INTERNAL REVENUE SERVICE
AN OVERVIEW WITH A FOCUS ON CHARITY OVERSIGHT
Marcus S. Owens
Caplin & Drysdale
Washington, DC
I.
Congressional Authorization
The existing federal tax structure is authorized by the 16th Amendment to the United States
Constitution which allowed Congress to enact an income tax without regard to apportionment
among the states or census data. The current iteration of that tax structure is the Internal
Revenue Code of 1986, although many of the provisions relevant to tax exempt
organizations, and charities in particular, have their antecedents in prior revenue acts and
Internal Revenue Codes, particularly the Internal Revenue Code of 1954.
The core of the IRS authority to enforce the Internal Revenue Code is found in section
7601(a) which directs the Secretary of the Treasury to “cause officers or employees of the
Treasury Department to proceed, from time to time, through each internal revenue district
and inquire after and concerning all persons therein who may be liable to pay any internal
revenue tax…” To facilitate the process, section 7805(b) gives the Treasury and the IRS the
authority to issue “all needful rules and regulations” for the enforcement of the tax law.
Section 6033(a) mandates the filing of returns and the maintenance of records, including the
authority to design returns to collect information for the “purpose of carrying out the internal
revenue laws.” Finally, section 7602(a) authorizes the examination of such books and
records as may be “relevant or material” to tax administration for the purpose of
“ascertaining the correctness of any return.”
Tax exempt status for charities is authorized by section 501(c)(3) which provides for the taxexempt status of organizations:
[O]rganized and operated exclusively for religious, charitable, scientific,
testing for public safety, literary, or educational purposes, or to foster national
or international amateur sports competition (but only if no part of its activities
involve the provision of athletic facilities or equipment), or for the prevention
of cruelty to children or animals, no part of the net earnings of which inures to
the benefit of any private shareholder or individual, no substantial part of the
activities of which is carrying on propaganda, or otherwise attempting, to
influence legislation (except as otherwise provided in subsection (h)), and
which does not participate in, or intervene in (including the publishing or
distributing of statements), any political campaign on behalf of (or in
opposition to) any candidate for public office.
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Organizations determined to be tax-exempt under section 501(c)(3) are further divided by
section 509 into either what are generally called “publicly-supported charities” or private
foundations. The distinction between a publicly-supported charity and private foundation is
based on the pattern of income of the organization, with organizations that receive
contributions from the general public considered “publicly-supported” and organizations that
subsist on investment income or contributions from a small group of persons or taxable
entities considered private foundations. Exceptions to the preceding general rule are made
for churches, schools (including colleges/universities), hospitals/medical research
organizations and “supporting organizations” (entities that are structurally required to support
the activities of particular publicly-supported charities), all of which are deemed to be
“publicly-supported.”
In addition to the preceding exempting provisions, the Internal Revenue Code includes a
number of regulatory provisions including:

the imposition of an income tax on income received by a charity or other taxexempt organization from activities that are not substantially-related to the
exempt purposes of the charity other than as a source of funds

an excise tax on excessive lobbying or political campaign activity (in lieu of or in
addition to loss of tax-exempt status)

an excise tax on organization managers who authorize acts of campaign
intervention

an excise tax on organization managers who are the beneficiaries of “excess
benefit transactions”

