IRS Isn't Best Suited to Regulate Non-Profits

I've always thought it odd that the agency charged with overseeing charities and other non-profits is the Internal Revenue Service (IRS). The IRS was created to collect taxes. Its ethos is to find revenue for the U.S. Treasury, and the reward system among its employees reflects that ethos--you succeed at the IRS when you collect taxes.

Yet, there is a small group within the agency whose job is to tell potential taxpayers in effect, "Never mind. You don't have to pay any taxes because we say you're tax-exempt." These employees do not find revenue for the Treasury. In fact, they spend a good bit of their time and resources on "recognizing" the organizations that will not have to pay taxes. It should be no surprise then that when the agency's budget is allocated, its Exempt Organizations division usually gets the short end of the stick. Granting exemptions from tax is simply not an IRS priority.

But shortchanging the charity watchdogs within the IRS might be a false economy given the way tax-exempt status is now achieved. By all accounts, the IRS is barely able to keep up with all the applications for such status. There is just not enough trained, experienced staff to do a thorough job on each applicant. The result is often a cursory review that could allow an unqualified entity to avoid tax. When that happens, the Treasury loses tax revenue.

The numbers are compelling. Americans donate about $300 billion to charities each year, and that translates into between $50 billion and $60 billion in taxes lost to the charitable deduction. And the number of charities and other tax-exempt organizations is increasing. The IRS has recognized at least 50,000 new charities in each of the past 10 years so that today there are approximately 1.2 million charities and private foundations.

These numbers have led to a debate over how to handle the flood of applications for tax exemption and how to regulate the resulting nontax-paying organizations thereafter.

Some non-profit sector observers say the IRS should simply increase its budget for what it calls the determinations process--the handling of applications. Others say we should drop all efforts to "determine" who deserves tax exemption because experience shows almost all applicants get approval anyway. Let them just file a few papers attesting to their compliance with the law, and let it go. Save the cost and delay of determinations and use resources instead for examinations (i.e., audits) of wayward, or likely wayward, tax-exempts. Still others say we should get the IRS out of the business of dealing with other non-profits altogether.

They adopt my instinct, which is that the IRS--the federal government's tax collector--has no business granting tax exemptions, for cryin' out loud. Let it focus on collecting revenue and let a completely separate agency with its own budget and authority regulate the non-profit and tax-exempt sector. My guess is an autonomous regulator of charities would pay for itself by doing a better job of screening out the undeserving applicants, by spotting taxable revenue within the sector, by identifying fraudulent charities, etc. Even if it didn't quite pay for itself, it would certainly serve the public interest by keeping the entire tax-exempt sector honest.

Then there's this: As newspapers dwindle in number and resources, we'll need more tax examiners just to keep up the rather modest level of enforcement we now enjoy. It is a fact that despite the annual filing requirements imposed on charities, the government nevertheless relies a good deal on newspaper reports to identify bad actors in the sector. A separate agency whose employees are rewarded for watching over a nontax-paying sector of the economy--not ignored for it--might even turn a profit back to the Treasury. Wouldn't that be ironic?

Contributing Author

Bruce D. Collins

Bio and more articles

Join the Conversation

Advertisement. Closing in 15 seconds.