Dark Days: Blindfolding Nonprofit Regulators

By: Philip Hackney.

The Ways and Means Committee voted Thursday in favor of a bill, H.R. 5053, that would seriously hamper the ability of the IRS to enforce charitable tax law and nonprofit tax law generally. It is a bad-no-good-bill, that comes from folks who champion protection from the IRS, but whose real motive is to make it possible for wealthy individuals to act without hindrance in influencing political campaigns and politics generally. It emanates not from a place of conservatism, but a place of reactionarism and plutarchism (neither of which are words, but both of which probably should be :)). The Koch brothers support this bad bill for a reason.

The Bill will harm IRS regulation and make our already relatively secret-and-subject-to-corruption political contribution system more secret and more subject to corruption (the issue that democrats and interest groups focused upon in attacking the bill). The harm though can be expected to extend to the ability of the federal government and states to regulate individuals using nonprofits to accomplish their ends. Sometimes people running nonprofits do bad things. It will increase the dark in which our regulators try to police the nonprofit sector. Unfortunately, the IRS leant a hand to those trying to give donors greater secrecy as high level officials discussed eliminating schedule B back in December 2015. It is still not clear to me what they were thinking, but I genuinely hope we do not make such a foolish choice. As explained below, we have long recognized a regulatory need for this particular information.

What does this dastardly, seemingly well-intentioned, bill do? Representative Roskam introduced the bill. It prevents the IRS from collecting names and addresses of substantial donors to nonprofit organizations. Since 1998, the Form 990 has included a Schedule B where a nonprofit must disclose to the IRS the names and addresses of donors who have provided “substantial contributions” to the organization. Generally, a $5,000 contribution is considered substantial. The bill creates some important exceptions: it requires the disclosure of donations from directors and officers of the nonprofit. Admittedly these are the individuals that regulators should be the most concerned about. Nevertheless, it sets a bad incentive system up to show that the way to abuse your nonprofit in the dark is to simply not be a director or officer to the organization.

History of the Requirement: The collection of donor names and addresses is, and long has been, mandated by Congress in section 6033(b)(5) of the Code. The IRS has collected this information since at least the 1940s. Front 1948 Form 990Form 990 1948,  The 1948 990 on its back page linked here expressly calls for “totals entered in line 5 (gifts) . . . [to] be supported by itemized schedules showing the amount, and the name and address of each person as defined by section 3797 of the IRC . . .” This applied as long as the contribution was greater than $4,000.

Congress added 6033 in the 1954 Code. The explicit Congressional requirement to require the listing of donor names and addresses, though, does not appear until 1969. In the TRA ’69 Congress subjected private foundations to a more restrictive regime than public charities. Because only a few donors would contribute to these organizations, there was concern that those few donors had great potential to abuse nonprofit to accomplish the donor’s own private ends. Congress expressly allowed the disclosure of donors to private foundations, but explicitly denied it at that time as to other organizations. That has remained the case to today, although Congress allows also the disclosure of donors to 527 organizations that do not already disclose those names to the FEC.

What is the harm of the bill? While many Congressmen have focused on the harm to the election system suggesting that it would allow foreign money into our election system, and would make the dark campaign donor disclosure system, even darker, I focus on the harm to charitable organization oversight. The harm to political campaign activity  regulation is problematic, but because I think the more fundamental harm is to charitable organization oversight I highlight it here.

Donor names and addresses help the IRS to police the  boundary between private foundations and public charities. Congress believed private foundation donors were the most likely to abuse a nonprofit. Without other individuals involved in contributing to a particular organization, the private donor could get the organization to fulfill the private donor’s own private ends. Conversely, greater public support would lead to greater nonprofit oversight. Congress likely expressly gave authority to the IRS to collect donor information in 1969  to police this boundary.  Requiring names and addresses simply makes organizations have to be more honest on this issue, and furthermore, allows the IRS to verify the claim of public charity status. An organization looking to hide that it is in fact supported by very few members of the public is aided greatly by this proposed law allowing an organization to hide most of its substantial donors. We should be very hesitant to reconsider this Congressional call that was made in 1969. Congress thought the information vital and allowed its collection for a good reason.

