Tax-Exempt Organizations: Improvements Possible in Public, IRS,  
and State Oversight of Charities (30-APR-02, GAO-02-526).	 
                                                                 
The tremendous outpouring of charitable donations in response to 
September 11 has raised concerns about whether some charities are
spending too much on fundraising and management and too little on
the charitable purposes related to their tax-exempt status. GAO  
found that Form 990 expense data is inadequate for public	 
oversight purposes because charities have considerable discretion
in recording their expenses when it comes to fundraising,	 
management, and charitable services. The Internal Revenue Service
(IRS) lacks data on the type and extent of possible compliance	 
issues among charities. Moreover, IRS oversight of charities	 
suffers from a lack of results-oriented goals and strategies.	 
Concerns have also been raised that IRS's resources have not kept
pace with the growth in the charitable sector, and some measures 
suggest that available resources may not be used as effectively  
as in the past. State officials consider inadequate the charity  
data IRS shares with them. IRS does not proactively share some	 
data that states are permitted to receive, such as denials and	 
revocations of charities' tax-exempt status. Federal law	 
prohibits sharing some data that state officials believe would be
valuable, such as the status and results of examinations of	 
charities' returns.						 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-02-526 					        
    ACCNO:   A03194						        
  TITLE:     Tax-Exempt Organizations: Improvements Possible in       
Public, IRS, and State Oversight of Charities			 
     DATE:   04/30/2002 
  SUBJECT:   Charitable organizations				 
	     Data collection					 
	     Data integrity					 
	     Oversight committees				 
	     Tax exempt status					 

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GAO-02-526
     
Report to the Chairman and Ranking Minority Member, Committee on Finance, U.
S. Senate

United States General Accounting Office

GAO

April 2002 TAX- EXEMPT ORGANIZATIONS

Improvements Possible in Public, IRS, and State Oversight of Charities

GAO- 02- 526

Page i GAO- 02- 526 Oversight of Charities Letter 1

Results in Brief 2 Background 4 Objectives, Scope, and Methodology 6 Little
is Known About Form 990 Data Accuracy Despite Concerns

of IRS and Others 8 Imbalances Between IRS?s Charity Oversight Workload and

Resources Necessitate Better Planning to Improve Compliance and Resource
Decisions 20 Although Federal and State Officials Generally Support More IRS

Sharing of Data with States, Many Issues Must Be Considered 26 Conclusions
33 Recommendations 34 Agency Comments and Our Evaluation 35

Appendix I Description of Form 990 Reporting Requirements 37 What is the
Form 990? 37 What Law Governs Use of the Form 990? 37 How is the Form 990
Used? 37 How Has the Form 990 Changed Over the Years? 38

Appendix II Analysis of Form 990 Data on Expenses Reported by Charities 45

Methodology and Statistical Variations for SOI Data 45 Total Charities,
Revenues, Expenses, and Assets 46 Functional Expenses 46 Object Class
Expenses 48 Charity Assistance Expenses 50 Description of Charities by NTEE
Code 50 Description of Charities by Asset Category 52 Joint- Cost Reporting,
Part II of Form 990 53

Appendix III The Internal Revenue Service?s Application Process 55 What are
the Steps to Apply for Tax- Exempt Recognition as a

Charity? 55 Which IRS Employees Review Applications? 57 How is the Work
Assigned? 57 What does a Revenue Agent do when He or She Receives a Charity

Application? 58 Contents

Page ii GAO- 02- 526 Oversight of Charities

How do Revenue Agents make Determinations for Charity Applications? 58 What
Happens after a Determination Is Made? 58 Can a Charity Change Its Purpose
once a Favorable

Determinations Letter Is Sent? 59 How Long does the Determination Process
Take? 60 How does IRS Measure the Quality of Decisions and Adherence to

Procedures? 61

Appendix IV IRS?s Process for Examining Forms 990 Filed by Tax- Exempt
Organizations 62

Identifying and Selecting Which Returns to Examine 62 Initiating the
Examination 64 Doing the Examination 64 Reviewing the Quality of the
Examination 65 Data on Examinations 66 Revocations 67

Appendix V Overview of Selected Federal Agencies that Can Oversee Charities
69

FBI 69 FEMA 69 FTC 70 USPIS 70 OPM 71

Appendix VI Comments from the Internal Revenue Service 72

Appendix VII Comments from the Department of the Treasury 76

Tables

Table 1: Line Items as a Percentage of Program Service Expense, Filing Years
1994- 1998 16 Table 2: Number of Charity Applications Received and Disposed,

by Fiscal Year 21 Table 3: Number of Examinations and Examination Rates for

Charity Returns, by Fiscal Year 22

Page iii GAO- 02- 526 Oversight of Charities

Table 4: Availability of IRS Application and Examination Data on Charities
to States 28 Table: 5: Number of Denied Charity Applications, Revoked

Charities, and Notices of Tax Deficiencies Sent to Charities, Fiscal Years
1996- 2001 29 Table 6: Sample Size and Coefficients of Variation, by Filing
Year 46 Table 7: Number of Charities and Reported Amounts of Revenues,

Assets, and Expenses, by Filing Year 46 Table 8: Total Expenses, Total
Functional Expense Amounts, and

Total Expenses Reported as ?Other,? by Filing Year 47 Table 9: Total
Functional and Total ?Other? Expenses as a

Percentage of Total Expenses, by Filing Year 48 Table 10: Representation of
Line Item as a Percentage of

Functional Category Total 49 Table 11: Assistance From Charities, by Filing
Year 50 Table 12: NTEE Categories 51 Table 13: Description of NTEE Major
Group Categories 52 Table 14: Overview of Charities by Asset Category, by
Filing Year 53 Table 15: Joint- Cost Reporting, by Filing Year 54 Table 16:
Joint- Cost Allocation by Functional Expense Category, by

Filing Year 54 Table 17: Number of Exempt Organizations Field Technical
Staff

and Total Staff, by Fiscal Year in FTEs 66 Table 18: Average Hours Per
Charity Examination by Type of

Closure, All Examinations, by Fiscal Year 66 Table 19: Average Hours Per
Charity Examination by Type of

Closure, Non- CEP Examinations, by Fiscal Year 67 Table 20: Average Hours
Per Charity Examination by Type of

Closure, CEP Examinations, by Fiscal Year 67 Table 21: Primary Reasons for
Revocations by Fiscal Year, 1996-

2001 68

Figures

Figure 1: Charity Expenses for Program Services, General Management, and
Fundraising as a Percentage of Total Expenses, 1994- 1998. 9 Figure 2: Total
Expenses Compared to Percent of Total Expenses

Reported as ?Other,? 1994- 1998 11 Figure 3: Percent of Charitable
Organizations Receiving Public

Contributions and Reporting No Fundraising Expenses, 1994- 1998 12

Page iv GAO- 02- 526 Oversight of Charities

Figure 4: Functional Expense Categories and Related Lines for Specific
Expenses 14 Figure 5: Form 990 39

Abbreviations

AICPA American Institute of Certified Public Accountants GPRA Government
Performance and Results Act IRC Internal Revenue Code IRS Internal Revenue
Service NASCO National Association of State Charity Officials SOI Statistics
of Income

Page 1 GAO- 02- 526 Oversight of Charities

April 30, 2002 The Honorable Max Baucus Chairman The Honorable Charles E.
Grassley Ranking Minority Member Committee on Finance United States Senate

Millions of donors annually give hundreds of billions of dollars to
charities. 1 While this giving helps meet charitable purposes, congressional
and media concerns have arisen about whether some charities spend too much
on fundraising and general management and not enough on program services to
meet the charitable purposes related to the tax- exempt status. 2 Such
concerns have heightened since the outflow of charitable giving after the
tragedies of September 11, 2001.

Given these concerns, you asked us to review the oversight of charities.
Oversight relies on the public (including donors, organizations that oversee
charities- referred to as ?watchdogs?- and the media), the Internal Revenue
Service (IRS), and states. This combined oversight not only checks
compliance with relevant laws, but also guides the public?s decisions about
donations and stems abuses by charities. Although the common belief is that
the vast majority of charities strive to meet their charitable purpose, if a
few charities abuse the public trust, the support given to the charitable
community can be undercut.

This report focuses on the adequacy of (1) publicly reported Form 990 (see
app. I) data on charity spending in facilitating public oversight of

1 Charities, recognized by Internal Revenue Code (IRC) Section 501( c)( 3),
are exempt from paying income taxes on the funds collected for charitable
purposes. Charitable purposes include serving the poor and distressed;
advancing religious, educational, and scientific endeavors; protecting
various human and civil rights; and addressing various societal problems.

2 Also known as ?management and general,? the term ?general management?
refers to expenses for salaries, rent, professional fees, and other
management functions that are not directly allocated to program services or
fundraising.

United States General Accounting Office Washington, DC 20548

Page 2 GAO- 02- 526 Oversight of Charities

charities, 3 (2) IRS?s oversight of charities, and (3) IRS?s data sharing
with state agencies that oversee charities. In researching these issues, we
met with IRS and Department of the Treasury officials and reviewed IRS
documents. We did the same at state and watchdog groups that oversee
charities. We reviewed studies on charities and analyzed IRS?s data on its
oversight of charities and its Forms 990 on charity operations from filing
years 1994 through 1999. Data for more recent years were not available when
we did our work.

Publicly available data on spending by charities can facilitate public
oversight of charities, but the Form 990 data alone are not adequate for
such oversight, and caution is warranted in using the data. Although one
principal use of Form 990 data on charities? spending is to show the portion
of funds that a charity spends on its charitable purpose, the accuracy of
such data has not been measured. Various groups such as public watchdog
groups have expressed concerns about expense reporting, and IRS has found
and acted on instances of inaccurate reporting. However, IRS has not
assessed, and is just beginning to develop plans to assess, the extent to
which charities are properly reporting expenses.

Moreover, caution is warranted in using the Form 990 expense data,
especially to compare charities, because charities have considerable
discretion in recording their expenses in the program services, general
management, and fundraising categories. Different approaches for charging
expenses as well as different allocation methods can result in charities
with similar types of expenses allocating them differently among the three
categories. IRS has added a checkbox to the Form 990 to collect information
about whether a charity is using the guidance issued in 1998 by the American
Institute of Certified Public Accountants (AICPA) for allocating certain
types of fundraising expenses. IRS also is asking for comments on whether
adherence to this guidance should be required for certain charities.

IRS has neither data on the type and extent of possible compliance issues in
the charity community nor results- oriented goals and strategies for its
oversight of charities. As a result, it is difficult to make judgments about

3 IRS Form 990 is the return charities report their financial data annually
and other activities. Our analysis did not include 990- EZ or 990- PF
filers. Results in Brief

Page 3 GAO- 02- 526 Oversight of Charities

the adequacy of its oversight of charities. At the same time, concerns arise
about the adequacy of oversight because IRS?s resources have not kept pace
with the growth in the charitable sector, and some measures indicate that
available resources may not be used as effectively as in the past. From 1996
through 2001, IRS staffing for overseeing exempt organizations fell by about
15 percent while the number of applicants to become tax- exempt charities
increased 9 percent, and the number of Forms 990 filed by charities
increased 25 percent. The rate at which IRS examined these returns rose from
0.64 percent in 1996 to 0. 73 percent in 1998 and 1999, before falling to 0.
43 percent in 2001. Although IRS has plans to improve its oversight of tax-
exempt organizations, including some in the charity community, it does not
plan to measure the overall compliance of charities with federal tax laws
and Form 990 reporting requirements, and it has not developed long- term,
results- oriented goals, and a strategy for achieving them across charities.

State officials believe that inadequate data are shared by IRS to assist
them in overseeing charities. IRS does not proactively share certain data
that states are permitted to receive, such as denials and revocations of
charities? tax- exempt status. Furthermore, federal tax law prohibits
sharing certain data that state officials believe would be valuable, such as
the status and results of examinations of charities? returns. IRS has agreed
to develop plans to improve its sharing of data currently available to
states and to work with Treasury and state officials to explore possible
changes to federal law to expand data sharing with the states, coupled with
protections of the confidentiality of the data.

We are recommending that IRS ensure that it obtains reliable data on
charities? compliance with applicable laws and regulations- including for
Form 990 reporting- and develop longer- range, results- oriented goals and
strategic plans to help identify the level of oversight and resources that
IRS should devote to charities. In addition, we are recommending that IRS
develop in consultation with states better ways to share data as allowed by
law and, identify whether and how additional IRS data that are unavailable
to the states could be shared to enhance their charitable oversight while
protecting the confidential nature of the data in concert with the
Department of the Treasury and state officials.

We obtained comments on a draft of this report from IRS. (See app. VI.) IRS
agreed with the findings in the report and said that the agency would assist
in tax administration related to charities and identified the actions
underway or planned to address our recommendations. IRS also said that the
report did not sufficiently recognize certain ongoing agency efforts

Page 4 GAO- 02- 526 Oversight of Charities

related to the issues covered in the report. While the IRS?s letter provided
additional context on those issues, we believe the issues did not need
additional elaboration in the report. We did change our draft to more
explicitly recognize that IRS is beginning to develop plans to assess the
accuracy of charities? expense reporting. The Agency Comments and Our
Evaluation section discusses the IRS?s comments.

The Department of the Treasury?s Office of Tax Policy also provided comments
on this report. (See app. VII.) Treasury officials said they would continue
pursuing legislation to expand state access to selected IRS oversight data.

Internal Revenue Code (IRC) Section 501( c) establishes 27 categories of
tax- exempt organizations. The largest number of such organizations falls
under Section 501( c)( 3), which recognizes charitable organizations.
Generally, charities pay no income taxes on contributions received, but they
can be taxed on income generated from unrelated business activities. These
charities and related parties may be subject to several additional IRS
excise taxes and penalties for certain actions, such as not filing a
required tax return. Generally, taxpayers may deduct the amount of any
contributions to charities from their taxable income.

By 2000, IRS had recognized 1.35 million tax- exempt organizations under
Section 501( c), of which 820,000 (60 percent) were charities. 4 Social
welfare, labor, and business leagues accounted for 280,000 (21 percent) of
the tax- exempt organizations. The remaining organizations (about 19
percent) were exempt under other Section 501( c) categories. At the end of
1999, the assets of Section 501( c)( 3) organizations approached $1.2
trillion and their annual revenues approached $720 billion.

The term charitable, as defined in the regulations that underlie IRC Section
501( c)( 3), includes assisting the poor, the distressed, or the
underprivileged; advancing religion; advancing education or science;
erecting or maintaining public buildings, monuments, or works; lessening
neighborhood tensions; eliminating prejudice and discrimination; defending
human and civil rights; and combating community deterioration

4 Because IRS has not identified how many of these organizations have ceased
to be active, these numbers are likely to be overstated. The Treasury
Inspector General for Tax Administration has recommended that IRS take steps
to improve such data. Background

Page 5 GAO- 02- 526 Oversight of Charities

and juvenile delinquency. An organization must apply for IRS recognition as
a tax- exempt charity that strives to meet one or more of these purposes. In
general, a charity is to serve broad public interests, rather than specific
private interests.

Generally, public charities are required to file annual information returns
with IRS that are also available to the public. The larger charities file
Form 990, Return of Organization Exempt from Income Tax. Smaller charities-
with gross receipts of less than $100,000 and total assets of less than
$250, 000- are allowed to file an abbreviated Form 990- EZ. The smallest
charities, with less than $25,000 in gross receipts, and certain other types
of organizations, such as churches and certain other religious
organizations, are not required to file. The Form 990 is to be filed within
about 5 months of the end of the charity?s accounting year, with extensions
available.

