News and analysis
June 04, 2013

Fixing the IRS: Improve the Application Process

The controversy over the Internal Revenue Service’s handling of applications for tax exemption from conservative groups has put the tax agency in the hot seat.

The Chronicle invited nonprofit and legal experts to suggest remedies:

We encourage you to join the discussion in the comments section.

Improve the Application Process

Ronald Jacobs photo

Ronald Jacobs

The process should be clearly time delimited and include one round of questions and then a follow-up round limited to questions raised by the answers.

For some straightforward 501(c)(3) charities, the process for obtaining recognition of federal tax exemption is simple and fairly efficient. In many other cases, however, the process breaks down and leads to many rounds of questions. These questions are often intrusive, of questionable relevance, and very time consuming. In some cases, it seems like the Internal Revenue Service is trying to win a war of attrition and avoid making hard decisions rather than getting the information it needs to make a timely decision.

There are instances when even the mere potential for an issue to arise may give rise to the denial of an application—for example, the possibility that someone might improperly benefit financially from the charity, based, for instance, on its organizational structure or certain relationships that are described on the application.

The IRS could take several concrete steps to help fix these problems. First, it should adopt internal rules that include clear timelines for action. The IRS could give itself the ability to extend the time in certain circumstances, but the normal process should be clearly time delimited. This timeline should include one round of questions and then a follow-up round limited to questions raised by the answers. All told, this process should be about 10 months from start to finish. For simple, straightforward applications, the timelines should be much shorter.

Second, the IRS should develop standardized questions to deal with certain situations. This would help to avoid the irrelevant and intrusive questions that often seem to come from the agency.

Third, it should establish clear, objective standards where possible for granting or denying exempt status.

Fourth, the IRS needs a better internal decision-making process. For example, if there are certain concerns, then the application should be forwarded to a knowledgeable person for a prompt review and decision, not simply sit in an inbox.

Finally, the only realistic way to make this happen is to increase the number of people reviewing the applications and to give them better training.

Ronald Jacobs is a lawyer who specializes in laws governing political activities.

Holden Karnofsky photo

Holden Karnofsky

We’d be more interested in changes that seek to inject some common sense and public participation into the process.

 Today, U.S.-recognized charities include the United States Golf Association (which hosts the U.S. Open) but not the Schistosomiasis Control Initiative (which treats children for parasite infections in low-income countries and is Number 3 in GiveWell’s top charities rankings). When a humanitarian organization isn’t recognized as a charity, it causes unnecessary hassle and tough choices for donors trying to help those in need.

We shouldn’t expect perfection from the IRS. In our experience, evaluating a charity takes in-depth analysis and judgment, and determining whether a group is serving the public good or private interests seems unlikely to be doable through bright-line tests.

We’d be more interested in changes that seek to inject some common sense and public participation into the process. Rather than lengthy applications and one-time decisions, it might be interesting to see the IRS make quick decisions—based on the kind of simple judgments that tell us deworming children is charity and putting on a golf tournament for professionals is not—and revisit these decisions when there is sufficient demand to do so from donors and concerned citizens.

We’d also like to see better coordination between the IRS and other countries’ agencies. Our Number-1 rated charity, the Against Malaria Foundation, has spent thousands of dollars and hundreds of person-hours filing for charitable status with different countries. A charity whose mission is distributing bed nets to protect the world’s poorest from malaria shouldn’t have to do that.

Holden Karnofsky is co-founder of GiveWell, a group that evaluates charities based on effectiveness and makes recommendations to donors.

Lloyd Hitoshi Mayer photo

Matt Cashore / University of Notre Dame

Lloyd Hitoshi Mayer
University of Notre Dame

There should be more in-person, video, and written training of Cincinnati employees and a greater willingness of those in Washington to respond promptly to their inquiries.

The Internal Revenue Service’s efforts to centralize the processing of applications for tax-exempt status in Cincinnati have created unintended problems. But that does not mean it should be abandoned.

The IRS started the centralization in the mid-1990s to create financial and managerial efficiencies. But the Cincinnati office appears to have become isolated in recent years, lacking timely support from IRS staff in Washington. As news articles have detailed, the IRS has reduced referrals of applications to Washington, eliminated systematic reviews of randomly selected applications, sharply cut public legal guidance for both applicants and IRS employees, and curtailed training, including by ending the publication of Continuing Professional Education articles.

But the IRS should not give up on centralization. First, abandoning the process now would waste the effort that went into staffing and developing the Cincinnati office. Second, distributing the duties of the Cincinnati office among other IRS offices would, if anything, require even more oversight by Washington, as well as coordination of multiple offices. Third, if early predictions by IRS managers were even close to being correct, centralization has likely saved millions of dollars a year at a time when resources are stretched thin and unlikely to be increased. Fourth, the system is not so broken that it would justify more radical and risky steps, such as shifting application processing to another part of the IRS, or even to an existing or new entity outside of the IRS.

Centralization can be saved. The agency must step up systematic contact between Cincinnati employees and Washington staff, including lawyers in the Chief Counsel’s office. This can happen through more in-person, video, and written training of Cincinnati employees and a greater willingness of those in Washington to respond promptly to their inquiries and accept responsibility for processing applications that raise particularly difficult legal issues.

The IRS must also offer more guidance and publicly identify issues in applications that require greater scrutiny. Such changes will strain a process that is already dealing with the surge in organizations seeking reversal of automatic revocations of their tax-exempt status for failing to file proper paperwork. However, the section 501(c)(3) applications, which still make up 85 percent of the exemption requests, that the IRS processed actually declined from a peak of almost 86,000 in fiscal year 2007 to fewer than 52,000 in fiscal 2012. The IRS should therefore have at least some capacity to make these changes even if Congress does not provide extra funding.

But more resources are almost certainly needed to make all of the necessary improvements.

Lloyd Hitoshi Mayer is a professor of law who specializes in tax and nonprofit issues at the University of Notre Dame.