Tax-Exempt Organizations
Collecting More Data on Donor-Advised Funds and Supporting Organizations Could Help Address Compliance Challenges Gao ID: GAO-06-799 July 27, 2006Donor-advised funds and supporting organizations are two charitable-giving options that have received attention from Congress and the Internal Revenue Service (IRS) for their potential to facilitate noncompliance with tax law. As requested, GAO is providing information on donor-advised funds and supporting organizations related to (1) federal laws and regulations, compared to private foundations; (2) financial and organizational characteristics; and (3) types of noncompliance and promotion methods and challenges identifying them.
Donor-advised funds, supporting organizations, and private foundations are all tax-exempt charitable-giving vehicles. Donor-advised funds are separate accounts held by a public charity to receive contributions from donors who may recommend, but not control, charitable distributions from the account. Supporting organizations are public charities that are to carry out their tax-exempt purpose by supporting one or more tax-exempt organizations, usually other public charities. Compared with private foundations, donor-advised funds and supporting organizations give donors less control over how their donation will be used but provide donors more favorable tax deductions, lower administration costs, less IRS oversight, and fewer reporting requirements. Donor-advised funds hold billions of dollars in assets, and supporting organizations and private foundations hold hundreds of billions of dollars in assets. Public charities and private foundations must annually file an IRS Form 990 or Form 990-PF, respectively, to report their activities. However, donor-advised fund data are limited because organizations that maintain the funds are not required to separately report fund data from other financial data on Form 990. Although some supporting organization characteristics can be determined from Form 990 data, other characteristics, such as the rate at which payments are made to charities and details about the recipients of loans from the organization, cannot be reliably determined. Concerns have arisen about the "payout" rate to charities, and Congress is considering a minimum payout requirement, similar to the one for private foundations. Further, supporting organizations are not required to report their supported organizations' identification numbers, making it more difficult to track the relationship between organizations. To collect additional data, IRS revised Form 990 for 2003 and 2005 and is considering further revisions, but no firm plans have been determined. According to IRS managers, examinations reveal that some donor-advised funds and supporting organizations are used in abusive schemes to unallowably benefit donors or related parties or give donors excess control of charitable assets and operations. In some cases, IRS is able to clearly determine noncompliance and assign appropriate corrective actions. However, in other cases, IRS faces challenges gathering evidence or addressing activities that do not seem to benefit charities, but do not violate any law or regulation, such as when a supporting organization loans money, at market rate, to a donor, director, or officer of the organization. Promoters, who are individuals or entities who facilitate abusive schemes, further complicate IRS's examination efforts.
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Director: Team: Phone:GAO-06-799, Tax-Exempt Organizations: Collecting More Data on Donor-Advised Funds and Supporting Organizations Could Help Address Compliance Challenges
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Report to the Chairman, Committee on Ways and Means, House of
Representatives:
United States Government Accountability Office:
GAO:
July 2006:
Tax-Exempt Organizations:
Collecting More Data on Donor-Advised Funds and Supporting
Organizations Could Help Address Compliance Challenges:
Tax Compliance:
GAO-06-799:
GAO Highlights:
Highlights of GAO-06-799, a report to the Chairman, Committee on Ways
and Means, House of Representatives
Why GAO Did This Study:
Donor-advised funds and supporting organizations are two charitable-
giving options that have received attention from Congress and the
Internal Revenue Service (IRS) for their potential to facilitate
noncompliance with tax law. As requested, GAO is providing information
on donor-advised funds and supporting organizations related to (1)
federal laws and regulations, compared to private foundations; (2)
financial and organizational characteristics; and (3) types of
noncompliance and promotion methods and challenges identifying them.
What GAO Found:
Donor-advised funds, supporting organizations, and private foundations
are all tax-exempt charitable-giving vehicles. Donor-advised funds are
separate accounts held by a public charity to receive contributions
from donors who may recommend, but not control, charitable
distributions from the account. Supporting organizations are public
charities that are to carry out their tax-exempt purpose by supporting
one or more tax-exempt organizations, usually other public charities.
Compared with private foundations, donor-advised funds and supporting
organizations give donors less control over how their donation will be
used but provide donors more favorable tax deductions, lower
administration costs, less IRS oversight, and fewer reporting
requirements.
Donor-advised funds hold billions of dollars in assets, and supporting
organizations and private foundations hold hundreds of billions of
dollars in assets. Public charities and private foundations must
annually file an IRS Form 990 or Form 990-PF, respectively, to report
their activities. However, donor-advised fund data are limited because
organizations that maintain the funds are not required to separately
report fund data from other financial data on Form 990. Although some
supporting organization characteristics can be determined from Form 990
data, other characteristics, such as the rate at which payments are
made to charities and details about the recipients of loans from the
organization, cannot be reliably determined. Concerns have arisen about
the ’payout“ rate to charities, and Congress is considering a minimum
payout requirement, similar to the one for private foundations.
Further, supporting organizations are not required to report their
supported organizations‘ identification numbers, making it more
difficult to track the relationship between organizations. To collect
additional data, IRS revised Form 990 for 2003 and 2005 and is
considering further revisions, but no firm plans have been determined.
According to IRS managers, examinations reveal that some donor-advised
funds and supporting organizations are used in abusive schemes to
unallowably benefit donors or related parties or give donors excess
control of charitable assets and operations. In some cases, IRS is able
to clearly determine noncompliance and assign appropriate corrective
actions. However, in other cases, IRS faces challenges gathering
evidence or addressing activities that do not seem to benefit
charities, but do not violate any law or regulation, such as when a
supporting organization loans money, at market rate, to a donor,
director, or officer of the organization. Promoters, who are
individuals or entities who facilitate abusive schemes, further
complicate IRS‘s examination efforts.
What GAO Recommends:
GAO suggests that Congress consider (1) directing IRS to collect Form
990 data for, and provide guidance on calculating payout rates for
donor-advised funds and supporting organizations, and (2) providing IRS
authority to protect from public disclosure the taxpayer identification
numbers (TIN) of loan recipients, so that IRS can collect the TINs on
the Form 990. GAO recommends that IRS require (1) more comprehensive
reporting of donor-advised fund data, (2) reporting of supported
organizations‘ identification numbers, and (3) reporting of TINs for
recipients of large loans, if granted authority to protect the TINs
from public disclosure.
IRS agrees with the first two recommendations but believes it needs
legislative authority to protect loan recipient TINs.
[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-06-799].
To view the full product, including the scope and methodology, click on
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[End of Section]
Contents:
Letter:
Results in Brief:
Background:
Scope and Methodology:
Federal Laws and Regulations Impose Fewer Requirements on Donor-Advised
Funds and Supporting Organizations and Their Donors, but Allow Donors
Less Control Compared to Private Foundations:
Donor-Advised Funds, Supporting Organizations, and Private Foundations
Hold Billions of Dollars in Assets, but Some Organizational
Characteristics Cannot Be Reliably Determined from Form 990 Data:
Private Benefit, Inurement, and Donor Control Have Been Found in Some
Cases Involving Donor-Advised Funds and Supporting Organizations, with
Promoters Sometimes Facilitating Schemes:
Conclusion:
Matters for Congressional Consideration:
Recommendations for Executive Action:
Agency Comments:
Appendix I: Tax-Exempt Excise Taxes:
Appendix II: Summary Data Tables for Section 501(c)(3) Tax-Exempt
Charities in 2005 Constant Dollars, Tax Years 1999-2003:
Appendix III: Noncash Contribution Valuation Methods:
Appendix IV: Methods and Materials Used to Market Donor-Advised Funds
and Supporting Organizations to Potential Donors:
Appendix V: Comments from the Internal Revenue Service:
Appendix VI: GAO Contact and Staff Acknowledgments:
Glossary:
Tables:
Table 1: Simplified Comparison of Differences and Similarities in
Federal Tax Laws for Donor-Advised Funds, Supporting Organizations, and
Private Foundations:
Table 2: Selected Financial Characteristics Reported by Supporting
Organizations and Private Foundations in 2005 Constant Dollars, Tax
Years 1999 and 2003:
Table 3: Medians and Related Data for Selected Financial
Characteristics Reported by Supporting Organizations and Private
Foundations in 2005 Constant Dollars, Tax Years 1999 and 2003:
Table 4: Number of Returns Filed, Tax Years 1999 through 2003:
Table 5: Total Assets Reported by Section 501(c)(3) Organizations in
Constant 2005 Dollars, Tax Years 1999 through 2003:
Table 6: Total Revenue Reported by Section 501(c)(3) Organizations in
Constant 2005 Dollars, Tax Years 1999 through 2003:
Table 7: Total Expenses Reported by Section 501(c)(3) Organizations in
Constant 2005 Dollars, Tax Years 1999 through 2003:
Table 8: Total Contributions Received Reported by Section 501(c)(3)
Organizations in Constant 2005 Dollars, Tax Years 1999 through 2003:
Table 9: Total Noncash Contributions Received Reported by Section
501(c)(3) Organizations in Constant 2005 Dollars, Tax Years 1999
through 2003:
Table 10: Total Grants Paid Reported by Section 501(c)(3) Organizations
in Constant 2005 Dollars, Tax Years 1999 through 2003:
Table 11: Total Executive Compensation Reported by Section 501(c)(3)
Organizations in Constant 2005 Dollars, Tax Years 1999 through 2003:
Figures:
Figure 1: Simplified Example of How Donor-Advised Fund Accounts
Operate:
Figure 2: Simplified Example of Governance and Structure of Type I, II,
and III Supporting Organizations:
United States Government Accountability Office:
Washington, DC 20548:
July 27, 2006:
The Honorable William M. Thomas:
Chairman:
Committee on Ways and Means:
House of Representatives:
Dear Mr. Chairman:
Each year, millions of donors give hundreds of billions of dollars to
charities.[Footnote 1] The Internal Revenue Service (IRS) estimated
that for tax year 2002, charitable contributions totaled over $229
billion, the largest portion coming from individuals and
foundations.[Footnote 2] In addition to traditional public charities
and private foundations, donors may make charitable contributions
through the use of donor-advised funds and supporting organizations.
Donor-advised funds are generally separate funds or accounts
established and maintained by a public charity to receive contributions
from a single donor or a group of donors.[Footnote 3] While the donor
may recommend charitable distributions from the account, the charity
must be free to accept or reject the donor's recommendations.
Supporting organizations are public charities that are to carry out
their tax-exempt purpose by supporting one or more tax- exempt
organizations, usually other public charities. IRS has recognized that
while the majority of tax-exempt organizations are trying to comply
with tax law, a significant compliance challenge involves the use of
donor-advised funds and supporting organizations in abusive
arrangements benefiting individuals or organizations other than
charities. Concerns about these abuses have led to proposed legislation
imposing requirements on the operation of donor-advised funds and
supporting organizations.
As requested, we are providing information on (1) federal laws and
regulations regarding donor-advised funds and supporting organizations,
as compared to private foundations;[Footnote 4] (2) financial and
organizational characteristics, such as loan recipients, of donor-
advised funds, supporting organizations, and private foundations, to
the extent data are available; and (3) types of potential or actual
noncompliance and promotion methods involving donor-advised funds and
supporting organizations and the challenges identifying them. In
addition, we agreed to provide information about noncash contribution
valuation methods and marketing methods involving donor-advised funds
and supporting organizations, which are discussed in appendixes III and
IV.
To compare current federal laws and regulations for donor-advised funds
and supporting organizations to those for private foundations, we
reviewed the Internal Revenue Code (IRC), Department of the Treasury
regulations, and IRS publications as they related to the purpose and
operation of these entities. To determine financial and organizational
characteristics of donor-advised funds, supporting organizations, and
private foundations, we analyzed IRS Forms 990 and 990-PF[Footnote 5]
data, as well as reviewed survey data that external organizations
collected on donor-advised funds. Unless otherwise noted, tax year 2003
was the most recent year of data available at the time of our analysis.
We converted 2003 dollar amounts to 2005 constant dollars. To identify
types of noncompliance and promotion methods involving donor-advised
funds and supporting organizations, we reviewed documents from IRS as
well as from our literature search. For each objective, we spoke to
various IRS managers and individuals knowledgeable about the tax-exempt
community. We conducted our review from July 2005 through May 2006 in
accordance with generally accepted government auditing standards.
Results in Brief:
Although donor-advised funds, supporting organizations, and private
foundations are all tax-exempt, charitable-giving vehicles, federal tax
laws and regulations treat them differently. In general, donors who
establish donor-advised funds and supporting organizations have less
control over the use of the charitable assets than those who establish
private foundations, but they generally incur less administrative
burden, receive less IRS oversight, have fewer limits in claiming
charitable tax deductions, and have fewer reporting requirements. Donor-
advised funds, unlike supporting organizations and private foundations,
are charitable-giving vehicles rather than entities and are not defined
under federal law. Supporting organizations fall in between a donor-
advised fund and a private foundation in terms of restrictions and
sanctions versus control over the use of the charitable assets. The
level of control that the supported charity has over the supporting
organization varies, depending on the type of relationship between the
two entities. Unlike donor-advised funds and supporting organizations,
private foundations are not public charities. They also face more types
of taxes and requirements, such as in annual reporting, making
investments, and paying out funds.
Donor-advised funds hold billions of dollars in assets, and supporting
organizations and private foundations hold hundreds of billions of
dollars in assets. However, IRS data on donor-advised funds are limited
because although organizations that maintain donor-advised funds are to
file a Form 990 that includes financial data for all organizational
activities, including for donor-advised funds, data on these funds are
not readily identified from the form because these data are not
separately reported. Limited data on donor-advised funds are available
from annual surveys by The Chronicle of Philanthropy, even though these
data are incomplete and only represent those who voluntarily
responded.[Footnote 6] For 2003, the 90 survey respondents reported
that their donor-advised fund accounts held over $11.9 billion in
assets and distributed over $2.2 billion to charities. Data from Forms
990 and 990-PF for 2003 showed differences between supporting
organizations and private foundations. For example, in 2003, supporting
organizations held over $239.4 billion in assets and paid over $10.7
billion in grants.[Footnote 7] Private foundations held over $449.5
billion in assets in 2003 and paid over $31.0 billion in grants.
Certain other characteristics cannot be reliably determined from Form
990. For example, supporting organizations are not required to compute
and report a "payout" rate equivalent to that for private foundations.
Questions have arisen about how much and how often supporting
organizations pay out to charities because, like private foundations,
some supporting organizations can be used to accumulate contributions
before distributing the money to charity. Further, other organizational
characteristics, such as detailed information on loan recipients and
supported organizations' identification numbers, are not readily
identified from the Form 990. IRS revised the Form 990 for 2003 to
include whether the Form 990 filer maintains donor-advised funds, and
for 2005, the type of supporting organization in terms of its
relationship to its supported organization. IRS is considering other
Form 990 revisions for donor-advised funds and supporting
organizations, but plans for making revisions are preliminary.
Through examinations, IRS is finding evidence that some donors or
related parties are exerting excess control over or receiving undue
benefits from a donor-advised fund or supporting organization. For
example, some donors to donor-advised funds and supporting
organizations participate in schemes which allow them to regain their
contribution, thus giving them a tax deduction on assets that did not
actually go to charity. These examinations were not intended to be a
statistically representative sample and even when finished will not
allow IRS to estimate the magnitude of noncompliance involving donor-
advised funds and supporting organizations. Although the examinations
have produced strong evidence of abusive schemes involving excess
control and undue benefits, IRS faces challenges when identifying and
examining noncompliance, namely the difficulty of gathering evidence on
the facts and circumstances of some cases. IRS is also challenged by
cases in which a donor-advised fund or supporting organization is
compliant because no law or regulation is violated, but engage in
activities that do not seem to benefit charity. For example, under
certain circumstances, a market rate loan made to a donor, officer, or
director from a supporting organization may not violate legal
requirements applicable to public charities even though it may appear
to be a conflict of interest and have no benefit to charity. Some
abusive schemes are instigated or facilitated by entities or
individuals, such as attorneys, accountants, and financial planners,
who promote the schemes. Because of the potentially criminal and
obscure nature of their activities, these entities and individuals are
often difficult to identify and investigate, which adds to the
challenges in IRS's examinations.
