Tax-Exempt Organizations: Better Compliance Indicators and Data, and More Collaboration with State Regulators Would Strengthen Oversight of Charitable Organizations
Published: 2014-12-17T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: IRS oversight of charitable organizations helps to ensure they abide by the purposes that justify their tax exemption and protects the sector from potential abuses and loss of confidence by the donor community. In recent years, reductions in IRS's budget have raised concerns about the adequacy of IRS oversight.
GAO was asked to review IRS oversight of charitable organizations. In this report, GAO (1) describes the charitable organization sector, (2) describes IRS oversight activities, (3) determines how IRS assesses its oversight efforts, and (4) determines how IRS collaborates with state charity regulators and U.S. Attorneys to identify and prosecute organizations suspected of engaging in fraudulent (or other criminal) activity.
GAO reviewed and analyzed IRS data, strategic planning and performance documents, and documented improvement efforts. We also interviewed IRS and Department of Justice officials, state charity regulators, and subject matter specialists. GAO compared IRS's practices to federal guidance on performance management.
section_title: What GAO Found
paragraphs: Charitable organizations play a major role in our economy and provide critical services and resources to families and individuals in need. Although charitable organizations vary considerably in size and purpose, in 2011 the largest number of organizations was in the human services sector, providing services such as employment and housing assistance. The highest concentration of assets was in the health and education sectors, which include hospitals and universities. In addition to being concentrated in a few sectors, a large proportion of all assets were controlled by a relatively small number of charitable organizations—less than 3 percent hold more than 80 percent of the assets.
Over the past several years, as the Internal Revenue Service (IRS) budget has declined, the number of full-time equivalents (FTEs) within its Exempt Organizations (EO) division has fallen, leading to a steady decrease in the number of charitable organizations examined. In 2011, the examination rate was 0.81 percent; in 2013, it fell to 0.71 percent. This rate is lower than the exam rate for other types of taxpayers, such as individuals (1.0 percent) and corporations (1.4 percent).
EO is grappling with several challenges that complicate oversight efforts. While EO has some compliance information, such as how often exams result in change of tax exempt status, it does not have quantitative measures of compliance for the charitable sector as a whole, for specific segments of the sector (such as universities and hospitals) or for particular aspects of noncompliance (such as personal inurement or political activity). Because EO does not have these measures and does not know the current level of compliance, it cannot set quantitative, results-oriented goals for increasing compliance or assess to what extent its actions are affecting compliance.
Statutory requirements for safeguarding taxpayer data limit both IRS's ability to share data and state regulators' ability to use it. A lack of clarity about how state regulators are allowed to use IRS data to build cases against suspect charitable organizations further impedes regulators' ability to leverage IRS's examination work.
The e-filing rate for tax-exempt organizations is significantly lower than for other taxpayers. This lower rate means there is less digitized data available for data analytics and higher labor costs for IRS. Expanded e-filing may result in more accurate and complete data becoming available in a timelier manner, which in turn, would allow IRS to more easily identify areas of noncompliance.
section_title: What GAO Recommends
paragraphs: GAO recommends IRS 1) develop compliance goals and additional performance measures that can be used to assess the impact of enforcement activities on compliance and 2) clearly communicate with state charity regulators how they are allowed to use IRS information related to examinations of charitable organizations. GAO also recommends that Congress consider expanding the mandate for 501(c)(3) organizations to electronically file their tax returns to cover a greater share of filed returns. In written comments, IRS agreed with GAO's recommendations.

section_title: Letter
paragraphs: The breadth and diversity of the tax-exempt sector, which encompasses  over 1.6 million entities, including 501(c)(3) charitable organizations,  allows it to address a wide range of needs, including comfort to the aging,  and food, shelter and other services for families and individuals in need.  Moreover, the tax-exempt sector represents an estimated 5 percent of  gross domestic product and is concentrated in two key sectors of the  economy, with the largest assets in healthcare and education. The  Internal Revenue Service (IRS), along with the states, has a vital role in  overseeing the tax-exempt sector. IRS oversight can help ensure that  exempt entities abide by the purposes that justify their tax exemption. IRS  can also help protect the sector from potential abuses and loss of  confidence by the donor community that could result from the abusive  activities of a small minority of charitable organizations.
IRS—which oversees charitable organizations’ compliance with the tax  code—has experienced budget cuts over the past several years. As we  previously reported, the IRS budget has declined by about $900 million  since fiscal year 2010 and funding is below fiscal year 2009 levels.  Staffing has also declined by about 10,000 full-time equivalents (FTE)  since fiscal year 2010, and performance has been uneven. Questions  about the impact of budget cuts on IRS’s operations have raised  concerns about the adequacy of oversight of charitable organizations.
You asked us to review a number of issues related to the IRS oversight of  charitable organizations. This report (1) describes what is known about  the number, type, size, and other characteristics of charitable  organizations; (2) describes IRS oversight activities for charitable  organizations; (3) determines how IRS assesses its oversight efforts of  charitable organizations to ensure they are meeting their charitable  purposes; and (4) determines how IRS collaborates with state charity  regulators and U.S. Attorneys to identify and prosecute organizations  suspected of engaging in fraudulent or other criminal activity.
To address the first objective, we reviewed IRS documentation and  analyzed data from IRS’s Statistics of Income (SOI) samples of tax- exempt organization information returns for tax year 2011, the most  recent year available. We used data from the charitable organizations  that filed Forms 990 and 990-EZ (which provide information on the filing  organization’s mission, programs, and finances). We do not report data  on private foundations (which are charitable organizations that file Form  990-PF) or report data on Form 990-N filers, because the data for these  organizations is less complete and has other limitations. In addition, our  data excludes certain religious organizations, which qualify as 501(c)(3)  organizations, but are not required to file a return. The SOI samples were  based on returns as filed, and did not reflect IRS audit results. The data  that we report are estimates based on the SOI sample; statements about  sampling errors are reported in appendix III.
For the second objective, we reviewed IRS documentation and obtained  IRS data on IRS oversight activities including referrals and examinations  performed on charitable organizations, and reviewed data on charitable  organizations that had their tax-exempt statuses revoked for fiscal years  2011 through 2013. We also interviewed IRS officials about their  oversight activities.
To assess the reliability of the data we analyzed, we reviewed IRS  documentation and interviewed agency officials familiar with the data. We  determined that these data were sufficiently reliable for the purposes of  this report.
For the third objective, we reviewed relevant strategic and performance  documents and interviewed IRS planning officials and division managers  to determine the extent to which managers overseeing the tax-exempt  sector do the following: set performance goals, develop measures to  monitor their progress toward meeting goals, and use data both to identify  challenges and their causes, and to develop strategies to address those  challenges. We reviewed past recommendations made by the Treasury  Inspector General for Tax Administration (TIGTA) and the National  Taxpayer Advocate related to performance management and interviewed  IRS managers about how they addressed the issues discussed in those  reports. For criteria, we compared IRS information on performance  measures and decision making to Standards for Internal Control in the  Federal Government and federal guidance on performance  management. We also applied the criteria concerning the administration,  compliance burden, and transparency that characterize a good tax  system, as developed in our guide for evaluating tax reform proposals.
To determine how IRS collaborates with state charity regulators and U.S.  Attorneys, we reviewed various IRS documents and interviewed IRS and  Department of Justice (DOJ) officials, and representatives from National  Association of State Charity Officials (NASCO). For criteria, we identified  different approaches for sharing information and collaboration, based on  our audit findings, as well as our past recommendations and  recommendations made by the Advisory Committee on Tax Exempt and  Government Entities (ACT).
To provide additional context for all three objectives, we interviewed IRS  officials, DOJ officials, state charity regulators, subject matter specialists,  and stakeholder groups representing different types of exempt- organizations and private watchdog organizations that oversee charities  about the following: the adequacy of IRS oversight of charitable  organizations, the challenges IRS faces providing effective oversight, and  strategies to address those challenges.
We conducted this performance audit from June 2014 to December 2014  in accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives. More detailed information on  our scope and methodology appears in appendix I.
subsections: section_title: Background
paragraphs: Section 501 of the Internal Revenue Code (IRC) provides for tax  exemption for certain corporations, trusts, and other organizations.  Section 501(c) establishes 29 categories of tax-exempt organizations,  ranging from cemeteries to professional football leagues—see appendix II  for complete list of different types of tax-exempt-organizations, as well as  more detailed information on the tax treatment for these organizations.  The largest number of such organizations falls under section 501(c)(3),  which recognizes charitable organizations. Generally, while charitable  organizations pay no income taxes on contributions received, these  entities can be taxed on income generated from business activities that  are unrelated to their charitable purposes. These charitable organizations  and related parties may be subject to several additional IRS penalties and  fines for certain actions, such as not filing a required tax return. Generally,  taxpayers who itemize their deductions may deduct the amount of any  contribution to charitable organizations from their taxable income.
