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IRS Oversight – A Misnomer

There are now over 1.5 million nonprofits in the US and 50,000 more are being added each year. The only national oversight authority in this sector is the IRS and they are neither staffed nor funded to do an adequate job. The challenge of oversight began in the late 1800’s before the function of a charity was even defined.

The Tariff Act of 1894 was the first attempt by Congress to define the role of charities and to exempt them from corporate income taxes. The Act specifically named four categories of charities which included:

  • Trusts for the relief of poverty
  • Trusts for the advancement of education
  • Trusts for the advancement of religion
  • Trusts for other purposes beneficial to the community

Between 1913 and 1976 other categories were included in the definition of what qualified as a charity. Legitimate charities can now be focused on scientific discovery, prevention of cruelty to children, literary purposes, testing for public safety and amateur athletics. The practical application of this list has been summarized by just two qualifying principles. First, a charity must perform a valued public function. Second, legitimate charities cannot exist for private benefit.1 Even when the original specific list is watered down into the two qualifying principles you still need some authority figure who reviews the applications and makes judgment calls on what gets approved and what gets denied. This is done by the IRS but their standards are not very stringent because 99.5% of all applications are approved. The real mystery here is not why so many get approved, but what in the world is being proposed by the .05% that gets rejected. Based on the wide range of things already approved it is difficult to imagine what could be rejected!

IRS oversight doesn’t improve after the approval process. In any given year only a tiny fraction of 1% of all nonprofits have their tax documents reviewed by the IRS. It isn’t clear what the IRS means by “reviewed” but one has to assume it is something short of a full scale on-site audit.

For the purposes of the donor the lack of oversight in the nonprofit sector means that we can’t take anything for granted. The organizations we contribute to need to be registered with the IRS so the donations will be tax deductible, but beyond that the 501(c) 3 designation doesn’t mean anything. Gaining the IRS designation as an approved charity does not mean the organization has the capacity to perform the tasks required by their mission. If we assume the tax deductible status granted by the IRS is a vote of confidence or a seal of approval we are in error. There are groups in the sector that do provide meaningful certifications, but the IRS isn’t one of them.

 

1Ken Stern, “With Charity For All” (New York: Doubleday, 2013), p 75-76.