How to fix the IRS nonprofit division

Agency employees, reformers offer three recommendations

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The Internal Revenue Service’s nonprofit regulation division has been systematically weakened — stripped of resources and authority — by Congress. And it’s all but quit regulating politically active nonprofits in a meaningful and consistent way.

That’s the grim takeaway from a Center for Public Integrity investigation published Tuesday.

Since then, many readers have asked what can be done.

Three potential fixes surfaced most frequently in interviews with more than two-dozen current and former IRS employees, as well as with lawyers and campaign reform advocates:

Find a better funding source for nonprofit regulation. The IRS’ exempt organizations division is ill-equipped to regulate the onslaught of political spending by nonprofits since the Supreme Court’s Citizens United v. Federal Election Commission decision in 2010. The nonprofit regulation division’s budget shrunk 6 percent since Citizens United, from $101.2 million during 2010 to $95.4 million during 2013. Division staffing dropped more than 8 percent, from 900 in 2010 to 824 in 2013.

But relying on Congress for additional funding will likely prove futile, as demonstrated by many lawmakers’ desire to further slash the IRS’ budget. Some former employees suggest using revenue from an existing tax on private foundations to help pay for nonprofit regulation. That was the intent of the tax, approved by law roughly 40 years ago. But Congress never appropriated the money for that cause. The tax could be applied to a broader range of nonprofit.

“The funding source should come from the sector. There was an old national association of securities dealers funded by fees from securities dealers,” said Marc Owens, who worked in the exempt organizations division for 25 years, including his final 10 as its director.

The private foundation tax amounted to more than $400 million during fiscal year 2012. That amount would have been more than enough to cover the entire Tax Exempt and Government Entities Division’s $270 million budget that year — including the exempt organizations unit’s portion, $101 million, according to IRS data.

Do more to limit political activity by nonprofits. The IRS’ nonprofit regulation division could more often reject or revoke tax-exempt status for highly political nonprofits — forcing them to register as political groups organized under Section 527 of the Internal Revenue Code. Political “527 groups” are tax exempt like 501(c)(4) social welfare groups and 501(c)(6) trade associations, but unlike them, they must disclose their donors.

When Section 527 was created, “everybody thought that would be it,” and questions related to political activity by nonprofits would be mostly resolved, said Milt Cerny, who worked at the IRS for nearly three decades, starting in 1960.

The agency could also require social welfare and other nonprofits to spend much smaller amounts supporting or opposing candidates. Such a change could be part of regulations the IRS is drafting to clarify rules on political activity by the groups. The proposed regulations are expected to be unveiled in early 2015.

Officials at public interest groups say they hope the Center for Public Integrity’s report will embolden the agency — particularly when it comes to advancing new rules and winning over legislators who have attempted to postpone the regulations.

The Center’s reporting "gives valuable insight to why clear rules are necessary at the IRS," Emily Peterson-Cassin, Public Citizen’s Bright Lines Project coordinator, wrote in an email Wednesday. "Our hope is that the agency takes this kind of work into account as they come up with new rules.” 

Fred Wertheimer, president of reform group Democracy 21, added in an email to supporters and others that changes to “flawed regulations could bring an end to the misuse of [nonprofits] laundering ‘dark money’ into our elections.”

Nonprofits have spent more than $32 million directly on 2014 elections as of Wednesday — more than double what they had spent at this point in the 2012 election cycle, a presidential election year, according to data from the Center for Responsive Politics.

Create a regulatory agency for nonprofits — one separate from the IRS. Autonomy for such an agency is key here, proponents argue, especially since politicians who oversee the IRS benefit from some nonprofit political spending.

“The agency has never committed itself to effectively regulating [nonprofits]. Part of the reason, of course, is that Congress does not want effective regulation,” Paul Streckfus, who worked in the exempt organizations division for six years, wrote Wednesday in his trade publication, EO Tax Journal. “Would moving [nonprofit regulation] out of the IRS fix all the problems? No, but it would allow the always beleaguered IRS to spend more time and resources on its primary function, collecting revenue.”

A new nonprofit regulatory agency could be modeled after the United Kingdom’s Charity Commission, which touts its autonomy and “quasi-judicial” approach on its website. It says it’s “completely independent of Ministerial influence and also independent from the sector it regulates.” There is a similar commission in Australia.

Streckfus’s hope: President Barack Obama’s next State of the Union address highlights the need for a new regulatory agency for nonprofits.