.

Commissioner EVERSON. Right.

Senator SANTORUM. How many charities are involved in these

kinds of activities?

Mr. JOSEPHSON. Senator, I can give you a clue about that. I have

about six accountants on my 50-person staff. They go through, annually, about 2,500 registration statements.

Annually, they refer to the lawyers on my staff about 200 matters. Now, we cannot, obviously, devote resources to all 200 of those

matters, but the accountants are picking up nearly 10 percent of
25

charities whose registration statements raise concerns. That is a

big number.

Senator SANTORUM. So, you are saying 10 percent raise concerns.

What percentage of those do you look at and then find problems?

Mr. JOSEPHSON. That is a triage problem. I have got 19 lawyers

to deal not only with those 200 referrals, but to deal with press reports, complaints, articles like appeared in the Chronicle of Philanthropy on illegal loans from charities to their directors and officers.

We are looking at all 165 of those from New York.

So far, we have restored to charity more than half a million dollars. Our examination is continuing. We have to look at the major

abuses. Therefore, it is very difficult for me to give you a precise

answer to your question.

Senator SANTORUM. I think that is a good point, to look at major

abuses. I certainly would like to see that happen. I am one who

strongly believes in charities and the tremendous purpose that they

serve.

While I commend the Chairman and Ranking Member for having

this hearing, at the same time I hope that people do not view this

hearing and say, well, gee, we need to walk away from charitable

giving, that this is a scandal-filled area that people are just using

charities to rip us off of our money.

I know comments were made about, how much money is going

to the bottom line, whether it is telemarketing or direct mail. I

daresay, if we look at our own campaigns and find out how much

money we send and spend on direct mail and telemarketing and

what our net is from doing prospecting and doing telemarketing

prospecting, you would find out that we do not make any money

doing that either, and I do not think we disclose that to our donors

when it comes to how much contributions we get.

But there is a point beyond how much money you get, and that

is to get names on the list who you can then get contributions from

in the future, and that it actually is worth not making any money

on some direct mail pieces to get names of donors who will give in

the future where you can make money.

So, I just want to make sure that we are not suggesting that

there are practices out there that are being engaged by charities

that are somehow traditional in nature, but nefarious by the fact

that you are not getting lead on the target, or dollars netted to the

charity.

Commissioner EVERSON. I could not agree with you more. I

would like to be clear on this, Senator. As I said in my oral statement, the vast majority of charities are still operating the way they

traditionally have. What I feel our job is here, is to find the pockets

where there are problems or where there are trends. So, I agree

that this is a very vital sector.

Senator SANTORUM. I see my time is up. Thank you, Mr. Chairman.

The CHAIRMAN. Before I dismiss the panel, Senator Baucus had

a follow-up question he wanted to ask.

Senator BAUCUS. My curiosity perked up a little bit when you

mentioned those Supreme Court cases that make it unconstitutional to what, to collect what kind of information?
26

Mr. PACELLA. Those three cases, Shaumberg, Munson and Reilly,

and Reilly was last decided in June of 1988, stand for the proposition that States cannot regulate by percentage the amount of

money that goes to program services. So, we cannot license or prohibit a charity’s ability to deliver its message, to conduct solicitations on the basis of how much gets to charity.

Senator BAUCUS. On the first amendment?

Mr. PACELLA. On the basis of the first amendment, that it is a

fully protected activity, and that to do so would unfairly discriminate against organizations that are newer that do not have an established donor base, that may have, particularly unpopular

causes, politically unpopular causes, or whatnot, and that the better practice that the constitutionally correct way to do it is to simply require the reporting and then allow the regulators to disseminate the information, that it is burdensome speech and will so alienate prospective donors if they are forced to hear, at the outset

of a solicitation, that only 5 percent of your contribution is going

to go to the cause I am about to ask you to support.

Senator BAUCUS. But you think you can get around that with

other forms of disclosure to help get at the problem?

Mr. PACELLA. As Mr. Josephson said, the court had made very

clear that States can vigorously prosecute fraudulent solicitations

in our anti-fraud laws. It is just that we cannot engage in a prophylactic practice that burdens the first amendment rights of nonprofits.

Mr. JOSEPHSON. Senator Baucus, I would like permission to submit for the record an article on exactly this issue that I have just

published in the New York Law Journal, which suggests to me that

the Madigan decision gives us some enforcement avenues that we

did not have before.

Senator BAUCUS. Mr. Chairman, I think that would be a good idea if—without objection, we could include that.

The CHAIRMAN. Without objection, it will be included.

[The information appears in the appendix.]

Senator BAUCUS. One brief point. Mr. Everson, the Son of Boss

program got an amnesty period which has just expired, and I sent

you a letter asking for the results, and you gave me a copy of your

letter today, which does not say very much.

Commissioner EVERSON. No, it does not.

Senator BAUCUS. But I would deeply appreciate if you could, as

quickly as possible, answer the questions in that letter so we have

a better idea of the magnitude of the Son of Boss program and the

degree to which people are coming in.

Commissioner EVERSON. Yes. Yes.

Senator BAUCUS. And whether there are serial abusers, et cetera.

Commissioner EVERSON. Yes. I am not prepared to comment

today. We have been seeing some pretty good volumes coming in

each day. As you can imagine, this kind of thing ramps up as you

go along. It is a little bit like when people mail their returns on

the 15th. I expect that, as early as next week, I will be able to talk

with you about it.

Senator BAUCUS. The Chairman and I wrote you a letter.

Commissioner EVERSON. Yes.
27

Senator BAUCUS. We would appreciate your response.

Commissioner EVERSON. Yes. We will get that to you as soon as

we have some good, hard numbers.

Senator BAUCUS. Thank you.

Thank you, Mr. Chairman.

The CHAIRMAN. Thank you. I will have some questions that I am

going to submit to this panel. I might as well announce, for other

panels as well, from members that cannot be here or people like

me that did not have time to ask all the questions you want to ask,

we will submit questions for response in writing.

Thank you, all of you on this panel, for a fine presentation.

[The questions appear in the appendix.]

The CHAIRMAN. Now I would like to call the next panel. Senator

Baucus has already done this, but would Mr. Adkisson come, Ms.

MacNab, come.

Then we have confidential witnesses whose names are not their

real name. I am going to call the first person ‘‘Mr. Car’’ and the

second person ‘‘Mr. House.’’ And when you hear their testimony,

you will understand why their identity cannot be known.

As I announced to you, we are in the middle of votes this morning. So, I am going to go over and vote while you folks testify, and

Senator Baucus will listen. In about 6 minutes, I will be back. Senator Baucus will go over and he will vote on the first vote, and stay

and vote on the second one, then come back and I will go over and

vote.

So, would you proceed with Senator Baucus chairing?

Senator BAUCUS. Ms. MacNab, why do you not proceed?

STATEMENT OF J.J. MacNAB, CFP CLU QFP, ANALYST,

INSURANCE BAROMETER, LLC, BETHESDA, MARYLAND

Ms. MACNAB. Mr. Chairman, Mr. Baucus, and members of the

committee, thank you for inviting me to speak before you today.

Americans are generous people. We love our charities. But when

we donate money to our favorite causes, we want to trust that

those charities will do the right thing with that money. Since charities are tax-exempt, we also want to know that they are not abusing the subsidies that our tax dollars are effectively funding.

I have three examples I would like to cover here today, and there

are many more outlined in my written testimony. All have a common theme. They allow people and corporations to do things that

they just could not do without the cooperation of a charity. All receive a benefit that would otherwise be unavailable to them.

A thief is able to steal, because wrapping his con game in a charity shell gives him credibility. A few thousand taxpayers are able

to fund personal expenses using tax-deductible donations to a nonprofit that is not picky about cutting grant checks.

And institutional investors are able to purchase billion dollar life

insurance pools, where ordinarily State insurance laws would make

such investment pools illegal.

The first topic I want to cover is outright fraud, where unwitting

consumers were duped into losing their life savings simply because

they trusted a charity.

In 1999, the Baptist Foundation of Arizona filed for Chapter 11

bankruptcy, owing more than $600 million to 13,000 investors,
28

most of them elderly and retired. In what turned out to be the largest fraud case ever involving a religious trust, thousands invested

their money with a foundation which promised high investment returns and charitable grants for Baptist causes, but turned out to

be nothing more than a complicated pyramid scheme.

Three foundation executives have pleaded guilty to defrauding investors, and in 2002, Arthur Andersen agreed to pay $217 million

in damages for their role in helping charity executives cover up the

scheme.

My next topic is donor-advised funds that allow donors to use

tax-deductible donations to fund personal expenses. While most of

the nonprofits in this arena place reasonable limits on their donors’

control, a few charities out there are not picky about where they

send grant checks.

On the contrary, they encourage their donors to use the money

for their own expenses. There are many more details in my written

testimony, but I would like to go through a very quick laundry list

of examples that I found on just one Virginia charity’s web site.

Example one: There are limits on adoption expenses that a person can deduct. Just run your adoption costs through the charity

and you can deduct 100 percent of those expenses, with no phaseout for higher adjusted gross incomes.

Example two: Set up a 501(c) plan with tax-deductible money

and repay yourself for charitable employment when you retire. The

tax benefits are the same as a qualified pension plan, but there are

no ERISA rules, higher contribution limits, no penalties for early

withdrawal, and the plan can discriminate in favor of highly compensated employees.

Example three: Donations to international charities are not generally tax-deductible, so before writing a check to a foreign country,

just set up an account with a U.S. charity, let them write the

check, and you can deduct 100 percent.

Example four: Use your donor-advised fund monies to pay for

your family’s reunion in Italy this summer.

Example five: Run your for-profit life insurance business through

your donor-advised fund. People will buy your insurance because

they like charity, and you can defer all of your taxable income until

you retire. Finally, use your donor-advised fund monies to pay your

children’s tuition costs.

Obviously, none of these examples are suitable uses for tax-deductible donations.

My last topic is perhaps the most serious and the fastest growing.

Senator NICKLES. Where did you find this?

Ms. MACNAB. All one charity, the National Heritage Foundation,

in Virginia. There are many, many more examples, many of which

were actually highlighted in some articles in national publications

in 1999.

My last topic is perhaps the most serious and fastest-growing of

them all. Charities participating in complicated shelters, which enable outside investors to enrich themselves by renting a charity’s

ability to purchase insurance on the life of a donor.

To summarize briefly, the charity sets up a trust, sells interests

in the trust to outside investors, which are usually insurance com-
29

panies, hedge funds, or private banking clients. The money raised

is used to purchase life insurance on the lives of the charity’s

wealthiest donors.

