Treasury Inspector General for Tax Administration (TIGTA) Issues New Report on Exempt Organizations’ Payroll Tax Noncompliance
Earlier this month, the Treasury Inspector General for Tax Administration (TIGTA) issued a report indicating that approximately 3.8 percent of tax-exempt organizations owed nearly $875 million in federal tax debt related to payroll taxes, interest and penalties as of June 16, 2012. The report also provides an in-depth review of 25 section 501(c)(3) organizations, revealing that they collectively owed more than $25 million in back taxes, interest and penalties. These organizations represent only a small percentage of tax-exempt organizations; however, as the IRS renews its focus on reigning in payroll tax debt as a way of closing the “tax gap,” it is critical that nonprofits understand the significance of the report’s findings, as well as what may be at stake for organizations that are not compliant with payroll tax laws.
The IRS has a distinct division that addresses only payroll taxes, which covers all taxpayers whether or not they are tax-exempt. The IRS’s Exempt Organization Examination Program can assess payroll taxes and ask for payment of delinquent taxes. But if the exempt organization does not make the payment, the matter is referred to the IRS Small Business/Self-Employed Division for collection. If the Division finds that an employer has withheld payroll taxes from employee compensation but has not paid those taxes to the government, the organization’s officers can be held personally liable and assessed a civil monetary penalty. If the actions are willful failures, the government could also bring criminal misdemeanor charges.
One of the issues raised by the TIGTA report was that revocation of exempt status was not an available enforcement tool for the IRS to use for exempt organizations that failed to pay payroll taxes. To be clear, revocation is only available as an enforcement tool by the IRS for cases in which there is a substantial nonexempt purpose or violations of the rules regarding exemption, such as private inurement. Furthermore, revocation has rarely been invoked by the IRS, as it often hurts the organization and the community it serves rather than the individuals who may have been responsible for the wrongdoing. For this very reason, in 1996, Congress enacted Intermediate Sanctions
(IRC 4958) as a way of addressing individual wrongdoing without unduly burdening the full organization.
Based on its findings, TIGTA has made several initial recommendations to the Exempt Organization (EO) Division for addressing the payroll tax issues, including:
1. Coordinate with Small Business/Self-Employed Division management to determine what information or systems are available from collection cases that would be useful in identifying exempt organizations potentially abusing the tax system.
The EO Division has disagreed with the recommendation, stating that this information would not be useful in identifying private inurement or issues that are of concern to EO.
2. Periodically complete analyses to identify tax-exempt organizations with significant unpaid payroll and other federal taxes and that receive funding from government grants and pay large salaries to executives and officers. Evaluate these organizations to determine if there are any issues that may warrant examinations.
The EO Division has disagreed with this recommendation, stating that they already collect sufficient data to identify organizations that are potentially operating to benefit board members, trustees, officers or key employees.
3. Work with the Treasury Department to evaluate whether a legislative proposal is warranted to strengthen the IRS’s ability to enforce payroll tax compliance.
The EO Division has agreed with this recommendation, and it is very likely we can expect to see legislative proposals emerge in the months ahead.
We know that the IRS already shares information with state charity regulators regarding potential state law violations, and also shares information with the Social Security Administration regarding noncompliance to help target cases and better use resources. As the government’s response to these findings continues to take shape, our team will monitor for new developments. In the meantime, organizations should be aware of the heightened focus on payroll taxes and take steps to ensure that they are in compliance.