The IRC requires that an organization adhere to certain accepted  charitable, religious, educational, scientific, or literary purposes to qualify  for 501(c)(3) tax-exempt status. The IRC also prohibits charitable  organizations from undertaking certain activities: no earnings of the  organization may benefit individual or private shareholders, no substantial  attempt may be made to spread propaganda or influence legislation, and  no effort may be made to campaign for or against a candidate for public  office. In order to receive 501(c)(3) tax-exempt status, an organization  must submit a Form 1023 or Form 1023-EZ and organizing documents to  IRS to describe its charitable purpose and financial data. The organizing  documents can include articles of incorporation or by-laws governing the  activities and charitable purpose of the entity. Submitting an application is  one of the first interactions a tax-exempt organization will have with IRS.  The organization will then receive a determination letter from IRS which  informs the organization whether its application for tax-exempt status has  been approved or denied. Alternatively, the organization may be told the  IRS is in need of additional information in order to make a determination.
If an organization is successful in receiving tax-exempt status, it will  continue to interact with IRS on an annual basis by submitting an  information return or an electronic notice. The form contains information  on the organization’s mission, programs, finances and governance  structure which helps IRS to determine whether the organization is  meeting its charitable purpose and therefore is eligible for tax-exempt  status. Certain organizations that have gross receipts of $50,000 per year  or less may submit the Form 990-N—an abbreviated electronic version of  the Form 990 return, often called the e-Postcard. The Form 990-EZ is  less abbreviated, though still more streamlined than the Form 990, and  may be used by certain entities with gross receipts under $200,000 and  assets under $500,000. Private foundations complete the 990-PF.
IRS oversees charitable organizations through its Exempt Organizations  (EO) Business Division (a part of IRS’s Tax Exempt and Government  Entities Division). EO’s oversight relies primarily on two sets of activities:  a front-end review of applications and a back-end review of a relatively  small number of information and tax returns. At the front end, the EO  Rulings and Agreements office reviews all applications for tax-exempt  status. At the back end, EO Examinations analyzes the operations and  finances of a small percentage of exempt organizations through  examinations (audits). Exam agents propose tax assessments or  changes to exempt status when necessary, as well as advise  organizations about how to comply with the law in the future. Through  these activities, IRS tries to ensure that charities merit the recognition of a  tax-exempt status as well as the retention of it.
IRS and state charity regulators both play a key role providing oversight  of charitable organizations. IRS’s oversight interests are in ensuring that  tax-exempt organizations comply with federal tax law. State charity  regulators have a broader oversight interest which includes the  application of state trust, non-profit corporation, consumer protection, and  charitable solicitation laws. Although these federal and state regulators  have distinct oversight interests, these interests are closely related and at  times, overlapping. Both IRS and state charity regulators seek to prevent  excess compensation, private inurement, conflicts of interest, and other  abusive practices by charitable organizations. IRS also collaborates with  U.S. Attorneys at the DOJ to identify and prosecute criminal tax  violations. Although EO does not collaborate directly with DOJ, criminal  investigations may be initiated within IRS at the recommendation of an  IRS revenue agent who has detected potential criminal activity.  Investigations may also be initiated at the advice of a U.S. Attorney’s  office, a law enforcement agency, or the public. IRS criminal  investigations are led by an IRS special agent. If substantial evidence is  found for a criminal case, then—after multiple rounds of supervisory  review—the investigation may be referred to the DOJ Tax Division or the  relevant U.S. Attorney’s office. If DOJ or the U.S. Attorney accepts the  investigation for prosecution, the case is then handled by the  prosecutors.
section_title: Charitable Organizations Comprise a Major Part of Our Economy and Vary Considerably in Size and Purpose
paragraphs: Charitable organizations comprise a significant part of our economy in  terms of their share of the gross domestic product (GDP) and their  importance in services vital to the well being of citizens. Available  estimates indicate that tax-exempt organizations serving households  generate about 5 percent of U.S. GDP. The federal government  increasingly relies on these organizations to deliver critical services: in  2012, government agencies paid an estimated $137 billion to nonprofit  organizations in grants and contracts for services. Also, for fiscal year  2013, the Department of the Treasury (Treasury) estimated the tax  expenditure for deductions for contributions to charitable organizations  totaled over $48 billion.
As shown in figure 1, the total population of nonprofit organizations can  be broken down by tax-exempt status and by the requirement to file  returns. In 2012, an estimated 2.3 million nonprofit organizations  operated in the United States, including organizations that have not  applied for tax-exempt status with IRS. Of nonprofits in 2011, 1.63  million had been recognized as tax-exempt by IRS and 1.08 million of  them were 501(c)(3) charitable organizations. An estimated 274,000 of  these charitable organizations filed returns—around 189,000 filed Form  990 and 85,000 filed Form 990-EZ.
As shown in figure 2, the number of charitable organizations that were  recognized as tax-exempt by IRS increased from more than 960,000 in  2003 to more than 1.28 million in 2010 (a 33 percent increase) but  declined to 1.05 million in 2013 (a 18 percent decrease from 2010). After  2010, this decline was primarily due to the Pension Protection Act of 2006  (PPA), which mandated that any organization—large or small—that failed  to file a required return or notice for three consecutive years would  automatically lose its federal tax exemption. Since PPA’s passage, more  than 570,000 organizations have lost their tax-exempt status through the  automatic revocation process. The net effect on the number of  charitable organizations (when new applicants and reinstated revocations  are included) is an average decline of about 200,000 from the peak in  2010.
subsections: section_title: Although Charitable Organizations Vary in Size and Purpose, a Small Number Concentrated in the Health and Education Sectors Control Most Assets
paragraphs: Charitable organizations, excluding private foundations, represent a  diverse array of mission areas and range greatly in asset size, the  amount of revenue they raise, and their expenses. As shown in figure 3,  the largest number of charitable organizations filing Forms 990 and 990- EZ were in the human services sector. However, the health and  education sectors had the largest amount of assets.
The human services sector represents 38 percent of the total population  of charitable organizations that file Form 990 or 990-EZ returns, followed  by the education sector at 18 percent and the health sector at 13 percent.  For more information by mission category, see appendix III. All three  sectors cover a diverse range of programs and serve different segments  of the population. The human services sector includes activities related to  employment, housing and shelter, and youth development. Education  includes elementary, secondary, vocational, and technical schools and  universities. Health includes hospitals, mental health and crisis  intervention, and medical research.
The assets of charitable organizations that file Forms 990 or 990-EZ  returns are concentrated in the health and education sectors, which held  about 75 percent of the total assets—more than $2 trillion—while the  human services sector held almost $324 billion (or about 11 percent) of  the total. In addition to being concentrated in a few sectors, a large  proportion of total assets were controlled by a relatively small number of  charitable organizations. Of the charitable organizations that file a Form  990 or Form 990-EZ, less than 3 percent held more than 80 percent of  the assets, as shown in figure 4. These organizations were primarily  from the health and education sectors. Over 59 percent of charitable  organizations that file Forms 990 or 990-EZ returns (with less than  $500,000 in assets) held less than 1 percent of all assets.
Most of the expenses of charitable organizations that filed Form 990 were  for program services, which are mainly activities that further the  organization’s tax-exempt purposes. Total expenses of charitable  organizations are broken down on the Form 990 into program service  expenses, management and general expenses, and fundraising  expenses. About eighty-seven percent of Form 990 charitable  organization expenses in 2011 were for program services, about 12  percent for general management, and about 1 percent for fundraising. As  we noted in our 2002 report, charitable organizations have discretion in  determining how to charge and allocate expenses for program services,  general management, and fundraising. The differences in methods can  result in charities with similar activities allocating expenses differently  among expense categories. This complicates interpretation of these data.  For more information on expenses, see appendix III.
section_title: EO Receives Indications of Noncompliance from a Variety of Sources, but Declining Resources Complicate Efforts to Effectively Oversee Charitable Organizations
subsections: section_title: EO Receives Indications of Noncompliance from a Variety of Sources
paragraphs: Through its examinations, IRS can analyze the operations and finances of  tax-exempt organizations and propose tax assessments or changes to  exempt status when necessary. In general, IRS attempts to select entities  that it believes are likely to have violated requirements, such as  unauthorized use of an organization’s assets, or engaging in political  activity. On the basis of these examinations, IRS can accept the Form  990 as filed or can change the status of the entity, impose excise taxes  for certain types of violations, or revoke the tax-exempt status if the  violations are serious enough. It can also assess taxes if an entity has not  fully paid employment taxes or taxes on unrelated business income. IRS  can also advise organizations on complying with the law in the future.  This can include sending written advisories to organizations advising  them of specific issues that need to be addressed.
