Monday, June 24, 2013

IRS Tex Exempt Oversight Ineptitude - By the Numbers

Logo of the Internal Revenue Service
Why do supposedly "automatic" revocations require ten months on average? Some astonishing findings when we look at the actual numbers.

We all subsidize tax exempt organizations. This little study is focused on 501(c)3 organizations. These are tax exempt and the donations that they receive are tax deductible for the donor. Moreover, federal tax exemption goes all the way down to the municipal level as these organization are generally exempt from sales and use taxes.

The Internal Revenue Service is supposed to automatically revoke the tax exempt status of any organization that does not file a tax return for three consecutive years. Revocations become official on the posting date retroactive to the effective date. In theory, since this is automatic, the difference between the two dates should be no more than a few days.

  • On average, revocations require 335 additional days from the time that the third tax return was due.
  • The range is 55 days to 1,105 days (three years+).

Let me put that in perspective. Let's assume that I start my non-profit on July 1, 2013 with a calendar fiscal year. Non-profit tax returns are due on May 15. I collect donations and purchase things without paying sales tax.  I could be doing just about anything with the money because I don't file returns; Not on May 15, 2014; Not on May 15, 2015; Not on May 15, 2016.

  • If the average holds true then the IRS will get around to revoking my non-profit status on April 15, 2017.
  • At the high end, the revocation will be May 25, 2019. That would allow me six years of doing just about anything, collecting tax deductible contributions and not paying any taxes - including state, federal, sales and use taxes.
The effective date becomes meaningless. Nobody is going to come after me for the taxes that I skirted and the likelihood that a donor's deduction would be nullified is infinitesimal.

So just how widespread is this problem?
  • Between June 9, 2011 and May 24, 2013; the IRS revoked the tax exempt status of 502,156 organizations for non-filing.
  • Of these, 316,181 were 501(c)3 organizations.
  • Only 14,576 were reinstated which is less than 5%.
The sheer number of revocations is troubling. As of May 31, 2013 there were only 829,549 organizations listed by the IRS as eligible to receive tax-exempt donations. Most of these are 501(c)3 organizations. Compare that number to the 316,181 501(c)3 revocations over a two year period of time. It amounts to a revocation rate of almost 20% per year.

Conclusions:
  1. The rules need to be changed. With extensions the May 15 due date could be protracted to November 15. If an organization cannot file a 2013 tax return by November 15, 2014, there should be no reason for the public to continue to subsidize it. Allowing three years is absurd.
  2. An automatic revocation should be just that and should be posted within ten days of the statutory due date.
  3. The IRS needs to mine some data on why so many 501(c)3 organizations ultimately get revoked. There seems a high probability that the approval process is lacking.
Methodology:

On June 1, I downloaded from the IRS the most recent revocation data.  This covered revocations posted between June 9, 2011 and May 24, 2013. I also downloaded Publication 78. This lists all organization eligible for tax deductible contributions as of May 31, 2013.

The data was parsed into two tables (data and pub78) within the same mySQL database:


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