Given the concerns about how much and how often donor-advised funds and
supporting organizations are paying out their assets to charities, this
report suggests that Congress should consider directing IRS to revise
the Form 990 to collect sufficient information so that a consistent
payout rate can be calculated for both types of charitable-giving
vehicles. This information could help inform decisions about whether to
adopt a minimum payout requirement and if so, whether the required rate
should be adjusted over time. To help IRS make these revisions,
Congress should direct IRS about the types of support that should be
included in the payout rate, as it has for private foundations. In
addition, given the lack of data from the Form 990 to be used to
determine certain characteristics of donor-advised funds and supporting
organizations and the concerns about noncompliance involving these
charitable-giving vehicles, we are making recommendations to IRS on
collecting better data on the Form 990. IRS agreed with our two
recommendations to require more comprehensive reporting of donor-
advised fund data and to require supporting organizations to report
their supported organizations' employer identification numbers (EIN).
However, IRS did not believe that it could implement our third
recommendation to require reporting of loan recipients' taxpayer
identification numbers (TIN) without legislative authority to protect
the TINs from public disclosure.[Footnote 8] In response, we have
revised our recommendation and, so that IRS can modify the Form 990 to
require reporting of TINs of loan recipients from supporting
organizations, we are also suggesting that Congress consider providing
IRS authority to protect that information from public disclosure.
Background:
IRC section 501(c) specifies 28 types of entities that are eligible for
tax-exempt status and over 1.6 million entities have been recognized as
exempt as of 2005. One subset of these tax-exempt entities is
classified as 501(c)(3) charitable organizations, of which slightly
over 1 million existed in 2005, according to IRS. In 1969, Congress
directed that all 501(c)(3) organizations would be private foundations
unless they qualify for exclusion from that status under IRC section
509. This change subdivided section 501(c)(3) organizations into two
general categories--"public charities" and "private foundations."
Within the public charities classification, Congress created supporting
organizations, which are defined in section 509(a)(3) as public
charities organized to support one or more public charities, including
churches and certain governmental units, and certain other tax-exempt
entities, such as membership-based organizations (e.g., unions and
professional organizations). Supporting organizations are classified as
public charities not because they are themselves publicly supported,
but because they are to support another public charity with which they
are to maintain a strong relationship. In creating supporting
organizations, Congress recognized that it can be beneficial and
prudent to place certain assets or activities in a separate legal
entity to insulate assets from liability or to facilitate separation of
functions for programmatic, accounting, or other reasons, according to
the Panel on the Nonprofit Sector Final Report.[Footnote 9]
Donor-advised funds are generally separate accounts operated by tax-
exempt public charities to receive contributions from a single donor or
group of donors. Donors can advise on the distributions from the
account. For the contribution to qualify as a completed gift, the
charity must have ultimate control over how the assets in the account
are invested and distributed. According to our interviews with
knowledgeable individuals and recent Senate testimony, donor-advised
funds have generally been in existence since the 1930s and have
traditionally been operated by community foundations.[Footnote 10] In
the 1990s, financial investment firms began establishing "commercial
funds," which are tax-exempt public charities that operate donor-
advised fund accounts. Investment of contributions to the fund accounts
is controlled by the commercial fund's board, which hires the
investment firm that established the commercial fund to manage the
fund's assets.
Generally, an entity must apply to IRS to obtain tax-exempt
recognition. Most organizations seeking recognition from federal income
tax must use specific forms, including Form 1023 (Application for
Recognition of Exemption under Section 501(c)(3) of the IRC) or Form
1024 (Application for Recognition of Exemption under Section 501(a)) as
well as other documentation.[Footnote 11] After receiving tax- exempt
recognition, public charitable entities must annually file a Form 990
information return to report their financial transactions and
activities for a tax year. Charities that have less than $100,000 in
gross receipts and $250,000 in year-end assets may use Form 990-EZ.
Entities with gross receipts below $25,000, and certain types of
entities, such as churches and certain entities associated with
churches, generally are not required to file. Form 990 collects
information on revenues, expenses, and assets, and has accompanying
schedules. Schedule A of Form 990 covers several areas such as
compensation, lobbying expenditures, and revenue sources. Schedule B
covers the source of contributions to charities and certain other
exempt entities.[Footnote 12] Congress has granted public access to
Form 990 data in recognition of the importance of public oversight to
inform donors about how their money is spent and to stem potential
abuses. Private foundations, regardless of their amounts of gross
receipts or assets, are required file a Form 990-PF information return
annually.
IRS oversight of tax-exempt entities generally relies on two
activities. First, IRS reviews applications for tax-exempt status to
determine whether a tax-exempt purpose is envisioned. IRS approves
those applications that are properly completed and for which the
applicant can demonstrate to the satisfaction of IRS that its
activities or proposed activities meet the requirements of the section
under which exemption is claimed. Second, IRS annually examines
selected Forms 990 to determine whether the exempt entities meet
various requirements (such as properly reporting unrelated business
income tax).[Footnote 13] In general, IRS attempts to select entities
that it believes are likely to have violated requirements. Based on
examination evidence, IRS can accept the Form 990 as filed or change
the status of the entity, impose excise taxes for certain types of
violations, or revoke the exempt status if the violations are serious
enough.[Footnote 14] As appropriate, IRS can also assess other types of
taxes, such as employment taxes or unrelated business income taxes.
In 2004, the Senate Committee on Finance asked a panel of experts to
make recommendations to Congress to improve oversight, transparency,
and governance in the tax-exempt sector. To do so, the Independent
Sector[Footnote 15] convened a Panel on the Nonprofit Sector in October
2004, which included 24 nonprofit and philanthropic leaders.[Footnote
16] The Panel issued a final report in June 2005 with over 120
recommendations, several focusing on donor-advised funds and supporting
organizations. On the basis of this report and other information,
Congress has considered proposals to impose more restrictions and
requirements on donor-advised funds and supporting organizations to
better ensure that their contributions advance charitable rather than
private interests and that their donors do not exert control or receive
private benefits. Provisions in legislative proposals that apply to
donor-advised funds have included providing a formal definition of a
fund, setting minimum payout requirements, and placing restrictions on
dealings with those who may privately benefit from charitable
activities. Provisions related to supporting organizations have
included those that would apply certain private foundation rules and
restrictions, such as those on the annual payout requirement and excess
business holding rules.
Scope and Methodology:
To compare the federal laws and regulations on donor-advised funds and
supporting organizations with those for private foundations, we
reviewed the IRC, Treasury regulations, IRS publications, and various
other documents describing these laws and regulations. We also
interviewed 18 IRS staff and 16 individuals knowledgeable about the tax-
exempt community, such as attorneys and governmental-affairs managers
at tax-exempt entities, to obtain their input about these laws and
regulations and our comparison of them.
To determine financial and organizational characteristics of donor-
advised funds, supporting organizations, and other tax-exempt
charitable organizations, we obtained and analyzed IRS Form 990 and
Form 990-PF data, as well as reviewed survey data on donor-advised
funds that were collected by The Chronicle of Philanthropy. We used the
surveys to obtain data on donor-advised funds because this information
was not identifiable on the Form 990. To determine the reliability of
the donor-advised fund data, we interviewed The Chronicle of
Philanthropy staff about their survey methodology. To obtain supporting
organization and other tax-exempt charitable organization data fields,
we obtained data from IRS's Returns Inventory and Classification System
(RICS) for tax years 1999 through 2003, the 5 most recent years of data
available at the time of our analysis. Because not all the data fields
we wanted were available from RICS, we obtained additional Form 990
data fields from GuideStar, an organization that electronically
captures Form 990 data for public access. To assess the reliability of
the RICS and GuideStar data, we interviewed agency officials and
conducted electronic data testing. In addition, we reviewed a selection
of Forms 990 submitted to IRS to confirm that the values on the form
matched those in the database. While we identified some minor
discrepancies, we determined that the Form 990 data were sufficiently
reliable for our purposes. The data files we obtained included the
population of tax-exempt charities filing returns for those years,
including supporting organizations and private foundations. Using
computer software to analyze these data files, we determined summary
statistics and converted dollar amounts to 2005 constant dollars. For
our discussion on "payout" rate, compensation, and Form 990 revisions,
we performed literature searches and interviewed 20 knowledgeable
individuals from IRS's Statistics of Income (SOI) program and Tax-
Exempt & Government Entities (TE/GE) division, Urban Institute, and
Congressional Research Service (CRS).[Footnote 17]
To describe the types of noncompliance and promotion methods involving
donor-advised funds and supporting organizations, we reviewed IRS
summaries of examination cases. To obtain anecdotal information about
noncompliance involving donor-advised funds and supporting
organizations, we also interviewed 4 managers at IRS who oversee
examinations of donor-advised funds and supporting organizations and 7
individuals knowledgeable about the tax-exempt community who work at
organizations such as the Council on Foundations and the Independent
Sector. We also interviewed 6 financial professionals and 11 community
foundation managers on how donor-advised funds and supporting
organizations are promoted to clients for abusive transactions. We also
reviewed an IRS research report on developing abusive promoter leads
through searching the Internet.
To provide additional information on noncash contribution valuation
methods (see app. III), we reviewed IRS publications and forms and
interviewed an IRS field specialist working on valuation issues in the
Large and Mid-Sized Business operating division. To obtain information
on the marketing of donor-advised funds and supporting organizations
(see app. IV), we spoke with 11 community foundation managers, 6
financial professionals, and 18 managers at IRS. The examples we
discuss come from materials that we were referred to or located online
based on our interviews, and do not necessarily represent all materials
and methods used to market donor-advised funds and supporting
organizations.
Federal Laws and Regulations Impose Fewer Requirements on Donor-Advised
Funds and Supporting Organizations and Their Donors, but Allow Donors
Less Control Compared to Private Foundations:
In recent years, donor-advised funds have become popular charitable-
giving vehicles, and the number of supporting organizations has also
continued to increase. At the same time, federal tax law generally
imposes fewer restrictions and requirements on donor-advised funds and
supporting organizations, but provides them and their donors less
control over the use and investment of the charitable assets compared
to private foundations; in fact, section 501(c)(3) and federal
regulations do not specifically mention donor-advised funds.
As a general principle, the more control that a donor has over the use
of the charitable contributions and assets, the more regulations and
restrictions apply. Table 1 discusses how federal tax law views donor-
advised funds and supporting organizations compared to private
foundations across a number of variables.
Table 1: Simplified Comparison of Differences and Similarities in
Federal Tax Laws for Donor-Advised Funds, Supporting Organizations, and
Private Foundations:
Tax code treatment;
Donor-advised funds: Although not statutorily defined, part of a public
charity that operates funds as separately identified accounts;
Supporting organizations: Public charities that carry out their
charitable purpose by supporting other public charities;
Private foundations: Charities that do not qualify as public charities.
Filing requirement;
Donor-advised funds: Fund administrators must apply for tax-exempt
status and annually file Form 990 if annual gross receipts are over
$25,000, indicating if they have separate accounts (on which separate
Forms 990 are not required);
Supporting organizations: Must apply for exempt status as a supporting
organization. Must annually file Form 990 if annual gross receipts are
over $25,000;
Private foundations: Must apply for exempt status as a private
foundation. Must annually file Form 990-PF as well as schedules on the
use, distribution, and investment of funds.
Donor control;
Donor-advised funds: Donors cannot have control but may advise on use
of funds;
Supporting organizations: Donors can be involved with boards but should
not directly or indirectly control the boards;
Private foundations: Donors and foundation's board have absolute
control, such as hiring staff and choosing charities to support.
Donor tax deductions;
Donor-advised funds: Follows rules for public charities. See
"Supporting organizations.";
Supporting organizations: Donors may deduct up to 50 percent of
adjusted gross income for cash donations and up to 30 percent of
adjusted gross income for donations of capital gain property at fair
market value;
Private foundations: Donors may deduct up to 30 percent of adjusted
gross income for donations of cash and up to 20 percent of adjusted
gross income on capital gain property at cost basis.
Excise taxation;
Donor-advised funds: Follows rules for public charities. See
"Supporting organizations.";
Supporting organizations: Subject to two excise taxes;
Private foundations: Subject to six excise taxes.
Payout rules;
Donor-advised funds: None;
Supporting organizations: None;
Private foundations: Must meet annual minimum payout requirement.
Association with foreign entities;
Donor-advised funds: Follows rules for public charities. See
"Supporting organizations.";
Supporting organizations: May make grants to foreign organizations, but
must ensure that funds are used for charitable purposes;
Private foundations: Must follow more detailed rules than for public
charities, including expenditure responsibility process.
Source: GAO analysis of Internal Revenue Code, Treasury Regulations,
and IRS Forms and Publications.
[End of table]
Among the three types of charitable-giving vehicles, donor-advised
funds allow donors to create a long-term vehicle for supporting
charities with relatively less administrative burden because the fund
is managed by a third party. Furthermore, donor-advised funds are not
required to file separate tax returns, file for tax-exempt status, or
adhere to private foundation rules. The donor can make a gift and take
an income tax deduction for that tax year, and at that time or later,
advise which charities should receive the distribution. However, in
doing so, the donor gives up control over the distribution of the gift
to charities.
Figure 1: Simplified Example of How Donor-Advised Fund Accounts
Operate:
[See PDF for image]
Source: GAO (analysis); Art Explosion (images).
[End of figure]
Supporting organizations are public charities that are to support one
or more public charities or certain other tax-exempt organizations.
They fall in between a donor-advised fund and a private foundation in
terms of restrictions and sanctions versus donor control over the use
of the charitable assets. For example, donors who create a supporting
organization avoid private foundation excise taxes and other rules and
face fewer restrictions on the deductibility of their donations at the
expense of having less control compared to donors at a private
foundation, such as involvement on the board. The level of control that
the supported charity has over the supporting organization varies by
the three basic types of supporting organizations. Type I supporting
organizations are "operated, supervised, or controlled by" the
supported charitable organization. Type II supporting organizations are
"supervised or controlled in connection with" the supported
organization. In contrast, Type III supporting organizations only are
"operated in connection with" the supported organization (see fig. 2).
Figure 2: Simplified Example of Governance and Structure of Type I, II,
and III Supporting Organizations:
[See PDF for image]
Source: GAO (analysis); Art Explosion (images).
[End of figure]
In reforming the rules for charitable organizations in 1969, Congress
made changes to restrict and regulate private foundations more than
public charities. Private foundations are generally funded and
controlled by a single or small number of donors and therefore may be
prone to potential abuses, particularly by disqualified
persons.[Footnote 18] As a result, private foundations are subject to
anti-abuse rules and related sanctions that are not applicable to donor-
advised funds, supporting organizations, and public charities as a
whole. For example, public charities, including donor-advised fund
operators and supporting organizations, are subject to restrictions and
two related excise taxes for activities involving political
expenditures (section 4955) and excess benefit transactions[Footnote
19] (section 4958). In contrast, private foundations are subject to six
excise taxes[Footnote 20] for activities involving:
* investment income[Footnote 21] (section 4940);
* self-dealing[Footnote 22] (section 4941);
* failure to distribute income (section 4942);
* excess business holdings (section 4943);
* investments that jeopardize the charitable purpose (section 4944);
and:
* certain "taxable expenditures" (section 4945).