Donor names and addresses also allow regulators to police charitable law. For instance, section 501(c)(3) prohibits inurement. The prohibition of inurement means a charity cannot allow its earnings to be given away to a private shareholder or individual. The people most likely to be “private shareholders” are those who are the charities substantial contributors.  Private benefit polices a very similar line. Section 4958 of the Code requires the IRS to impose a penalty on organizations that provide excess benefits to “substantial contributors.” Donor names allow the IRS and other regulators to see the connections between substantial donors and the nonprofit. Substantial donors can engage in self-dealing with the charity they support. A big donor has power over a charity and can get it to do things that are not necessarily in the best interest of the charity. For a couple of examples, see for instance, the scandal regarding the Nature Conservancy with questionable transactions with insiders, or a recent investigation into the Audubon Commission where there were suggestions that a major donor and boardmember had questionable business dealings with the nonprofit. In many instances a donor relationship and a board member relationship will be coupled such that the new bill will not harm those situations. It will make dark though, the situations where the donor has no apparent control through a director or officer postion. It would also make dark connections between family members of officers and directors who contribute and the nonprofit. It creates a real blindspot for regulators that is foolish for us to create.

Additionally, this information provides a useful check against large charitable contributions claimed by individuals. It is a useful form of third party reporting that can allow an auditor an independent check on charitable contribution claims by organizations.

With all of that said, the IRS did recently publicly state it was thinking of eliminating the Schedule B. It is really hard to understand why they would do that given the importance of the information and the statutory requirement that they collect it. My best guess is that they were thinking that the disclosure problem created real headaches. They may also have been thinking that currently given the underfunded nature of the IRS itself they were not able to really use the information anyway, so why bother going through the motions that create a headache for the organization. I would answer that just because the organization is not able to use the information now, is a very poor reason to end its collection. Additionally, many state regulators are able to use the information effectively. And, finally the information is probably used and could be used in more effective ways by the IRS if it tried.

What is the Bill’s Justification? The justification seems to be this information is wrongly publicly disclosed by the IRS too often. As Representative Roskam said: “The IRS has demonstrated inability to hold confidential information close, and if it’s not necessary for tax administration, then let’s mitigate this problem and not require organizations to submit it.” There also seems to be a subtext of a claim that the IRS uses this information to “target” taxpayers too. Because I have dealt with the claim of need already above, I focus here on the primary focus that the information is improperly disclosed by the IRS.

Former IRSers tell me that the IRS created Schedule B in 1998. The information was still required before then though as noted above. Under the system prior to 1998 donor names and addresses were improperly disclosed with some regularity, I understand. Because there was no rhyme or reason to where that information needed to be included on the form, the IRS systems had a tough time redacting the appearance of the names and addresses. The IRS received lots of Form 990s and there were a lot of inadvertent disclosures. Thus, the birth of the Schedule B in 1998 in order to solve this problem. With the Schedule B, the IRS could then just remove the schedule when it made a 990 publicly available. Of course, some of the information in the Schedule B is disclosable and the IRS still had to figure out a way to provide that information to the public when requested. Unfortunately there has been disclosure of donor information under this regime as well, although not as severe a problem as prior to the Schedule B. The IRS most recently disclosed that information with respect to the National Organization for Marriage and an organization associated with the Republican Governors Association.

While I am agnostic on the matter of whether these names should be disclosed or not, it is  the law that the names and addresses are not to be disclosed in the case of most nonprofits. Thus, the fact that the disclosure does happen is problematic. However, it seems that the answer is not to throw out the need for the information because of these problems. We must assess whether the value of the information is somehow outweighed by the harm of inadvertent disclosure. Or if it is possible to get the IRS to disclose even less. It appears that the inadvertent disclosures are not happening with regularity today. So we are really focused on a few isolated, but prominent incidents. I would contend that the information is vital and outweighs some inadvertent disclosures. I would also encourage Republicans to work on providing the IRS more funds so that it could properly operate its systems. Frankly, I think what we are seeing is a problem associated with underfunding the IRS rather than a more nefarious targeting purpose.

