Tax-Exempt Organizations: Collecting More Data on Donor-Advised Funds and Supporting Organizations Could Help Address Compliance Challenges
Published: 2006-07-27T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Donor-advised funds and supporting organizations are two charitable-giving options that have received attention from Congress and the Internal Revenue Service (IRS) for their potential to facilitate noncompliance with tax law. As requested, GAO is providing information on donor-advised funds and supporting organizations related to (1) federal laws and regulations, compared to private foundations; (2) financial and organizational characteristics; and (3) types of noncompliance and promotion methods and challenges identifying them.
section_title: What GAO Found
paragraphs: Donor-advised funds, supporting organizations, and private foundations are all tax-exempt charitable-giving vehicles. Donor-advised funds are separate accounts held by a public charity to receive contributions from donors who may recommend, but not control, charitable distributions from the account. Supporting organizations are public charities that are to carry out their tax-exempt purpose by supporting one or more tax-exempt organizations, usually other public charities. Compared with private foundations, donor-advised funds and supporting organizations give donors less control over how their donation will be used but provide donors more favorable tax deductions, lower administration costs, less IRS oversight, and fewer reporting requirements. Donor-advised funds hold billions of dollars in assets, and supporting organizations and private foundations hold hundreds of billions of dollars in assets. Public charities and private foundations must annually file an IRS Form 990 or Form 990-PF, respectively, to report their activities. However, donor-advised fund data are limited because organizations that maintain the funds are not required to separately report fund data from other financial data on Form 990. Although some supporting organization characteristics can be determined from Form 990 data, other characteristics, such as the rate at which payments are made to charities and details about the recipients of loans from the organization, cannot be reliably determined. Concerns have arisen about the "payout" rate to charities, and Congress is considering a minimum payout requirement, similar to the one for private foundations. Further, supporting organizations are not required to report their supported organizations' identification numbers, making it more difficult to track the relationship between organizations. To collect additional data, IRS revised Form 990 for 2003 and 2005 and is considering further revisions, but no firm plans have been determined. According to IRS managers, examinations reveal that some donor-advised funds and supporting organizations are used in abusive schemes to unallowably benefit donors or related parties or give donors excess control of charitable assets and operations. In some cases, IRS is able to clearly determine noncompliance and assign appropriate corrective actions. However, in other cases, IRS faces challenges gathering evidence or addressing activities that do not seem to benefit charities, but do not violate any law or regulation, such as when a supporting organization loans money, at market rate, to a donor, director, or officer of the organization. Promoters, who are individuals or entities who facilitate abusive schemes, further complicate IRS's examination efforts.

section_title: Letter
paragraphs: Each year, millions of donors give hundreds of billions of dollars to  charities. The Internal Revenue Service (IRS) estimated that for tax year  2002, charitable contributions totaled over $229 billion, the largest portion  coming from individuals and foundations. In addition to traditional public  charities and private foundations, donors may make charitable  contributions through the use of donor-advised funds and supporting  organizations. Donor-advised funds are generally separate funds or  accounts established and maintained by a public charity to receive  contributions from a single donor or a group of donors. While the donor  may recommend charitable distributions from the account, the charity  must be free to accept or reject the donor’s recommendations. Supporting  organizations are public charities that are to carry out their tax-exempt  purpose by supporting one or more tax-exempt organizations, usually  other public charities. IRS has recognized that while the majority of tax- exempt organizations are trying to comply with tax law, a significant  compliance challenge involves the use of donor-advised funds and  supporting organizations in abusive arrangements benefiting individuals or  organizations other than charities. Concerns about these abuses have led  to proposed legislation imposing requirements on the operation of donor- advised funds and supporting organizations.
As requested, we are providing information on (1) federal laws and  regulations regarding donor-advised funds and supporting organizations,  as compared to private foundations; (2) financial and organizational  characteristics, such as loan recipients, of donor-advised funds, supporting  organizations, and private foundations, to the extent data are available;  and (3) types of potential or actual noncompliance and promotion  methods involving donor-advised funds and supporting organizations and  the challenges identifying them. In addition, we agreed to provide  information about noncash contribution valuation methods and marketing  methods involving donor-advised funds and supporting organizations,  which are discussed in appendixes III and IV.
To compare current federal laws and regulations for donor-advised funds  and supporting organizations to those for private foundations, we  reviewed the Internal Revenue Code (IRC), Department of the Treasury  regulations, and IRS publications as they related to the purpose and  operation of these entities. To determine financial and organizational  characteristics of donor-advised funds, supporting organizations, and  private foundations, we analyzed IRS Forms 990 and 990-PF data, as well  as reviewed survey data that external organizations collected on donor- advised funds. Unless otherwise noted, tax year 2003 was the most recent  year of data available at the time of our analysis. We converted 2003 dollar  amounts to 2005 constant dollars. To identify types of noncompliance and  promotion methods involving donor-advised funds and supporting  organizations, we reviewed documents from IRS as well as from our  literature search. For each objective, we spoke to various IRS managers  and individuals knowledgeable about the tax-exempt community. We  conducted our review from July 2005 through May 2006 in accordance  with generally accepted government auditing standards.
subsections: section_title: Background
paragraphs: IRC section 501(c) specifies 28 types of entities that are eligible for tax- exempt status and over 1.6 million entities have been recognized as  exempt as of 2005. One subset of these tax-exempt entities is classified as  501(c)(3) charitable organizations, of which slightly over 1 million existed  in 2005, according to IRS. In 1969, Congress directed that all 501(c)(3)  organizations would be private foundations unless they qualify for  exclusion from that status under IRC section 509. This change subdivided  section 501(c)(3) organizations into two general categories—”public  charities” and “private foundations.”
Within the public charities classification, Congress created supporting  organizations, which are defined in section 509(a)(3) as public charities  organized to support one or more public charities, including churches and  certain governmental units, and certain other tax-exempt entities, such as  membership-based organizations (e.g., unions and professional  organizations). Supporting organizations are classified as public charities  not because they are themselves publicly supported, but because they are  to support another public charity with which they are to maintain a strong  relationship. In creating supporting organizations, Congress recognized  that it can be beneficial and prudent to place certain assets or activities in  a separate legal entity to insulate assets from liability or to facilitate  separation of functions for programmatic, accounting, or other reasons,  according to the Panel on the Nonprofit Sector Final Report.
Donor-advised funds are generally separate accounts operated by tax- exempt public charities to receive contributions from a single donor or  group of donors. Donors can advise on the distributions from the account.  For the contribution to qualify as a completed gift, the charity must have  ultimate control over how the assets in the account are invested and  distributed. According to our interviews with knowledgeable individuals  and recent Senate testimony, donor-advised funds have generally been in  existence since the 1930s and have traditionally been operated by  community foundations. In the 1990s, financial investment firms began  establishing “commercial funds,” which are tax-exempt public charities  that operate donor-advised fund accounts. Investment of contributions to  the fund accounts is controlled by the commercial fund’s board, which  hires the investment firm that established the commercial fund to manage  the fund’s assets.
Generally, an entity must apply to IRS to obtain tax-exempt recognition.  Most organizations seeking recognition from federal income tax must use  specific forms, including Form 1023 (Application for Recognition of  Exemption under Section 501(c)(3) of the IRC) or Form 1024 (Application  for Recognition of Exemption under Section 501(a)) as well as other  documentation. After receiving tax-exempt recognition, public charitable  entities must annually file a Form 990 information return to report their  financial transactions and activities for a tax year. Charities that have less  than $100,000 in gross receipts and $250,000 in year-end assets may use  Form 990-EZ. Entities with gross receipts below $25,000, and certain types  of entities, such as churches and certain entities associated with churches,  generally are not required to file. Form 990 collects information on  revenues, expenses, and assets, and has accompanying schedules.  Schedule A of Form 990 covers several areas such as compensation,  lobbying expenditures, and revenue sources. Schedule B covers the source  of contributions to charities and certain other exempt entities. Congress  has granted public access to Form 990 data in recognition of the  importance of public oversight to inform donors about how their money is  spent and to stem potential abuses. Private foundations, regardless of their  amounts of gross receipts or assets, are required file a Form 990-PF  information return annually.
IRS oversight of tax-exempt entities generally relies on two activities.  First, IRS reviews applications for tax-exempt status to determine whether  a tax-exempt purpose is envisioned. IRS approves those applications that  are properly completed and for which the applicant can demonstrate to  the satisfaction of IRS that its activities or proposed activities meet the  requirements of the section under which exemption is claimed. Second,  IRS annually examines selected Forms 990 to determine whether the  exempt entities meet various requirements (such as properly reporting  unrelated business income tax). In general, IRS attempts to select entities  that it believes are likely to have violated requirements. Based on  examination evidence, IRS can accept the Form 990 as filed or change the  status of the entity, impose excise taxes for certain types of violations, or  revoke the exempt status if the violations are serious enough. As  appropriate, IRS can also assess other types of taxes, such as employment  taxes or unrelated business income taxes.