an excise tax on organization managers who authorize excess benefit transactions

an excise tax on the net investment income of private foundations

a series of excise taxes on private foundations that apply to self-dealing, excess
business holdings (concentrated business ownership), investments that jeopardize
the ability of the foundation to carryout its purposes, and taxable expenditures
(grants for non-charitable purposes, lobbying or political campaign intervention)
The excise taxes on private foundations and on publicly-supported charities (on excess
benefit transactions, political campaign activities but not excessive lobbying) include a
requirement that the improper expenditure giving rise to the excise tax be corrected, e.g. the
charity made whole, in order to avoid the imposition of a second-tier excise tax and, in the
case of private foundations, a third-tier excise tax under section 507 calculated as the lesser
of the aggregate tax benefit that accrued to the foundation as a result of its tax-exempt status
or the value of its net assets – essentially forced dissolution of the foundation and
confiscation of its assets by the IRS.
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II.
Agency Structure
The IRS is headed by the Commissioner of Internal Revenue, an appointed position requiring
Senate confirmation. The Commissioner is one of only two positions within the agency
requiring Senate confirmation; the other position is that of the Chief Counsel. In 1998,
Congress established a five-year term for the position of Commissioner, in part to provide
continuity and help insulate tax administration from political pressure. Prior to 1998, the
average term of a Commissioner had been three years.
Reporting directly to the Commissioner are two Deputy Commissioners, the highest ranking
career employees within the agency. The Deputy Commissioner for Services and
Enforcement oversees the four primary operating divisions and other service and
enforcement functions. The Deputy Commissioner for Operations Support oversees the
support functions including information technology, human resources, agency finances and
privacy. Other direct reports to the Commissioner include the IRS Chief Counsel, the
Director of IRS Appeals, the Taxpayer Advocate as well as offices responsible for diversity,
statistical research and media relations.
From the standpoint of tax law enforcement, the Deputy Commissioner for Services and
Enforcement is the relevant official. The four operating divisions reporting to that office are
the Wage and Investment Division, the Large Business and International Division, the Small
Business/Self-Employed Division and the Tax-Exempt and Government Entities Division.
Additional functions reporting to the Deputy Commissioner include Criminal Investigation,
the Office of Professional Responsibility and the Whistleblower Office.
As is reflected in their names, the operating divisions are organized around particular
categories of taxpayers, rather than types of tax or functions, and, as a general jurisdictional
principle, the operating divisions will not interact with taxpayers that are the responsibility of
a different division without coordination or prior clearance. Certain exceptions do exist,
however, for example, the excess benefits excise tax in section 4958 is payable by the
individual who receives the excess benefit, not the charity that provides it. That particular
Code section is administered by the Tax-Exempt and Government Entities Division, rather
than the Wage and Investment Division.
III.
Charity Oversight Structure
The administration of the Internal Revenue Code provisions relating to charities is housed
within the Tax-Exempt and Government Entities Division, which is, itself, divided into three
divisions – the Employee Plans Division (responsible for pension and retirement plans), the
Government Entities Division (responsible for tax issues affecting federal, state and local
government entities, Indian tribal governments and tax-exempt bonds) and the Exempt
Organizations Division (responsible for tax-exempt organizations, including charities, and
political organizations).
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The Exempt Organizations Division is headed by a Director, located in Washington, DC,
who oversees three functional units: Rulings & Agreements, Customer Education &
Outreach and Examinations.
Rulings & Agreements is responsible for the processing of applications for tax-exempt status,
the issuance of private letter rulings on proposed transactions, the provision of technical
advice to revenue agents conducting examinations, and the development and issuance of
formal and informal guidance on matters involving tax-exempt organizations and political
organizations. The Rulings & Agreements function is primarily located in Cincinnati, OH,
where virtually all applications for exemption and simple private letter ruling requests are
processed, and in Washington, DC, where more significant interpretative questions are
addressed. The
Customer Education & Outreach is responsible for the development and dissemination of
general information for tax-exempt organizations, including simplified publications and
workshops for smaller tax-exempt entities. The staff is located primarily in Washington, DC.
The Exempt Organizations Examinations function is responsible for the enforcement
programs, including strategic enforcement planning, examinations, compliance checks and
enforcement program analysis. The office is headed by the Director, EO Examinations
whose office is located in Dallas, TX. The Dallas office oversees groups of revenue agents
who specialize in tax-exempt organizations. The revenue agent groups are arranged in five
EO Areas dispersed geographically around the US, each supervised by an EO Area Manager:
IV.

Northeast Area Office – located in Brooklyn, NY and responsible for New York
and New England.

