2017 Nonprofit Industry Update Seminar Recap Part 3 of 3: Form 990: Understanding and Avoiding IRS Examination TriggersBy Robert Lyons | January 29, 2018
When it comes to a nonprofit organization getting in potential audit trouble with the IRS, it will most likely start with IRS Form 990. Officially known as the “Return of Organization Exempt from Income Tax”, this form provides the public (and the IRS) with a nonprofit organization’s financial information.
An IRS nonprofit examination (or audit) can involve reviews of records, interviews and other time-consuming requests that can be a drain on productivity and resources – and it all comes with the pressure of knowing that your tax-exempt status may be at stake.
It’s important that your organization be aware of the issues your Form 990 may raise that fall into what the IRS considers “high-risk areas of noncompliance” with federal tax requirements. You also need to understand what the technical requirements are for demonstrating your compliance.
IRS Form 990 is also used by government agencies to prevent organizations from abusing their tax-exempt status. In addition to Form 990, tax-exempt organizations are also subject to a variety of disclosure and compliance requirements through various schedules attached to Form 990.
Form 990 was at the center of attention at our 2017 Nonprofit Industry Update Seminar in New York City – in the context of understanding and avoiding IRS examination triggers.
Form 990 was first used for the tax year ending in 1941. In June 2007, the IRS released a new Form 990 requiring significant disclosures on corporate governance and boards of directors. Charity Navigator uses IRS Form 990 to rate charities and offers a digitized Form 990 decoder, a free and open-sourced software dataset and tools to analyze Form 990 filings. These filings are required, by law, to be made available to the public.
Engaged attendee takes notes during Form 990: Understanding and Avoiding IRS Examination Triggers session at Marks Paneth’s 2017 Nonprofit Industry Update Seminar.
The Risk of Mission Drift
Fluctuation in mission – or “mission drift” – is a common examination trigger.
Mission drift is a term used when an organization finds that it has moved – whether intentionally or unintentionally – away from its original purpose. Your nonprofit’s mission statement should be reviewed annually to ensure it remains accurate and reflects exactly what your organization is doing. If there are any changes to your nonprofit's services or programs, Questions 2 and 3 under Part III of the Form 990 should reflect that.
An organization is free to update its mission statement. The mission may evolve as the organization becomes more settled and experienced or the needs of its target change. If an organization intends to take its mission in a new direction, this needs to be discussed and ratified by the board in accordance with the nonprofit’s organizing documents – the Articles of Incorporation and bylaws. All discussions, research and studies about the change should be undertaken and the organization must notify the IRS on its 990 filing.
However, if mission drift occurs and it’s unintentional, it may have a negative impact on the organization and its exempt status. If confusion develops about what your organization exists to do and for whom and how, resources can end up being wasted on different factions working in different and conflicting areas.
As Mr. Lyons observed, “Be sure to make a full copy of Form 990 available to the Board of Directors. It’s like making board meeting notes available – if you don’t do it, you can get in trouble with the IRS. This is not the place to skimp, especially when it comes to dealing with the IRS.”
How are Nonprofit IRS Examinations Selected?
How is the IRS going to decide whether to audit your organization? Ms. McKenna identified the following:
- “Squeal Letter” and Referrals
- As the result of an area of study by the IRS – such as programs or projects
- From IRS data analytics on red-flag “triggers”
Steps in an IRS Examination
There are several ways that the IRS goes about conducting an examination, according to Ms. Kenna:
- You will always be notified in writing
- You may receive a “soft contact” – here, the IRS may use a third-party credit reporting company to help them confirm your identity and ensure that your tax information is coming from and going to you only. The credit reporting company uses information from your credit report to generate questions for you to answer.
- Delivery of IRA “Pub 1” or Publication 1 “Your Rights as a Taxpayer”
- Scheduling and Information Document Request (IDR)
- An IRS Revenue Agent will schedule a call or meeting – they are responsible for conducting tax audits of businesses.
- Closing conference
- Final Letter showing the results of the examination
- Appeal Rights
Ms. McKenna observed, “The IRS does not call anyone to start the examination process. It is always in writing, along with your rights and an IDR request. Ensure that your organization is still operating in compliance for which it was granted a tax-exemption.” She added “Make sure that when you file Form 990, it includes all the necessary schedules.”
What Triggers an Examination?
A trigger is either an activity, or something reported and/or omitted on Form 990 that would increase the chance of being selected for an IRS examination. Common triggers include:
- Missing schedules and incomplete returns.
- Unrelated business income (UBI) issues – Form 990 reports UBI or a mortgage and rental income, but the entity does not file a form 990-T for Unrelated Business Income.
- The Form 990 reports a significant diversion of assets (indicating embezzlement or theft) indicated by answering “Yes” on Form 990 Part VI, line 5.
- The Form 990 reports political campaign activity (schedule C) which is definitely not appropriate for a 501(c)(3)
- Excess benefit transactions with a disqualified person (such as unreasonable officer compensation)
- Reports fees for non-employee services (Part IX lines 11a through 11g) but does not report that any 1099s were issued (part V, line 1a) or
- Reports that outstanding amount of loans to, and other receivables from, disqualified persons do not decrease from the prior year / prior Form 990 (part X, lines 5-6)
Ms. McKenna’s closing remarks: “Everything the nonprofit does has to tie back to its primary mission – otherwise problems can arise” and “Don’t forget about New York State – for example if a nonprofit makes a loan to a disqualified person (like a board member), you will receive a letter from the New York State Department of Taxation and Finance.”
For more information on our capabilities serving tax-exempt organizations, please contact:
Tax Director, Nonprofit, Government & Healthcare Group
212.201.3153 | firstname.lastname@example.org
Tax Director, Nonprofit, Government & Healthcare Group
212.212.1736 | email@example.com
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This material has been prepared for general informational and educational purposes only and is not intended, and should not be relied upon, as accounting, tax or other professional advice. Please refer to your advisors for specific advice.
About Robert Lyons
Robert (Rob) Lyons, CPA, MST, is a Tax Director, Exempt Organizations in the Nonprofit, Government & Healthcare Group at Marks Paneth LLP. Mr. Lyons brings to this role the skills he has developed during more than 30 years of providing tax and consulting services to his clients in the nonprofit, higher education, and public sector industries. His experience includes handling substantial exempt organization tax issues. Mr. Lyons has testified in front of the House and Ways Committee in... READ MORE +
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