Form 990 has 105 line items on 6 pages, as well as 45 pages of instructions.
The data on various finances and activities provide a basis for reviewing
whether the organization continues to meet the requirements for tax
exemption. The form also has two schedules: Schedule A and Schedule B.
Schedule A covers several areas, including compensation of employees and
independent contractors earning over $50,000 annually; lobbying activities;
sources of revenue; and relationships with noncharitable exempt
organizations, such as social welfare organizations. Schedule B is to be
filed by certain charities that receive contributions of $5,000 or more from
one or more donors. Charities may be required to file other forms in
specific situations. 5 Appendix I describes the Form 990.

IRS and various stakeholders- such as the states and ?charity

watchdogs?- oversee charitable operations to protect the public interest in
part by reviewing the Forms 990. Certain charities, including those
receiving federal and private grants, obtain independent financial audits.
To the extent that such audit information is available in conjunction with
Forms 990, those doing the oversight have more information on the financial
status of the charities, and individuals can make more informed

5 Forms include Form 990- T, Exempt Organizations Business Income Tax
Return, which reports taxable business income unrelated to a charitable
purpose; Form 1120- POL, U. S. Income Tax Return for Certain Political
Organizations, which reports net investment income of more than $100 and
spending to influence an election; and Form 4720, Return of Certain Excise
Taxes on Charities and Other Persons, which reports excess lobbying
expenses.

Page 6 GAO- 02- 526 Oversight of Charities

choices about donations to specific charities. Recognizing the importance of
public oversight and a ?free market?, where charities compete for donations,
Congress expanded public disclosure of and access to the Form 990. Such
oversight is important to help support charities, inform donors about how
their money is spent on a charitable purpose, and stem potential abuses.

Our objectives in this review were to analyze the adequacy of (1) publicly
reported Form 990 data on charity spending in facilitating public oversight
of charities, (2) IRS?s oversight activities for charities, and (3) IRS?s
data sharing with state agencies that oversee charities.

For the spending data reported by charities, we interviewed IRS officials
and experts (e. g., AICPA, the Urban Institute) to learn about charities?
reporting of expense data on the Form 990 and about independent financial
audits. We reviewed studies such as those done by the Urban Institute,
academicians, and the Chronicle on Philanthropy to better understand the
expense data. We analyzed expense data reported by charities on the Form
990. IRS?s Statistics of Income (SOI) Division had available data on charity
expenses, but those data only covered up to 1998 and did not include data on
?joint- cost allocations? (e. g., allocating selected expenses between
education and fundraising). 6 To obtain at least 2 years of joint- cost
data, we purchased filing years 1998 and 1999 data from the Urban Institute
which contracts with IRS to digitize Form 990 data for the full population
of charities that filed Form 990. For some large charities, primarily
hospitals, expense data such as by line items of the Form 990 were not
available to the Urban Institute. Thus, only joint- cost data and aggregate
data for expenses, assets, and revenues for 1999 are presented throughout
our report. Because several sources of data were used, data are presented by
filing, tax, and fiscal years in this report.

For IRS oversight of charities, we talked with responsible IRS officials to
identify oversight processes when charities apply for recognition of their
tax- exempt status and when IRS examines Forms 990 filed by charities. For
these types of oversight, we reviewed documentation on IRS?s processes and
criteria used to review applications and examined Forms

6 SOI collects its data through stratified random samples of all Forms 990
filed for a year. As a result, the weighted data estimates developed from
the samples are subject to sampling errors that affect their precision.
Appendix II discusses these data estimates and the sampling issues.
Objectives, Scope,

and Methodology

Page 7 GAO- 02- 526 Oversight of Charities

990. We also analyzed related data for fiscal years 1996 through 2001. For
applications, such IRS data included the number and types of applications
received and their dispositions. For examinations, such data focused on the
number and types of examinations and their results. In addition, we
contacted other federal agencies, such as the Federal Trade Commission, to
understand the types of oversight of charities that they conducted and the
extent to which they coordinated that oversight with IRS. Appendix V
discusses our selection of the agencies and our work.

For IRS data sharing with states, we interviewed IRS officials and reviewed
IRS documents. We did the same at the National Association of State Charity
Officials (NASCO), which represents 38 states that oversee charities to
protect public interests. We participated in an October 9, 2001, annual
NASCO conference. At the conference, we asked state officials about their
oversight and coordination with IRS or others. We talked with Treasury, IRS,
and state officials about the tradeoffs of changing the law to allow IRS to
share oversight data (e. g., examination results) with state charity
officials. We also reviewed related studies and articles.

For all three objectives, we collected documents from and talked with
officials at various organizations. We talked with officials at the Joint
Committee on Taxation about its reports in 2000 on disclosure of tax data on
charities and on public, IRS, and state oversight. On the basis of referrals
from IRS and NASCO, we talked with and collected documents from officials at
the Council on Foundations, the Independent Sector, the GuideStar project at
Philanthropic Research Inc., the Direct Marketing Association, and others
that were knowledgeable about charity data, oversight, or fundraising. We
reviewed documents from and talked with officials at three watchdog groups-
Better Business Bureau Wise- Giving Alliance, Charity Navigator, and
American Institute of Philanthropy- that oversee charities.

We also asked for comments on short sections or summaries of the draft
report from the organizations that provided data or perspectives on those
sections. We made technical changes to the report where appropriate after
receiving their comments. For example, we did not use the 1999 detailed
expense data from the Urban Institute after receiving its comments. The
Urban Institute did not have the necessary data to resolve certain
discrepancies with the detailed data (e. g., reported line item amounts not
equaling reported aggregate amount for expenses) before we issued the
report. As a result, we deleted analyses of the detailed expense data for
1999 that had been in the draft report.

Page 8 GAO- 02- 526 Oversight of Charities

We conducted our work in Washington, D. C., from June 2001 through March
2002, in accordance with generally accepted government auditing standards.
We provided a draft of this report to IRS for review and comment. IRS?s and
Treasury?s comments are in appendices VI and VII, respectively.

Although disclosure of charity spending data can facilitate public
oversight, caution in interpreting the data, is warranted. No measures are
available on the accuracy of the expense data and substantial discretion in
allocating the expenses makes use of the data problematic in comparing
charities. Given such data limitations, public oversight of charities cannot
rely solely on the expense data reported on the Form 990.

A key potential use of data on charities? spending is to show what portion
is spent on charitable purposes through program services (i. e.,
efficiency). In aggregate, the data show that from 1994 through 1998,
charities allocated, on average, 87 percent of their spending to charitable
program services and the remainder to fundraising and general management, 7
suggesting a high- level of spending efficiency, as shown in figure 1. These
percentages did not vary much by size of the charity. 8

7 Program services means activities that provide goods and services to
beneficiaries or members to fulfill the charitable purposes. Fundraising
means activities associated with soliciting funds. General management
includes salaries, travel, professional fees, and other expenses.

8 These percentages vary somewhat when analyzing only part of the charity
universe. For example, when analyzing only charities that reported
fundraising expenses, the percentages change to 85 percent for program
service, 13 percent for general management, and 3 percent for fundraising.
Note that, due to rounding, the total does not add to 100 percent. Little is
Known About

Form 990 Data Accuracy Despite Concerns of IRS and Others

Page 9 GAO- 02- 526 Oversight of Charities

Figure 1: Charity Expenses for Program Services, General Management, and
Fundraising as a Percentage of Total Expenses, 1994- 1998.

Source: SOI 1994- 1998.

Although Form 990 expense data are a principal source to support donors?
informed judgments about whether to support a charity, the accuracy of the
expense data has not been measured. At the same time, however, IRS officials
and watchdog groups have expressed concerns about potential or actual
inaccuracy in Form 990 expense data.

Because efficiency is a criterion that donors may use in selecting among
charities, charities have an incentive to report their expenses in a manner
that makes them appear to be efficient. IRS has discovered instances in
which charity fundraising expenses have been underreported because charities
have ?netted? such expenses against the funds raised. According to IRS,
fundraising expenses include fees paid to professional fundraisers as well
as in- house expenses (e. g., salaries) for fundraising.

For example, a charity might contract with a professional fundraiser to
raise donations. The fundraiser might raise $250,000, charge the charity a
fee of $150,000, and give the charity the remaining $100,000. When reporting
to IRS, the charity ?nets fundraising expenses? by reporting the $100,000 as
a direct public contribution and does not report the $150,000 Accuracy of
Form 990

Data Has Not Been Measured

12% 1%

Fundraising General management

Program services 87%

Page 10 GAO- 02- 526 Oversight of Charities

retained by the professional fundraiser as a fee. Such reporting does not
comply with IRS instructions, under which the charity should report the full
amount raised ($ 250,000) as the direct public contribution and the fee
retained by the fundraiser ($ 150, 000) on line item 30 of the Form 990.

As with netting of fundraising expenses, IRS has found that some charities
have misreported professional fundraising fees as ?other? expenses, but has
not measured the extent to which charities do this. In these cases, a
charity would report professional fundraising fees on line item 43 of the
Form 990, along with other expenses, rather than on line item 30 for such
fees. 9 IRS requires charities to itemize expenses on 22 different line
items on Form 990 and expressly prohibits reporting professional fundraising
or other fees on line item 43 with ?other? expenses that are not appropriate
for the accompanying 21 line items. Available data do not show the extent to
which charities may fail to properly itemize their expenses such as for
professional fundraising, but ?other? expenses represent a significant
portion of all reported expenses. Our analysis showed that for 1994 through
1998, on average, 26 percent of all expenses were reported as

?other? expenses, as shown in figure 2. 9 The Urban Institute and GuideStar
also have reported on problems they have found with some charities
misreporting fundraising expenses on Forms 990. GuideStar maintains, for
public use, a database of nonprofit organizations and charities, their
financial details, and their purposes and programs.

Page 11 GAO- 02- 526 Oversight of Charities

Figure 2: Total Expenses Compared to Percent of Total Expenses Reported as
?Other,? 1994- 1998

Source: Form 990; SOI, 1994- 1998.

Despite not knowing the extent of misreporting, IRS has been sufficiently
concerned that it has taken steps to better ensure charities properly report
their expenses, especially for fundraising. Regarding netting of fundraising
fees, IRS clarified its reporting instructions in 2001 and publicized the
changes. Regarding reporting fundraising (and ?other? fees) on the
designated Form 990 line item rather than on the ?other? expense line item,
IRS believed its instructions were clear, but has reiterated them in its
Continuing Professional Educational text for fiscal year 2002 and in
training for its examiners. IRS makes this text available to tax
practitioners and the public to inform them about the proper application of
tax laws and regulations. IRS is instructing its examiners during fiscal
year 2002 to check whether fundraising is being properly reported and to
impose penalties where appropriate. IRS plans to convene a taskforce to
consider what projects should be undertaken involving fundraising and Form
990 reporting, but the details have not yet been determined.

0 100

200 300

400 500

600 700

X 1998 1997 1996 1995 1994 Dollars in Billions

Years 26.2% 26.6% 26.2% 24.6% 25.2%

Total expenses Total expenses reported as other

Page 12 GAO- 02- 526 Oversight of Charities

Within the charitable community, various organizations have been concerned
about the accuracy of charitable expense reporting, with concerns often
focusing on fundraising expenses. A 1999 Urban Institute study of Form 990
expense data found that 59 percent of 58,127 charities that received public
donations either reported zero fundraising expenses or left this line item
blank on the Form 990. Using the same criteria as the Urban Institute, our
analysis of the Form 990 data from 1994 through 1998 found the number, on
average, to be 64 percent, as shown in figure 3. 10

Figure 3: Percent of Charitable Organizations Receiving Public Contributions
and Reporting No Fundraising Expenses, 1994- 1998

Source: SOI 1994- 1998.

Charity experts have noted that those receiving donations are likely to
incur some fundraising expenses, depending on certain circumstances (e. g.,
size or area of operation). The Urban Institute found it perplexing

10 We did similar analyses for all charities, regardless of whether they
received public donations. From 1994 to 1998, 69 percent of all charities
reported either no fundraising expenses or left this line item blank (line
item 15) on the Form 990. We further analyzed how many charities reported no
fees paid to professional fundraisers on the Form 990 from 1994 through
1998. On average, over 93 percent of all charities reported either no fees
paid to professional fundraisers or left this line item blank (line item 30)
on the Form 990.

0 10

20 30

40 50

60 70

80 90

100 J I H G F 1998 1997 1996 1995 1994 Percentage reporting no fundraising
expenses

Years 62.6 64.3 63.4 64.4 65.8

Page 13 GAO- 02- 526 Oversight of Charities

that so many charities would report no fundraising expenses, but
acknowledged that several factors could account for low fundraising
expenses. 11 For instance, it noted that the smaller the amount of funds
raised, the less likely charities may be to incur fundraising expenses.
However, the Urban Institute did not indicate the amount that could be
raised without incurring fundraising expenses. Thus, it would not be
surprising for some charities, such as small ones or newer ones, to have
little or no fundraising expenses.

The Urban Institute also notes that charities that raise revenues through

?special events and activities? (Form 990, line item 9c) may legitimately
report little or no fundraising expenses. When we accounted for those
reporting special event expenses among those represented in figure 3, we
found that, on average for 1994- 1998, 34.8 percent of all remaining
charities that received contributions did not report fundraising expenses.

In addition, various articles have discussed problems in charities?
reporting of fundraising expenses. For example, a May 2000 article in the
Chronicle of Philanthropy discussed how some charities leave the ?public

in the dark? by not reporting fundraising expenses. 12 The article discussed
how some charities in three states reported no fundraising expenses on the
Form 990, although state records indicated that they had such expenses.

Charities have discretion in determining how to charge expenses to program
services as well as allocating expenses among the Form 990 functional
categories for charitable program services, general management, and
fundraising. The differences in the methods used can result in two charities
with similar activities allocating their expenses differently among the
functional expense categories on the Form 990. Figure 4 shows the three
functional expense categories and the related lines for specific expenses.

11 The Urban Institute also has discussed how the amount of fundraising
reported can be skewed when supporting charities raise funds for affiliates.
In such cases, IRS instructions state that the supporting charity should
report these expenses as fundraising.

12 ?Charities Zero Sum Game: By Claiming No Fundraising Costs, Groups Keeps
the Public in the Dark?, Chronicle of Philanthropy, May 18, 2000. Charities
Have Discretion

in Determining How to Charge or Allocate Expenses to Program Services

Page 14 GAO- 02- 526 Oversight of Charities

Figure 4: Functional Expense Categories and Related Lines for Specific
Expenses

 Expense object classes

13 Program services (from line 44, column (B)) . . . . . . . . . . . . 13 14
Management and general (from line 44, column (C)). . . . . . . . . . 14 15
Fundraising (from line 44, column (D)) . . . . . . . . . . . . . 15 16
Payments to affiliates (attach schedule) . . . . . . . . . . . . . 16 17
Total expenses (add lines 16 and 44, column (A)) . . . . . . . . . . 17

Expenses

Page 15 GAO- 02- 526 Oversight of Charities

Although the three expense categories differ, their boundaries overlap.
Fundraising activities may be mixed with program services, especially when a
charity provides education related to its charitable purpose in a
fundraising solicitation. Similarly, general management expenses may be
mixed with the delivery of program services and fundraising. Charity
employees may, for instance, spend time managing the daily support of the
charity, spend time participating in raising funds, and spend time providing
program services.

