Internal Revenue Code (IRC) Section 501(c) establishes 27 categories of tax-exempt organizations. The largest number of such organizations falls under Section 501(c)(3), which recognizes charitable organizations. Generally, charities pay no income taxes on contributions received, but they can be taxed on income generated from unrelated business activities. These charities and related parties may be subject to several additional IRS excise taxes and penalties for certain actions, such as not filing a required tax return. Generally, taxpayers may deduct the amount of any contributions to charities from their taxable income. By 2000, IRS had recognized 1.35 million tax-exempt organizations under Section 501(c), of which 820,000 (60 percent) were charities. Social welfare, labor, and business leagues accounted for 280,000 (21 percent) of the tax-exempt organizations. The remaining organizations (about 19 percent) were exempt under other Section 501(c) categories. At the end of 1999, the assets of Section 501(c)(3) organizations approached $1.2 trillion and their annual revenues approached $720 billion. The term charitable, as defined in the regulations that underlie IRC Section 501(c)(3), includes assisting the poor, the distressed, or the underprivileged; advancing religion; advancing education or science; erecting or maintaining public buildings, monuments, or works; lessening neighborhood tensions; eliminating prejudice and discrimination; defending human and civil rights; and combating community deterioration and juvenile delinquency. An organization must apply for IRS recognition as a tax-exempt charity that strives to meet one or more of these purposes. In general, a charity is to serve broad public interests, rather than specific private interests. Generally, public charities are required to file annual information returns with IRS that are also available to the public. The larger charities file Form 990, Return of Organization Exempt from Income Tax. Smaller charities—with gross receipts of less than $100,000 and total assets of less than $250,000—are allowed to file an abbreviated Form 990-EZ. The smallest charities, with less than $25,000 in gross receipts, and certain other types of organizations, such as churches and certain other religious organizations, are not required to file. The Form 990 is to be filed within about 5 months of the end of the charity’s accounting year, with extensions available. Form 990 has 105 line items on 6 pages, as well as 45 pages of instructions. The data on various finances and activities provide a basis for reviewing whether the organization continues to meet the requirements for tax exemption. The form also has two schedules: Schedule A and Schedule B. Schedule A covers several areas, including compensation of employees and independent contractors earning over $50,000 annually; lobbying activities; sources of revenue; and relationships with noncharitable exempt organizations, such as social welfare organizations. Schedule B is to be filed by certain charities that receive contributions of $5,000 or more from one or more donors. Charities may be required to file other forms in specific situations. Appendix I describes the Form 990. IRS and various stakeholders—such as the states and “charity watchdogs”—oversee charitable operations to protect the public interest in part by reviewing the Forms 990. Certain charities, including those receiving federal and private grants, obtain independent financial audits. To the extent that such audit information is available in conjunction with Forms 990, those doing the oversight have more information on the financial status of the charities, and individuals can make more informed choices about donations to specific charities. Recognizing the importance of public oversight and a “free market”, where charities compete for donations, Congress expanded public disclosure of and access to the Form 990. Such oversight is important to help support charities, inform donors about how their money is spent on a charitable purpose, and stem potential abuses. Our objectives in this review were to analyze the adequacy of (1) publicly reported Form 990 data on charity spending in facilitating public oversight of charities, (2) IRS’s oversight activities for charities, and (3) IRS’s data sharing with state agencies that oversee charities. For the spending data reported by charities, we interviewed IRS officials and experts (e.g., AICPA, the Urban Institute) to learn about charities’ reporting of expense data on the Form 990 and about independent financial audits. We reviewed studies such as those done by the Urban Institute, academicians, and the Chronicle on Philanthropy to better understand the expense data. We analyzed expense data reported by charities on the Form 990. IRS’s Statistics of Income (SOI) Division had available data on charity expenses, but those data only covered up to 1998 and did not include data on “joint-cost allocations” (e.g., allocating selected expenses between education and fundraising). To obtain at least 2 years of joint-cost data, we purchased filing years 1998 and 1999 data from the Urban Institute which contracts with IRS to digitize Form 990 data for the full population of charities that filed Form 990. For some large