July 25, 2012

IRS Struggles to Know if Big Nonprofits Pay the Taxes They Owe


Four years after the Internal Revenue Service started requiring nonprofits to submit more information about their charitable and commercial activities, the agency still struggles to determine which income earned by colleges, hospitals, and other big institutions is taxable, an IRS official said today.

Steven T. Miller, deputy IRS commissioner, made the comment at a Congressional  hearing devoted to an issue that has vexed lawmakers and regulators—how to ensure that charities pay taxes on income they generate through businesslike activities such as magazine publishing and retail sales.

Figuring out if an organization’s business income is “substantially related” to its charitable mission, and therefore tax-exempt, “is a remarkably difficult and soft sort of issue to deal with,” Mr. Miller told the oversight subcommittee of the House Ways and Means Committee. For example, the agency has to determine questions like whether to tax money a nonprofit museum earns from post cards sold in its gift shop, he said.

The rules governing unrelated business income taxes are an “ongoing source of confusion,” said Rep. Charles W. Boustany Jr., a Louisiana Republican who chairs the subcommittee, which oversees the IRS.

2008 Chronicle investigation found that more than half of 91 large charities with unrelated business activities reported overall losses or no taxable income. Many were taking advantage of vague language or exemptions built into the law to avoid paying taxes, it found.

Lawmakers and agency officials should consider taxing all commercial income earned by charities, regardless of whether it relates to the groups’ missions, said John Colombo, a law professor at the University of Illinois who specializes in tax-exempt organizations.

“If you just tell charities all of their commercial activities are taxable, you eliminate this very difficult-to-enforce line between what is related and unrelated,” Mr. Colombo told the panel. “I’m not sure that will have much effect on charities, other than giving them clarity that they can engage in commercial activities, and it will not cause them to lose their tax exemption."

Mr. Miller said the IRS’s 2008 revisions to the Form 990, the federal return used by most tax-exempt groups, have been a success because they gave the IRS a more complete picture of the activities of complex nonprofits. Still, some of the form’s new requirements may be too burdensome, Mr. Miller said.

“We need to talk to folks and look at what they’re saying in terms of have we gotten it right,” he said. “I think we have, but by no means is the discussion over.”

In response to a question, he said the IRS also is “open to discussion” on whether its revenue threshold for determining which charities must file a Form 990 are "correct." Under current rules, nonprofits with less than $50,000 in annual gross receipts can file information by e-postcard.

Asked by several lawmakers whether the IRS has enough resources to oversee tax-exempt groups, given the $2.7-trillion in assets they hold, Mr. Miller said the agency has always been “somewhat understaffed” in that area.

“We could always use more resources,” he said. “I believe we have sufficient resources if we decide to place them in the places we need to place them.”

Mr. Boustany said the hearing, the second in a series on tax-exempt groups, will inform the subcommittee as it begins to “think about changes that will help tax-exempt organizations work most effectively to meet their goals.”

Send an e-mail to Molly Peterson.