In 2004, the Senate Committee on Finance asked a panel of experts to  make recommendations to Congress to improve oversight, transparency,  and governance in the tax-exempt sector. To do so, the Independent  Sector convened a Panel on the Nonprofit Sector in October 2004, which  included 24 nonprofit and philanthropic leaders. The Panel issued a final  report in June 2005 with over 120 recommendations, several focusing on  donor-advised funds and supporting organizations. On the basis of this  report and other information, Congress has considered proposals to  impose more restrictions and requirements on donor-advised funds and  supporting organizations to better ensure that their contributions advance  charitable rather than private interests and that their donors do not exert  control or receive private benefits. Provisions in legislative proposals that  apply to donor-advised funds have included providing a formal definition  of a fund, setting minimum payout requirements, and placing restrictions  on dealings with those who may privately benefit from charitable  activities. Provisions related to supporting organizations have included  those that would apply certain private foundation rules and restrictions,  such as those on the annual payout requirement and excess business  holding rules.
section_title: Scope and Methodology
paragraphs: To compare the federal laws and regulations on donor-advised funds and  supporting organizations with those for private foundations, we reviewed  the IRC, Treasury regulations, IRS publications, and various other  documents describing these laws and regulations. We also interviewed 18  IRS staff and 16 individuals knowledgeable about the tax-exempt  community, such as attorneys and governmental-affairs managers at tax- exempt entities, to obtain their input about these laws and regulations and  our comparison of them.
To determine financial and organizational characteristics of donor-advised  funds, supporting organizations, and other tax-exempt charitable  organizations, we obtained and analyzed IRS Form 990 and Form 990-PF  data, as well as reviewed survey data on donor-advised funds that were  collected by The Chronicle of Philanthropy. We used the surveys to obtain  data on donor-advised funds because this information was not identifiable  on the Form 990. To determine the reliability of the donor-advised fund  data, we interviewed The Chronicle of Philanthropy staff about their  survey methodology. To obtain supporting organization and other tax- exempt charitable organization data fields, we obtained data from IRS’s  Returns Inventory and Classification System (RICS) for tax years 1999  through 2003, the 5 most recent years of data available at the time of our  analysis. Because not all the data fields we wanted were available from  RICS, we obtained additional Form 990 data fields from GuideStar, an  organization that electronically captures Form 990 data for public access.  To assess the reliability of the RICS and GuideStar data, we interviewed  agency officials and conducted electronic data testing. In addition, we  reviewed a selection of Forms 990 submitted to IRS to confirm that the  values on the form matched those in the database. While we identified  some minor discrepancies, we determined that the Form 990 data were  sufficiently reliable for our purposes. The data files we obtained included  the population of tax-exempt charities filing returns for those years,  including supporting organizations and private foundations. Using  computer software to analyze these data files, we determined summary  statistics and converted dollar amounts to 2005 constant dollars. For our  discussion on “payout” rate, compensation, and Form 990 revisions, we  performed literature searches and interviewed 20 knowledgeable  individuals from IRS’s Statistics of Income (SOI) program and Tax-Exempt  & Government Entities (TE/GE) division, Urban Institute, and  Congressional Research Service (CRS).
To describe the types of noncompliance and promotion methods involving  donor-advised funds and supporting organizations, we reviewed IRS  summaries of examination cases. To obtain anecdotal information about  noncompliance involving donor-advised funds and supporting  organizations, we also interviewed 4 managers at IRS who oversee  examinations of donor-advised funds and supporting organizations and 7  individuals knowledgeable about the tax-exempt community who work at  organizations such as the Council on Foundations and the Independent  Sector. We also interviewed 6 financial professionals and 11 community  foundation managers on how donor-advised funds and supporting  organizations are promoted to clients for abusive transactions. We also  reviewed an IRS research report on developing abusive promoter leads  through searching the Internet.
To provide additional information on noncash contribution valuation  methods (see app. III), we reviewed IRS publications and forms and  interviewed an IRS field specialist working on valuation issues in the Large  and Mid-Sized Business operating division. To obtain information on the  marketing of donor-advised funds and supporting organizations (see app.  IV), we spoke with 11 community foundation managers, 6 financial  professionals, and 18 managers at IRS. The examples we discuss come  from materials that we were referred to or located online based on our  interviews, and do not necessarily represent all materials and methods  used to market donor-advised funds and supporting organizations.
section_title: Federal Laws and Regulations Impose Fewer Requirements on Donor-Advised Funds and Supporting Organizations and Their Donors, but Allow Donors Less Control Compared to Private Foundations
paragraphs: In recent years, donor-advised funds have become popular charitable- giving vehicles, and the number of supporting organizations has also  continued to increase. At the same time, federal tax law generally imposes  fewer restrictions and requirements on donor-advised funds and  supporting organizations, but provides them and their donors less control  over the use and investment of the charitable assets compared to private  foundations; in fact, section 501(c)(3) and federal regulations do not  specifically mention donor-advised funds.
As a general principle, the more control that a donor has over the use of  the charitable contributions and assets, the more regulations and  restrictions apply. Table 1 discusses how federal tax law views donor- advised funds and supporting organizations compared to private  foundations across a number of variables.
Among the three types of charitable-giving vehicles, donor-advised funds  allow donors to create a long-term vehicle for supporting charities with  relatively less administrative burden because the fund is managed by a  third party. Furthermore, donor-advised funds are not required to file  separate tax returns, file for tax-exempt status, or adhere to private  foundation rules. The donor can make a gift and take an income tax  deduction for that tax year, and at that time or later, advise which charities  should receive the distribution. However, in doing so, the donor gives up  control over the distribution of the gift to charities.
Supporting organizations are public charities that are to support one or  more public charities or certain other tax-exempt organizations. They fall  in between a donor-advised fund and a private foundation in terms of  restrictions and sanctions versus donor control over the use of the  charitable assets. For example, donors who create a supporting  organization avoid private foundation excise taxes and other rules and  face fewer restrictions on the deductibility of their donations at the  expense of having less control compared to donors at a private  foundation, such as involvement on the board. The level of control that the  supported charity has over the supporting organization varies by the three  basic types of supporting organizations. Type I supporting organizations  are “operated, supervised, or controlled by” the supported charitable  organization. Type II supporting organizations are “supervised or  controlled in connection with” the supported organization. In contrast,  Type III supporting organizations only are “operated in connection with”  the supported organization (see fig. 2).
In reforming the rules for charitable organizations in 1969, Congress made  changes to restrict and regulate private foundations more than public  charities. Private foundations are generally funded and controlled by a  single or small number of donors and therefore may be prone to potential  abuses, particularly by disqualified persons. As a result, private  foundations are subject to anti-abuse rules and related sanctions that are  not applicable to donor-advised funds, supporting organizations, and  public charities as a whole. For example, public charities, including donor- advised fund operators and supporting organizations, are subject to  restrictions and two related excise taxes for activities involving political  expenditures (section 4955) and excess benefit transactions (section  4958). In contrast, private foundations are subject to six excise taxes for  activities involving  investment income (section 4940);    self-dealing (section 4941);  failure to distribute income (section 4942);    excess business holdings (section 4943);   investments that jeopardize the charitable purpose (section 4944); and    certain “taxable expenditures” (section 4945).
Although public charities, such as donor-advised fund operators and  supporting organizations, and private foundations are subject to different  restrictions on transactions with disqualified persons, both excess benefit  and self-dealing restrictions are intended to prevent inurement or undue  private benefit, which are prohibited for all section 501(c)3 organizations.  Inurement is the transfer or use of the charity’s assets or income to or for  the benefit of a charity’s insiders. All transactions that more than  incidentally benefit insiders, other than reasonable compensation and  arm’s length transactions, are prohibited inurement transactions. Private  benefit is a broader concept, and may involve a transfer or use of a  charity’s assets or income by private persons who are not necessarily  insiders. Some private benefit may be allowed, but if present, must be no  more than incidental to the exempt purpose being served.
Unlike with donor-advised funds and supporting organizations, a private  foundation is required under section 4942 to distribute annually a  minimum amount of its funds, equal to approximately 5 percent of the fair  market value of the foundation’s noncharitable use of assets (generally,  stocks and other investments that compose the foundation’s endowment).  In 1984, Congress passed legislation that clarified what expenses can be  included towards meeting this minimum “payout” requirement. If this  “payout” rate is unmet, the foundation is subject to paying taxes on the  undistributed amount.
section_title: Donor-Advised Funds, Supporting Organizations, and Private Foundations Hold Billions of Dollars in Assets, but Some Organizational Characteristics Cannot Be Reliably Determined from Form 990 Data
paragraphs: Donor-advised funds hold billions of dollars in assets, and supporting  organizations and private foundations hold hundreds of billions of dollars  in assets. Financial data on donor-advised funds are not separately  identified and reported on the Form 990. Although some data on donor- advised funds have been collected through an annual survey, these data  are incomplete and not statistically representative of the fund population.  Using 2003 data from Forms 990 and 990-PF, we found differences  between supporting organizations and private foundations. For instance,  in 2003, private foundations tended to report more total assets and  contributions received but fewer revenues and expenses compared to  supporting organizations. However, certain other characteristics of  supporting organizations cannot be reliably determined from the Form 990  because this information is either not required to be reported or may be  misreported for various reasons, according to IRS. Specifically, supporting  organizations are not required to report a payout rate or to pay out a  minimum amount of funds to charities, as private foundations must do.  IRS has recently revised the Form 990 to better identify supporting  organizations and donor-advised funds and is considering additional  revisions, but plans to further revise the Form 990 are still preliminary.
subsections: section_title: Limited Data Are Available for Donor-Advised Funds
paragraphs: Data on donor-advised funds are limited because, unlike supporting  organizations and private foundations, the funds usually are not entities  that file a Form 990 to report their activities. Organizations that maintain  donor-advised funds are to file a Form 990 that includes the assets and  other aggregate information for all activities, including for donor-advised  funds, but data on these funds are not readily identified from the form  because these data are not separately reported.
