Best Practices for Your Tax-Risk FunctionOctober 23, 2017
Laura J. Kenney, CPA, MST
As we indicated in our previous articles, tax-exempt organizations risk embarrassment and possibly sanctions if they make tax-related mistakes. Seemingly simple mistakes on a tax filing or engaging in certain activities could force an organization to spend valuable time and resources for months—or even years—on damage control.
We’ve already outlined the top 10 federal tax issues facing non-profit organizations. We’ve also gone through our list of queries the IRS may be using to identify organizations to audit.
In this article, we’ll attempt to answer a simple question: What can tax-exempt organizations preemptively do, right now, to protect themselves?
Here are a few best practices and policies non-profits should consider.
Adopt and follow written policies
One of the best ways to implement good controls across your organization is to create and enforce written policies. Organizations should have clear, thoughtful, well-communicated policies and procedures that guide anything from what board members should do if they have a conflict of interest to how the organization should accept nontraditional contributions.
The IRS believes that if non-profits have strong policies and procedures in place, they’ll be more likely to comply with tax laws.
Know the tax rules
Tax-exempt entities need to be aware of all tax requirements that may impact them.
Remaining compliant with every tax rule and regulation isn’t always easy. Organizations are often tight on resources; rules are sometimes counterintuitive; and a common perception is that non-profits don’t have any tax issues.
One of the more common tax rules for a tax-exempt organization is that net revenue from business activities not related to the organization’s exempt purpose may be subject to unrelated business income tax.
For example, many organizations receive revenue from renting their conference space. Some organizations treat this as unrelated business taxable income and other do not. As is often the case with many tax positions, it is essential to understand the many nuances, exceptions and gray areas in the rules. The answer to whether the conference rental is taxable or not is very dependent on the specific facts and circumstance—and there’s not always a bright line test.
Understanding the tax rules also provides a foundation for good tax planning and beneficial structuring, as well as minimizing tax risks.
A few other tax areas that tax-exempt organizations should understand include:
- Is there any worker reclassification exposure? If so, that could be a costly mistake.
- Are your nonqualified deferred compensation agreements set up correctly? Especially in light of recently proposed regulations, it’s important to carefully consider items like severance agreements, sabbaticals and early retirement incentives.
- Is your executive fringe benefit tax treatment in order? The federal rules related to this item are not always intuitive, leading to tax exposure for many organizations.
All organizations should ensure they’re following the accountable plan rules carefully for all travel, meals and entertainment reimbursements.
If organizations have alternative investments, we recommend they make sure they’re complying with federal and state tax filing requirements. This means that, like those in the for-profit sector, tax-exempt organizations may need to be aware of quarterly estimated tax requirements; know the tax extension requirements to avoid penalties; and understand how to calculate the alternative minimum tax. They need to be aware of any additional disclosure filings generated from direct and indirect foreign investments to avoid the potential for huge penalties.
Documentation is key
Documentation is another excellent risk management tool.
We recommend reviewing and documenting not only any new activities, to determine if they are related to the exempt purpose or not, but also revisiting certain existing activities with a fresh set of eyes.
Sometimes there is turnover in the financial management level, and executives “inherit” tax positions from their predecessors. Sometimes the facts change—or the tax laws change. So, it can be very worthwhile to have good documentation; then there’ll be no need to completely reinvent the wheel.
To give a typical example, many colleges, universities and private schools provide their Presidents and Heads of School with campus housing. Most of the time the President or Head of School is required to live in the President’s house, and living there is essential to the performance of the job. Customarily, schools treat it as nontaxable. But to qualify for tax-free treatment, the requirements in the tax law must be followed.
What if the Headmaster of a nonresidential day school, rather than a boarding school, is provided the on-campus housing? What if the college President’s house is a couple of miles away from the main campus? What if there are three Presidents over a period of time, and the middle one negotiates the ability to forgo living in the President’s house; does this mean that the first and third were not also technically required to live in the house to perform their responsibilities? Do all of these qualify as tax-free?
Properly documenting previous tax-related decisions goes a long way in helping non-profit financial management avoid expending valuable time and energy trying to remember, explain or justify why they came to their conclusion.
And although being consistent is often a fine approach, just because “that’s how we’ve always done it” or the perception “that’s how everyone else treats it” is not always the strongest stance.
Proper documentation helps reduce tax exposure—and helps an organization’s leadership enjoy confidence in its excellence.
Review the IRS’s new Audit Technique Guides
The IRS recently provided us with the latest tax risk management tool. A new item in the IRS’s FY 2018 work plan for tax-exempt entities is its “Audit Technique Guides” for various types of tax-exempt organizations. The guides are meant to help IRS examiners, but also can be excellent resources for tax-exempt board members, executives and their advisors.
Interestingly, but also predictably, a few of the many areas the IRS audit plans cover are:
- Unrelated business activities that produce continual losses;
- Donors reported on the IRS form as anonymous when “otherwise identifiable”; and
- Employer-provided housing.
There are several guides, including those for public charities, private schools and colleges/universities, other educational organizations, religious organizations, other 501(c)(3) organizations, social clubs, business leagues, and one audit guide for fundraising activities that applies to many types of exempt organizations. Here is a link to the guides for you.
Ask for help
Clearly, there are various potential tax-related issues that non-profit organizations need to consider. In addition to everything we’ve laid out in our series of non-profit tax articles, there are many additional potential red flag areas, from corporate sponsorship rules to tax-exempt bond requirements to state charitable registration requirements.
The good news is that, with a continual improvement frame of mind, just about any tax-related mistake can be corrected. And organizations can avoid the risk from most tax-related oversights by planning ahead, implementing strong governance and written policies, and investing in a team of specialized tax-exempt financial professionals that you trust.
How BlumShapiro Can Help
BlumShapiro offers the accounting, tax and business consulting expertise non-profits need today. We are one of the largest non-profit accounting service providers in New England, our blend of accounting expertise and knowledge of non-profit organizations means we can offer you tremendous added value. We can assist you in complying with state and federal grant requirements, charitable giving rules, capital campaigns, endowment fund responsibilities and other specialized needs. Learn more >>
Disclaimer: Any written tax content, comments, or advice contained in this article is limited to the matters specifically set forth herein. Such content, comments, or advice may be based on tax statues, regulations, and administrative and judicial interpretations thereof and we have no obligation to update any content, comments or advice for retroactive or prospective changes to such authorities. This communication is not intended to address the potential application of penalties and interest, for which the taxpayer is responsible, that may be imposed for non-compliance with tax law.