The Internal Revenue Service has decreased its oversight of charities in recent years due to budget cuts and political pressure.

A new report from the Government Accountability Office found that over the past several years, as the IRS budget has declined, the number of full-time-equivalent employees within its Exempt Organizations division has fallen, leading to a steady decrease in the number of charitable organizations examined. In 2011, the examination rate was 0.81 percent, but in 2013, it fell to 0.71 percent. This rate is lower than the exam rate for other types of taxpayers, such as individuals (1.0 percent) and corporations (1.4 percent), the GAO noted.

The IRS’s EO unit is grappling with several challenges that complicate oversight efforts, including the scandal that erupted last year after former EO director Lois Lerner’s admitted that the EO unit had used terms such as “Tea Party” to screen applications for tax-exempt status from political groups. But the problem goes beyond examinations of political groups, and the GAO report focuses on the charitable sector.

Although charitable organizations vary considerably in size and purpose, in 2011 the largest number of organizations was in the human services sector, providing services such as employment and housing assistance. The highest concentration of assets was in the health and education sectors, which include hospitals and universities. In addition to being concentrated in a few sectors, a large proportion of all assets were controlled by a relatively small number of charitable organizations—less than 3 percent hold more than 80 percent of the assets.

While the IRS’s EO division has some compliance information, such as how often exams result in a change of tax exempt status, it does not have quantitative measures of compliance for the charitable sector as a whole, for specific segments of the sector (such as universities and hospitals) or for particular aspects of noncompliance (such as personal inurement or political activity). Because EO does not have these measures and does not know the current level of compliance, it cannot set quantitative, results-oriented goals for increasing compliance or assess to what extent its actions are affecting compliance.

Statutory requirements for safeguarding taxpayer data limit both the IRS's ability to share data and state regulators' ability to use it, the GAO noted. “A lack of clarity about how state regulators are allowed to use IRS data to build cases against suspect charitable organizations further impedes regulators' ability to leverage IRS's examination work,” said the report.

The e-filing rate for tax-exempt organizations is significantly lower than for other taxpayers, the GAO noted, and this lower rate means there is less digitized data available for data analytics and higher labor costs for the IRS. Expanded e-filing may result in more accurate and complete data becoming available in a timelier manner, which in turn, would allow the IRS to more easily identify areas of noncompliance.

IRS oversight of charitable organizations helps to ensure they abide by the purposes that justify their tax exemption and protects the sector from potential abuses and loss of confidence by the donor community, the GAO noted. However, in recent years, reductions in the IRS's budget have raised concerns about the adequacy of IRS oversight.

GAO recommended that the IRS develop compliance goals and additional performance measures that can be used to assess the impact of enforcement activities on compliance and clearly communicate with state charity regulators how they are allowed to use IRS information related to examinations of charitable organizations. The GAO also recommended that Congress consider expanding the mandate for 501(c)(3) organizations to electronically file their tax returns to cover a greater share of filed returns. In written comments, the IRS agreed with GAO's recommendations.

“We appreciate your acknowledgment that the IRS Exempt Organizations (EO) Division has in recent years been operating in a challenging environment in which budgets and staffing have decreased while the number of organizations applying for and obtaining recognition of tax-exempt status has increased,” wrote IRS deputy commissioner for services and enforcement John M. Dalrymple in response to the report. “Despite these challenges, EO has worked diligently at the complex and sensitive task of overseeing and regulating the tax-exempt sector.”

He pointed out that in fiscal year 2014, the EO division developed new processes and tools to improve the application process for tax-exempt organizations and reduce the substantial backlog of applications that had accrued in recent years due in part to the receipt of applications for reinstatement from organizations whose status had been revoked under the automatic revocation requirements enacted in the Pension Protection Act of 2006. Starting in April of this year, he pointed out, the EO unit put in place a streamlined process that simplified and accelerated handling of all applications. But he added that the EO division recognizes the importance of continuing to promote compliance while making improvements to the efficiency of the determinations process.

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