To provide more information about donor-advised funds, The Chronicle of  Philanthropy has been conducting an annual survey of organizations that  maintain donor-advised funds. Started in 2000, the survey focuses on the  largest donor-advised funds and collects data such as the total assets held  and the amount of grants awarded. For 2003, The Chronicle of  Philanthropy reported that the 90 organizations participating in its survey  held over $11.9 billion in assets and distributed over $2.2 billion to  charities from their donor-advised fund accounts.
However, these survey results, which are one of the few data sources  available for donor-advised funds, do not represent the entire population  of donor-advised funds and also have other data limitations. The survey  does not try to capture information for all donor-advised funds, as the  population of donor-advised funds to be surveyed is unknown, and focuses  on the largest funds, such as the 50 largest community foundations, by  amount of money raised. Also, while some efforts are made to generate a  high response rate and to check unusual responses, the survey response  rate has ranged between 53 percent to 57 percent. Further, survey  respondents vary from year to year, and the data are self-reported and  cannot be checked for accuracy. Finally, the survey does not collect data  for individual donor-advised fund accounts.
section_title: Data on Supporting Organizations Highlight Differences from Private Foundations
paragraphs: From our analysis of Forms 990 and 990-PF, we found that supporting  organizations filed nearly 21,400 Forms 990, and private foundations filed  over 80,300 Forms 990-PF for tax year 2003. Table 2 summarizes  differences in the amounts of assets, revenues, expenses, and  contributions received when comparing 1999 and 2003. Appendix II  provides additional related data, including data for the years 1999 through  2003.
Table 2 shows that in 2003, the number of private foundations  outnumbered the number of supporting organizations by more than a  factor of 3, reported over $200 billion more in assets, and reported more  contributions received. However, supporting organizations reported more  revenue but also more expenses by 2003 compared to private foundations.  Furthermore, comparing 1999 to 2003, supporting organizations tended to  report growth in all of these areas while private foundations reported  declines in revenue and contributions received. We were unable to  determine the reasons for these changes, but the year-to-year variations  during 2000, 2001, and 2002, in part due to a significant stock market  decline during this time, provided some insights (see app. II for summary  tables with annual data). Median values for the dollar amounts reported  are shown in table 3.
For the four financial characteristics listed in table 3, median values for  supporting organizations were much higher compared to private  foundations in both 1999 and 2003, in contrast to the higher total values  for private foundations listed in table 2. Also, the declines in supporting  organization median values between 1999 and 2003 were much less  compared to private foundations. We excluded zero values from our  median analyses. IRS officials said that organizations might be reporting  zero values if filing a final return or for other reasons. However, we were  unable to conduct additional analysis on these zero values, particularly for  total contributions received in which over 50 percent of the values  reported by supporting organizations and private foundations were zero.
section_title: Some Financial and Organizational Characteristics of Supporting Organizations Cannot Be Reliably Determined from 990 Data
paragraphs: Some financial characteristics of supporting organizations cannot be  reliably determined because they are not required to be reported on the  Form 990 or may be misreported. As a result, directly comparing  supporting organizations and private foundations or other tax-exempt  charitable organizations can pose challenges. Being able to make these  comparisons is important in order to address concerns, such as how much  and how often supporting organizations pay out to charities, since, like  private foundations, supporting organizations can be used to accumulate  contributions prior to distributing the money to charity, but, unlike private  foundations, they do not have a minimum payout requirement to support  charities that must be annually reported.
Because supporting organizations do not have this payout requirement,  they do not explicitly report a payout rate, as is required for private  foundations. Certain lines on the Form 990-PF allow IRS, and the public, to  determine whether private foundations have met their required payout  rate. For supporting organizations, factors that are included in the payout  calculation for private foundations might not be readily determined from  the Form 990. Absent being able to identify these additional data and  clarifying how they are to be accounted for in a supporting organization  payout rate, consistently comparing supporting organizations’ and private  foundations’ payout rates cannot be done. Similarly, for donor-advised  funds, payout rate has not been statutorily required or defined and  consequently is also not required to be reported on the Form 990, and  available data do not allow a payout rate to be determined.
Despite these difficulties, researchers have studied different ways to  compute a payout rate for supporting organizations. A 2005 Urban  Institute study found that supporting organization payout rates could vary  due to factors such as the purpose of the organization and which lines on  the Form 990 were included in determining how much support was  provided. The study pointed out that differences in supporting  organization payout rates may reflect differences in the purpose and  operation of the supporting organizations, rather than the amount of  charitable support provided. For example, some supporting organizations  provide operational services to their supported charities, rather than  provide grants. Supporting organizations can serve to pool or manage  investments or endowments for their supported organization, hold real  estate, or provide services, such as office or property management. Payout  rates for these types of supporting organizations might indeed be low or  infrequent, since these organizations do not hold and distribute charitable  funds like other supporting organizations or private foundations whose  primary purpose is grant-making.
While the Form 990 includes a supporting organization’s grants and net  assets, using only those lines to determine a payout rate may provide an  incomplete picture of the supporting organization’s charitable activity. In  2002, supporting organizations reported over $7 billion in grants as  transfers of charitable support. However, in the Urban Institute study,  researchers found that transfers of support from a supporting organization  to its supported organizations were reported on 1 or more of at least 10  lines on the Form 990. While the amounts reported on these lines might  include transfers of support, the Form 990 line data alone are generally not  enough to determine how much of the amount reported, if any, supports  charities. For example, they found that organizations they sampled  sometimes reported transfers of support to a supported organization on  the line for rental expenses. However, only by examining Form 990-related  documentation, which an Urban Institute researcher said required  considerable effort, could they determine this result. In 2003, supporting  organizations reported over $431 million on this Form 990 line, but  without significant effort, one cannot determine how much, if any, of this  amount consisted of transfers of support to supported organizations.
Another challenge in using Form 990 data to determine financial  characteristics arises when analyzing compensation paid to executives and  employees of tax-exempt organizations, such as supporting organizations.  In 1999 and 2003, supporting organizations reported over $894 million and  over $1 billion, respectively, in total executive compensation. Private  foundations reported almost $739 million in 1999 and about $812 million in  2003 in total executive compensation (see app. II for data tables).  Organizations are required to report compensation for certain employees  on the Form 990 and Schedule A. However, according to IRS managers,  misreporting is not uncommon, although some may be unintentional, in  such areas as deferred executive compensation, payments made to  relatives, and compensation paid from related entities, such as a for-profit  subsidiary of a tax-exempt organization paying the salary of an employee  or board member of its parent tax-exempt organization. In addition, an IRS  researcher had concerns that compensation could be overreported for tax- exempt organizations within a network, such as a health care network of  hospitals. In such networks, which commonly include supporting  organizations, compensation for board members can be misreported on  the Forms 990 when related organizations have common board members.
IRS is currently working on an initiative to identify and stop abuses by  public charities and private foundations that pay excessive compensation  and benefits to their officers and other insiders. Beginning in late 2004, IRS  contacted a broad spectrum of over 1,800 public charities and private  foundations seeking information about their compensation practices and  procedures. IRS also just started a new phase of the initiative, involving an  additional 250 contacts about loans to officers, directors, and key  employees. The goals for the initiative are to  learn how exempt organizations determine and manage compensation;    gauge the existence and effectiveness of exempt organizations’  controls over compensation issues;  learn how exempt organizations report compensation on Forms 990  and 990-PF;    address instances of questionable compensation practices, as well as  compensation of specific individuals; and  increase exempt organizations’ awareness of compensation-related tax  issues.
The initial results of the compensation initiative will be included in a  report that is expected to be completed in late August or September 2006.  All examinations are expected to be completed by or during 2007.
In addition to financial characteristics such as payout rate and executive  compensation, organizational characteristics about supporting  organizations are difficult to determine from the Form 990. For example,  Form 990 does not collect the EINs of their supported organizations,  which according to IRS officials, would facilitate IRS’s ability to track the  flow of donations. In addition, an IRS manager said that having supported  organizations’ EINs would facilitate IRS’s ability to track how  compensation is treated between supporting organizations and supported  organizations. IRS emphasized that any form changes must be balanced  against the increased burden on taxpayers of supplying additional  information.
Other organizational characteristics for which IRS collects limited data on  Form 990 include relationships with foreign entities, noncash  contributions, loan recipients, and donor information. We were unable to  closely evaluate these characteristics because IRS had limited data and  information to provide and because of time constraints. Although the costs  and burdens of collecting additional data to determine these  organizational characteristics and protecting taxpayer privacy are  legitimate concerns, IRS has acknowledged the need for greater  transparency and better data to track the flow of funds between donors  and charities. For example, IRS does not have TINs of loan recipients to  track the flow of funds.
section_title: IRS Has Made and Is Considering Changes to the Form 990 Regarding Donor-Advised Funds and Supporting Organizations
paragraphs: IRS has begun to take steps to help address the lack of information  reported on donor-advised funds and supporting organizations. For  example, IRS has revised the 2005 Form 990 Schedule A to include a check  box to indicate whether a supporting organization is Type I, II, or III. This  information will be transcribed into IRS’s electronic databases beginning  in 2007, which, according to IRS, would allow it to better focus its  examination and educational resources on compliance issues particular to  each type. Also, starting with the 2003 Form 990 Schedule A, organizations  must indicate whether they maintain separate accounts for donors, such  as donor-advised funds. In January 2006, IRS began transcribing this  information, which is a first step towards identifying how many and which  charities have donor-advised funds. However, these organizations are not  required to separately report data on the donor-advised funds from the  other activity reported on the Form 990, meaning that data on the funds  are not easily identified. While IRS is considering revising the Form 990 to  include more information about donor-advised funds, it does not have  details on what data they might collect or how or when they would revise  the form.
