By David Ingram and Matt Spetalnick
WASHINGTON (Reuters) - U.S. Attorney General Eric Holder said on Tuesday he had ordered the FBI to open a criminal probe in a growing scandal over the Internal Revenue Service's targeting of conservative political groups for extra tax scrutiny.
Holder's announcement came about four hours before an inspector general's report on the IRS portrayed the tax agency as plagued by disarray and "insufficient oversight" during its struggles to review the cases of hundreds of advocacy groups that claimed they should be tax exempt.
The audit, which drew some backlash from IRS officials, also underscored what the agency had acknowledged last Friday: that the IRS had used "inappropriate criteria" for evaluating tax-exempt groups, in part by singling out scores of conservative Tea Party and "Patriot" organizations for increased scrutiny.
The report by the Treasury Inspector General for Tax Administration sharply criticized the way the IRS had screened the conservative groups, citing poor management and processing delays. The report suggested that such practices could damage public confidence in the agency.
The criteria used to target the conservative groups "gives the appearance that the IRS is not impartial in conducting its mission," the report said. However, the report stopped short of saying the IRS actions had been politically motivated.
For President Barack Obama - who late on Tuesday said the report showed that the IRS had failed to apply the law fairly in dealing with conservative groups - the revelations have added to a sense of a White House under siege.
Republicans continue to bash the Obama administration's handling of the attack last year on the U.S. mission in Benghazi, Libya, that killed a U.S. ambassador and three other Americans. And on Monday, Obama's Justice Department came under bipartisan fire for seizing phone records of journalists from the Associated Press as part of a wide-ranging criminal probe into intelligence leaks.
In Washington on Tuesday, the IRS case appeared to have the most potency, as lawmakers and administration officials alike described the symbolic and legal importance of having a non-partisan tax agency that Americans can trust.
For the IRS and the U.S. government, the stakes are particularly high in the scandal because the tax agency is playing an increasingly significant role not only in vetting the tax status of non-profit groups that dabble in politics, but also in enforcing parts of Obama's ongoing overhaul of the nation's healthcare system.
Some of the IRS's conservative critics, including Republican Senator Ted Cruz, have said the current scandal is a sign that the agency shouldn't be trusted to enforce a vast array of tax regulations related to healthcare.
The IRS's embattled acting commissioner, Steven Miller, met privately with lawmakers on Capitol Hill, apparently seeking to calm the political uproar, even as some Republicans called for his resignation.
The IRS said on Monday that Miller, then the IRS deputy commissioner, was first informed in early May 2012 that some groups seeking tax-exempt status had been "improperly identified by name" and subjected to extra scrutiny.
Lawmakers say that neither Miller nor his predecessor, Douglas Shulman, ever made them aware of the targeting.
Senator Orrin Hatch, the top Republican on the tax-writing Finance Committee, said that Miller - who spent more than two decades working his way up through the IRS bureaucracy and was named acting chief six months ago - should step down.
"He basically misled me," Hatch told reporters. "I really think it is time for him to leave."
'HEADS NEED TO ROLL'
Hatch was part of a growing Republican chorus on Capitol Hill calling for the resignations of Miller and Lois Lerner, head of the IRS tax-exempt organizations office. Lerner apologized on behalf of the agency when she revealed the targeting of conservative groups last week.
Conservative groups, particularly those that have sprung up in recent years to promote limited government and lower taxes, have long complained about mistreatment by the IRS.
On Tuesday, Miller met with Senator Max Baucus, the Democratic chairman of the Finance Committee who has promised that his panel will conduct its own investigation of the IRS case. Miller later declined to answer reporters' questions.
Senate Republican leader Mitch McConnell urged Obama to make all of those who knew about IRS misconduct available for questioning, and said there should be "no more stonewalling."
"Heads need to roll today," said Republican Representative Vern Buchanan, a member of the tax-writing House Ways and Means Committee, which oversees the IRS and is scheduled to hold a hearing on the scandal on Friday.
It's unclear precisely what charges a criminal probe of the IRS could yield.
Analysts said that a federal criminal prosecution of IRS employees for allegedly violating a taxpayer's speech rights - by delaying or rejecting a conservative group's legitimate claim to tax-exempt status, for example - could be unprecedented and that the offense would need to be egregious.
Holder said on Monday that the FBI "is coordinating with the Justice Department to see if any laws were broken."
He said that the actions disclosed so far "were, I think as everyone can agree, if not criminal, they were certainly outrageous and unacceptable. But we are examining the facts to see if there were criminal violations."
Despite efforts by some conservative commentators to cast the IRS troubles as something akin to the Watergate scandal of the 1970s - or to former President Richard Nixon's use of the IRS to target his political enemies - there was no sign of White House involvement.
Obama spokesman Jay Carney said the results of independent investigations must be known "before we can jump to conclusions about what happened, whether there was a deliberate targeting of groups inappropriately and, if that's the case, what action should be taken."
THREE YEARS OF TARGETING
The targeting of conservative groups began in 2010, shortly after the emergence of the conservative Tea Party movement. The movement helped Republicans gain control of the U.S. House in the 2010 elections.
Hundreds of Tea Party-inspired groups have formed in recent years, and the IRS has struggled to handle campaign finance issues dealing with such politically active organizations seeking tax-exempt status. Such groups generally can be tax-exempt as long as they do not directly support particular political candidates.
Higher-level IRS officials took part in discussions as far back as August 2011 about targeting by lower-level tax agents of Tea Party and other conservative groups, according to documents reviewed by Reuters on Monday.
The documents show the offices of the IRS's chief counsel and deputy commissioner for services and enforcement communicated about the targeting with lower-level officials on August 4, 2011, and March 8, 2012, respectively.
The communications occurred weeks and months before Shulman, then the commissioner of the IRS, told congressional panels in late March 2012 that no groups were being targeted for extra scrutiny by the tax agency.
The IRS has been dragged reluctantly into partisan politics at a time when it is also under increasing pressure to make rulings on campaign finance issues and matters related to implementation of Obama's 2010 healthcare overhaul.
The agency must impose an excise tax on large employers if they fail to meet certain minimum healthcare coverage requirements for employees. In addition, the IRS must provide tax credits to low- and middle-income taxpayers who seek healthcare coverage on one of the new state-based insurance exchanges.
Timothy Jost, a specialist on the healthcare overhaul who teaches law at Washington and Lee University, said the controversy has no real bearing on implementation of Obama's healthcare laws, aside from politics.
"I just don't see a connection, other than that I'm sure there will be efforts to make one," Jost said.
(Additional reporting by Patrick Temple-West, Thomas Ferraro, Richard Cown, Kim Dixon, Kevin Drawbaugh, Susan Heavey and Laura MacInnis; Writing by Matt Spetalnick; Editing by David Lindsey and Eric Beech)