IRS faces obstacles uncovering noncompliance of tax-exempt groups

The Internal Revenue Service is confronting some barriers in detecting improper conduct by tax-exempt organizations that abuse the federal tax laws, according to an inspector general report.

The report, released Monday by the Treasury Inspector General for Tax Administration, probed the Examinations unit at the IRS’s Exempt Organizations function, which is responsible for oversight of tax-exempt groups’ compliance with tax laws. The report found that for fiscal year 2019, the chance of examination for exempt organizations was one in 742, compared to one out of 156 for businesses, and one out of 226 for individual taxpayers. One obstacle facing IRS examiners is that churches and certain other religious organizations aren’t required to file annual information returns. That makes it difficult for IRS examiners to track the activities of those organizations to ferret out noncompliance. For fiscal 2019, the chance of examination for churches was about one in 5,000.

The report’s release comes as the IRS faces pressure in ensuring tax compliance while avoiding the perception of having a heavy hand, particularly when it comes to religious groups and charities. The IRS also came under pressure in 2013 when TIGTA released a report that found the Exempt Organization’s unit was using terms like “Tea Party” and “Patriot” to filter out applications for tax-exempt status from conservative groups and subject them to extra scrutiny, as well as the term “progressive” for liberal groups, ahead of the 2012 election. The scandal led to the departure of the director of the EO unit, the IRS acting commissioner and other top IRS officials. To mollify complaints from Congress about the long delays in approval, the IRS allowed groups to self-certify themselves for tax-exempt status before the IRS officially approves them. But the IRS also regularly receives complaints about groups abusing their tax-exempt status for private gain and needs to be able to respond.

Pamela Au/wingedwolf - Fotolia

“If the EO Examinations unit does not follow established procedures and effectively identify noncompliance, unscrupulous taxpayers may conduct abusive schemes using tax-exempt organizations for their own financial gain,” said the report. “This could cause taxpayers to question the integrity of all tax-exempt organizations and affect the amount of charitable contributions made to these important entities.”

The Compliance Planning and Classification function in the IRS’s Exempt Organization unit is responsible for identifying and selecting examination cases with potential noncompliance issues. But the report noted that in fiscal year 2019, 20 percent of tax-exempt organization returns selected for examination were closed without an examination being completed, resulting in an inefficient use of resources. For the examinations that are completed, there’s no formal feedback mechanism in place to track the results of each noncompliance issue identified by the examiners. However, the IRS is implementing a new process to improve the issue-tracking process.

On the positive side, TIGTA looked at a random sample of 53 of the 3,675 closed EO examination cases during fiscal year 2019 and found that examiners generally followed examination procedures. The EO examiners and managers claimed the EO function has enough information during examinations to detect noncompliance.

IRS employees are encouraged to submit ideas for future examinations through an online submission site, but during TIGTA’s interviews with EO examiners and managers, it discovered that, with the exception of receiving an acknowledgement notice, employees who make submissions don’t receive any kind of feedback or updates on them. The lack of feedback could discourage employees from submitting their ideas, the report noted, and perhaps result in missed opportunities to identify potential noncompliance.

The report recommended that the IRS EO unit’s Compliance Planning and Classification function should provide feedback to examiners who have submitted issues through the online submissions portal. The IRS agreed with the recommendation and plans to develop a process to offer feedback to examiners who have sent in issues through the online submissions portal, without violating internal control separation of duties for examination selection.

“TE/GE is focused on continuously improving our ability to provide oversight in an environment where, as your report observes, resources available to conduct audits are limited,” wrote Edward Killen, acting commissioner of the IRS’s Tax-Exempt and Government Entities Division, in response to the report. “The creation of the Compliance, Planning & Classification (CP&C) unit in 2017 reflects this effort as a comprehensive approach to identifying, researching and monitoring compliance risks using data analytics. TIGTA observes that case identification can be improved, and TE/GE continually works to this end.”

He pointed out that his division is piloting a data grid to record issue-specific exam results that CP&C can use to compare exam results with the compliance issues they’ve identified and adjust the criteria as necessary.