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Foundations' tax returns left unchecked

This story was reported by the Globe Spotlight Team: Reporters Beth Healy, Francie Latour, Sacha Pfeiffer, and Michael Rezendes, and editor Walter V. Robinson. It was written by Pfeiffer and Healy. Last in a series of occasional articles.

In a 14th-floor storage room in a state office building on Beacon Hill, floor-to-ceiling rows of metal shelves hold tens of thousands of paper files bulging with nonprofit tax returns, many tattered and dog-eared. New filings arrive at a pace so relentless that paperwork once sat unprocessed for three years.

This sea of paper, generated by the 22,000 public charities in Massachusetts, includes the federal tax filings of several thousand private foundations. State officials barely have a chance to look beyond the first page of foundation returns, let alone pinpoint those where there may be abuses, like excessive salaries and conflicts of interest. In fact, because the files are only partially computerized, state regulators don't even know how many foundations there are.

Neither does the Internal Revenue Service.

Inadequate hardly describes the system now in place to keep watch over the $429 billion in assets held by private charitable foundations. A Globe Spotlight Team investigation of hundreds of foundations nationwide found that oversight is virtually nonexistent, allowing excesses and abuses to go unchecked.

Trustees of private foundations know they can flout the law with almost no risk of detection, much less penalty. That's because the IRS has neither the resources nor the incentive to police this sector. And state regulators, including those in Massachusetts, admit that with their present budgets and staff they can do little more than warehouse the foundations' annual returns.

Massachusetts doesn't do much, but the state is considered among the nation's best at regulating foundations. That's because many states don't even try. In some, there is no one assigned to oversee foundations. In others, regulators seem blind to abuses.

In San Francisco, for example, a judge approved $750,000 in retroactive fees to each of the four trustees of the $147 million Larry L. Hillblom Foundation -- pay for four years in which the foundation made no grants. In Waco, Texas, the IRS audited the $131 million Christ Is Our Salvation Foundation, but expressed no concern that the foundation, which supports Christian education and evangelism, owned a private jet.

In Massachusetts, as the Globe reported in October, neither the attorney general's office nor the IRS was aware that Paul C. Cabot Jr. of Needham was paying himself more than $1.3 million a year from a family foundation with assets of less than $6 million. Cabot reported his pay on the tax returns of the Paul and Virginia Cabot Charitable Trust, which was created to fund arts and education. But the government's computer software is so ineffective that the most flagrant excesses go undetected.

Even the foundation world is crying out for more oversight.

"I am deeply concerned that there are not enough resources allocated at the federal level and the state attorney general offices to fulfill their responsibility to take out the bad guys," said Diana Aviv, president and CEO of Independent Sector, a national coalition of nonprofits and corporations.

Trustees at the vast majority of foundations take no fees. But there are many who violate federal rules requiring that trustee compensation be "fair and reasonable." The Spotlight investigation found trustees voting themselves excessive salaries, spending lavishly on travel and perks, operating for-profit businesses under the cover of nonprofit foundations, and using foundation assets to buff their own public profiles.

These are the kinds of abuses that were supposed to have been stopped by the Tax Reform Act of 1969, which was designed to increase compliance with laws regulating charitable giving by foundations. Yet they persist.

Foundations are typically established by wealthy, philanthropically inclined families or individuals who receive large tax breaks in exchange for setting aside assets for charitable causes. Foundation boards of trustees are required by law to give away at least 5 percent of the foundations' assets each year, but the Globe found numerous examples of foundations giving away far less, and sometimes nothing at all -- without drawing the attention or ire of regulators.

If they are discovered, abuses can result in significant penalties. Foundation executives involved in "self-dealing" can be forced to repay the funds, plus a penalty that can range from 5 to 200 percent. In egregious cases, foundations can lose their tax-exempt status.

A former head of the IRS's tax-exempt division, Marcus Owens, a Washington attorney who now represents private foundations, called the division the "stepchild" of the agency, a poor fit with the IRS's overall mission of collecting taxes. The division's budget has barely increased in the last decade, despite explosive growth in the number of foundations during the market boom of the 1990s.

The IRS estimates there are about 100,000 private foundations, though the agency doesn't know how many of those are defunct or fail to file tax returns. Industry groups put the number at 62,000. But one number is not in dispute: The IRS audits fewer than 120 foundations annually.

Asked why the IRS reviews so few foundation tax returns, Steve Miller, the current chief of the agency's tax-exempt group, said, "I'm not going to even remotely claim that we do as much as we could in the area."

He said the IRS is working to develop new systems to flag foundations with high expenses. "That doesn't take an MIT education," he said, "and we should be doing a better job of that."

