Nonprofits that are chosen for IRS audits need to begin organizing a response as soon as possible after receiving the dreaded notice. The overarching goal of an IRS audit of a nonprofit is to verify tax compliance. If significant noncompliance is found, the organization can lose its tax exempt status, with all the attendant consequences.
The IRS approaches audits in several different ways. An audit may be conducted by IRS officials at the offices of the nonprofit, where they will review documents and interview key staff members. These so-called “field audits” can vary in terms of their intrusiveness, based on the purpose and goals of the audit. A common alternative is a correspondence audit, conducted by mail. In a correspondence audit the organization is expected to mail the auditor copies of requested materials.
The IRS can ask for many kinds of records. Even for relatively new or small organizations, the volume of records can be daunting. Large organizations with complex operating histories often face significant costs to comply with IRS requests. The complexity of preparing for an audit will depend on how organized the nonprofit is. Generally speaking, organizations that follow good records management processes and periodically conduct internal audits will be in better shape than those that operate on a more haphazard basis.
During the preparation process it can be helpful for someone in the organization to study existing records from the perspective of the IRS. Has the organization engaged in activities that might undermine its qualification for tax-exempt status, like self-dealing transactions or, for 501(c)(3)s, too much spending on political activities? Has the organization generated revenue in unrelated businesses that would be subject to income tax? Does the organization have a clean compliance record, or have mistakes been made?
The audit will also examine management practices and records, looking in particular for evidence that the organization is being operated for the benefit of a private individual or group. All documents reviewed by the managing board can be requested.
The key goal of conducting a pre-audit preparation is to find problems before the IRS auditor does, so the organization can make a plan for dealing with the issue. The IRS tends to look more favorably upon taxpayers that make a good faith effort to comply with its rules. But when serious problems are uncovered, the organization must begin preparing a response with the help of qualified professionals. The Church Law Center of California advises religious and secular nonprofits on governance and risk management matters. To find out how we can assist your organiation, call us today at (949) 689-0437 or reach out to us through our contact page.