Mid-Atlantic Area Office – located in Mountainside, NJ and responsible for the
Mid-Atlantic States, Ohio, Virginia and North Carolina.

Great Lakes Area Office – located in Chicago, IL and responsible for the
Midwest, portions of Colorado, Minnesota and Kentucky.

Gulf Coast Area Office – located in Atlanta, GA and responsible for the
southeastern US and Texas.

Pacific Coast Area Office – located in Los Angeles, CA and responsible for the
west coast, including Alaska, Hawaii and portions of Colorado.
Charity Oversight Process
The term “charity,” when used in the context of federal tax law, refers to all organizations
described in section 501(c)(3) of the Internal Revenue Code, regardless of the specific
activities or pattern of support, including churches, donor-supported organizations, private
foundations, hospitals and colleges/universities. Because the term is as defined by the
Internal Revenue Code and regulations, it is not perfectly congruent with the concept of
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charity under common law or even necessarily the statutory law of a particular state. For
example, organizations recognized as tax-exempt under section 501(c)(4) may have purposes
that qualify as charitable for state law purposes, but are not charities for federal tax purposes.
The IRS interacts with charities in three major ways: the application for tax-exempt status,
the annual return filing process and in the context of an examination or audit. The only
exceptions to the preceding are with regard to churches and closely allied religious
organizations (“integrated auxiliaries”), which are not required to file applications for taxexempt status in order to hold themselves out as tax-exempt nor are they required to file the
annual information return, the Form 990.
As a general proposition, an organization must first be created under state law as either a
non-profit, non-stock corporation, a charitable trust or a non-profit association before it can
file for federal income tax exemption. Individuals, partnerships or other flow-through
entities cannot qualify for tax-exempt status. In order to have tax-exempt status recognized
retroactively to its date of formation, the organization must file an application for tax-exempt
status on Form 1023 within 27 months of its formation. Because of the limitation on
retroactive tax-exempt status, organizations usually file the application based on proposed
activities, before actual activities or fundraising has begun. As a result, the application
process provides some assurance that an organization will be structured as a charity, but
because actual activities may legitimately differ from activities as they were anticipated at
the point of the application filing, the efficacy of the application process in establishing that
actual operations of an organization are charitable is less certain. As part of the application
process, the IRS may request additional information beyond that required by the questions in
the application, but the agency does not have the practical ability to require a period of actual
operations before processing the application. The reason for that is because an applicant
organization is entitled to seek a declaratory judgment from the Tax Court, the U.S. District
Court for the District of Columbia or the Court of Federal Claims if the IRS has failed to rule
on its application within 270 days of its filing. In such a declaratory judgment action, the
burden of proof is shifted to the IRS, making it difficult to assert that an applicant does not
qualify for tax-exemption. Once an application for tax-exempt status has been approved, a
determination letter reflecting the tax exemption is issued. At that point, the application, all
attachments and all correspondence to or from the applicant and the IRS becomes publiclyavailable, either from the IRS or from the organization itself. It should be noted that the fact
of a pending application or the denial of an application are not a matter of public record.
The second major aspect of charity oversight involves the filing of the annual information
return, that is, one of the variations of the Form 990, including the Form 990-N for small
entities, the Form 990-EZ, the long-form Form 990 for larger entities, and the Form 990-PF
for private foundations. With the exception of churches and integrated auxiliaries of
churches, all charities are required to file a Form 990. The Form 990-T is used to report
unrelated business income and pay tax on any net unrelated income, and, unlike the Form
990 itself, would be filed by all charities, including churches, that have such income.
The third major point of interaction between charities and the IRS occurs in the context of an
examination, popularly referred to as an audit. As noted above in the discussion on
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Authorization, section 7602 gives the IRS the authority to ascertain whether a particular
return is correct or not, thus placing the audit focus on returns, not on organizations or
activities more generally, and effectively precluding the IRS from opening an examination
prior to the due date of a return. Slightly more that half of the employees in the Exempt
Organizations Division are involved in the examination program, which is conducted
pursuant to an annual workplan issued by the Director of the Division and implemented by
the Director of EO Examinations. Historically, the annual workplan has been publicly
released in order to stimulate voluntary compliance with tax law requirements through the
highlighting of particular issues of concern.
With the exception of examinations of churches, the IRS is authorized to select returns for
review based on specific leads (complaints, media reports, information arising through the
application or private letter ruling processes), as a result of surveys, or through random
selection. Churches can only be examined pursuant to procedures specified in section 7611
and the Treasury regulations promulgated under that section, which effectively restrict the
ability of the IRS to examine churches without reasonable cause. In view of resource
constraints, the IRS is able to examine the returns of only a few thousand organizations in
any given year.
V.
IRS – State Attorney General Interaction
IRS interaction with state attorney generals in the context of charity enforcement activities
are constrained by the privacy rules in the Internal Revenue Code. By way of background,
the privacy rules (primarily sections 6103 and 6104) were enacted in the wake of the
Watergate scandal and the Nixon Administration’s efforts to use the IRS for partisan political
purposes, as is reflected in the legislative history of those Code sections and in the records of
related Congressional investigations and hearings.
As a result of that background, the privacy rules broadly protect IRS enforcement activity
and taxpayer/tax return information from disclosure to any unauthorized person, enforced
through criminal sanctions. That having been said, a number of exceptions are applicable in
the context of charities and state regulators, including the state attorney general. In particular,
section 6104(c) authorizes the IRS to share certain otherwise protected enforcement
information regarding charities with state regulators. It is important to note, however, that
the authorized information sharing is with regard to final and proposed enforcement actions,
not with regard to ongoing investigations more generally. State attorney generals should be
aware that this situation is in stark contrast to the coordination that the same privacy rules
permit in the context of tax administration with regard to taxable organizations and
individuals. When taxable organizations and individuals are involved, the privacy rules
permit the negotiation of information-sharing agreements and joint enforcement actions
between the IRS and state revenue officers (but not state attorneys general).
The net effect of the privacy rules, even with the exceptions for certain types of information,
is to make real-time enforcement information sharing difficult. In addition, the timing of IRS
enforcement efforts, based on the filing of annual returns, means that any IRS review will be
of a prior time period, rather than of current activities. It is possible, nevertheless, that state
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attorney general investigations may focus on activities in the same time period as an IRS
investigation, and efforts at obtaining IRS enforcement information may help further state
efforts.
VI.
Tax Glossary