Although public charities, such as donor-advised fund operators and
supporting organizations, and private foundations are subject to
different restrictions on transactions with disqualified persons, both
excess benefit and self-dealing restrictions are intended to prevent
inurement or undue private benefit, which are prohibited for all
section 501(c)3 organizations. Inurement is the transfer or use of the
charity's assets or income to or for the benefit of a charity's
insiders. All transactions that more than incidentally benefit
insiders, other than reasonable compensation and arm's length
transactions, are prohibited inurement transactions. Private benefit is
a broader concept, and may involve a transfer or use of a charity's
assets or income by private persons who are not necessarily insiders.
Some private benefit may be allowed, but if present, must be no more
than incidental to the exempt purpose being served.
Unlike with donor-advised funds and supporting organizations, a private
foundation is required under section 4942 to distribute annually a
minimum amount of its funds, equal to approximately 5 percent of the
fair market value of the foundation's noncharitable use of assets
(generally, stocks and other investments that compose the foundation's
endowment). In 1984, Congress passed legislation that clarified what
expenses can be included towards meeting this minimum "payout"
requirement.[Footnote 23] If this "payout" rate is unmet, the
foundation is subject to paying taxes on the undistributed amount.
Donor-Advised Funds, Supporting Organizations, and Private Foundations
Hold Billions of Dollars in Assets, but Some Organizational
Characteristics Cannot Be Reliably Determined from Form 990 Data:
Donor-advised funds hold billions of dollars in assets, and supporting
organizations and private foundations hold hundreds of billions of
dollars in assets. Financial data on donor-advised funds are not
separately identified and reported on the Form 990. Although some data
on donor-advised funds have been collected through an annual survey,
these data are incomplete and not statistically representative of the
fund population. Using 2003 data from Forms 990 and 990-PF, we found
differences between supporting organizations and private foundations.
For instance, in 2003, private foundations tended to report more total
assets and contributions received but fewer revenues and expenses
compared to supporting organizations. However, certain other
characteristics of supporting organizations cannot be reliably
determined from the Form 990 because this information is either not
required to be reported or may be misreported for various reasons,
according to IRS. Specifically, supporting organizations are not
required to report a payout rate or to pay out a minimum amount of
funds to charities, as private foundations must do. IRS has recently
revised the Form 990 to better identify supporting organizations and
donor-advised funds and is considering additional revisions, but plans
to further revise the Form 990 are still preliminary.
Limited Data Are Available for Donor-Advised Funds:
Data on donor-advised funds are limited because, unlike supporting
organizations and private foundations, the funds usually are not
entities that file a Form 990 to report their activities. Organizations
that maintain donor-advised funds are to file a Form 990 that includes
the assets and other aggregate information for all activities,
including for donor-advised funds, but data on these funds are not
readily identified from the form because these data are not separately
reported.
To provide more information about donor-advised funds, The Chronicle of
Philanthropy has been conducting an annual survey of organizations that
maintain donor-advised funds. Started in 2000, the survey focuses on
the largest donor-advised funds and collects data such as the total
assets held and the amount of grants awarded. For 2003, The Chronicle
of Philanthropy reported that the 90 organizations participating in its
survey held over $11.9 billion in assets and distributed over $2.2
billion to charities from their donor-advised fund accounts.[Footnote
24]
However, these survey results, which are one of the few data sources
available for donor-advised funds, do not represent the entire
population of donor-advised funds and also have other data
limitations.[Footnote 25] The survey does not try to capture
information for all donor-advised funds, as the population of donor-
advised funds to be surveyed is unknown, and focuses on the largest
funds, such as the 50 largest community foundations, by amount of money
raised. Also, while some efforts are made to generate a high response
rate and to check unusual responses, the survey response rate has
ranged between 53 percent to 57 percent. Further, survey respondents
vary from year to year, and the data are self-reported and cannot be
checked for accuracy. Finally, the survey does not collect data for
individual donor-advised fund accounts.
Data on Supporting Organizations Highlight Differences from Private
Foundations:
From our analysis of Forms 990 and 990-PF, we found that supporting
organizations filed nearly 21,400 Forms 990, and private foundations
filed over 80,300 Forms 990-PF for tax year 2003.[Footnote 26] Table 2
summarizes differences in the amounts of assets, revenues, expenses,
and contributions received when comparing 1999 and 2003. Appendix II
provides additional related data, including data for the years 1999
through 2003.
Table 2: Selected Financial Characteristics Reported by Supporting
Organizations and Private Foundations in 2005 Constant Dollars, Tax
Years 1999 and 2003:
(Dollars in billions).
Number of returns filed;
Tax year: 1999;
Supporting organizations: Total: 20,217;
Supporting organizations: Percentage change: N/A;
Private foundations: Total: 69,812;
Private foundations: Percentage change: N/A.
Number of returns filed;
Tax year: 2003;
Supporting organizations: Total: 21,372;
Supporting organizations: Percentage change: 6%;
Private foundations: Total: 80,365;
Private foundations: Percentage change: 15%.
Total assets[A];
Tax year: 1999;
Supporting organizations: Total: $211.1;
Supporting organizations: Percentage change: N/A;
Private foundations: Total: $428.4;
Private foundations: Percentage change: N/A.
Total assets[A];
Tax year: 2003;
Supporting organizations: Total: 239.4;
Supporting organizations: Percentage change: 13%;
Private foundations: Total: 449.5;
Private foundations: Percentage change: 5%.
Total revenue[B];
Tax year: 1999;
Supporting organizations: Total: 63.0;
Supporting organizations: Percentage change: N/A;
Private foundations: Total: 84.6;
Private foundations: Percentage change: N/A.
Total revenue[B];
Tax year: 2003;
Supporting organizations: Total: 65.0;
Supporting organizations: Percentage change: 3%;
Private foundations: Total: 53.6;
Private foundations: Percentage change: -37%.
Total expenses[C];
Tax year: 1999;
Supporting organizations: Total: 50.0;
Supporting organizations: Percentage change: N/A;
Private foundations: Total: 40.6;
Private foundations: Percentage change: N/A.
Total expenses[C];
Tax year: 2003;
Supporting organizations: Total: 55.6;
Supporting organizations: Percentage change: 11%;
Private foundations: Total: 41.1;
Private foundations: Percentage change: 1%.
Total grants paid;
Tax year: 1999;
Supporting organizations: Total: 8.5;
Supporting organizations: Percentage change: N/A;
Private foundations: Total: 32.4;
Private foundations: Percentage change: N/A.
Total grants paid;
Tax year: 2003;
Supporting organizations: Total: 10.7;
Supporting organizations: Percentage change: 27%;
Private foundations: Total: 31.0;
Private foundations: Percentage change: -4%.
Total contributions received[D];
Tax year: 1999;
Supporting organizations: Total: 14.2;
Supporting organizations: Percentage change: N/A;
Private foundations: Total: 31.3;
Private foundations: Percentage change: N/A.
Total contributions received[D];
Tax year: 2003;
Supporting organizations: Total: $15.5;
Supporting organizations: Percentage change: 9%;
Private foundations: Total: $27.7;
Private foundations: Percentage change: -12%.
Source: GAO analysis of data from IRS's Returns Inventory and
Classification System and from GuideStar, 1999 and 2003.
[A] Total assets include cash and investments in securities, land,
buildings, and equipment.
[B] Total revenue includes contributions received and dividends and
interest earned from the investmentnt of securities.
[C] Total expenses include grants paid, executive compensation,
salaries and wages, and other administrative expenses, which can be
both program-related and nonprogram-related.
[D] Total contributions received include direct contributions from
individuals, indirect contributions through federated fundraising
campaigns or affiliate organizations, and government grants.
[End of table]
Table 2 shows that in 2003, the number of private foundations
outnumbered the number of supporting organizations by more than a
factor of 3, reported over $200 billion more in assets, and reported
more contributions received. However, supporting organizations reported
more revenue but also more expenses by 2003 compared to private
foundations. Furthermore, comparing 1999 to 2003, supporting
organizations tended to report growth in all of these areas while
private foundations reported declines in revenue and contributions
received. We were unable to determine the reasons for these changes,
but the year-to-year variations during 2000, 2001, and 2002, in part
due to a significant stock market decline during this time, provided
some insights (see app. II for summary tables with annual data). Median
values for the dollar amounts reported are shown in table 3.
Table 3: Medians and Related Data for Selected Financial
Characteristics Reported by Supporting Organizations and Private
Foundations in 2005 Constant Dollars, Tax Years 1999 and 2003:
Total assets;
Tax year: 1999;
Supporting organizations: Median[A]: $1,249,657;
Supporting organizations: Percentage change: N/A;
Supporting organizations: Percentage returns reporting: zero[B]: 20%;
Private foundations: Median[A]: $392,542;
Private foundations: Percentage change: N/A;
Private foundations: Percentage returns reporting Median[B]: 5%.
Tax year: 2003;
Supporting organizations: Median[A]: : 1,221,457;
Supporting organizations: Percentage change: -2%;
Supporting organizations: Percentage returns reporting: Median[B]: 18%;
Private foundations: Median[A]: 377,827;
Private foundations: Percentage change: -4%;
Private foundations: Percentage returns reporting Median[B]: 6%.
Total revenue;
Tax year: 1999;
Supporting organizations: Median[A]: 286,340;
Supporting organizations: Percentage change: N/A;
Supporting organizations: Percentage returns reporting: Median[B]: 19%;
Private foundations: Median[A]: 66,180;
Private foundations: Percentage change: N/A;
Private foundations: Percentage returns reporting Median[B]: 5%.
Tax year: 2003;
Supporting organizations: Median[A]: 196,376;
Supporting organizations: Percentage change: -31%;
Supporting organizations: Percentage returns reporting: Median[B]: 17%;
Private foundations: Median[A]: 27,632;
Private foundations: Percentage change: -58%;
Private foundations: Percentage returns reporting Median[B]: 6%.
Total expenses;
Tax year: 1999;
Supporting organizations: Median[A]: 164,172;
Supporting organizations: Percentage change: N/A;
Supporting organizations: Percentage returns reporting: Median[B]: 21%;
Private foundations: Median[A]: 45,346;
Private foundations: Percentage change: N/A;
Private foundations: Percentage returns reporting Median[B]: 7%.
Tax year: 2003;
Supporting organizations: Median[A]: 159,935;
Supporting organizations: Percentage change: -3%;
Supporting organizations: Percentage returns reporting: Median[B]: 18%;
Private foundations: Median[A]: 41,019;
Private foundations: Percentage change: -10%;
Private foundations: Percentage returns reporting Median[B]: 6%.
Total grants paid;
Tax year: 1999;
Supporting organizations: Median[A]: 66,001;
Supporting organizations: Percentage change: N/A;
Supporting organizations: Percentage returns reporting: Median[B]: 49%;
Private foundations: Median[A]: 41,538;
Private foundations: Percentage change: N/A;
Private foundations: Percentage returns reporting Median[B]: 19%.
Tax year: 2003;
Supporting organizations: Median[A]: 73,578;
Supporting organizations: Percentage change: 11%;
Supporting organizations: Percentage returns reporting: Median[B]: 46%;
Private foundations: Median[A]: 37,079;
Private foundations: Percentage change: -11%;
Private foundations: Percentage returns reporting Median[B]: 18%.
Total contributions received;
Tax year: 1999;
Supporting organizations: Median[A]: 141,474;
Supporting organizations: Percentage change: N/A;
Supporting organizations: Percentage returns reporting: Median[B]: 55%;
Private foundations: Median[A]: 57,294;
Private foundations: Percentage change: N/A;
Private foundations: Percentage returns reporting Median[B]: 54%.
Tax year: 2003;
Supporting organizations: Median[A]: $133,474;
Supporting organizations: Percentage change: -6%;
Supporting organizations: Percentage returns reporting: Median[B]: 53%;
Private foundations: Median[A]: $41,938;
Private foundations: Percentage change: -27%;
Private foundations: Percentage returns reporting Median[B]: 58%.
Source: GAO analysis of data from IRS's Returns Inventory and
Classification System and from GuideStar, 1999 and 2003.
[A] Medians were calculated using returns reporting a nonzero value for
the characteristic being analyzed. A median is the number above and
below which 50 percent of organizations fall for the characteristic
measured. We present the median because it better represents the
typical organization than would the average, which could be affected by
extreme dollar values for each measure.
[B] Although medians were calculated using returns reporting a nonzero
value, we included, for context, returns that reported a zero value for
these characteristics.
[End of table]
For the four financial characteristics listed in table 3, median values
for supporting organizations were much higher compared to private
foundations in both 1999 and 2003, in contrast to the higher total
values for private foundations listed in table 2. Also, the declines in
supporting organization median values between 1999 and 2003 were much
less compared to private foundations. We excluded zero values from our
median analyses. IRS officials said that organizations might be
reporting zero values if filing a final return or for other reasons.
However, we were unable to conduct additional analysis on these zero
values, particularly for total contributions received in which over 50
percent of the values reported by supporting organizations and private
foundations were zero.
Some Financial and Organizational Characteristics of Supporting
Organizations Cannot Be Reliably Determined from 990 Data:
Some financial characteristics of supporting organizations cannot be
reliably determined because they are not required to be reported on the
Form 990 or may be misreported. As a result, directly comparing
supporting organizations and private foundations or other tax-exempt
charitable organizations can pose challenges. Being able to make these
comparisons is important in order to address concerns, such as how much
and how often supporting organizations pay out to charities, since,
like private foundations, supporting organizations can be used to
accumulate contributions prior to distributing the money to charity,
but, unlike private foundations, they do not have a minimum payout
requirement to support charities that must be annually
reported.[Footnote 27]
Because supporting organizations do not have this payout requirement,
they do not explicitly report a payout rate, as is required for private
foundations. Certain lines on the Form 990-PF allow IRS, and the
public, to determine whether private foundations have met their
required payout rate. For supporting organizations, factors that are
included in the payout calculation for private foundations might not be
readily determined from the Form 990.[Footnote 28] Absent being able to
identify these additional data and clarifying how they are to be
accounted for in a supporting organization payout rate, consistently
comparing supporting organizations' and private foundations' payout
rates cannot be done. Similarly, for donor-advised funds, payout rate
has not been statutorily required or defined and consequently is also
not required to be reported on the Form 990, and available data do not
allow a payout rate to be determined.
Despite these difficulties, researchers have studied different ways to
compute a payout rate for supporting organizations. A 2005 Urban
Institute study found that supporting organization payout rates could
vary due to factors such as the purpose of the organization and which
lines on the Form 990 were included in determining how much support was
provided.[Footnote 29] The study pointed out that differences in
supporting organization payout rates may reflect differences in the
purpose and operation of the supporting organizations, rather than the
amount of charitable support provided. For example, some supporting
organizations provide operational services to their supported
charities, rather than provide grants. Supporting organizations can
serve to pool or manage investments or endowments for their supported
organization, hold real estate, or provide services, such as office or
property management. Payout rates for these types of supporting
organizations might indeed be low or infrequent, since these
organizations do not hold and distribute charitable funds like other
supporting organizations or private foundations whose primary purpose
is grant-making.
