A Project of the American Enterprise Institute and the Federalist Society

I.R.S. Finds Tax Errors in Reports of Nonprofits

New York Times

March 1, 2007

Some 600 charities and foundations have had to file amended tax forms after an Internal Revenue Service study found flaws in the way they reported payments to executives and other employees.

The I.R.S. has also asked 40 individuals to pay a total of $20 million in excise taxes, which is the penalty it imposes when it determines a nonprofit executive has been paid excessively.

"We found some problems," said Steven T. Miller, the commissioner in charge of the I.R.S. division overseeing tax-exempt and government entities. "Whether they were due to confusion, poor design of the tax forms used by these organizations or something more nefarious, I can't tell you."

He said the results of the inquiry, which found flaws in the tax forms of a third of the 1,800 charities and foundations examined, convinced the agency that it needed to do more in the area of compensation at nonprofits.

The names of the affected organizations and executives were not released.

Organizations that had to file amended returns either failed to report, or reported incorrectly, perquisites like an executive's personal use of an organization's vehicles, travel payments for spouses of executives or other payments and reimbursements, I.R.S. officials said.

Those whose executives have been asked to pay penalties may have failed to use comparable figures from similar organizations in setting compensation or otherwise failed to justify executive pay levels.

"That shouldn't be read to mean that high compensation wasn't paid in the other cases," Mr. Miller cautioned. "What it means is that in some cases where we found high compensation - and we did find it - the organization has done a good job of using comparables and establishing a procedure to determine it."

The results of the study highlight problems with what many regard as primary tools for assessing nonprofits, the forms they file with the I.R.S. and many state governments, which become public record.

"For better or for worse, the tax form is the nonprofit disclosure instrument," said Peter Swords, an expert on nonprofit tax reporting and the former head of the New York Nonprofit Coordinating Committee. "It is to nonprofits what the whole S.E.C. regime is to regulated companies, and it is something that ought to be taken very seriously."

Last week, Dan Prives, a blogger and former finance director at World Relief, questioned the way Yale University completes parts of its tax forms.

Mr. Prives noted on his blog, www.wheremostneeded.org, that the university, which has one of the largest endowments in the nation, does not fully report on its securities transactions, nor does it describe what portion of specific expenses were spent on its programs, administration and fund-raising. In contrast, Harvard provides that information in its tax forms.

"It surprised me because usually A-list nonprofits like Yale are pretty accurate in their reporting," Mr. Prives said in a telephone interview. "It threw a whole monkey wrench into my thinking about what's being achieved by publishing these forms. You can have errors in plain sight and nobody's picking it up."

Tom Conroy, a Yale spokesman, said the university did not break down specific expenses but did report totals spent on administration and fund-raising. "We believe we follow an option that's provided for in the instructions that accompany the form," Mr. Conroy said.

Mr. Swords said reporting about compensation, in particular, is fraught with problems.

"For obvious, human reasons, people are reluctant to have salaries disclosed," he said. "It's one of the biggest topics of gossip, so there's been a tendency to underreport it or not to report it at all."

Many charities simply do not adequately understand the reporting requirement, experts say. For example, the Buckley School, a private boys school in New York City, stopped listing compensation for its headmaster and other top officials several years ago. Its tax forms stated that "compensation information can be obtained at the school."

"That's not adequate, flatly not adequate," Mr. Swords said.

Ogden N. Lewis, a Buckley board member, said the school had just filed an amended 2005 tax form spelling out the compensation of its five highest-paid employees.

Mr. Lewis said a parent had brought the problem to his attention in a letter. "I checked on the rules when I received that information and learned that we needed to report compensation differently," he said. "Once I was aware of it, it seemed clear, very clear."

The I.R.S. study, the largest ever undertaken by the exempt organizations division, began in 2004 amid heightened interest in the issue of nonprofit compensation in the news media and Congress. It involved two new units, one devoted to monitoring tax law compliance among nonprofit groups and the other focused on data analysis.

Among its aims were to identify and stop excessive compensation to nonprofit executives and other insiders through audits and questionnaires and to help nonprofits better understand laws governing reporting and payments to senior employees.

Mr. Miller said the exercise had spawned further ideas for I.R.S. inquiries. The agency has already begun a deeper inquiry into loans made to insiders at charities and foundations, contacting 200 organizations by letter and starting audits at 50 others, he said.

The potential for recovering additional revenue challenges what current and former I.R.S. officials describe as a long-held belief at the agency that policing nonprofits produces little reward, unlike scrutiny of individuals and for-profit companies. Mr. Miller said that with 70 audits still open, he expects the I.R.S. to recoup more than $20 million in excise taxes.

"There are penalties, too, for incomplete returns, and one of the things we need to look at is are we assessing those penalties in the right circumstances," he said.

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