An IRS audit is rarely a fun affair.
It can involve reviews of records, interviews and other time-consuming requests that can be a drain on productivity – and it all comes with the pressure of knowing that your tax-exempt status may be at stake. It’s important that your organization is aware of the issues your form 990 may raise that fall into what the IRS considers to be “high-risk areas of noncompliance” with federal tax requirements. You also need to understand what the technical requirements are for demonstrating your compliance. This article will share some of the audit-triggering issues that can be unearthed by your nonprofit’s answers to certain questions on the Form 990.
Fluctuation in mission – or “mission drift” is a common audit 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 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, Part III of the Form 990, questions 2 and 3, 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 population 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 organization’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. In addition, mission drift can confuse donors and the community the organization serves. In addition the potential impact of mission drift can be catastrophic when donors only want to give their dollars to specific programs.
Mission drift can happen gradually – but there are definitely signals you should watch for. Your organization may be facing mission drift if you notice your board of directors is no longer focused on the mission, you’re not as focused on making an impact on the community, you’ve experience a large turnover of staff or board members, or you’ve begun to prioritize producing income from programs rather than targeting your constituency.
Here are some ways to help keep your organization on track:
• Regularly reaffirm your mission as stated on Form 990 at board meetings and include the reaffirmation in the minutes.
• Ensure that the organization’s mission is still aligned with the purpose for which it was originally granted exemption .
• Make a list of all programs, services and products your organization provides or sells that are related to the organization’s mission statement, without regard to the funds the program may generate.
• Ensure that you have buy-in from all stakeholders prior to any change in the organization’s mission statement. If there is no buy-in from stakeholders, change in mission will be difficult.
Along with mission drift, there are other audit triggers you should be aware of. Based on our experience working with the nonprofit sector, and drawing from the IRS’s “Tax Exempt and Government Entities FY 2017 Work Plan”, other Form 990 responses that may serve as red flags include:
• Program service revenue reported on page 2 that is not equal to revenue reported on on page 9 Part VIII line 2.
• Filing an incomplete return due to a missing schedule. For example, if you state you have Unrelated Business Income and you don’t attach a Form 990-T that is an automatic trigger.
• Failure to file your 990, 990-EZ, 990-PF for three consecutive years will result in automatic revocation.
• If you answer yes on Form 990 Part VI, line 5, it may indicate embezzlement or theft and trigger an audit.
• Reported excess benefit transactions with disqualified persons (such as unreasonable officer compensation).
• Any political campaign activity indicated on Schedule C.
• Reporting fees for non-employee services (Part IX, lines 11a through 11g), without reporting that any 1099’s were issued (part V, line 1a).
• If part X, lines 5-6 show that outstanding amounts of loans and other receivables from disqualified persons do not decrease from the prior year.
• Unreported information regarding related organizations or improper reporting of joint venture activity.
• Unreported foreign activity including investments, fundraising, travel, programs and grants; schedule B should list donors that donate from foreign countries.
Lastly, you should be aware that the IRS can also rely on public sources of information, including complaints or referrals from a federal or state regulatory agency, or referrals from the public, to initiate an audit.
It is your organization’s responsibility to apply due diligence when preparing the Form 990, and ensure that you are operating in accordance with the purpose for which you were granted exemption. Manage that responsibility well.
Frances McKenna, MBA, EA, joined Marks Paneth LLP in 2017 as a Tax Director in its Nonprofit, Government and Healthcare Group. She’d spent the prior twenty six years of her career with the Internal Revenue Service (IRS).
Robert Lyons, CPA, MST, is a Tax Director in the Nonprofit, Government and Healthcare Group at Marks Paneth LLP. He brings more than 30 years’ experience providing tax and consulting services to the nonprofit, higher education and public sector industries.