While the Form 990 includes a supporting organization's grants and net
assets, using only those lines to determine a payout rate may provide
an incomplete picture of the supporting organization's charitable
activity. In 2002, supporting organizations reported over $7 billion in
grants as transfers of charitable support. However, in the Urban
Institute study, researchers found that transfers of support from a
supporting organization to its supported organizations were reported on
1 or more of at least 10 lines on the Form 990.[Footnote 30] While the
amounts reported on these lines might include transfers of support, the
Form 990 line data alone are generally not enough to determine how much
of the amount reported, if any, supports charities. For example, they
found that organizations they sampled sometimes reported transfers of
support to a supported organization on the line for rental expenses.
However, only by examining Form 990-related documentation, which an
Urban Institute researcher said required considerable effort, could
they determine this result. In 2003, supporting organizations reported
over $431 million on this Form 990 line, but without significant
effort, one cannot determine how much, if any, of this amount consisted
of transfers of support to supported organizations.
Another challenge in using Form 990 data to determine financial
characteristics arises when analyzing compensation paid to executives
and employees of tax-exempt organizations, such as supporting
organizations. In 1999 and 2003, supporting organizations reported over
$894 million and over $1 billion, respectively, in total executive
compensation. Private foundations reported almost $739 million in 1999
and about $812 million in 2003 in total executive compensation (see
app. II for data tables). Organizations are required to report
compensation for certain employees on the Form 990 and Schedule A.
However, according to IRS managers, misreporting is not uncommon,
although some may be unintentional, in such areas as deferred executive
compensation, payments made to relatives, and compensation paid from
related entities, such as a for-profit subsidiary of a tax-exempt
organization paying the salary of an employee or board member of its
parent tax-exempt organization. In addition, an IRS researcher had
concerns that compensation could be overreported for tax-exempt
organizations within a network, such as a health care network of
hospitals. In such networks, which commonly include supporting
organizations, compensation for board members can be misreported on the
Forms 990 when related organizations have common board members.
IRS is currently working on an initiative to identify and stop abuses
by public charities and private foundations that pay excessive
compensation and benefits to their officers and other insiders.
Beginning in late 2004, IRS contacted a broad spectrum of over 1,800
public charities and private foundations seeking information about
their compensation practices and procedures. IRS also just started a
new phase of the initiative, involving an additional 250 contacts about
loans to officers, directors, and key employees. The goals for the
initiative are to:
* learn how exempt organizations determine and manage compensation;
* gauge the existence and effectiveness of exempt organizations'
controls over compensation issues;
* learn how exempt organizations report compensation on Forms 990 and
990-PF;
* address instances of questionable compensation practices, as well as
compensation of specific individuals;
and:
* increase exempt organizations' awareness of compensation-related tax
issues.
The initial results of the compensation initiative will be included in
a report that is expected to be completed in late August or September
2006. All examinations are expected to be completed by or during 2007.
In addition to financial characteristics such as payout rate and
executive compensation, organizational characteristics about supporting
organizations are difficult to determine from the Form 990. For
example, Form 990 does not collect the EINs of their supported
organizations, which according to IRS officials, would facilitate IRS's
ability to track the flow of donations. In addition, an IRS manager
said that having supported organizations' EINs would facilitate IRS's
ability to track how compensation is treated between supporting
organizations and supported organizations. IRS emphasized that any form
changes must be balanced against the increased burden on taxpayers of
supplying additional information.
Other organizational characteristics for which IRS collects limited
data on Form 990 include relationships with foreign entities, noncash
contributions, loan recipients, and donor information. We were unable
to closely evaluate these characteristics because IRS had limited data
and information to provide and because of time constraints. Although
the costs and burdens of collecting additional data to determine these
organizational characteristics and protecting taxpayer privacy are
legitimate concerns, IRS has acknowledged the need for greater
transparency and better data to track the flow of funds between donors
and charities. For example, IRS does not have TINs of loan recipients
to track the flow of funds.
IRS Has Made and Is Considering Changes to the Form 990 Regarding Donor-
Advised Funds and Supporting Organizations:
IRS has begun to take steps to help address the lack of information
reported on donor-advised funds and supporting organizations. For
example, IRS has revised the 2005 Form 990 Schedule A to include a
check box to indicate whether a supporting organization is Type I, II,
or III.[Footnote 31] This information will be transcribed into IRS's
electronic databases beginning in 2007, which, according to IRS, would
allow it to better focus its examination and educational resources on
compliance issues particular to each type. Also, starting with the 2003
Form 990 Schedule A, organizations must indicate whether they maintain
separate accounts for donors, such as donor-advised funds. In January
2006, IRS began transcribing this information, which is a first step
towards identifying how many and which charities have donor-advised
funds. However, these organizations are not required to separately
report data on the donor-advised funds from the other activity reported
on the Form 990, meaning that data on the funds are not easily
identified. While IRS is considering revising the Form 990 to include
more information about donor-advised funds, it does not have details on
what data they might collect or how or when they would revise the form.
IRS is considering additional changes to the Form 990 that, pending
management approval, would include reorganizing the form in stages. A
pending proposal includes recommendations to create new sections or
schedules on the Form 990 with questions on donor-advised funds and
supporting organizations. Because the Form 1023 asks questions
regarding donor-advised funds and supporting organizations, the
proposal recommends aligning the Form 990 with Form 1023 so that IRS
can track a charity from its formation. If the recommendation is
approved, IRS's Form 990 Redesign Team plans to rewrite the Form 990
instructions and add a glossary consistent with the Form 1023 which,
according to IRS, may provide better data.
According to IRS staff and others we interviewed, these form revisions,
along with increased use of electronic filing, could improve the
quality of data available to IRS to better identify noncompliance
through its research and compliance efforts, as well as to the public
to improve the effectiveness of tax-exempt charitable organizations.
Private Benefit, Inurement, and Donor Control Have Been Found in Some
Cases Involving Donor-Advised Funds and Supporting Organizations, with
Promoters Sometimes Facilitating Schemes:
IRS program managers report that some donor-advised funds and
supporting organizations cases highlight concerns about private
benefit, inurement, and donor control. Some of these cases demonstrate
clear noncompliance, allowing IRS to propose appropriate corrective
actions. However, IRS is confronted with many cases that require
detailed assessments of evidence, which makes addressing noncompliance
challenging. Additionally, IRS contends with activities involving donor-
advised funds and supporting organizations that do not violate laws or
regulations, yet do not seem to benefit charities. Entities or
individuals, such as financial advisers or attorneys, sometimes
facilitate abusive schemes, introducing additional complexities to
IRS's examination process.
Private Benefit, Inurement, and Donor Control Are Prevailing Concerns
in Donor-Advised Fund and Supporting Organization Noncompliance Cases:
Private benefit, inurement, and donor control are common concerns for
IRS in examinations of potential noncompliance involving donor-advised
funds and supporting organizations. IRS is unable to provide estimates
about the prevalence of this noncompliance, and noncompliance in
general. Thus, the examples presented are intended to illustrate known
cases of private benefit and donor control, and do not represent the
entire range of noncompliance.[Footnote 32]
Private Benefit and Inurement Lead to Personal Gains:
Private benefit occurs when a 501(c)(3) organization is not operated or
organized exclusively for exempt purposes because it serves a private
rather than public interest. Because they are subject to section
501(c)(3), both donor-advised funds and supporting organizations must
avoid private benefit that is more than incidental to the charitable
purpose being served; if private benefit is substantial enough, it may
jeopardize an organization's tax-exempt status. If the organization's
assets or income are transferred to an individual who is a charity
insider, the benefit is called "inurement."[Footnote 33] Private
benefit and inurement schemes involving donor-advised funds and
supporting organizations may benefit various individuals and may vary
in complexity.
IRS has encountered multiple cases of private benefit where donors to
donor-advised funds are able to regain some or all of their
contribution. For example, IRS has concerns about one fund offering a
"loan program," where donors were able to repossess their donation,
with no obligation for repayment. IRS also sees inurement cases, in
which individuals other than the donor receive private benefit. For
example, IRS is examining one exempt organization and donor-advised
fund operated by a for-profit company. The company offered the fund as
a charitable giving vehicle for its employees. The exempt organization
lacked an independent board, with the president-who also served as
president of the for-profit company-receiving potentially high
commissions and fees from contracts with the donor-advised fund.
While donor-advised fund schemes often involve private benefit, schemes
involving supporting organizations more often result in inurement and
are typically more complex, according to IRS management. Schemes can
involve direct payment of benefits to donors or, more indirectly,
payments routed through offshore entities. One direct payment scheme,
designed to benefit a donor's children, funneled school tuition
payments through a supporting organization intended to support their
child's school. More complex schemes enable the donor to regain his or
her donation after it is routed offshore. One typical scheme begins
with a donation to a supporting organization, which is then transferred
to an account in an offshore investment firm controlled by a financial
planner, accountant, or other knowledgeable insider working with the
donor. The money is then transferred to a domestic mortgage lender,
also controlled by the insider, giving the donor access to the money
for use toward an interest-only mortgage. As a result, the donor
benefits from a tax deduction on his or her contribution, while still
retaining access to the donation. To justify the scheme, the supporting
organization claims that earnings from their investment in the offshore
firm will benefit charity.
Donor Control May Involve Assets or Charity Operations:
Donor control arises when a donor holds authority that exceeds what is
permissible for donor-advised funds or supporting organizations.
Illegal control can occur when a donor or disqualified person has
control over the charity's assets, operations, or governance, or the
organizations receiving support.[Footnote 34] It is possible for donor
control to occur without private benefit. A donor may control a
function or operation of a supporting organization or donor-advised
fund without receiving benefits, according to IRS management. Donor
control involving donor-advised funds and supporting organizations
manifests in different ways.
Donor control of a donor-advised fund occurs when the donor oversteps
his or her advisory role and retains ultimate authority over the
distribution of fund assets. One IRS manager told us that, although
more common in supporting organization cases, a donor-advised fund
donor may also achieve control by controlling the exempt organization
receiving the benefits of their donation. For example, IRS is pursuing
a case where a donor-advised fund appears to be making distributions to
a public charity, which is controlled by the donor-advised fund's
donor. If the donor-advised fund did not exist, the public charity
recipient would likely be classified as a private foundation. IRS is
investigating whether the charity has other support sources.
For supporting organizations, control of the organization's board or
the donor's ability to designate charitable recipients can constitute
donor control.[Footnote 35] Board control can occur directly by
controlling more than 50 percent of board voting power or veto power
granted to disqualified persons. Alternatively, board control can occur
indirectly through a disqualified person influencing board members who
are not disqualified persons, according to IRS managers. Retaining
access to assets can also signify direct or indirect control of a
supporting organization. In one case, IRS has questioned whether or not
a donor controlled the operations and investments of the supporting
organization that the donor founded, although the donor did not receive
private benefit. Donor control can also occur indirectly through
control of an asset donated to the supporting organization. For
example, in one case, IRS is concerned that a donor is continuing to
collect and retain rent from building tenants after the building was
donated to a supporting organization.
Other Types of Noncompliance Exist:
Although private benefit, inurement, and donor control are reoccurring
themes in IRS's caseload, other types of noncompliance involving donor-
advised funds and supporting organizations can occur. Specifically, a
supporting organization could fail to maintain a relationship with its
supported organization(s).[Footnote 36] A representative from the tax-
exempt community told us of situations where charities listed as
supported organizations were unaware of a purported relationship with a
supporting organization. The Panel on the Nonprofit Sector also
recognized this problem in its June 2005 report. Similarly, IRS
managers told us that a major issue in supporting organization
examinations is whether or not the organization maintains a sufficient
relationship with its supported organization. Form 990 only requires
that supporting organizations report the name of their supported
organizations; it does not require them to report the EIN of the
supported organization. IRS managers told us that not knowing the EIN
makes it harder for IRS staff to track the relationship between the two
organizations.
IRS Has Various Efforts to Identify and Correct Noncompliance, but Does
Not Know the Rate of Noncompliance:
IRS uses resources from a variety of units to identify and examine
noncompliance involving donor-advised funds and supporting
organizations. Toward these ends, IRS created two teams, one on donor-
advised funds and one on supporting organizations.[Footnote 37] As of
June 2006, the donor-advised fund team had opened but had not yet
closed 27 examinations, according to an IRS manager.[Footnote 38] As of
June 2006, the supporting organization team had opened 102 examinations
and closed 20 of them; 18 of which were found to be noncompliant,
according to IRS. IRS managers also told us that other programs-
including the Tax Examination Program and the Excessive Compensation
Program-have also examined and closed supporting organization cases,
and are currently examining 655 supporting organizations.[Footnote 39]
Regardless of the type of noncompliance found, IRS can propose
corrective actions when the evidence shows that a law or regulation has
been unmistakably violated. IRS is developing criteria for proposing
corrective actions for donor-advised funds as the related team finishes
its examinations; many of the examinations are in the early stages. For
supporting organization cases, IRS officials said, in general, they
will propose a change to private foundation status for issues of donor
control. Intermediate sanctions or revocation of the tax-exempt status
are typically proposed for inurement cases, according to IRS.[Footnote
40] Criminal charges may be brought upon individuals found to be
exhibiting criminal behavior while participating in abusive schemes,
and may occur in conjunction with corrective actions resulting from
examinations. In cases where the donor-advised fund or supporting
organization is believed to be beneficial overall but needs correction
in order to be fully compliant, IRS managers told us they may also
initiate a closing agreement, which provides a set of requirements
intended to correct flaws in the donor-advised fund or supporting
organization structure or operations.
For various reasons, IRS does not know the overall rate of
noncompliance or the prevalence of different forms of noncompliance
involving donor-advised funds and supporting organizations. First, IRS
did not use a random sample to identify cases for examination. Instead,
it used methods that led to examining the most egregious noncompliance
schemes. For example, the manager for the donor-advised fund team told
us it selected cases for examination based on large asset size or other
unusual characteristics, such as high compensation or high
fees.[Footnote 41] Supporting organizations cases were selected based
on referrals from other IRS units, according to the team's manager.
Second, IRS has no established population of donor-advised funds for
which to estimate a noncompliance rate. An IRS manager said IRS is
unable to identify the population because exempt organizations have not
been required to report their use of donor-advised funds, which
prevents IRS from employing statistical sampling methodology to
estimate donor-advised fund noncompliance. Third, examinations by IRS's
teams are relatively new; examinations began in 2005 for donor-advised
funds and began in 2004 for supporting organizations, according to IRS
managers.[Footnote 42]
IRS Faces Challenges in Addressing Noncompliance Involving Donor-
Advised Funds and Supporting Organizations:
Not all cases involving donor-advised funds and supporting
organizations are clear; IRS faces challenges in identifying and
examining potential noncompliance. In part, these challenges are due to
uncertainty about whether the evidence unequivocally points to
noncompliance, and to the difficulty in exhaustively collecting
evidence on the facts and circumstances of a case.
To evaluate facts and circumstances, IRS managers said that agents may
evaluate minutes of meetings, correspondence among trustees, contracts
or agreements on loans or rent, news articles, or the organization's
trust document. Although exempt organizations must maintain
documentation that they operate exclusively for exempt purposes, the
existence and quality of these documents may differ among
organizations, according to IRS managers. Therefore, IRS may need to
collect evidence that is time-or resource-intensive to uncover.
Evidence that does not readily exist or that is difficult to uncover,
combined with the practical limits of the examination process, make
some noncompliance nearly impossible to detect, as the following
examples illustrate.
* In determining influence on or control of a board, regulations define
permissible relationships between disqualified persons and supporting
organization boards. Despite regulatory guidance, IRS is unable to
identify all noncompliant situations because it cannot always identify
influence on board members by disqualified persons, especially when
attempting to identify a disqualified person's indirect influence.