We analyzed the portions of total program service expenses (line item 13 of
Form 990) during 1994 through 1998 that came from (1) grants and specific
assistance (line items 22 and 23) that can only be charged to program
service expenses to meet the charitable purpose or (2) expenses such as
salaries, travel, etc. (line items 24 through 43) that can be charged to the
program service, fundraising, and general management categories. It is
important to recognize that expenses such as salaries and travel can be
charged to program services when they are incurred in connection with
meeting the charitable purpose. Table 1 shows the analysis of the types of
expenses comprising program service expenses. Many Types of Expenses

Comprise Program Service Functional Expenses

Page 16 GAO- 02- 526 Oversight of Charities

Table 1: Line Items as a Percentage of Program Service Expense, Filing Years
1994- 1998

Line item object classes 1994 1995 1996 1997 1998 5- year

average

Grants and allocations 5. 8 5.3 5. 2 5.8 6. 5 5.7 Specific assistance to
individuals 1.6 0. 7 7.1 8. 8 1.2 3. 9

Grants and specific assistance, subtotal 7.4 6. 0 12.3 14.6 7. 7 9.6

Benefits to/ for members 2. 7 6.9 0. 6 0.7 0. 8 2.3 Compensation to
officers, directors 0. 6 0.7 0. 7 0.7 0. 8 0.7 Other salary & wages 34.5
32.6 32.6 32.7 36.4 33.8 Pension contributions 1. 1 1.1 1. 1 1.0 1. 1 1.1
Other employee benefits 4. 2 3.9 3. 7 3.6 3. 9 3.9 Payroll taxes 2. 3 2.2 2.
2 2.1 2. 3 2.2

Compensation related, subtotal 45.5 47.3 41.0 40.9 45.2 44.0

Professional fundraising fees a a a 0.01 0.02 0.01 Supplies 8. 3 7.9 8. 2
8.1 8. 9 8.3 Occupancy 2. 6 2.5 2. 6 2.6 2. 9 2.6 Depreciation, depletion,
etc. 3.7 3. 8 3.8 3. 8 4.2 3. 8 Travel 0.8 0. 7 0.8 0. 7 0.8 0. 8
Miscellaneous other categories b 4.9 4. 7 4.7 4. 6 4.9 4. 8 Other expenses
(line 43) 26.8 27.2 26.7 24.8 25.5 26.2

All other expenses, subtotal 47.1 46.7 46.7 44.6 47.2 46.4 Total 100 100 100
100 100 100

Note: Totals may not add to 100 percent due to rounding. a Professional
fundraising fees were allocable only to the fundraising expense column.

b Includes accounting fees, legal fees, telephone, postage and shipping,
equipment rental and maintenance, printing and publications, conferences,
conventions and meetings, and interest. Source: IRS SOI data.

Charities can use different methods (which are not reported on the Form 990)
for charging and allocating expenses. Such differences can affect
comparisons across charities. Thus, charity watchdog groups, organizational
donors, or others may draw inappropriate conclusions when comparing the
expenses charged to program services or allocated across the three
functional categories. Neither IRS nor the professional accounting
accrediting bodies require or prohibit particular allocation Expense
Allocation Methods

Affect Comparisons Among Charities

Page 17 GAO- 02- 526 Oversight of Charities

methods. In general, any method for charging or allocating expenses should
be reasonable, logical, and consistently applied given the circumstances and
facts. Organizations that provide funds or grants to charities are likely to
provide guidance or requirements for charging and allocating expenses and to
require independent financial audits.

Among the methods for allocating joint fundraising costs, the three methods
mentioned routinely by accounting professionals and in accounting texts are
the: (1) physical units method, (2) relative direct cost method, and (3)
stand- alone joint- cost allocation method. Each method can produce a
different financial ?portrait,? and no one method is appropriate for all
circumstances.

The method used determines the allocation of expenses among fundraising,
program services and general management. For example, suppose a charity
contracts with an external fundraiser to conduct a mail solicitation in
which the letter combines program service (education) and fundraising text
over 100 lines. The fundraiser?s $1 million fee covers expenses for
identifying potential donors and creating and mailing the letter. The
charity must devise a way to equitably allocate the fundraiser?s expenses.
One way is to use the physical units method of allocation. The physical
units method uses identifiable, measurable, and calculable physical aspects
of fundraising instruments to allocate expenses. In this example, the
physical aspects are the number of text lines in the solicitation letter. If
10 lines of text covered fundraising and 90 lines covered program services,
an allocation based on counting lines would allow the charity to allocate
$100,000 to fundraising and $900,000 to program services.

However, this method of allocation may be inappropriate if most of the
expenses incurred actually related to the use of the donor mailing list- the
value of which relates more to fundraising than to program services. The
stand- alone joint- cost- allocation method might provide a more reasonable
allocation in this circumstance. If this method were used, and if $750,000
of the fundraiser?s fee covered the value of its mailing list, at least
$750,000 of the $1 million in total costs would be for fundraising and no
more than $250,000 would count for program services. Thus, the method used
can materially influence the allocation of a charity?s expenses.

In March 1998, the AICPA published Statement of Position 98- 2 (SOP 98- 2)

?Accounting for Costs of Activities of Not- for- Profit Organizations and
State and Local Governmental Entities That Include Fundraising? to

Page 18 GAO- 02- 526 Oversight of Charities

provide guidance on the allocation of joint activities, such as those when
program services and fundraising are involved. SOP 98- 2 was intended to
provide consistent, clear, and detailed guidance for reporting joint
activities. SOP 98- 2 sets three criteria (purpose, audience, and content)
that must be met to allocate such joint- cost expenses to the Form 990
program services or management and general categories, rather than to
fundraising. The three SOP 98- 2 criteria are:

 Purpose: should show that fundraising activities will help meet a program
service or general management purpose.

 Audience: should show that donors are selected to meet a program service
or a general management purpose rather than to contribute only funds.

 Content: should show that the content of the joint activity supports the
charity?s program service or general management purpose.

According to AICPA, if any of these criteria are not met, then all expenses
should be allocated to fundraising. All three criteria require a call for
action in order to allocate expenses to program services. A call for action
makes general requests for involvement with an activity or cause, regardless
of whether the individual contributes funding to those requesting the
involvement. Absent a call to action, SOP 98- 2 recognizes the activity as
fundraising, and no expenses should be allocated to program services.

IRS added a checkbox to the 2001 Form 990 to indicate whether SOP 98- 2 had
been used to account for joint costs. IRS noted that the purpose was to
facilitate the understanding of those reading the Form 990. IRS also is
asking for comments on whether the use of SOP 98- 2 should be required for
certain filers (such as those above a specified amount of assets) to ensure
greater uniformity in expense allocations and better comparison of
fundraising expenses across charities. According to an AICPA official,
charitable organizations may use this guidance, regardless of their
accounting method.

Caution in relying on Form 990 expense data for public oversight of
charities is also warranted because spending efficiency can vary for a
number of reasons. Charity watchdog groups, GuideStar, the Urban Institute,
and others have spoken against reliance on spending efficiency ratios as the
sole measure of a charity?s worthiness. The expense data and related
efficiency ratios (such as program service expenses compared with all
expenses) do not provide much perspective on other attributes of Evaluating
Charities Relies

on More than Ratios on Spending Efficiency

Page 19 GAO- 02- 526 Oversight of Charities

charities, such as how well they accomplish their charitable purpose,
regardless of the amounts spent.

Charity watchdogs have evolved to help monitor charities and enhance public
oversight. In general, within the resources they have, these watchdog groups
use the Form 990 data and other available data to analyze aspects of
selected charities. These watchdog groups analyze spending efficiency
ratios, but note limitations that could mislead the public on which
charities are and are not doing well. Spending efficiency fluctuates with
factors such as the popularity of the cause, age of the charity, and type of
charitable activities. For example, an established, wellknown charity may
spend more money on fundraising than a newer charity. A charity also may
have wide swings in its spending for charitable purposes if, for instance,
those purposes are affected by sudden changes from events such as natural
disasters. Also, a charity saving funds to build a facility to serve its
charitable purpose may have no program service expenses until adequate funds
are raised to begin the project.

When evaluating a charity, the public also considers how well a charity
accomplishes its charitable purposes, which is not measured by spending
data. However, measuring accomplishments and comparing charities on that
basis is difficult to do according to the Independent Sector, the Urban
Institute, and others (such as academicians). Given the wide diversity in
the charity community, no standard rules have been devised to guide
charities in reporting accomplishments. The Form 990 has a section that asks
charities to report what was accomplished with the program service expenses;
IRS?s instructions allow discretion on reporting those accomplishments.

Other standards that the charity watchdog groups have suggested for
evaluating charities include the manner in which the charity governs itself,
raises funds, informs the public, accounts for its finances, prepares
budgets and financial documents, and has independent audits or reviews. Each
of these standards can be viewed as contributing information that can be
useful for evaluating charities.

Page 20 GAO- 02- 526 Oversight of Charities

Determining the adequacy of IRS?s oversight of charities is difficult, in
part, because IRS has little data on the compliance of charities, and
because IRS generally has not established results- oriented goals for its
oversight of charities against which to measure progress. Concerns also
arise with the adequacy of oversight because IRS has not kept up with growth
in the charitable sector. IRS staffing for overseeing tax- exempt
organizations fell between 1996 and 2001 while at the same time the number
of new applications for tax exemption and the number of Forms 990 filed
increased. By shifting staff, IRS has continued to process new applications
and, as a consequence, has generally decreased its examinations of existing
charities.

IRS has recognized that its oversight of charities and other tax- exempt
organizations is limited and is formulating plans to measure tax- exempt
organizations? compliance levels and improve its oversight activities.
Because IRS does not have an accurate picture of charities? compliance and
it is unclear how its plans would yield such data, IRS lacks key information
for making decisions on how much charity oversight is needed, the amount of
resources needed for the oversight, and how to improve its use of available
resources. In addition, IRS?s plans for improving its oversight activities
generally do not define what results it intends to achieve in overseeing
charities.

IRS oversight of charities primarily consists of two activities. First, IRS
reviews and approves applications filed by charities for the recognition of
tax- exempt status. Second, IRS annually examines a small percentage of the
annual returns filed by charities. Through these activities, IRS tries to
ensure that charities merit the recognition of a tax- exempt status as well
as the retention of it.

In carrying out these two functions, IRS generally is not responsible for
taking adverse actions or even suggesting improvements in a charity?s
operations based on evidence about how well a charity spends its funds or
meets its charitable purpose. Rather, IRS focuses on other issues related to
the tax exemption for charities. For instance, in reviewing applications for
recognition as tax- exempt charities, IRS focuses on whether applicants plan
to undertake activities that meet the criteria for tax- exempt status and
that adhere to standards such as restrictions on private benefits accruing
to charity officials. Similarly, when examining charities? Forms 990, IRS
checks for compliance with specific requirements applicable to charities,
such as meeting a recognized charitable purpose. On the basis of discussions
with IRS and state officials, oversight of charities? efficiency Imbalances
Between

IRS?s Charity Oversight Workload and Resources Necessitate Better Planning
to Improve Compliance and Resource Decisions

IRS Focuses on Reviewing Applications and Examining Annual Returns

Page 21 GAO- 02- 526 Oversight of Charities

and effectiveness is more likely to be accomplished through the public?s
decisions about which charities to support and through states? efforts to
ensure that charities do not abuse their charitable status.

As for oversight of applications, IRS revenue agents review the applications
of organizations seeking tax- exempt status as charities. If an application
is approved, IRS provides a letter to the charity approving its tax- exempt
status. Comparing fiscal years 1998 through 2001, the number of applications
for charity status submitted to IRS has increased from about 54,000 to about
59,000, or about 9 percent, as shown in table 2. Over all 4 years, the
number of applications denied stayed below 100. (See app. III for a
description of the application process.)

Table 2: Number of Charity Applications Received and Disposed, by Fiscal
Year Types of disposals of applications Fiscal year Applications

received Approved Denied Did not submit fee Withdrawn

by charity Did not

submit all documents

1998 54,119 36,743 73 1, 473 883 11,056 1999 50,724 39,281 39 764 890 8,433
2000 58,029 45,233 59 390 899 8,853 2001 58,938 42,308 58 450 894 9,204

Note: IRS did not have the data for fiscal years 1996 and 1997. Source: IRS
data.

In examinations, IRS seeks to ensure that charities meet federal tax
requirements. In examining a return, the revenue agent requests and reviews
information from a charity to check the accuracy of items on the return and
to verify that a charity is operating to meet a charitable purpose. As shown
in table 3, comparing fiscal years 1996 through 2001, the number of annual
returns (Forms 990) increased from about 228,000 to about 286,000 (25
percent) while the number examined dropped from 1,450 to 1,237 (15 percent).
Thus, IRS examined a smaller percentage of returns and charities-- dropping
by 2001 to 0.43 percent and 0.29 percent, respectively. (See app. IV for a
description of the examination process.)

Page 22 GAO- 02- 526 Oversight of Charities

Table 3: Number of Examinations and Examination Rates for Charity Returns,
by Fiscal Year Fiscal year Number of annual

returns filed Number of annual returns examined Examination

rate (returns) Number of charities examined Examination

rate (charities)

1996 228,013 1, 450 0.64 896 0.39 1997 231,161 1, 584 0.69 946 0.41 1998
260,885 1, 912 0.73 1,238 0.48 1999 235,333 1, 723 0.73 1,294 0.55 2000
273,649 1, 294 0.47 875 0.32 2001 285,733 1, 237 0.43 835 0.29

Note: Because some examinations of larger charities involve Forms 990 filed
for more than 1 year, the number of returns examined exceeds the number of
charities examined each year.

Source: IRS examination data.

In addition, examinations are taking longer. (See app. IV for the results.)
For fiscal years 1996 through 2001, the time required to examine charity
returns nearly tripled when a charity agreed to changes proposed by IRS and
increased about seven times when a charity disagreed. IRS officials did not
know the reasons for such increases in time and were concerned. Given the
concern, IRS has started analyzing ways to better select the most
noncompliant returns for examination. The date for completing the analysis
was not set, as of March 2002.

At least three related reasons help explain the decline in the number of
charity examinations. First, IRS has had to adjust the level of charity
oversight given many other priorities involving all other types of
taxpayers. Second, the resources devoted to oversight dropped for fiscal
years 1996 through 2001. Last, IRS moved revenue agents from doing
examinations to processing the increased application workload.

IRS has many other priorities as the agency that collects the proper amount
of revenue to fund the programs that Congress and the executive branch have
approved. For example, to deal with millions of individual and business
taxpayers, IRS has established four operating divisions organized around the
type of taxpayer- Wage and Investment, Small Business/ Self- Employed, Large
and Mid- Size Business, and Tax- Exempt and Government Entities (TE/ GE).
TE/ GE deals with charities, many other types of exempt organizations,
pension plans, Indian tribal governments, and other types of government
entities. Each of these activities competes Multiple Priorities and

Limited Resources Contribute to Fewer Examinations

Page 23 GAO- 02- 526 Oversight of Charities

for staffing and funding. Furthermore, although TE/ GE has the major charity
oversight role among federal agencies, 13 its oversight is limited.