IRS is considering additional changes to the Form 990 that, pending  management approval, would include reorganizing the form in stages. A  pending proposal includes recommendations to create new sections or  schedules on the Form 990 with questions on donor-advised funds and  supporting organizations. Because the Form 1023 asks questions regarding  donor-advised funds and supporting organizations, the proposal  recommends aligning the Form 990 with Form 1023 so that IRS can track a  charity from its formation. If the recommendation is approved, IRS’s Form  990 Redesign Team plans to rewrite the Form 990 instructions and add a  glossary consistent with the Form 1023 which, according to IRS, may  provide better data.
According to IRS staff and others we interviewed, these form revisions,  along with increased use of electronic filing, could improve the quality of  data available to IRS to better identify noncompliance through its research  and compliance efforts, as well as to the public to improve the  effectiveness of tax-exempt charitable organizations.
section_title: Private Benefit, Inurement, and Donor Control Have Been Found in Some Cases Involving Donor- Advised Funds and Supporting Organizations, with Promoters Sometimes Facilitating Schemes
paragraphs: IRS program managers report that some donor-advised funds and  supporting organizations cases highlight concerns about private benefit,  inurement, and donor control. Some of these cases demonstrate clear  noncompliance, allowing IRS to propose appropriate corrective actions.  However, IRS is confronted with many cases that require detailed  assessments of evidence, which makes addressing noncompliance  challenging. Additionally, IRS contends with activities involving donor- advised funds and supporting organizations that do not violate laws or  regulations, yet do not seem to benefit charities. Entities or individuals,  such as financial advisers or attorneys, sometimes facilitate abusive  schemes, introducing additional complexities to IRS’s examination  process.
subsections: section_title: Private Benefit, Inurement, and Donor Control Are Prevailing Concerns in Donor-Advised Fund and Supporting Organization Noncompliance Cases
paragraphs: Private benefit, inurement, and donor control are common concerns for  IRS in examinations of potential noncompliance involving donor-advised  funds and supporting organizations. IRS is unable to provide estimates  about the prevalence of this noncompliance, and noncompliance in  general. Thus, the examples presented are intended to illustrate known  cases of private benefit and donor control, and do not represent the entire  range of noncompliance.
subsections: section_title: Private Benefit and Inurement Lead to Personal Gains
paragraphs: Private benefit occurs when a 501(c)(3) organization is not operated or  organized exclusively for exempt purposes because it serves a private  rather than public interest. Because they are subject to section 501(c)(3),  both donor-advised funds and supporting organizations must avoid private  benefit that is more than incidental to the charitable purpose being served;  if private benefit is substantial enough, it may jeopardize an organization’s  tax-exempt status. If the organization’s assets or income are transferred to  an individual who is a charity insider, the benefit is called “inurement.”  Private benefit and inurement schemes involving donor-advised funds and  supporting organizations may benefit various individuals and may vary in  complexity.
IRS has encountered multiple cases of private benefit where donors to  donor-advised funds are able to regain some or all of their contribution.  For example, IRS has concerns about one fund offering a “loan program,”  where donors were able to repossess their donation, with no obligation for  repayment. IRS also sees inurement cases, in which individuals other than  the donor receive private benefit. For example, IRS is examining one  exempt organization and donor-advised fund operated by a for-profit  company. The company offered the fund as a charitable giving vehicle for  its employees. The exempt organization lacked an independent board,  with the president–who also served as president of the for-profit  company–receiving potentially high commissions and fees from contracts  with the donor-advised fund.
While donor-advised fund schemes often involve private benefit, schemes  involving supporting organizations more often result in inurement and are  typically more complex, according to IRS management. Schemes can  involve direct payment of benefits to donors or, more indirectly, payments  routed through offshore entities. One direct payment scheme, designed to  benefit a donor’s children, funneled school tuition payments through a  supporting organization intended to support their child’s school. More  complex schemes enable the donor to regain his or her donation after it is  routed offshore. One typical scheme begins with a donation to a  supporting organization, which is then transferred to an account in an  offshore investment firm controlled by a financial planner, accountant, or  other knowledgeable insider working with the donor. The money is then  transferred to a domestic mortgage lender, also controlled by the insider,  giving the donor access to the money for use toward an interest-only  mortgage. As a result, the donor benefits from a tax deduction on his or  her contribution, while still retaining access to the donation. To justify the  scheme, the supporting organization claims that earnings from their  investment in the offshore firm will benefit charity.
section_title: Donor Control May Involve Assets or Charity Operations
paragraphs: Donor control arises when a donor holds authority that exceeds what is  permissible for donor-advised funds or supporting organizations. Illegal  control can occur when a donor or disqualified person has control over  the charity’s assets, operations, or governance, or the organizations  receiving support. It is possible for donor control to occur without  private benefit. A donor may control a function or operation of a  supporting organization or donor-advised fund without receiving benefits,  according to IRS management. Donor control involving donor-advised  funds and supporting organizations manifests in different ways.
Donor control of a donor-advised fund occurs when the donor oversteps  his or her advisory role and retains ultimate authority over the distribution  of fund assets.  One IRS manager told us that, although more common in  supporting organization cases, a donor-advised fund donor may also  achieve control by controlling the exempt organization receiving the  benefits of their donation. For example, IRS is pursuing a case where a  donor-advised fund appears to be making distributions to a public charity,  which is controlled by the donor-advised fund’s donor. If the donor- advised fund did not exist, the public charity recipient would likely be  classified as a private foundation. IRS is investigating whether the charity  has other support sources.
For supporting organizations, control of the organization’s board or the  donor’s ability to designate charitable recipients can constitute donor  control. Board control can occur directly by controlling more than 50  percent of board voting power or veto power granted to disqualified  persons. Alternatively, board control can occur indirectly through a  disqualified person influencing board members who are not disqualified  persons, according to IRS managers. Retaining access to assets can also  signify direct or indirect control of a supporting organization. In one case,  IRS has questioned whether or not a donor controlled the operations and  investments of the supporting organization that the donor founded,  although the donor did not receive private benefit. Donor control can also  occur indirectly through control of an asset donated to the supporting  organization. For example, in one case, IRS is concerned that a donor is  continuing to collect and retain rent from building tenants after the  building was donated to a supporting organization.
section_title: Other Types of Noncompliance Exist
paragraphs: Although private benefit, inurement, and donor control are reoccurring  themes in IRS’s caseload, other types of noncompliance involving donor- advised funds and supporting organizations can occur. Specifically, a  supporting organization could fail to maintain a relationship with its  supported organization(s). A representative from the tax-exempt  community told us of situations where charities listed as supported  organizations were unaware of a purported relationship with a supporting  organization. The Panel on the Nonprofit Sector also recognized this  problem in its June 2005 report. Similarly, IRS managers told us that a  major issue in supporting organization examinations is whether or not the  organization maintains a sufficient relationship with its supported  organization. Form 990 only requires that supporting organizations report  the name of their supported organizations; it does not require them to  report the EIN of the supported organization. IRS managers told us that  not knowing the EIN makes it harder for IRS staff to track the relationship  between the two organizations.
section_title: IRS Has Various Efforts to Identify and Correct Noncompliance, but Does Not Know the Rate of Noncompliance
paragraphs: IRS uses resources from a variety of units to identify and examine  noncompliance involving donor-advised funds and supporting  organizations. Toward these ends, IRS created two teams, one on donor- advised funds and one on supporting organizations. As of June 2006, the  donor-advised fund team had opened but had not yet closed 27  examinations, according to an IRS manager. As of June 2006, the  supporting organization team had opened 102 examinations and closed 20  of them; 18 of which were found to be noncompliant, according to IRS.  IRS managers also told us that other programs–including the Tax  Examination Program and the Excessive Compensation Program–have  also examined and closed supporting organization cases, and are currently  examining 655 supporting organizations.
Regardless of the type of noncompliance found, IRS can propose  corrective actions when the evidence shows that a law or regulation has  been unmistakably violated. IRS is developing criteria for proposing  corrective actions for donor-advised funds as the related team finishes its  examinations; many of the examinations are in the early stages. For  supporting organization cases, IRS officials said, in general, they will  propose a change to private foundation status for issues of donor control.  Intermediate sanctions or revocation of the tax-exempt status are typically  proposed for inurement cases, according to IRS. Criminal charges may be  brought upon individuals found to be exhibiting criminal behavior while  participating in abusive schemes, and may occur in conjunction with  corrective actions resulting from examinations. In cases where the donor- advised fund or supporting organization is believed to be beneficial overall  but needs correction in order to be fully compliant, IRS managers told us  they may also initiate a closing agreement, which provides a set of  requirements intended to correct flaws in the donor-advised fund or  supporting organization structure or operations.
