Section 501 of the Internal Revenue Code (IRC) provides for tax exemption for certain corporations, trusts, and other organizations. Section 501(c) establishes 29 categories of tax-exempt organizations, ranging from cemeteries to professional football leagues—see appendix II for complete list of different types of tax-exempt-organizations, as well as more detailed information on the tax treatment for these organizations. The largest number of such organizations falls under section 501(c)(3), which recognizes charitable organizations. Generally, while charitable organizations pay no income taxes on contributions received, these entities can be taxed on income generated from business activities that are unrelated to their charitable purposes. These charitable organizations and related parties may be subject to several additional IRS penalties and fines for certain actions, such as not filing a required tax return. Generally, taxpayers who itemize their deductions may deduct the amount of any contribution to charitable organizations from their taxable income. The IRC requires that an organization adhere to certain accepted charitable, religious, educational, scientific, or literary purposes to qualify for 501(c)(3) tax-exempt status. The IRC also prohibits charitable organizations from undertaking certain activities: no earnings of the organization may benefit individual or private shareholders, no substantial attempt may be made to spread propaganda or influence legislation, and no effort may be made to campaign for or against a candidate for public office. In order to receive 501(c)(3) tax-exempt status, an organization must submit a Form 1023 or Form 1023-EZ and organizing documents to IRS to describe its charitable purpose and financial data. The organizing documents can include articles of incorporation or by-laws governing the activities and charitable purpose of the entity. Submitting an application is one of the first interactions a tax-exempt organization will have with IRS. The organization will then receive a determination letter from IRS which informs the organization whether its application for tax-exempt status has been approved or denied. Alternatively, the organization may be told the IRS is in need of additional information in order to make a determination. If an organization is successful in receiving tax-exempt status, it will continue to interact with IRS on an annual basis by submitting an information return or an electronic notice. The form contains information on the organization’s mission, programs, finances and governance structure which helps IRS to determine whether the organization is meeting its charitable purpose and therefore is eligible for tax-exempt status. Certain organizations that have gross receipts of $50,000 per year or less may submit the Form 990-N—an abbreviated electronic version of the Form 990 return, often called the e-Postcard. The Form 990-EZ is less abbreviated, though still more streamlined than the Form 990, and may be used by certain entities with gross receipts under $200,000 and assets under $500,000. Private foundations complete the 990-PF. IRS oversees charitable organizations through its Exempt Organizations (EO) Business Division (a part of IRS’s Tax Exempt and Government Entities Division). EO’s oversight relies primarily on two sets of activities: a front-end review of applications and a back-end review of a relatively small number of information and tax returns. At the front end, the EO Rulings and Agreements office reviews all applications for tax-exempt status. At the back end, EO Examinations analyzes the operations and finances of a small percentage of exempt organizations through examinations (audits). Exam agents propose tax assessments or changes to exempt status when necessary, as well as advise organizations about how to comply with the law in the future. Through these activities, IRS tries to ensure that charities merit the recognition of a tax-exempt status as well as the retention of it. IRS and state charity regulators both play a key role providing oversight of charitable organizations. IRS’s oversight interests are in ensuring that tax-exempt organizations comply with federal tax law. State charity regulators have a broader oversight interest which includes the application of state trust, non-profit corporation, consumer protection, and charitable solicitation laws. Although these federal and state regulators have distinct oversight interests, these interests are closely related and at times, overlapping. Both IRS and state charity regulators seek to prevent excess compensation, private inurement, conflicts of interest, and other abusive practices by charitable organizations. IRS also collaborates with U.S. Attorneys at the DOJ to identify and prosecute criminal tax violations. Although EO does not collaborate directly with DOJ, criminal investigations may be initiated within IRS at the recommendation of an IRS revenue agent who has detected potential criminal activity. Investigations may also be initiated at the advice of a U.S. Attorney’s office, a law enforcement agency, or the public. IRS criminal investigations are led by an IRS special agent. If substantial evidence is found for a criminal case, then—after