While the donors are alive, the trust pays interest income to the

investors, and when the donors pass away, a small portion of the

death benefit goes to the charity, while the investors collect the

bulk.

The institutional investors investing in this plan would be unable

to purchase the insurance contracts on their own. They must borrow or rent the charity’s insurable interest. The charities are willing to sell this interest for pennies on the dollar, simply for the reason that those are pennies they would not have had otherwise.

Each insurance pool ranges in size from $200 million to $2.5 billion, and the charities who participate collect anywhere from $10

million to $30 million. Under most current State laws, these ‘‘dead

pool’’ schemes are already prohibited, because while a charity may

have an insurable interest in the life of a donor, the trust, funded

by the outside investors, does not.

For this reason, the promoters have been aggressively lobbying

at the State level to get the insurable interest laws expanded, effectively gutting the important consumer protections inherent in these

laws, just so they can arrange more dead pools for their institutional clients.

Thank you for your consideration today. It is my hope that shining a harsh light on the very few abuses that do occur in this industry will have the effect of wiping out the bad practices before

they have a chance to spread.

Senator BAUCUS. Thank you, Ms. MacNab.

[The prepared statement of Ms. MacNab appears in the appendix.]

Senator BAUCUS. Mr. Adkisson?

STATEMENT OF JAY D. ADKISSON, EDITOR OF QUATLOOS.COM

AND DIRECTOR OF PRIVATE CLIENT SERVICES SELECT

PORTFOLIO MANAGEMENT, INC., ALISO VIEJO, CALIFORNIA

Mr. ADKISSON. Thank you, Senator Baucus and members of the

committee.

Congress is presented with a challenge of furthering contributions to charities and foundations, protecting their integrity while

simultaneously discouraging their abuses. In doing so, Congress

must be careful not to throw out the baby with the bath water: a

fine against a charity hurts the charitable purposes; a revocation

of the tax-exempt status hurts the donors.

Instead, the director should be held personally liable for their

misconduct, and the misconduct of the charity taken at their behest. The reforms of Sarbanes-Oxley should be applied to directors

of charities and foundations, and the IRS should implement an effective whistleblower program for those employed by charities and

for foundations gone astray.

Some private foundations serve as little more than glorified personal trusts for their beneficiaries and are primarily formed to private a source of perpetual employment for errors.
30

In these cases, the hard dollar donations made by the foundation

are just the thinnest sliver of the foundation’s wealth thought necessary to maintain its tax-free status.

That private foundations are subject to little oversight has resulted in some persons using them as conduits for offshore tax evasion. Donations are made to foreign charities and foundations, and

this is shown on the diagram on the right, which then funnel the

donations back to the control of the original donor.

Because foreign charities and foundations are subject to no oversight or U.S. reporting requirements, these schemes are generally

successful so long as the U.S. donor is willing to commit offshore

tax evasion.

This is a gamble that some are willing to make because of the

perception that their odds of being caught are low. Obviously, a

concern with such arrangements is that they are a potential to act

as conduits for money laundering and terrorism.

To combat these abuses, the private inurement rules must be

strengthened and given teeth. Oversight of private foundations

must be increased to a sufficient level to deter such abuses, particularly to foreign charities and foundations.

In the past several years, some charities have allowed themselves to be used as accommodating parties for complex and abusive tax shelters.

The display diagram on the left shows one such transaction. An

S corporation issues a second class of stock, which the S corporation’s owner then donates to an accommodating charity.

For several years, a large portion of S corporation’s tax liability,

but little cash, is flowed to the charity. This practice is known as

‘‘parking a tax-producing asset.’’

After a few years, the charity either re-sells the parked stock

back to the S corporation’s owner, or better yet, to an electing

small business trust forum to benefit the owner’s children, thus

also avoiding the estate tax.

Only at this time does a charity receive any real benefit from the

transaction when the stock is repurchased from the charity, usually

at a pretty substantial discount.

It is telling that the owner of the S corporation is told by the promoters not to take a charitable deduction for the donation of the

parked stock. The reason for that is, if they take the donation, they

are concerned that it will raise red flags and scrutiny of the transaction will be triggered.

Rather, what they want to do is park this S corporation stock,

leave it there for a few years, and potentially avoid millions of dollars of tax liabilities flowing up to the charity, which simply is not

going to pay any taxes. Or, as Commissioner Everson said on the

first panel, ‘‘they feel no pain’’ for participating in abusive transactions.

While this particular arrangement has been made a listed transaction and is no longer widely promoted in this particular forum,

it is just the latest and greatest of tax schemes involving the parking of tax-producing assets with charities. It is likely that we will

see a return of this scheme in a more sophisticated form, and probably involving complex derivative contracts.
31

Instead of attacking these parking transactions on an abuse-byabuse basis, limitations should be imposed that restrict the consequences absorbed by the charity to the hard dollar benefits that

are actually received by the charity.

In other words, if a charity receives a hard dollar benefit of only

$10,000 from a donation, that should be the limit of the tax liability that it can sponge up, and not the $1 million in tax liability

that the parked asset would attribute to it.

Taking on parked transactions is removing single weeds on the

tax shelter landscape. Congress should finally address one of the

root causes of tax shelters, both charitable and corporate, which

are the opinion letters given by the major tax law and accounting

firms to cover abusive transactions, and presumably avoid penalties.

From a marketing standpoint, the opinion letter is a critical part

of a tax shelter sale. Tax shelter promoters tell their clients that

they should play the tax audit lottery, since audit rates are historical lows.

According to the promoters, the client would pay the tax anyway,

and thus has no disincentive to engage in the tax shelter, since

penalties are presumably avoided by the existence of a thick and

expensive opinion letter.

Congress should require the filing of tax opinion letters concurrent with the first tax return for the involved transaction. Such filing would worry tax shelter purchasers that the IRS would immediately know about the transaction, thus ending the entire concept

of the audit lottery.

I expect that requiring the filing of tax opinion letters would immediately eliminate the vast majority of tax shelter sales, at least

for the time being, with little cost to the government.

There is an old saying that goes around in my circles, which is,

as the tax laws get tighter, the tax lawyers get smarter. Only by

requiring the filing of opinion letters are you ever really going to

put an end to the tax shelter business.

Thank you very much.

Senator BAUCUS. Well, thank you, Mr. Adkisson. I like your last

suggestion very much. It would seem to have some effect.

Regrettably, the vote has expired over in the Senate, so I have

got to run over so I can vote. So the committee will be in temporary

recess until Chairman Grassley returns.

[Whereupon, at 11:38 a.m., the hearing was recessed to reconvene at 11:40 a.m.]

The CHAIRMAN. Could we call to order, please?

The next witness—and I am sorry I missed the two witnesses

that have already testified—is ‘‘Mr. Car.’’

Would you start with your testimony, please?

STATEMENT OF ‘‘MR. CAR,’’ A CONFIDENTIAL WITNESS, TO

DISCUSS FUNDRAISING

Mr. CAR. Mr. Chairman, members of the committee, I want to

thank you today for giving me the opportunity to testify. I am

speaking to you regrading the issue of middlemen and car donations.
32

The reason I want to speak today is in honor of my mother, who

passed away from cancer, and my frustration that well-meaning

families who donate cars in the hopes of helping those in need are

not seeing real benefit from the donation of their cars.

I speak to you from first-hand knowledge. I was a manager at

an auto auction for over a year, and then I worked as a vehicle

wholesaler for approximately a year. Now I am in retail sales of

used and new cars.

Let me start by giving you the basics on how car donation works.

First, people see an advertisement in their local newspaper proposing fair market value as a tax deduction.

Second, there is a toll-free number to call, at which point either

the charity will answer the call, or the call is forwarded to a third

party broker. AT this point, you give a description of your vehicle

to the broker, year, make and model.

The broker will verify if they are accepting those cars at the

present time. The broker will then tell you to refer to Kelly Blue

Book for your tax deduction.

Next, the broker will tell you that your car will be picked up by

a local towing company in 5 to 10 working days. In most cases, the

towing company is owned by either an auto action or a used car

dealer.

At this point, if the car goes to an auction, standard commission

for the auto auction is 25 percent of the vehicle’s sale price. If the

car goes to a used car dealer, there is usually flat rate pricing. Flat

rate pricing will typically be $75 for a car, and $125 for a truck.

These are the rates for cars produced between 1985 to today.

In addition, the broker, at the beginning, gets a sliding scale reimbursement between 30 and 45 percent of the check value they

receive for performing the following duties: advertising, operating

the toll-free hotline, and title work, and assigning auctions to pick

up the cars. The check value is NOT what the car is sold for.

I have provided an example of this in my written testimony.

However, this is unfortunately the best case scenario.

Let me now tell you how flat rate prices and fees are a way for

insiders to cheat the charities. Again, these are cases that I know

first-hand. We received a vehicle donation from a charity of a 1999

Ford Contour. We received a fax to pick up the order, and the car

was a $75 unit.

This meant the car was already assigned to be sold at a used car

lot, and regardless of the sale price, the most the broker would get

is $75, and the charity would only get a percentage of that, between $30 to $40. The car actually sold for $3,500. Thus, the middlemen got over $3,000 profit, and the charity, pennies. This is

common industry practice across the board and it is known as flat

rate sale fees.

Another example of an even more terrible practice is what is

known as ‘‘fixing cars,’’ where middlemen are purposely disabling

vehicles that were pre-screened as running vehicles, and therefore

worth more, so when the vehicle arrives on an auto auction or used

car dealership, they can call the broker and inform them that the

car was misrepresented. The broker, 99 percent of the time, does

not contact the donor to reconfirm the vehicle’s condition. Again,

this is common practice.
33

For example, a 1996 Ford Crown Victoria was picked up in running condition and driven onto the truck. However, 2 days prior to

auction the vehicle was disabled by a middleman turning a distributor cap to off-set the timing. In this case, the auto auction disabled the vehicle and then they sold it to themselves through their

used car license.

The Crown Victoria went for $275, and then the middlemen took

a timing light to re-set the distributor, and drove the car away. The

insiders later sold the car for $3,700.

Mr. Chairman, I was personally approached by a couple who had

donated their car because their son died from a fatal illness. They

wanted to donate the vehicle to charity to try and make a difference. The car was sold at auction for $4,200. Once all percentages were taken out, the charity received less than $300.

There has to be something that can be done about this. So many

people out there donate their cars to make a difference for research, treatment, and transplant. But the truth is, there would

not be enough money from that car donation to buy my late mother’s medication for 1 month, let alone help the progress of research

and treatment.