Nomination of a majority of board members by a disqualified person may
signify this influence, but IRS cannot consistently track the
origination of a board nomination. Only in some cases are trust
documents and meeting minutes available that may document the
nomination process, according to IRS. Additionally, IRS may have
difficulty identifying a disqualified person's indirect influence on a
board when this influence may occur in private conversations.
* It may also be challenging to find evidence that ensures that donor-
advised funds are operating on "donor advice" rather than "donor
control." To establish that donors are not exercising undue control,
IRS may examine the process by which a donor makes a funding
recommendation, according to the manager of IRS's donor-advised fund
team. Specifically, IRS managers said this examination could include
verification of an independent board, the process by which the fund
operator investigates donor recommendations or provides documents that
show that a donor's recommendations are not all accepted. However,
similar to the challenges of identifying board control, IRS may not be
able to detect subtle coercion occurring in payout decisions.
* Detecting control of assets may also be difficult. For example, a
donor may contribute a large portion of interest in a business
partnership to a supporting organization.[Footnote 43] The donor,
serving as the business's general partner, retains some ownership of
the partnership and has a management responsibility or controls voting
stock. According to an IRS manager, unless the supporting organization
has other assets, this situation would likely allow the donor to have
effective control over the assets of the supporting organization. In
some situations, the business may claim that the general partner lacks
controlling power, in which case IRS managers said examiners must rely
on available evidence, such as partnership agreements, to determine the
donor/partner's control over the business. Once again, evidence of more
subtle control may not be available or practical for IRS to pursue.
Some Compliant Activities Involving Donor-Advised Funds and Supporting
Organizations Do Not Seem to Benefit Charity, Thus Introducing Areas
for Potential Future Scrutiny:
Not all cases involving donor-advised funds and supporting
organizations are clear cases of private benefit, inurement, or donor
control, or involve the challenges of gathering evidence. IRS managers
said they encounter scenarios where no statute or regulation was
violated, but where activities involving donor-advised funds or
supporting organizations do not seem to benefit charity. In these
situations, noncompliance cannot be alleged, but IRS may still question
an organization's or individual's charitable purposes. A general lack
of data as well as a lack of legal definitions and regulations for
donor-advised funds contribute to these uncertainties for IRS, which
have prompted both IRS and Congress to consider different solutions for
reform, as the following examples illustrate.
* One IRS manager told us that IRS is uncertain about whether or not
donor-advised funds with low payout rates are supporting charitable
purposes. No laws or regulations require annual minimum payouts to
charities from donor-advised funds, but according to IRS management,
idle assets are unlikely to result in benefits. Conversely, a donor-
advised fund may be idle in paying out to build an endowment. If a
supporting organization has a low payout rate, however, IRS said this
can sometimes signify that it is not fulfilling its requirement.
Legislation has been introduced in Congress to impose a minimum payout
on donor-advised funds and supporting organizations. As of early July
2006, legislation on this issue had not passed.
* IRS managers told us that examiners have discovered loans made from a
supporting organization to a donor or insider. Loans made by public
charities to officers, directors, donors, and others are legal,
provided that they are repaid and not made at terms lower than the
market rate.[Footnote 44] According to IRS, charities could justify
these loans as an investment. However, these loans may carry risk or
introduce a conflict of interest. For example, if a borrower has some
form of control over the organization, such as that of a board member
or executive, it is less likely that the organization will take legal
action if the loan is not repaid. Also, loans may prevent assets from
being paid out to charitable purposes. Furthermore, if a loan is made
as part of an employee compensation package, in some cases it may be
classified as an excess benefit under IRC section 4958, according to
IRS management. Additionally, these loans may signify control by
disqualified persons. Even if a loan's interest rate is reasonable, or
the borrower is not an employee or in control of the organization, the
terms of the loan may give a borrower other benefits, thus making a
case that the organization serves private rather than public purposes.
In recognition of such potential improprieties, 19 states have banned
such loans, according to The Chronicle of Philanthropy. As part of a
broader study of executive compensation at public charities, IRS is
examining loans made to insiders, but is not specifically focusing on
supporting organizations.
Promoters May Aid in Abusive Schemes, and May Be Difficult to Identify
and Examine:
In addition to examining donor-advised funds, supporting organizations,
and donors, IRS investigates the promoters--creators and facilitators
of abusive schemes. Some abusive schemes are organized or participated
in by professionals or entities who work in concert with the donor.
Identifying and examining the roles of these professionals or entities
can be difficult and therefore may exacerbate the challenges in
examining donor-advised fund and supporting organizations cases.
A promoter is an individual or entity that organizes or assists in the
organization of a partnership, trust, investment plan, or any other
arrangement to be sold to a third party and designed to be used or is
actually used in obtaining illegal tax benefits.[Footnote 45]
Accountants, financial planners, attorneys, community foundations, and
tax preparers could serve as promoters, and may not just be involved in
schemes involving exempt organizations. Cases involving promoters
address both the material used to promote noncompliance, which must
adhere to tax law, as well as the actual activities implementing a
scheme.[Footnote 46] Because promoters may be committing fraud,
promoters could face criminal charges. See appendix IV for a discussion
of materials and methods for publicizing donor-advised funds and
supporting organizations which are not intended to lead to abusive
schemes.
According to IRS managers, some schemes, particularly those benefiting
high-income donors, originate with a financial planner, accountant, or
lawyer. Other promoters may play a role in facilitating schemes, such
as the mortgage inurement scheme previously described in this report.
According to the manager of IRS's donor-advised fund team, promoters
are typically more involved in schemes involving supporting
organizations than donor-advised funds due to the complexity of
supporting organizations' schemes.
For some cases IRS is able to identify the promoter, noncompliant
material, and transactions that promote noncompliance.[Footnote 47] For
example, material from a financial planner offered a hypothetical
estate plan proposing that a supporting organization hold a wealthy
donor's personal assets, thus facilitating a reduction in estate taxes
upon the donor's death. The plan proposed transferring land owned by
the donor to the supporting organization, who would offer the sale of
the land to the donor's heirs at about 10 percent of its fair market
value. Furthermore, the plan proposed that the supporting organization
also lease the estate assets back to the donor's business. If the plan
were carried out, inurement, private benefit, excess benefit, and donor
control would be significant legal concerns.
However, according to IRS managers identifying and investigating
promoters is often challenging. IRS managers said they rely on
referrals and Internet searches to find promoters. Although some
promoters advertise on the Internet, they may sometimes only share
details about the promotion in conversations with a donor. IRS's donor-
advised fund and supporting organization teams have investigated nine
promoters involved in potentially abusive schemes, according to IRS
managers. In addition to the work of the issue teams, IRS's civil Lead
Development Center is tasked with identifying promoters and
coordinating promoter investigations. IRS managers told us that once
IRS identifies potential promoters, examiners must seek information
that is typically carefully hidden among complex transactions involving
multiple entities. This requires that IRS carefully craft document
requests and summonses, which can be a lengthy process. Furthermore,
once IRS refines its examination process to target certain schemes,
promoters quickly alter their approaches.
Finally, like some of the cases described earlier in this section, some
marketing material may not violate a law or regulation, but may have a
questionable purpose which may indicate potential noncompliance by
misleading donors with incomplete information. This may occur when
marketing material may be providing incomplete information on the
limits of donor-advised funds and supporting organizations versus
private foundations. We found examples of Web sites that describe a
donor-advised fund or supporting organization as a giving option with
all the benefits and advantages of a private foundation, which may
mislead potential donors into believing they can retain control over
their donation.
Conclusion:
Donor-advised funds, supporting organizations, and private foundations
are vehicles for charitable giving. Donors can use these approaches for
long-term giving or to accumulate assets to address some larger need.
They also may create donor-advised funds or supporting organizations to
avoid the costs, burdens, excise taxes, and restrictions associated
with private foundations.
However, concerns have been expressed about the potential for abuses by
those who create and operate donor-advised funds and supporting
organizations, prompting legislative proposals to deter abuses. IRS has
found examples of abuses in these funds and organizations involving
those who do not give up control of their donations and who benefit
privately at the expense of the charitable interest. Although IRS has
efforts to focus on such abuses, IRS examiners lack sufficient data,
which complicates efforts to identify and address the noncompliance.
Congress is considering proposals to require donor-advised funds and
supporting organizations to annually pay out a certain percentage of
their assets to serve charities, which would roughly mirror the
requirement for private foundations. However, no defined way exists to
calculate a payout rate for these funds and these organizations, and
current Form 990 data do not allow for full or consistent analyses of
the payout rate for donor-advised funds or supporting organizations.
Guidance is needed on what types of support should be included in a
payout rate so that the Form 990 collects the necessary data. If a
payout rate requirement is not adopted, these Form 990 requirements
would provide data to inform future congressional decisions about
whether a requirement should be instituted. If a payout rate is
adopted, the data would help in tracking compliance and determining
whether the requirement may need to be adjusted.
Collecting payout information on the Form 990, however, would not be
possible for donor-advised funds due to limitations in annual Form 990
reporting. Starting in tax year 2003, IRS has been able to identify
Forms 990 that report donor-advised fund activity. However, IRS will
not have data that separate the fund activity from other activity.
Adding a requirement to separately report the donor-advised fund
activity from other activity on the Form 990 would allow IRS to check
the payout rate as well as other fund activity that looks suspicious.
IRS also has concerns with supporting organizations that do not support
their supported organizations or that make loans to individuals or
organizations. IRS would be better able to track the flow of funds to
the charities to be supported and loan recipients if it knew their
TINs, which are generally Social Security numbers for individuals or
EINs for organizations. Collecting the TINs of loan recipients raises
concerns about the potential costs and burdens and the protection of
the TINs from unauthorized use. IRS could address these concerns by
only requiring TIN reporting for loans above a certain dollar threshold
and by not making the information publicly available. If the Form 990
is changed to separately report data on donor-advised fund activity,
IRS should consider extending this TIN reporting to donor-advised
funds.
Matters for Congressional Consideration:
Given the concerns about payout rates for both donor-advised funds and
supporting organizations, Congress should consider directing IRS to
revise the Form 990 to collect sufficient information so that a
consistent payout rate can be calculated for both types of charitable-
giving vehicles. This information could help inform decisions about
whether to adopt a minimum payout requirement and if any required rate
should be adjusted. To help IRS in making these revisions, Congress
should direct IRS about the types of support that should be included,
as it has for private foundations. In addition, so that IRS can modify
the Form 990 to require TINs of loan recipients from supporting
organizations, Congress should also consider providing IRS authority to
protect that information from public disclosure.
Recommendations for Executive Action:
To better understand the characteristics of donor-advised funds and
supporting organizations and to better identify possible noncompliance,
the Commissioner of Internal Revenue should, as part of the Form 990
revision process, (1) require more comprehensive reporting of donor-
advised fund activity, (2) require supporting organizations to report
their supported organizations' EINs, and (3) require that the TINs for
recipients of large loans be reported, if IRS is granted authority to
protect the TINs from public disclosure.
Agency Comments:
The Commissioner of Internal Revenue provided written comments on a
draft of this report in a July 19, 2006, letter, which is reprinted in
appendix V. IRS said our recommendations would help it deter abuse
within tax-exempt and government entities and the misuse of such
entities by third parties. IRS agreed with our two recommendations
regarding requiring more comprehensive reporting of donor-advised fund
activity and requiring supporting organizations to report their
supported organizations' EINs on the Form 990. IRS said it will
consider these form changes as part of the Form 990 revision process,
but the timing of these revisions will depend on available resources.
IRS also said that reporting supported organizations' EINs would
potentially help with early identification of abuses involving
promoters and donors getting back their donations in the form of a
purported loan that may never be repaid. Regarding our third
recommendation, which had been to require that the TINs for large-loan
recipients be reported on the Form 990, IRS agreed that greater
transparency and better tracking of loans are needed. However, IRS did
not believe that it had the authority under current law to protect the
TINs of loan recipients from public disclosure if the TINs were
reported on the Form 990. As a result, we have added a matter for
congressional consideration to provide IRS the authority to protect
loan recipient TINs on the Form 990 from public disclosure and revised
the recommendation so that if provided the authority to protect the
information from public disclosure, IRS should revise the Form 990 to
collect loan recipient TINs.
As agreed with your office, unless you publicly announce its contents
earlier, we plan no further distribution of this report until 30 days
from its issue date. At that time, we will send copies to the Ranking
Minority Member, the Senate Committee on Finance;
the Secretary of the Treasury;
the Commissioner of Internal Revenue;
and other interested parties. We will make copies available to others
on request. In addition, the report will be available at no charge on
the GAO Web site at [Hyperlink, http://www.gao.gov].
If you or your staff have any questions about this report, please
contact me at (202) 512-9110 or brostekm@gao.gov. Contact points for
our Offices of Congressional Relations and Public Affairs may be found
on the last page of this report. Key contributors to this report are
listed in appendix VI.
Sincerely yours,
Signed by:
Michael Brostek:
Director, Tax Issue:
Strategic Issues:
[End of section]
Appendix I: Tax-Exempt Excise Taxes:
Over the years, Congress has imposed various excise taxes that affect
tax-exempt entities, particularly private foundations under section
501(c)(3). Public charities differ in several ways from private
foundations. Public charities have broad public support and tend to
provide charitable services directly to beneficiaries. Private
foundations are often tightly controlled and receive a significant
portion of their funds from a small number of donors, and tend to make
grants directly to other organizations rather than directly provide
charitable services. Since these differences create the potential for
self-dealing or abuse by a small group, private foundations are subject
to anti-abuse rules not applicable to public charities. In addition,
both public charities and private foundations are generally prohibited
from engaging in certain types of transactions. Excise taxes are to be
levied on public charities and private foundations, as well as a few
other types of tax-exempt entities, that violate the rules. Details on
these rules and excise taxes follow.
Excise Tax on Section 501(c)(3) Political Expenditures (Section 4955):
Section 4955 was added by the Revenue Act of 1987, P.L. 100-203.
According to the House Report[Footnote 48] for the Act, the committee
believed that the excise tax applicable to private foundations for
making prohibited political expenditures (section 4945) should also
apply to public charities. Section 4955 imposes an initial 10 percent
excise tax on each political expenditure of a section 501(c) (3)
organization. An additional 2-½ percent excise tax is imposed on the
organization's manager if the manager knew that it was a political
expenditure. Political expenditures include any amounts paid or
incurred by the organization in any participation or intervention in
any political campaign on behalf of any candidate for public office. If
an initial tax has been imposed regarding a political expenditure and
that expenditure is not corrected, an additional tax equal to 100
percent of the amount is to be imposed on the organization. An
additional tax equal to 50 percent of the amount of the expenditure is
to be imposed on the organization's manager if that manager refuses to
agree to part or all of the correction.
Excise Tax on Section 501(c)(3) and (4) Excess Benefit Transactions
(Section 4958):
Section 4958 was added in 1996 by the Taxpayer Bill of Rights 2, P.L.
104-168. According to the related House Report[Footnote 49] this excise
tax was added to ensure that the advantages of tax-exempt status
benefit the community and not private individuals. The act provided for
this intermediate sanction (i.e., something short of a loss of tax-
exemption) to be imposed when nonprofit organizations engage in
transactions with certain insiders that result in private inurement.
Section 4958 imposes an initial tax of 25 percent on each excess
benefit transaction entered into between a disqualified person and tax-
exempt organizations under sections 501(c)(3) and (4). The initial tax
is to be paid by this disqualified person, including any person who at
any time during the 5-year period ending on the date of the transaction
was in a position to exercise substantial influence over the
organization, a member of this person's family, and a 35 percent
controlled entity. Such an entity exists when a disqualified person
owns more than 35 percent of the voting power of a corporation, more
than 35 percent of the profit interest of a partnership, or more than
35 percent of the beneficial interest of a trust or estate. If an
initial tax is imposed on the disqualified persons, an additional tax
of 10 percent is to be imposed on the organization's manager if that
manager participated knowing that it was an excess benefit transaction.