multiple rounds of supervisory review—the investigation may be referred to the DOJ Tax Division or the relevant U.S. Attorney’s office. If DOJ or the U.S. Attorney accepts the investigation for prosecution, the case is then handled by the prosecutors. Charitable organizations comprise a significant part of our economy in terms of their share of the gross domestic product (GDP) and their importance in services vital to the well being of citizens. Available estimates indicate that tax-exempt organizations serving households generate about 5 percent of U.S. GDP. The federal government increasingly relies on these organizations to deliver critical services: in 2012, government agencies paid an estimated $137 billion to nonprofit organizations in grants and contracts for services. Also, for fiscal year 2013, the Department of the Treasury (Treasury) estimated the tax expenditure for deductions for contributions to charitable organizations totaled over $48 billion. As shown in figure 1, the total population of nonprofit organizations can be broken down by tax-exempt status and by the requirement to file returns. In 2012, an estimated 2.3 million nonprofit organizations operated in the United States, including organizations that have not applied for tax-exempt status with IRS. Of nonprofits in 2011, 1.63 million had been recognized as tax-exempt by IRS and 1.08 million of them were 501(c)(3) charitable organizations. An estimated 274,000 of these charitable organizations filed returns—around 189,000 filed Form 990 and 85,000 filed Form 990-EZ. As shown in figure 2, the number of charitable organizations that were recognized as tax-exempt by IRS increased from more than 960,000 in 2003 to more than 1.28 million in 2010 (a 33 percent increase) but declined to 1.05 million in 2013 (a 18 percent decrease from 2010). After 2010, this decline was primarily due to the Pension Protection Act of 2006 (PPA), which mandated that any organization—large or small—that failed to file a required return or notice for three consecutive years would automatically lose its federal tax exemption. Since PPA’s passage, more than 570,000 organizations have lost their tax-exempt status through the automatic revocation process. The net effect on the number of charitable organizations (when new applicants and reinstated revocations are included) is an average decline of about 200,000 from the peak in 2010. Charitable organizations, excluding private foundations, represent a diverse array of mission areas and range greatly in asset size, the amount of revenue they raise, and their expenses. As shown in figure 3, the largest number of charitable organizations filing Forms 990 and 990- EZ were in the human services sector. However, the health and education sectors had the largest amount of assets. The human services sector represents 38 percent of the total population of charitable organizations that file Form 990 or 990-EZ returns, followed by the education sector at 18 percent and the health sector at 13 percent. For more information by mission category, see appendix III. All three sectors cover a diverse range of programs and serve different segments of the population. The human services sector includes activities related to employment, housing and shelter, and youth development. Education includes elementary, secondary, vocational, and technical schools and universities. Health includes hospitals, mental health and crisis intervention, and medical research. The assets of charitable organizations that file Forms 990 or 990-EZ returns are concentrated in the health and education sectors, which held about 75 percent of the total assets—more than $2 trillion—while the human services sector held almost $324 billion (or about 11 percent) of the total. In addition to being concentrated in a few sectors, a large proportion of total assets were controlled by a relatively small number of charitable organizations. Of the charitable organizations that file a Form 990 or Form 990-EZ, less than 3 percent held more than 80 percent of the assets, as shown in figure 4. These organizations were primarily from the health and education sectors. Over 59 percent of charitable organizations that file Forms 990 or 990-EZ returns (with less than $500,000 in assets) held less than 1 percent of all assets. Most of the expenses of charitable organizations that filed Form 990 were for program services, which are mainly activities that further the organization’s tax-exempt purposes. Total expenses of charitable organizations are broken down on the Form 990 into program service expenses, management and general expenses, and fundraising expenses. About eighty-seven percent of Form 990 charitable organization expenses in 2011 were for program services, about 12 percent for general management, and about 1 percent for fundraising. As we noted in our 2002 report, charitable organizations have discretion in determining how to charge and allocate expenses for program services, general management, and fundraising. The differences in methods can result in charities with similar activities allocating expenses differently among expense categories. This complicates interpretation of these data. For more information on expenses, see appendix III.