The explosive growth of the U.S. economy's nonprofit sector over the last decade has fueled tax fraud, terrorist financing schemes and illegal political activities, Internal Revenue Service Commissioner Mark W. Everson said Tuesday.
"We are at an important juncture ... tax abuse is increasingly present in the sector and we must work to address it," Everson told the Senate Finance Committee, which is preparing legislation to tighten controls on about 1.8 million nonprofit corporations.
Abusive practices by charities -- including the soliciting of worthless junk cars for tax deductions and the diversion of contributions for victims of the Sept. 11 terrorist attacks -- have prompted consideration of the first major reforms of the tax-exempt sector since 1969.
Everson said that IRS scrutiny of the nonprofit sector lapsed over the last decade, though the agency had attempted more recently to strengthen its surveillance. Some of the nation's tax-exempt charities are "wantonly abusing the generosity and faith of the public," he said.
IRS agents, Everson said, are examining more than 100 charities that make grants overseas to determine whether they are supporting terrorism. Investigations have led to 32 criminal prosecutions for terrorist money-laundering activities. The agency is developing technology to search tax records for terrorists' names and is trying to gather more information about nonprofit activities abroad.
The IRS received 200 allegations of illegal political activity during the 2004 presidential election by nonprofit groups, three times the number of reports during the 2002 midterm elections. Tax-exempt foundations and charities are barred from involvement in elections but have become increasingly involved in partisan issues.
And more generally, Everson said, the agency is conducting a broad range of investigations into tax abuses by nonprofits involving illegal charitable trusts, excessive compensation for corporate officers and abusive credit counseling organizations.
The IRS is also looking at whether Indian tribes have abused their tax-exempt status in handling gaming revenue, Everson said. In a letter to Sen. Charles E. Grassley (R-Iowa), the Senate Finance Committee chairman, Everson said that the IRS had uncovered evidence that some casinos were funneling gaming revenue to tribal members through questionable tax-exempt welfare programs, though distributions of gaming revenue were supposed to be subject to federal income tax.
The Tuesday hearing was part of a broad, new assessment of the sector, the first since the regulatory system was enacted in the 1970s. There are 1.8 million nonprofit corporations, three times as many as in 1995, controlling assets of $8 trillion.
Although conservative Republicans have alleged that the nonprofit sector is generally controlled by liberals and is used to back liberal causes, a number of experts said the motives of the IRS and Grassley were nonpolitical.
"I don't think there is an ideological split here," said Terry Scanlon, president of Capital Research Center, a conservative think tank in Washington that studies the nonprofit sector.
A number of witnesses at the hearing testified about high-profile abuses that have occurred, including the alleged pillaging of the Maddox Foundation, a Tennessee organization that was left by a wealthy couple killed in a boating accident.
The foundation was taken under control by a single person, who moved it to another state, purchased two ailing sports teams, squandered millions of dollars on lavish trips, imprudent investments and received $3.2 million in compensation over several years, according to Richard Johnson, a lawyer involved in a civil suit.
Johnson said the IRS should be reviewing the tax-exempt status of certain foundations every five years, a precaution that would have exposed the alleged abuses at Maddox. Another proposed reform would require independent audits of tax-exempt corporations' financial books.
"It will take a two-pronged approach to fix the problems in the nonprofit sector," said Grassley, who last year wrote a law that tightened rules on used-car donations. "One is better, targeted enforcement from the IRS. The other is legislative changes to reflect the new realities in charity. No one has updated these issues in detail since 1969. That's a generation. Creative people have taken advantage of the lull to make money for themselves at charities' expense."
Diane Aviv, president of Independent Sector, a group representing about 500 nonprofits, including the Salvation Army, the Gates Foundation and the Rockefeller Foundation, acknowledged the need for stronger controls but expressed concern about the potential fallout.
"The abuses are limited to a small number of organizations, but that doesn't mean people shouldn't take it seriously," she said.
Aviv said in an interview that government regulation and oversight of the nonprofits had lagged behind the sector's growth in recent years. Although reforms are supported by her group, there are concerns that the reforms could do more harm than good, particularly if the American public loses confidence in charities. Her group has proposed reforms involving voluntary self-governance.
Despite the growth, the IRS has been cutting back on scrutiny of nonprofits each year from 1995 to 2003.
Since then, spending on exempt organizations has grown by 30%, and the IRS is adding dozens of new agents.