For various reasons, IRS does not know the overall rate of noncompliance  or the prevalence of different forms of noncompliance involving donor- advised funds and supporting organizations. First, IRS did not use a  random sample to identify cases for examination. Instead, it used methods  that led to examining the most egregious noncompliance schemes. For  example, the manager for the donor-advised fund team told us it selected  cases for examination based on large asset size or other unusual  characteristics, such as high compensation or high fees. Supporting  organizations cases were selected based on referrals from other IRS units,  according to the team’s manager. Second, IRS has no established  population of donor-advised funds for which to estimate a noncompliance  rate. An IRS manager said IRS is unable to identify the population because  exempt organizations have not been required to report their use of donor- advised funds, which prevents IRS from employing statistical sampling  methodology to estimate donor-advised fund noncompliance. Third,  examinations by IRS’s teams are relatively new; examinations began in  2005 for donor-advised funds and began in 2004 for supporting  organizations, according to IRS managers.
section_title: IRS Faces Challenges in Addressing Noncompliance Involving Donor-Advised Funds and Supporting Organizations
paragraphs: Not all cases involving donor-advised funds and supporting organizations  are clear; IRS faces challenges in identifying and examining potential  noncompliance. In part, these challenges are due to uncertainty about  whether the evidence unequivocally points to noncompliance, and to the  difficulty in exhaustively collecting evidence on the facts and  circumstances of a case.
To evaluate facts and circumstances, IRS managers said that agents may  evaluate minutes of meetings, correspondence among trustees, contracts  or agreements on loans or rent, news articles, or the organization’s trust  document. Although exempt organizations must maintain documentation  that they operate exclusively for exempt purposes, the existence and  quality of these documents may differ among organizations, according to  IRS managers. Therefore, IRS may need to collect evidence that is time- or  resource-intensive to uncover. Evidence that does not readily exist or that  is difficult to uncover, combined with the practical limits of the  examination process, make some noncompliance nearly impossible to  detect, as the following examples illustrate.
In determining influence on or control of a board, regulations define  permissible relationships between disqualified persons and supporting  organization boards. Despite regulatory guidance, IRS is unable to  identify all noncompliant situations because it cannot always identify  influence on board members by disqualified persons, especially when  attempting to identify a disqualified person’s indirect influence.  Nomination of a majority of board members by a disqualified person  may signify this influence, but IRS cannot consistently track the  origination of a board nomination. Only in some cases are trust  documents and meeting minutes available that may document the  nomination process, according to IRS. Additionally, IRS may have  difficulty identifying a disqualified person’s indirect influence on a  board when this influence may occur in private conversations.
It may also be challenging to find evidence that ensures that donor- advised funds are operating on “donor advice” rather than “donor  control.” To establish that donors are not exercising undue control, IRS  may examine the process by which a donor makes a funding  recommendation, according to the manager of IRS’s donor-advised  fund team. Specifically, IRS managers said this examination could  include verification of an independent board, the process by which the  fund operator investigates donor recommendations or provides  documents that show that a donor’s recommendations are not all  accepted. However, similar to the challenges of identifying board  control, IRS may not be able to detect subtle coercion occurring in  payout decisions.
Detecting control of assets may also be difficult. For example, a donor  may contribute a large portion of interest in a business partnership to a  supporting organization. The donor, serving as the business’s general  partner, retains some ownership of the partnership and has a  management responsibility or controls voting stock. According to an  IRS manager, unless the supporting organization has other assets, this  situation would likely allow the donor to have effective control over  the assets of the supporting organization. In some situations, the  business may claim that the general partner lacks controlling power, in  which case IRS managers said examiners must rely on available  evidence, such as partnership agreements, to determine the  donor/partner’s control over the business. Once again, evidence of  more subtle control may not be available or practical for IRS to pursue.
section_title: Some Compliant Activities Involving Donor-Advised Funds and Supporting Organizations Do Not Seem to Benefit Charity, Thus Introducing Areas for Potential Future Scrutiny
paragraphs: Not all cases involving donor-advised funds and supporting organizations  are clear cases of private benefit, inurement, or donor control, or involve  the challenges of gathering evidence. IRS managers said they encounter  scenarios where no statute or regulation was violated, but where activities  involving donor-advised funds or supporting organizations do not seem to  benefit charity. In these situations, noncompliance cannot be alleged, but  IRS may still question an organization’s or individual’s charitable  purposes. A general lack of data as well as a lack of legal definitions and  regulations for donor-advised funds contribute to these uncertainties for  IRS, which have prompted both IRS and Congress to consider different  solutions for reform, as the following examples illustrate.
One IRS manager told us that IRS is uncertain about whether or not  donor-advised funds with low payout rates are supporting charitable  purposes. No laws or regulations require annual minimum payouts to  charities from donor-advised funds, but according to IRS management,  idle assets are unlikely to result in benefits. Conversely, a donor- advised fund may be idle in paying out to build an endowment. If a  supporting organization has a low payout rate, however, IRS said this  can sometimes signify that it is not fulfilling its requirement. Legislation  has been introduced in Congress to impose a minimum payout on  donor-advised funds and supporting organizations. As of early July  2006, legislation on this issue had not passed.
IRS managers told us that examiners have discovered loans made from  a supporting organization to a donor or insider. Loans made by public  charities to officers, directors, donors, and others are legal, provided  that they are repaid and not made at terms lower than the market rate.  According to IRS, charities could justify these loans as an investment.  However, these loans may carry risk or introduce a conflict of interest.  For example, if a borrower has some form of control over the  organization, such as that of a board member or executive, it is less  likely that the organization will take legal action if the loan is not  repaid. Also, loans may prevent assets from being paid out to charitable  purposes. Furthermore, if a loan is made as part of an employee  compensation package, in some cases it may be classified as an excess  benefit under IRC section 4958, according to IRS management.  Additionally, these loans may signify control by disqualified persons.  Even if a loan’s interest rate is reasonable, or the borrower is not an  employee or in control of the organization, the terms of the loan may  give a borrower other benefits, thus making a case that the  organization serves private rather than public purposes. In recognition  of such potential improprieties, 19 states have banned such loans,  according to The Chronicle of Philanthropy. As part of a broader study  of executive compensation at public charities, IRS is examining loans  made to insiders, but is not specifically focusing on supporting  organizations.
section_title: Promoters May Aid in Abusive Schemes, and May Be Difficult to Identify and Examine
paragraphs: In addition to examining donor-advised funds, supporting organizations,  and donors, IRS investigates the promoters—creators and facilitators of  abusive schemes. Some abusive schemes are organized or participated in  by professionals or entities who work in concert with the donor.  Identifying and examining the roles of these professionals or entities can  be difficult and therefore may exacerbate the challenges in examining  donor-advised fund and supporting organizations cases.
A promoter is an individual or entity that organizes or assists in the  organization of a partnership, trust, investment plan, or any other  arrangement to be sold to a third party and designed to be used or is  actually used in obtaining illegal tax benefits. Accountants, financial  planners, attorneys, community foundations, and tax preparers could  serve as promoters, and may not just be involved in schemes involving  exempt organizations. Cases involving promoters address both the  material used to promote noncompliance, which must adhere to tax law,  as well as the actual activities implementing a scheme. Because  promoters may be committing fraud, promoters could face criminal  charges. See appendix IV for a discussion of materials and methods for  publicizing donor-advised funds and supporting organizations which are  not intended to lead to abusive schemes.
According to IRS managers, some schemes, particularly those benefiting  high-income donors, originate with a financial planner, accountant, or  lawyer. Other promoters may play a role in facilitating schemes, such as  the mortgage inurement scheme previously described in this report.  According to the manager of IRS’s donor-advised fund team, promoters  are typically more involved in schemes involving supporting organizations  than donor-advised funds due to the complexity of supporting  organizations’ schemes.
For some cases IRS is able to identify the promoter, noncompliant  material, and transactions that promote noncompliance. For example,  material from a financial planner offered a hypothetical estate plan  proposing that a supporting organization hold a wealthy donor’s personal  assets, thus facilitating a reduction in estate taxes upon the donor’s death.  The plan proposed transferring land owned by the donor to the supporting  organization, who would offer the sale of the land to the donor’s heirs at  about 10 percent of its fair market value. Furthermore, the plan proposed  that the supporting organization also lease the estate assets back to the  donor’s business. If the plan were carried out, inurement, private benefit,  excess benefit, and donor control would be significant legal concerns.
However, according to IRS managers identifying and investigating  promoters is often challenging. IRS managers said they rely on referrals  and Internet searches to find promoters. Although some promoters  advertise on the Internet, they may sometimes only share details about the  promotion in conversations with a donor. IRS’s donor-advised fund and  supporting organization teams have investigated nine promoters involved  in potentially abusive schemes, according to IRS managers. In addition to  the work of the issue teams, IRS’s civil Lead Development Center is tasked  with identifying promoters and coordinating promoter investigations. IRS  managers told us that once IRS identifies potential promoters, examiners  must seek information that is typically carefully hidden among complex  transactions involving multiple entities. This requires that IRS carefully  craft document requests and summonses, which can be a lengthy process.  Furthermore, once IRS refines its examination process to target certain  schemes, promoters quickly alter their approaches.
