“Lifting the Veil” on the IRS Exempt Organizations Office

Posted by Jonathan D. Moll, CPA

I often discuss with my nonprofit clients the importance of knowing what the IRS is thinking about. Most of my clients agree with me. A few of my dissenting clients disagree based on the technicality that they do not believe “thought” is a process applied at the IRS. Nevertheless, keeping your finger on the pulse of emerging issues is critical in managing compliance with exempt organization regulations. For this reason I feel that the recent remarks of the IRS Director of Exempt Organizations to be quite interesting.

On April 19th, IRS Director of Exempt Organizations, Lois Lerner, spoke at Georgetown University Law School in what was stated as an attempt to “lift the veil on the Exempt Organizations office” and to “share some of the things that (they’re) mulling over.” The full transcript of the prepared remarks is available on the IRS’ website (EO Director Speaks at Georgetown Law CLE). I highly recommend it as an interesting read. Among the topics discussed in the remarks are a project the IRS is launching regarding significant diversions of assets and the risk of identity theft as a result of including social security numbers on Form 990 filings. However, I found the most insightful portion of the remarks to be the section on governance.

The remarks on governance are based on a fundamental philosophy of the IRS that there is a direct relationship between exempt organizations adopting and following good governance practices and their compliance with tax code. Part VI of the revised Form 990 is touted as the “crown jewel” of their governance efforts. However, the remarks identify a pushback due to a perceived lack of authority for the IRS to concern itself with corporate governance as well as a lack of statistical data correlating good governance with tax compliance. As a result, the IRS conducted its own study as part of its examination process. The preliminary results identified a significant correlation between certain governance practices and tax compliance.

In the study, the following governance practices were directly associated with organizations more likely to be compliant:

  • A written mission statement
  • Always use comparability data when making compensation decisions
  • Procedures in place for proper use of charitable assets
  • 990 reviewed by entire board before it is filed

Also in the study, the following governance practice was directly associated with organizations less likely to be compliant:

  • Control concentrated with one individual, or in a small selected group of individuals

Although the aforementioned statistics are interesting, the most fascinating information in the remarks is the following statement by Director Lerner:

“Organizations have been filing the redesigned 990 for several years now and that has provided us with a wealth of information on these organizations. We have used this information to develop risk models to assess the likelihood of noncompliance by organizations, allowing more effective use of our examination resources.”

Although we all expected it, this has been the most definitive statement that I have heard as to why the IRS redesigned the Form 990. The next time you hear your advisor state that the policies and practices identified on Part VI of the Form 990 are “best practices” and not required by the IRS, think twice. The effort to implement these practices might be worth the reduced risk of an examination.

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