According to Owens, the IRS's shortcomings force auditors in its tax-exempt unit to "figure out ways to make a big splash with a small pebble." That means federal regulators typically crack down only on the most serious violators, often only after they are identified in media reports.

As a result, much of the oversight role falls to the states. In a handful of states with active attorneys general -- including Massachusetts, New York, and California -- officials say they police foundations as part of their broader effort to supervise all public charities. In general, the roster of states that pay any attention to foundations is very short, and also includes Connecticut, Illinois, Minnesota, Pennsylvania, and Texas.

Yet even in states that try to regulate foundations, like Massachusetts, enforcement action is rare. In recent years, only the Yawkey Foundation, whose assets came from the sale of the Boston Red Sox, has received any public criticism from the office of Attorney General Thomas F. Reilly: for making a major grant to an institution, Boston College, to which several of its trustees are closely tied.

Jamie Katz, chief of Reilly's public charities division, said his office has "on infrequent occasions" investigated private foundations, "but it's not many, and I can't quantify it." Typically, Katz said, his office reaches informal resolutions with foundations and sometimes refers cases to the IRS. But state officials say they are never told whether the IRS follows up.

William Josephson, chief of the New York attorney general's charities division, said one barrier to enforcement is an IRS confidentiality policy that limits cooperation between state and federal investigators. This can lead to absurdities, he said. In one recent case, Josephson recounted, an IRS agent called to ask him for a file on a charity that the IRS had misplaced. The IRS agent said he couldn't identify the charity, and asked Josephson to guess which file he might have lost.

Finding problems at private foundations is tougher than at other nonprofits, according to Katz, because they receive no money from the public, so they have no disaffected donors. They rarely have disgruntled employees, and grant recipients are not inclined to complain about them for fear of retribution. One notable exception is the C. K. Blandin Foundation in Grand Rapids, Minn. The paper mill and newspaper owner who created the foundation earmarked all of his charitable wealth for Grand Rapids, a small town 90 miles south of the Canadian border. But by 2001, large sums were going to other parts of the state and trustees of the $390 million foundation were spending $5 million on pay and expenses to award grants of $13.8 million. Local residents decided to take action.

On Dec. 17, a state court ordered that at least 55 percent of Blandin's annual grants go to the local community. The foundation agreed to hire a court-appointed "special master" who would ensure that the foundation follows the order.

But public involvement of that sort is rare. Private foundations are largely run in secret.

"Many foundations operate out of the limelight, so the public doesn't know the funds are there for their benefit," Katz said.

At many of the foundations investigated by the Globe, trustees refused to discuss their work. They argued that the foundations they run are private entities and balked at questions about what they do and how they spend foundation money.

One example: Leslie Peery Howa of the Louis Scowcroft Peery Charitable Foundation in Salt Lake City refused to answer questions about high expenses and apparent conflicts of interest on the foundation's board. Asked whether she felt any obligation to respond to inquiries, given the foundation's tax-exempt status, she said, "You're out of your mind, pal," before hanging up on a reporter.

Josephson, in a recent speech, said that many foundation benefactors and their offspring lose sight of the fact that foundation assets are reserved for charitable purposes. "Often they seem not to be able to distinguish between the money they gave to their foundations and their own," he said. And while many states focus enforcement on unscrupulous public charities that raise money from average taxpayers, he said, "The truth of the matter is, there appears to me to be more abuse in the private foundation area."

Change is coming slowly, prompted in part by corporate scandals at Enron and Tyco, among others, that have called attention to how the misuse of funds is often linked to conflicted or passive boards of directors.

A high-tech answer to the problem remains elusive, as if the last decade's technology boom bypassed the IRS and offices of state charities watchdogs. Even as Massachusetts and other states strive to get years of unwieldy paper tax filings into computer databases and archive new documents by scanning them when they come in the door, the near-term plans for upgrades are modest in scope.

Federal and state regulators would like to have quick computer access to reports and documents when they need them. But higher-level systems designed to ferret out abuses -- by flagging high expenses, for example -- are barely on the drawing board. Katz, for instance, said Massachusetts plans to adopt a system being tested in Illinois. Illinois said it is testing a system being used in California. But in California, an official said, the state is still "working to establish a new computer system."

On the federal level, foundations will be able to file their 2004 tax returns electonically for the first time, marking a step toward widespread automation. But the IRS has no plans for mandatory electronic filing. Some foundation specialists say profligate foundation trustees are unlikely to file electronically if doing so facilitates IRS scrutiny.

