Fast Facts

When taxpayers overstate how much they've donated to charities on their tax forms, it improperly reduces their tax bills. In some cases, the charity is complicit, while in others, it is being exploited.

IRS’s different offices may find evidence of abusive schemes involving charities and other tax-exempt organizations in their audits.

Yet IRS doesn’t consistently analyze data from its offices to help identify these types of schemes—even though information about them may be available in existing databases.

We recommended that IRS improve its use of data, databases, and analytics to better combat this problem.

Itemized deduction form on clipboard, hand, pen

Itemized deduction form on clipboard, hand, pen

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Highlights

What GAO Found

Taxpayers have used a variety of abusive tax schemes involving tax-exempt entities. In some schemes, the tax-exempt entity is complicit in the scheme, while in others it is not. For example, an abusive tax scheme could involve multiple donors grossly overvaluing charitable contributions, where the tax-exempt entity is not part of the scheme. Conversely, some patient assistance programs—which can help patients obtain medical care or medications—have been used by pharmaceutical manufacturers to make charitable donations that can be viewed as furthering private interests.

Internal Revenue Service (IRS) audits of abusive tax schemes are trending downward, as the figure below shows audits by IRS's Large Business and International division. This trend has occurred amid generally declining IRS resources and corresponds with an overall decrease in audit activity by IRS over recent years.

IRS has a variety of programs working collectively to identify abusive tax schemes involving tax-exempt entities, but some internal control weaknesses exist in its approach. For example, GAO found three ways that IRS data or programs were inconsistent with internal control standards for using quality information. First, database project codes used for identifying data on abusive tax schemes are not linked across IRS's audit divisions and do not consistently identify whether a tax-exempt entity was involved. Second, IRS has not leveraged a database with cross-divisional information to facilitate its analysis and monitoring of audit data across divisions. Finally, IRS has not used existing analytic tools to mine the narrative fields of tax forms. Doing so could provide audit leads on abusive schemes involving tax-exempt entities. These deficiencies inhibit IRS's ability to identify abusive tax schemes and develop responses to those schemes.

Large Business and International Abusive Transaction Audits, Fiscal Years 2008 through 2017

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Why GAO Did This Study

Abusive tax schemes contribute to the tax gap and threaten the tax system's integrity. When abusive tax schemes involve tax-exempt entities, they also can erode the public's confidence in the charitable sector.

GAO was asked to review what is known about abusive transactions involving tax-exempt entities and how IRS addresses them. This report, among other things, (1) describes ways in which taxpayers have abused an entity's tax-exempt status; (2) examines trends in IRS's compliance efforts; and (3) assesses how IRS identifies emerging abusive tax schemes involving tax-exempt entities.

GAO reviewed research on tax schemes involving tax-exempt entities, and interviewed relevant professionals and researchers about tax schemes involving tax-exempt entities; compiled statistics from IRS audit and disclosure data; and compared documentation and testimony from IRS officials on IRS programs and guidance from its operating divisions with certain internal control and GAO fraud framework criteria.

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Recommendations

GAO is making five recommendations to IRS to strengthen its internal controls, including that it link data across operating divisions, test the ability of a database to facilitate analysis of audit data, and use existing analytic tools to further mine information on tax forms. In commenting on a draft of this report, IRS agreed with all of GAO's recommendations.