Finally, like some of the cases described earlier in this section, some  marketing material may not violate a law or regulation, but may have a  questionable purpose which may indicate potential noncompliance by  misleading donors with incomplete information. This may occur when  marketing material may be providing incomplete information on the limits  of donor-advised funds and supporting organizations versus private  foundations. We found examples of Web sites that describe a donor- advised fund or supporting organization as a giving option with all the  benefits and advantages of a private foundation, which may mislead  potential donors into believing they can retain control over their donation.
section_title: Conclusion
paragraphs: Donor-advised funds, supporting organizations, and private foundations  are vehicles for charitable giving. Donors can use these approaches for  long-term giving or to accumulate assets to address some larger need.  They also may create donor-advised funds or supporting organizations to  avoid the costs, burdens, excise taxes, and restrictions associated with  private foundations.
However, concerns have been expressed about the potential for abuses by  those who create and operate donor-advised funds and supporting  organizations, prompting legislative proposals to deter abuses. IRS has  found examples of abuses in these funds and organizations involving those  who do not give up control of their donations and who benefit privately at  the expense of the charitable interest. Although IRS has efforts to focus on  such abuses, IRS examiners lack sufficient data, which complicates efforts  to identify and address the noncompliance.
Congress is considering proposals to require donor-advised funds and  supporting organizations to annually pay out a certain percentage of their  assets to serve charities, which would roughly mirror the requirement for  private foundations. However, no defined way exists to calculate a payout  rate for these funds and these organizations, and current Form 990 data do  not allow for full or consistent analyses of the payout rate for donor- advised funds or supporting organizations. Guidance is needed on what  types of support should be included in a payout rate so that the Form 990  collects the necessary data. If a payout rate requirement is not adopted,  these Form 990 requirements would provide data to inform future  congressional decisions about whether a requirement should be instituted.  If a payout rate is adopted, the data would help in tracking compliance and  determining whether the requirement may need to be adjusted.
Collecting payout information on the Form 990, however, would not be  possible for donor-advised funds due to limitations in annual Form 990  reporting. Starting in tax year 2003, IRS has been able to identify Forms  990 that report donor-advised fund activity. However, IRS will not have  data that separate the fund activity from other activity. Adding a  requirement to separately report the donor-advised fund activity from  other activity on the Form 990 would allow IRS to check the payout rate as  well as other fund activity that looks suspicious.
IRS also has concerns with supporting organizations that do not support  their supported organizations or that make loans to individuals or  organizations. IRS would be better able to track the flow of funds to the  charities to be supported and loan recipients if it knew their TINs, which  are generally Social Security numbers for individuals or EINs for  organizations. Collecting the TINs of loan recipients raises concerns about  the potential costs and burdens and the protection of the TINs from  unauthorized use. IRS could address these concerns by only requiring TIN  reporting for loans above a certain dollar threshold and by not making the  information publicly available. If the Form 990 is changed to separately  report data on donor-advised fund activity, IRS should consider extending  this TIN reporting to donor-advised funds.
section_title: Matters for Congressional Consideration
paragraphs: Given the concerns about payout rates for both donor-advised funds and  supporting organizations, Congress should consider directing IRS to revise  the Form 990 to collect sufficient information so that a consistent payout  rate can be calculated for both types of charitable-giving vehicles. This  information could help inform decisions about whether to adopt a  minimum payout requirement and if any required rate should be adjusted.  To help IRS in making these revisions, Congress should direct IRS about  the types of support that should be included, as it has for private  foundations. In addition, so that IRS can modify the Form 990 to require  TINs of loan recipients from supporting organizations, Congress should  also consider providing IRS authority to protect that information from  public disclosure.
section_title: Recommendations for Executive Action
paragraphs: To better understand the characteristics of donor-advised funds and  supporting organizations and to better identify possible noncompliance,  the Commissioner of Internal Revenue should, as part of the Form 990  revision process, (1) require more comprehensive reporting of donor- advised fund activity, (2) require supporting organizations to report their  supported organizations’ EINs, and (3) require that the TINs for recipients  of large loans be reported, if IRS is granted authority to protect the TINs  from public disclosure.
section_title: Agency Comments
paragraphs: The Commissioner of Internal Revenue provided written comments on a  draft of this report in a July 19, 2006, letter, which is reprinted in appendix  V. IRS said our recommendations would help it deter abuse within tax- exempt and government entities and the misuse of such entities by third  parties. IRS agreed with our two recommendations regarding requiring  more comprehensive reporting of donor-advised fund activity and  requiring supporting organizations to report their supported organizations’  EINs on the Form 990. IRS said it will consider these form changes as part  of the Form 990 revision process, but the timing of these revisions will  depend on available resources. IRS also said that reporting supported  organizations’ EINs would potentially help with early identification of  abuses involving promoters and donors getting back their donations in the  form of a purported loan that may never be repaid. Regarding our third  recommendation, which had been to require that the TINs for large-loan  recipients be reported on the Form 990, IRS agreed that greater  transparency and better tracking of loans are needed. However, IRS did  not believe that it had the authority under current law to protect the TINs  of loan recipients from public disclosure if the TINs were reported on the  Form 990. As a result, we have added a matter for congressional  consideration to provide IRS the authority to protect loan recipient TINs  on the Form 990 from public disclosure and revised the recommendation  so that if provided the authority to protect the information from public  disclosure, IRS should revise the Form 990 to collect loan recipient TINs.
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If you or your staff have any questions about this report, please contact me  at (202) 512-9110 or brostekm@gao.gov. Contact points for our Offices of  Congressional Relations and Public Affairs may be found on the last page  of this report. Key contributors to this report are listed in appendix VI.
section_title: Appendix I: Tax-Exempt Excise Taxes
paragraphs: Over the years, Congress has imposed various excise taxes that affect tax- exempt entities, particularly private foundations under section 501(c)(3).  Public charities differ in several ways from private foundations. Public  charities have broad public support and tend to provide charitable  services directly to beneficiaries. Private foundations are often tightly  controlled and receive a significant portion of their funds from a small  number of donors, and tend to make grants directly to other organizations  rather than directly provide charitable services. Since these differences  create the potential for self-dealing or abuse by a small group, private  foundations are subject to anti-abuse rules not applicable to public  charities. In addition, both public charities and private foundations are  generally prohibited from engaging in certain types of transactions. Excise  taxes are to be levied on public charities and private foundations, as well  as a few other types of tax-exempt entities, that violate the rules. Details  on these rules and excise taxes follow.
subsections: section_title: Excise Tax on Section 501(c)(3) Political Expenditures (Section 4955)
paragraphs: Section 4955 was added by the Revenue Act of 1987, P.L. 100-203.  According to the House Report for the Act, the committee believed that  the excise tax applicable to private foundations for making prohibited  political expenditures (section 4945) should also apply to public charities.  Section 4955 imposes an initial 10 percent excise tax on each political  expenditure of a section 501(c) (3) organization. An additional 2-½ percent  excise tax is imposed on the organization’s manager if the manager knew  that it was a political expenditure. Political expenditures include any  amounts paid or incurred by the organization in any participation or  intervention in any political campaign on behalf of any candidate for  public office. If an initial tax has been imposed regarding a political  expenditure and that expenditure is not corrected, an additional tax equal  to 100 percent of the amount is to be imposed on the organization. An  additional tax equal to 50 percent of the amount of the expenditure is to be  imposed on the organization’s manager if that manager refuses to agree to  part or all of the correction.
section_title: Excise Tax on Section 501(c)(3) and (4) Excess Benefit Transactions (Section 4958)
paragraphs: Section 4958 was added in 1996 by the Taxpayer Bill of Rights 2, P.L. 104- 168. According to the related House Report this excise tax was added to  ensure that the advantages of tax-exempt status benefit the community  and not private individuals. The act provided for this intermediate sanction  (i.e., something short of a loss of tax-exemption) to be imposed when  nonprofit organizations engage in transactions with certain insiders that  result in private inurement. Section 4958 imposes an initial tax of 25  percent on each excess benefit transaction entered into between a  disqualified person and tax-exempt organizations under sections 501(c)(3)  and (4). The initial tax is to be paid by this disqualified person, including  any person who at any time during the 5-year period ending on the date of  the transaction was in a position to exercise substantial influence over the  organization, a member of this person’s family, and a 35 percent controlled  entity. Such an entity exists when a disqualified person owns more than 35  percent of the voting power of a corporation, more than 35 percent of the  profit interest of a partnership, or more than 35 percent of the beneficial  interest of a trust or estate. If an initial tax is imposed on the disqualified  persons, an additional tax of 10 percent is to be imposed on the  organization’s manager if that manager participated knowing that it was an  excess benefit transaction. If the excess benefit transaction is not  corrected within the taxable period, a tax equal to 200 percent of the  excess benefit transaction will be imposed on the disqualified person.  Private foundations are not subject to this excise tax.
section_title: Excise Tax on Private Foundation Investment Income (Section 4940)
paragraphs: Section 4940 was added by the Tax Reform Act of 1969, P.L. 91-172. The  related Senate Report described the excise tax as an “audit fee tax” that  was believed to be necessary to cover IRS’s costs for increased  supervision over private foundations under the act. Section 4940 imposes a  2 percent excise tax on the net investment income of tax-exempt private  foundations. Net investment income includes income from interest,  dividends, and net capital gains that is reduced by the expenses incurred  to earn it. This tax is 1 percent if a private foundation meets certain  distribution requirements. Private foundations that meet the requirements  to be an “exempt operating foundation” are not subject to this excise tax.  Among these requirements are stipulations that the foundation be publicly  supported for at least 10 years and that it have a governing body that is  broadly representative of the general public. Private foundations that are  not exempt from taxation are subject to this excise tax and unrelated  business income tax.