IRS receives indications of noncompliance from a variety of sources that  can lead to examinations, as shown in figure 5.
EO initiated 8,413 exams of tax-exempt organization returns in 2013 and  4,495 of these (or about 53 percent) were exams of charitable  organizations. As shown in table 2, the largest source for these exams  (41 percent) was the category that includes the IRS National Research  Program project. EO participated in an IRS National Research Program  project on employment taxes in 2013, which contributed to an unusually  high number of exams during that year.
The next largest source (22 percent) was Form 990 data analytics. In  2008, IRS redesigned the Form 990 for the purposes of promoting  compliance and increasing transparency. The redesigned form requires  filing organizations to supply more in-depth information than previous  versions. For example, the form includes new questions on governance,  compensation, activities, relationships with related organizations,  international activities, fundraising, non-cash contributions, and other  compliance areas. A team of EO specialists developed data-mining  queries (based on the redesigned form) to identify suspected  inaccuracies or anomalies. For example, with the new Form 990, EO can  search for whether an organization reports that it has a mortgage and  receives rental income—suggesting that it has unrelated business  income. If the organization does not file a Form 990-T, Exempt  Organization Business Income Tax Return to report any unrelated  business income, IRS is more likely to select the organization for  examination. As of April 2014, EO had developed a list of over 150  condition codes based on return line entries to identify potential  noncompliance issues.
Of the charitable organization examinations initiated in fiscal year 2013,  632 (or 14 percent) were the result of referrals (including news items)— communication EO receives from internal and external sources alleging  potential noncompliance with the tax law. EO managers told us referrals  are prioritized so that those involving a serious breach of public trust or  abuse—such as financial investigations or allegations of terrorism—are to  be examined right away. On the other hand, high profile referrals— referrals resulting from a media exposé or involving a well-known  organization—are not necessarily high priority, and may not be examined  right away. The two most common sources of referrals for all tax-exempt  organizations in 2013 were the general public, with about 81 percent of  the 6,940 total referrals, and other IRS functional areas, with about 12  percent of the total. The specific potential violations most commonly  alleged were that income or assets were being used for private benefit,  the organization was involved in a political campaign; or the organization  failed to report employment, income, or excise tax liability properly.
section_title: Limited Resources Contribute to Fewer Examinations
paragraphs: With IRS budget cuts, the number of EO FTEs has declined over the past  several years, leading to a steady decrease in the number of  organizations examined. The total number of FTEs in the EO division  decreased from 889 to 842 (about 5 percent) and the number of FTEs  doing examinations declined from 529 to 493 (about 7 percent) between  fiscal years 2010 and 2013, as shown in table 3.
IRS examines only a small percentage of charitable organizations that file  returns, including private foundations, as shown in table 4. EO  examination rates were lower, relative to other IRS divisions. For  charitable organizations, the examination rate was about 0.7 percent in  2013, while for individual and corporate tax returns it was 1 percent and  1.4 percent, respectively. A comparison of tables 3 and 4 also shows  that the number of employees performing exams has declined while the  number of returns filed has increased. From fiscal year 2011 to 2013, the  exam rate decreased from .81 percent to .71 percent (by about 12  percent).
As shown in table 5, examinations may result in no change to the amount  of taxes owed or the tax-exempt status, the assessment of taxes or  penalties, or the revocation of tax-exempt status. The no-change rate  over the past three years has been between 30 and 34 percent.  According to EO officials, IRS uses change and no-change rates as one  indicator of how well it is targeting exams. Therefore higher no-change  rates indicate that IRS is spending resources examining compliant  entities. The 30 percent no-change rate for charitable organizations is  relatively high when compared to the rate for some other filers. For  example, in 2013, the no-change rate for all examinations of individual tax  returns ranged from 9 to 12 percent, depending on the type of exam that  was conducted.
An organization may be subject to a tax assessment or penalty charges  for filing a late return, for failure to provide required document, or for late  payment of taxes. IRS can also revoke tax-exempt status when charitable  organizations (or individuals responsible for the organization) violate  certain rules. The organization would have to reapply as a tax-exempt  organization and start the process over. Revocations may result when an  organization is found to be engaging in non-exempt activities, operating in  a commercial manner, or allowing inurement of net earnings or assets of  the organization to benefit an officer, director, or a key employee who has  a personal or private interest in the activities of the organization. This type  of enforcement action happens infrequently.
An exam may also identify issues—such as a proposed expansion of an  unrelated business income producing activity, or a failure to properly  report required information, such as special fundraising activities or officer  compensation. If enlarged, these issues could jeopardize the tax-exempt  status of the organization. However, there is no change in the tax-exempt  status of the organization. Instead, the examiner will issue a closing letter  with a written advisory addendum to the organization identifying the non- compliance issues found during the examination which, if corrected,  would bring the organization into compliance.
As figure 6 shows, the number of charitable organization returns with  revocations declined from 2011 to 2013. Generally, the most often-cited  reason for the revocation was that the charitable organization was not  operating for a charitable purpose. The exception was in 2011, where the  failure to file returns and other records was slightly higher. Operating for  the benefit of private interests was another reason for a revocation.
section_title: The Impact of EO Compliance Efforts on Charitable Organizations Is Unknown, Due to Lack of Key Performance Measures and Goals and Lack of Complete Data
paragraphs: The EO Business Division has faced challenges over the past several  years from declining budgets and staffing and from the complexity and  the sensitivity of their workload, which includes regulating the political  activity of tax-exempt organizations. EO’s ability to address these  challenges has been hindered by a lack of performance measures that  EO management could use to fully assess and communicate how  effective their efforts have been. EO managers have introduced some  timeliness measures that may lead to efficiency gains by helping them  track their inventory of applications, referrals, and exam cases and  identify bottlenecks as they occur. However, EO managers lack  compliance goals and measures for assessing their progress in ensuring  that charitable organizations are conforming to their charitable purpose  and other aspects of the tax law. EO is developing a new approach to  identify and select organizations for examination. EO also introduced a  streamlined application form for smaller organizations seeking tax-exempt  status that may reduce administrative burden. However, the limited  amount of information that will be available about these organizations  raises questions about how IRS will identify noncompliance issues for this  particular segment of charitable organizations. In addition, a lack of  timely, accurate digitized data from the Form 990 further complicates  oversight efforts.
subsections: section_title: Lack of Quantitative, Results-Oriented Goals and Measures for Improving Compliance Limits Ability to Assess Effectiveness of EO Oversight
paragraphs: EO has developed measures and goals to track its output of application  reviews and examinations, but these do not measure impact on  compliance. EO managers develop an annual work plan, which lists the  research projects and exams they plan to initiate over the course of the  year. The work plan includes goals for the number of cases they plan to  start and close within the year, and the estimated number of staff days for  each project. EO management uses a quarterly dashboard to track their  progress against the workload goals, as set forth in their annual work  plan. However, these performance goals and measures do not show the  impact of EO efforts on compliance. These are measures that are useful  for monitoring processes within EO, but they do not measure outcomes— such as improvements in the compliance rate for the charitable  organization sector. Developing outcome-oriented goals and establishing  measures to assess the actual results of EO activities (compared to their  intended purpose) can help EO improve performance and determine  whether programs have produced desired results.
EO Examinations managers use the examination change rate as a  measure of compliance. The change rate is measured as the percentage  of exams that result in a written advisory, a change in the amount of  taxes, penalties, or fines an organization owes, or a change in the  organization’s tax-exempt status. This change rate that EO reports from  exams may be a useful indicator of how accurately EO is selecting  charitable organizations for exam but it has limitations as a compliance  measure. EO does not use a random sample of organizations to estimate  the change rate for the charitable sector as a whole and—except in the  case of certain projects described below—it does not estimate the rate by  type of charitable organization or by compliance issue. Change rates  based on nonrandom exam selection procedures cannot be used to  enhance compliance by focusing enforcement efforts on areas with the  highest risk of noncompliance. In addition, EO’s change rate is  ambiguous as a measure of compliance because while it includes the  number of written advisories that EO managers send following an exam,  EO managers do not track the percentage of organizations that received  a written advisory in the past and continued to be noncompliant.
In addition to lacking some key compliance measures, EO managers do  not set specific, measurable goals related to improving the compliance  levels of tax-exempt organizations, either as a whole or for charitable  organizations in particular. One reason it is difficult to set compliance  goals, according to IRS and EO officials, is that IRS has not completed a  study for charitable organizations that establishes a compliance baseline.  In order to track progress toward a compliance goal, generally-accepted  evaluation standards require establishing a baseline for compliance  measures and recording how these measures change over time.
