Thank you, Mr. Chairman, Senator Baucus, and distinguished members of this Committee, for the opportunity to explain the role of the Internal Revenue Service (IRS) in a number of issues relating to tax-exempt organizations. We can be proud of the vast majority of exempt organizations that are fully and effectively carrying out their important missions. I must emphasize that my remarks, which by necessity will focus on problems we have observed, should not be interpreted as an indictment of the tax-exempt sector. The vast majority of tax-exempt entities carry out their valuable role in full compliance with the letter and spirit of the laws.

As you know the Administration strongly supports efforts to encourage and support donations to our Nation’s charities. The Administration’s FY 2005 Budget includes a number of tax relief proposals designed to stimulate charitable giving. However, I share your concern that some entities are using their status to achieve ends that Congress clearly did not intend when it conferred the privilege of tax-exemption.

Before I begin, let me give you a few statistics on the population I am here to discuss. When the subject of tax-exempt organizations arises, we commonly think of charities. This is understandable, given the prominent and valuable role of charitable organizations. But the tax-exempt sector is far broader. The approximately 3,000,000 tax-exempt entities include almost 1,000,000 section 501(c)(3) charities and almost 1,000,000 employee plans. The other million entities include state and local governmental entities, Indian tribal governments, and other tax-exempt organizations such as labor unions and business leagues. This sector is a vital part of our nation’s economy that employs about one in every four workers in the U.S. In addition, nearly one-fifth of the total U.S. securities market is held by employee plans alone.

As I will discuss, there are abuses of charities that principally rely on the tax advantages conferred by the deductibility of contributions to those organizations. Other abuses involve not only charities, but other exempt organizations that allow themselves to further purposes other than those for which tax-exemption is authorized. When abusive tax avoidance transactions are involved, the facilitators of those abuses include not only charities and other exempt organizations, but also employee retirement plans, state and local governments, and Indian tribal governments. While the abuse in this sector may still be isolated, I share your view that we must quickly and effectively act now. If these abuses are left unchecked, I believe there is the risk that Americans not only will lose faith in and reduce support for charitable organizations, but that the integrity of our tax system also will be compromised.

I am committed to combating abuse in this area. We recently released our IRS Strategic Plan for 2005-2009. Along with improving service and modernizing our computer systems, one of our strategic goals is to enhance enforcement of the tax law.

The President has asked for an IRS fiscal year 2005 budget of $10.674 billion, a $490 million (4.8%) increase over the FY 2004 appropriation. Most of this increase, $300 million, will be used to restore and reinvigorate our enforcement presence. If funded, we expect to increase our spending in the examination area with respect to tax-exempt and government entities by 17% in 2005. This funding is crucial, particularly with respect to charities. Historically, IRS functions regulating tax-exempt entities have not been well funded due to the lack of revenue they generated. This view is misdirected in light of the size and importance of the sector. With staffing in this area flat at best and with the number of charities increasing annually, our audit coverage has fallen to historically low levels, compromising our ability to maintain an effective enforcement presence in the exempt organizations community.

One of our four specific objectives is to deter abuse within tax-exempt and governmental entities, and misuse of these entities by third parties for tax avoidance or other unintended purposes. I will align my remarks today with this strategic objective. First, I will talk about IRS deterrence of abuses within tax-exempt and governmental entities. Second, I will discuss IRS deterrence of the misuse of these entities by third parties for tax avoidance or other unintended purposes. For the most part, I will focus my remarks on charities, but the abuse of tax-exempt organizations transcends charities. I believe it is important to give the Committee a comprehensive overview of the problems we face in this area.

I would like to start by highlighting the Administration’s legislative proposals to address abusive tax avoidance transactions generally, including those that may involve tax-exempt organizations, and legislative proposals to address specific abuses involving tax-exempt organizations. The Administration’s FY 2005 Budget contains a number of legislative proposals, originally announced by the Treasury Department in March 2002 to combat abusive transactions. These proposals include statutory changes that would create better, coordinated disclosure of abusive transactions by taxpayers and promoters, and would back these improved disclosure rules with meaningful penalties. Other proposals would increase promoter penalties, increase accuracy-related penalties for certain undisclosed abusive transactions, target egregious behavior, curtail frivolous submissions, and reinforce the disclosure rules for off-shore accounts that may be used in some abusive transactions. Under this Committee’s leadership, these proposals are closer to enactment. In March 2002, The Treasury Department also announced a number of administrative actions to combat abusive transactions, and virtually all of these actions have been completed. I will describe other administrative actions the IRS is taking to combat abuses in the tax-exempt area.

In addition, although the Administration is committed to encouraging gifts to charity, it also wants to ensure that taxpayers are accurately valuing property they donate to charity. As described below, the Administration’s Budget includes proposals to address the problem of overvaluation of certain gifts of property to charity.

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