section_title: Excise Tax on Private Foundation Acts of Self- Dealing (Section 4941)
paragraphs: Because a tax-exempt entity cannot operate to confer a benefit on private  parties, Section 4941 was enacted by the Tax Reform Act of 1969.  According to the Senate Report, generally prohibiting self-dealing  transactions would minimize the need to apply the subjective arm’s-length  standard that was used for loans, payments of compensation, and  preferential availability of services under the 1950 amendments. Section  4941 imposes a 5 percent excise tax on acts of self-dealing between a  private foundation and disqualified persons. This tax is to be paid by the  disqualified person who participated in the self-dealing. An additional tax  equal to 200 percent of the amount involved is to be imposed if the self- dealing is not corrected during the taxation period. A separate tax equal to  2-½ percent of the amount involved is to be imposed on the foundation’s  manager if that manager knowingly participated in the act of self-dealing.  If this additional tax has been imposed on the foundation manager and  that manager refuses to agree to part or all of the correction, an additional  tax equal to 50 percent of the amount is to be imposed. Acts of self-dealing  include sales, exchanges, or leases of property; lending of money or other  extensions of credit; and payment of compensation. Disqualified persons  include substantial contributors to the foundation, foundation managers,  an owner of more than 20 percent of a business enterprise that is a  substantial contributor, and certain government officials.
section_title: Excise Tax on Private Foundation Failure to Distribute Income (Section 4942)
paragraphs: Section 4942 was enacted by the Tax Reform Act of 1969. Prior to it, a  private foundation could lose its exemption if it failed to make  distributions towards its charitable purposes instead of just accumulating  income. According to the Senate Report, the committee believed that loss  of exempt status as the only sanction was often ineffective or harsh, and  that substantial improvement could be achieved by providing a graduation  of sanctions if income is not distributed. Section 4942 imposes a 15  percent excise tax on the undistributed income of a private foundation for  any taxable year in which the required amount has not been distributed  before the first day of the next taxable year. If an initial tax has been  imposed under section 4942 and the income remains undistributed at the  end of the taxable period, a tax equal to 100 percent of the remaining  undistributed amount is to be imposed. This excise tax does not apply to  private operating foundations that meet distribution requirements or to the  extent that the failure to distribute is due solely to an incorrect valuation  of assets as long as other requirements are met.
section_title: Excise Tax on Private Foundation Excess Business Holdings (Section 4943)
paragraphs: Section 4943 was enacted by the Tax Reform Act of 1969. According to its  Senate Report, the use of foundations to maintain control of a business  appeared to be increasing, and some who wished to use a foundation’s  stock holdings to control a business were relatively unconcerned about  producing income for charitable purposes. Where the charitable  ownership predominated, the business could unfairly compete with  businesses whose owners were required to pay taxes on their business  income. The committee concluded that a limit on the extent to which a  private foundation may control a business was needed. Section 4943  imposes a 5 percent excise tax on certain excess business holdings of a  private foundation. Permitted holdings generally include up to 20 percent  of the voting stock of an incorporated business enterprise (reduced by the  percentage of the voting stock owned by all disqualified persons) and  similar holdings in partnerships and other unincorporated enterprises  (except sole proprietorships). If the excise tax has been imposed,  foundations that fail to make the required divestiture of excess holdings  above the permitted amounts are subject to an additional tax equal to 200  percent of the excess holdings. In certain cases, foundations are allowed a  5-year period to dispose of the excess holdings and may receive an  additional 5-year extension.
section_title: Excise Tax on Private Foundation Investments Which Jeopardize Charitable Purpose (Section 4944)
paragraphs: Section 4944 was enacted by the Tax Reform Act of 1969. Under prior law,  a private foundation could lose its exemption if it invested in a manner  that jeopardized its exempt purpose. In the Senate Report, the committee  concluded that limited sanctions were preferable to the loss of exemption.  Section 4944 imposes an initial 5 percent excise tax on the amount  involved if a private foundation invests in a manner that jeopardizes its  exempt purpose (e.g., investing with the purpose of income production or  property appreciation). If this tax is imposed on the foundation, a separate  5 percent excise tax is to be imposed on the foundation manager if that  manager knew that making the investment would jeopardize the  foundation’s exempt purpose. If an initial tax is imposed, an additional tax  equal to 25 percent of the amount of the investment is to be imposed on  the foundation if the investment is not withdrawn within the taxable  period. An additional tax equal to 5 percent of the amount of the  investment is to be imposed on the foundation manager if the investment  is not withdrawn.
section_title: Excise Tax on Private Foundation Taxable Expenditures (Section 4945)
paragraphs: Section 4945 was enacted by the Tax Reform Act of 1969. Under prior law,  the only sanction against prohibited political activity by a foundation was  loss of exemption. The Senate Committee Report noted that the standards  for determining the permissible level of political activity were so vague as  to encourage subjective application of the sanction. As a result, section  4945 was added to clarify the types of impermissible activities and provide  more limited sanctions. Section 4945 imposes an initial 10 percent excise  tax on each taxable expenditure made by the foundation. An additional 2- ½ percent excise tax is to be imposed on the foundation manager if that  manager knowingly participated in the taxable expenditure. Taxable  expenditures include amounts paid to carry on propaganda or otherwise  influence legislation or the outcome of a public election, or to directly or  indirectly carry on a voter registration drive. If the expenditure is not  corrected within the taxable period, an additional tax equal to 100 percent  of the amount of the expenditure is to be imposed on the foundation and  an additional tax equal to 50 percent of the amount of the expenditure is to  be imposed on the foundation manager.
section_title: Appendix II: Summary Data Tables for Section 501(c)(3) Tax-Exempt Charities in 2005 Constant Dollars, Tax Years 1999-2003
paragraphs: The following tables summarize data reported on the annual Forms 990  and 990-PF filed by tax-exempt charitable entities under section 501(c)(3)  of the Internal Revenue Code.  The tables cover number of returns filed  and the reported totals for the following characteristics: assets, revenues,  expenses, contributions received, noncash contributions received, grants  paid, and executive compensation. The data are categorized by supporting  organizations, private foundations, and all other 501(c)(3) charities.
section_title: Appendix III: Noncash Contribution Valuation Methods
paragraphs: IRS’s Publication 561 provides guidance to taxpayers on determining the  value of property donated to qualified organizations. It defines “fair market  value” (FMV) as the price a willing, knowledgeable buyer would pay a  willing, knowledgeable seller when neither has to buy or sell. Future  events that may affect the property cannot be included in FMV unless they  are known at the time of the donation. In addition, past events, such as  rapid growth of value over the short term, may have to be balanced out  over a longer time frame for a realistic projection of value. While there is  no single method to determine FMV, factors to consider include the cost  or selling price, sales of comparable properties, replacement costs, and  opinions of experts.
Although there are many categories of noncash contributions including  vehicles, used clothing, and works of art that charities may receive, donor- advised funds and supporting organizations typically receive larger  noncash gifts, according to IRS.
For stocks and bonds, the fair market value is the average price between  the highest and lowest trading price on the date of donation. This method  is only to be used for items for which an active market exists. If the item is  traded on multiple exchanges, then the principle exchange must be used.  In addition, large blocks of stock may require an expert to assist in the  appraisal.
For closely-held securities, determining FMV would include considering  the company’s net worth, prospective earning power, dividend-paying  capacity, and other factors such as the economic outlook in the particular  industry and the company’s relative position within it, and the value of  securities of companies engaged in the same or similar business.
For real estate, a detailed appraisal by a qualified appraiser is required.  Certain items must be included such as complete description, legal  description, lot and block number, physical features, condition, dimension,  zoning, and potential uses. Three valuation methods may be used— comparable sales, capitalization of income, and replacement cost new or  reproduction cost minus observed depreciation (this method used alone  does not determine FMV but rather tends to set the upper limit of value).
IRC section 170, particularly Sec 170(f)(8), provides the basis for reporting  noncash charitable contributions, such as using a qualified appraiser. The  American Jobs Creation Act of 2004 also contains provisions regarding  noncash contributions, including requiring the donor to attach a qualified  appraisal to the tax return if the contribution is over $500,000.
Taxpayers are required to file IRS Form 8283 (Noncash Charitable  Contributions) if the charitable tax deduction claimed is greater than $500.  Form 8283 should be filed for the tax year that the deduction is claimed.  Different sections of the form are to be completed based on type of  property donated and whether the amount claimed is less than or greater  than $5,000. Generally appraisals are required by a qualified appraiser for  donations of more than $5,000. Charitable organizations receiving donated  property must file Form 8282 to report information to IRS about  disposition of certain charitable deduction property made within 2 years  after the donor contributed the property.
According to an IRS manager, closely-held stock is a growing concern and  challenge to IRS, since it can involve a broad base of taxpayers. He added  that artwork, while well-publicized in terms of valuation issues, is less of a  concern since the dollar amounts involved are small compared to other  types of noncash contributions. In addition, the IRS manager identified the  following challenges to addressing noncompliance, gathered from about  100 examination cases:    donors are sometimes vague when describing the contribution on Form  8283, impeding IRS’s understanding and ability to address any  problems;    donors can submit Form 8283 upon examination, creating problems  with detecting problems early;    corporate donors of patents can structure the contribution (e.g., pay  maintenance fees on the patent) so that the donee is not required to file  a Form 8282 upon disposition of the contribution;    no requirement exists that noncash contribution amounts reported on a  donor’s tax return and a charity’s Form 990 must match;    donors take improper deductions without adverse impact to the    multiple appraisals of contribution value are not helpful because  appraisals are very subjective.