Inadvertent or improper disclosure is a problem. However this information is vital to nonprofit oversight at state and federal levels. Let’s not put our regulators in the dark. It’s in all our interest to have good oversight of this incredibly important sector of our economy and our democracy.

Hopefully Congress does not pass this bill, but if it does, President Obama should be prepared to veto it.




3 thoughts on “Dark Days: Blindfolding Nonprofit Regulators

  1. In a blog article entitled Dark Days: Blindfolding Nonprofit Regulators, Professor Phil Hackney commented that “The Ways and Means Committee voted Thursday in favor of a bill, H.R. 5053, that would seriously hamper the ability of the IRS to enforce charitable tax law and nonprofit tax law generally. It is a bad-no-good-bill . . . “

    H.R. 5053 is titled “Preventing IRS Abuse and Protecting Free Speech Act.”
    Well, Schedule B lists information about significant contributions, including amounts and contributors. The information is collected so that IRS (and to some extent the interested public) can monitor the organization for abuses.
    For private foundations, the entire schedule is available for public inspection. For public charities, amounts of contributions are available for public inspection but not names of contributors.

    For starters, IRS has erroneously released contributor information by mistake. This is unacceptable. Perhaps two forms are required. A names and addresses of substantial contributors Schedule B that is totally privileged information for public charities. And a Schedule B (1) that lists amounts of donations keyed to the names of substantial contributors. Perhaps IRS has fixed the problem(s) that led to erroneous disclosures. Erroneous public disclosure is the exception (still unacceptable) but not a full on disaster. So, throwing the baby out with the bathwater (always liked this macabre, Lemony Snicket -a series of unfortunate events – type phrase) is not the best solution.

    A second issue concerns whether IRS needs substantial donor information.
    IRS’ information returns collect information about potential excess benefit transactions for public charities through the Schedule L. And they collect information about potential self-dealing for private foundations through the Form 990-PF. But, the problem with these schedules is that they ask whether bad acts were committed. Perhaps the organization is reluctant to admit to a bad act (tongue in cheek) or does not realize it committed a bad act.
    That is where the Schedule B comes in handy. It lists individuals with whom the organization is more likely to engage in an abusive act of private benefit that might arise in a self-dealing or excess benefit transaction context. It also helps keep public charities honest by asking for specific names of substantial contributors so that the IRS, presumably, could check to ensure that the organization is entitled to keep its public charity status.

    These point are well made lots better by Phil Hackney in the blog that objects to eliminating Schedule B information than my poor attempts.

    I recall a feckless EO Examination Director who bravely trudged over to The Big House (main IRS at 1111 Constitution Ave., DC) to explain to IRS Commissioner Charles O. Rossotti why a newly designed Form 990 should be approved. She came back dragging and deflated. Apparently, Commissioner Rossotti tactfully (not) suggested that until EO could specifically explain how it was going to employ each and every line toward enforcement, hell would freeze over before he would sign off.

    So, the question is whether IRS or the states or the public use Schedule B information for tax law enforcement purposes. I would suggest that legitimate use of the Schedule B information would include enforcement of the federal tax laws by states and the public. I am not arguing for more disclosure of Schedule B information. I also realize that the beneficial consequence of forcing organizations to reveal substantial donor information is probably not measurable. That is, what bad acts were not committed because an organization had to reveal the names of substantial contributors?

    I do believe IRS has an obligation to justify the substantial contributor information it collects. That is, can the IRS point to enforcement action taken or assisted because Schedule B information was available?

    One last point. I had always hoped that IRS’ EO function would hire or contract with analysts who could utilize Form 990 and Form 990-PF information combined with other publicly available documents to develop algorithms that might assist enforcement. On bare bones budgets, that is likely a pipe dream.
    But, I also agree with Professor Hackney’s comment that just because IRS is unable to fully utilize its audit resources now due to budget constraints, it no reason to eliminate a useful tool.

    Marv Friedlander
    Chief, EO Technical (retired)

    Liked by 1 person

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