Action on Decision – An announcement by the IRS with regard to whether it
considers a particular court decision to have settled a point of law or whether the
agency will continue to litigate the same issue when it arrises in other courts or
other jurisdictions. The announcements are published in the semi-annual
Cumulative Bulletin.

Cumulative Bulletin – a semi-annual compendium of matters originally published
in the Internal Revenue Bulletin and intended as the permanent citable source for
the matters.

Determination Letter – a determination letter is issued in response to the filing of
an application for tax-exempt status. Unlike a private letter ruling, it does not
recite or analyze specific facts in light of the law, but rather provides an overall
conclusion based on the information provided in the application. It may be relied
upon by the applicant so long as the material facts remain unchanged, and in the
case of charities, it may be relied upon by donors until public notice of revocation
is made in the Internal Revenue Bulletin.

Field Service Advice – advice provided by IRS Counsel to revenue agents
conducting audits and to other field personnel, such as service center employees,
who encounter issues requiring legal interpretation. Field service advice is
publicly-disclosed in redacted form to prevent disclosure of identifying
information.

General Counsel Memorandum – The practice of IRS Counsel’s Office until the
1990s was to provide legal advice to the enforcement staff of the IRS, including
the Exempt Organizations Division, in the form of formal memoranda. The
memoranda were publicly released, however, IRS Counsel’s Office has
abandoned the practice of providing formal memoranda, nevertheless, such
memoranda are still referenced by revenue agents and taxpayers in the course of
discussions of particular tax issues.

