TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Monday, January 2, 2017

The IRS Scandal, Day 1334:  The IRS’s Diminished Role In Overseeing Tax-Exempt Organizations

IRS Logo 2Evelyn Brody (Chicago-Kent) & Marcus Owens (Loeb & Loeb, Washington, D.C.), Exile to Main Street: The I.R.S.’s Diminished Role in Overseeing Tax-Exempt Organizations, 91 Chi.-Kent. L. Rev. 859 (2016):

The Chicago-Kent conference on charity oversight took place on Day 924 of the TaxProf blog's “IRS Scandal”—Day 1 being the Friday two-and-a-half years ago that the Internal Revenue Service's Lois Lerner apologized for inappropriate use of Tea Party and other names in selecting applicants for Internal Revenue Code § 501(c)(4) status for further review. This article examines the IRS's role in administering the regime for federally tax-exempt organizations. Our focus, however, should not obscure the very real corrosive impact, whether deserved or pretextual, that the IRS's exempt-organization imbroglio has had on the health of the entire agency, and thus to the revenue needs of the federal government.

The IRS—an agency which in the best of times suffers from a siege—is now starved for resources both financial and political. The IRS has predictably and understandably responded to the “scandal” by retreating into a shell of bureaucratic reshuffling, management mumbo-jumbo, and paper moving. There has never been a better time to apply for tax-exempt status or push the boundaries of permissible activities.

Will the IRS's decision to exile the Exempt Organization Division from Washington, D.C. to Cincinnati save the agency as well as the exempt-organization function by removing its operations from the glare of Washington's perpetual partisan politics? Or will this attempt to jettison the albatross from the sinking ship instead stifle the effectiveness of the IRS's role in charity and nonprofit oversight, suggesting—as co-author Marcus Owens has written about at length—the need for a new and independent agency to carry out that role?

This article proceeds in three parts. Part I describes the framework for federally tax-exempt organizations engaged in advocacy and political activity, and recites the sorry saga of the recent unpleasantness. Part II summarizes the IRS's managerial reaction. Part III focuses on the IRS's new procedure for granting speedy recognition of tax-exemption to new small charities—perhaps setting the agency up for the next debacle. Our conclusion sets out the not-so-great choices, mindful that the goal is to avoid making the wrong mistake. ...

On July 21, 2015, President Barack Obama commented to Jon Stewart, host of The Daily Show on Comedy Central: “When there was that problem with the IRS, everyone jumped . . ., saying, ‘Look, you've got this back office, and they're going after the Tea Party.’ Well, it turned out, no, Congress had passed a crummy law that didn't give people guidance in terms of what it was they were trying to do. They did it poorly and stupidly.” The president added: “The truth of the matter is that there was not some big conspiracy there. They [(the IRS)] were trying to sort out these conflicting demands. You don't want all this money pouring through not-for-profits, but you also want to make sure everybody is being treated fairly.” Alluding to the bigger problem, he emphasized: “Now, the real scandal around the IRS right now is that it has been so poorly funded that they cannot go after these folks who are deliberately avoiding tax payments . . . .”

Jon Stewart, of course, did not point out to the president that ambiguous concepts—such as “unrelated business activity” and “educational”—are the hallmark of the federal tax rules applicable to tax—exempt organizations, and have defied specific definition since their enactment.

The IRS has taken a series of major organizational and procedural steps, clearly moving as quickly as it can to address the May 2013 TIGTA Report's recommendations and to align the Exempt Organizations Division (and the Employee Plans Division) with the organizational structures of the rest of the IRS National Office. These changes, though, are being developed by an entirely new cadre of senior management, virtually all of whom lack significant experience in the function or with the tasks required to administer the relevant substantive sections of the Internal Revenue Code.

In addition, the agency is proceeding piecemeal, focusing initially on the exemption-application processing function, to be followed at some point by a review of the examination function. In view of the huge amounts of funds flowing into the nonprofit sector, particularly to social welfare organizations exempt under section 501(c)(4), the IRS's sense of urgency is understandable. However, this emphasis on granting recognition of exemptions now and (possibly) asking questions later does not seem sustainable. The nonprfit sector and practitioners should be alert to developments to target noncompliance, as they are likely to occur quickly, and without an opportunity for public comment and discussion. In addition, the decoupling of the enforcement function from the interpretative function, now located in a different organization unit (the Office of Chief Counsel), suggests that there may be a greater risk for inconsistent or incorrect positions being taken in IRS audits.

As for small charities, regardless of whether Congress or the IRS adopts the five-year provisional-exemption proposal described in Part III, the agency should expand information collection. Importantly, a charity that grows sufficiently—which could happen even before five years pass—will have to file a Form 990-EZ or even a Form 990. Thus, the IRS should require a successful Form 1023-EZ applicant, when it first files one of those information returns, to submit the organizational documents and certain other information (notably, about activities and related party transactions and relationships) that would have been required on a full Form 1023 application. In addition, the IRS should continue sampling to ensure the eligibility of 1023-EZ applicants.

The bigger question—should the IRS be the locus of federal regulation of charities?—might more usefully be narrowed to “should the IRS be the locus of regulation for political activity by tax-exempt organizations?” If significant abuse arises, particularly if due even in part to the reduction in scrutiny of applications for tax-exempt status and in audit enforcement, one of us has proposed that it might be appropriate to move the entire regulatory function over tax-exempt organizations to a different governmental or quasi-governmental structure.

http://taxprof.typepad.com/taxprof_blog/2017/01/the-irs-scandal-day-1334the-irss-diminished-role-in-overseeing-tax-exempt-organizations.html

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Comments

A new agency would simply be weaponized the way the first was. The solution is, and always has been to fire the people who participated in this deliberate violation of peoples' rights, No lesser solution will make them whole again.

Not that one could ever expect that out of washington, or the outgoing administration. They're just shocked, shocked, that anyone at the IRS could go after the same people that the president loudly and repeatedly called for them to go after every single time he got behind a teleprompter. Would noone rid him of that troublesome Tea Party, indeed.

Posted by: Voyager | Jan 2, 2017 11:14:25 AM