I.R.S. Takes on Tax Abuse by Charity Support Groups

In the last five years, the Internal Revenue Service has revoked the tax exemption of 72 groups, known as supporting organizations, that obscure philanthropies created to support specific charities.  The revocations, made during an investigation of supporting organizations begun by the I.R.S. in 2004, were disclosed this month at a meeting in Baltimore of tax advisers to nonprofit groups. In 2005, Mark W. Everson, its commissioner from 2003 to 2007, put such entities on the agency’s Dirty Dozen list of the worst tax swindles.

Among the problems the I.R.S. found were supporting organizations that were created as tools in shady financial planning programs to let donors take a tax deduction, only to get their supposed charitable donation back through offshore investments or interest-free loans to relatives.

An additional 30 supporting groups examined by the I.R.S. agreed to end their business in audits. The agency reclassified 59 more as charities or private foundations, making them subject to more stringent reporting and granting requirements.

“Hats off to the I.R.S. for finally showing some giddyap and enforcing the law,” said Dean A. Zerbe, a tax consultant who, as a staff lawyer for the Senate Finance Committee, wrote legislation in 2006 to make supporting organizations more accountable. “We’ve known for a long time that these things were problematic, and the high number of revocations is further proof.”

I.R.S. officials do not discuss specific organizations, but the agency does publish lists of nonprofit groups that have lost their tax exemption through revocation.

Lois G. Lerner, director of the exempt organizations division of the I.R.S., said the organizations that had been examined in the continuing investigation were largely those linked to promoters that had been identified by other I.R.S. divisions.

“Many of the organizations we looked at were ones where we already knew there was an apparent connection with a scheme, so it’s not surprising that we found problems with them,” Ms. Lerner said.

She said the most common abuse involved promoters who set up supporting organizations on behalf of their clients. The client would take a deduction for donating money to the organization. Then, through a series of promoter-controlled transactions — some involving offshore activity — the “donation” would be returned to the client or a relative, often in the form of a no-interest loan.

Several supporting organizations that have lost tax exemptions in the last several years, for example, were involved with Merrill Scott & Associates Ltd. of Utah. Merrill Scott is in receivership after a Securities and Exchange Commission investigation that claimed it had operated a Ponzi scheme. (In 2008, Merrill Scott’s principals were charged, among other things, with tax evasion and money laundering.)

The tax exemption for the HFZ Charitable Supporting Organization of Santa Barbara, Calif., was revoked because of its relationship with Merrill Scott, said Scott Haskins, its co-founder. “We were just looking for some financial planning advice, we weren’t hiding money offshore or doing anything weird,” said Mr. Haskins, a specialist in art restoration and conservation. “The I.R.S. came in pretty much like a bull in a china closet, and for the last eight years, we’ve been through line-item audits of all our personal and business matters.”

HFZ’s tax forms show that it was set up primarily to support the Dove Center, a nonprofit group in southern Utah that Mr. Haskins said helped women who were victims of domestic violence. “We never made any donations to them,” he said. “We were going to provide some support for them, but never really got to that point.”

Mr. Haskins said he and his wife now plan to establish a donor-advised fund at the Santa Barbara Foundation, a community foundation where he lives. “I know that there are a lot of people who set up supporting organizations as a kind of cloak for other activities, so I understand that it’s bureaucratically difficult to distinguish those who’ve done so for the right reason from those who’ve done it for other reasons,” he said. “In our case, it was totally justified.”

The most common types of supporting organizations are what are known as “Friends of” groups, which typically raise money of behalf of a university sports program or an arts institution.

Congress ordered revisions to the regulations governing supporting organizations in the 2006 Pension Protection Act, effectively applying some of the rules that govern private foundations to prevent private benefit. In particular, the law took aim at Type III supporting organizations, which, unlike their Type I and Type II cousins, are not controlled by the charity they were created to support and are free to support any nonprofit organization.

A major provision of the act requires the Treasury Department to establish a mandatory payout rate for Type III organizations to ensure they are giving money to charity. The Treasury has proposed a payout rate of 5 percent of assets, which is the rate required of private foundations, but the American Bar Association and others are challenging that recommendation, seeking a lower rate. Senator Charles E. Grassley, Republican of Iowa, led the push in Congress for greater control of supporting organizations that preceded the Pension Protection Act. “At the time, some critics of reform said concerns about abuse were overblown,” Mr. Grassley said in an e-mail. “It turns out there’s plenty of cause for concern, and the new proposed payout rules will help. But the I.R.S. needs to hold firm on applying them.”