I want to close, Senators, by asking you how you would feel if you donated your vehicle to a charity that was worth $4,000, and

after all expenses were paid out, less than $400, 10 percent, went

to research to save lives, and in some cases less than 5 percent.

I hope the answer is that you see the real need for reform in this

area to make sure car donations are being used to help those in

need, and not opportunistic middlemen.

The CHAIRMAN. Thank you, Mr. Car.

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

The CHAIRMAN. Now we go to ‘‘Mr. House.’’

STATEMENT OF ‘‘MR. HOUSE,’’ A CONFIDENTIAL WITNESS, TO

DISCUSS EXPLOITATION OF CHARITABLE ASSETS FOR PRIVATE GAIN

Mr. HOUSE. Mr. Chairman and Senators, thank you very much

for inviting me to testify today. I am a licensed financial professional with over 23 years of experience, and I have been in a prime

position to witness a nonprofit run amuck.

I will talk about how a seemingly good idea gets twisted and perverted in the hands of the wrong individuals. The story involves

fraud, deception, waste, and abuse, all cloaked in the shroud of a

nonprofit organization.

The organization I am speaking about is AmeriDream, Inc., a

public charity and the largest home purchase, down-payment assistance nonprofit in America.

I should make it clear before I begin that my story is about

AmeriDream as it was 18 or so months ago. Things have changed

at this organization for the better. It is a much different and a

much better organization than the one I will describe today.

My testimony will focus on two key individuals, the foundations

of AmeriDream, who I will call Mr. Red and Mr. White, both who

made millions from the charity they controlled.

First, though, let me begin by describing what AmeriDream does.

AmeriDream provides down-payment gifts to low and moderate in-
34

come families who cannot save enough money to provide the downpayment themselves.

In the simplest of terms, the gift program works like this. A

home seller has a buyer who has sufficient earnings to pay a

monthly mortgage payment. For whatever reason, though, the

buyer cannot scrape together enough money for a down-payment,

and the home seller, through their real estate agent or potential

mortgage lender, enrolls the property in the AmeriDream gift program.

In turn, AmeriDream provides a down-payment to the buyer of

up to 3 percent and receives a 3.75 percent ‘‘fee’’ in return from the

home seller.

HUD requires that the home seller not give the buyer the downpayment directly. In order for HUD to insure the buyer’s mortgage

loan, HUD regulations require a 501(c)(3) organization to act as a

go between for the buyer and the seller.

On the face of the transaction, everyone is a winner. The home

seller sold his home, the buyer is now a new homeowner, the real

estate agent receives a commission, and the mortgage lender loans

their money and receives ‘‘points.’’

Let me give you a typical example. Joe has a house he wants to

sell that should sell for $100,000. The selling agent knows about

AmeriDream. The seller finds a buyer, Mary, who does not have

the funds for a down-payment, but can make the monthly payments.

Then Joe’s house is enrolled in the AmeriDream program. It is

enrolled as the transaction goes forward. The price is then massaged to $103,750, or alternatively it is set for $103,750 initially

with an eye to the AmeriDream program and the fact that the

$100,000 will ultimately be the amount going to Joe as money

back.

The reason for this is, as part of enrolling, Joe needs to pay

AmeriDream 3.75 percent, or $3,750. So at the end of the day,

Mary buys the $100,000 home for $103,750, and of the $3,750, it

all goes to AmeriDream, which then retains $750 itself and reimburses itself the $3,000 it paid the bank earlier for Mary’s downpayment.

Now, let me talk to you about what the insiders, Mr. Red and

Mr. White, did at AmeriDream to fleece the charity from revenues

it got from this program, I estimate in the $20 million range.

The founders and board members of AmeriDream, Mr. Red and

Mr. White, first set up, along with Mr. Blue, a marketing company

called Synergistic Marketing, LLC, now a corporation located in

Ohio.

Mr. Red and Mr. White ensured that Synergistic Marketing received a contract from AmeriDream. Synergistic’s contract was to

market to real estate agents, brokers, and homebuilders.

According to AmeriDream’s Form 99 in 2002, Synergistic was

getting $1 million a month, $12 million for the year. Out of a million a month, approximately $600,000 to $700,000 would go to

these three individuals, or $6 or 7 million to those three for the

year. The rest went to employees, salaries, and operating expenses

at Synergistic.
35

At the same time, Mr. Red and Mr. White were getting a salary

of $175,000 approximately per year from AmeriDream. This inside

deal where they got millions more in outside contracts was at best

approved by a rubber stamp board that was dominated by Mr. Red

and Mr. White. This is only one example.

At a time when Mr. Red and Mr. White had a desire for more

cash, they created a fake investment company, Valao Mortgage,

and transferred $4 million from AmeriDream to Valao. Mr. Red

borrowed a million dollars from Valao through Avalar Properties,

LLC. Mr. White, through his business partner, also borrowed a million dollars.

I understand Mr. Red and Mr. White used part of this money to

pay $250,000 each to become percentage owners in the Playboy golf

scramble. Mr. Red defaulted on his loan.

In my limited time to speak, this gives you a general flavor of

the situation at AmeriDream that I saw from the front row, where

insiders took advantage of a weak and absent board to enrich

themselves with the assets of the charity.

Let me end by noting that while the good news is that Mr. Red

and Mr. White are no longer at AmeriDream, unfortunately, to my

knowledge, there have been no actions taken against Mr. Red or

Mr. White at either the State or Federal level.

Thank you, Mr. Chairman.

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

The CHAIRMAN. Thank you very much.

We will have five minute rounds of questioning.

Mr. House, I understand that AmeriDream had a jet. Could you

please explain?

Mr. HOUSE. Yes. AmeriDream had a jet, and it was Mr. Red and

Mr. White who enjoyed it. Mr. Red wanted to buy a jet. He found

one to purchase. But he and Mr. White could not have financed it

by themselves, and had the chairman of the board of AmeriDream

sign off on a statement that made AmeriDream effectively a cosigner of the loan.

The jet was used almost exclusively by Mr. Red and Mr. White

for personal pleasure, for example, using it to fly to Mexico for golfing. As a side note, the then-chairman of the board is a former fraternity brother of Mr. White and lives in Mr. White’s basement.

The then-board chairman was allowed to invest $1 million of

AmeriDream assets for which he received a monthly management

fee of $3,000 for managing these assets. It is not disclosed in the

Form 990. He then lost over $700,000 of the million dollars.

The CHAIRMAN. Mr. Car, why are charities getting pennies on the

dollar for the cars that are donated?

Mr. CAR. Why are they getting only pennies on the dollar for the

vehicles donated, Mr. Chairman?

The CHAIRMAN. Yes.

Mr. CAR. Because the charities are not paying attention to what

options they are using to get the highest market value for the vehicle, and there are overlooking the flat sale fee of $75 and $125 that

I mentioned earlier.

They are basically not minding the store. If they did, the charities would see the cars going for much more money than they are
36

now, and the charities would be getting more money to those that

need it.

The CHAIRMAN. Ms. MacNab and Mr. Adkisson, I would ask your

views on why these abuses are happening, why charities are willing to participate, and, finally, your thoughts and views on how

widespread is the trend of abuses involving charities.

Ms. MACNAB. I see it happening right now because regulatory

supervision is almost non-existent. Whereas, in the financial world,

you have State and Federal agencies fighting a turf war over who

gets to take care of the bad guys,when it comes to charities, it is

kind of a reverse turf war. Everybody assumes that someone else

will handle it. Even though there are several agencies that can

take over the regulatory spanking, no one is stepping up to the

plate.

Also, audits are non-existent. If you talk to a handful of charities,

no one can remember the last time anybody lost their tax-exempt

status. If you are going to have a voluntary compliance system,

there has to be some expectation that you can get caught if you do

something wrong.

The second thing that is going on, why charities are participating

in these plans, is right now charities are having a couple of hard

years. Fundraising is down, corporate donations are down. They

have lost money on their own portfolios in the market, and they

are looking for money anywhere they can get it.

There is also an expectation that they should be acting more like

the corporate world. They see corporate executives getting paid

more. Charity pay is increasing quite quickly. They see corporations engaged in complicated schemes and making a lot of money

off of it. They mimic their corporate brothers and try to do the

same thing, and there is nobody right now that tells them no.

The CHAIRMAN. Mr. Adkisson, did you have anything to add?

Mr. ADKISSON. What I would add to that is, very simply, in a

charity there are no angry shareholders. In a corporation, you have

people that, if things start to go south, you know you have shareholders that rise up and eventually they throw out the directors.

You do not have that in a charity.

With regard to how widespread the problem is, I think with regard to the large corporate tax shelters that we are seeing, they are

promoted by some of the large tax and accounting firms. I really

do not think that the major charities are getting involved in those.

What I tend to see, are sort of intermediate level charities, charities that are having trouble raising money otherwise that are getting caught up in these things.

But as Commissioner Everson said, from their perspective, if

they take in $100,000 in donations but there was $10,000 of taxes

attributed to them, they have nothing to lose because they are not

going to pay tax on the larger sum. There is no pain for a charity

to be involved in a tax shelter, none, as we said here today.

The CHAIRMAN. As a follow-up, what then would you suggest we

should do about it, particularly to deter charities from participating

in tax shelters?

Mr. ADKISSON. My suggestion would be, and there are a wide

range of things that you have to do. One of them is, of course, that
37

you start making the directors have some liability for participating

in these schemes.

Charities fail my ‘‘beer and barbecue’’ test. You cannot have a

charity over to your house for beer and barbecue. You can have the

directors over, but you cannot have the charity over. Until you

start holding the directors of the charities responsible, you are not

going to make any progress.

The CHAIRMAN. Do you have anything to add to that, Ms.

MacNab?

Ms. MACNAB. Can you repeat the question, please?

The CHAIRMAN. Well, it is kind of, what do you do to deter charities from participating in tax shelters, and also to follow up on the

situation you just described in answer to my first question.

Ms. MACNAB. I think the most important thing they have to do

right now, is actually find some of these tax shelters and handle

them, perhaps punish the charities, perhaps close down a few charities. There need to be some examples made so that the rest of the

charity world say, all right, that technique does not work, let us

not do that type of game. Right now, there is no fear.

The CHAIRMAN. All right. Thank you.

Senator Baucus?

Senator BAUCUS. Yes. Thank you, Mr. Chairman.

How do you make directors more accountable? What requirements? How do we do that?

Mr. ADKISSON. Well, I think the first thing you start doing, is

you start making them responsible similar to how directors are

made responsible under Sarbanes-Oxley. You start making them

file the 990’s. You start making them to where they cannot turn

a blind eye to things as they, to a large degree, can now. I think

that the suggestions of the staff’s white paper are probably right

on point in what they need to do to bring accountability.

