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As I See It

Tax-exempt organizations under intensifying scrutiny

I have long suspected that some charities and other nonprofit organizations use their tax-exempt status to help donors escape taxation in ways not contemplated by the law. Now, let me be quick to say that most charities operate in a legal and responsible manner and serve the public good most admirably.

However, with roughly three million nonprofit organizations registered with the IRS, there’s bound to be some engaging in illicit financial shenanigans.

Both Congress and the IRS are beginning to focus on identifying and rousting out some of the bad apples.

Recently, IRS commissioner Mark W. Everson said, “We can see that tax abuse is increasingly present in the (nonprofit) sector.” And, without effective government action, such organizations risk “the loss of faith and support that the public has always given to this sector.”

Congress is also taking an interest in the abuse it perceives to be marring the otherwise excellent reputation of American nonprofits. Responding to the IRS report, Senate Finance chairman Charles E. Grassley (R-Iowa) said, “It’s a seminal letter that rips off the rose-colored glasses with which we usually look at tax-exempt organizations. What’s going on isn’t a pretty picture in the harsh light.”

The term “nonprofits” is used to describe a fairly diverse group of entities, which range from churches and hospitals to colleges, pension plans and trade associations. These entities provide invaluable service in helping the poor, advancing medical technology, educating young people and really do make an enormous contribution to the quality of life we enjoy here in the U.S. Too bad that a few miscreants are scarring the reputation of the whole nonprofit community.

What are they doing? It all seems to revolve around either making donations that are inflated in value or allowing the donor to retain some control of the donated funds. In essence, the wrongdoing is a variation of the typical contribution whereby the donor writes a check to the charity and gets nothing but a warm fuzzy feeling in return. These exceptions to the norm are where the trouble lies.

We’ve all heard stories about someone donating an old ‘82 Pontiac, which hasn’t run in years, in part because, over the years, the engine and the front axle have been removed, and then claiming a $4,500 tax deduction for their generosity in parting with such a valuable asset. In many cases, these questionable tax planning maneuvers escape detection because the IRS’ auditing budget has been cut to the bone over the years.

The ‘82 Pontiac example is fairly simple to pull off. The schemes get more complex and devious as one ascends the income ladder. Some rise to the level of outright fraud, such as when a nonprofit is used mainly to pay the living expenses of the donor. In other cases, the nonprofit acts as an enabler for tax-shelter promoters, such as when a municipality or union takes a fee to participate in a deal that allocates “profit” to itself and losses to wealthy individuals.

Commissioner Everson’s report says that, of the IRS’ list of 31 major abusive tax-shelter schemes, nearly half involve a nonprofit entity. Specifically, Everson’s letter to the Senate Finance Committee raised concerns about nonprofit hospitals and how hard it is to distinguish them from for-profit hospitals; political activity of nonprofits; misuse of nonprofits set up to allow religious leaders to hold property and conduct business for the benefit of a religious organization; and deals designed to allow members of a tribe to benefit from gambling revenue without owing taxes.

Among the most serious problems identified by the IRS is the increasing donations to entities that allow the taxpayer to make a deductible donation but retain access to the donated funds for some period of time. This scam is frequently an arrangement whereby the charity receives the donation, thereby establishing the tax deduction, but then loans the funds back to the donor at no interest.

One obvious result of all this chicanery by nonprofits is lost tax revenue. Though significant, the larger issue is the threat to the reputation and credibility of all nonprofits. Should the public lose faith in charitable organizations, our society will suffer mightily as these folks are forced to curtail programs that benefit so many of our citizens.

Confidence in the fairness of the system is key to operating a self-assessment tax system such as ours. I have long felt that the Congress’s continually cutting IRS compliance resources damages confidence in the system. Most of us don’t even know anyone who’s been audited in recent years, and that chips away at the motivation to comply with the tax law.

I am convinced that our income tax system is such a mess that no reform measures would be sufficient to clean it up. I also have real qualms about whether granting nonprofit status to any organization or allowing tax deductions for donations is good policy. Nevertheless, we need to either change the system or enforce the one we have. Allowing slipshod tax avoidance schemes to continue is a slap in the face to the vast majority of taxpayers who play by the rules and the charities who serve our communities so well.

Thought for the Moment

Happiness is a butterfly, which, when pursued, is always just beyond your grasp, but which, if you will sit down quietly, may alight upon you. — Nathaniel Hawthorne (1804-1864)

Joe D. Jones, CPA (retired), is publisher of the Mississippi Business Journal. Contact him at cpajones@msbusiness.com.


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