Inspector general faults IRS process for denying tax exemptions to charities

The Internal Revenue Service's Exempt Organizations unit needs to change its procedures and training when deciding whether to deny tax-exempt status to charities, according to a new report.

The report, released Thursday by the Treasury Inspector General for Tax Administration, came in response to a request from a group of 13 U.S. senators who had objected to the IRS's denial of tax-exempt status under Section 501(c)3 of the Tax Code, which covers charities and other types of nonprofits, such as religious and educational institutions and foundations. The IRS endured a scandal in 2013 involving its denial of tax-exempt status to a different set of groups, known as 501(c)4 organizations, which are supposed to be "social welfare" organizations, but have increasingly been used for political purposes. The IRS had denied tax-exempt status to groups using labels such as "Tea Party," "Patriot" and "Progressive" in their names, spurring complaints that such groups were being targeted and improperly denied tax exemptions. The scandal led to the departures of several top officials at the IRS, including the director of the Exempt Organizations unit and the acting commissioner of the IRS. Since that time, the IRS has reformed its procedures for granting and reviewing tax-exempt status under both Sections 501(c)3 and 501(c)4.

The IRS's Exempt Organizations Determinations unit is responsible for reviewing applications to determine whether the organizations qualify for 501(c)3 tax-exempt status and issuing determination letters. If the EOD specialist proposes to deny the tax exemption, organizations have a right to protest the decision. "Failure to follow established procedures and document all actions taken when processing proposed denials of tax exemption could lead to case processing delays, incorrect determinations, or denials of taxpayer rights," said the report. 

TIGTA found that determination case files were sometimes incomplete, however, and employees didn't always document the actions they took when processing proposed and final adverse determinations. The inspector general's review of all 68 proposed adverse determination case files that closed in fiscal year 2021 identified 40 case files (59% of the total) that were missing required documents or information needed to support the actions taken by EOD specialists and quality assurance reviewers. In 18 of the 68 cases (26%), EOD specialists didn't document their manager's agreement with the proposed adverse determination, as required. 

Samuel Corum/Bloomberg

However, TIGTA couldn't always confirm the EOD specialists and quality assurance reviewers carried out all the necessary actions to process the proposed adverse determinations on tax-exempt status because of that missing documentation. On top of that, EOD management didn't always effectively use the quality measurement process results to address the quality issues that had been identified. 

On the positive side, EOD specialists, quality assurance reviewers and managers did receive religious, civil and Constitutional rights training on how to determine if an organization was a church and they participated in discussions about the Bill of Rights and the Civil Rights Act of 1964, including freedom of religion and nondiscrimination based on religion. 

TIGTA recommended that the director of the IRS's Exempt Organizations unit make sure EOD specialists complete and managers review all of the required actions when processing proposed denials of tax exemption. The IRS should also require its EOD specialists to fully document discussions with taxpayers and actions taken, and require quality assurance reviewers to document that applicants did not submit a protest, TIGTA suggested. The report also recommended the IRS provide refresher training to EOD specialists and quality assurance reviewers; make sure the actions taken to address common quality deficiencies actually resolve the issues; and develop baseline goals for quality review scores and adjust them regularly as needed. IRS officials agreed with all of TIGTA's recommendations and plan to take corrective actions. 

In response to the report, Eric Slack director of employee plans at the IRS's Tax-Exempt and Government Entities division, pointed out that in fiscal year 2021, the IRS closed approximately 90,000 applications for Section 501(c)3 status, approving approximately 78,000 of them and denying only about 60 applications, while around 12,000 were closed in other ways, such as withdrawal by the applicant before a determination was made.

"We make determinations of tax-exempt status based solely on the facts, attestations and representations in the administrative file of each individual case," he wrote. "We are committed to respecting taxpayer rights in this process, including the right to be informed, to challenge the IRS's decision and be heard, and to appeal the IRS's position in an independent forum.

Separately, the investigative news site ProPublica reported Thursday that the IRS has fallen behind on releasing approximately half a million Form 990 information returns filed by tax-exempt organizations, another sign of the lingering delays and backlogs from the pandemic. In this case, that is making it difficult for charity watchdog groups to advise taxpayers who are making end-of-year charitable contributions about the worthiness of the organizations.