In an extraordinary development, all fifty states, the District of Columbia, and the Federal Trade Commission filed a federal lawsuit in May 2015 against four charities and their operators, alleging that they had defrauded more than $187 million from donors.1While the dollar amount was staggering, the most unusual aspect of the lawsuit was the incredible level of cooperation among state nonprofit regulators. This cooperation was evident not only in the bringing of the lawsuit but also in its successful settlement less than a year later, with the defendant charities and their principal officers surrendering substantial assets, agreeing to dissolution of the charities, and acquiescing to being banned from fundraising and management of charities and charitable assets in the future.2
This development highlights the growing sophistication and cooperation of state nonprofit regulators. And it is not an isolated incident. Building on seeds planted over the past several decades, state regulators are both individually and collectively increasing their oversight of nonprofits.
This trend is fortunate for those who care about oversight of nonprofits, because it comes at a time when the Internal Revenue Service’s efforts in this area are atrophying. Even before the recent controversy related to the handling of exemption applications filed by politically active nonprofits, the IRS faced a tight budget and a growing list of responsibilities, including significant rulemaking and administrative duties related to the Affordable Care Act, or Obamacare. These pressures, in turn, led to a growing backlog of applications for recognition of exemption, a decline in the already low audit rate for tax-exempt nonprofits, and limited new guidance for nonprofits seeking to comply with the complex federal tax rules applicable to them.3
The mess involving exemption applications filed with the IRS by Tea Party and other conservative-leaning groups worsened this situation in several ways, however. It accelerated the development of streamlined application procedures—including, but not limited to, the new Form 1023-EZ—that significantly reduce the level of IRS review for new organizations. It also gave Congress another reason to underfund the IRS, forced a wholesale change in the leadership of the IRS Exempt Organizations Division, and almost certainly made employees throughout that division wary of pursuing all but the most egregious violations of federal tax law. IRS examinations of annual information returns (primarily the Form 990 series) are now at an anemic level of less than four-tenths of a percent annually. This is at a time when the number of tax-exempt nonprofit organizations has grown to over one and a half million—not including churches and other houses of worship that are not required to seek such recognition from the IRS.
So, what have state nonprofit regulators been doing during this time of decline in IRS oversight? Individually, many of them have been working hard to review and improve their laws and procedures governing nonprofits, as well as increase efforts to reach the regulated community and those who advise that community.
