By Kim Dixon and Kevin Drawbaugh
WASHINGTON (Reuters) - A U.S. government watchdog faulted the Internal Revenue Service for targeting conservative groups on Tuesday, criticizing senior IRS leaders for poor management of a policy that spun out of control and compromised the tax agency's political impartiality.
As the FBI mounted a criminal investigation of the matter, the U.S. Treasury Inspector General for Tax Administration (TIGTA) reported that the IRS used "inappropriate criteria" when it singled out groups for extra scrutiny based on their names.
President Barack Obama called the findings "intolerable" and "inexcusable." He said he would direct Treasury Secretary Jack Lew to hold those responsible for the agency's actions accountable.
The report cited long delays, excessive requests for donor information and general dysfunction in handling cases.
Beginning in 2010, IRS agents in a Cincinnati field office screened thousands of non-profit groups' applications for tax-exempt status based on the presence of key words in their names such as "Tea Party" and "Patriot."
This practice was carried out in Cincinnati and other locations by agents responsible for deciding if groups deserved to get tax-exempt status, based on limits imposed on their political activities by Section 501(c)(4) of the U.S. tax code.
The IRS responded to the TIGTA report in a short statement late on Tuesday, conceding that "inappropriate shortcuts were used" to screen groups for political activity.
"There was no intent to hide this issue, but rather we waited until TIGTA completed their fact finding, made recommendations, and we reviewed their findings," the IRS said.
In targeting only conservative groups for closer scrutiny, IRS agents gave "the appearance that the IRS is not impartial in conducting its mission," the TIGTA report said.
Lois Lerner, a senior IRS official, on Friday apologized for the targeting at a legal conference in Washington. Her remarks triggered a storm of controversy, embarrassing the IRS and giving Republicans a new line of attack on the Obama administration.
Top IRS officials told investigators no one outside the agency had a hand in developing the targeting criteria.
The TIGTA report accused no officials by name. Some congressional Republicans have called for Lerner and acting IRS Commissioner Steven Miller to resign.
"I don't see any indication that this was some sort of Nixonian dirty trick, but there must be some accountability," said Ofer Lion, a lawyer at the firm of Hunton & Williams. He represents tax-exempt organizations and reviewed the report.
The TIGTA report points to dysfunction at the agency that employs more than 90,000 people, including a lack of management oversight and political tone deafness by lower-level employees.
IRS agents, who said they used the conservative terms as a shorthand to sift through a flood of applications, "did not consider the public perception of using politically sensitive criteria when identifying these cases," the report said.
POOR MANAGEMENT CITED
The report also criticized the IRS for inept management.
For example, when Lerner was briefed on the screening in June 2011, she immediately called for changes. This resulted in the dropping of key words such as "Tea Party," the report said.
But by January 2012, a team of lower-level staffers had changed the screening criteria back to focus on policy positions "without executive approval," the report said.
The criteria was changed back again in May 2012 to delete "Tea Party" and other conservative references.
"Confusion" and "miscommunication" are cited in descriptions of agency officials attempting to coordinate their work.
For instance, there was a 13-month delay from October 2010 to November 2011 when a team of specialists waited for guidance from another unit because of a miscommunication about the status of 40 cases, the report said.
Overall, during the time period studied, the watchdog found it took 574 calendar days to process applications flagged as potential political cases, compared with 238 days for other applications for tax-exempt status, the report said.
In written responses to the inspector general, the IRS pushed back against two TIGTA recommendations. One urged better IRS documentation to justify how applications are chosen for extra scrutiny. Another called for development of guidance for specialists on how to process requests for tax-exempt status.
The agency said such changes would only cause further delays and proposed alternative actions. TIGTA said those options would not fix the problems, however.
Treasury Secretary Lew said in a statement that there would be accountability and that the IRS should implement the recommendations "without delay."
"Like the American people, I have zero tolerance for any action that could undermine public confidence in the impartial and non-partisan administration of the tax code," he said.
In addition to the targeting of selected groups, IRS agents missed some applications with "significant political campaign intervention," according to TIGTA.
Campaign finance reformers have been pushing for the IRS to probe big 501(c)(4) groups such as ones operated by American Crossroads, co-founded by Republican strategist Karl Rove, and Priorities USA, started by top aides to Obama.
The TIGTA report found from a sample of about 2,500 applications that 6 percent should have gotten extra attention due to red flags suggesting inappropriate political activity.
One of the recommendations the IRS did agree with was a call for the IRS and Treasury to issue guidance on how to measure the "primary activity" of 501(c)(4) "social welfare" organizations.
Vagueness in the definition of the primary purpose of these groups has left open the potential for abuse and been a burden to the IRS, campaign finance reformers have said.
(Reporting by Kim Dixon and Kevin Drawbaugh; Additional reporting by Richard Cowan and Patrick Temple-West; Editing by Lisa Shumaker and Eric Beech)