Senator BAUCUS. I asked an earlier witness their reaction to the

white paper. Would you modify it in any way?

Mr. ADKISSON. I do not have any substantial problems with the

white paper and the way that it is drafted. I do think that we have

to be careful not to penalize the charities, except in worst case scenarios, because when you penalize a charity, you are really penalizing the charitable purpose for which it was formed.

Now, some charities are just shams. To the extent that a charity

is just a sham, there is no need to treat it as a charity in the first

place. If you pull the plug on that, that is great. If you go out and

you hit a major charity that is conducting significant charitable activities and you fine it, all you are really doing is hurting the purpose of the charity.

Senator BAUCUS. Ms. MacNab, did you have any thoughts on directors?

Ms. MACNAB. No, I agree with that. For example, I gave six examples of donor-advised funds that were used for dreadful personal

expenses. The vast majority of the donor-advised fund marketplace

is doing the right thing. They are limited grants to 501(c)(3) charities. They are making sure that when money gets paid out, it is

not for personal expenses.

I actually think that the items outlined in the white paper try

to take into account that most of the charities out there are very
38

good at what they do, while it still tries to curb some of the worst

practices.

Senator BAUCUS. Right.

Now, again, trying to get a handle on the problem, Mr. Josephson said that in his department, one rough estimate is maybe

about 10 percent of the filings are red flagged. In your gut feeling,

what percentage of charities are bad actors, bad apples here?

Ms. MACNAB. It is very hard to tell. I would have to say at least

10 percent of the Form 990’s that I have reviewed have had many

red flags on them.

Senator BAUCUS. Why are the Form 990’s so sloppy? Does the

IRS just not look at them?

Ms. MACNAB. It is my theory that no human actually reviews

them. [Laughter]. No, seriously. I look at a Form 990 and I see two

or three sections left blank. I see information put on page one that

has nothing to do with information on page three.

I have problems getting Form 990’s from certain charities. For

example, a charity in Upstate New York is interesting because it

uses a tax-exempt shell to market de-tax strategies. They are tax

protestors. I cannot get Form 990’s from that charity.

Senator BAUCUS. Now, maybe it is a logistical nightmare, but

what if these are all made publicly available on the web or something? Would that help?

Ms. MACNAB. Well, it is true that it takes too long to get the

data, but even once you get the data, it is almost useless.

Senator BAUCUS. Because they are just not filled out completely.

Ms. MACNAB. They are not filled out completely. There are discrepancies that anyone who reads them would find.

Senator BAUCUS. Now, one of the earlier witnesses mentioned

another form that might be helpful here. I have forgotten what it

was.

Ms. MACNAB. Well, there is the initial application.

Senator BAUCUS. Form 1023.

Ms. MACNAB. The initial application is what gets the charity its

initial tax-exempt status. Most of the charities I run into that are

problematic are not doing anything of the mission they originally

claim to be.

I mean, they might say, well, we want to educate people in a certain thing, and now they are selling insurance products. It has

nothing to do with what they put on the initial application.

Senator BAUCUS. What about financial statements filing? Would

that help? Is that overkill or would that help?

Ms. MACNAB. It would help. But, again, someone has to review

them and someone has to make sure they are accurate. I have a

case in my testimony where I talk about a foundation, a public

charity in Arizona, that took in $53 million in donations of charitable gift annuities. One week before he closed up shop in bankruptcy, he sent out financial statements showing he had $42 million in assets.

Senator BAUCUS. I agree with you. I mean, I think I agree with

you that probably nobody reads them. I think that is probably correct. But how do we solve that? Does that mean a lot more IRS personnel? What does it mean?
39

Ms. MACNAB. Or a lot better targeted audits. I do not know that

you need more people. I do not know the logistics of the IRS. I do

know that, from what I can tell, how they choose to audit a particular person or a particular charity, is they comb through forms

and they look for red flags.

Sometimes you have to look outward, go look at what promoters

are promoting, and target those for audit. If you can see that a particular accounting firm is marketing a particular tax shelter, go

look for those tax shelters. Talk to people in the field.

Senator BAUCUS. I am showing my ignorance here, but the 1023

is the initial filing?

Ms. MACNAB. Yes.

Senator BAUCUS. And the purpose of the 990 is what?

Ms. MACNAB. That is the annual filing.

Senator BAUCUS. Annual filing.

And I read somewhere that you file once to get your tax-exempt

status.

Ms. MACNAB. To my knowledge, no one reviews it in the future

to make sure you are still doing something charitable.

Senator BAUCUS. That is my question. That is my question. Over

time, they may change.

Ms. MACNAB. That may be occurring. I do see it happening.

Senator BAUCUS. Again, you think part of the answer is audits?

Ms. MACNAB. I think part of the answer is smart audits. Jay and

I work out in the field. There are numerous attorneys, CFPs, CPAs

out there that are running into these things on a daily basis. Why

not set up a dialogue where the IRS can actually ask us what we

are seeing?

Senator BAUCUS. Right. So, you agree that there should be much

more sharing between State governments and——

Ms. MACNAB. And sharing between the private sector. They do

not need to share information with us, but we do need to share information with them.

Senator BAUCUS. All right.

Are there any privacy questions there?

Ms. MACNAB. I am perfectly willing to turn in, if I run into tax

shelters—I am sure Mr. Adkisson is, too—and there are many,

many lawyers out there that run into plans that they think are just

awful and would be happy to turn them in if something were to

happen to those plans.

Senator BAUCUS. All right.

Before I let you go here, has anybody said anything that is outrageous that you want to respond to, or is there something you

want to say, something in the back of your mind, so we make the

most out of this hearing, that has not yet come up or should come

up, or should be emphasized?

Ms. MACNAB. I would like to reiterate that the charity world is

still the good guys. We hear all these horror stories, we hear all

these abuses. It is still a fairly limited number of groups that are

doing these horrible things. For the most part, charities mean well.

They invest well. They take their fiduciary duty very, very seriously. I want to protect those guys from the bad ones. I just wanted

to make that clear.
40

Senator BAUCUS. Are the good guys getting a bad name? Do you

find that confidence in charitable giving is starting to decline because it is known that there are a lot of bad apples?

Ms. MACNAB. I think confidence is having some problems. I

think people are delaying donations that they would otherwise

make. I told my doctor I was coming to this hearing. He said, what

is it about? I said, charity abuses. The first thing he said is, oh,

like United Way.

That is not what should be popping in people’s minds when they

think about charity, and I would like to clean up some of the bad

characters, so that the first thing they think of is, oh, what a great

sector that is.

Mr. ADKISSON. I think you can see an erosion in confidence based

on the number of private foundations that are being formed. I have

a lot of clients that come and say, I really do not want to give to

a charity because I do not know how my money is going to be

spent, so what are my alternatives?

The alternative for them is to start a private foundation. An increase in the formation of private foundations reflects, to some degree, a loss of confidence in public charities.

Senator BAUCUS. I am told I am supposed to ask a question of

Mr. House. I guess you know as well as we, you are referring to

Mr. Red or Mr. White, they apparently sought to shelter some income through the Virgin Islands. I wonder if you could comment

on that.

And Ms. MacNab, if you can speak to how big a problem this is,

in general, sheltering, either generally, or sheltering in tax havens.

Mr. House?

Mr. HOUSE. Yes. Mr. Red sought to shelter the approximately $3

million he was making a year from the marketing company, and

how he did that, was he established a residency in the U.S. Virgin

Islands, which has a separate tax system than mainland United

States.

He became a shareholder of a company located in the U.S. Virgin

Islands that, through various management contracts, siphoned off

the $3 million to the U.S. Virgin Islands company.

The U.S. Virgin Islands company had obtained an economic development credit certificate from the U.S. Virgin Islands government that granted him an income tax credit of over 95 percent of

taxable income which the individual shareholders received from the

dividends paid to them by the U.S. Virgin Islands company. So, on

a $3 million income, the net tax was potentially $150,000.

Senator BAUCUS. What was the key that allowed this to happen,

or is allowing this to happen? Is it a certain part of the Code? Is

it offshore havens? Is it lack of audits? What is it that is allowing

this to happen?

Ms. MACNAB. You have some creative promoters out there that

put together the program and sold it for large fees. It is remarkably commonplace. The Virgin Islands plans, I keep bumping into

it everywhere I go.

The same mind-set that is perfect happy to use a charity to do

a tax shelter is the same mind-set that was perfectly happy to set

up their residence in the Virgin Islands in order to get the tax
41

credit, although I find most of these people never actually move to

the Virgin Islands.

Senator BAUCUS. So what is the solution?

Ms. MACNAB. More audits, I am afraid. And, again, looking outward. If I can go online and I can target realistically and figure out

who those people are that are doing the U.S. Virgin Islands deal

just on public data that I find on the Internet, the IRS can do that,

too.

Senator BAUCUS. A question for Mr. Car, is how much should

charities generally be receiving from car donations? What should

they receive, as opposed to, in some of these scams, they are actually receiving?

Mr. CAR. They should be getting at least 60 percent of the sale

price. My first-hand experience is that 40 percent goes to the middlemen, which will certainly allow them modest profit, and 25 percent goes to the auction house.

I also believe there should not be a buyer’s fee at an auction

house to purchase a donated vehicle. They should be eligible for the

public and not just automotive dealers.

Senator BAUCUS. I assume a lot of this would subside if the

donor actually knew that the charity was getting such a low percentage. Is there a way for the donor to know the bottom amount

that is actually going to the charity? What if there were some reporting procedure of some kind. Would that help? Anybody? Mr.

Car?

Mr. CAR. I feel, if a donor is going to donate their car, wherever

the car is going to be sold, they should go by the market report for

what auction is selling that car. The screening process allows you

to get a good idea of what the vehicle is going to sell for.

Then once the vehicle is sold, the donor is notified of the writeoff at that time. That way, we do not see $300 cars being sold at

auction and $1,500 tax deductions.

Senator BAUCUS. Thank you.

The CHAIRMAN. We thank this panel for their participation.

I am going to call the next panel. I think maybe Senator Baucus

had introduced all of you, but I want to go back and say that we

have Diana Aviv, president and CEO of Independent Sector here

in Washington, DC; Mr. Derek Bok, president emeritus, Harvard

University; Mr. Willard Boyd, professor of law, president emeritus,

University of Iowa, and also a director there of the Iowa Nonprofit

Resource Center, and chairman of the Iowa Governor’s Task Force

on the Role of Nonprofit Organizations in Iowa. He lives in Iowa

City.