A possible source for such a baseline is IRS’s National Research  Program (NRP) but the cost of establishing a baseline may be large. The  NRP examines a sample of tax returns to estimate rates of  noncompliance for all taxpayers and for different types of taxpayers and  tax issues. According to IRS and Exempt Organizations officials, it would  be useful to have a research program like the NRP identify compliance  baselines for EO. More compliance data on the EO sector would allow  EO examiners to better select organizations for exam and would  potentially reduce the no-change rate. However, these officials also point  out that such a project requires a considerable investment of resources.  They also say undertaking such a large-scale long-term project may not  be feasible, given the resource constraints faced by IRS.
Another possible source of baseline data is the projects initiated by the  EO Examinations Unit. EO Examinations sponsors new research projects  each year to help identify non-compliance (which can include estimating a  change rate) by types of operations, by segments of the charitable sector,  or around a particular issue or item from the Form 990. A project can  begin when EO decides that potential for noncompliance exists for a  certain issue based on data analytic queries, referrals, or some other  source (as described above). A random sample of organizations in that  segment is selected for review. EO managers said they generally judge a  project to be successful if it achieves a change rate of 80 percent or  higher. For example, if 80 percent or more of the returns examined as  part of the review result in a change in the amount of taxes, penalties, or  fines the organization owes, a change in the organization’s tax-exempt  status, or a significant change in the organization’s operations, EO  managers may then decide to incorporate the original query as part of  their regular examination selection criteria.
However, EO does not use the results of the projects as baselines to  assess whether the strategies adopted as a result of the projects have  improved compliance among the segments of the tax-exempt sector that  were studied in the projects. EO managers see these projects as a way to  gather information they can use to develop strategies to address  emerging issues, measure overall levels of compliance, and address  areas of known non-compliance. But the impact on compliance remains  unclear, because EO does not consistently follow up to measure the  project impact in subsequent years or policy changes made as a result of  the project. Even when a full research project using a representative  sample is not justified given EO’s resource limitations, other approaches  may still provide useful information about compliance. For example,  tracking the frequency in exams of issues that were identified in the  project, while not an adequate compliance measure due to the  nonrandom exam selection procedures, could provide insight into whether  the issues are still a reason for concern.
An example of how establishing a baseline could have helped EO  measure the effect on compliance of policy changes is EO’s project that  reviewed charitable organizations providing consumer credit counseling.  The project examined over 200 organizations and IRS revoked,  terminated, or proposed revoking the exemptions of around 60 percent of  these organizations for abuses such as failure to provide education,  operating as a commercial business, or serving the private interest of  directors, officers, and related entities. According to the 2011 Exempt  Organizations Annual Report, this project helped to stimulate legislative  changes in 2006, including new tax rules governing exempt credit  counseling organizations.
However, IRS has not evaluated the effect of changes in the law that  came about as a result of the project on subsequent compliance by  charitable organizations that provide credit counseling. Because the  project examined over 200 of the credit counseling organizations,  including the 63 largest, it may have had sufficient coverage of this part of  the charitable sector to provide a baseline for assessing the effect of the  legislative changes on compliance. According to EO officials, they  decided not to open a large volume of new credit counseling cases after  the initial project was completed because the initial project still had cases  in the appeals process and the relevant sections of the 2006 legislation  had phase-in provisions under which the provision took full effect for tax  years after January 1, 2011. However, EO currently has no plans to  undertake such a study in the future.
EO officials told us that they intend to change their source-based  approach to selecting and conducting exams starting in 2015, in order to  make better use of limited resources. They said they intend to rely more  on data mining queries based on the redesigned Form 990 to detect high- risk areas of noncompliance and to prioritize enforcement efforts. This  approach may also better conform to strategies IRS lays out in their  strategic plan for 2014-2017, which calls for IRS to develop improved  research-driven methods and tools to detect and combat noncompliance  and improve resource allocation. As an example, EO officials also report  they will prioritize case selection according to criteria that give more  weight to more consequential outcomes. A data mining query generating  a lot of revocations would take priority over a query that may only  generate written advisories. They hope their new approach will allow  them to better select cases for exam and to measure their effectiveness.  However, this new approach is still in early stages of development and  they are starting to implement it in FY 2015. Also, without compliance  goals, related performance measures, and more complete indicators of  compliance, it will be difficult to assess the effectiveness of the new  strategy.
Developing measures of compliance and determining the impact of  projects and exams on compliance is challenging. As we’ve discussed in  past reports, IRS researchers have found it difficult to determine the  extent to which its enforcement actions deter noncompliance or its  services improve compliance among taxpayers who want to comply.  The challenges to determining impact include collecting reliable  compliance data, developing reasonable assumptions about taxpayer  behavior, and accounting for factors outside of IRS’s actions that can  affect taxpayer compliance, such as changes in the tax law.  Nevertheless, even if IRS (or in this case, EO) is unable to empirically  estimate the extent to which its actions directly affected compliance rates,  periodic measurements of compliance levels can indicate the extent to  which compliance is improving or declining and can provide a basis for  reexamining existing programs and triggering corrective actions, if  necessary.
Best practices indicate that establishing results-oriented goals can help  agency officials demonstrate they have thought through how the activities  and initiatives they are undertaking are likely to lead to meaningful results  in line with programmatic goals. An example of a results-oriented goal for  EO would be a specific, measurable increase in compliance rates for  particular types of organizations (such as for the credit counseling  organizations described above) or for certain issues that have been  problematic in the past (such as failure to pay employment taxes). We  have also previously reported that setting results-oriented goals,  establishing performance measures and related performance indicators  with targets in meeting such goals, and reporting on progress against  those goals are the hallmarks of effective management. The absence of  results-oriented goals and related performance measures for compliance  does not allow EO officials to compare the success of different initiatives  against one another, determine whether their compliance strategy is  working as intended, or allocate resources to those activities that have  the most impact on compliance levels.
section_title: New Streamlined Application and Review Process Raises Questions about Whether IRS Will Collect Adequate Information to Indentify Noncompliance among Smaller-Sized Organizations
paragraphs: In May 2013, Treasury Inspector General for Tax Administration (TIGTA)  found that applicants for tax-exempt status experienced significant delays  in the review of their applications. Specifically, it reported that as of  December 2012, many organizations had not received an approval or  denial letter—more than two years after they submitted their applications.  TIGTA also reported that the EO Rulings & Agreements function did not  have specific timeliness goals for processing applications, such as  potential political cases, that require significant follow-up with the  organizations. The Taxpayer Advocate also reviewed EO operations and  concluded that EO management did not have meaningful performance  measures required for effective management oversight of the application  process such as how long it takes, on average, to process applications  that cannot be disposed of during initial screening and what percentage of  inventory had not been reviewed in nine months or more.
The lack of meaningful performance measures compounded other  challenges faced by EO management. As discussed earlier, the number  of charitable organizations recognized as tax-exempt by IRS increased  over the past decade, as the number of employees has declined along  with budget cuts. In addition, the auto-revocation process that began in  2011 (following changes to legislation in 2006) inadvertently led to an  increase in the number of applications. By revoking the status of  organizations that had not filed in three years, the process revoked the  status of hundreds of thousands of organizations that no longer existed  as intended, but also purged thousands of organizations that still merited  tax-exempt status, but may have been unaware of their filing  requirements. Once their status was automatically revoked, many applied  for reinstatement, leading to a spike in applications. According to IRS  senior officials, other challenges faced by EO management included  outdated information technology records management systems, making it  difficult for managers to understand and manage the size of the  application backlog.
EO managers introduced performance measures and goals to help  address these challenges and the concerns about applications inventory  raised by TIGTA and the Taxpayer Advocate. For fiscal years 2013 and  2014, EO managers set a goal to eliminate the backlog of applications  waiting for review for 270 days or more. To assess their progress in  managing the inventory of applications, EO managers focused on  performance measures such as number of applications received and  closed, average age of applications inventory, and number of cases still  pending after 270 days. They anticipate that these measures will allow  them (for the first time) to track their progress, to more readily identify  choke points and the reasons why slowdowns are occurring, and to react  accordingly. Managers can now access this information through a weekly  dashboard to monitor the inventory and communicate to senior EO  management on a quarterly basis. As of September 2014, IRS Exempt  Organizations officials reported they had closed over 117,000 cases in FY  2014, an increase of 121 percent over the prior year’s closings. They also  reported that the end of year inventory was 22,759, as compared to  65,718 at the end of FY 2013.