To address some of these concerns, IRS has several initiatives looking at  specific types of noncash contributions, such as vehicle donations and art  valuations. Additionally, IRS has a program that compares valuations of  noncash contributions claimed by taxpayers (on Form 8283) with the price  obtained by recipient charities when they resell the property. IRS has used  data from this program to complete a study of large noncash  contributions.
section_title: Appendix IV: Methods and Materials Used to Market Donor-Advised Funds and Supporting Organizations to Potential Donors
paragraphs: Earlier in this report, we discussed some of the methods and materials  used to publicize donor-advised funds and supporting organizations that  may lead to noncompliance with tax laws. The following is a discussion of  donor motivations and materials and methods that are not intended to lead  to abusive schemes. To obtain this information, we spoke with 11  community foundation managers, 6 financial professionals, and 18  managers at IRS. The examples we discuss come from materials that we  were referred to or located online based on our interviews, and do not  necessarily represent all materials and methods used to market donor- advised funds and supporting organizations.
Because donor-advised funds and supporting organizations are just two  among many charitable giving options, potential donors must select an  option that best suits their goals and donation plan. Factors that may  influence a donor’s decision include: types of causes they wish to support,  the size and type of donation they wish to give, and their desired  involvement level in directing the use of their donation. For example,  some donors, who desire to donate to a specific community or to have in- depth information on charities receiving their funds, might find that a  donor-advised fund administered by a community foundation is an  appealing option. Community foundations, which typically have a local  focus, may do particularly well at performing due diligence on charities  receiving their funds, according to one estate planner. Due diligence may  include identifying organizations listed in IRS Publication 78, or  interacting with exempt organizations that are potential recipients of  funds, according to community foundation managers.
To evaluate giving options in relation to their goals, donors may seek  information from accountants, financial planners, lawyers, community  foundations, the Internet, and tax-exempt organizations, among others.  Some exempt organizations’ efforts to market donation options tend to be  limited, according to a study by a nonprofit philanthropic research and  development organization. This makes personal and business relationships  important ways for donors to learn about donor-advised funds and  supporting organizations, according to community foundation managers.  Because many donor-advised funds are administered by community  foundations or are housed in charities affiliated with commercial  investment firms, such as Vanguard and Fidelity, these relationships may  be particularly important sources for introducing donors to donor-advised  funds, according to a community foundation manager interviewed by The  Chronicle of Philanthropy. According to several community foundation  managers, many donors to community foundation donor advised funds are  referred from professional advisers. Recognizing the importance of these  relationships, some community foundations have launched specific  outreach efforts aimed at financial advisers and other professionals who  could refer donor-advised fund clients.
In addition to discussions with professionals, donors may encounter or be  presented with a variety of material explaining charitable giving options.  Material may contain details of giving options in relation to both tax  incentives to the donor and charitable benefits for the exempt  organization. Some firms advertise services for clients in magazines or  national publications, according to IRS managers and an estate lawyer,  while others depend on the Internet. Descriptions of professional services  can include outlines of charitable giving options, some of which attempt to  explain giving options based on the legal, practical, and charitable  characteristics of each option. For example, some community  foundations, philanthropy organizations, and investment firms provide  tables or descriptions comparing various combinations of donor-advised  funds, supporting organizations, private foundations, and other donation  options. These tables describe and compare levels of donor involvement,  tax status, deductions by asset type, start-up costs, and administrative  requirements. Other material outlines the steps and requirements  necessary to establish a donor-advised fund or supporting organization.
section_title: Appendix V: Comments from the Internal Revenue Service
section_title: Appendix VI: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact
section_title: Acknowledgments
paragraphs: In addition to the contact named above, Tom Short, Assistant Director;  Mark Bondo; Marta Chaffee; Elizabeth Fan; Evan Gilman; Nancy Hess;  Shirley Jones; Donna Miller; John Mingus; Coltrane Stansbury; Paul  Thacker; and Lindsay Welter made key contributions to this report.
section_title: Glossary
subsections: section_title: Charity insider
paragraphs: An individual such as an officer, board member, or other persons able to  exercise substantial influence over a tax-exempt organization. Donors to  donor-advised funds are rarely considered to be insiders, while donors to  supporting organizations can sometimes be insiders if they also serve on  the supported organization’s board.
section_title: Community foundation
paragraphs: An organization, usually a nonoperating charity, providing charitable  support through grants to local or regional communities. Typically a  community foundation will aggregate contributions from local residents,  build endowments, and distribute grants to communities.
section_title: Disqualified person
paragraphs: An individual, defined in IRC section 4946, who may have a significant  conflict of interest with a charity due to financial, executive, or voting  powers, such as those held by donors, officers, or directors. The definition  applies to individuals involved with private foundations and supporting  organizations, and has a limited application to public charities that are not  supporting organizations.
Charitable giving accounts that are held by a public charity. A donor  contributes to an individual account within a charity’s donor-advised fund,  and maintains an advisory role on distribution of the funds. No statutory  or regulatory definition currently exists.
section_title: Donor control
paragraphs: Authority exerted by a donor that exceeds what is allowable for a donor- advised fund or supporting organization. Donor control includes direct or  indirect power over decisions regarding an organization’s assets or  operations.
section_title: Excess benefit
paragraphs: A transaction, directly or indirectly, between a disqualified person and a  tax-exempt organization that results in economic benefit to the  disqualified person exceeding the value of service to the organization.  Subject to excise taxation under IRC section 4958.
section_title: Excise tax
paragraphs: A tax imposed on an act, occupation, privilege, manufacture, sale, or  consumption and that is usually designed to influence taxpayer behavior.
section_title: Expenditure responsibility process
paragraphs: A set of procedures used by private foundations to ensure responsible use  of grants to charities. The assessment may include:  a pre-grant inquiry on the recipient charity, establishment of commitments  for grant recipient, investment requirements, or agreements on actions if  agreements are violated.
section_title: Intermediate sanctions
paragraphs: Excise taxes that provide a corrective remedy for excess benefit  transactions. The excise taxes are paid by the disqualified person, as  defined in IRC 4958, who receives excess benefit, or by a charity manager  who knowingly participates in the transaction.
section_title: Inurement
paragraphs: The transfer or use of a charity’s assets or income for the benefit of a  charity’s insiders. Inurement is a specific form of private benefit, and is  prohibited for all 501(c)(3) organizations.
section_title: IRS Form 1023
paragraphs: Application for Recognition of Exemption under IRC Section 501(c)(3)  that organizations must file in order to receive tax-exempt status.
section_title: IRS Form 990
paragraphs: IRS information return that public charities are required to file annually  unless the organization is a church or entity associated with a church, a  certain type of governmental unit affiliate, or falls below certain gross  receipts thresholds.
section_title: IRS Form 990-PF
paragraphs: IRS information return that private foundations must file annually.
section_title: Noncash contribution
paragraphs: An asset other than cash donated to a tax-exempt organization, for  example, stocks, bonds, vehicles, artwork, or real estate.
section_title: Payout
paragraphs: An organization’s expenditures to individuals or charities for certain  operational or administrative functions. Private foundations must  distribute about 5 percent of the average market value of their  noncharitable use assets, generally stocks or other investments that  compose the foundation’s endowment; donor-advised funds and  supporting organizations do not have to meet a minimum payout.
section_title: Private foundation
paragraphs: A 501(c)(3) organization, further defined in IRC section 509(a), that does  not qualify as a public charity. Generally, private foundation rules and  regulations are more complex and limiting than those for public charities.
section_title: Private benefit
paragraphs: The transfer or use of a charity’s assets or income, or the conferment of  undue advantage, to private persons who are not necessarily charity  insiders. Some private benefit is permitted, but it must not be more than  incidental to the charitable purpose being served. Private benefit is a  broad term that includes inurement and applies to all 501(c)(3)  organizations.
section_title: Public charity
paragraphs: A tax-exempt organization defined in IRC section 501(c)(3) that receives  broad financial support or is a supporting organization. Public charities  have fewer legal requirements than private foundations.
section_title: Revocation
paragraphs: A corrective action that removes a charity’s tax-exempt charter.  Revocation is used for violations such as inurement, performing  nonexempt activities, operating in a commercial manner, and operating for  private use.
section_title: Section 501(c)(3) organization
paragraphs: A tax-exempt organization operated for a charitable purpose. Purposes  considered to be charitable include serving the poor and distressed;  advancing religious, educational, or scientific endeavors; and protecting  human or civil rights. All 501(c)(3) organizations are considered either  public charities or private charities, known as private foundations.  Contributions to charities are tax deductible under IRC section 170.
Transactions, either direct or indirect, made between a private foundation  and disqualified person that involve (1) sale, exchange, or lease of  property; (2) lending of money or other extensions of credit;   (3) providing goods, services, or facilities; (4) paying compensation to or  reimbursing expenses of a disqualified person; (5) transferring foundation  income or assets to, or for the use or benefit of, a disqualified person; and  (6) certain agreements to make payments of money or property to  government officials.
section_title: Supported organization
paragraphs: A tax-exempt organization that receives funds or services from a  supporting organization.
section_title: Supporting organization
subsections: section_title: Type I
section_title: Type II
section_title: Type III
paragraphs: operated in connection with the supported organization(s).