Then we have Rick Cohen, executive director of the National

Committee for Responsible Philanthropy; Mr. Herman Art Taylor,

president and CEO of BBB Wise Giving Alliance, Arlington, Virginia, and then as my colleague has said, Rock Ringling, from Helena, Montana.

We will take you in the order that you were introduced.

Diana?
42

STATEMENT OF DIANA AVIV, PRESIDENT AND CEO,

INDEPENDENT SECTOR, WASHINGTON, DC

Ms. AVIV. Chairman Grassley, Senator Baucus, and distinguished members of the committee, thank you for inviting me here

today to talk about how we might work together to strengthen our

Nation’s public charities and private foundations.

I serve as the CEO of Independent Sector, which is a national

coalition of nonprofit organizations, foundations, and corporate philanthropy programs that collectively represent tens of thousands of

charitable organizations.

Senator Grassley, thank you for your dedication to upholding the

highest possible standards of good governance for our nonprofit sector, while also recognizing the important contributions of the nonprofit community. Thank you, Senator Baucus, for the same commitments. We appreciate it.

Through the actions of tens of millions of donors, volunteers and

professionals, the Nation’s charitable sector has improved the quality of life for generations of people. Our national voluntary network, now number 1.4 million organizations, is facilitated by invaluable tax policy intended to stimulate the impulse to give.

It is also built on a solid foundation of laws and regulations designed to ensure that charitable organizations are working exclusively for the public good. That said, the greatest measure of the

value of nonprofits is the public trust in our work, our methods,

and our high purpose.

Today, that trust is being jeopardized by the actions of a very

small number of individuals who have used charities and foundations for personal gain or who have engaged in practices that compromise their missions. We have heard a little bit about that already today.

There are many factors that have led to the kinds of problems

that have been highlighted today, including the following. In the

last 25 years, the charitable sector has grown considerably and

some of its leaders are not familiar with good governance practices.

The legal framework has not kept pace with growth and the diversity of organizations, and public resources are not sufficient to

ensure that laws governing the sector are properly enforced. The

forms 990 and 990 PF filed annually by charities and foundations

too often are inaccurate and inconsistent.

The current challenges do not lend themselves to quick fixes.

Changes must be given careful consideration and tested before sector-wide reform is implemented. As we consider ways to address

the problems within the charitable sector, it may be useful to be

guided by the following principles.

One: preserving the vitality and independence of the sector and

its effective ethical operation must be at the core of policy changes.

Two: preventing, discouraging, and eliminating unethical and illegal practice will require a multi-faceted approach. No singular action will succeed in fully addressing the issues at hand.

Three: it is essential that corrective efforts do not produce outcomes that stifle the great American traditions of giving and volunteering. Reforms should not be so draconian that people of honorable intent are discouraged from serving on boards, working in

nonprofit organizations, or giving to good causes. Equally impor-
43

tant, the legal framework must not be so laissez faire that people

are able to manipulate the system for personal gain.

Four: accommodations should be made for smaller organizations

for whom the burden of compliance would hurt their work.

Five: the range of solutions will depend on the involvement both

of government and of the voluntary sector, each with different and

discreet responsibilities.

Distinguished members, my written testimony provides a number of specific recommendations. I will highlight a few for your consideration.

First: revise the tax reporting forms 990 and 990 PF to enhance

the quality, consistency and transparency of information, and ensure full adoption of electronic filing of these forms.

Second: eliminate barriers to shared enforcement by Federal and

State regulators and increase oversight funding for such enforcement.

Third: increase penalties for wrongdoing and work with the charitable community to explore the best way to clarify rules on a range

of issues, including appropriate compensation, donor-advised funds,

and the evaluation of gifts of property.

Fourth: support voluntary sector efforts to expand and coordinate

existing successful initiatives to set clear standards and self-regulation programs.

Fifth: encourage work by the sector to promote ethical, accountable, and transparent practice and create a coordinated system for

education and technical assistance. This will require additional resources, both from government and from the sector.

We in the charitable community are keenly aware of our responsibilities to take on these challenges. We appreciate your willingness to work with us to separate the good actors from the bad, and

in so doing preserve all that is valuable in America’s nonprofit sector.

Thank you.

The CHAIRMAN. Thank you.

[The prepared statement of Ms. Aviv appears in the appendix.]

Now, Mr. Bok?

STATEMENT OF DEREK BOK, PRESIDENT EMERITUS,

HARVARD UNIVERSITY, CAMBRIDGE, MASSACHUSETTS

Mr. BOK. Yes, Chairman Grassley, Mr. Chairman. Thank you for

inviting me here.

I am currently the faculty chair of the Hauser Center on Nonprofits and Philanthropy at Harvard and I guess I am here in that

capacity.

Like the last speaker, with whose remarks I feel a great deal of

sympathy, I applaud your desire to look carefully at the governance

and accountability of nonprofits.

They have become a major sector. There is not enough accountability or oversight at the present time. I think we all understand

that. There are recent abuses, very well catalogued, this morning.

I see in the white paper a number of good steps that begin to

address this problem—the basic standards for 990’s, electronic filing, provisions to ensure more prompt filing, independent audits,

prohibiting conflicts of interest and insider dealing.
44

But trying to regulate this sector runs into two very difficult

problems. I speak, now, as an old professor of regulation.

One, is that you are dealing with an extraordinarily heterogeneous sector. For example, when I was a CEO of a nonprofit, I

guess, with a budget between $1–2 billion, my daughter was the

head of a small community development corporation, trying to get

six buildings renovated in Salem, Massachusetts, with a board

composed of people drawn from that poor neighborhood.

Trying to get a set of rules that will provide the proper accountability and oversight for the first organization without imposing

enormous burdens of red tape on the second organization, of which

there are countless wonderful small organizations like it throughout the United States, is a first-class problem.

It is also difficult to know how to regulate such a heterogeneous

sector because we have not yet had nearly the research and debate

about this sector that we have had with the corporate or the government sector.

I wanted to give a few illustration from the white paper of things

that seem to me to run into these dangers and illustrate the general points I just made.

First of all, there is a proposal that there be no more than 15

members on a nonprofit board. I just got through serving as a

member of an independent review committee for Nature Conservancy that tried to restructure their board so it could be more effective.

We found we needed seven different committees on that board to

attend to seven very different, but important, aspects of the operation of that organization. We also found that if you are going to

have those seven subcommittees of the board operate effectively,

you do not want to give people multiple assignments, because if

you have board members on two or three committees, they are likely not to do an adequate job for one or two.

So if you are going to get seven subcommittees and you are going

to avoid multiple assignments that will dilute the sense of responsibility, you are going to have to have more than 15 members.

So, in a sense, you would be defeating the purposes of proper

board surveillance if you imposed that kind of a limitation.

I could add, from my experience with universities, that I do not

know of any university board that does not have more than 15 people. There are more than 15 members, because these are very large

and complicated institutions. If you are going to have adequate

oversight, you need a substantial-sized board to look at all these

organizational activities. So, that would be one example of a questionable regulatory proposal.

Another, is the requirement that each nonprofit establish goals,

and list publicly its goals, and its performance measures and how

it has performed in light of those measures.

The first problem here is that some organizations have hundreds

and hundreds of different programs. When I think of the university

that I once presided over, I cannot even guess how many hundreds

of separate programs we have.

To have meaningful goals, you would have to have separate goals

for each of them. It would be a prodigious job to try to establish

the performance goals for all of these programs.
45

The second problem is that the nature of what many nonprofits

do does not lend itself to performance measures. I mean, I do not

know how you would develop a performance measure for, say, Harvard College, to try to measure how Harvard College has performed, or how the divinity school has performed, or how the

classics department has performed.

And universities are not unique. I think the nature of many nonprofit organizations, like symphonies, opera societies, and battered

women’s shelters, is that they are dealing with intangibles, not

market shares, profit and loss, and so forth where you can establish quantitative goals, but areas of activity in which it is extremely difficult to measure performance.So, I fear that, although

one can see why such a requirement would be proposed for this sector, it is not likely to work very well.

Another example of a troublesome rule is the provision saying

there can be no compensation for members of the board of a foundation, with accompanying limits on the travel expenses and the

kinds of hotels they can stay in, and so forth. One can also see how

abuses could appear in that area.

But if you go too far and forbid any compensation at all and you

limit the expenses to deny business class travel and so forth, you

wonder whether you are not going to discourage people from serving who are, after all, donating their time and spending lots of days

a year for nothing.You could easily make that service sufficiently

difficult that you will have a hard time attracting the kinds of people that you want to give the kind of oversight which we are all

concerned about supplying.

I will not go on, but simply say that I think that if we look carefully at this white paper, there is a lot of good in it. But I think

it goes beyond simply trying to identify abuses and tries the much

more ambitious task of trying to mandate a set of optimum standards of performance.

I think that is very, very difficult to do at this stage for any set

of organizations, but particularly for a sector this large, this uncharted, this heterogeneous.

So, I would favor a more limited approach in which one tried to

identify abuses and tried to eliminate them and also enacted rules

to provide the essential kinds of information and disclosure, but not

try, at this stage, the more ambitious step of attempting to specify

what is the optimum sized board, what is the optimum compensation that its members should receive, and some of the other, more

detailed provisions that I see in the white paper.

Thank you very much.

The CHAIRMAN. Yes. And we thank you, because your observations and your experience is something that we obviously want.

That is why I made very clear that we had a staff draft out there

for comment.

Mr. BOK. Right. I appreciate it.

The CHAIRMAN. So, we will take that into consideration.

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

The CHAIRMAN. Mr. Boyd?
46

STATEMENT OF WILLARD L. BOYD, PROFESSOR OF LAW AND

PRESIDENT EMERITUS, UNIVERSITY OF IOWA, DIRECTOR,

IOWA NONPROFIT RESOURCE CENTER, AND CHAIR, THE

IOWA GOVERNOR’S TASK FORCE ON THE ROLE OF NONPROFIT ORGANIZATIONS IN IOWA, IOWA CITY, IOWA

Mr. BOYD. Mr. Chairman and Senator Baucus, we are grateful

to you for holding this hearing emphasizing the importance of the

nonprofit community to the Nation. Even though we live our lives

in an increasingly globalized society, we actually live our lives locally.

In the American tradition, our voluntary nonprofit organizations

are the building blocks of community. Through our local nonprofits,

we provide community service, develop community values, and take

community action together as citizens.

Now, I want to speak particularly about the small nonprofits

such as we have in Iowa. In Iowa, our 3,600 charitable 501(c)(3)

nonprofits that filed 990 forms in 2003 are small and rely heavily

on volunteers in all aspects of their operations.