EO managers also introduced a streamlined application review process to  reduce their inventory of aged cases. Initially, application reviewers relied  more heavily on attestation statements made under penalty of perjury,  rather than with substantiating documents. For example, if an  organization failed to include a narrative statement describing its activities  as required by the application Form 1023, IRS would ask the organization  to attest that it met the operational test for tax-exempt status, rather than  hold the case open until the organization submitted the appropriate  paperwork. Similarly, applicants that failed to submit organizing  documents—which are important because they describe how the  organization’s purpose and assets comply with tax-exempt purposes set  forth in section 501(c)(3)—would need to attest that they had the  appropriate organizing documents and that they met statutory and  regulatory requirements, rather than provide actual documents. EO  officials said attestation statements allowed applicants to indicate that  they were fully aware of the application requirements, but they were not  used in isolation. For example, if an application indicated the possibility of  private inurnment, the reviewer was supposed to ask the applicant about  this issue and would not rely solely on attestation. In the spring of 2014,  EO managers determined the interim guidance for application reviewers  was unclear, and they told reviewers there must be a narrative and  organizing documents, although the IRM has not yet been updated to  reflect this change. The new, streamlined procedures initially applied only  to cases in the applications inventory that were more than a year old, but  were extended in May, 2014 to all existing inventory. EO officials told us  these streamlined review procedures are temporary and they are  commissioning a study to evaluate their effectiveness and efficiency.
In addition, in July 2014, EO managers introduced a new application form  for relatively small organizations. This application adopts the same  approach of substituting attestation for documentation as used initially in  the streamlined inventory procedure. The new application (Form 1023- EZ) can be used by certain organizations with annual gross receipts of  $50,000 or less and assets of $250,000 or less seeking tax-exempt  status. This form is considerably shorter than Form 1023 (3 pages  compared to 12 pages), asks fewer questions, and the questions are  primarily yes/no questions or checking a box for attestation. Form 1023- EZ does not require detailed information, such as organization  documents, financial statements, or explanations, descriptions, or  narratives about activities, as is required on Form 1023. EO managers  anticipate that the majority of new applicants will use the streamlined  Form 1023-EZ.
Several organizations, including the National Council of Nonprofits and  National Association of State Charity Officials (NASCO) have raised  concerns about the impact of the shorter application Form 1023-EZ on  compliance. These concerns include decreasing the quality of information  the IRS needs to make informed decisions about granting tax-exempt  status, making it easier for “scam” charities to obtain tax-exempt status,  and shifting IRS oversight obligations onto the public, the funding  community, and state charity regulators. Likewise, the Taxpayer Advocate  also raised concerns about the streamlined 1023-EZ form, including a  lack of empirical data demonstrating that organizations anticipating less  than $50,000 in gross annual receipts pose low risks to compliance, a  failure to conduct a comprehensive evaluation of downstream  consequences of the streamlined application, and a post-implementation  evaluation plan that relies on the limited effect of a small number of audits  to correct potential compliance problems. EO officials told us they  disagreed with the Taxpayer Advocate’s findings.
EO officials said that they conducted a risk assessment of their new  streamlined application process. As part of the risk assessment, IRS  identified several compliance-related risks, including the possibility of an  increase in fraudulent applications and consequent potential loss of  revenue, due to tax deductible contributions to organizations that were  not eligible for exemption. To address these compliance risks, the IRS  risk assessment cited the need for a more robust back-end review of  newly-exempt organizations that had received their status through the  streamlined process. This would include increased use of quality control  checks, audits, and other reviews, and an enhanced EO Examination  process to identify ineligible organizations.
EO managers intend to review a sample of organizations that used the  Form 1023-EZ to apply for tax exempt status to learn about the  population of organizations applying for exemption using the new, shorter  form, including their eligibility to use the form. This phase started in July  2014 (when the new form was introduced to the public), and occurs after  an organization submits an application and before IRS makes a  determination on tax-exempt status. IRS plans to review a random  sample of 3 percent—an estimated 1,260—of applications submitted  using the new streamlined 1023-EZ form. According to EO officials, this  sample size was based on a reliability factor and was then adjusted  based on staffing resource capacity. As part of determining eligibility to  use the shorter form, the reviewers are supposed to request from the  filers in the sample such items as a detailed description of past, present,  and future activities, and revenues and expenses for the most recently  completed year.
The EO Examinations function will also conduct post-determination (i.e.  after tax exempt status has been determined) compliance reviews of  organizations that applied for and received their tax-exempt status  through the streamlined application review as well as organizations that  applied for and received their tax-exempt status using the shorter Form- 1023-EZ. The compliance reviews of the first group—organizations that  received their tax-exempt status through the streamlined review  process—will begin during FY 2015. For this review, EO plans to select a  random sample of exempt organizations reviewed under the streamlined  process to provide information about the subsequent compliance  characteristics of organizations that received their status in this way. EO  recently approved guidance for reviewing these returns, which lists  potential areas of noncompliance, such as legislative or overseas  activities, compensation issues, and unrelated business activity.
According to Tax-Exempt and Government Entities Division and EO  officials, post-determination compliance reviews of organizations that  used the Form 1023-EZ to apply for tax-exempt status will begin in late  FY 2015 or early FY 2016. For this review, EO plans to take a random  sample of exempt organizations that filed the Form 1023-EZ to provide  information about the subsequent compliance characteristics of  organizations that filed the shorter form. They anticipate they will use the  same review procedures for the Form 1023-EZ exams as they use for the  streamlined review process. However, they also report some  modifications will be necessary due to the limited information on the EZ  application itself as well as the fact that eligible organizations would  typically be filing the Form 990-N as opposed to the more detailed Form  990 or even Form 990-EZ. The limited amount of information that will be  available about these organizations because of the shorter application  form and information return raises questions about how IRS will identify  noncompliance issues for this particular segment of charitable  organizations.
section_title: Lack of Timely and Complete Data Limits IRS Ability to Provide Adequate Oversight of Charitable Organizations and to Provide for the Transparency of the Tax- Exempt Sector
paragraphs: The e-filing rate for tax-exempt organizations is significantly lower than for  other taxpayers and organizations. In 2013, 38 percent of Forms 990,  990-EZ, and 990-PF were filed electronically, while in 2011, 64 percent of  partnerships and 66 percent of S Corporations filed electronically. The  lower rate is due in large part to current law, requiring only very small and  very large tax-exempt organizations to file electronically. Larger tax- exempt organizations (those that that file at least 250 returns during the  calendar year) are required to file electronically and smaller organizations  (those that are excused from filing Form 990 or Form 990-EZ, generally  because their gross receipts are normally less than $50,000 annually),  must file an annual notice (Form 990-N) in electronic format. Medium- sized organizations—those too big to file the Form 990-N, but not big  enough to file 250 returns—are not required to file electronically.
This lower rate means that there is less digitized data available for data  mining and analytics and that IRS will have higher labor costs. IRS  officials said that having more return information available electronically  might improve examination selection. For instance, when IRS  examination specialists suggested filters for an EO project to use in  identifying potentially noncompliant issues, the lack of available electronic  data prevented EO from using all of the filters. Further, IRS officials  estimate that mandated electronic filing would save EO more than an  estimated $1 million in labor costs over a three year period, although a  complete study has not been performed.
In the FY 2015 Budget proposal, the administration proposed that  Congress expand e-filing for tax-exempt organizations. Expanded e- filing may result in more accurate and complete data becoming available  in a timelier manner, which in turn, would allow IRS to more easily identify  areas of noncompliance. In our 2014 report on partnerships and S  corporations, we recommended that Congress consider expanding the  mandate for partnerships and corporations to electronically file their tax  returns in order to cover a greater share of filed returns. We concluded  that increased e-filing would increase the amount of digitized data  available to IRS, which examiners could then use to identify which  partnership and S corporation tax returns could be most productive to  examine. Since many charitable organizations are organized as not-for- profit corporations, the same mandate could also cover 501(c)(3)  charitable organizations.
Any option for an e-filing mandate would impose some burden on some  tax return filers if (for example) they do not already possess the e-filing  technology and they need to get access to it. However, expanded e-filing  could also reduce taxpayer burden, since greater accuracy would reduce  false-positives, allowing IRS to identify “bad actors” rather than  organizations who made mistakes on their returns. In addition, the burden  could be mitigated. The 2015 budget proposal would allow transition relief  for up to three additional years after the date of enactment to begin  electronic filing, for smaller organizations and organizations for which  electronic filing would be an undue hardship without additional transition  time.