The staffing devoted to IRS?s exempt organization function and oversight has
declined in recent years. IRS was unable to provide the staffing levels for
reviewing charity applications and examining the Form 990. However, from
fiscal years 1996 through 2001, total staffing for the exempt function has
fallen from 958 to 811, or about 15 percent. For application and examination
oversight of all exempt organizations, the staffing fell from 609 to 546, or
about 10 percent. A 1997 IRS memorandum pointed out that the staffing level
for the entire organization that is now TE/ GE had been essentially flat
since its creation in 1974 (2,075 in 1974 to 2,123 in 1997) while the
workload in terms of the size of the sectors that it regulated had doubled.

IRS also shifted revenue agents from doing examinations to help process the
increasing application workload. Because all applications must be processed
and oversight staff had not increased, IRS moved agents from doing
examinations. In fiscal year 2001, IRS took steps to hire about 40
additional staff to help process applications, which would allow revenue
agents to return to doing examinations.

Given increased workload and declining resources, IRS officials are
developing an approach to better gauge the extent and types of compliance
issues for tax- exempt organizations and to improve their oversight
strategies. However, the current approach would not provide information on
compliance problems of the full charitable community. Nor does it define the
overall results IRS hopes to achieve in a manner that would facilitate
strategic investments of resources and that can be used to assess IRS?s
overall progress in improving its oversight strategies.

IRS?s new approach is to study segments of the tax- exempt community, that
is, market segments, to better understand existing compliance issues. 14
Through these studies, IRS intends to develop indicators of

13 Appendix V discusses the limited oversight roles provided by other
selected agencies such as the Federal Trade Commission and United States
Postal Inspection Service. 14 Market segments involve homogeneous groups of
tax- exempt organizations. IRS also plans to start 9 compliance projects in
2002 to address known areas of noncompliance such as unrelated business
income. New IRS Approach to

Improve Compliance and Oversight Will Not Cover All Charities and Does Not
Define Desired Compliance Results

Page 24 GAO- 02- 526 Oversight of Charities

compliance for 35 selected market segments and analyze ways to address
compliance problems. According to IRS, the results of the market segment
studies are intended to help refine the selection criteria for identifying
noncompliant returns for examination as well as help identify other
strategies to improve compliance such as additional guidance, clearer
instructions, or correspondence on apparent noncompliance. Understanding
compliance problems and measuring compliance among the various types of
charities also is intended to help determine where to focus resources.

As of February 2002, about half of the selected segments dealt with a wide
variety of tax- exempt organizations that were not charities and about half
dealt with various types of charities such as those for hospitals, colleges,
and churches. 15 It was not clear how IRS would use the results to get a
picture of compliance across all charities, even though charities account
for most of the applications and Forms 990. Without an understanding of the
extent and nature of compliance problems across all charities, IRS will have
difficulty in making data- driven decisions about the strategies for
improving oversight as well as the level of oversight and resources needed.

IRS plans to start work on these market segments as resources and data
allow. Due to resource limitations, IRS believes that at the present rate
the completion of all planned studies will take until fiscal year 2008.
During fiscal year 2002, IRS plans to work on six segments. 16 IRS officials
said that they selected segments based on experience and judgment.

As part of IRS?s overall performance management system, TE/ GE has developed
a plan to guide its operations. That plan covers TE/ GE?s responsibilities,
including those for charities. The plan specifies, for instance, the number
of employees to be assigned to each activity, the number of applications and
examinations IRS expects to process, and how long such activities take, and
the satisfaction of tax- exempt organizations with IRS?s services and its
employees.

15 The other charity segments include organizations involving amateur
athletics, childcare, community trusts, economic development, education,
grant making, health maintenance, low- incoming housing, nursing homes,
private foundations, religious organizations, schools, science and research,
social service, charitable support, charitable trusts, and veterans.

16 These include social clubs, labor organizations, business leagues,
community trusts, social service organizations, and religious organizations
that are not churches.

Page 25 GAO- 02- 526 Oversight of Charities

For fiscal years 2003 and 2004, TE/ GE has proposed staffing increases in
two initiatives for known concerns. Although the proposed increases do not
focus on charities, their implementation might assist IRS?s charitable
oversight. One initiative calls for adding 20 staff to work on improving the
quality and quantity of IRS data and studying uses of non- IRS databases.
The second initiative requests 30 additional staff to enhance IRS?s
examination presence in the exempt organization community. IRS officials
said both initiatives would require similar increases in staff during future
years.

Although TE/ GE?s plan and initiatives provide an understanding of what IRS
intends to do with its staff and other resources, IRS has not identified
what longer- range results it intends to achieve for charities. The planning
principles in the Government Performance and Results Act (GPRA) and
incorporated into IRS?s Strategic Planning, Budgeting, and Performance
Management process call for agencies to define the measurable results they
are attempting to achieve, generally over several years. This approach is
intended to ensure that agencies have thought through how the activities and
initiatives they are undertaking are likely to add up to a meaningful result
that their programs are intended to accomplish. The TE/ GE plan does not,
for instance, provide goals for improving the compliance levels of tax-
exempt organizations as a whole or for charities in particular. The plan
also does not discuss the basis for IRS?s judgment that the proposed
initiatives are the best ways to improve compliance.

IRS officials said that longer- range planning could be useful. They noted,
however, that their ability to undertake significant initiatives for
charities must be considered in the context of IRS?s overall
responsibilities. Furthermore, they said that establishing a link between
their activities and changes in charities? compliance is challenging and
this makes planning to achieve certain types of results difficult. Many
agencies face this challenge. 17 However, GPRA?s and IRS?s planning
requirements suggest that the process of focusing on intended results, while
often challenging, promotes strategic and disciplined management decisions
that will be more likely to be effective than planning that is not results-
oriented.

17 See General Accounting Office, Managing for Results: Using GPRA to Assist
Oversight and Decisionmaking, GAO- 01- 872T, (Washington, D. C.: June 19,
2001) and Managing for Results: Federal Managers? Views Show Need for
Ensuring Top Leadership Skills,

GAO- 01- 127, (Washington, D. C.: Oct. 20, 2000).

Page 26 GAO- 02- 526 Oversight of Charities

IRS data sharing with the states to facilitate state oversight of charities
is limited in two ways. First, IRS does not have a process to proactively
share data that it is allowed to provide to states, such as data on the
denial or revocation of tax- exempt status. Second, federal law generally
prohibits IRS from sharing data with states about its reviews of
applications for recognition of charities and its examinations of existing
charities. State officials believe that accessing IRS?s oversight data would
help them allocate resources in overseeing charities. Because federal
taxpayer data are subject to statutory confidentiality protections, a number
of issues, such as security procedures to protect federal tax data, would
need to be considered if data sharing were expanded.

Many states oversee charities to protect the public. Although overlap
exists, IRS and state oversight differs. IRS focuses on whether the charity
meets tax- exempt requirements and complies with federal laws, such as those
governing the use of funds for a charitable purpose rather than private
gain. States have an interest in whether charitable fundraising is
fraudulent and whether the charity is meeting the charitable purpose for
which it was created.

The majority of states oversee charities through their attorneys general and
charity offices. State attorneys general usually have broad power to
regulate charities in their states. These states monitor charities for
compliance with statutory and common- law standards and have the option of
correcting noncompliance through the courts. Furthermore, these states
usually regulate the solicitation of funds for charitable purposes. Some
states require professional fundraisers to register and file information on
specific fundraising contracts.

IRS does not have a process to proactively share oversight data with states
as permitted by federal law and cannot share much of its data because of
legal prohibitions. IRC Sections 6103 and 6104 govern the types of oversight
data that IRS can share with states for purposes of overseeing charities.

In general, to protect taxpayer confidentiality, Section 6103 prevents IRS
from publicly disclosing tax return data for all types of taxpayers, unless
Although Federal and

State Officials Generally Support More IRS Sharing of Data with States, Many
Issues Must Be Considered

Many States Oversee Charities to Protect the Public

IRS Does Not or Cannot Share Much of Its Oversight Data on Charities with
States

Page 27 GAO- 02- 526 Oversight of Charities

explicitly allowed. 18 For charities, this means IRS cannot share most data
about examinations. The general restriction against disclosure stems
primarily from a right to privacy. Congress only granted the explicit
exceptions when it determined that the need for the disclosure of the data
outweighed the right to privacy. Criminal and civil sanctions apply for the
unauthorized disclosure or inspection of federal tax returns and return
data.

Although tax- exempt organizations also may assert a right to privacy for
interactions with IRS, Congress has developed different disclosure rules and
has been expanding the levels of public disclosure. The rationale for
disclosure has been that the public supports tax- exempt organizations
through direct donations and the tax benefits accruing from their taxexempt
status and, thus, has a strong interest in information about the
organizations. Section 6104 exists to provide more disclosure about
taxexempt organizations. For charities, it provides some exceptions to
Section 6103 prohibitions so that states can request access to certain IRS
data, such as details on revocations of tax- exempt status, to support state
oversight of charities.

Table 4 shows the types of IRS oversight data that states can and cannot
get. The second column indicates IRS data that are available to states, the
third column indicates IRS data that state charity officials can request
through Section 6104 under certain conditions, and the fourth column
indicates IRS data that cannot be shared due to Section 6103 prohibitions.

18 For example, IRS can share such data with states for administering state
tax programs, enforcing child support programs, verifying eligibility/
benefits for public assistance, and investigating criminal activities.

Page 28 GAO- 02- 526 Oversight of Charities

Table 4: Availability of IRS Application and Examination Data on Charities
to States Types of IRS data states might want to access a Available to
states Available to state charity

officials if designated b Not available to state charity officials

Approved application X Denied application X Withdrawn application X Pending/
appealed application X Notice of revocation X Notice of deficiency X c
Details on denials, revocations, or notices of deficiency X c Receipt of
state referrals X Actions on state referrals X Ongoing examination data X
Closed examination files X d

a IRS officials are researching whether states can gain access to data on
intermediate sanctions against individuals at a charity due to excess
benefits and IRS closing agreements with the charity. b For Section 6104(
c), an appropriate state officer can receive this information. For example,
a state

attorney general, state tax officer, or any state official charged with
overseeing organizations of the type described in Section 501( c)( 3), if so
designated. c Applies to a mailing of a notice of deficiency under Section
507 and chapters 41 or 42. Section 507

applies to penalties on the termination of private foundations. Chapter 41
applies to charity lobbying expenditures and chapter 42 applies to charity-
related excise taxes, such as for intermediate sanctions. d Can request
access to closed files only for those resulting in a revocation or certain
notices of deficiency and only if they can show they need the files and how
they will use the files. Source: IRC Sections 6103 and 6104 and IRS
officials.

As table 4 shows, the appropriate state officials can obtain details about
the final denials of applications, final revocations of tax- exempt status,
and notices of a tax deficiency under Section 507, or Chapter 41 or 42.
However, IRS does not have a process to regularly share such data.

Under Section 6104, IRS cannot share these details with the appropriate
state officials unless they formally request these details and disclose
their intent to use the data to fulfill their official functions under state
charity law. IRS is to ensure that each request is reasonable, relevant, and
necessary before releasing the data. Appropriate state officials may ask IRS
for details such as examination results, work papers, reports, filed
statements, application documents, and other information on determinations.
State charity officials can have access to such data if they prove they are
an appropriate state official as evidenced by a letter from the state
attorney general on the functions and authority of appropriate IRS Does Not
Have a

Process to Regularly Share Data That States Can Obtain

Page 29 GAO- 02- 526 Oversight of Charities

officials with enough facts for IRS to determine that they can access the
data.

State charity officials would like regular access to such data. NASCO
officials- state officials in 38 states who oversee charities- said that
quicker access to information on denied applications and revocations helps
stop charities from continuing suspicious activity. If such data are not
provided quickly, the charity can dispose of assets or change its
operations. Knowing the details about the revocation can also help states
track individuals who try to re- establish similar suspicious operations in
other states.

IRS and the state officials said that data on denials, revocations, and
notices are worth sharing. However, from fiscal years 1996 through 2001, few
charity applications were denied compared to the over 50,000 applications
submitted annually (see table 2), and few examinations resulted in
revocations or notices of deficiency compared to over 1,000 examinations
closed annually (see table 3), as shown in table 5.

Table: 5: Number of Denied Charity Applications, Revoked Charities, and
Notices of Tax Deficiencies Sent to Charities, Fiscal Years 1996- 2001

Number of IRS actions per fiscal year IRS actions on charities 1996 1997
1998 1999 2000 2001

Denied applications a a 73 39 59 58 Revoked charities 16 12 24 8 27 9
Notices of tax deficiency b b bb bb a Data not available.

b IRS could not provide data on the number of notices of tax deficiency sent
for taxes assessed under Section 507 as well as Chapters 41 and 42. However,
the number of these notices would be less than the number of examinations
that closed with a proposed assessment of any type of tax or a penalty. For
fiscal years 1996 through 2001, about 140 examinations, on average, closed
annually with some type of tax or penalty assessment against charities.

Source: IRS data.

However, IRS lacked a proactive process to regularly inform state officials
of steps to be taken to request the data that are available under Section
6104. NASCO officials said many states are not clear about the rules for
making these requests and about the types of details that are available.
Such requests used to be sent to the district office director. IRS?s
reorganization has abolished this position, and IRS has not developed a new
process due to its focus on other priorities related to its reorganization.

Page 30 GAO- 02- 526 Oversight of Charities

IRS plans to develop a new process. IRS officials said in February 2002 that
they started compiling a list of state officials who can receive IRS data on
charities. They said that a barrier has been having enough staff to develop
the process and negotiate agreements with each state on requesting,
transmitting, protecting, and overseeing use of the data. Afterwards,
managing this data- sharing process could pose additional resource
challenges, depending on how the process would work. Officials said that a
proposed system could be ready to discuss with states during the spring of
2002.

Although IRS and the states have a common interest in overseeing charities,
Section 6103 generally prohibits IRS from sharing data with state agencies
about actions, such as examinations of charities. These prohibitions apply
even to IRS examinations that result when a state agency refers concerns
about specific charities to IRS. Neither can IRS disclose actions on pending
or withdrawn applications.

State officials who oversee charities believe that Section 6103 hampers
their efforts to identify charities that defraud the public or otherwise
operate improperly. They offered only anecdotal information on the extent to
which such charities exist, but they believed that even a few abusive
charities should be pursued because the betrayal of public trust could
adversely affect the support given to all charities.

At the annual NASCO conference in October 2001, state charity officials
offered favorable comments about IRS?s outreach and education efforts, but
pointed to problems created by IRS not being able to share data on pending
and closed examinations and on pending and withdrawn applications. State
officials were particularly concerned about not being able to get feedback
on IRS actions on a state referral because of Section 6103 prohibitions. IRS
officials said that state referrals are productive to examine, but IRS only
can confirm receipt of the referral and whether the tax exemption was
revoked. Other concerns expressed by state charity officials with IRS not
being allowed to share its oversight data follow.

 States might waste resources investigating a charity that IRS is examining
or has found to be compliant (at least in those areas that IRS examined).

 States might be unaware of questionable charities for a long time, which
allows those charities to continue operating before the states know to
pursue them.

 States might miss opportunities to build better cases against charities
when they observe suspicious activities. States Want Access to

Protected IRS Data on Charity Applications and Examinations

Page 31 GAO- 02- 526 Oversight of Charities

State officials say that often times they cannot fully use their powers to
protect the public because of the lack of readily available data. State
officials said that when they learn of a suspicious activity, they need
information quickly. The officials said that they could head off a
suspicious activity by asserting their state powers, noting that usually the
threat of action is enough. However, questionable charities tend to move
from state to state. State officials cited a need to compare IRS application
data with state charity registration information to quickly deal with
registrants that have a questionable past.