charities, primarily hospitals, expense data such as by line items of the Form 990 were not available to the Urban Institute. Thus, only joint-cost data and aggregate data for expenses, assets, and revenues for 1999 are presented throughout our report. Because several sources of data were used, data are presented by filing, tax, and fiscal years in this report. For IRS oversight of charities, we talked with responsible IRS officials to identify oversight processes when charities apply for recognition of their tax-exempt status and when IRS examines Forms 990 filed by charities. For these types of oversight, we reviewed documentation on IRS’s processes and criteria used to review applications and examined Forms 990. We also analyzed related data for fiscal years 1996 through 2001. For applications, such IRS data included the number and types of applications received and their dispositions. For examinations, such data focused on the number and types of examinations and their results. In addition, we contacted other federal agencies, such as the Federal Trade Commission, to understand the types of oversight of charities that they conducted and the extent to which they coordinated that oversight with IRS. Appendix V discusses our selection of the agencies and our work. For IRS data sharing with states, we interviewed IRS officials and reviewed IRS documents. We did the same at the National Association of State Charity Officials (NASCO), which represents 38 states that oversee charities to protect public interests. We participated in an October 9, 2001, annual NASCO conference. At the conference, we asked state officials about their oversight and coordination with IRS or others. We talked with Treasury, IRS, and state officials about the tradeoffs of changing the law to allow IRS to share oversight data (e.g., examination results) with state charity officials. We also reviewed related studies and articles. For all three objectives, we collected documents from and talked with officials at various organizations. We talked with officials at the Joint Committee on Taxation about its reports in 2000 on disclosure of tax data on charities and on public, IRS, and state oversight. On the basis of referrals from IRS and NASCO, we talked with and collected documents from officials at the Council on Foundations, the Independent Sector, the GuideStar project at Philanthropic Research Inc., the Direct Marketing Association, and others that were knowledgeable about charity data, oversight, or fundraising. We reviewed documents from and talked with officials at three watchdog groups—Better Business Bureau Wise-Giving Alliance, Charity Navigator, and American Institute of Philanthropy—that oversee charities. We also asked for comments on short sections or summaries of the draft report from the organizations that provided data or perspectives on those sections. We made technical changes to the report where appropriate after receiving their comments. For example, we did not use the 1999 detailed expense data from the Urban Institute after receiving its comments. The Urban Institute did not have the necessary data to resolve certain discrepancies with the detailed data (e.g., reported line item amounts not equaling reported aggregate amount for expenses) before we issued the report. As a result, we deleted analyses of the detailed expense data for 1999 that had been in the draft report. We conducted our work in Washington, D.C., from June 2001 through March 2002, in accordance with generally accepted government auditing standards. We provided a draft of this report to IRS for review and comment. IRS’s and Treasury’s comments are in appendices VI and VII, respectively. Although disclosure of charity spending data can facilitate public oversight, caution in interpreting the data, is warranted. No measures are available on the accuracy of the expense data and substantial discretion in allocating the expenses makes use of the data problematic in comparing charities. Given such data limitations, public oversight of charities cannot rely solely on the expense data reported on the Form 990. A key potential use of data on charities’ spending is to show what portion is spent on charitable purposes through program services (i.e., efficiency). In aggregate, the data show that from 1994 through 1998, charities allocated, on average, 87 percent of their spending to charitable program services and the remainder to fundraising and general management,suggesting a high-level of spending efficiency, as shown in figure 1. These percentages did not vary much by size of the charity. Although Form 990 expense data are a principal source to support donors’ informed judgments about whether to support a charity, the accuracy of the expense data has not been measured. At the same time, however, IRS officials and watchdog groups have expressed concerns about potential or actual inaccuracy in Form 990 expense data. Because efficiency is a criterion that donors may use in selecting among charities, charities have an incentive to report their expenses in a manner that makes them appear to be efficient. IRS has discovered instances in which charity fundraising expenses have been underreported because charities have “netted” such expenses against the funds raised.