Part 1 of this series, discussed Form 990 best practices. If you missed that article or would like to refresh your memory, click on the following link; Know Your Form 990: Filing a Fine Form.
The reality of any IRS filing is that even if you File a Fine Form 990, you may find yourself under audit by the IRS. As with individual tax filings, the process by which the IRS determines which returns to audit is not entirely random. The total number of audits is small in proportion to the number of forms filed. However, there are several items or triggers which may make your Form 990 more likely to be selected for audit.
The purpose of this post is to alert you as to the triggers so that you can make educated business decisions. Some are reasonable items done for reasonable business or operational purposes. This post does not suggest that you should avoid the triggers at all costs, however, be mindful of them and prepare. If you are considering a transaction that may trip one of these triggers, include the cost of any additional compliance in the cost/benefit analysis on the transaction. Factor the additional audit risk into your risk management plan.
Several of these items deal with Board-level issues, so educate your Board and institute good record keeping practices via Board minutes and policies.
IRS Form 990 triggers
Compliance and governance issues
- Missing or incomplete schedules (see Know Your Form 990, Part 1)
- Mismatching data between schedules
- Lack of Board-level policies;
- Policies are not required via regulation, but answering “No” to questions on Board-level policies raises audit risk
- Absence of a Conflict of Interest Policy is a potential red flag
- Missing or inaccurate figures, schedules that do not foot, etc. which can indicate a lack of reasonable effort or care in completing the Form
- Weak or non-disclosed Form 990 review process
Compensation and Benefits
- For officers and key employees, set compensation by the Board via assessment of comparable salary information (salary surveys, comparable Form 990s or independent compensation consultants)
- Process, compensation discussions and decisions made by the Board should be documented and disclosed on the Form 990, as required
- Weak process descriptions or unusual compensation determination practices will draw attention and increase likelihood of audit
- Be wary of housing allowances, company-paid spousal travel and other items specifically disclosed on the Form
- If your organization has a compensated board, then the process for determining its compensation should be well documented
Board member independence
- Payments from the organization to the Board member or member’s family for services rendered may result in lack of independence
- All members need not be independent; however, risk of audit increases if you have a higher proportion of non-independent board members
Lobbying and political activities
- This is organization specific. Political activity mostly prohibited, except for some types, such as trade associations (recent developments may change this for some religious organizations)
- Limited lobbying is permitted, note however, that publicized activities may draw the attention of the IRS and increase risk of being audited
Tax exempt financing (Schedule K)
- Financing, such as tax exempt bonds can provide a significant cost savings to the organization, however, the savings comes with a compliance burden
- Compliance requirements continue for the entire term of the financing; however, they are fairly straight forward and easily documented (visit IRS’s website for Tax Exempt Bond Post Issuance Compliance)
- While having tax exempt financing increases the risk of being audited, the compliance costs should have already been considered when entering into the financing arrangement
- Have bond council review policies and disclosures
Foreign activity (Schedule F), required when the organization;
- Has facilities, activities, employees or agents outside of the United States
- Holds investments in foreign entities exceeding $100,000 at any point during the tax year
- Earns revenues (program, grant, fundraising or investment) more than $10,000 during the tax year
- Provides grants to foreign individuals or entities
What to do about Triggers
Only your organization’s management team, in coordination with the Board, can determine the organization’s appetite for audit risk. It is important to remember that these triggers only make the audit somewhat more likely. The organization may face an audit even if none of these situations exist. Be sensitive to these issues and prepare, by;
- Educating leaders about this topic and reviewing regularly as part of risk management
- Selecting a financial audit firm with experience with these issues and with IRS audits of NFP organizations
- Having conversations with financial audit firm to stay current on topic
- Being conscious of decision making in these areas
- Building solid policies and adhering to them
- Maintaining clear and complete documentation
- Considering any significant additional compliance costs when entering into transactions
- Getting help when in doubt (CPA, tax lawyer, etc.)
A note on Unrelated Business Income Tax (UBIT)
While having UBIT is not necessarily an audit trigger, the IRS will take notice if unrelated business revenue grows to a significant portion of total revenue. I have heard several opinions of what constitutes “significant,” but I have not found any clear guidance. In addition, if you have unrelated business income that is completely offset by costs on a regular basis, this could draw attention to the organization’s cost allocation practices.
UPDATE: 2017 Tax reform changed a number of items, specifically the IRS no longer allows pooling of UBIT projects.
UBIT is very complicated. To properly understand the nuances of UBIT, discuss it with the organization’s financial audit firm and potentially a tax lawyer. Boards should discuss UBIT on a periodic basis with management.
Extra Note: Remember that the IRS will gather information on your organization prior to and during an audit. Review your public website regularly. Look for information that may appear to contradict information disclosed in your Form 990.
You never know when your organization will be audited by the IRS, however, being aware of red flags and triggers can help you prepare and reduce the impact. Make conscious management decisions when it comes to the risks associated with IRS audit triggers. Keep current on IRS practices and focus areas (look at their website). Talk to your audit firm periodically on triggers and best practices. Document, document, document! By following sound policies, processes and documentation best practices you can help your organization make it through an audit cleanly if it comes.
Disclaimer: This post is meant to provide guidance on issues to consider related to the Form 990. Any decisions involving these issues should be made with the advice of a NFP tax professional or CPA. That organization or individual should be well versed in NFP tax issues and have a full understanding of the context of the situation.
Learning is a shared experience, so please share your thoughts, experience and expertise on this topic in the comments section. Thanks, –mike