State charity officials saw an advantage in greater data sharing because IRS
does not have the authority to correct the fraudulent or suspicious
charitable activities that states can correct. IRS can deny or revoke the
charity?s tax- exempt status. As a tax administrative agency, IRS is
interested in the tax- exempt status of a charity and whether it should
continue. IRS generally does not pursue charity- related fraud. If others
(such as states) have proved fraud, that proof can justify denial or
revocation of a tax exemption.

State charity officials provided examples of how expanded sharing of
examination and application data would help the states. Having examination
results would allow the states to better monitor the operations of specific
charities, determine their compliance with state laws, and correct any
noncompliance earlier. Having data about pending and withdrawn applications
could help states to be aware of potential problems and be more proactive in
protecting the public. According to state officials, during the months that
an application is pending, a so- called charity may not be operating to
serve charitable purposes, and the public may incorrectly assume that it is
tax- exempt and that donations are tax deductible.

Treasury officials noted, however, that sharing examination data could be
misleading. For example, the examination may involve issues unrelated to the
organization?s tax- exempt status. In addition, sharing data about pending
applications could result in disclosure of taxpayer information that is
entitled to the confidentiality protections of Section 6103 if the taxpayer
is not ultimately determined to be tax- exempt.

Page 32 GAO- 02- 526 Oversight of Charities

IRS and Treasury officials said that while they see value in the principle
of sharing data with states, certain issues need to be considered in
determining the scope of data sharing and the protection that should govern
such sharing. In addition, the officials noted that both the IRS and states
would incur various costs and burdens that need to be balanced in judging
which data should be shared, what benefits would be obtained, and which
means of sharing data would be the most appropriate. The officials said that
they were formulating a position on legislative proposals to expand access,
with appropriate taxpayer protections. Treasury officials said they
supported a provision included in draft legislation (H. R. 3991, Taxpayer
Protection and IRS Accountability Act of 2002) that would permit IRS to
share more data with state officials to assist them in administering state
laws regulating charitable organizations. Issues raised by IRS regarding any
legislative proposals included:

 Any disclosure of IRS data raises the issues of how the data are used and
who uses the data. Understanding these issues is needed to make informed
judgments about how best to share the data and to protect against improper
disclosures.

 Granting access to pending applications and examination data raises more
challenges compared to those for final application and examination data.
These challenges relate in part to concerns about privacy and due process
rights. To the extent IRS shares data on issues for which it has not
completed its work, use of the data by states would need to recognize this
significant limitation. Influencing this issue is the fact that the
interests of IRS as a tax administrator do not fully converge with the
interests of state charity officials who are not tax officials.

 The proper legal vehicle for expanding access to IRS?s application and
examination data would need to be considered. Two basic legal provisions are
Section 6103 (which prevents disclosure) and Section 6104 (which enhances
disclosure). Other legislative provisions might be worth considering,
depending on the types of data that state charity officials want to access
and their intended uses.

 The legal vehicle chosen would also affect the types and rigors of the
controls created to protect the data from improper disclosure and misuse.
For example, Section 6103 imposes rigorous requirements on the receipt,
storage, and use of the data in all forms (e. g., paper versus electronic)
to protect IRS data as well as imposes various training and oversight
requirements to ensure conformance to the protections. The controls and
protections under Section 6104 generally are considered to be less rigorous.
The level of protection that should be provided for data shared with states
is an important issue. Sharing IRS Oversight Data

on Charities Requires Consideration of Various Issues

Page 33 GAO- 02- 526 Oversight of Charities

Considering the previously mentioned issues, IRS and states would need to be
aware of the resources required to develop and implement agreements on how
the data are to be used, who can use the data, and how the data are to be
transmitted, maintained, and protected. In some cases, the resources in
terms of staffing, training, space, and computer capabilities could be
significant.

With assets approaching $1. 2 trillion and annual revenues approaching $720
billion, charities represent a substantial presence in American society. The
approximately 250,000 active charities range from very small, local efforts
to very large, sophisticated hospitals and universities. The public--
including the donors, media, and watchdog groups- IRS, and the states
oversee charities. In this oversight framework, IRS has a limited role in
considering how well charities are spending funds or accomplishing
charitable purposes. Instead, the framework envisions a ?free market? in
which charities compete for donations, in part, based on such spending or
accomplishments. Key to the proper functioning of this marketplace is the
availability of reliable data, such as Form 990 data, that donors can use to
make informed choices about which charities merit their contributions.

However, due to suspected but unmeasured inaccuracy in some charities?
reporting of their expenses and to the range of discretion that charities
have in charging and allocating expenses, Form 990 expense data alone are
not adequate for public oversight of charities and should be used with
caution. Recently, IRS officials have taken steps to address incidents of
inaccurate expense reporting and have sought comments on one set of guidance
for allocating expenses.

IRS?s investment in reviewing charity applications and examining charity
returns has not kept pace with the growth in the number of applications and
returns. More informed decisions about the resources to devote to this
investment could be made if IRS had a better understanding of the type and
extent of compliance problems in the charitable community as well as a clear
plan for how IRS would use its resources to achieve certain results, such as
specific improvements in the compliance of charities. Neither of these is
currently available, even though IRS has initiatives to increase its
staffing for all exempt organizations. IRS?s plan for improving compliance
will not provide data on the extent of the compliance problems and the level
of oversight needed across the charitable community. Nor does the plan
identify results- oriented goals and strategies, resources needed to
accomplish such goals, and measures to gauge its progress toward goal
accomplishment. Conclusions

Page 34 GAO- 02- 526 Oversight of Charities

However, given the size of the charitable community, it is unrealistic to
expect that IRS would ever review more than a minor portion of charities.
Furthermore, certain issues related to charities, such as the extent to
which their fundraising activities may be misleading, can be addressed by
state officials. Thus, helping to make state oversight of charities as
effective as possible would enhance oversight of the charity community.
State officials who oversee charities believe data that IRS can provide, but
that often does not flow to them, as well as certain data that IRS is
prohibited from sharing due to federal protections for taxpayers?
confidentiality, would make their oversight more effective. IRS and Treasury
officials recently have started to discuss whether and how to share more
data with the states. However, the timing and likely outcomes of these
discussions is not yet clear. Also, the specific types of data that would be
useful, the best means of sharing that data, the resources needed, and the
taxpayer protections that would apply to the data, need to be worked out
between federal and state officials. Furthermore, any proposal to change the
law that restricts disclosure of certain IRS data to the states would
require Congress and Treasury to make policy decisions about the balance
between the privacy rights of charities and the public?s interest in more
disclosure.

To improve oversight by the public, IRS, and the states, we recommend that
the commissioner of Internal Revenue

 ensures (either through the planned market segment studies or other means)
that IRS obtains reliable data on compliance issues (including expense
reporting) for the full charity community;

 develops results- oriented goals, strategies (including levels of staffing
and other resources to accomplish the goals), and measures to gauge progress
in accomplishing those goals when overseeing the charity community; and

 develops, in consultation with state charity officials, a procedure to
regularly share IRS data with states as allowed by federal tax law.

In addition, we recommend that IRS, in concert with the Department of the
Treasury and state charity officials, identify the specific types of IRS
data that may be useful for enhancing state charity officials? oversight of
charities, the appropriate mechanisms for sharing the data, the resources
needed, and the types and levels of protections to be provided to prevent
improper disclosure and misuse. IRS and Treasury should continue drafting
specific legislation to expand state access to selected IRS oversight data
and ensure adequate levels of protection for any data that would be shared.
Recommendations

Page 35 GAO- 02- 526 Oversight of Charities

We obtained comments on a draft of this report from IRS. (See app. VI.) IRS
agreed with the findings in the report and said that the agency would assist
in tax administration related to charities and identified actions underway
or planned to address our recommendations.

We support IRS?s timely actions on our recommendations and believe IRS?s
actions are generally responsive to our recommendations. As IRS moves
forward with its plans, however, we encourage the commissioner of Internal
Revenue to ensure that the actions IRS takes will cover all aspects of our
recommendations. For instance, although IRS?s comments indicate that IRS
will develop goals and measures for its oversight of charities, the comments
do not mention identifying the levels of staffing and other resources needed
to accomplish such goals.

Although generally agreeing with our findings and indicating that actions
were planned or being taken in relation to our recommendations, IRS had
certain reservations about the report. First, IRS said that our draft report
implied that IRS was not looking at the extent to which charities are
properly reporting expenses. Also, according to IRS, the agency has
established a task force to develop examination projects for reporting
accuracy and that examiners have been instructed to review this issue. Our
draft report did recognize these actions. However, the task force had not
yet begun to develop projects at the time we did our work, and examiners
look at only a very small portion of charities annually. Thus, neither of
these actions indicated that IRS would be obtaining reliable overall
measures of how accurately charities report their expense data. We did
modify our Results in Brief discussion to more explicitly recognize that IRS
is beginning to consider how to assess charities? expense reporting.

IRS also said that the draft report did not sufficiently recognize the
breadth of IRS?s responsibilities related to tax- exempt organizations. In
the draft, we recognized IRS?s other responsibilities both in providing
statistics on the portion that charities represent of all tax- exempt
organizations and by explicitly noting the range of responsibilities that
fall under TE/ GE and that those responsibilities compete for staffing and
funding with IRS?s efforts to oversee charities. IRS?s letter provided some
additional data demonstrating the breadth of IRS?s responsibilities.

Finally, IRS did not believe that our draft report provided sufficient
recognition of the strategic planning process followed by TE/ GE. IRS was,
in part, concerned that the draft report indicated it was not clear that
IRS?s current plans would yield an accurate picture of charities?
compliance. IRS said TE/ GE?s long- term plan to do market segment studies
will provide Agency Comments

and Our Evaluation

Page 36 GAO- 02- 526 Oversight of Charities

reliable information on the compliance level of various segments of the
charitable community. Our draft report described IRS?s strategic planning
efforts related to its oversight of charities and thus did recognize that
some planning has been done. However, as shown in the comments, those plans
do not yet include such things as results- oriented goals or performance
measures to assess IRS?s progress. Furthermore, although we believe the
market segment studies should provide useful information on charities?
compliance, as discussed earlier, we did not see sufficient evidence to
conclude that reliable data on charities? expense reporting would be
generated. In addition, at the time of our report, IRS was requesting public
comments on whether it should define additional market segments to study,
thus raising uncertainty over whether the currently planned work would cover
all charities to yield adequate data on their compliance issues.

The Department of the Treasury supports the overall goal of increasing the
information IRS can share with state officials who oversee charities. (See
app. VII.) Treasury also recognized that appropriate safeguards must be in
place to protect the confidentiality of taxpayer information. Treasury
officials said that they intend to pursue developing appropriate legislation
to expand state access to IRS?s oversight data. Treasury?s plans are
consistent with our recommendations.

As arranged with your office, unless you publicly announce its contents
earlier, we plan no further distribution of this report until 30 days after
the date of this report. We will then send copies of this report to the
secretary of the Treasury; the commissioner of Internal Revenue; the
director, Office of Management and Budget; and other interested parties. We
will also make copies available to others on request. The report is also
available on GAO?s home page at http:// www. gao. gov.

This report was prepared under the direction of Tom Short. Other major
contributors were Rodney Hobbs, Daniel Mesler, Demian Moore, and Oliver
Walker. If you have any questions about this report, please contact Tom
Short or me at (202) 512- 9110.

Michael Brostek Director, Tax Issues

Appendix I: Description of Form 990 Reporting Requirements

Page 37 GAO- 02- 526 Oversight of Charities

Tax- exempt organizations recognized by the Internal Revenue Service (IRS)
are required to annually file Form 990 or Form 990- EZ (Return of
Organization Exempt From Income Tax) if their annual gross receipts are
normally more than $25,000. Organizations that have less than $100,000 in
gross receipts and total end of year assets of less than $250, 000 may use
Form 990- EZ. This appendix describes the Form 990 and the information
requested and provides a copy of the Form 990.

The Form 990 is used primarily as an IRS information return and a public
information document. The Form 990 relies on self- reported information from
filers. Most of the 27 types of exempt organizations that fall under Section
501( c) 1 use this form along with Section 527 political entities and
Section 4947 (a)( 1) nonexempt charitable trusts.

Section 6033( a)( 1) of the Internal Revenue Code (IRC) grants the secretary
of the Treasury the power to use any forms or regulations to obtain
financial information from 501( c)( 3) organizations, such as gross income,
receipts, and disbursements. In addition, this section requires all 501( c)
organizations to file an annual information return. Form 990 is due by the
15th day of the 5th month of the organization?s accounting cycle, after the
close of the taxable year.

The Form 990 and any additional schedules can facilitate the public?s
ability to scrutinize the activities of tax- exempt entities. For many
years, Section 6104 (b) permitted an interested person to request a copy of
Form 990 from IRS. However, Congress created Section 6104 (d)( 1)( B) to
allow interested persons to obtain the Form 990 from the tax- exempt
organizations. Furthermore, IRS and state regulatory bodies use the
financial information listed on the Form 990 to help monitor activities of
charities, including their spending. 2 The states have had significant input
in developing the Form 990 and are working with IRS to implement
refinements.

1 Except black lung benefit trusts or private foundations. Private
foundations file the Form 990- PF. 2 The Form 990 is also filed with some
state tax/ revenue agencies. Appendix I: Description of Form 990

Reporting Requirements What is the Form 990? What Law Governs Use of the
Form 990?

How is the Form 990 Used?

Appendix I: Description of Form 990 Reporting Requirements

Page 38 GAO- 02- 526 Oversight of Charities

The first Form 990 covered tax- year 1941. This 2- page form included only
three yes/ no questions, an income statement, and a balance sheet, although
some line items required attached schedules. By 1947, the form (including
instructions) had reached 4 pages, although some portions applied only to
certain types of organizations. The required financial information was more
extensive and incorporated a line item on the income statement for the total
compensation of all officers and a $3,000 reporting threshold for
contributions made to the organization. IRS also included a checkbox for
affiliated organizations that file group returns. By 2001, the Form 990 had
6 pages (10 parts with 105 line items), 2 schedules (A and B) covering 13
pages, and a 45- page instruction book. Figure 5 shows the 6 pages
comprising the Form 990. How Has the Form

990 Changed Over the Years?

Appendix I: Description of Form 990 Reporting Requirements

Page 39 GAO- 02- 526 Oversight of Charities

Figure 5: Form 990

Appendix I: Description of Form 990 Reporting Requirements

Page 40 GAO- 02- 526 Oversight of Charities

Appendix I: Description of Form 990 Reporting Requirements

Page 41 GAO- 02- 526 Oversight of Charities

Appendix I: Description of Form 990 Reporting Requirements

Page 42 GAO- 02- 526 Oversight of Charities

Appendix I: Description of Form 990 Reporting Requirements

Page 43 GAO- 02- 526 Oversight of Charities

Appendix I: Description of Form 990 Reporting Requirements

Page 44 GAO- 02- 526 Oversight of Charities

Appendix II: Analysis of Form 990 Data on Expenses Reported by Charities

Page 45 GAO- 02- 526 Oversight of Charities

The tables in this appendix describe charities by expenses, revenues,
assets, joint- cost reporting, and direct assistance payments. The data are
from Parts I and II of the Form 990 (excluding Forms 990- EZ and 990- PF).
Data for tables in this appendix represent all Form 990 filers for filing
years 1994- 1998. IRS?s Statistics of Income (SOI) Division provided data
for filing years 1994- 1998. SOI data represent a weighted sample based on a
stratified random sample of all returns filed by charities in a filing year.
Filing year 1998 and 1999 data were purchased from the Urban Institute.
Urban Institute data represent the actual population of charity filers.
Except for the section on joint- cost reporting and for 1999 totals reported
in table 7, for consistency, we used SOI data exclusively for analyzing
filing years 1994- 1998.