If the excess benefit transaction is not corrected within the taxable
period, a tax equal to 200 percent of the excess benefit transaction
will be imposed on the disqualified person. Private foundations are not
subject to this excise tax.
Excise Tax on Private Foundation Investment Income (Section 4940):
Section 4940 was added by the Tax Reform Act of 1969, P.L. 91-172. The
related Senate Report[Footnote 50] described the excise tax as an
"audit fee tax" that was believed to be necessary to cover IRS's costs
for increased supervision over private foundations under the act.
Section 4940 imposes a 2 percent excise tax on the net investment
income of tax-exempt private foundations. Net investment income
includes income from interest, dividends, and net capital gains that is
reduced by the expenses incurred to earn it. This tax is 1 percent if a
private foundation meets certain distribution requirements. Private
foundations that meet the requirements to be an "exempt operating
foundation" are not subject to this excise tax. Among these
requirements are stipulations that the foundation be publicly supported
for at least 10 years and that it have a governing body that is broadly
representative of the general public. Private foundations that are not
exempt from taxation are subject to this excise tax and unrelated
business income tax.
Excise Tax on Private Foundation Acts of Self-Dealing (Section 4941):
Because a tax-exempt entity cannot operate to confer a benefit on
private parties, Section 4941 was enacted by the Tax Reform Act of
1969. According to the Senate Report, generally prohibiting self-
dealing transactions would minimize the need to apply the subjective
arm's-length standard that was used for loans, payments of
compensation, and preferential availability of services under the 1950
amendments. Section 4941 imposes a 5 percent excise tax on acts of self-
dealing between a private foundation and disqualified persons. This tax
is to be paid by the disqualified person who participated in the self-
dealing. An additional tax equal to 200 percent of the amount involved
is to be imposed if the self-dealing is not corrected during the
taxation period. A separate tax equal to 2-½ percent of the amount
involved is to be imposed on the foundation's manager if that manager
knowingly participated in the act of self-dealing. If this additional
tax has been imposed on the foundation manager and that manager refuses
to agree to part or all of the correction, an additional tax equal to
50 percent of the amount is to be imposed. Acts of self-dealing include
sales, exchanges, or leases of property; lending of money or other
extensions of credit; and payment of compensation. Disqualified persons
include substantial contributors to the foundation, foundation
managers, an owner of more than 20 percent of a business enterprise
that is a substantial contributor, and certain government officials.
Excise Tax on Private Foundation Failure to Distribute Income (Section
4942):
Section 4942 was enacted by the Tax Reform Act of 1969. Prior to it, a
private foundation could lose its exemption if it failed to make
distributions towards its charitable purposes instead of just
accumulating income. According to the Senate Report, the committee
believed that loss of exempt status as the only sanction was often
ineffective or harsh, and that substantial improvement could be
achieved by providing a graduation of sanctions if income is not
distributed. Section 4942 imposes a 15 percent excise tax on the
undistributed income of a private foundation for any taxable year in
which the required amount has not been distributed before the first day
of the next taxable year. If an initial tax has been imposed under
section 4942 and the income remains undistributed at the end of the
taxable period, a tax equal to 100 percent of the remaining
undistributed amount is to be imposed. This excise tax does not apply
to private operating foundations that meet distribution requirements or
to the extent that the failure to distribute is due solely to an
incorrect valuation of assets as long as other requirements are met.
Excise Tax on Private Foundation Excess Business Holdings (Section
4943):
Section 4943 was enacted by the Tax Reform Act of 1969. According to
its Senate Report, the use of foundations to maintain control of a
business appeared to be increasing, and some who wished to use a
foundation's stock holdings to control a business were relatively
unconcerned about producing income for charitable purposes. Where the
charitable ownership predominated, the business could unfairly compete
with businesses whose owners were required to pay taxes on their
business income. The committee concluded that a limit on the extent to
which a private foundation may control a business was needed. Section
4943 imposes a 5 percent excise tax on certain excess business holdings
of a private foundation. Permitted holdings generally include up to 20
percent of the voting stock of an incorporated business enterprise
(reduced by the percentage of the voting stock owned by all
disqualified persons) and similar holdings in partnerships and other
unincorporated enterprises (except sole proprietorships). If the excise
tax has been imposed, foundations that fail to make the required
divestiture of excess holdings above the permitted amounts are subject
to an additional tax equal to 200 percent of the excess holdings. In
certain cases, foundations are allowed a 5-year period to dispose of
the excess holdings and may receive an additional 5-year extension.
Excise Tax on Private Foundation Investments Which Jeopardize
Charitable Purpose (Section 4944):
Section 4944 was enacted by the Tax Reform Act of 1969. Under prior
law, a private foundation could lose its exemption if it invested in a
manner that jeopardized its exempt purpose. In the Senate Report, the
committee concluded that limited sanctions were preferable to the loss
of exemption. Section 4944 imposes an initial 5 percent excise tax on
the amount involved if a private foundation invests in a manner that
jeopardizes its exempt purpose (e.g., investing with the purpose of
income production or property appreciation). If this tax is imposed on
the foundation, a separate 5 percent excise tax is to be imposed on the
foundation manager if that manager knew that making the investment
would jeopardize the foundation's exempt purpose. If an initial tax is
imposed, an additional tax equal to 25 percent of the amount of the
investment is to be imposed on the foundation if the investment is not
withdrawn within the taxable period. An additional tax equal to 5
percent of the amount of the investment is to be imposed on the
foundation manager if the investment is not withdrawn.
Excise Tax on Private Foundation Taxable Expenditures (Section 4945):
Section 4945 was enacted by the Tax Reform Act of 1969. Under prior
law, the only sanction against prohibited political activity by a
foundation was loss of exemption. The Senate Committee Report noted
that the standards for determining the permissible level of political
activity were so vague as to encourage subjective application of the
sanction. As a result, section 4945 was added to clarify the types of
impermissible activities and provide more limited sanctions. Section
4945 imposes an initial 10 percent excise tax on each taxable
expenditure made by the foundation. An additional 2-½ percent excise
tax is to be imposed on the foundation manager if that manager
knowingly participated in the taxable expenditure. Taxable expenditures
include amounts paid to carry on propaganda or otherwise influence
legislation or the outcome of a public election, or to directly or
indirectly carry on a voter registration drive. If the expenditure is
not corrected within the taxable period, an additional tax equal to 100
percent of the amount of the expenditure is to be imposed on the
foundation and an additional tax equal to 50 percent of the amount of
the expenditure is to be imposed on the foundation manager.
[End of section]
Appendix II: Summary Data Tables for Section 501(c)(3) Tax-Exempt
Charities in 2005 Constant Dollars, Tax Years 1999-2003:
The following tables summarize data reported on the annual Forms 990
and 990-PF filed by tax-exempt charitable entities under section
501(c)(3) of the Internal Revenue Code. The tables cover number of
returns filed and the reported totals for the following
characteristics: assets, revenues, expenses, contributions received,
noncash contributions received, grants paid, and executive
compensation. The data are categorized by supporting organizations,
private foundations, and all other 501(c)(3) charities.
Table 4: Number of Returns Filed, Tax Years 1999 through 2003:
Tax year: 1999;
Supporting organizations: 20,217;
Percentage change: N/ A;
Private foundations: 69,812;
Percentage change: N/A;
All other 501(c)(3) tax-exempt charities: 280,033;
Percentage change: N/A.
Tax year: 2000;
Supporting organizations: 20,817;
Percentage change: 3%;
Private foundations: 74,056;
Percentage change: 6%;
All other 501(c)(3) tax-exempt charities: 283,826;
Percentage change: 1%.
Tax year: 2001;
Supporting organizations: 21,466;
Percentage change: 3%;
Private foundations: 77,229;
Percentage change: 4%;
All other 501(c)(3) tax-exempt charities: 301,043;
Percentage change: 6%.
Tax year: 2002;
Supporting organizations: 21,057;
Percentage change: - 2%;
Private foundations: 80,631;
Percentage change: 4%;
All other 501(c)(3) tax-exempt charities: 289,381;
Percentage change: -4%.
Tax year: 2003;
Supporting organizations: 21,372;
Percentage change: 1%;
Private foundations: 80,365;
Percentage change: 0%;
All other 501(c)(3) tax-exempt charities: 298,897;
Percentage change: 3%.
Source: GAO analysis of data from IRS's Returns Inventory and
Classification System, 1999 through 2003.
[End of table]
Table 5: Total Assets Reported by Section 501(c)(3) Organizations in
Constant 2005 Dollars, Tax Years 1999 through 2003:
(Dollars in billions).
1999;
Supporting organizations: $211.1;
Percentage change: N/A;
Private foundations: $428.4;
Percentage change: N/A;
All other 501(c)(3) tax-exempt charities: $1,514.1;
Percentage change: N/A.
2000;
Supporting organizations: 213.5;
Percentage change: 1%;
Private foundations: 470.5;
Percentage change: 10%;
All other 501(c)(3) tax-exempt charities: 1,544.1;
Percentage change: 2%.
2001;
Supporting organizations: 214.6;
Percentage change: 1%;
Private foundations: 451.9;
Percentage change: - 4%;
All other 501(c)(3) tax-exempt charities: 1,583.1;
Percentage change: 3%.
2002;
Supporting organizations: 215.8;
Percentage change: 1%;
Private foundations: 447.8;
Percentage change: - 1%;
All other 501(c)(3) tax-exempt charities: 1,546.7;
Percentage change: -2%.
2003;
Supporting organizations: $239.4;
Percentage change: 11%;
Private foundations: $449.5;
Percentage change: 0%;
All other 501(c)(3) tax-exempt charities: $1,646.3;
Percentage change: 6%.
Source: GAO analysis of data from IRS's Returns Inventory and
Classification System, 1999 through 2003.
[End of table]
Table 6: Total Revenue Reported by Section 501(c)(3) Organizations in
Constant 2005 Dollars, Tax Years 1999 through 2003:
(Dollars in billions).
1999;
Supporting organizations: $63.0;
Percentage change: N/A;
Private foundations: $84.6;
Percentage change: N/A;
All other 501(c)(3) tax-exempt charities: $896.4;
Percentage change: N/A.
2000;
Supporting organizations: 62.5;
Percentage change: -1%;
Private foundations: 84.4;
Percentage change: 0%;
All other 501(c)(3) tax-exempt charities: 915.8;
Percentage change: 2%.
2001;
Supporting organizations: 55.2;
Percentage change: -12%;
Private foundations: 50.0;
Percentage change: -41%;
All other 501(c)(3) tax-exempt charities: 934.0;
Percentage change: 2%.
2002;
Supporting organizations: 55.4;
Percentage change: 0%;
Private foundations: 35.6;
Percentage change: -29%;
All other 501(c)(3) tax-exempt charities: 925.6;
Percentage change: -1%.
2003;
Supporting organizations: $65.0;
Percentage change: 17%;
Private foundations: $53.6;
Percentage change: 51%;
All other 501(c)(3) tax-exempt charities: $987.4;
Percentage change: 7%.
Source: GAO analysis of data from IRS's Returns Inventory and
Classification System, 1999 through 2003.
[End of table]
Table 7: Total Expenses Reported by Section 501(c)(3) Organizations in
Constant 2005 Dollars, Tax Years 1999 through 2003:
(Dollars in billions).
1999;
Supporting organizations: $50.0;
Percentage change: N/A;
Private foundations: $40.6;
Percentage change: N/A;
All other 501(c)(3) tax-exempt charities: $806.5;
Percentage change: N/A.
2000;
Supporting organizations: 53.3;
Percentage change: 6%;
Private foundations: 44.0;
Percentage change: 8%;
All other 501(c)(3) tax-exempt charities: 845.2;
Percentage change: 5%.
2001;
Supporting organizations: 51.3;
Percentage change: -4%;
Private foundations: 43.5;
Percentage change: -1%;
All other 501(c)(3) tax-exempt charities: 894.6;
Percentage change: 6%.
2002;
Supporting organizations: 52.9;
Percentage change: 3%;
Private foundations: 41.6;
Percentage change: -4%;
All other 501(c)(3) tax-exempt charities: 903.3;
Percentage change: 1%.
2003;
Supporting organizations: $55.6;
Percentage change: 5%;
Private foundations: $41.1;
Percentage change: - 1%;
All other 501(c)(3) tax-exempt charities: $927.5;
Percentage change: 3%.
Source: GAO analysis of data from IRS's Returns Inventory and
Classification System, 1999 through 2003.
[End of table]
Table 8: Total Contributions Received Reported by Section 501(c)(3)
Organizations in Constant 2005 Dollars, Tax Years 1999 through 2003:
(Dollars in billions).
1999;
Supporting organizations: $14.2;
Percentage change: N/A;
Private foundations: $31.3;
Percentage change: N/A;
All other 501(c)(3) tax-exempt charities: $195.9;
Percentage change: N/A.
2000;
Supporting organizations: 16.3;
Percentage change: 14%;
Private foundations: 36.0;
Percentage change: 15%;
All other 501(c)(3) tax-exempt charities: 211.8;
Percentage change: 8%.
2001;
Supporting organizations: 14.7;
Percentage change: -10%;
Private foundations: 31.3;
Percentage change: -13%;
All other 501(c)(3) tax-exempt charities: 225.0;
Percentage change: 6%.
2002;
Supporting organizations: 13.3;
Percentage change: -9%;
Private foundations: 25.2;
Percentage change: -19%;
All other 501(c)(3) tax-exempt charities: 211.9;
Percentage change: -6%.
2003;
Supporting organizations: $15.5;
Percentage change: 17%;
Private foundations: $27.7;
Percentage change: 10%;
All other 501(c)(3) tax-exempt charities: $219.4;
Percentage change: 4%.
Source: GAO analysis of data from IRS's Returns Inventory and
Classification System, 1999 through 2003.
[End of table]
Table 9: Total Noncash Contributions Received Reported by Section
501(c)(3) Organizations in Constant 2005 Dollars, Tax Years 1999
through 2003:
(Dollars in billions).
1999;
Supporting organizations: $2.7;
Percentage change: N/A;
Private foundations[A] N/A ;
Percentage change: N/ A;
All other 501(c)(3) tax-exempt charities: $16.7;
Percentage change: N/A.
2000;
Supporting organizations: 2.6;
Percentage change: -1%;
Private foundations[A]: N/A ;
Percentage change: N/ A;
All other 501(c)(3) tax-exempt charities: 20.3;
Percentage change: 22%.
2001;
Supporting organizations: 2.6;
Percentage change: -2%;
Private foundations[A]: N/A ;
Percentage change: N/ A;
All other 501(c)(3) tax-exempt charities: 21.0;
Percentage change: 3%.
2002;
Supporting organizations: 1.8;
Percentage change: -30%;
Private foundations[A]: N/A ;
Percentage change: N/ A;
All other 501(c)(3) tax-exempt charities: 18.0;
Percentage change: - 14%.
2003;
Supporting organizations: $2.4;
Percentage change: 33%;
Private foundations[A]: N/A ;
Percentage change: N/ A;
All other 501(c)(3) tax-exempt charities: $25.8;
Percentage change: 43%.
Source: GAO analysis of data from GuideStar, 1999 through 2003.
[A] Unlike organizations that file a form 990, private foundations do
not report the amount of noncash contributions received on the Form 990-
PF.
