June 22 (Bloomberg) -- Abusive tax shelters increasingly involve charities and other nonprofit organizations, including foundations, housing programs, and credit-counseling services, witnesses told a Senate panel.

Others profit from the tax-free status of charities by establishing foundations to pay for family vacations and other private expenses, exploiting rules governing the donation of cars and boats, and abusing rules involving tax-free life insurance, witnesses said.

``While the vast majority of tax-exempt entities follow the law, there are increasing indications of failures in governance and outright abuse within this sector,'' Commissioner of Internal Revenue Mark Everson told the Senate Finance Committee.

Senators held the hearing before drafting legislation to stem the abuses that may be used to trim budget deficits or balance new tax cuts.

Everson said the IRS has stepped up enforcement of laws governing the nation's 3 million tax-exempt organizations, a third of which are public charities. Americans deducted $136.5 billion in charitable donations from their income in 2002, according to the most recent IRS data.

Everson said of the 31 specific tax shelter transactions the IRS has identified as abusive, about half have the potential to involve tax-exempt organizations such as charities, Indian tribes, and churches.

Exploiting Tax Status

He said the IRS recently shut down a transaction called ``Foreign Currency Options Strategy'' that used a charity to generate a $500,000 capital gain that was transferred back to the taxpayer minus a $50,000 accommodation fee.

Jay D. Adkisson, director of private client services at Select Portfolio Management in Aliso Viejo, California, said accountants and lawyers who marketed abusive tax shelters in the 1990s are revamping their products to exploit the tax-free status of charities.

``As moths to the flame, those whose livelihoods consist of torturing the tax code for the economic benefit of their clients and themselves are drawn to charities not because of any philanthropic reasons, but solely, only, and exclusively because of the technical tax exemption for such organizations,'' said Adkisson, who runs a Web site that debunks tax shelters.

William Josephson, New York's assistant attorney general in charge of charities, told the committee as many as 10 percent of tax-exempt organizations reviewed by his office ``raise concerns'' because of their activities.

Changes Urged

He urged Congress to revise the tax forms non-profits must make public to make them more transparent, require a periodic review of organizations' tax-exempt status by the IRS, and allow the IRS and state regulators to share information.

Other witnesses told how taxpayers are setting up charities with the only purposes of enriching themselves.

``In addition to well-meaning charities being led astray, we also have a growing number of individuals who knowingly set up a charity to evade taxes,'' Finance Committee Chairman Charles Grassley said.

One anonymous witnesses, testifying behind screens and with his voice electronically distorted, told how used car dealers and auto auctioneers profit from cars donated to charity by picking up cars donated to charity, paying a flat fee as low as $30 to the benefiting organization, and selling the vehicle for as much as $3,500, with the middlemen pocketing the difference.

Everson said the IRS by the end of the summer will audit half of all credit counseling agencies, some of which are set up by for-profit creditors as a way to sell debt-service packages.

The tax collector is also auditing 100 people who've set up a ``donor advised'' mutual fund, which allows them to use tax- deductible contributions for personal expenses, he said.

To contact the reporter on this story: Ryan J. Donmoyer in Washington at rdonmoyer@bloomberg.net

Last Updated: June 22, 2004 16:38 EDT