SOI provides data on charities by selecting a sample of each year?s Form 990
data and keypunching the sample data into a database. Filing year 1998 was
the most recent year for which SOI data were available when we did our work.
Data are classified into strata defined by amount of total assets. The
sampling rate by stratum ranges from 100 percent for organizations with
assets of $10 million 1 or more to 0.45 percent for the smallest asset class
in both 1994 and 1995. From these samples, SOI calculates a weighted total
number of Form 990 filers for each filing year.

Because the SOI data are based on samples, coefficients of variation should
be taken into account. Sampling sizes and the corresponding coefficients of
variation for selected yearly aggregate categories are presented in table 6.
Because coefficients of variation are associated only with aggregate data,
and because weighting factors are associated with asset data only, we do not
present data other than that which are available at the aggregate level and
by asset category.

1 In 1997, SOI increased the lower bound of the 100 percent sample rate to
$30 million. Appendix II: Analysis of Form 990 Data on

Expenses Reported by Charities Methodology and Statistical Variations for
SOI Data

Appendix II: Analysis of Form 990 Data on Expenses Reported by Charities

Page 46 GAO- 02- 526 Oversight of Charities

Table 6: Sample Size and Coefficients of Variation, by Filing Year
Coefficient of variation (percent) Year Sample

size Weighted charity population Total

charities Total revenues Total

expenses Total assets

1994 10,788 136,627 1. 61 0. 73 0. 78 1. 20 1995 11,553 142,790 1. 60 1. 50
1. 63 1. 29 1996 12,474 149,902 1. 57 1. 43 1. 57 1. 46 1997 13,058 155,330
1. 09 0. 48 0. 55 0. 06 1998 13,954 162,559 1. 05 0. 42 0. 47 0. 07 Source:
IRS SOI Division.

Financial category totals for individual filers include revenues, expenses,
and assets. The yearly aggregate totals for these categories are presented
in table 7. Each financial category provides information about the resources
or operations of charities. Revenue amounts help describe how successful a
charity is in raising funds. Asset amounts describe the resources owned by
charities that support its mission. Total expenses, in relation to total
revenues, help show whether the charity is generating surpluses, deficits,
or breaking even from its operations during the period.

Table 7: Number of Charities and Reported Amounts of Revenues, Assets, and
Expenses, by Filing Year

Dollars in millions

Year Total number of charities filing Total revenues Total assets Total
expenses

1994 136,627 $ 587,428 $ 991,605 $ 546,649 1995 142,790 $ 661,584 $
1,141,409 $ 602,985 1996 149,902 $ 702,291 $ 1,291,492 $ 636,065 1997
155,330 $ 752,565 $ 1,437,156 $ 675,233 1998 162,559 $ 749,890 $ 1,349,649 $
682,558 1999 163,414 $719,251 $1,215,218 $ 655,028 Source: Tabulation of
data from Form 990: SOI, 1994- 98 and Urban Institute, 1999.

Total expenses found on line item 17 of the Form 990 are comprised of three
?functional? expense categories and ?payments to affiliates.? 2 The

2 For each of the 5 years analyzed, fewer than 5 percent of all charities
reported any payments to affiliates. For 1994- 1998, ?payments to
affiliates? does not exceed .70 percent of total expenses in any year. Total
Charities,

Revenues, Expenses, and Assets

Functional Expenses

Appendix II: Analysis of Form 990 Data on Expenses Reported by Charities

Page 47 GAO- 02- 526 Oversight of Charities

three types of functional expenses are reported in separate columns of Form
990 Part II as Program Services, General Management and Fundraising. Twenty-
two specific object class expenses (line items 22- 43) further break down
these categories. ?Other expenses? (line item 43) is for reporting expenses
not captured by line items 22- 42. IRS instructions prohibit reporting
professional fundraising fees, accounting fees, or legal fees on line item
43, and require other expenses to be itemized on line item 43. Tables 8 and
9 describe the three functional expense categories and the

?other? expense category.

Table 8: Total Expenses, Total Functional Expense Amounts, and Total
Expenses Reported as ?Other,? by Filing Year

Dollars in millions

Year Total expenses Program services General management Fundraising ?Other?

1994 $546,649 $471,332 $68,715 $5,283 $142,746 1995 $602,985 $522,785
$73,145 $5,519 $159,950 1996 $636,065 $549,857 $77,299 $6,037 $165,920 1997
$675,233 $584,286 $81,135 $6,581 $165,604 1998 $682,558 $583,030 $87,248
$7,499 $171,026

Note: ?Total expenses? are reported on line item17 and on line item 44,
column A of Form 990 and are the sum of the three functional expense
category totals. Functional expense category totals are reported on Form 990
line item 44, Columns B- D, and are the sum of line items 22- 43. ?Other?
expenses are reported on line 43 of Part II.

Source: Tabulation of data from Form 990: SOI, 1994- 98.

Appendix II: Analysis of Form 990 Data on Expenses Reported by Charities

Page 48 GAO- 02- 526 Oversight of Charities

Table 9: Total Functional and Total ?Other? Expenses as a Percentage of
Total Expenses, by Filing Year

Year Program services General management Fundraising ?Other?

1994 86.4 12.6 1. 0 26.2 1995 86.9 12.2 0. 9 26.6 1996 86.8 12.2 1. 0 26.2
1997 87.0 12.1 1. 0 24.6 1998 86.0 12.9 1. 1 25.2 Average 86.6 12.4 1. 0
25.8 Source: Tabulation of data from Form 990: SOI, 1994- 98.

Functional expenses in Part II are further broken down by 22 specific object
classes, including one class for ?other? expenses. Each object class, except
for- grants and allocations, specific assistance to individuals, and
benefits paid to or for members- may be allocated across the three
functional expense categories. Table 10 shows these expenses. Object Class

Expenses

Appendix II: Analysis of Form 990 Data on Expenses Reported by Charities

Page 49 GAO- 02- 526 Oversight of Charities

Table 10: Representation of Line Item as a Percentage of Functional Category
Total 5- Year Average, Filing Years 1994- 98 Line item Object class Program
service General

management Fundraising

22 Grants and Allocations 5.7 a a 23 Specific Assistance to Individuals 3.9
a a

Direct Assistance, subtotal 9.6 a a

24 Benefits to/ for members 2. 3 a a 25 Compensation to officers, directors
0. 7 4.4 3. 9 26 Other salary & wages 33.8 35.1 32.9 27 Pension
contributions 1. 1 1.6 1. 3 28 Other employee benefits 3. 9 5.1 3. 6 29
Payroll taxes 2. 2 2.9 2. 4

Compensation Related, subtotal 44.0 48.9 44.2

30 Professional Fundraising fees b b 6.1 33 Supplies 8. 3 5.3 3. 4 36
Occupancy 2. 6 4.2 2. 3 38 Printing and Publications b b 7.2 39 Travel b b
2.5 42 Depreciation, depletion, etc. 3.8 6. 2 1.6

Miscellaneous categories c 4.8 11.5 9. 2

Line items 30- 42, and miscellaneous subtotal 20.3 28.2 32.1

43 ?Other? expenses 26.2 22.9 23.7 44 Total 100 100 100

Note: Totals may not add to 100 due to rounding. a These categories are only
allocable as program services expenses.

b Less than 1 percent of total functional category expenses are represented.
c ?Miscellaneous categories? includes the remaining Form 990 object class
items not listed above: accounting fees, legal fees, telephone, postage and
shipping, equipment rental, conferences, and interest.

Source: Tabulation of data from Form 990: SOI, 1994- 98.

Appendix II: Analysis of Form 990 Data on Expenses Reported by Charities

Page 50 GAO- 02- 526 Oversight of Charities

?Assistance? describes the amount paid out by a charity in support of its
charitable purpose. 3 We define assistance as the sum of line items 22
(grants and allocations) 4 and 23 (specific assistance to individuals),
which can only be allocated to the program service expense category. Table
11 describes assistance paid out by charities in 1994- 1998.

Table 11: Assistance From Charities, by Filing Year

Dollars in millions

Year Grants and allocations Specific assistance to individuals Total
assistance

Assistance as a percentage of total

program service expenses

Assistance as a percentage of total

expenses

1994 $27,217 $7,629 $34,845 7. 4 6.4 1995 $27,755 $3,619 $31,375 6. 0 5.2
1996 $28,633 $38,900 $67,533 12.3 10.7 1997 $34,044 $51,124 $85,168 14.6
12.7 1998 $37,741 $6,681 $44,421 7. 6 6.6

Source: Tabulation of data from Form 990: SOI, 1994- 98.

The National Taxonomy of Exempt Entities (NTEE) 5 classification system was
developed by the National Center for Charitable Statistics (NCCS). IRS uses
NTEE codes to categorize charities by 26 major group (A- Z) classifications
that are aggregated into 10 broad categories. Because of the difficulties
noted above with analyzing the data at a more precise level, we do not
present expense, revenue, or asset data on charities at the NTEE level.
Tables 12 and 13 describe the NTEE categories.

3 Line item 24, ?Benefits paid to or for members? is also allocable only to
program services. Since this amount represents assistance paid to members or
dependents of members of the charity, we did not include it in our
description of assistance.

4 Line item 22 is further broken out by ?cash? and ?noncash? amounts, which
SOI does not report separately. 5 To see the entire classification taxonomy,
visit http:// nccs. urban. org/ ntee- cc/ index. htm. Charity Assistance

Expenses Description of Charities by NTEE Code

Appendix II: Analysis of Form 990 Data on Expenses Reported by Charities

Page 51 GAO- 02- 526 Oversight of Charities

Table 12: NTEE Categories Broad category Major group( s)

I. Arts, culture, and humanities A II. Education B III. Environment and
animals C, D IV. Health E, F, G, H V. Human services I, J, K, L, M, N, O, P
VI. International, foreign affairs Q VII Public, societal benefit R, S, T,
U, V, W VIII. Religion related X IX. Mutual/ membership benefit Y X.
Unknown, unclassified Z Source: National Center for Charitable Statistics.

Appendix II: Analysis of Form 990 Data on Expenses Reported by Charities

Page 52 GAO- 02- 526 Oversight of Charities

Table 13: Description of NTEE Major Group Categories NTEE core code (major
group) Description

A Arts, culture, and humanities B Education

C Environmental quality, protection, and beautification

D Animals E Health F Mental health, crisis intervention

G Diseases, disorders, and medical disciplines

H Medical research I Crime, legal J Employment K Food, agriculture, and
nutrition L Housing, shelter

M Public safety, disaster preparedness, and relief

N Recreation, sports O Youth development P Human services

Q International, foreign affairs, and national security

R Civil rights, social action, and advocacy S Community improvement,
capacity building T Philanthropy, voluntarism, and grantmaking U Science and
technology research V Social science research W Public, society benefit X
Religion, spiritual development Y Mutual, membership benefit Z Unknown
Source: National Center for Charitable Statistics.

Table 14 presents descriptive data on assets and expenses by size of
charity, which are defined by the amount of reported assets. 6 Note that in
all years, the largest category includes less than 5 percent of all
organizations, but accounts for more than 70 percent of all expenses and
more than 80 percent of all assets.

6 We did not purchase detailed asset data from the Urban Institute.
Description of

Charities by Asset Category

Appendix II: Analysis of Form 990 Data on Expenses Reported by Charities

Page 53 GAO- 02- 526 Oversight of Charities

Table 14: Overview of Charities by Asset Category, by Filing Year Year

Asset category (millions of

dollars segments) Number of

charities Percent of total charities Percent of

total assets Percent of

total expenses 1994 <1 95,773 70.1 2. 4 6.1

1- 5 26,188 19.2 6. 0 9.8 5- 10 5,676 4.2 4. 0 5.0 10- 20 3,404 2.5 4. 8 5.6

20+ 5,585 4.1 82.7 73.5

Total 136,626 100.0 100.0 100.0 1995 <1 99,324 69.6 2. 1 5.9

1- 5 27,768 19.5 5. 5 10.5 5- 10 6,026 4.2 3. 7 4.8 10- 20 3,646 2.6 4. 5
5.4

20+ 6,026 4.2 84.1 73.5

Total 142,790 100.0 100.0 100.0 1996 <1 103,025 68.7 2. 0 5.9

1- 5 29,599 19.8 5. 3 10.3 5- 10 6,575 4.4 3. 5 4.8 10- 20 4,142 2.8 4. 5
5.7

20+ 6,561 4.4 84.7 73.4

Total 149,902 100.0 100.0 100.0 1997 <1 105,256 67.8 1. 9 5.8

1- 5 31,523 20.3 5. 0 9.1 5- 10 7,114 4.6 3. 5 5.1 10- 20 4,361 2.8 4. 3 5.6

20+ 7,076 4.6 85.4 74.5

Total 155,330 100.0 100.0 100.0 1998 <1 109,091 67.1 2. 1 5.9

1- 5 33,370 20.5 5. 6 9.2 5- 10 7,803 4.8 4. 1 5.5 10- 20 4,694 2.9 4. 8 6.0

20+ 7,601 4.7 83.3 73.5

Total 162,559 100.0 100.0 100.0

Note: Totals may not add to 100 due to rounding. Source: Tabulation of data
from Form 990: SOI.

IRS recognizes that charities may include a non- fundraising purpose in its
solicitation materials (usually an educational component) and directs
charities to disaggregate the expenses of a combined fundraising and
education solicitation through joint- cost reporting. IRS forbids reporting
of Joint- Cost Reporting,

Part II of Form 990

Appendix II: Analysis of Form 990 Data on Expenses Reported by Charities

Page 54 GAO- 02- 526 Oversight of Charities

fundraising expenses as program service expenses. Charities that included in
program service expenses (Column B- Part II, Form 990) any jointcosts from a
combined educational campaign and fundraising solicitation must disclose in
a separate section how the total joint- costs of all such combined
activities were reported in Part II. The disaggregation of jointcost
expenses is by functional expense category- program services, management and
general, and fundraising- and not by amount allocated to educational versus
fundraising purposes. Since joint- cost reporting can refer to a combined
educational and fundraising campaign, all charities reporting joint- costs
would be expected to also report some fundraising expenses. That is not the
case, as noted in the last column of table 15. In 1998 and 1999,
respectively, 7.7 percent and 8.9 percent of charities reporting joint-
costs did not report any fundraising expenses.

Table 15: Joint- Cost Reporting, by Filing Year Form 990, Part II, Reporting
of Joint- Costs

Year Number of charities Number of charities reporting joint- costs Percent
reporting

joint- costs Percent reporting

fundraising expenses that reported joint- costs

Percent reporting joint- costs that reported fundraising

expenses

1998 153,763 920 0.6 1. 7 92.3 1999 163,369 975 0.6 1. 7 91.1

Source: The Urban Institute.

