According to 2019 data, the Internal Revenue Service recognized approximately 1.9 million tax-exempt organizations in the United States. Of this population, more than 263,000 of the organizations were identified as either churches or religious organizations. This likely accounts for why the Internal Revenue Service received nearly 1.6 million tax-exempt returns in 2019. Unfortunately, tax-exempt organizations, including charities and religious organizations, may perpetrate fraud and abuse federal tax laws. The Treasury Inspector General for Tax Administration (“TIGTA”) recently performed an audit to assess the effectiveness of the Internal Revenue Service’s efforts to ensure the compliance of tax-exempt organizations.

Section 501 and the EO Function Examinations Unit

Section 501 of the Internal Revenue Code governs the tax provisions related to certain types of corporations, trusts, and other organizations that are exempt from federal taxes.[1] Many U.S. citizens are likely familiar with 501(c)(3) organizations (e.g., charities, churches, etc.), but Section 501 describes many other types of exempt organizations, including: agricultural organizations, chambers of commerce, and teachers’ retirement fund associations.[2] Most tax-exempt organizations are required to file an annual return or notice (e.g., Form 990, Return of Organization Exempt From Income Tax; Form 990-EZ, Short Form Return of Organization Exempt From Income Tax; Form 990-PF, Return of Private Foundation; Form 990-N, Electronic Notice (e-Postcard) for Tax-Exempt Organizations Not Required to File Form 990 or Form 990-EZ; and Form 990-T, Exempt Organization Business Income Tax Return). However, churches, for example, are exempt from such reporting requirements.[3]

As a part of the Internal Revenue Service’s Tax Exempt and Government Entities (TE/GE) Division, the Exempt Organizations (EO) function Examinations unit is responsible for oversight of tax-exempt organizations’ compliance with tax laws. Such “oversight” includes conducting examinations of exempt organizations to determine if: (1) the organization is organized and operated in accordance with its exempt purpose; (2) the organization has properly filed all required returns and forms; and (3) the organization or its related entities are liable for other taxes.[4]

According to TIGTA, 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. 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.[5]

TIGTA’s Final Audit Report – February 17, 2021

TIGTA performed an audit of the Internal Revenue Service’s policies and audit procedures related to tax-exempt organizations and also determine whether the IRS has sufficient information to fight abuse and enforce the federal tax laws. Requested by Representative Brad Schneider, a member of the House Ways and Means Committee, the review resulted in a number of determinations, including: the IRS faces obstacles in detecting noncompliance of tax-exempt organizations, case identification can be improved, and examiners generally followed procedures and obtained sufficient information to detect noncompliance of tax-exempt organizations.

Among its findings, TIGTA noted the following:

The more examinations that take place, the greater likelihood of detecting noncompliance; however, resources are limited. During FY 2019, there were almost 1.5 million Form 990 series returns and notices filed; however, the EO function examined approximately 2,000 (0.13 percent) Form 990 series returns during the same year. Put another way, an exempt organization’s chance of examination was one in 742. Meanwhile, although still low, the chances of examination for other kinds of entities are materially higher than that of exempt organizations.[6]

By comparison, the chances of a return filed in FY 2019 being examined for corporations was 1 in 156 and for individuals was 1 in 226. Moreover, TIGTA’s review also noted several other findings, such as:

In FY 2019, the EO Examinations unit did not examine approximately 20 percent of the tax-exempt organization returns selected for examination, resulting in an inefficient use of resources. Examiners and managers spent time reviewing unproductive cases that were surveyed instead of examined. In response to the recent Government Accountability Office report, the IRS agreed to analyze the reasons for non-examined closures and take actions to address them, so we are not making a recommendation for this issue. . . .

We identified a population of more than 263,000 churches and other religious organizations that IRS systems showed were not required to file tax-exempt annual information returns with the IRS. Of those, 39 (0.01 percent) organizations had 52 returns examined during FY 2019, which is about a one in 5,000 chance of examination. The EO managers and examiners we interviewed stated that they believe churches’ exemptions from filing annual information returns hinders detection of potential noncompliance. The IRS instead relies on other types of returns that churches and religious organizations must file, such as employment tax returns, to identify church noncompliance. The IRS may also identify church noncompliance through referrals.[7]

For more details related to TIGTA’s review and findings, see TIGTA’s Final Audit Report.

Conclusion

Based on TIGTA’s final audit report, continued improvement is necessary to ensure the Internal Revenue Service’s oversight of exempt organizations. The Internal Revenue Service also recognizes this. While resources are generally limited, the Internal Revenue Service suggests that it continually works towards an ongoing goal of identifying cases, detecting abusive or illegal activity, and operating within the parameters of current tax laws. Tax exempt organizations, particularly churches, enjoy a unique status with respect to federal tax laws, and it is this “unique status” (or the IRS’s limited resources) that can potentially create issues in detecting abuse.

[1] See I.R.C. § 501.

[2] Id.

[3] See generally I.R.C. §§ 6033, 7611.

[4] TIGTA, Obstacles Exist in Detecting Noncompliance of Tax-Exempt Organizations (Feb. 17, 2021).

[5] Id.

[6] TIGTA, Obstacles Exist in Detecting Noncompliance of Tax-Exempt Organizations (Feb. 17, 2021).

[7] Id.

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