[End of table]
Table 10: Total Grants Paid Reported by Section 501(c)(3) Organizations
in Constant 2005 Dollars, Tax Years 1999 through 2003:
(Dollars in billions).
1999;
Supporting organizations: $ 8.5;
Percentage change: N/A;
Private foundations: $32.4;
Percentage change: N/A;
All other 501(c)(3) tax-exempt charities: $42.6;
Percentage change: N/A.
2000;
Supporting organizations: 11.3;
Percentage change: 33%;
Private foundations: 34.9;
Percentage change: 8%;
All other 501(c)(3) tax-exempt charities: 45.5;
Percentage change: 7%.
2001;
Supporting organizations: 8.0;
Percentage change: -29%;
Private foundations: 35.9;
Percentage change: 3%;
All other 501(c)(3) tax-exempt charities: 48.2;
Percentage change: 6%.
2002;
Supporting organizations: 7.9;
Percentage change: -2%;
Private foundations: 33.9;
Percentage change: -6%;
All other 501(c)(3) tax-exempt charities: 47.4;
Percentage change: -2%.
2003;
Supporting organizations: $10.7;
Percentage change: 37%;
Private foundations: $31.0;
Percentage change:
-9%;
All other 501(c)(3) tax-exempt charities: $58.2;
Percentage change: 23%.
Source: GAO analysis of data from IRS's Returns Inventory and
Classification System for private foundations, and from GuideStar for
supporting organizations and all other 501(c)(3) tax-exempt charities,
1999 through 2003.
[End of table]
Table 11: Total Executive Compensation Reported by Section 501(c)(3)
Organizations in Constant 2005 Dollars, Tax Years 1999 through 2003:
(Dollars in billions).
1999;
Supporting organizations: $0.9;
Percentage change: N/A;
Private foundations: $0.7;
Percentage change: N/A;
All other 501(c)(3) tax-exempt charities: $11.1;
Percentage change: N/A.
2000;
Supporting organizations: 1.0;
Percentage change: 6%;
Private foundations: 0.8;
Percentage change: 8%;
All other 501(c)(3) tax-exempt charities: 11.5;
Percentage change: 3%.
2001;
Supporting organizations: 1.0;
Percentage change: 4%;
Private foundations: 0.9;
Percentage change: 9%;
All other 501(c)(3) tax-exempt charities: 12.9;
Percentage change: 12%.
2002;
Supporting organizations: 1.0;
Percentage change: 2%;
Private foundations: 0.8;
Percentage change: -3%;
All other 501(c)(3) tax-exempt charities: 12.8;
Percentage change: -1%.
2003;
Supporting organizations: $1.1;
Percentage change: 7%;
Private foundations: $0.8;
Percentage change: -4%;
All other 501(c)(3) tax-exempt charities: $13.0;
Percentage change: 2%.
Source: GAO analysis of data from IRS's Returns Inventory and
Classification System, 1999 through 2003.
[End of table]
[End of section]
Appendix III: Noncash Contribution Valuation Methods:
IRS's Publication 561 provides guidance to taxpayers on determining the
value of property donated to qualified organizations. It defines "fair
market value" (FMV) as the price a willing, knowledgeable buyer would
pay a willing, knowledgeable seller when neither has to buy or sell.
Future events that may affect the property cannot be included in FMV
unless they are known at the time of the donation. In addition, past
events, such as rapid growth of value over the short term, may have to
be balanced out over a longer time frame for a realistic projection of
value. While there is no single method to determine FMV, factors to
consider include the cost or selling price, sales of comparable
properties, replacement costs, and opinions of experts.
Although there are many categories of noncash contributions including
vehicles, used clothing, and works of art that charities may receive,
donor-advised funds and supporting organizations typically receive
larger noncash gifts, according to IRS.
For stocks and bonds, the fair market value is the average price
between the highest and lowest trading price on the date of donation.
This method is only to be used for items for which an active market
exists. If the item is traded on multiple exchanges, then the principle
exchange must be used. In addition, large blocks of stock may require
an expert to assist in the appraisal.
For closely-held securities, determining FMV would include considering
the company's net worth, prospective earning power, dividend-paying
capacity, and other factors such as the economic outlook in the
particular industry and the company's relative position within it, and
the value of securities of companies engaged in the same or similar
business.
For real estate, a detailed appraisal by a qualified appraiser is
required. Certain items must be included such as complete description,
legal description, lot and block number, physical features, condition,
dimension, zoning, and potential uses. Three valuation methods may be
used--comparable sales, capitalization of income, and replacement cost
new or reproduction cost minus observed depreciation (this method used
alone does not determine FMV but rather tends to set the upper limit of
value).
IRC section 170, particularly Sec 170(f)(8), provides the basis for
reporting noncash charitable contributions, such as using a qualified
appraiser. The American Jobs Creation Act of 2004[Footnote 51] also
contains provisions regarding noncash contributions, including
requiring the donor to attach a qualified appraisal to the tax return
if the contribution is over $500,000.
Taxpayers are required to file IRS Form 8283 (Noncash Charitable
Contributions) if the charitable tax deduction claimed is greater than
$500. Form 8283 should be filed for the tax year that the deduction is
claimed. Different sections of the form are to be completed based on
type of property donated and whether the amount claimed is less than or
greater than $5,000. Generally appraisals are required by a qualified
appraiser for donations of more than $5,000. Charitable organizations
receiving donated property must file Form 8282 to report information to
IRS about disposition of certain charitable deduction property made
within 2 years after the donor contributed the property.
According to an IRS manager, closely-held stock is a growing concern
and challenge to IRS, since it can involve a broad base of taxpayers.
He added that artwork, while well-publicized in terms of valuation
issues, is less of a concern since the dollar amounts involved are
small compared to other types of noncash contributions. In addition,
the IRS manager identified the following challenges to addressing
noncompliance, gathered from about 100 examination cases:
* donors are sometimes vague when describing the contribution on Form
8283, impeding IRS's understanding and ability to address any problems;
* donors can submit Form 8283 upon examination, creating problems with
detecting problems early;
* corporate donors of patents can structure the contribution (e.g., pay
maintenance fees on the patent) so that the donee is not required to
file a Form 8282 upon disposition of the contribution;
* no requirement exists that noncash contribution amounts reported on a
donor's tax return and a charity's Form 990 must match;
* donors take improper deductions without adverse impact to the
charity; and:
* multiple appraisals of contribution value are not helpful because
appraisals are very subjective.
To address some of these concerns, IRS has several initiatives looking
at specific types of noncash contributions, such as vehicle donations
and art valuations. Additionally, IRS has a program that compares
valuations of noncash contributions claimed by taxpayers (on Form 8283)
with the price obtained by recipient charities when they resell the
property. IRS has used data from this program to complete a study of
large noncash contributions.
[End of section]
Appendix IV: Methods and Materials Used to Market Donor-Advised Funds
and Supporting Organizations to Potential Donors:
Earlier in this report, we discussed some of the methods and materials
used to publicize donor-advised funds and supporting organizations that
may lead to noncompliance with tax laws. The following is a discussion
of donor motivations and materials and methods that are not intended to
lead to abusive schemes. To obtain this information, we spoke with 11
community foundation managers, 6 financial professionals, and 18
managers at IRS. The examples we discuss come from materials that we
were referred to or located online based on our interviews, and do not
necessarily represent all materials and methods used to market donor-
advised funds and supporting organizations.
Because donor-advised funds and supporting organizations are just two
among many charitable giving options, potential donors must select an
option that best suits their goals and donation plan. Factors that may
influence a donor's decision include: types of causes they wish to
support, the size and type of donation they wish to give, and their
desired involvement level in directing the use of their donation. For
example, some donors, who desire to donate to a specific community or
to have in-depth information on charities receiving their funds, might
find that a donor-advised fund administered by a community foundation
is an appealing option. Community foundations, which typically have a
local focus, may do particularly well at performing due diligence on
charities receiving their funds, according to one estate planner. Due
diligence may include identifying organizations listed in IRS
Publication 78,[Footnote 52] or interacting with exempt organizations
that are potential recipients of funds, according to community
foundation managers.
To evaluate giving options in relation to their goals, donors may seek
information from accountants, financial planners, lawyers, community
foundations, the Internet, and tax-exempt organizations, among others.
Some exempt organizations' efforts to market donation options tend to
be limited, according to a study by a nonprofit philanthropic research
and development organization. This makes personal and business
relationships important ways for donors to learn about donor-advised
funds and supporting organizations, according to community foundation
managers. Because many donor-advised funds are administered by
community foundations or are housed in charities affiliated with
commercial investment firms, such as Vanguard and Fidelity, these
relationships may be particularly important sources for introducing
donors to donor-advised funds, according to a community foundation
manager interviewed by The Chronicle of Philanthropy. According to
several community foundation managers, many donors to community
foundation donor advised funds are referred from professional advisers.
Recognizing the importance of these relationships, some community
foundations have launched specific outreach efforts aimed at financial
advisers and other professionals who could refer donor-advised fund
clients.
In addition to discussions with professionals, donors may encounter or
be presented with a variety of material explaining charitable giving
options. Material may contain details of giving options in relation to
both tax incentives to the donor and charitable benefits for the exempt
organization. Some firms advertise services for clients in magazines or
national publications, according to IRS managers and an estate lawyer,
while others depend on the Internet. Descriptions of professional
services can include outlines of charitable giving options, some of
which attempt to explain giving options based on the legal, practical,
and charitable characteristics of each option. For example, some
community foundations, philanthropy organizations, and investment firms
provide tables or descriptions comparing various combinations of donor-
advised funds, supporting organizations, private foundations, and other
donation options. These tables describe and compare levels of donor
involvement, tax status, deductions by asset type, start-up costs, and
administrative requirements. Other material outlines the steps and
requirements necessary to establish a donor-advised fund or supporting
organization.
[End of section]
Appendix V: Comments from the Internal Revenue Service:
Department Of The Treasury:
Internal Revenue Service:
Washington, D.C. 20224:
Commissioner:
July 19, 2006:
Mr. Michael Brostek:
Director, Tax Issues:
U.S. Government Accountability Office:
441 G Street, N.W.
Washington, D.C. 20548:
Dear Mr. Brostek:
I am pleased to respond to your draft report concerning donor-advised
funds and supporting organizations and ways in which collecting more
data on these entities could enhance compliance (GAO-06-799).
I welcome your study. One of the IRS's strategic objectives is to deter
abuse within tax-exempt and government entities and the misuse of such
entities by third parties for tax avoidance and other unintended
purposes. Your report makes several recommendations that can help us
meet that objective.
The recommendations address aspects of a project we currently have
underway to redesign the Form 990, the annual information report filed
by many public charities. Our goal, an aggressive one which is still
subject to available funding, approval of major design considerations,
and final approval of schedule, is to complete this project in stages
for the 2009 filing season. As part of the first stage, we plan to
release a draft revised Form 990 for public comment no later than May
2007. The draft will present information about public charities in a
more coherent fashion, contain new and clearer instructions, and
include a glossary of terms. We plan to take comments we receive from
the public into account in a subsequent revision, and add questions
related to organizational governance, compensation, and related-party
transactions.
In the next stage, we plan to revise the revenue and expense statements
and the balance sheet. We also plan to create new sections for areas of
special concern, including donor-advised funds, supporting
organizations, and health care/hospitals. At that point, the Form 990
will be a superior information return that increases the transparency
of the operations of tax-exempt organizations and improves the
usefulness of the Form 990 as a compliance tool.
In the final stage, we plan to harmonize the Form 990 with the Form
1023, and will consider the creation of new sections for additional
areas of special concern, such as credit-counseling, low-income and
elderly housing, gaming, and professional fundraising.
This comprehensive revision of the Form 990 is a matter of interest and
concern not only to the IRS, but also to the exempt organizations
community generally, to state charity regulators, and to our partners
in the software industry who provide Form 990-related software. The 990
project requires close consultation among the affected parties, and the
development and introduction of new software. We are looking for ways
to accelerate the project as much as possible, but recognize that it
will require steady funding and several years to complete.
Our response to the report's three recommendations is enclosed. If you
have any questions, please contact Lois G. Lerner, Director of Exempt
Organizations, Tax Exempt and Government Entities Division at (202) 283-
2300.
Sincerely,
Signed by:
Mark W. Everson:
Enclosure:
Enclosure:
Recommendation 1: require more comprehensive reporting of donor-advised
fund activity as part of the Form 990 revision process.
The IRS agrees with this recommendation. We are now conducting
compliance work on donor-advised funds. One type of fund we are
addressing is the large commercial donor-advised fund, often associated
with large investment firms. We also are examining organizations that
appear to be abusing the basic concepts underlying donor-advised funds.
More comprehensive reporting of donor-advised fund activity on an
organization's Form 990 could help expose this sort of abuse and
enhance tax compliance. Your staff has been in contact with IRS
personnel working on the on-going comprehensive revision of the Form
990, and we will incorporate this recommendation as part of the
revision process. We expect this phase of the project to be completed
for filings due in 2009, subject to approval of final design and
available funding.
Recommendation 2: require supporting organizations to report their
supported organization's employer identification number as part of the
Form 990 revision process.
The IRS agrees with this recommendation. We have undertaken a
compliance project to examine organizations that have been established
by promoters, and are finding abuse in this area. An identifying
characteristic of these cases is that a donor makes a "charitable"
contribution to the supporting organization. The supporting
organization then returns the donated amount to the donor, often in the
form of a sham loan that may never be repaid. Reporting the supported
organization's employer identification number on the Form 990 could aid
us in the early identification of this type of abuse. Our current
schedule is to include this change in a revision of the Form 990 to be
available by December 31, 2007, subject to approval of final design
considerations and available funding.
Recommendation 3: require reporting of the taxpayer identification
number (TIN) for recipients of large loans, while safeguarding taxpayer
privacy, as part of the Form 990 revision process.
The IRS agrees that there is a need for greater transparency within
donor-advised funds and for tracking the flow of funds from donors and
charities. However, under current law, we do not believe that we can
protect the TINs of individual loan recipients from public disclosure
if the TINs are entered on a Form 990. Section 6033 of the Internal
Revenue Code requires an annual information return to be filed by
organizations exempt from taxation under section 501(a), with certain
specified exceptions. Section 6104 of the Code requires that
information required to be furnished by section 6033 be disclosed and
made available for public inspection both by the IRS and by the
organization. Sections 6104(b) and 6104(d)(3)(A) provide that the names
and addresses of contributors to an organization which is not a private
foundation within the meaning of section 509(a) or a political
organization exempt from taxation under section 527 are excepted from
disclosure. However, there is no corresponding provision that would
protect information concerning loan recipients.
We have considered whether we could redact the TINs of loan recipients
before releasing Forms 990 to the public, or in some other manner
protect this information from public disclosure, but we have concluded
that we cannot do so under the statute. Implementation of this
recommendation therefore would require the IRS to disclose individual
taxpayer identification numbers to the general public. This is
inconsistent with the expectation of taxpayer privacy that individual
taxpayers generally have when they provide such sensitive information
to the IRS. We therefore cannot agree with this recommendation.
[End of section]
Appendix VI: GAO Contact and Staff Acknowledgments:
GAO Contact:
Michael Brostek, (202) 512-9110:
Acknowledgments:
In addition to the contact named above, Tom Short, Assistant Director;
Mark Bondo; Marta Chaffee; Elizabeth Fan; Evan Gilman; Nancy Hess;
Shirley Jones; Donna Miller; John Mingus; Coltrane Stansbury; Paul
Thacker; and Lindsay Welter made key contributions to this report.