According to IRS, electronic filing also increases transparency for the tax- exempt community because more searchable data becomes publicly  available faster than paper-filed returns, which must first be converted to  machine readable format. Once publicly available, the Form 990 data  may be used by donors to make more informed contribution decisions  and by researchers, analysts, and entrepreneurs to understand the tax- exempt sector better and to create information tools and services to meet  the needs of the sector. Having Form 990 series return data faster would  also be useful to state and local regulators, charity watch-dog groups,  charitable beneficiaries, and the press. In addition, e-filing would allow the  IRS to process returns more quickly and at a lower cost than when paper  returns are filed. Representatives from across the nonprofit and law  enforcement community with whom we spoke support this reform as a  strategy for improving transparency and accountability.
section_title: Uncertainty about How Taxpayer Data Can Be Shared and Used Limits Collaboration between IRS and State Charity Regulators
paragraphs: To oversee charitable organizations, IRS collaborates with different  federal and state entities, including DOJ and state charity regulators. IRS  and DOJ officials identified no obstacles that prevent their collaboration  for the enforcement of tax laws. IRS refers cases involving possible  criminal matters to the DOJ Tax Division for investigation and possible  prosecution. According to DOJ officials, the review and referral process is  designed to maintain a separation between IRS and DOJ decision making  to avoid the appearance of (or actual) abuse of executive power. As such,  DOJ attorneys have little involvement with the IRS review and referral  process. Once a case is referred to DOJ, prosecutors have access to the  taxpayer information under IRC section 6103(h)(2). DOJ Tax Division  attorneys said they are familiar with the information-sharing framework  under this IRC provision. This framework allows prosecutors access to  the information they need to build a case.
However, state regulators and other subject matter specialists said  statutory requirements for safeguarding taxpayer information and  uncertainty about how these safeguards must be implemented limit state  regulators’ ability to use relevant information shared by IRS. They add  that this may reduce regulators’ ability to use that information to build  cases against charitable organizations engaged in fraudulent or other  criminal activity.
Barriers to information sharing between IRS and state charity regulators  have been a long-standing challenge. Before legislation passed in 2006,  IRS was only permitted to disclose to state charity regulators information  concerning final denials of applications for tax-exempt status, revocations  of tax-exempt status, and final notices of deficiencies. In 2002 and  2005, we reported that this limited data sharing hampered state charity  officials’ efforts to identify charities which are defrauding the public or  otherwise operating improperly. At the time, state charity regulators told  us that the lack of details impeded their efforts to track individuals who  tried to re-establish similar, suspicious operations in other states. We  recommended IRS propose revised legislation that would allow IRS to  share more data—such as information about ongoing and closed  examinations of charities—as a way to help IRS and states better use  limited resources and to allow the states to more quickly respond to  noncompliance.
In 2006, the PPA was enacted with provisions to facilitate information- sharing between IRS and state charity regulators. The PPA expanded  the type of information state charity regulators can receive to include  sensitive, confidential information, such as revenue agents’ reports  regarding proposed revocations and notices of deficiencies. IRS can  now share information about certain proposed revocations and proposed  denials before an administrative appeal is made and a final revocation or  denial issued. In addition to the information IRS is now allowed to share  with state charity regulators, IRS also makes revocations publicly  available: IRS lists revocations in the Internal Revenue Bulletin, although  the reason for revocations resulting from exam are not given or made  public.
While the PPA expanded the types of information IRS could share with  state charity regulators, the law also placed safeguards on that  information. For the first time, the PPA subjected state charity regulators  to the same criminal penalty provisions of the Internal Revenue Code that  all other recipients of tax information are subject to, making it a criminal  offense for any state official to willfully disclose information shared by the  IRS under Section 6104(c) in a manner unauthorized by the Internal  Revenue Code. To have access to the increased types of information  now available, state charity regulators must sign a disclosure agreement  with IRS in which they agree to certain safeguarding procedures for  receiving and handling taxpayer data.
State charity regulators and other subject matter specialists we spoke  with believe these safeguard requirements are unclear and difficult to  implement. Although these requirements are the same as those that IRS  and any state tax agencies receiving federal tax data must follow, most  states do not have the resources, capacity, or infrastructure within their  charitable oversight function to fulfill the requirements, according to  subject matter experts with whom we spoke. For example, all disclosures  provided by IRS must be reviewed by a state charity official, logged to  record the receipt of the information, and stored behind at least two  secured barriers, such as locked doors or cabinets. State charity  regulators are also prohibited from entering the IRS shared data in a word  processing program on a networked computer, unless lengthy security  requirements are met.
Since the passage of the PPA, charity regulators in three states— California, New York, and Hawaii—signed a memorandum of  understanding (MOU) with IRS to share information. However, despite the  MOU, these state charity regulators still report challenges in storing and  receiving data from IRS. A lack of clarity surrounding how they can use  the data from IRS to build their own cases, and the criminal penalties  attached to improper disclosure of the data, have prevented state charity  regulators from incorporating IRS data into their investigations. For  example, state charity regulators said when they learn that IRS is  examining a charity located in their state for violating federal tax law, they  must first contact the charity and request the documents it has already  turned over to IRS. However, if the charity refuses or denies it has the  requested documents, the state charity regulators do not believe they can  enforce their request by citing the information provided to them by IRS.  As a result, they seek to independently verify the information from the IRS  (to the extent they are available) through other sources (such as the  internet or the state registration database) before contacting the charity.
Also, according to subject matter experts, IRS interpretation of these rules  has been inconsistent. As a result, regulators are unsure whether they  are in violation of the safeguards requirements. According to state charity  regulators, other states have not entered into information-sharing  agreements with IRS because they view the safeguard requirements as  overly burdensome, given their limited resources.
NASCO and the National Association of Attorneys General (NAAG)  representatives credit IRS with trying to educate state regulators about  the PPA requirements. IRS staff has given presentations at joint NAAG  and NASCO conferences. According to the ACT 2013 report on exempt  organizations, the IRS’s designated EO federal/state liaison has worked  to educate participating state agencies in the mechanics of PPA  participation, has assisted with the safeguard procedure, and has linked  state officials with appropriate IRS officials conversant in necessary  information technology and security issues. The report also credited IRS  with initiating discussions with state charity regulators through a task  force to develop a pragmatic approach for taking advantage of what is  presently available under the PPA. IRS officials are also working on a  new MOU that will clarify how state charity regulators can communicate to  charities to let them know they have received information about them  from IRS. In addition, to facilitate information sharing between IRS and  state charity regulators, Treasury officials are in the process of reviewing  the PPA and Congress’s intent in drafting this legislation to determine  whether additional flexibilities exist.
Despite these education and outreach efforts, state charity regulators are  still unclear about how they are permitted to use IRS information to  identify organizations violating state law and to build cases against them.  The types of information PPA makes available would bolster state  oversight efforts in a variety of ways.   For example, according to the ACT  report, state receipt of the names of organizations applying for exempt  status would help states monitor startup entities that cease operations  before the IRS responds to their for 1023 applications.  EO officials told  us that there are efforts underway to reduce processing times that should  address this particular concern. Also according to the ACT report, state  receipt of information about tax-exempt organizations receiving a  proposed revocation of exemption would raise immediate questions about  whether those organizations’ assets are being properly applied to  charitable purposes as required by state law.
The challenges to information sharing between IRS and state charity  regulators are related to uncertainty about what is permissible under the  PPA. With limited access to IRS information, state charity regulators do  not always know why a charity has had its tax-exempt status revoked, if it  is under examination, or if it has been fined, but maintains its tax-exempt  status. The lack of information impedes state charity regulators’ ability to  identify and prosecute bad actors for violating state laws and hinders  states’ ability to inform donors of scam charities.
section_title: Conclusions
paragraphs: EO oversight of charitable organizations helps ensure that these entities  abide by the purposes that justify their tax exemption and protects the  sector from potential abuses and loss of confidence by the donor  community. Over the past several years, reviewers have found that  various units within the EO division could not fully assess or communicate  their effectiveness because they lacked meaningful performance  measures. EO managers have taken actions to address this deficiency by  adding performance measures to help them track their inventory of  applications, referrals, and exam cases and to ensure a level of quality  assurance. EO has also developed its data analytics capacity to assist in  selecting organizations for exam with greater audit potential. It has used  these techniques and other information sources to select returns for  examination and in some cases, has used the results of these exams to  more systematically review certain tax issues. However, these actions  have not addressed measuring the outcomes of EO activities (such as the  effect of EO’s actions on the compliance rate for the charitable sector as  a whole), for specific segments of the sector (such as universities and  hospitals), or for particular aspects of noncompliance (such as personal  inurement or political activity). EO does not have the compliance  measures or the quantitative, results-oriented compliance goals needed  to assess its effect on the compliance of charitable organizations in any of  these areas. Because EO does not measure the current level of  compliance, it cannot set goals for increasing compliance or know to what  extent its actions are affecting compliance.