Table 16: Joint- Cost Allocation by Functional Expense Category, by Filing
Year Dollars in millions Year Total joint- cost amount Percent allocated to

program services Percent allocated to management and general Percent
allocated

to fundraising

1998 $ 1,283 60.8 9. 7 29.4 1999 $ 1,096 56.0 5. 1 38.9

Source: The Urban Institute.

Appendix III: The Internal Revenue Service?s Application Process

Page 55 GAO- 02- 526 Oversight of Charities

Any organization that is able to satisfy the requirements defined by
Congress in Section 501( a) of the Internal Revenue Code (IRC) is entitled
to exemption from taxation. To obtain recognition of its tax- exempt status,
a charity must apply to the Internal Revenue Service (IRS). 1 This appendix
describes the steps in the application process for charities to be
recognized as tax- exempt organizations.

The steps necessary to obtain recognition of exemption from taxation as a
charity involve the submission of written information to IRS. First, the
entity makes a decision to meet a charitable purpose as a charitable
taxexempt organization, under the guidelines in Section 501( c)( 3) of the
IRC. According to the Treasury regulations that underlie section 501( c)(
3),

?charitable? purposes include:

 relief of the poor, the distressed, or the underprivileged;

 advancement of education or science;

 advancement of religion;

 erection or maintenance of public buildings, monuments, or works;

 lessening the burdens of government; lessening of neighborhood tensions;

 elimination of prejudice and discrimination;

 defense of human and civil rights secured by law; and

 combating community deterioration and juvenile delinquency. After deciding
on its charitable purpose or purposes, an entity must submit its request for
recognition by completing forms for recognition of exemption from taxation.
2 All charitable organizations are required to complete the forms for
recognition with three exceptions. 3 The forms are:

 Form 1023 (Application for Recognition of Exemption from Taxation).

 Form 8718 (User Fee for Exempt- Organization Determination Letter
Request).

 Form SS- 4 (Application for Employer Identification Number).

 Form 872- C, which is used for organizations wanting an advanced ruling. 1
In addition, other types of tax- exempt organizations are required to file
for recognition of exemption (e. g., employee benefit organizations). 2 Nine
pages of instructions and 28 pages of forms.

3 Exceptions include churches, church- affiliated entities, or any
organization that is not a private foundation with less than $5, 000 in
gross receipts per year. Appendix III: The Internal Revenue Service?s

Application Process What are the Steps to Apply for Tax- Exempt Recognition
as a Charity?

Appendix III: The Internal Revenue Service?s Application Process

Page 56 GAO- 02- 526 Oversight of Charities

In addition to the application forms, the organization is required to submit
the following documents:

 Organizational documents containing dissolution and limiting clauses, 4
which limit the organization?s purposes to one or more of the exempt
purposes in Section 501( c)( 3).

 A conformed copy of the organization?s articles of incorporation.

 Four years of financial statement information (projected or actual income
and expenses). 5

 The signature of an organizational officer or trustee, who is authorized
to sign or another person authorized by the power of attorney to sign and
send the forms.

 The appropriate application fee ($ 150 fee for organizations with gross
receipts of less than $10, 000 and $500 for organizations with higher gross
receipts and for those seeking group exemptions).

To help applicants complete the application forms, the IRS suggests the
following texts as guides:

 Publication 557 (Tax- Exempt Status for Your Organization).

 Publication 598 (Tax on Unrelated Business Income of Exempt
Organizations).

 Publication 578 (Tax Information for Private Foundations and Foundation
Managers).

Proper preparation of an application for recognition of tax- exempt status
involves more than responding to the questions. An applicant must fully
describe the activities in which it expects to engage, including the
standards, criteria, or other means for carrying out the activities, the
sources of receipts, and the nature of expenditures. A mere restatement of
purposes or a statement that proposed activities will further the
organization?s purposes does not satisfy this requirement.

4 Dissolution clauses define how the organization?s assets will be
distributed if the organization ceases its operational activities. Limiting
clauses define the operational activities to which the organization may
engage.

5 If the organization has not yet begun operations, or has operated for less
than 1 year, a proposed budget for 2 full accounting periods and a current
statement of assets and liabilities will be acceptable.

Appendix III: The Internal Revenue Service?s Application Process

Page 57 GAO- 02- 526 Oversight of Charities

The Exempt Organizations Rulings and Agreements function is in charge of
reviewing applications for exemption from taxation. The primary
determinations office is located in Cincinnati, Ohio. In addition, staff in
six field offices do determinations work. 6 These staff are determination
specialists, most of whom are revenue agents, and as of January 2002
accounted for 207 full- time equivalent positions. Revenue agents review
applications in order to approve or deny recognition of exemption from
taxation, also known as ?making a determination.? The Cincinnati office has
112 revenue agents among 10 determination groups. The other 95 revenue
agents are divided among the six field offices. The Washington, D. C.,
office has 50 tax law specialists who also do determinations work. 7

Once applications are received at the Cincinnati office, a decision is made
on where the applications should be sent. Depending on the information
contained in the application or other circumstances, the application will
be: (1) processed by the Cincinnati office (e. g., applications for group
rulings, foreign organizations, and cases to be expedited); (2) sent to any
of six field offices; or (3) sent to the national office in Washington, D.
C., (e. g., when published precedents are lacking).

Applications are assigned to offices on the basis of a formula that assumes
agents will close, on average, five applications per week. Before using the
formula method to assign work, IRS assigned cases based on the number of
agents in each office. The Cincinnati office assigned cases to other offices
after estimating how much work could be done in Ohio. It stopped this
practice because it could not control the backlog that occurred in other
offices. Now, the office?s goal is to process all determinations in
Cincinnati, except those that need to go elsewhere.

6 Brooklyn, NY; Baltimore, Md; Atlanta, Ga; Monterey Park, Calif.; Denver,
Colo.; and Dallas, Tex. 7 Forty- one tax law specialists do determination
reviews, 4 tax law specialists perform group reviews, and 5 reviewers
perform second- level reviews. Which IRS Employees

Review Applications? How is the Work Assigned?

Appendix III: The Internal Revenue Service?s Application Process

Page 58 GAO- 02- 526 Oversight of Charities

A revenue agent reviews the application materials submitted by the
organization to ascertain if the purpose or purposes match those allowed for
charities (also known as a screening). All of the submitted documents should
enable the revenue agent to conclude that the organization satisfied or
failed to satisfy the particular IRC requirements for charities. IRS,
generally supported by the courts, usually will refuse to recognize an
organization?s tax- exempt status unless it submitted sufficient information
on its operations and finances.

Generally, revenue agents use the relevant tax law as the basis for
approving or denying a charity application. Agents compare the application
material to the applicable IRC section to check for conformity. Discussions
with other agents and managers are also incorporated. 8 During a
determination screening, the agents use the following tools:

 Title 26, Section 501 and other relevant sections of the Internal Revenue
Code.

 Determination Letter Program Procedures (Section 7.4.4 of the Internal
Revenue Manual).

 The Handbook on Exempt Organizations.

 The Exempt Organizations Continuing Professional Education (CPE) material.

 Various revenue rulings and revenue procedures. A revenue agent, with the
concurrence of the manager, can quickly determine that the application meets
all of IRS?s criteria and can close the application on its merit. The
application can be processed more rapidly if the articles of incorporation
(or articles of organization) include a provision insuring permanent
dedication of assets for exempt purposes. Closures on merit can take as
little as 10 days, if all information needed is provided during the initial
submission of the application materials.

If the documentation does not allow the revenue agent to close the
application on its merits, it will receive a further review. This usually
occurs when: (1) an application is incomplete, (2) the budget or financial
information is inconsistent, or (3) the agent cannot conclude that the

8 Manager involvement in the determination can be appropriate at any time in
the application process. What does a Revenue

Agent do when He or She Receives a Charity Application?

How do Revenue Agents make Determinations for Charity Applications?

What Happens after a Determination Is Made?

Appendix III: The Internal Revenue Service?s Application Process

Page 59 GAO- 02- 526 Oversight of Charities

organization satisfied IRC requirements for charities. While under further
review, the revenue agent is required to request additional information from
the applicant. When requesting information, the agent should

?correctly determine the appropriate scope and depth of information required
for making a proper determination.?

Here are examples of the ways IRS closes determination applications
submitted by charities:

 Approved

 Disapproved

 Withdrawn by applicant

 Fee not remitted If the exemption is granted, IRS issues a favorable
determination letter (Letter 1045) to the charity. If the determination is a
proposed denial of the tax exemption for any reason (e. g., the organization
failed to establish the basis for the exemption), the revenue agent is
required to notify the applicant of the proposed adverse action as well as
thoroughly explain the consequences and their appeal rights. The
organization can submit additional information to explain any discrepancies
related to the adverse action. The agent is to carefully review any new
information and reconsider the proposed denial. After any denial is
finalized, IRS is required to notify the appropriate state regulatory agency
of the applicant?s denial (including failure to establish the exemption).

After a favorable determination letter is sent, a charity can undertake
additional activities that are consistent with section 501( c)( 3) even if
it did not mention them in its application. Each letter includes a paragraph
stating that the charity should notify IRS of substantial changes in its
operations. The purpose is to allow IRS to assess whether the changes affect
exemption, private foundation status, unrelated business income tax, excise
taxes, etc., and if so, whether IRS needs to begin an examination.

According to an IRS official, IRS would like to be informed of the new
activities, however, the law does not require charities to notify IRS of the
changes. If a charity does not fully and accurately disclose its activities
in the application or does not inform IRS of changes, the charity cannot
rely on its determination letter to protect itself in the event of an IRS
examination. If IRS determines in an examination that the new activities
jeopardize exemption, revocation of exemption could be retroactive to the
Can a Charity Change

Its Purpose once a Favorable Determinations Letter Is Sent?

Appendix III: The Internal Revenue Service?s Application Process

Page 60 GAO- 02- 526 Oversight of Charities

date the new activities were undertaken. In contrast, if activities upon
which a revocation is based were disclosed to IRS, the charity may qualify
for relief under IRC section 7805( b), and any revocation or adverse action
will be prospective only. However, if it wants IRS approval in advance of
its change to protect itself against a possible retroactive adverse action,
it can request a private letter ruling from the national office in
accordance with Revenue Procedure 2001- 4.

Organizations are notified that the determinations process may take up to
120 days. IRS has indicated that the average time to approve an application
is currently 91 days. Delays and backlogs can occur for reasons such as

 an application was incomplete or inaccurate;

 taxpayers raised new issues or submitted additional evidence after the
proposed determination; and

 a determination letter contained a misspelling of the organization?s name
or an irrelevant addendum.

In situations involving disaster relief, emergency hardship programs, or
other situations where time is of essence, IRS?s procedures permit
charitable relief organizations to request expedited handling when it
applies or during the review of its application. The revenue agent is to
fully consider the request, grant it if appropriate, and inform the
applicant of the decision. The expedited request and the agent?s response
should be documented in appropriate work papers. IRS has had expedited
request procedures since 1994.

The relief organizations created to address the September 11th tragedies
received expedited application processing. From September 11, 2001, to March
20, 2002, IRS approved 262 applications for disaster relief organizations
under expedited processing. Although the requirements for exemption were not
waived, the average time for processing took approximately 7 days. IRS is
planning follow- up reviews of all of these organizations and charities
where necessary to determine if they are complying with the requirements
that govern tax- exempt charities. How Long does the

Determination Process Take?

Appendix III: The Internal Revenue Service?s Application Process

Page 61 GAO- 02- 526 Oversight of Charities

To measure the quality of the reviews of applications, IRS uses the Tax
Exempt Quality Measurement System. This measurement is based on a sample of
determination cases that are closed. It is not used to evaluate the quality
of the employee?s performance. Rather, the purpose is to measure and improve
quality in making determinations on applications. An offshoot of the quality
review process is to educate IRS staff involved in the determinations
process by highlighting weaknesses that should be corrected.

The six quality standards for determination cases deal with:

 Completeness of the application prior to closing.

 Timely processing.

 Technical issues.

 Work papers support conclusion.

 Case administration.

 Customer relations/ professionalism. How does IRS

Measure the Quality of Decisions and Adherence to Procedures?

Appendix IV: IRS?s Process for Examining Forms 990 Filed by Tax- Exempt
Organizations

Page 62 GAO- 02- 526 Oversight of Charities

The following describes IRS?s processes for examining returns filed by
exempt organizations, including charities. The discussion follows IRS?s
processes from selecting returns through reviewing the results of the
examinations. In April 2000, the centralized examination management concept
was adopted, and examination- related activities were centralized in Dallas
to improve consistency, coordination, and use of resources.

IRS uses keypunched information to begin the process of identifying returns
for examination. All returns (Forms 990) are sent to the Ogden Service
Center for processing. When returns are received, Ogden staff keypunch about
20 percent of the line items, such as the tax year, identifying information,
and various other data such as program service revenue, contributions, and
fundraising expenses. The keypunched information is transferred
electronically to the Exempt Organizations Business Master File and, if a
return is selected for examination, to the Audit Information Management
System (AIMS), which is used to track the status of examinations.

At the conclusion of the keypunching process, the return information is
available to be queried by another automated system- the Returns Information
and Classification System (RICS). RICS allows for searches of returns on the
basis of a variety of criteria, including known compliance problems and the
size, location, and type of exempt organization such as charities. IRS uses
a variety of ways to select returns for examination, but relies primarily on
two methods: 1 analysis of automated IRS data on RICS and referrals from
outside the examination group. 2

IRS uses RICS to analyze the automated data. RICS applies the criteria
selected by the Planning and Program Group to identify returns and line
items for potential examination. For example, RICS could be used to identify
returns in which charities are reporting political expenditures, allocating
expenses to reflect unrelated business income, reporting compensation and
wages, but not filing Form 941, and not filing

1 Other methods used to select returns include the Coordinated Examination
Program, where a team of experienced auditors examines returns filed by
large exempt organizations and national guidelines that identify certain
types of organizations or activities that may warrant examination.

2 Although this discussion focuses on charities, IRS also uses RICS and
referrals to select returns for examination for other types of exempt
organizations. Appendix IV: IRS?s Process for Examining

Forms 990 Filed by Tax- Exempt Organizations

Identifying and Selecting Which Returns to Examine

Appendix IV: IRS?s Process for Examining Forms 990 Filed by Tax- Exempt
Organizations

Page 63 GAO- 02- 526 Oversight of Charities

Form 990- T as required. The Classification Unit is responsible for pulling
the returns that meet the criteria, and RICS is used to select a random
sample of returns.

Returns identified by RICS are considered to be general casework, which
includes 12 conditions identified as ?likely to have issues? that will lead
to a change in the tax computation or even revocation of a charity?s
taxexempt status. Examination of these returns is intended to be ?limited

scope? addressing only the issue identified for which the return was
selected. However, according to the Manager, EO Classification, revenue
agents review the return to check for consistency with the basic exemption
requirement for the charity.

Another method used by IRS to select returns for examination is using a
referral, that has the highest priority among returns to be examined. IRS
receives referrals from parties inside and outside IRS, including the
general public, corporations, and private and public sector employees. All
referrals are sent to Dallas, where IRS staff input information on each
referral into a database that includes the name of the exempt organization,
its address, employer identification number, name of informant, and a
sequential number. The database includes a paragraph summarizing the
potential for an examination and the reason the referral- maker believes an
examination is warranted.

Returns Classification Specialists work referrals on a first- in, first- out
basis and decide whether to send the referral for examination. Specialists
use their knowledge of the law and judgment to determine whether the
information referred provides a basis for ?a reasonable belief of
noncompliance.? Afterwards, the database is updated to note whether the
referral is sent for examination.

