The IRS and many sector leaders are concentrating on enforcement. Here is a round up of recent initiatives in that area.
Everson's Law: Enforcement + Customer Service = ComplianceOn March 15, IRS commissioner Mark W. Everson told an audience at the National Press Club that "scrutiny of the nonprofit sector will increase."
Everson's tenure as the IRS commissioner has been marked with an increased emphasis on enforcement; he has made enforcement in the tax-exempt sector one of the IRS's top four priorities. Everson used to lead the Office of Management and Budget, the executive agency in charge of proposing how the federal government should spend its money. He is now in charge of the agency that collects taxes to fund the government.
There is a new operating philosophy at the IRS. Some call it Everson's Law. According to Everson's Law, Enforcement + Customer Service = Compliance.
The IRS, an agency with a budget of $11 billion, is one of very few non-Defense, non-Homeland Security agencies to see a budget increase in this period of growing federal deficits. Everson's emphasis on increased compliance with the nation's tax laws is seen by many as a safe bet to closing the tax gap—an estimation of the nation's unpaid tax obligation.
Enforcement: IRS Cracks Down on Private Benefit in Credit Counseling AgenciesIn 2004, the IRS began targeting credit counseling agencies for review and audit examination. It has sent compliance letters to every credit counseling agency in the Business Master File of tax-exempt organizations and initiated audits of 63 of them. Each of the 41 audits completed so far has resulted in revoking the organization's tax-exempt status.
In theory, credit counseling organizations can provide a legitimate charitable mission, offering financial education, advice, and assistance. The importance of these nonprofits has grown because the Bankruptcy Reform Act of 2005 requires anyone who files for bankruptcy to visit a credit counseling agency first.
The IRS is finding that these organizations fail to provide a level of public benefit that warrants the privileges of tax exemption. Many offer little or no education or counseling, and many officers and directors of the nonprofit agencies also serve as officers and directors of related for-profit businesses.
"Over a period of years, tax-exempt credit counseling became a big business dominated by bad actors," said IRS commissioner Everson. "Our examinations substantiated that these organizations have not been operating for the public good and don't deserve tax-exempt status. They have poisoned an entire sector of the charitable community."
In addition to expanding compliance activities in the credit counseling area, the IRS has also tightened up its determination process. Of the 110 new applications for tax exemption for credit counseling, the IRS has rejected 95 and only approved 3. Twelve more applications remain under review.
See more information
Enforcement: IRS Addresses Political Activities by 501(c)(3) OrganizationsEarlier this year, the IRS released a report on political activity by 501(c)(3) organizations, including churches, during the 2004 political campaign. Organizations exempt under section 501(c)(3) of the tax code—i.e., private foundations and public charities, including churches—are prohibited from either supporting or opposing candidates for office.
The IRS found that "nearly three-quarters of the organizations examined under this initiative had engaged in prohibited political activities." Such activities included supporting or opposing candidates in printed materials, on Web sites, and from the pulpit; posting campaign signs; and giving preferential treatment to specific candidates by allowing them to speak at functions.
The IRS is continuing its Political Activity Compliance Initiative and has issued guidance for this year's elections. See more information on both the report on the 2004 election and guidance for the 2006 elections
Customer Service: Phone Forums Further Compliance through Education and OutreachCompliance is also aided by clear guidance and education opportunities. The IRS recently convened a free phone forum on executive compensation. This education or customer service program followed on the heels of a larger compliance effort by the IRS.
In 2004, IRS began an executive compensation initiative that explored a number of issues related to the compensation practices of tax-exempt organizations. More than 1,800 exempt organizations were contacted, and 600 examinations were initiated.
During the phone forum, the IRS identified the factors triggering a compliance check. All relate to improper or incomplete disclosure on IRS Form 990, the annual information return thousands of exempt organizations must file with the IRS and which are available on the GuideStar Web site.
One factor leading to a compliance check is failing to answer or answering "Yes" with no explanation on a question about sales, exchanges, or leasing of property on Schedule A, Part III. Part III deals with whether a nonprofit directly or indirectly engaged in acts such as leasing property, lending money, or furnishing goods, services, or facilities to substantial contributors, trustees, directors or other key employees or members of their families, or to any taxable organizations with which such a person is affiliated. These activities trigger a conflict of interest analysis by the IRS and raise questions about possible improper private benefit by nonprofit insiders.
Other triggers are an entry with no explanation on Line 50 of Part IV of Form 990, which involves receivables from officers, directors, or other key employees. No answer or a "Yes" answer with no explanation to questions about excise taxes imposed by IRS during the year due to excess benefit transactions can also trigger a compliance check.
Compliance checks differ from audits in that their goals are to alert organizations to reporting errors and to obtain further explanation by the nonprofit. There is no guarantee, however, that a compliance check will not result in an audit.
According to the IRS, nonprofits continue to struggle with setting reasonable compensation and making full and accurate disclosures on the Form 990. The IRS's educational outreach efforts will help clarify the rules surrounding nonprofit compensation and should result in better disclosures and improved compliance.
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More Money for IRS EnforcementThe response by many in the nonprofit sector to the proposals coming from the Senate Finance Committee is that more enforcement of current laws is preferable to new laws on the nonprofit sector. The reality at the IRS is that increased enforcement requires more resources. Additional resources can come from two sources—shifting resources from current expenditures or adding more resources to the IRS for enforcement.
Independent Sector is leading an effort to support additional resources to the IRS for increased enforcement. GuideStar supports these efforts. For more information, go to Independent Sector.
Dan Moore and Suzanne E. Coffman, June 2006
© 2006, Philanthropic Research, Inc. (GuideStar)
Dan Moore is GuideStar's vice president for public affairs. Suzanne Coffman is GuideStar's director of communications and editor of the Newsletter.