Approximately 72 percent of all Iowa charitable organizations fil- ing tax returns have revenues under $500,000. Forty-four percent

have revenue less than $100,000. So, we believe that Iowa nonprofits do a lot with very little. We are committed to doing good,

well and responsibly.

While we share the desire for accountability and transparency,

we are nevertheless concerned about over-regulation of very small,

very effective, and very dedicated volunteer organizations.

The majority of our Iowa nonprofits have less than six full-time

paid employees. Staff compensation is very low compared to what

the private for-profit sector and the government sector are able to

provide, and seldom are we able to provide health and other fringe

benefits.

Now, little or no funds are available for training, but this does

not deter the staff from improving their effectiveness and efficiency. Their commitment to serving the public sets an example for

all Iowans.

Now, President Bok spoke about his association with an educational program at Harvard, and I want to speak on behalf of the

associations of nonprofits, which many States have, and the nonprofit programs in many of our colleges and universities.

For example, in Iowa, our three regions universities and the community colleges provide inexpensive and accessible training opportunities. In particular, the University of Iowa and the University

of Northern Iowa work with Iowa State University in providing

nonprofit training activities in various parts of the State at low

cost.

The University of Iowa’s Nonprofit Resource Center also works

with the University of Northern Iowa in support of its important

National Center for Public and Private Schools Foundations, with

which you, Senator Grassley, are particularly well versed.

We are concerned in the white paper about the elimination of

Section 3, ‘‘Supporting Foundations,’’ and what that might mean in

that regard.

The Iowa Nonprofit Resource Center at the University of Iowa

concentrates on the generation and dissemination of substantive in-
47

formation on legal, tax, and managerial issues confronting nonprofit organizations such as how to fill out 1023, and a 990 IRS

forms.

Our web site is a major vehicle for reaching every Iowan nonprofit. It contains a number of important resource sections. First,

we list over 50 informative, practical books on different aspects of

nonprofit organizations which can be reached using the State library system to find the book closest to you geographically.

Second, all of our higher educational institutions, including the

community colleges, can list directly on our web site courses that

they are offering in their communities that would be useful for nonprofit personnel and boards. Third, we list useful local, State, and

national web links such as Independent Sector.

Fourth, we list consultants who can help with respect to information technology, finance, and the like. Finally, we have a ‘‘frequently asked questions’’ section. We also have started a monograph series. The first one is ‘‘Legal Guide for Iowa Nonprofits,’’

which includes tax information, and ‘‘The Governing Board for

Iowa Nonprofits.’’ This monograph contains practical appendices,

including a job description for the board, what are the board members to do specifically, and a job description for the chairman of the

board.

Now, the chair of the board is a critical figure in the effectiveness

of the nonprofit organization. Very little attention is paid to identifying and training board chairs. So, we are emphasizing the importance of board chair development and succession.

We also include a board self-evaluation form, a requirement of

Sarbanes-Oxley, committee charters, an outline of an informational

board manual, a listing of important policies that the governing

board should have in place, as well as conflict of interest bylaws,

and disclosure forms. We are developing other monographs such as

‘‘Human Relations,’’ ‘‘Community Foundations,’’ et cetera.

Our Governor’s Task Force is focused on improving nonprofits.

We are in the process of developing a compendium of good practices

modeled on the Minnesota standards for nonprofit excellence which

are similar to those in Maryland and Utah.

In doing so, we are involving the offices of Iowa’s Secretary of

State and Attorney General. We are eager for them to publish

these practices on their web sites in order to notify all nonprofit organizations of good practices and the importance of adhering to

them.

We also want to develop a legal compliance audit for nonprofits

over and above the financial audit. We believe that this would help

assure compliance with those operational, tax, and accountability

laws and regulations which govern.

We are also developing a board bank training system where, with

the local chambers of commerce, we are identifying outstanding

people to serve on boards, and working with the organizations, to

train boards.

We have a new State nonprofit corporation statute in Iowa which

clearly defines the fiduciary duties. We also want to stress mission

statements and accountability, but we want to develop our own

kind of very small, very simple annual report that can be distributed, by each nonprofit organization.
48

What I basically want to say, is our nonprofit organizations are

fragilely financed. We cannot afford a very elaborate system of certification or accreditation. We are basically concerned about buying

health insurance, reasonably.

We are basically concerned about indemnification of board members who give of their time voluntarily. They could have a successful defense against a harassing suit, but they would not be able to

get reimbursed from the nonprofit because it did not have enough

money. So, we are trying to find directors’ and officers’ insurance

for them that is reasonable.

In Iowa, our community foundations are growing. Those must be

meeting national standards in order to be qualified. We are appreciative of what you are doing with respect to non-itemizer tax deductibility. I want to simply say, is that we believe very strongly

in education.

I am very happy to have been here today because I met somebody from the Internal Revenue Service who might help us to get

training sessions in Iowa. They speak about being able to hold sessions for 150 in six or seven different cities. The nearest to us

would be Chicago. I want seven sessions in Iowa on how to fill out

the 990’s and how to fill out the 1023s, and what we should do better.

My time is up, but I do want to say that we are eager to work

with you. Thank you.

The CHAIRMAN. Thank you, Mr. Boyd.

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

The CHAIRMAN. Now, Rick Cohen?

STATEMENT OF RICK COHEN, EXECUTIVE DIRECTOR, NATIONAL COMMITTEE FOR RESPONSIVE PHILANTHROPY,

WASHINGTON, DC

Mr. COHEN. Thank you. Thank you for permitting me to offer the

perspectives of the National Committee for Responsive Philanthropy on this important issue of nonprofit and philanthropic accountability.

For nearly three decades, NCRP has been the Nation’s nonprofit

philanthropic watchdog, representing mostly the grassroots nonprofits, monitoring the charitable grant making of foundations and

corporations and their responsiveness and accountability to people

in need.

Like you, the board and staff of NCRP have seen the past year’s

news coverage of disappointing, sometimes appalling, excesses involving mismanagement and misappropriation of foundation resources.

These cases traverse foundations by type, size, and geography.

There is no one problem area any worse than any other. The response of many has been to bemoan the presence of a few bad apples, to bemoan the lack of government oversight, but to do just

about nothing to clean the bad apples out of the barrel.

As a philanthropic watchdog organization, we have released an

18-point agenda with specific suggestions for reform of public and

private philanthropy which is responsible for $500 million of philanthropic assets.
49

Our agenda is premised on three fundamentals. One, the laws

and regulations for addressing accountability of foundations and

correcting the excesses reported in the press need to be strengthened.

Two, notwithstanding the improved statutory and regulatory

standards, the philanthropic sector itself has to get serious about

dealing with the malefactors that sully the good work of so much

of organized philanthropy.

And three, there should be an increase in the resources devoted

to governmental oversight of philanthropy at the Federal and state

levels, and we issued a program for this a few months ago.

NCRP’s agenda for increasing philanthropic accountability is consistent with much of the intent and content of the committee’s

white paper. I will highlight six salient points of our agenda which

we submitted as written material to the committee.

First, we call for reducing the private foundation excise tax to 1

percent of investment income, and devoting the bulk of that payment to government oversight of nonprofits and foundations, consistent with the purpose of the original enactment of that tax in

1969.

In January of 2004, we estimated that the reduction of the excise tax would free up $140 million for foundation grant making to

which it should be dedicated, and then we outlined a specific agenda for the use of the entire remaining $350 million that included

doubling the budget of the tax-exempt government entities division

of the Internal Revenue Service to enable it to carry out its oversight functions far more efficiently and effectively than it currently

does now.

Also, creating a fund of $140 million for the Commissioner of IRS

to use to supplement the charity investigative and oversight arms

of the State Attorney General offices, and using the remainder for

research and data collection by IRS and other nonprofit organizations.

Second, like some of the other speakers, we call for a radical

overhaul of the IRS Forms 990 and 990 PF to generate the pertinent information about foundations and public charities for review

and oversight, including information that would reveal potential insider relationships between foundations and vendors or inappropriate and excessive expenditures. Right now, the reporting forms

simply do not do the trick.

In addition, the routine and automatic delays in submitting 990’s

cannot be given a green light. We believe that 990’s and 990 PFs

should be e-filed whenever possible, and that data should be publicly searchable on the Internet.

Third, we call for expansion of charitable grant making disclosure beyond private foundations. Even with enforcement potential

and improved 990’s, unless there is enhanced disclosure of grant

making, the public will be ill served in its oversight of philanthropy.

Corporate charitable grant making should be disclosed across the

board, not just corporate grant making that occurs in private foundations. The grant making of public charities should be better disclosed and meeting the standards that currently only pretty much

community foundations address in the public charity field.
50

And all grant makers should meet the currently unenforced IRS

standard of reporting not only the grantee and the amount of the

grant, but the specific purpose of the grant and disclosure of any

potential conflicts of interest.

Fourth, while NCRP does not advocate any specific limits or caps

on the salaries of foundation CEOs, we do believe that foundation

trustees have not given enough attention to the total compensation

of top foundation staff, including severance packages, delayed compensation, all benefits, stock options, and even the non-foundation

compensation of foundation executives that they get from serving

on corporate boards, and other plums.

What we also believe, is that foundation administrative expenses

should be removed from their qualified distributions currently set

at 5 percent of net assets of private foundations. Right now, some

significant portion of foundation payout is not granted to nonprofits, but the foundation’s administrative expenses.

We believe it is actually entirely appropriate to raise the payout

to 6 percent and make it all grants. The committee’s white paper

suggestion of a higher private foundation payout in return for

lower foundation excise tax or other fees is also attractive, although

we think it might be worthwhile examining a calibration of different levels of higher payout in return for different alternative tax

and fee scenarios.

Fifth, we are concerned about the fees paid to foundation trustees. We believe that, in general, there is no reason to pay trustees

for their services other than compensating them for their travel

and accommodations, which should be reasonable.

However, if there is a need to pay trustees for what is supposed

to be a voluntary role, we believe that the annual payment to trustees of no more than $8,000 a year is more than sufficient, and we

hope that nearly all foundation trustees would refuse it.

More to the point, we believe there should be absolutely no selfdealing, where foundation trustees or firms associated with foundation trustees or other foundation leaders get hired to deliver investment, accounting, legal, or other services to the foundations. There

needs to be a stop to the kinds of self-dealing that escape through

legal loopholes and do not get tackled by the IRS or the States’ attorney generals.

Last, we are concerned about donor-advised funds. The rather

lax requirements we are talking about for strengthening public and

private foundations do not exist virtually at all for donor-advised

funds.

