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TIGTA: IRS Needs to Improve Evaluation and Enforcement of Potentially Illegal Tax-Exempt Organizations

By:
S.J. Steinhardt
Published Date:
Oct 7, 2022

TIGTA logo

A pair of reports from the Treasury Inspector General for Tax Administration (TIGTA) has found fault with the way that the IRS's efforts to streamline applications for tax-exempt status, and to root out potential fraud, are still lacking.

One report found that more information is needed by the IRS to make informed decisions on the streamlined Form 1023-EZ applications for 501(c)(3) status under the Internal Revenue Code. This form, introduced in 2014 in response to budget cuts, as well as a controversy in which the agency was accused of targeting conservative groups for undue scrutiny, reduced the previous Form 1023 from 11 to three pages. It included nine boxes to check and a small blank for groups to describe their mission. 

This audit noted that “Form 1023-EZ requires applicants to attest, rather than demonstrate, that they meet the requirements for I.R.C. § 501(c)(3) status. For example, Form 1023-EZ applicants are not required to submit their organizing documents to the IRS; they instead attest that they meet organizational requirements,” determining that “the information provided on the Form 1023-EZ is insufficient to make an informed determination about tax-exempt status and does not educate applicants about eligibility requirements for tax exemption.”

"Without sufficient information on the streamlined application, the IRS may approve tax exemption for organizations that do not meet the legal requirements, and could allow unscrupulous individuals to use the exemption for illegal activities," the report read.

To test the application process, TIGTA submitted five fictitious 501(c)(3) applications, obtaining exemptions for four of them.

“Our undercover testing illustrates vulnerabilities in the IRS’s tax-exempt status determination process,” the report read.

These issues came to public attention in July, when the New York Times article how the IRS approved multiple fake charities that sought tax-exempt status. The story focused on one particular scammer who used the same address in Staten Island to apply for tax-exempt status for 76 fake charities using the names of seemingly legitimate-sounding nonprofits. In most cases, the scammer used the streamlined Form 1023-EZ.

The Times story prompted House Ways and Means Oversight Subcommittee Chairman Bill Pascrell (D-N.J.) to send a letter to IRS Commissioner Chuck Rettig, requesting answers to three questions about the controversy.

TIGTA recommended that the IRS:

- revise the activities description narrative on Form 1023-EZ;
- assess the feasibility of requiring applicants to submit their organizing documents as an attachment to Form 1023-EZ;
  - notify applicants when additional time is needed to process their Form 1023-EZ applications, and update online guidance with accurate information on the application process for Form 1023-EZ filers.

The IRS agreed with the second and fourth recommendations, and “will consider notifying applicants when their submissions need additional time to process.” In disagreeing with the first recommendation, the agency said that it believes that requiring detailed activity descriptions is unnecessary to make determination decisions.

In the other report, requested by Rep. Pascrell, TIGTA reviewed the IRS's enforcement program for tax exempt organizations that participate in illegal or nonexempt activities. It found that “both the IRS and State charity regulators are limited by their respective laws and procedures for coordinating with each other as a means to identity tax-exempt organizations potentially engaging in illegal or other nonexempt activities,” and that “no State Attorneys General Offices have formal disclosure agreements with the IRS.”

TIGTA examined The IRS’s Exempt Organizations and Government Entities function, which is responsible for oversight of tax-exempt organizations. In an audit of its closed referral database, it found inaccurate results for some cases, conflicting information on the final dispositions of some referrals, and thousands of missing data fields throughout because “referral database system controls do not require these fields to be completed prior to the case.”

“If the IRS does not identify potential illegal or fraudulent activities by tax-exempt organizations, unscrupulous individuals could take advantage of this preferred tax status to commit crimes,” it read. “This could result in diminished public trust in legitimate tax-exempt organizations.”

TIGTA recommended that the IRS should:

- ensure that Classification managers periodically emphasize to classifiers the importance of including supporting documentation in the case files for selecting or not selecting referrals for examination;
- implement referral database system controls to ensure that complete and accurate data is input into the database; and
- review the fields on the referral database and determine if any may be eliminated to avoid confusion, conflicting information in similar fields, and redundancy.

The IRS agreed with the recommendations and plans to take corrective action.

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