Maybe, although we will never know for sure. There were certainly enough yellow flags in IRS filings of the nonprofit at the center of the biggest college-admissions scam in history to signal something was wrong.
To address them, the Internal Revenue Service would have needed the capacity to review those filings carefully and to pursue those flags. In its current underfunded form, the tax agency is not able to do either task except in a very small proportion of cases, which the organizers of this scheme seemed to have recognized.
This situation, therefore, illustrates why Congress needs to ensure the IRS has sufficient funding to adequately enforce the legal rules for tax-exempt charities and other nonprofits. Or, more radically, Congress could consider revamping how oversight of charities is done, including possibly moving that oversight out of the IRS.
At the heart of the scandal was Key Worldwide Foundation, an organization that had received charity status from the IRS. As detailed in the FBI agent’s affidavit that accompanied the indictment, most of the funds involved allegedly flowed from the parents to the foundation and from there to the bribed test administrators and coaches, as well as to an individual who took standardized tests in place of some students. This arrangement not only obscured the money flow but also made the payments appear to be tax-deductible charitable contributions by the parents.
Indeed, the Justice Department affidavit charging wrongdoing repeatedly notes that the foundation’s receipts included the “no goods or services were exchanged” language that federal tax law requires to substantiate a deductible charitable contribution.
Relationship With For-Profit
Shortly after its 2012 incorporation, Key Worldwide Foundation applied for tax-exempt status under section 501(c)(3), according to its filings with the California Attorney General’s office. The attachment to that application provided to the California AG is mostly innocuous, but there is one indication of a possible problem: The foundation would be using materials developed by a for-profit company owned by one of the organization’s directors, which also employed the foundation’s chief financial officer and treasurer.
While the attachment emphasized that the for-profit would not benefit significantly from KWF’s activities, this close relationship should have been enough to flag the organization for a follow-up audit – if the IRS had had the resources to do that audit, which it apparently did not.
The foundation’s annual 990s — the informational returns nonprofits must file with the IRS — similarly revealed a number of troubling facts that if pursued might have caused the scheme to unravel earlier.
For example, they showed that KWF only had three directors and none of them met the IRS’s definition of “independence,” indicating they all had financial ties to the foundation or related entities.
The returns also reported no paid employees or volunteers even as the foundation was annually collecting and spending hundreds of thousands and eventually millions of dollars. Instead, KWF reported paying a single individual hundreds of thousands annually for “consulting,” growing from $144,000 in 2013 to over $200,000 in both 2014 and 2015 and then to $825,000 in 2016. That consultant was the head tennis coach at Georgetown University, who allegedly was a critical part of the scheme.
In addition, KWF reported zero fundraising expenses on all of its returns, despite raising eventually millions of dollars in contributions annually, which should have led the IRS to question the accuracy of that information.
Lack of Details
The returns also revealed incomplete information and odd patterns in the grants distributed by the foundation. On its 2014 and later returns, the organization listed $7,000 or more each year in grants to “community donations” as a single lump sum without any further details but with the foundation’s address, even though the applicable instructions require listing the specific organizations that received grants of over $5,000 as well as their addresses. The foundation’s returns also rarely included an employer identification number for listed grant recipients, although the instructions require that information.
KWF also stated in its returns that none of the grant recipients were tax-exempt charities. While charities can make grants to businesses and governments in limited cases, the complete lack of charity recipients raises the issue of how KWF ensured that its grants would be used only for charitable purposes. This issue is compounded by the fact that for the purpose of each grant KWF only listed “donation” even though the instructions say not to use general terms.
Finally, it turns out this statement was wrong for some of the recipients. For example, KWF reported in 2014 giving a $25,000 grant to Generation W, which is an IRS-registered charity. This is significant because if the recipient was a charity, it should have been required to report the grant on its Schedule B, the list of significant contributors it provides to the IRS, which would have allowed the agency to verify that the grant was in fact made.
News reports state that at least some purported grant recipients claim they never received any grants from KWF, which raises the question of whether such checking would have revealed that KWF’s returns were inaccurate. Unlike the rest of the annual informational returns, Schedule B is not publicly disclosed, to protect the identities of donors, so only the IRS could have done this matching.
Given the required IRS filings and the fact they are for the most part publicly disclosed, why would the people behind this scheme have chosen a tax-exempt charity as the vehicle for most of the payments? There appear to have been at least three reasons.
First, using a charity may have caused fewer questions to arise when people not involved in the scheme happened to see the checks or electronic transfers.
Second, it allowed the parents to claim a charitable deduction for their payments or, according to the affidavit, to instead make their payments from what appear to be family foundations, in the case of two parents, and from a “personal charitable donation fund” (maybe a donor-advised fund) in the case of a third parent.
The third reason is that the organizers and maybe some of the parents knew that the IRS is mostly asleep at the switch. The understaffing and underfunding of the IRS, especially in the wake of the beating it took as a result of the Tea Party application controversy, is well documented. For example, and as I detailed in a 2016 Columbia Journal of Tax Law article, approximately as many IRS employees were dedicated to tax-exempt organization audits in 2013 as was the case 40 years earlier, even as the number of such organizations roughly doubled.
As a result, the most recently reported audit rate for annual informational returns filed by such organizations is less than half a percent: That is fewer than one in 200 in a given year. Similar staffing and funding issues also affect the rest of the IRS, including the part responsible for enforcing the limits on charitable-contribution deductions.
It is, therefore, not surprising that an apparently unrelated FBI investigation led to the discovery of this scheme instead of an IRS investigation, given this lack of resources and resulting low audit coverage.
Indeed, the affidavit mentions the IRS in only two contexts. One is the IRS’s approval of KWF’s initial application. The other is in connection with a ruse the FBI had a cooperating witness use: telling parents that the foundation was under IRS audit in an often successful attempt to get them to admit that they knew their payments were for bribes or other improper payments aimed at getting their kids into desirable schools.
It appears from the affidavit, however, that the audit was just a deception and so may never have actually occurred.
Technology No Substitute for Staff
The IRS is trying to do the best it can with the limited resources available to it. For example, it is increasingly using big-data techniques to identify tax-exempt organizations that probably are running afoul of the law. Those techniques, however, are both highly dependent on the information self-reported on annual returns — which as this scandal illustrates may be incomplete and inaccurate — and are often no substitute for careful review by an experienced human.
And while IRS filings are generally publicly disclosed and readily available, most do not receive any public scrutiny absent a scandal such as this one.
Bottom line: There is only so much that technology and public disclosure of information can do. If Congress is serious about requiring tax-exempt organizations to comply with federal tax law, it has to consistently provide the IRS with enough funding to support sufficient oversight of such organizations. Sufficient oversight would both help identify wrongdoers, such as the Key foundation, and deter new bad players from seeing charities as easy vehicles to use for such schemes.
More radically, Congress could consider revamping how oversight of charities is done, such as by taking up the proposal put forward by Marcus Owens, the former IRS Exempt Organizations division director, and others to move that oversight into a quasi-public, self-regulatory body.
But regardless of which approach is taken, it is clear that if we continue with the status quo, the one question that will arise in future charity scandals will almost certainly be, “Where was the IRS?”
Lloyd Hitoshi Mayer is a professor at the University of Notre Dame Law School.