[End of section]
Glossary:
Charity insider:
An individual such as an officer, board member, or other persons able
to exercise substantial influence over a tax-exempt organization.
Donors to donor-advised funds are rarely considered to be insiders,
while donors to supporting organizations can sometimes be insiders if
they also serve on the supported organization's board.
Community foundation:
An organization, usually a nonoperating charity, providing charitable
support through grants to local or regional communities. Typically a
community foundation will aggregate contributions from local residents,
build endowments, and distribute grants to communities.
Disqualified person:
An individual, defined in IRC section 4946, who may have a significant
conflict of interest with a charity due to financial, executive, or
voting powers, such as those held by donors, officers, or directors.
The definition applies to individuals involved with private foundations
and supporting organizations, and has a limited application to public
charities that are not supporting organizations.
Donor-advised fund:
Charitable giving accounts that are held by a public charity. A donor
contributes to an individual account within a charity's donor-advised
fund, and maintains an advisory role on distribution of the funds. No
statutory or regulatory definition currently exists.
Donor control:
Authority exerted by a donor that exceeds what is allowable for a donor-
advised fund or supporting organization. Donor control includes direct
or indirect power over decisions regarding an organization's assets or
operations.
Excess benefit:
A transaction, directly or indirectly, between a disqualified person
and a tax-exempt organization that results in economic benefit to the
disqualified person exceeding the value of service to the organization.
Subject to excise taxation under IRC section 4958.
Excise tax:
A tax imposed on an act, occupation, privilege, manufacture, sale, or
consumption and that is usually designed to influence taxpayer
behavior.
Expenditure responsibility process:
A set of procedures used by private foundations to ensure responsible
use of grants to charities. The assessment may include:
a pre-grant inquiry on the recipient charity, establishment of
commitments for grant recipient, investment requirements, or agreements
on actions if agreements are violated.
Intermediate sanctions:
Excise taxes that provide a corrective remedy for excess benefit
transactions. The excise taxes are paid by the disqualified person, as
defined in IRC 4958, who receives excess benefit, or by a charity
manager who knowingly participates in the transaction.
Inurement:
The transfer or use of a charity's assets or income for the benefit of
a charity's insiders. Inurement is a specific form of private benefit,
and is prohibited for all 501(c)(3) organizations.
IRS Form 1023:
Application for Recognition of Exemption under IRC Section 501(c)(3)
that organizations must file in order to receive tax-exempt status.
IRS Form 990:
IRS information return that public charities are required to file
annually unless the organization is a church or entity associated with
a church, a certain type of governmental unit affiliate, or falls below
certain gross receipts thresholds.
IRS Form 990-PF:
IRS information return that private foundations must file annually.
Noncash contribution:
An asset other than cash donated to a tax-exempt organization, for
example, stocks, bonds, vehicles, artwork, or real estate.
Payout:
An organization's expenditures to individuals or charities for certain
operational or administrative functions. Private foundations must
distribute about 5 percent of the average market value of their
noncharitable use assets, generally stocks or other investments that
compose the foundation's endowment;
donor-advised funds and supporting organizations do not have to meet a
minimum payout.
Private foundation:
A 501(c)(3) organization, further defined in IRC section 509(a), that
does not qualify as a public charity. Generally, private foundation
rules and regulations are more complex and limiting than those for
public charities.
Private benefit:
The transfer or use of a charity's assets or income, or the conferment
of undue advantage, to private persons who are not necessarily charity
insiders. Some private benefit is permitted, but it must not be more
than incidental to the charitable purpose being served. Private benefit
is a broad term that includes inurement and applies to all 501(c)(3)
organizations.
Public charity:
A tax-exempt organization defined in IRC section 501(c)(3) that
receives broad financial support or is a supporting organization.
Public charities have fewer legal requirements than private
foundations.
Revocation:
A corrective action that removes a charity's tax-exempt charter.
Revocation is used for violations such as inurement, performing
nonexempt activities, operating in a commercial manner, and operating
for private use.
Section 501(c)(3) organization:
A tax-exempt organization operated for a charitable purpose. Purposes
considered to be charitable include serving the poor and distressed;
advancing religious, educational, or scientific endeavors;
and protecting human or civil rights. All 501(c)(3) organizations are
considered either public charities or private charities, known as
private foundations. Contributions to charities are tax deductible
under IRC section 170.
Self-dealing:
Transactions, either direct or indirect, made between a private
foundation and disqualified person that involve (1) sale, exchange, or
lease of property; (2) lending of money or other extensions of credit;
(3) providing goods, services, or facilities; (4) paying compensation
to or reimbursing expenses of a disqualified person; (5) transferring
foundation income or assets to, or for the use or benefit of, a
disqualified person; and (6) certain agreements to make payments of
money or property to government officials.
Supported organization:
A tax-exempt organization that receives funds or services from a
supporting organization.
Supporting organization:
A public charity defined under IRC section 509(a)(3) that provides
money or services to one or more supported organizations. There are
three types of supporting organizations defined by their relationship
with their supported organization(s):
Type I:
operated, supervised, or controlled by a supported organization (parent-
subsidiary relationship);
Type II:
supervised or controlled in connection with the supporting organization
(brother-sister relationship);
and:
Type III:
operated in connection with the supported organization(s).
FOOTNOTES
[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. Contributions to charities are tax
deductible under IRC section 170. See glossary for terms used
throughout this report.
[2] The most recent IRS estimate available at the time of our review
was for tax year 2002. We have converted IRS's reported dollar amounts
to 2005 constant dollars.
[3] The term donor-advised funds has been used to refer to both the
individual accounts donors establish, as well as the charities that
maintain these accounts. For this report, we will be using the terms
donor-advised funds or donor-advised fund accounts to refer to the
accounts that donors establish, unless otherwise noted.
[4] Private foundations are defined by IRC as section 501(c)(3)
domestic or foreign tax-exempt organizations except those specifically
excluded from the definition by section 509(a), including universities,
churches, and hospitals, and similar organizations that meet a public
support test or that support one of these organizations.
[5] IRS Forms 990 and 990-PF are federal information returns filed
annually by tax-exempt public charities, such as supporting
organizations, and private foundations, respectively. Information
reported on these returns includes assets held, contributions received,
and grants paid.
[6] The Chronicle of Philanthropy is a newspaper that publishes
articles about the tax-exempt sector and is a source cited by IRS and
others on the tax-exempt sector. Its most recent survey of donor-
advised funds collected 2005 data, but in order to compare the data to
that for supporting organizations, we used 2003 survey data that we
adjusted to 2005 constant dollars. Results from this survey cannot be
interpreted as being representative of all donor-advised funds.
[7] Beyond grants, supporting organizations can also provide support
through other means, such as providing direct services. At the time of
our analysis, the most recent data available were from 2003. For data
that IRS did not transcribe, such as amount of grants paid for
supporting organizations, we obtained the data from GuideStar.
GuideStar is a nonprofit organization that transcribes data from Form
990 into searchable databases. IRS has not assessed in detail the
quality of GuideStar's data, but did include quality control provisions
in its contract with GuideStar.
[8] A taxpayer identification number (TIN) is generally a Social
Security number for individuals or employer identification number for
organizations.
[9] The Panel on the Nonprofit Sector Final Report was published in
June 2005 and contains recommendations for charitable reform. We
discuss the Panel Report further in the Background section of this
report.
[10] Community foundations are charitable organizations established to
hold funds contributed from a variety of sources and to use those funds
to make charitable grants for the benefit of the local community. See
also U.S. Senate, Committee on Finance, statement of Jane G. Gravelle,
Charities and Charitable Giving: Proposals for Reform, 109th Cong., 1st
session, April 5, 2005.
[11] Entities that are not required to apply include those that are not
private foundations and that have gross receipts normally not more than
$5,000, as well as churches and certain entities associated with
churches. The other documentation to be submitted includes organizing
and enabling documents, such as the Articles of Incorporation,
financial data and budgets, and a full description of its exempt
purposes and activities.
[12] In this report, when we refer to Form 990, we are also referring
to Form 990-related schedules, such as Schedules A and B.
[13] Tax-exempt organizations are required to file a Form 990-T federal
tax return and pay taxes on income of $1,000 or more earned from
activities unrelated to their exempt purposes.
[14] GAO, Tax-Exempt Organizations: Improvements Possible in Public,
IRS, and State Oversight of Charities, HTGAO-02-526 TH(Washington,
D.C.: Apr. 30, 2002) discusses IRS examinations of tax-exempt
organizations and reasons for tax-exempt status revocation.
[15] The Independent Sector is a national coalition of nonprofit
organizations, private foundations, and corporate-giving programs that
is to support the tax-exempt sector.
[16] The Panel is assisted by over 100 executives of nonprofit entities
and other experts on five work groups.
[17] IRS's SOI program collects and processes tax data and annually
publishes statistics related to the tax system. IRS's TE/GE division
covers the areas of employee plans, exempt organizations, and
government entities. The Urban Institute is a nonpartisan public policy
research center that operates the National Center for Charitable
Statistics. CRS is the public policy research arm of Congress.
[18] A disqualified person is an individual, defined in IRC section
4946, who may have a significant conflict of interest with a charity
due to financial, executive, or voting powers, such as those held by
donors, officers, or directors. The definition applies to individuals
involved with private foundations and supporting organizations, and has
limited application to public charities other than supporting
organizations. See section 4958.
[19] An excess benefit transaction is a transaction in which an
economic benefit is provided by an applicable tax-exempt organization,
directly or indirectly, to or for the use of a disqualified person, and
the value of the economic benefit provided by the organization exceeds
the value of the consideration received by the organization.
[20] See appendix I for a more detailed description of tax-exempt
excise taxes.
[21] This excise tax is not related to any perceived abusive activity.
[22] Self-dealing includes the following transactions, whether direct
or indirect, between a private foundation and a disqualified person:(1)
sale, exchange, or lease of property; (2) lending money or other
extensions of credit; (3) providing goods, services, or facilities; (4)
paying compensation or reimbursing expenses to a disqualified person;
(5) transferring foundation income or assets to, or for the use or
benefit of, a disqualified person; and (6) certain agreements to make
payments of money or property to government officials.
[23] Pub. L. No. 98-369 (1984).
[24] The Chronicle of Philanthropy's most recent survey on donor-
advised funds was published in May 2006 and collected 2005 data. It
reported that 88 organizations participating in the survey held $15.5
billion in assets and distributed $3.3 billion to charities. We report
2003 survey data that we adjusted to 2005 constant dollars to be
comparable to our other data.
[25] We did not assess the reliability of the survey results from this
and other studies on donor-advised funds. In addition to this survey,
in 2001, the Council on Foundations collaborated with the Columbus
Foundation to survey donor-advised funds offered by community
foundations. The Council on Foundations provides legal and other
services to its members and the general public. The Columbus Foundation
is a community foundation serving central Ohio. In 2003, the Council on
Foundations also collaborated on a study on donor-advised funds
focusing on donor preferences. Both of these studies can be found at
[Hyperlink,
http://www.cof.org/files/Documents/Community_Foundations/CF_Columbus_DAF
.pdf] and [Hyperlink,
http://www.cof.org/files/Documents/Community_Foundations/External_Report
s/FSG2_Oct2003.pdf].
[26] Data for tax year 2003 were the most recent complete IRS and
GuideStar data available at the time of our analysis. In our past work
(HTGAO-02-526TH), we have reported that 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.
[27] Type III supporting organizations can demonstrate that they are an
integral part of their supported organizations by paying substantially
all--85 percent or more--of their income to, or for the use of, one or
more of their supported organizations. The amount of support provided
must also be enough to ensure the attentiveness of these supported
organizations.
[28] Factors include administrative expenses, program-related
investments, trustee fees, amounts set aside for future charitable
projects, and monthly average of fair market value of noncharitable use
securities.
[29] Thomas H. Pollak and Jonathan D. Durnford, TThe Scope and
Activities of 501(c)(3) Supporting Organizations T(Washington, D.C.:
Urban Institute), June 2005, http://www.urban.org/url.cfm?ID=411175
(downloaded Aug. 8, 2005).
[30] As described by the Urban Institute, transfers of support are the
flow of funds from the supporting organization to the supported
organization, including grants, payments, and loans.
[31] Supporting organization type is now also being indicated on IRS's
determination letters.
[32] All examples in this section are from ongoing or past IRS
investigations, and were described by IRS officials.
[33] A charity insider is an individual such as an officer, board
member, or other persons able to exercise substantial influence over a
tax-exempt organization. Donors to donor-advised funds are rarely
considered to be insiders, while donors to supporting organizations can
be insiders, for example, if they also serve on the supported
organization's board.
[34] In order for a charitable contribution to be considered a donation
eligible for a tax deduction, the donor must relinquish control of the
asset. IRC section 170 defines charitable contributions and provides
the rules and limits for tax deductions for individuals and
corporations.
[35] Definitions of "control" and the limits of power for disqualified
persons are found in Treas. Reg. §1.509(a)-4(j)(1). Also see Rev. Rul.
80-207 for analysis of indirect influence on a board.
[36] Because of required structures and board oversight for Type I and
II supporting organizations, this problem is more likely for Type III
supporting organizations.
[37] Each team will report on noncompliance trends and possible
regulatory or legislative actions. The donor-advised fund team, which
formed in 2002, plans to issue a report by the end of 2006, according
to an IRS manager. The supporting organization team, which formed in
2003, told us it plans to issue reports-the first of which would be
released in August 2006 and the last of which would be released at the
end of fiscal year 2007-on each of the three waves of cases they are
investigating.
[38] The 27 examination cases involved 27 tax returns for 22 different
organizations.
[39] Between October 1, 2001, and September 30, 2005, these other IRS
units have closed 715 cases involving supporting organizations, 400 of
which were found to be noncompliant. For fiscal year 2006, 94 cases
have been closed so far;
64 of which were found to be noncompliant.
[40] "Intermediate sanctions" in this context generally refers to
excise taxes paid by a disqualified person receiving private benefit or
a charity manager with knowledge of a scheme, as defined in IRC section
4958. IRS officials said that, in the most egregious cases, IRS may
recommend intermediate sanctions in conjunction with revocation of the
supporting organization's tax-exempt status.
[41] IRS identified donor-advised funds for potential examination using
(1) data from IRS's Rulings and Agreements office, which assesses
organizations' applications for tax-exempt status, and (2) outside
sources, including TThe Chronicle of Philanthropy.T:
[42] Although the donor-advised fund and supporting organizations teams
began in 2002 and 2003, respectively, examinations did not begin until
later.
[43] A donor-advised fund can receive a donation of interest in a
partnership, but the legal analysis required to determine donor control
differs from that for a supporting organization.
[44] IRS encounters transactions between supporting organizations and
donors that are labeled as "loans" but do not result in repayment.
These transactions are likely cases of inurement and are a separate
issue from true loans, which result in repayment. As described in IRC
section 4941, loans made from a private foundation to a disqualified
person are subject to excise taxation.
[45] The definition of promoters is for purposes of IRC section 6700.
[46] Promoters are subject to laws prohibiting the promotion of abusive
tax structures, covered in IRC sections 6700 and 6701.
[47] IRS is unable to determine the extent of the role of promoters in
noncompliance.
[48] H. Rep. No. 100-391 (1987).
[49] H. Rep. No. 104-506 (1996).
[50] S. Rep. No. 91-552 (1969).
[51] Pub. L. No. 108-357 (2004).
[52] IRS's Publication 78, the Cumulative List of Organizations
described in Section 170(c) of the Internal Revenue Code of 1986,
contains a list of all organizations eligible to accept tax-deductible
donations.
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