The recent phenomena of donor-advised funds tops billions of dollars managed by a range of institutions. Unfortunately, there is no

payout requirement on donor-advised funds, and there should be.

It should be at least comparable to private foundations.

And the grant making of donor-advised funds, currently basically

unreported, should be completely reported, meeting the public disclosure requirements placed on private and public charities.

There is no requirement for the kind of detailed grant reporting

and conflict of interest identification that private foundations are

supposed to comply with. These standards, too, should be extended

to donor-advised funds as well.
51

I see I have extended past my time. I will cease now and take

questions later.

The CHAIRMAN. Thank you.

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

The CHAIRMAN. Mr. Taylor?

STATEMENT OF HERMAN ART TAYLOR, PRESIDENT AND CEO,

BBB WISE GIVING ALLIANCE, ARLINGTON, VIRGINIA

Mr. TAYLOR. Thank you, Senator Grassley, for asking me to participate in these hearings.

What I would like to do, is talk today about the parallel role of

government and private monitoring efforts that attempt to get to

the accountability of nonprofit organizations.

I agree with what has been said earlier, that no one solution can

get at the problem, but that there must be balanced energies expended by both government and the private sector for us to tackle

this difficult challenge.

As has been heard earlier, government seeks to identify and

prosecute fraud, abuse, abusive tax-exempt status, and other financial improprieties, while private monitoring efforts like ours seek to

help donors make informed judgments.

This is important because a major survey we commissioned in

2001 showed that 70 percent of Americans say it is difficult to

know which charity is legitimate and which one is not.

We believe that standards can play an important role in the voluntary self-regulation of the sector. We have come up with standards which are the result of a three-year, open process where we

have received input from charity leaders, foundation executives, accountants, philanthropic experts, and other regulators, as well as

the donating public.

The standards are comprehensive and not simply a review of

charity finances. These 20 standards cover areas such as charity

governance, charity effectiveness in meeting their mission, finances, most importantly, and also ensuring that appeals are accurate and complete.

In spite of the diversity of our sector, we believe that standards

can be strong and still not reach to the lowest common denominator.

Some of the typical problems we see in doing reviews of charities

in relation to our standards are that 53 percent of the charities we

review that do not meet our standards have financial improprieties,

including things such as reports that do not cover the financial

statements properly. Coincidentally, finances are also the donor’s

major primary concern.

We also found that 29 percent of organizations that do not meet

our standards have problems with their fundraising programs, and

we like to see that you know about that.

We believe, as I said, that more needs to be done on the government side, as well as on the private side. On the private side, we

will be announcing very soon an online system that will allow any

charity to register its information with us and be reviewed in part

of our charity review program.

We think this will go a long way in allowing charities that want

to demonstrate their accountability to be able to do so. We also
52

have introduced recently a national charity seal that will allow organizations that want to promote the fact of their accountability,

to do so.

We will also be working with the local Better Business Bureaus

so that this technology will be available to them so that they can

do reviews of local charities.

We believe that government can be helpful in this effort to increase the accountability of our charities, and you have already

heard from several speakers who want to see the 990’s improve.

We echo that. We also think that there should be electronic filing

of 990’s.

There should obviously be additional support for Federal and

State agencies that are doing accountability work, such as the IRS

and State charity regulators.

We also think, though, that government can encourage voluntary

efforts that are aimed at strengthening the nonprofit infrastructure, and these would be supportive of organizations that are involved in improving the management of nonprofit organizations,

that are involved in offering governance technical assistance so

that organizations can be governed properly, and other areas that

will strengthen organizations so that they know how to do the right

thing.

Finally, we believe that government can also help us by encouraging organizations to use voluntary accountability programs such

as ours.

We just want you to know that, whatever steps government decides to take, we will continue to stand in for the donor and provide

them with the information that they need in order to make good

decisions.

Thank you.

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

The CHAIRMAN. Mr. Ringling?

STATEMENT OF ROCK RINGLING, MANAGING DIRECTOR,

MONTANA LAND RELIANCE, HELENA, MONTANA

Mr. RINGLING. Mr. Chairman and members of the Senate Finance Committee, I appreciate the opportunity to share with you

my perspective as a managing director of the Montana Land Reliance on the future direction of the conservation easement program.

In my limited time this morning, I would like to accomplish three

things. First, I would like to give you a brief introduction to the

Montana Land Reliance, our mission, and our values.

Second, I would like to share with you some of my views regarding the potential for reform that would both protect taxpayers and

put this program within reach of the average farm and ranch

households in America.

Third, I would like to answer any questions you may have in this

regard.

The Montana Land Reliance was founded by a group of forwardthinking Montana farmers and ranchers in 1978. Today, some 26

years later, the mission of our organization remains the same as

when it began, to provide protection for private lands that are ecologically significant for agricultural production, fish and wildlife

habitat, and open space.
53

In those 26 years, Montana private land owners have protected

the unique Montana heritage of 537,000 acres. To put that in perspective, even though we restrict ourselves to working only with

Montana land owners, the Montana Land Reliance holds an estimated 15 percent of the easement acreage granted to local and regional land trusts in the United States.

We accomplished this work through a strict adherence to a number of important principles. First, we have a strong, independent

board of directors, two of whom have testified before this committee.

The board has hands-on oversight over organizational policy and

takes an active role in reviewing easement agreements.

Second, we have an operating policy of strict adherence to accounting and legal standards. In addition to adopting the national

standards and practices developed by the Land Trust Alliance, we

have in place a set of policies that constitute what we believe to

be a conservative, but appropriate, approach to the utilization of

the conservation easement program.

The CHAIRMAN. Mr. Ringling, would you stop there just for a

minute? Senator Baucus is on his way back up. I have only got a

couple of minutes to get over to the floor to cast my vote. I have

not missed one in 11 years, and I do not want to miss one now.

Mr. RINGLING. Do not start now.

[Whereupon, at 12:54 p.m., the hearing was recessed to reconvene at 1:00 p.m.]

Senator BAUCUS. The hearing will come back to order.

I guess we are in the middle of testimony by Rock Ringling.

Rock, I do not know where you were, but why do you not take

up where you were? Handle it any way you want.

Mr. RINGLING. All right.

Senator BAUCUS. First of all, I want to introduce Rock Ringling.

He is a Montanan. He is a great guy. I have known Rock for years.

He just does a lot for Montana in lots of different ways. The Montana Land Reliance is certainly one, but he is just a real solid citizen of our State, and we are very proud of him.

I am proud to have you here, Rock.

Mr. RINGLING. Thank you, Senator.

Third, we create a personal relationship with each easement

donor. This allows us to understand their motivation for wanting

to join with us in creating an easement agreement and to determine how best to craft an agreement that meets their objective as

property owners.

That is in keeping with the public benefit requirements of the

conservation easement law and is consistent with our mission at

the Montana Land Reliance.

Mr. Chairman, these operational values are at the core of everything we do at the Montana Land Reliance, and I believe similar

values are at the core of the work done by the vast majority of our

fellow members of the land trust community in your States and

throughout America.

Before I close, I would like to take just a moment to discuss the

potential reforms to the conservation easement system. As you

know, we have engaged very directly in this discussion with committee staff and we hope our observations have been helpful.
54

We believe there are a number of reforms you can enact that

would help to protect the integrity of the conservation easement

program. Let me touch on a few.

First: encouraging land trust to meet accreditation standards

would be a step forward and can be done without creating additional bureaucracy. In Montana, we have taken the initiative of

putting together a Montana Association of Land Trusts that will

provide independent oversight and accreditation for Montana’s land

trust community.

Second: requiring that appraisals meet uniform, national requirements could be a useful tool, as long as the proper standard is determined. More specifically, mandating the use of uniform standards of professional appraisal practice would, we believe, be inappropriate reform.

Third: making it easier for the IRS to review easement donation

is consistent with current Montana Land Reliance policy. As a matter of practice, we recommend land owners attach the easement

agreement, the appraisal, and a letter from the land trust detailing

the public benefit of the easement. Codifying this practice would,

in our view, make good sense.

Fourth: increasing existing fines and penalties will be of no concern to most land trusts like ours who already insist on the highest

legal and accounting standards.

Last: I want to touch on what we believe is the most important

reform, which is to level the playing field in the conservation easement arena. For the past three years, the Montana Land Reliance

has been proud to work with Chairman Grassley, Senator Baucus,

and over 200 endorsing land trusts in proposing legislation to allow

working farmers and ranchers equal access to the conservation

easement program.

This legislation, S. 701, passed by this committee last year as

part of the CARE Act, would help remove inherent inequities in the

current system that favor land owners with high personal incomes

over the bulk of working farmers and ranchers in America for

whom the current system does not work.

Mr. Chairman, we are proud to be a part of the land trust community and honored to have been asked to visit with you today. We

believe that by leveling the playing field through passage of S. 701

and by consideration of additional technical reforms, the current

successful conservation easement program in America can be improved to work better for all of us.

We at the Montana Land Reliance and the land trust community

stand ready to work closely with you and this committee on this

important work.

Thank you.

Senator BAUCUS. Thank you very much, Mr. Ringling.

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

Senator BAUCUS. Mr. Bok, how would you more precisely get at

the problems you were addressing, namely, more oversight, et

cetera, but recognizing the vast heterogeneity of charities and not

basically throwing the baby out with the bath water?

That is, how do you solve that? You have got smaller charities,

you have big charities. Some charities should have larger boards.
55

Should we even get into the area of trying to decide the size of

boards, for example? You appropriately raised questions, and I am

just curious how you try to address them.

Mr. BOK. Well, I think it depends on the particular rule involved.

For example, there are one or two of the proposed rules that have

to do with the 5-year certification, for example, with the IRS. These

rules propose fairly detailed reporting requirements.

It would be very simple for a large organization to comply, but

it would really be quite beyond the totally amateur, small neighborhood group. I think that problem can be taken care of pretty

easily by developing some kind of a threshold.

I mean, one can estimate pretty easily what the budget of an organization has to be in order to hire some kind of professional management.

But if you impose complicated rules and reporting requirements

on smaller organizations that do not have professional management, organizations that are just working with part-time volunteers from the neighborhood, they will be totally baffled. But that

could be taken care of by just having a reasonable threshold

amount.

Maybe you might have some very simple reporting requirements

for your small, neighborhood organization, but you should not get

into the more complicated filings where you have to explain the nature of your procedures and whether you are complying with accreditation practices, and so forth until you are up at the size

where you can be pretty sure people will have full-time, trained

managers who can deal with those kinds of requests.

Senator BAUCUS. Yes. Right. But you heard what Montana is

doing, as you heard from Rock Ringling. Are those kinds of requirements, at least with respect to easements and donations, you think

appropriate, generally? Maybe you could explain again, Rock, what

we are doing in Montana.