Recommendations for Executive Action

Agency Affected Recommendation Status
Internal Revenue Service The Commissioner of Internal Revenue should undertake a risk assessment of tax-exempt entity Form 8886-T filings. Based on the findings of the risk assessment, IRS should then determine whether steps are needed to increase compliance, such as, for example, through increased outreach to tax-exempt entities or assessment of nonfiling penalties. (Recommendation 1)
Open
IRS agreed with the recommendation. In May 2021, IRS said the Tax Exempt/Government Entities division undertook a risk assessment of Form 8886-T filings. The assessment concluded that there was minimal risk and that TE/GE should maintain its current compliance mechanisms for Form 8886-T. However, the assessment also led to further actions on internal referrals that it found should have occurred but did not. GAO is in the process of reviewing IRS's study and will continue to monitor IRS's progress.
Internal Revenue Service The Commissioner of Internal Revenue should link audit data on abusive tax schemes involving tax-exempt entities across operating divisions and use the linked data to assess emerging issues and develop policy responses. (Recommendation 2)
Open
The Internal Revenue Service (IRS) partially agreed with GAO's September 2019 recommendation and has taken steps to fully implement it. As of May 2021, IRS plans to create a list of existing project codes identifying abusive schemes involving tax exempt entities. IRS plans to determine if each operating division can add the same codes in its systems so that the entities can be tracked in audit data across the operating divisions. Separately, IRS's Office of Research, Applied Analytics and Statistics (RAAS) plans to evaluate and use, where possible, existing analytic tools to mine narrative fields of tax forms to provide leads on abusive schemes involving tax-exempt entities. RAAS also plans to identify who would manage cross-division analysis that could enhance IRS's objective to assess emerging issues and develop policy responses. IRS is scheduled to complete these actions in 2021 using data from existing systems. IRS plans to consider including business requirements aimed at linking audit data to assess emerging issues in its enterprise case management system under development. Successfully completing these efforts should help ensure that IRS is using its existing data resources effectively and help identify more abusive tax schemes involving tax-exempt entities.
Internal Revenue Service The Commissioner of Internal Revenue should test the ability of the Return Inventory Classification System to facilitate analysis and monitoring of audit data across the operating divisions and to support the IRS's enforcement objectives. (Recommendation 3)
Open
The Internal Revenue Service (IRS) agreed with GAO's September 2019 recommendation and has taken steps to implement it. As of May 2021, IRS said it had held cross-business unit meetings to determine what data it can share among its audit divisions. IRS's Office of Research, Applied Analytics and Statistics was working on determining how to link audit data across divisions. Furthermore, the Tax Exempt/Government Entities division, which has audit responsibility over tax-exempt entities, was developing a cost estimate to determine if RICS can be used to link data across divisions. IRS expects to complete these efforts in 2022. Successfully completing these actions should improve IRS's ability to detect abusive tax schemes using existing data and improve compliance.
Internal Revenue Service The Commissioner of Internal Revenue should use existing data analytic tools to further mine Form 8886 and Form 8918 data, which could be used to find audit leads on tax-exempt entity involvement in potentially abusive tax schemes. (Recommendation 4)
Open
The Internal Revenue Service (IRS) agreed with GAO's September 2019 recommendation and has taken steps to implement it. As of May 2021, IRS's Office of Research, Applied Analytics and Statistics (RAAS) was exploring the use of data analytic tools and plans to continue to evolve its existing image processing and test analytics pipelines to identify audit leads. Specifically, RAAS will determine if existing tools can identify keywords in disclosure reports and determine whether a tax-exempt entity was party to a reportable transaction that warrants further compliance investigation. IRS will also determine whether continued analyses are productive. IRS expects to complete the project in 2022. Successfully completing these actions will help IRS better leverage existing resources and identify noncompliance among tax-exempt entities.
Internal Revenue Service The Commissioner of Internal Revenue should develop guidance to help managers ensure referrals about abusive schemes involving tax-exempt entities are made across operating divisions. This could be accomplished by, for example, adopting specific guidance for audit managers to look for referral accuracy in their reviews of case closings. (Recommendation 5)
Open
IRS agreed with GAO's September 2019 recommendation and plans action to implement it. In May 2021, IRS said it will develop guidance to help managers across audit divisions ensure referrals involving tax-exempt entities are directed to the Tax-Exempt/Government Entities (TE/GE) division. TE/GE will provide training for auditors in other IRS divisions on making referrals. As part of this, IRS said it will update procedural guidance in the Internal Revenue Manual. Additionally, TE/GE will revise audit quality review systems procedures to assess whether referrals of abusive schemes involving tax-exempt entities are properly identified and routed. IRS expected to complete the guidance and training in late 2021. GAO continues to monitor IRS's progress.

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