Lax IRS Oversight Fostered Costly Charity Scams

By DAN EPSTEIN    June 20, 2013


In addition to its clean beaches, rolling hills and exclusive real estate, Pacific Palisades, California, was home to the International Humanities Center (IHC), a tax-exempt sponsor of over 300 charitable endeavors. Its executive director, Steve Sugarman, rose to non-profit stardom by leading IHC-supported organizations to over $6 million in combined revenue.

But by December 2011, several IHC-sponsored projects received a shocking letter from Sugarman. It disclosed that IHC was “running a considerable deficit that has severely impacted all operations,” and warning the projects that future payments may not be processed.IHC became so successful so quickly that by 2009 the organization had to place a moratorium on sponsoring new projects. Sugarman’s secret was fiscal sponsorship – a term of art referring to tax-exempt 501(c)(3) charities that raise tax-deductible contributions on behalf of projects that lack the resources to operate as independent, tax-exempt charities themselves.

One month later, Sugarman informed IHC’s projects that their fiscal sponsor was shutting down. Donations to hundreds of charitable causes – and the sponsor entrusted with them – had vanished. The FBI subsequently launched an investigation into the apparent disappearance of an estimated $1 million in donations that about 200 non-profits reported losing when the organization abruptly shut down.

The story of IHC is not unique. Fiscal sponsors that engage in money laundering and fraud are systemic. And these CEOs are not on Wall Street or in the boardrooms of large, publicly-traded corporations. This kind of corporate fraud occurs in small, tax-exempt nonprofits, often run by one or two individuals who have discovered an opening in the tax code that allows them to dupe unsuspecting start-up charities and fly under the radar of an over-complicated tax code.

While the Internal Revenue Service got into trouble for targeting Tea Party groups, many fiscal sponsors have wrongly obtained charitable status to engage in a dangerous pattern of abuse that destroys jobs and ruins charitable aims toward the public good. Sadly, despite evidence of fiscal sponsors having fabricated tax documents and bank statements or mismanaged federal grant money, fiscal sponsorship has been unmanaged, unchecked, and undefined by the IRS.

The importance of IRS oversight of fiscal sponsorship is not just in the interest of those charitable projects that rely on the practice for their support – but for the American taxpayers as well. IHC received economic stimulus funding from the U.S. Department of Energy – yet no shovel-ready jobs were created.

In fact, the IHC’s use of these funds was subject to a DOE Inspector General investigation, with a criminal and civil case pending against IHC as of April 2012. Proper IRS oversight over fiscal sponsorship would have averted whatever bureaucratic wisdom concluded that IHC merited tax dollars or that it would employ out-of-work Americans.

Moreover, fiscal sponsorship has been abused in ways that threaten American security interests. Many are familiar with the Freedom Flotilla, which was led by the pro-Hamas Free Gaza Movement; it resulted in the death of nine people. But few are aware that the Free Gaza Movement is fiscally sponsored by a Washington, D.C.-based tax-exempt nonprofit, the American Educational Trust. For the IRS, fundraising for terrorism abroad apparently does not raise the same red flags as does being a “patriot” or supporting the constitution.

The IRS must regulate fiscal sponsorship by clearly defining the parameters and standards of the practice. Fiscal sponsorship agreements should be treated as contracts that identify the fiscal sponsorship arrangement between sponsor and client, as well as provide evidence that the sponsoring organization will exercise discretion and control over its client. The IRS, through rulemaking, should require that any 501(c)(3) organization that engages in fiscal sponsorship file with its Form 990 copies of all of its written fiscal sponsorship arrangements. Additionally, the IRS should require that fiscal sponsors disclose in their 990s when the gross receipts of a sponsored project exceeds $50,000.

Cases like IHC and the Free Gaza Movement underscore the substantial lack of guidance regarding fiscal sponsorship. Those gaps in oversight have exposed hundreds of charities to abuse and allowed substantial sums of donations – including federal government grants – to be mismanaged by unaccountable sponsors.

The IRS’s failure to properly oversee tax-exempt groups puts all projects that find themselves under an incompetent or disreputable fiscal sponsor at risk of losing funding and shutting down.

Dan Epstein is executive director of Cause of Action, a nonprofit, nonpartisan group that promotes government accountability and transparency. The group has filed a request with the IRS to develop rules and standards for tax-exempt fiscal sponsors.