You’re probably already aware that the IRS has increased its scrutiny of nonprofits in recent years. In fact, the agency audited 8,000 nonprofits (out of 1.6 million tax-exempt groups) in 2014. So if your organization is chosen, you’re in good company. Here’s what to expect.
What is an audit?
An audit begins with the initial contact from the IRS and continues until audit findings are discussed in a closing conference and a closing letter is issued. An officer of your nonprofit, your representative (such as a CPA) and the agent will discuss the agent’s conclusions at the closing conference. Both the conference and the letter will explain your appeal rights.
Audits can cover many areas. For example, the IRS may want to learn whether your organization filed all returns and forms as required by law and whether they’re complete and accurate. Or it might delve into whether your activities were consistent with your tax-exempt purpose, or whether any tax liabilities such as employment taxes or unrelated business income tax were properly paid.
During the audit the IRS will request various records. These include Form 990 returns, employment tax returns, Form 1099 informational tax returns, governing documents, board minutes and internal financial records. The request will detail the time period that will be covered in the audit, but three years is typical.
Field vs. correspondence
If your initial contact letter schedules an agent to visit your premises, the IRS is conducting a field audit or in-person examination. Field audits are performed at your location, your representative’s office or an area IRS office.
Field audits fall into two categories:
- General program exam, which typically is conducted by a single IRS agent, or
- Team Examination Program audit, which focuses on large, complex organizations and may involve a team of examiners.
If your initial IRS letter asks you to deliver documents to an IRS office by mail, the agency is conducting an office or correspondence audit. An agent generally will perform the audit via letters and phone calls to your officers or representative. Although a correspondence audit may seem less stressful, it can expand to become a field audit if the issues grow more complex or your nonprofit doesn’t respond. Both correspondence and field audits can grow in scope to include prior and subsequent tax years.
The IRS might also contact you to announce a compliance check. This isn’t an audit; it’s a determination of whether your organization is adhering to record-keeping and information reporting requirements. Compliance checks often relate to a specific issue, such as Form 990 disclosures and whether your nonprofit’s activities are consistent with its tax-exempt purpose.
Compliance checks are simpler and less burdensome than audits and don’t directly determine a tax liability for any particular period. They can, however, lead to an audit — particularly if you don’t cooperate.
Nonprofits are chosen for audits for several reasons. The igniting spark might be an IRS examination initiative or project, or the agency might receive complaints about potential noncompliance at your organization.
Other reasons include:
- Risk modeling from the nonprofit’s Form 990, including an evaluation of governance policies in place,
- The incidence of fraud, as reported on the organization’s Form 990,
- Related examinations of other taxpayers, such as business partners, clients or vendors, whose returns were selected for audit,
- Document matching — when payer records, such as Forms W-2 or 1099, don’t match the information you’ve reported, and
- Certain claims for refunds or requests for abatements.
In general, Form 990 plays a strong role in the selection process.
Rely on an expert
Receiving an audit letter can be scary. But your nonprofit doesn’t need to go through the audit process alone. Contact your CPA as soon as possible, and this expert can help you assemble the necessary documentation and represent you at meetings with IRS agents.