The Exempt Organizations Business Division is grappling with several  other challenges that complicate oversight efforts. The e-filing rate for tax- exempt organizations is significantly lower than for other taxpayers. This  lower rate means that there is less digitized data available for data mining  and analytics and higher labor costs for IRS. Expanded e-filing may result  in more accurate and complete data becoming available in a timelier  manner; in turn this would allow IRS to more easily identify areas of  noncompliance. This legislative reform would also be useful to state and  local regulators, charity watch-dog groups, charitable beneficiaries, and  the press as a strategy for improving transparency and accountability.
A lack of clarity about how state charity regulators can use IRS data to  build cases against suspect charitable organizations impedes regulators’  ability to leverage IRS’s examination work. IRS and Treasury officials are  reviewing the statutory protections of taxpayer data and whether there is  flexibility in regard to how state regulators must protect and can use  federal tax data. IRS officials are also working on a new MOU that will  clarify how state charity regulators can communicate to charities about  information they have received from IRS. Once completed, these actions  have the potential to enable greater collaboration between IRS and state  charity regulators.
IRS budget and staffing levels have declined significantly over recent  years. Officials and stakeholders we spoke to noted that IRS resources  dedicated to EO oversight have not kept pace with growth in the sector  and with the complexity of issues related to tax-exempt organizations.  IRS faces difficult decisions about how to allocate resources dedicated to  tax-exempt sector oversight and about what specific compliance issues to  audit. IRS has already made trade-offs—such as examining fewer  organizations and streamlining the application process for organizations  seeking tax-exempt status—which may lead to some efficiencies, but will  also result in less available information about these organizations. If IRS  does not collect and use performance data to make sound decisions— especially given the likelihood of constrained budgets for the foreseeable  future—the agency risks missing noncompliance, burdening tax-exempt  organizations, and wasting scarce resources. Furthermore, it will be  difficult for IRS to communicate agency progress to Congress and the  public and thus, be held accountable.
section_title: Matter for Congressional Consideration
paragraphs: Congress should consider expanding the mandate for 501(c)(3)  organizations to electronically file their tax returns to cover a greater  share of filed returns.
section_title: Recommendations
paragraphs: To improve oversight of charitable organizations, we recommend that the  Commissioner of Internal Revenue take the following steps:  1.  Direct EO to develop quantitative, results-oriented compliance goals  and additional performance measures and indicators that can be used  to assess impact of exams and other enforcement activities on  compliance.  2.  Continue to work with Treasury officials to do the following: review the  flexibility afforded under PPA consistent with statutory protections of  taxpayer data, clarify what flexibility state regulators have in how they  protect and use federal tax data, make modifications to guidance,  policies, or regulations as warranted, and clearly communicate this  information with state charity regulators.
section_title: Agency Comments and Our Evaluation
paragraphs: We sent a draft of this report to the Commissioner of Internal Revenue  and Assistant Attorney General for Administration, Department of Justice  for comment. DOJ had no comments on our report. We received written  comments from IRS’s Deputy Commissioner for Services and  Enforcement on December 4, 2014 (for the full text of the comments, see  appendix IV).
In its comments, IRS concurred with our recommendations and described  ongoing and planned steps to 1) improve the application process for  organizations seeking tax-exempt status and reduce the backlog of  applications that had accrued in recent years, 2) refine its strategy and  approach to better determine the effect of enforcement actions on  compliance by tax-exempt organizations, including charitable  organizations, and 3) improve the efficiency with which taxpayer  information may be shared with state charity regulators through education  efforts and outreach.
IRS also noted in its written comments that IRS’s National Research  Program (NRP) may not be well-suited for the tax-exempt sector, given  the diversity that exists across the sector in regard to characteristics and  compliance issues. Although we made no specific recommendation that  EO be part of an NRP study, we note that the NRP has helped other IRS  divisions determine compliance baselines and rates for types of  taxpayers, such as corporations, where considerable diversity exits.   While an NRP study could be a source for baseline data, we  acknowledge that because of the high cost of such a study, it may not be  practical at this time. Whatever approach to measuring compliance EO  adopts, it should be consistent with our recommendation that EO develop  quantitative, results-oriented compliance goals and additional  performance measures that can be used to assess the impact of its  activities on compliance.
We also received technical comments from IRS, which we incorporated  into the final report where appropriate.
We plan to send copies of this report to the Secretary of the Treasury, the  Commissioner of Internal Revenue, the Assistant Attorney General for  Administration, DOJ, and other interested parties. The report is available  at no charge on the GAO website at http://www.gao.gov.
If you or your staff has any questions about this report, please contact us  at (202) 512-9110 or mctiguej@gao.gov. Contact points for our offices of  Congressional Relations and Public Affairs are on the last page of this  report. GAO staff members who made major contributions to this report  are listed in appendix V.
section_title: Appendix I: Scope and Methodology
paragraphs: This report (1) describes what is known about the number, type, size, and  other characteristics of 501(c)(3) charitable organizations; (2) describes  IRS oversight activities for charitable organizations; (3) determines how  IRS assesses its oversight efforts of charitable organizations to ensure  they are meeting their charitable purposes; and (4) determines how IRS  collaborates with state charity regulators and U.S. Attorneys to identify  and prosecute organizations suspected of engaging in fraudulent or other  criminal activity.
To address the first objective, we reviewed Internal Revenue Service  (IRS) forms and publications. We also analyzed data from the IRS’s  Statistics of Income (SOI) files for Form 990, Return of Organization  Exempt from Income Tax and Form 990-EZ Short Form, Return of  Organization Exempt from Income Tax for tax year 2011 (the most recent  year available). Although private foundations are considered charitable  organizations, we did not analyze data from Form 990-PF, Return of  Private Foundation or Form 990-N, e-Postcard because the data for these  organizations is less complete and has other limitations. These limitations  included total expenses not broken out into program service,  management and general, and fundraising expenses; and private  foundations not identified by mission category. In addition, our data  excludes certain religious organizations, which qualify as 501(c)(3)  organizations, but are not required to file a return. We also did not report  data from prior years for the Form 990 and 990-EZ filers since the  reporting threshold for organizations filing these returns varied from year  to year, which makes year-to-year comparisons of the data difficult.  These SOI samples were based on returns as filed, and did not reflect  IRS audit results. Using SOI sampling weights, we estimated sampling  errors for our estimates, which are reported in appendix III. Statements of  difference are statistically significant.
SOI is a data set widely used for research purposes. SOI data on tax- exempt organizations are available to the public on the IRS website  (http://www.irs.gov). IRS performs a number of quality control steps to  verify the internal consistency of SOI sample data. For example, it  performs computerized tests to verify the relationships between values on  the returns selected as part of the SOI sample, and manually edits data  items to correct for problems, such as missing items. We conducted  several reliability tests to ensure that the data excerpts we used for this  report were complete and accurate. For example, we electronically tested  the data and used published data as a comparison to ensure that the data  set was complete. To ensure accuracy, we reviewed related  documentation and electronically tested for obvious errors. We concluded  that the data were sufficiently reliable for the purposes of this report.
For the second objective, we reviewed IRS documentation and  interviewed Exempt Organization (EO) officials on IRS oversight  activities, such as the examination and revocation of charitable  organizations. We also obtained data from IRS’s Return Inventory  Classification System (RICS) on examinations and results for fiscal years  2011 through 2013. Based on our review of documentation and  interviews, we determined that this data was reliable for the purposes of  this report. We also obtained data from IRS’s Referral database on  referrals received on charitable organizations and all tax-exempt  organizations for fiscal years 2011 through 2013. Although we received  referral data on charitable organizations, we did not use the data because  we found it was not reliable for the purposes of this report. According to  EO officials, reviewers were encouraged but not required to enter the  organization’s subsection category (i.e. that it was a 501(c)(3) charitable  organization) into the referrals data base .The EO officials said that if the  referral was found to have “no issue” by the reviewer, it may not have  been assigned a subcategory because the subcategory was not required  and it would be viewed (in this case) as not useful. Therefore, data on the  number of referrals received, the source of referrals, and the type of  referral violations that we received could have been undercounted if the  data had been used. Although we did not use charitable organization  referral data, we did use referral data on all tax-exempt organizations, as  we found that data was reliable for the purposes of this report.
