‘Shadow’ nonprofits creative, but not illegal, sources say

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Corporations are getting creative in finding ways to receive millions of dollars in federal earmarks, but their creativity is not illegal, tax experts say.

The House Appropriations Committee banned earmarks in March, but the New York Times reported on Tuesday that for-profit corporations are creating “shadow” nonprofit entities under the same leadership to continue receiving federal money.

“Is this practice illegal? Not on its face,” said Pete Sepp, executive vice president of the National Taxpayers Union. “Could individual instances raise legal questions? Yes.”

The IRS has very little power to regulate how the money is being spent, a review of federal law shows. Some nonprofits are a product of state law and therefore are not directly regulated by the IRS, although they are required to submit income forms like other corporations, according to a source inside the IRS.

“What offends me is that these for-profit corporations can form a nonprofit entity, and they would never have to go to the IRS,” said a tax lawyer at a D.C law firm.

The loopholes in the ban on earmarks reveal the difficulty in limiting the amount of money that politicians can send back to their home states, a practice mastered by the late Sen. Robert Byrd and the late Rep. John Murtha.

Indeed, current lawmakers are helping for-profits beat the system.

The Times reported that Rep. Marcy Kaptur (D-Ohio) has asked for over $10 million in earmarks for a nonprofit entity run by the same people running a small Ohio defense contractor. Kaptur has come under fire since the report surfaced.

Groups that supported the House’s decision to swear off earmarks to for-profits now find themselves wishing that the same applied to nonprofits.

“We warned at the time that games like these could become commonplace, which was why the total ban proposed by Rep. Jeff Flake (R-Ariz.) was probably the best reform to convince a skeptical public that earmarkers had changed their ways,” Sepp said.

The ban was pushed by House Democrats who hoped to show that they were serious about cutting spending in a tough midterm election year. Not to be outdone, House Republicans tossed around the idea of banning earmarks of all kinds.

More recently, the bipartisan Earmark Transparency Act seemed to be moving steadily through committee until Sen. Carl Levin, (D-Mich.) blocked its exit from the Senate Committee on Homeland Security and Government Affairs.

Nonprofits by definition have no shareholders to whom they distribute profit and are often run by a board of governors.

The inspectors general of each federal agency are tapped with auditing 5 percent of the earmarks going to nonprofits, but no reports have been issued since March on the issue.