It does not really get to the size of the board and it does not get

to the stated goals, I do not think, that were listed in the white

paper. But I am just curious of your reaction to what Montana is

doing. You might, again, Rock, explain what it is.

Mr. RINGLING. Mr. Chairman and Senator Baucus, what we have

done in Montana is we have formed a Montana Association of Land

Trusts. Within that, we have put together standards and practices

that were just basically operating principles for those land trusts

to follow, and also basically pure audits, where other people in the

land trust community can basically do an audit to make sure that

those principles are being followed.

Basically what we have realized, is that we are an industry and

we need to act and basically be accountable, not only to the people

who make donations to the nonprofit, but also those private landowners who make donations of easements.

Senator BAUCUS. Mr. Bok, how does that sound?

Mr. BOK. I think the only answer I can give, is I am a great admirer of the Montana land trust, but I do not know enough about

land and easements so that I would wish to hazard a guess.

My offhand feeling would probably be that organizations that get

into the business of donations of land are already substantial

enough that they can manage this process pretty well.
56

It is when you get into battered women’s shelters and local opera

societies and things like that that you are into wonderful groups

that are really pretty much purely amateur and cannot deal with

much complexity when it comes to government filing and accountability requirements.

Senator BAUCUS. Right.

I wonder if you could share with us what lessons you have

learned after reviewing Nature Conservancy and all that they were

going through. What are some of the lessons learned that are applicable generally to this committee’s inquiry?

Mr. BOK. I am trying to think of what we learned in Nature Conservancy that really could be generalized safely into rules. I think

an awful lot of good was done and a lot of useful reforms have come

through, but only a few of them, I think, are generally applicable.

The white paper includes some of those, such as prohibiting various kinds of self-dealing and conflicts of interest.

As for the rest of it, I would really have to go over our report

point by point and ask myself that question, is this generalizable

or not. I have the feeling it would not be a very long list. What we

were dealing with was fairly specific, such as our proposals on the

work of the board and the size of it, and the subcommittees, and

the independent audit.

Most of our proposals were done pretty much with the specifics

of a very large nonprofit in mind, and I do not think would be generalizable.

Senator BAUCUS. All right. Thank you.

Mr. Taylor, you were going to say something.

Mr. TAYLOR. I wanted to comment on Mr. Ringling’s example, because I believe it is a great opportunity, a great learning moment

for what self-regulation can do, subsector self-regulation of a problem area.

It appears to me that what has been done there—and I have not

seen the standards—is the kind of thing that organizations in subsectors of the nonprofit community can do to police themselves. I

just wanted to highlight that and applaud it.

Senator BAUCUS. All right. I have no other questions at this

time. Thank you, Mr. Chairman.

The CHAIRMAN. Thank you. I thank you for cooperating while we

had to vote. I thank you very much.

I am just going to take 5 minutes for questions. I will probably

have some to submit for answer in writing.

Mr. Boyd, I think you made very clear a very valid point about

not being so eager for reform that we hurt and discourage small

foundations and charities.

Is there any way you can quantify for me kind of the tipping

scale or the balance between reform and burden, like, for instance,

some sort of dollar figure or asset figure that we should use so that

we do not get that burden too much for organizations that maybe

cannot follow it.

If it is difficult for you to quantify that now, it may be that I am

just asking you to think about it and get back to us. But if you

have a thought, I would take that right now.

Mr. BOYD. Well, it is a thought. I think, certainly maybe $5 million in revenue. Otherwise, I think you are going to run into some
57

difficulties. I noticed, you, in your regulation, are speaking about

the larger national charities. They have a sliding scale for reviews.

I think $10 million might be it.

On the other hand, what we are trying to do, again, locally, as

in Montana and elsewhere, is to improve the standards for everybody in the community, try to improve their capacity. That is one

of the things I look at. There is a matching grant program suggested.We do not have much money to match right now in the

States, so we are trying to work very hard with the Attorney General and the Secretary of State in our State to develop this program for all. But I would say $10 million is the dollar figure for

grant oversight.

The CHAIRMAN. All right.

The next question is not directed to a specific person, but two or

three of you might respond to this.

This comes from the fact that there were a lot of organizations

we should have heard from today and just did not have time to do

it. One group that came in to visit with staff was the Evangelical

Council on Financial Accountability. I think this is an organization

started, in part, by Billy Graham to bring financial accountability

through an accreditation program for churches.

In meeting with the Finance Committee, the head of the organization made an interesting point. In their site visits to churches,

the number-one problem, and usually the reason for many other

problems, was weak governance and oversight by the board.

So, I would like your response to this observation. How important is a board’s quality, primarily? Yes, sir, Mr. Cohen?

Mr. COHEN. Well, obviously the board is at the heart of the governance of nonprofits and foundations, so there is no underestimating the role that it plays, and also the importance of board

members taking their job seriously in knowing what actually constitutes proper board behavior.

I would say, however, that the board is not the only player in

that. When you have the evangelical group, that shows an outside

organization that also promotes standards for organizations.

When Mr. Josephson talked about the Albany Urban League, you

had both funders, standard-setters, and other organizations that

were aware of this that could have also intervened.

So there is a mutual accountability, both board members knowing the right kind of behavior, but the sector paying attention to

its peers and making sure that the bad issues, the bad behavior is

brought to the surface.

Mr. TAYLOR. I will comment.

The CHAIRMAN. Go ahead, sir.

Mr. TAYLOR. The boards of directors are key in the governance

and oversight of a particular organization. One of the things we

must do with boards, is make sure that they are free of conflicts

and that they are independent in order to do their jobs effectively.

I think anything we can do to assure that boards are conflict-free

would do a great job in making sure that nonprofits are well-managed and well-governed.

The CHAIRMAN. All right.

Mr. Bok, then Ms. Aviv.
58

Mr. BOK. I do think you have a real dilemma on your hands. Of

course the board ought to be key, and often is key. On the other

hand, in large numbers of organizations, which, again, are relatively small, board members are real amateurs and volunteers.

They do not know a great deal about the kinds of things that

have been said today, and they may be very good at understanding

the local community and its needs, but not very good at understanding what a really effective board is supposed to do by way of

oversight.

Another problem is that most of these people are not paid. They

are volunteers. They think they are doing a great favor to the organization by showing up at the meetings.

So, you can try to impose accountability and penalties if the

board is not sufficiently vigilant, but you are going to discourage

a lot of people from serving because you are going to frighten them.

They are not people who are serving for money; they are doing

it for love. So, if it becomes an unpleasant burden with government

sanctions, you are going to cut into the quality of people who will

serve.

So, yes, the board is very important, but there is a first-class

problem of developing model boards with the right expertise and

the right motivation to serve. So, I just would not underestimate

the difficulty you have got in making all boards of nonprofits serve

as effectively as they ideally should.

The CHAIRMAN. Ms. Aviv, and then we will close down.

Ms. AVIV. Senator Grassley, in response to the earlier question

as well about the size of nonprofits and so on, of the 1.4 million

nonprofits, 70 percent of them have budgets of less than $500,000.

So, the vast majority of nonprofits do not have large budgets.

We believe that in many of the instances there are folks who

come in to serve on boards who do not have the education, and

where the problem is a matter of education and technical assistance, it needs to be provided by the sector. We need to set some

standards. There are such diverse groups. You mentioned one, the

Evangelical Council. Art Taylor runs another.

There are many local groups as well, in Minnesota, in Maryland,

that have developed all kinds of standards that can help facilitate

and educate these groups so that at least they have the knowledge

base that is needed and the resources available to be able to provide the kind of oversight that is needed. We obviously need strong

boards and good governance.

The CHAIRMAN. Yes. Besides thanking you, I wanted to say this

about the hearing, generally. I think that we have heard some very

sobering things. As I mentioned earlier, this hearing is just the beginning of a discussion about how to bring about reforms of the

charitable sector.

I think that areas that we particularly need to think about is

balancing the requirements that might be placed on charities, particularly small charities, and not overwhelming the ability of charities to achieve their important mission.

Finding that balance will be a task in the weeks ahead. My hope,

with the help of Senator Baucus, is that we can look at introducing

legislative reforms yet this fall, and even earlier on for some provisions. I appreciate very much the nonprofit sector working with us
59

to find that balance, and all of you have spoken to that, and I

thank you and this panel.

Senator BAUCUS. Mr. Chairman?

The CHAIRMAN. Yes?

Senator BAUCUS. I just wanted to say, I think this has been a

good hearing. It has been very thoughtful. A lot of people have

given their heartfelt and thoughtful and reflective reviews.

It is not just a big rush to judgment, but it is trying to deal with

some of the subtleties and some of the ambiguities, and I deeply

appreciate the time that you all have taken. Thank you very much.

The CHAIRMAN. Thank you all very much.

[Whereupon, at 1:20 p.m., the hearing was concluded.]

(61)

A P P E N D I X

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

PREPARED STATEMENT OF JAY D. ADKISSON
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PREPARED STATEMENT OF HON. JIM BUNNING

Whether guided by a strong faith in religion or a desire to give back and improve

society, Americans consistently choose to give freely of their time and money.

Thanks to this philanthropic spirit, American charities are among the most successful and dynamic in the world to further encourage this generosity, the United States

government has long given charities preferred tax status and greater latitude in the

marketplace. The tax code was designed to convey these special benefits while preventing abuses in the system, but it is far from perfect. The I.R.S. has generally

exercised limited review of not-for-profit organizations, as they face a large number

of new organizations with increasingly complex structures and missions.

While most of the work of charitable organizations continues with the best intentions and successes, we have unfortunately seen growing problems with the activities and regulation of a few American charities. The last few years have been

marred by scandal, often involving good, thoughtful groups that were enticed to

bend the rules and exploit loopholes by greedy investors.

Not-for-profits and foundations should not be tax shelters or fronts for fraudulent

investment schemes.

In order to ensure that the thousands of charities doing good work are not tainted

by the inappropriate activities of a few, we need to take a close look at the tax code,

I.R.S. oversight, and penalties for fraudulent activities.

We owe the charities that work to better society and the Americans who share

their hard-earned pay to ensure charities are fullfilling their mission.

I look forward to hearing the views of our witnesses today, both those who work

in tax enforcement and those who work at the charities themselves. I thank the witnesses for appearing before the committee to testify on this important issue.

Thank you Mr. Chairman.
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(249)

COMMUNICATIONS

STATEMENT OF THE AMERICAN ASSOCIATION OF HOMES AND

SERVICES FOR THE AGING (AAHSA)
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Æ