For the third objective, we reviewed relevant strategic and performance  documents such as the annual reports and work plans, quarterly  performance reports, and project summary reports. We interviewed IRS  planning officials and division managers to determine the extent to which  managers overseeing the tax-exempt sector set performance goals;  develop measures to monitor their progress toward meeting goals; and  use data to identify challenges, the cause of those challenges, and  develop strategies to address those challenges. We reviewed past  recommendations made by the Treasury Inspector General for Tax  Administration (TIGTA) and National Taxpayer Advocate related to  performance management and interviewed IRS managers about how  they addressed the issues discussed in those reports. For criteria, we  compared IRS information on performance measures and decision- making to Standards for Internal Control in the Federal Government and  federal guidance on performance management. We also applied the  criteria concerning the administration, compliance burden and  transparency that characterize a good tax system, as developed in our  guide for evaluating tax reform proposals. We also reviewed IRS plans to  streamline the application process through the introduction of Form  1023EZ. We interviewed EO officials on how they plan to assess the  impact of the new streamlined process on oversight efforts and reviewed  available evaluation plans. We applied criteria from our 2012 guide on  designing evaluations.
To determine how IRS collaborates with state charity regulators and U.S.  Attorneys, we reviewed various IRS documents, such as policy manuals,  guidance, and memoranda of understanding. We also interviewed  officials from IRS , U.S. Department of Justice (DOJ), and the National  Association of State Charity Officials. For criteria, we identified different  approaches for sharing information and collaboration based on our audit  findings, as well as our past recommendations and recommendations  made by the Advisory Committee on Tax Exempt and Government  Entities.
To provide additional context for all three objectives, we interviewed IRS  officials, DOJ officials, state charity regulators, subject matter specialists,  and stakeholder groups representing different types of exempt- organizations and private watchdog organizations that oversee charities  about the adequacy of IRS oversight of charitable organizations; the  challenges IRS faces providing effective oversight; and strategies to  address those challenges.
section_title: Appendix II: Tax Benefits and Requirements for Different Types of Tax Exempt Organizations
paragraphs: The federal tax code provides a variety of tax benefits to organizations  often referred to as “tax exempt.” The exact nature of those benefits  varies depending on the nature of the organization. Section 501 provides  an exemption from federal income tax for the broadest range of  organizations. In addition to section 501, there are various other  scattered provisions which give a full or partial tax exemption to certain  specific types of entities and income. This appendix focuses on  organizations qualifying for a tax exemption under section 501, which will  be referred to as tax exempt organizations. Within section 501, there is a  division between charitable organizations, also known as 501(c)(3)  organizations (after the subsection in which they are defined), and all  other organizations qualifying for an exemption under section 501. The  organizations that qualify for an exemption under section 501 but are not  charitable organizations have been referred to as mutual benefit  organizations or non-charitable nonprofits. Charitable organizations are  further divided between those that are private foundations and all other  charitable organizations, and private foundations are divided between  operating and non-operating foundations. Each of these types of tax  exempt organization—(1) mutual benefit organization, (2) charitable  organization, (3) operating private foundation, and (4) non-operating  private foundation—are subject to different requirements and receive  different tax benefits.
Tax exempt organizations of all types are prohibited from engaging in  certain transactions with the creator of an organization, a person who  made a substantial contribution to the organization, a member of the  family of the creator or substantial contributor, or a corporation controlled  by a creator or substantial contributor. Additionally, an organization  operated for the primary purpose of carrying on a trade or business for  profit is not exempt, on the grounds that all of its profits are payable to an  exempt organization. These restrictions apply to all types of tax exempt  organizations. Certain types of mutual benefit organizations and all  charitable organizations are also subject to the restriction that no part of  their net earnings inures to the benefit of any private shareholder or  individual. Additionally, a tax is imposed on income from any trade or  business unrelated to the exercise or performance of the organization’s  exempt purpose. “Corporations, and any community chest, fund, or foundation, organized and operated  exclusively for religious, charitable, scientific, testing for public safety, literary, or  educational purposes, or to foster national or international amateur sports competition (but  only if no part of its activities involve the provision of athletic facilities or equipment), or for  the prevention of cruelty to children or animals, no part of the net earnings of which inures  to the benefit of any private shareholder or individual, no substantial part of the activities of  which is carrying on propaganda, or otherwise attempting, to influence legislation (except  as otherwise provided ), and which does not participate in, or intervene in  (including the publishing or distributing of statements), any political campaign on behalf of  (or in opposition to) any candidate for public office.”
As stated above, no part of a charitable organization’s net earnings can  inure to the benefit of any private shareholder or individual. Additionally  they must satisfy two tests: the organizational test and the operational  test. To pass the organizational test, an entity must be organized  exclusively for one or more exempt purposes, meaning that the governing  instrument (such as a trust instrument, articles of incorporation, or  association charter) must limit the purposes of the organization to one or  more exempt purposes and does not expressly empower the organization  to engage in activities not in furtherance of an exempt purpose except to  an insubstantial degree. The operational test requires that organizations  engage primarily in activities that accomplish one or more of the exempt  purposes listed in statute. In general, new organizations seeking  charitable organization status must apply for a determination of exempt  status. Churches, their integrated auxiliaries, and conventions or  associations of churches, as well as organizations with gross receipts of  $5,000 or less and that are not private foundations do not need to apply.
Organizations which meet all the requirements to be charitable  organizations receive tax benefits beyond those available to mutual  benefit organizations. Contributions of cash or property to charitable  organizations are deductible by individuals and corporations for federal  income tax purposes up to certain percentages of adjusted gross  income. Such contributions are also exempt for estate and gift tax  purposes. Charitable organizations are exempt from the federal  unemployment tax and the federal gambling tax on lotteries.  Additionally, charitable organizations are exempt from certain  requirements related to establishing and maintaining retirement plans for  employees.
Within the category of charitable organizations are private foundations.  When applying for charitable organization status, an applicant is  presumed to be a private foundation unless it can demonstrate that it is  not a private foundation. A charitable organization is not a private  foundation if it is a church or convention or associations of churches, an  educational institution, a medical or hospital care provider, medical  education or research provider, or a government unit. A charitable  organization is also not a private foundation if it is broadly publicly  supported, as defined in section 509, or is a supporting organization of a  broadly publicly supported organization. Organizations organized and  operated exclusively for testing for public safety are also not private  foundations. Charitable organizations not meeting one of these definitions  are private foundations.
Private foundations are subject to certain tax consequences which do not  apply to other charitable organizations. A 2 percent excise tax is imposed  on the net investment income of private foundations. A private  foundation is also subject to additional taxes if it engages in self-dealing,  has excessive business holdings, makes investments which jeopardize its  charitable purpose, or makes certain taxable expenditures. Finally,  private foundations are subject to additional reporting requirements.
Additional taxes and restrictions are imposed on foundations which do not  meet the definition of an operating foundation. A private foundation is an  operating foundation if is uses at least 85 percent of its income directly for  the active conduct of charitable activities rather than for grantmaking and  meets either an asset test, endowment test, or support test. Private  foundations that are not operating foundations are generally subject to a  tax of 30 percent of the amount of undistributed income. The  percentage limits on the deductibility of contributions to non-operating  private foundations are lower than for other charitable organizations.
Aside from charitable organizations, section 501 lists 28 other types of  nonprofits, often referred to as mutual benefit organizations, and which  include unions, civic leagues, chambers of commerce, credit unions, and  veteran organizations, among many others. For a complete list of the  organizations listed in section 501, including charitable organizations, see  below. Qualified pension, profit-sharing, and stock bonus plans are also  exempt under section 501. Unlike charitable organizations, gifts to these  mutual benefit organizations are not deductible. Mutual benefit  organizations are not generally exempt from the federal unemployment  tax or the gambling tax, and do not have the additional flexibility in  establishing employee retirement plans that is allowed charitable  organizations.
subsections: section_title: Types of Tax Exempt Organizations Listed in Section 501
section_title: Appendix III: Additional Tables
paragraphs: The tables in this statistical appendix supplement those in the letter and  provide population estimates for Statistics of Income (SOI) data. After  each table, notes indicate the sampling errors. We are confident the true  estimates would be within these percentage points in 95 out of every 100  samples. The tables are for charitable organizations that filed Forms 990  or 990-EZ. Private foundations that file Form 990-PF, small charitable  organizations that file Form 990-N, and charitable organizations that do  not file returns have been excluded from this analysis.
section_title: Appendix IV: Comments from the Internal Revenue Service
section_title: Appendix V: GAO Contact and Staff Acknowledgments
subsections: section_title: Contact
section_title: Staff Acknowledgements
paragraphs: In addition to the contact named above, Kevin Daly, Assistant Director,  Jeff Arkin, Sara Daleski, Jillian E. Feirson, Laurie C. King, Lawrence M.  Korb, Donna L. Miller, Ed Nannenhorn, Jessica Nierenberg, Karen  O’Conor, Dae Park, Amy Radovich, Cynthia Saunders, Albert Sim,  Stewart Small, Andrew J. Stephens, Lindsay W. Swenson, Meredith  Trauner Moles, Sonya Vartivarian, James R. White, and John Zombro  made major contributions to this report.