Information Letter – an information letter is a letter that describes generally
settled matters of tax compliance without the specificity or reliance of a private
letter ruling. Information letters are publicly released.

Internal Revenue Bulletin – the Bulletin is the weekly official publication of the
IRS, typically containing new regulations, revenue procedures and rulings, as well
as other announcements.
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
Internal Revenue Manual – The Manual is literally a guide to running the Internal
Revenue Service. Sections describe everything from personnel rules to the
processing of taxpayer cases. Part IV of the IRM provides information about
procedures and law applicable to audits generally, and charity audits in particular;
Part VII describes the tax rules applicable to charities and other tax-exempt
organizations.

Private Letter Ruling – a private letter ruling is a letter from the IRS that analyzes
a particular proposed activity or action and provides the IRS’s conclusion as to
the tax impact. While private letter rulings are made public, only the taxpayer
that requested the ruling is entitled to rely on it. Others may only use it as an
indication of how the IRS might interpret similar facts in future situations.
Private letter rulings are made public in redacted form to shield the particular
taxpayer’s identity.

Revenue Procedure – revenue procedures provide official guidance on how
taxpayers may meet their obligations under the Internal Revenue Code. For
example, revenue procedures describe how to request private letter rulings or the
current user fee schedule.

Revenue Ruling – revenue rulings are the IRS’s interpretation of tax law as it
applies to a particular fact pattern and are published in the weekly Internal
Revenue Bulletin. Taxpayers may rely on revenue rulings, however, because
revenue rulings are not issued through the public notice and comment process,
courts tend to view them as simply the opinion of the IRS, and do not necessarily
accord them much weight.

Technical Advice – technical advice is the response of the IRS National Office to
a request for assistance from a revenue agent conducting an audit. The advice is
based on facts and law gathered by the agent, which are also provided to the
taxpayer. After a formal conference of right, the National Office will issue a
technical advice memorandum to the agent setting forth the analysis of the law to
the particular facts uncovered in the examination. Technical advice memoranda
are publicly released in redacted form to shield the particular taxpayer involved.

Technical Assistance – technical assistance is general information provided by the
National Office to a field office of the IRS , that is, it does not purport to analyze
a particular taxpayer’s facts as in the technical advice process. Technical
assistance memoranda are made public.

Thirty-Day Letter – the colloquial name for a proposed adverse finding coming
from an IRS audit in which the the taxpayer has 30 days to decide whether to take
the tentative finding to the IRS Appeals function before it becomes final.

Treasury Regulations – are jointly developed by the Treasury and the IRS through
a public notice and comment process and constitute the official government
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interpretation of the Internal Revenue Code. Regulations may be relied upon by
taxpayers and generally have the force and effect of law. Courts tend to give
regulations deference.

Ninety-Day Letter – the colloquial name for the final adverse finding coming
from an IRS audit. The letter provides that the taxpayer has 90 days to challenge
the conclusion in court.

Publication 78 – A telephone book-sized list of organizations to which
contributions are deductible as charitable contributions for purposes of federal
income tax. Donors are entitled to rely on a listing in Publication 78 for purposes
of contribution deduction until notice of a change in the listed organization’s
status is published in the Internal Revenue Bulletin.

Publication 557 – A summary of the federal tax rules that apply to tax-exempt
organizations, with an emphasis on charities.
Forms

Form 990 – The annual information return series filed by a tax-exempt
organization. It includes the Form 990-N, the Form 990-EZ and the Form 990.

Form 990-PF – The annual combined information and tax return filed by a private
foundation.

Form 990-T – The annual tax return filed by an otherwise tax-exempt
organization to report and pay income tax on the income from activities that are
not substantially related to the achievement of the organization’s tax purpose.

Form 1023 – The application for federal income tax exemption filed by an
organization seeking recognition of tax-exempt status under section 501(c)(3).

Form 1024 – The application for federal income tax exemption filed by an
organization seeking recogntion of tax-exempt status under provisions other than
section 501(c)(3), e.g. section 501(c)(4).
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