If you ask management and board members of nonprofit organizations to identify the issues keeping them up at night, an IRS audit/examination probably isn’t on their top ten list. Daily operational struggles that nonprofit organizations face include managing their donor base, keeping key employees happy, engaging active board members, and identifying the threats to their primary mission. Therefore, it is easy to overlook risks that you can’t immediately see on the horizon. However, if they weigh the potential consequences of an IRS examination, organizations should be prepared for the possibility of an examination and be confident that they will succeed if one occurs.
In its Tax Exempt and Government Entities FY 2017 Work Plan, the IRS stated that it had embarked on a compliance strategy to ensure organizations enjoying tax-exempt status complied with the requirements for exemption. Their selection process was “data-driven” to identify existing and emerging high-risk areas of noncompliance. During the 9 months ended June 30, 2016, the IRS completed 4,984 examinations of nonprofit organizations. Those examinations resulted in revocations of tax-exempt status for 43 organizations.
The most common reason nonprofit organizations are examined by the IRS is due to the information provided on its annual information return (Form 990 series). The IRS lists the following as examples of why returns are selected for review:
- Information on a filed return (Forms 990-EZ, 990, 990-T, or 990-PF) appears to be inconsistent or incomplete.
- IRS receives a complaint (referral) from the public or a federal or state regulatory agency about potential noncompliance by an exempt organization.
- The Exempt Organizations Division participates in an IRS-wide examination initiative, such as initiatives generated by the National Research Program.
- Related returns may be selected for audit when they involve issues or transactions with other taxpayers, such as business partners or investors.
- One of the IRS document matching programs identifies a discrepancy between information reported by a payor and payee, such as on Forms 1099 or W-2.
- A claim for refund or request for abatement requires further review.
However, the ultimate “formula” for how the IRS assesses risk in selecting organizations for examination remains a secret. The best chance to avoid an audit and/or successfully survive an audit is to demonstrate continued compliance with IRS regulations. Organizations must have more than just an awareness of the issues the IRS considers to be high-risk areas of noncompliance; they must also understand the technical issues needed to demonstrate compliance. The following are generally recognized as the high-risk areas:
- Private Benefit and Inurement
- Political Campaign and Lobbying Activities
- Tax Gaps including employment tax and unrelated business income tax
- International activities including oversight on funds spent outside of the U.S.
The IRS provides resources for organizations with questions about the items listed above. And needless to say, if you do receive a notice from the IRS regarding a potential examination of your nonprofit organization, reach out to a CPA to help you navigate the process.