In almost every state, officials complain that funding is the problem. In New York, Josephson said he has been frustrated in getting funds for technology to better scrutinize charities, including foundations. He suggests the technology -- priced in the "very low seven digits" -- will quickly pay for itself in recovered revenue. In just one recent case, his office is expected to recover a significant portion of the $3.4 million trustees reaped improperly at the Grand Marnier Foundation. But the New York legislature has yet to allocate money for the system.

In 1969, a US Senate version of the tax reform bill earmarked the annual excise tax paid by foundations -- 1 or 2 percent of annual income -- to fund IRS oversight of the sector. But that provision was never enacted. So the tax, which eats up $500 million in charitable funds annually, goes directly to the US Treasury, while the IRS's tax-exempt division has an annual budget of $72 million. That, said Josephson, is "an outrage."

Given the complexity and enormous size of many foundation tax returns, the lack of automation creates huge barriers to enforcement. Some returns reviewed by the Globe ran to hundreds of pages -- the return of one $5 million foundation in Salt Lake City was 823 pages -- with critical attachments tucked in remote places. Without electronic filing and automated searching techniques, finding key information in a single return can literally take hours. Meanwhile, filing errors are so common that 25 percent of all nonprofit returns are missing data or filled out incorrectly, according to the IRS.

In many states, foundations file their annual returns to the secretary of state's office, and no one ever looks at the forms again. In Oklahoma, for example, where the Globe found that the $900 million Samuel Roberts Noble Foundation purchased a $5.7 million jet that is often used improperly, no state official has taken action. A spokesman for Oklahoma's attorney general, Drew Edmondson, said he had no idea who regulated foundations in his state: "If somebody does, it's not our office."

Also in Oklahoma, the $28 million Kerr Foundation, established to fund local social and cultural causes, spends twice as much on travel, administration, and perks, such as a $44,000 Jaguar, as it gives in grants. The foundation has been audited more than once by the IRS but has been cleared each time.

Paula Ross, a spokeswoman for the Oklahoma Tax Commission, said, "We just receive the income tax return. We have no regulatory oversight."

Marjorie Welch, a commission lawyer, said, "I do not see any designated regulatory body [in Oklahoma]. . . . If there's some sort of crime, our [district attorney] would look at it."

Similarly, in Florida, where the Globe revealed serious problems at two foundations -- including a $36 million private jet bought by the $444 million Arthur S. DeMoss Foundation, the mission of which is to fund Christian organizations -- the attorney general's office said it would investigate a foundation only if it received local complaints.

Even states that take an active role in regulating charities tend to let transgressions by foundations slide -- sometimes for years.

In the mid-1990s in California, for instance, the attorney general's office sent out yearly letters to Franklin Holding Corp., pointing out several glaring problems with the foundation's tax return, including excessive pay and an improper $350,000 loan to the CEO, both of which were detailed in the Spotlight series. The letters went into the state's public files, but regulators apparently never followed up.

In 1999, California stopped issuing the type of red-flag letters sent to Franklin, according to Tom Dresslar, a spokesman for California's attorney general, Bill Lockyer. The letters had been aimed at helping charities avoid potential audit problems but, he said, "they really weren't that helpful to our enforcement." That was due in part to insufficient resources to follow up on them, he said.

Following the Globe report, the attorney general is now reviewing Franklin's spending, including a $3.5 million payment in 1998 to Franklin's chief executive, Gregory Monardo. Monardo has not returned repeated phone calls seeking comment.

"The bottom line," said Dresslar, "is that these foundations are not supposed to be about profit motive. They're not about funding lifestyles of the rich and famous. They're about helping people in need and supporting worthy programs."

In Minnesota, active probate courts have played a significant role in making the state one of the most successful in policing foundations. Historically, Minnesota has required trustees to file a court petition every three to five years listing foundation expenses, such as trustee pay, fees paid to lawyers, and other spending. Not only does a probate judge have to approve those expenses, but the attorney general's office routinely reviews the filings. That gives Minnesota regulators a window into abuses that other states lack.

The court petitions provide vital leads for the charities division, according to Lori Swanson, head of charities oversight in Minnesota's attorney general's office. The documents often highlight lavish trustee pay and conflicts that are not apparent in the cumbersome federal tax filings.

"We take it very seriously," Swanson said. "If charitable assets are being diverted or squandered, that doesn't serve anybody's

interests -- other than those who are taking the assets for themselves." The charities division sees its role not only as guarding charitable assets, Swanson said, but also as protecting donors -- many of them long dead -- who left their wealth for good works.

"There definitely are problems in the private foundation area," she said, because so often "the person whose money it is, is really no longer there."

Sacha Pfeiffer can be reached at

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