The IRS is implementing more than 200 queries in its internal data-driven compliance approach. Learn how it will impact you.
When it comes to assessing tax compliance and selecting which tax-exempt organizations to examine or audit, the IRS has limited and reduced resources. According to its FY 2018 Work Plan for Tax-Exempt and Government Entities, agency leaders are continuing to focus on making their processes more efficient and effective.
One “creative response” to its “declining workforce” and strategic goal of increasing efficiency in its audit process, according to the IRS, is implementing more than 200 queries in its internal data-driven compliance approach.
Every organization, whether it files a Form 990, 990-EZ, or 990-PF, is run through the list of queries.
The IRS hasn’t publicly released the list of queries in its compliance model, but-as financial professionals with years of experience in the non-profit sector-we’ve put together a few educated guesses.
If it is reported that a non-profit organization has suffered an embezzlement, the IRS will almost certainly audit it. Even if the organization found the significant diversion itself and disclosed what happened, the IRS will want to make sure that corrections were made and controls were put in place to ensure it won’t happen again.
The IRS believes that organizations with good governance processes and policies are more likely to be tax compliant. Does the non-profit organization provide a complete copy of Form 990 to all governing body members before it is filed with the IRS? Does the organization have a record retention and destruction policy? Is there a whistleblower policy? Does the non-profit follow best practices for determining and approving the compensation packages of the CEO and other executives? Is there a written conflict of interest policy?
Any of these questions answered “no” is likely to trigger one of the IRS audit filters.
Non-profit organizations should monitor and enforce their written conflict of interest policies by requiring board members and executives to complete conflict of interest questionnaires, at least annually. Responses regarding conflicts and potential conflicts of interest should be carefully reviewed and handled. Conventional wisdom says it’s better to have a high percentage of independent board members, those without conflicts of interests. A low percentage of independent board members may be an IRS flag, so the higher, the better.
Any related-party transaction, such as a business transaction or a loan to or from interested persons, is also likely a flag in the IRS’s query list.
It is a likely query item if the non-profit organization has any missing policies. In addition to a conflict of interest policy and the other governance policies listed above, organization leaders may want to consider having policies that are relevant for their organizations, such as gift acceptance, grant-making, joint venture and tax-exempt bond post-issuance policies. These are all questions on the Form 990 and are likely IRS filters.
As mentioned in a previous e-book article, the Form 990 provides a roadmap to a number of risk areas within a non-profit organization.
The IRS’s compliance model can identify potential employment tax noncompliance by comparing the total Form 1099 payments to total W-2 wages paid every year. If the number of 1099s vastly outweighs the number of W-2s, the IRS may question whether the organization is appropriately treating a high number of its workers as independent contractors rather than employees.
Of course, this needs to be adjusted for certain industries, which may have specific queries, for example regarding Form 1098-Ts required for colleges and universities.
Fundraising is a surprisingly complicated function of any charitable organization. It includes a wide variety of potential tax issues to review.
For example, if fundraising expenses are high, that may be a filter for the IRS to rate whether an organization should be examined. Or, if the fundraising event shows a net loss, that may lead the IRS to believe the organization isn’t appropriately reporting the value of goods and services participants receive at the event, such as the dinner or the golf outing. There are many possible filters for the IRS to check the likelihood of noncompliance with contributions-fundraising events and noncash contributions-and if the organization is allowing donors to claim more charitable contributions than they should.
Other potential queries in its compliance model may include:
Reported loss on sales of items other than stock: The IRS may wonder: Did the organization charge too little, giving an insider buyer too much benefit?
Sales of donated property: The IRS may wonder: Did the donor claim a higher value than the charity ultimately received?
Any inconsistency across various filings is a major red flag for tax-exempt organizations. We’d expect the IRS’s list of queries to target several common areas of inconsistent reporting, including:
Public support test for charities: Is the charity using the right test? Is it done properly?
Lobbying: Is there a high amount or percentage of lobbying activities?
Art & Historical Treasures: Does the organization control a collection of art or historical treasures? If so, are donors using the charity to help them in claiming excessive donations?
Endowments: Endowments are a major issue with colleges and universities. The IRS may ask: Does the organization spend endowments to further the exempt educational purposes?
Alternative Investments: If an organization reports a large number of alternative investments, it’s likely to have other tax issues and reporting requirements.
Foreign Investments: Is the organization properly disclosing and reporting its foreign investments? There are plenty of opportunities for the IRS to cross-check an organization’s likelihood of having noncompliance with the tax rules based on items in the Form 990.
Compensation: In addition to the review of executive compensation, related-party transactions and loans, there are a myriad of flags relevant to executive compensation, fringe benefits, meals, travel and entertainment. Compensation is one of the most sensitive areas of all.
As mentioned earlier, the IRS has not released its list of 200 queries, and the predictions we listed above are just some of the areas of tax-exempt organizations the IRS may be targeting.
The overall lesson is simple: It’s never been more important to ensure your tax-exempt organization’s documentation is complete, its filings are accurate and its tax risk management processes are robust.
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.