The IRS’ Tax Exempt and Governmental Entities Division (TE/GE) is preparing for more audits and examinations of tax-exempt organizations by hiring 155 new employees, 100 of which will perform examinations.  These examinations are expected to begin as the 2008 Form 990 data is evaluated. On top of this, the TE/GE expects to conduct approximately 500 random employment tax compliance audits.

A Passing Glance or a Full-Body Cavity Search?

A compliance check is a review to determine whether an organization is maintaining adequate record keeping and information reporting requirements, unlike an examination, the purpose of which is to determine a tax liability for a particular period. A TE/GE specialist conducts a compliance check through phone calls or letters, focusing on determining if specific reporting requirements have been met and whether the organization’s activities are consistent with its exempt purpose. You have the option of declining participation in a compliance check, but refusing can lead to a formal examination.

An examination goes beyond verification of the numbers into reviewing the organization’s activities to ensure consistency with their exempt purpose. Initially, management will be required to provide items such as bylaws and organizational documents, printed materials describing the organization’s activities, board and committee meeting minutes, records of assets, liabilities, receipts and disbursements, and employment tax and other returns.

Two types of examinations are performed – correspondence examinations and field examinations. Correspondence examinations are much less invasive, focusing on perhaps only a few items on the return, and are conducted via letters or over the phone. However, keep in mind, circumstances can lead to a correspondence exam converting to a field examination.  A field examination is conducted at the organization’s office. The type and experience of the field agent assigned to the examination varies given the size and complexity of the organization.

Why me?

Organizations can be selected for an audit due to several reasons – random selection; compliance check responses that may point to the need for a more in-depth investigation; Form 990 disclosures and responses; an evidenced whistle blower complaint; bad media publicity; or other complaints filed with the IRS, primarily over issues related to abuses of tax-exempt status.

As you probably have guessed, the IRS’ scrutiny over Form 990 can play a big part in auditee selection – e.g. poor governance practices, indicators of potential for unrelated business income, lax controls over executive compensation determination and certain related party transactions (private inurement).

Get Your Ducks in a Row

It’s critical that organizations be prepared. Having practices in place and sufficient documentation ahead of time means less stress and effort upon being selected. Here are a few suggestions to consider:

  • All positions taken on the Form 990 should be supported and documented.

 

  • Ensure minutes are taken for all board and committee meetings.

 

  • Independent contractor classifications should be documented and defensible.

 

  • Adopt written policies over whistle blower, conflict of interest, document retention and destruction, and executive compensation and evaluation policies.

 

The IRS has developed for their agents Form 14114, Governance Check Sheet (http://www.irs.gov/pub/irs-tege/governance_check_sheet.pdf), for the purpose of gathering information over your governance practices and internal controls. Make sure your “yes” means “yes” on those questions in Part VI of the Form 990, and that you have the written policies in place.

Manage the Examination, not the Agent

It’s important to be mindful of the manner in which you deal with IRS officials. This may help avoid a few headaches.  Here are just a few things to keep in mind:

  • Be courteous and respectful to the agent.

 

  • Provide prompt responses to IRS officials.  Don’t make them wait. Responses should be well thought out and thorough.

 

  • Make things easier for the agent when providing documents – provide them in the same order as requested and references to documents to allow for an easier trail, and, if necessary, explanations as to the relevance of the document. Assign a designated employee (or an outside professional) to be the go-to person for the agent. All document requests should be handled through this person. Consider having your professionals review documents before providing them to the IRS.

 

  • Provide only information requested. Don’t volunteer any more information. This may slow down the process by adding more information requests.

 

  • Prepare a list of all documents and information provided to the agent. Employees interviewed should document questions asked and responses provided.

 

Since your normal day-to-day activities can’t take a back seat (still have to make payroll?), adding an IRS examination can be quite disruptive. Be prepared and follow these suggestions to make for a less painful and intrusive examination.

Adapted from and article titled, Is an IRS Audit in Your Future?, The PPC Nonprofit Update, July 2010, Volume 17, No. 7.

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