Referrals that are viewed as ?sensitive? require a second review. Sensitive
referrals involve churches or media attention; are received from a Member of
Congress, the White House, or from IRS in Washington, D. C.; or are
otherwise considered as political or sensitive. Beginning in 1999, the
second review was required to be done by a three- person committee, which
decides whether to initiate an examination.

IRS also receives two other types of referrals. Future year referrals are
received from determinations specialists (who review applications for
taxexempt status) and who can request an examination in 2 or 3 years on
charities recently granted tax- exempt status. The purpose of these
examinations is to determine whether actual charitable activities conform

Appendix IV: IRS?s Process for Examining Forms 990 Filed by Tax- Exempt
Organizations

Page 64 GAO- 02- 526 Oversight of Charities

to what was intended when the tax- exempt application was approved. For
these referrals, the database is updated to reflect the year the future
return is to be selected for examination. If a return has not yet been
filed, the examination is deferred until the return is filed and the future
year portion of the referral database is so noted. In essence, the future
year record acts as a suspense file, and referrals are later reviewed to
determine if they should be sent to examination or given another suspense
date.

The other type of referral is a request for collateral examination. All
these referrals are received from the Small Business/ Self- Employed
Division (SB/ SE). SB/ SE requests these examinations of tax- exempt
organizations in connection with its examinations of small businesses that
are related to tax- exempt organizations.

To initiate an examination, such as when a group manager (who manages groups
of revenue agents) determines that more examination work is needed, a
request is sent by e- mail for a specific number of returns at specified
revenue agent grade levels. Group managers decide how to distribute the
requested number of returns by the specified grade levels in priority order
on first- in, first- out basis.

For returns selected by RICS, an IRS employee orders the related returns
from the Ogden Service Center, which usually takes 6 to 9 weeks to arrive.
All examination cases are entered on the automated system EOICS (Exempt
Organizations Inventory Control System) that is used to track their status.

The examination is conducted to ensure compliance with the provisions of the
IRC relating to qualification, reporting and disclosure, and the excise and
income taxes related to tax- exempt organizations. A revenue agent starts by
contacting an organization to request information to check compliance for
specific issues or lines on the return (Form 990). The agent is to compare
that information for those issues to the return as well as to verify whether
the organization is operating within its stated purpose.

The number of return issues being examined can vary. Examinations vary in
scope, depending on the type of issues, adequacy of the organization?s books
and records, existence of effective internal controls, and size of the
entity. Normally, revenue agents are expected to pursue the examination to
the point at which they can resolve the specific issues that led to the
examination and reasonably conclude that all items necessary for a proper
Initiating the

Examination Doing the Examination

Appendix IV: IRS?s Process for Examining Forms 990 Filed by Tax- Exempt
Organizations

Page 65 GAO- 02- 526 Oversight of Charities

determination of tax- exempt status have been considered. In general, when
agents have completed examinations, the completed case files are provided to
their group managers for review before the cases are closed.

In addition to the group manager?s review of the examination, IRS has a
separate group dedicated to reviewing the quality of examinations of exempt
organizations such as charities. Reviewers are independent of the
examination group and are experienced revenue agents. A reviewer is
responsible for measuring and reporting on the quality of the examination
and efforts to improve the work of the examination function. Examinations
can be reviewed in two ways- special or mandatory review.

In special reviews, the computer selects closed examinations randomly, so
the reviews represent a statistically valid sample. The reviewer completes a
check sheet that asks 57 questions about each closed examination. Most of
the questions are to be answered yes or no, with yes being the preferred
answer. However, some questions may not be applicable to each review. The
questions address the examination quality standards and include topics such
as the power of attorney requirements, the scope of the examination, and
application of the law. The checklist also asks the reviewer to make an
overall judgment on whether the action taken by the revenue agent was
appropriate in meeting the examination quality standards.

In contrast to special reviews, mandatory reviews are done while the
examination is still open. Examinations that are required to be reviewed
under mandatory review include those in which: (1) the exempt organization
disagrees with a revenue agent?s decisions; (2) the group manager asks for
the review to determine whether the actions taken by the agent were correct
and appropriate; (3) the agent proposed revoking or modifying the tax-
exempt status of a charity; (4) a final revocation for certain other tax-
exempt organizations is made; and (5) technical advice 3 was obtained.

3 Technical advice is provided by the Washington, D. C. office on legal
issues normally at the request of the examining office and sometimes at the
request of the taxpayer. Reviewing the Quality

of the Examination Special Review

Mandatory Review

Appendix IV: IRS?s Process for Examining Forms 990 Filed by Tax- Exempt
Organizations

Page 66 GAO- 02- 526 Oversight of Charities

Like special reviews, the purpose of a mandatory review is to ensure the
quality of cases and to provide quality assurance. Mandatory reviewers use
the checklist used by special reviewers to review an examination. In
addition, mandatory reviewers are to review whether the work papers
adequately document the examination. Since the examinations are open,
mandatory reviewers can send them back to the examination group for
additional work. If this is done, a memorandum is prepared that discusses
the results of the review. The group is to decide if it agrees and to notify
mandatory reviewers of the decision. More broadly, trends are monitored and
if a theme is identified, a memorandum could be sent to the examination
group on the findings or concerns.

Table 17 provides data on the number of staff available to do examinations.

Table 17: Number of Exempt Organizations Field Technical Staff and Total
Staff, by Fiscal Year in FTEs

Fiscal year Number of field examination staff Number of all staff

1996 439 958 1997 411 924 1998 395 891 1999 390 895 2000 324 801 2001 294
811

Note: The number of field staff examination staff is calculated from
technical time reported on examinations. Total EO staff is estimated through
FY 2000; actual per the Automated Financial System in 2001.

Source: IRS official.

We also reviewed the number of examination hours charged by IRS staff, as
shown in table 18.

Table 18: Average Hours Per Charity Examination by Type of Closure, All
Examinations, by Fiscal Year Type of Closure 1996 1997 1998 1999 2000 2001

Agreed examination hours 132.7 182.9 525.2 378.1 332.4 461.8 Unagreed
examination hours 81.3 107.6 121.1 141.8 189.3 420.4 No change examination
hours 44.0 53.6 52.9 45.4 59.1 57.3 All examination hours 53.5 69.5 114.3
74.2 103.4 89.9

Source: IRS AIMS.

Data on Examinations

Appendix IV: IRS?s Process for Examining Forms 990 Filed by Tax- Exempt
Organizations

Page 67 GAO- 02- 526 Oversight of Charities

Because Coordinated Examination Program (CEP) audits may run over several
years and take more time, IRS officials suggested that we compare CEP and
non- CEP examination hours for charities. Table 19 shows average hours for
non- CEP examinations.

Table 19: Average Hours Per Charity Examination by Type of Closure, Non- CEP
Examinations, by Fiscal Year Type of Closure 1996 1997 1998 1999 2000 2001

Agreed examination hours 106.1 177.1 349.6 323.3 169.2 112.4 Unagreed
examination hours 81.3 107.6 106.0 82.4 189.3 315.0 No change examination
hours 40.3 51.8 48.8 42.9 49.9 55.3 All examination hours 47.5 66.1 84.4
63.1 67.2 62.5

Source: IRS AIMS.

Table 20 shows the examination hours per charity return reported for CEP
examinations.

Table 20: Average Hours Per Charity Examination by Type of Closure, CEP
Examinations, by Fiscal Year 1996 1997 1998 1999 2000 2001

Agreed examination hours 254.2 213.4 1, 525.6 707.2 644.9 994.1 Unagreed
examination hours a a 1,027.0 616.5 a 841.8 No change examination hours
116.8 110.0 239.2 281.0 468.3 110.8 All examination hours 152.4 148.5 899.5
526.8 598.0 501.3

a Data not available. Source: IRS AIMS.

IRS can revoke tax- exempt status for all charities. A revocation basically
removes the tax- exempt charter for operating. The organization would have
to reapply as a tax- exempt organization and start the process over. Table
21 shows the number and reasons for revocations for fiscal years 1996
through 2001. Revocations

Appendix IV: IRS?s Process for Examining Forms 990 Filed by Tax- Exempt
Organizations

Page 68 GAO- 02- 526 Oversight of Charities

Table 21: Primary Reasons for Revocations by Fiscal Year, 1996- 2001 FY1996
FY1997 FY1998 FY1999 FY2000 FY2001

Delinquent filing of EO return 1 1 1 - - Discontinued operations - - 2 - 1
Inadequate records 1 - 2 - 2 Inurements 6 5 2 1 1 1 Non- exempt activities 2
- 1 1 11 1 Operating in a commercial manner 1 0 1 1 - Met operational test 3
3 3 1 2 Private vs. public 2 1 3 - - Private use - - - - 3 Others a -29477

Total 16 12 24 8 27 9

a Others includes revocations for problems associated with grassroots
lobbying and unrelated trade or business activities. Source: IRS AIMS.

Appendix V: Overview of Selected Federal Agencies that Can Oversee Charities

Page 69 GAO- 02- 526 Oversight of Charities

To determine the extent to which other federal agencies oversee charities
and if IRS coordinates its oversight of charities with those agencies, we
contacted officials at the Federal Trade Commission (FTC), Federal Emergency
Management Agency (FEMA), Federal Bureau of Investigation (FBI), United
States Postal Inspection Service (USPIS), and Office of Personnel Management
(OPM). 1 This is not an exhaustive analysis of all federal agencies that
work with charities.

Charities are not specifically under the oversight authority of any single
federal agency. In addition, no agencies we spoke with reported ongoing
coordination with IRS to identify fraudulent charities or to oversee general
charity operations. 2 In most cases, IRS would only be contacted if its
expertise as a tax authority were needed in an investigation, or to verify
an organization?s tax- exempt status. The following summaries describe the
charity oversight activities of the various federal agencies.

Within its Economic Crimes Unit, the FBI?s goal is to reduce the amount of
economic loss by national and international telemarketing fraud throughout
the United States. Additionally, the mission of the FBI?s Governmental Fraud
Program is to oversee the nationwide investigation of allegations of fraud
related to federal government procurement, contracts, and federally- funded
programs. According to FBI officials, the FBI does not have a charity-
specific investigation classification. An investigation may involve a
charity, but it would likely be due to telemarketing fraud or mail fraud.
Since the tragedies of September 11th, the FBI has been scrutinizing some
charities for fraudulent activities related to terrorism. An FBI official
said the FBI would contact IRS if their tax expertise were needed.

FEMA?s mission is to reduce loss of life and property and protect critical
infrastructure from all types of hazards through a comprehensive, riskbased,
emergency management program of mitigation, preparedness, response, and
recovery. FEMA coordinates its disaster relief work through

1 OPM oversees the annual Combined Federal Campaign, which is the
?solicitation of employees in the Federal workplace on the behalf of
charitable organizations.? 2 IRS does receive and track referrals regarding
charities. In fiscal year 2001, IRS received 13 referrals from other federal
agencies, the White House, or a Member of Congress out of 1,096 referrals
received. Appendix V: Overview of Selected Federal

Agencies that Can Oversee Charities FBI FEMA

Appendix V: Overview of Selected Federal Agencies that Can Oversee Charities

Page 70 GAO- 02- 526 Oversight of Charities

the National Voluntary Organizations Active in Disaster (NVOAD)
organization. NVOAD members are 501( c)( 3) organizations that are
experienced in disaster relief work. FEMA sometimes works with larger, well-
established organizations that are not NVOAD members, such as the United
Way. According to a FEMA official, FEMA does not work with IRS to assess
charities, but IRS has held two training sessions for FEMA on accounting for
disaster donations. In addition, FEMA has neither made referrals to IRS nor
received specific information from IRS about fraudulent charities.

FTC enforces federal antitrust and consumer protection laws. 3 FTC attempts
to stop actions that threaten consumers? opportunities to exercise informed
choices. Recently, within the USA Patriot Act of 2001, under Section 1011,
?Crimes Against Charitable Americans,? FTC?s authority regarding
telemarketing and consumer fraud abuse was broadened. 4 FTC also is a member
of an online watchdog site, Consumer Sentinel, 5 which tracks in a database
consumer complaints and investigations relating to fraud. FTC often acts on
referrals from state attorneys general, but does not coordinate its
enforcement activities with IRS except for occasional work on criminal
investigations.

The USPIS is responsible for combating mail fraud. 6 Thus, fundraising
solicitations conducted via the mail are under its authority. USPIS also
participates in Consumer Sentinel. USPIS does not coordinate investigations
of charities with IRS unless an organizations? tax- exempt status is being
questioned, or if the tax expertise of IRS is needed. A USPIS official said
they would welcome referrals from IRS, as IRS is the appropriate agency to
take the lead on charity issues.

3 The ?consumer protection? statute is Section 5( a) of the FTC Act, which
states, inter alia, that ?unfair or deceptive acts or practices in or
affecting commerce are declared unlawful? (15 U. S. C. Sec. 45( a)( 1)).
?Unfair? practices are defined to mean those that ?cause or [are] likely to
cause substantial injury to consumers which is not reasonably avoidable by
consumers themselves and not outweighed by countervailing benefits to
consumers or to competition? (15 U. S. C. Sec. 45( n)). www. ftc. gov/ ogc/
auth4. htm

4 FTC officials said they did not yet have an opinion on how the Patriot Act
would affect their oversight activities regarding charities. See Public Law
107- 56. 5 The database is restricted to members, which are primarily law-
enforcement agencies. Visit the site at www. consumer. gov/ sentinel/. 6 See
the Mail Fraud Statute at 18 U. S. C. Sec. 1341. FTC

USPIS

Appendix V: Overview of Selected Federal Agencies that Can Oversee Charities

Page 71 GAO- 02- 526 Oversight of Charities

OPM oversees the annual Combined Federal Campaign (CFC). Charities are
selected for CFC through an application process. Selection criteria may be
found at 5 CFR, Part 950, or, www. opm. gov/ cfc/ html/ regs. htm. The
criteria include:

 Submitting annual audits and annual reports and having a responsible
governing board with no conflicts of interest. Audits are only required if
the revenue dollar level was over a certain level.

 Fundraising and administrative costs should be no more than 25 percent of
total costs, or be ?reasonable? with documentation that suggests appropriate
justification.

 Less than 80 percent of their funding must come from government sources.

National and international applicants are approved by OPM. At the local
level, the Local Federal Coordinating Committee makes the approvals. OPM?s
inspector general conducts risk- based audits of regional CFCs to check that
funds are being collected and disbursed according to CFC guidelines and
according to the intent of donors. According to officials at the office of
inspector general, OPM neither audits charities directly nor works with IRS
to identify fraudulent charities. OPM

Appendix VI: Comments from the Internal Revenue Service

Page 72 GAO- 02- 526 Oversight of Charities

Appendix VI: Comments from the Internal Revenue Service

Appendix VI: Comments from the Internal Revenue Service

Page 73 GAO- 02- 526 Oversight of Charities

Appendix VI: Comments from the Internal Revenue Service

Page 74 GAO- 02- 526 Oversight of Charities

Appendix VI: Comments from the Internal Revenue Service

Page 75 GAO- 02- 526 Oversight of Charities

Appendix VII: Comments from the Department of the Treasury

Page 76 GAO- 02- 526 Oversight of Charities

Appendix VII: Comments from the Department of the Treasury

(440063)

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