For not-for-profit organizations, filing Form 990 is crucial in maintaining tax-exempt status. This critical document serves as a beacon of transparency, providing the IRS with a comprehensive view of an organization's financial and operational activities. As the IRS scrutinizes this form with an eagle eye, not-for-profit organizations must diligently ensure they comply with federal tax laws. Because while many not-for-profits file this form without any issues, there are still potential red flags that can trigger an audit.
Reasons a Form 990 May Trigger an Audit
It's no secret that not-for-profit organizations are driven by a noble cause. However, even with the best intentions, errors or inconsistencies on Form 990 can inadvertently draw the attention of the IRS. Let's explore five common reasons why Form 990 can trigger an audit.
Incomplete, Inconsistent, or Inaccurate Information
When it comes to filing Form 990, any discrepancies, no matter how seemingly small, can quickly raise the ire of the IRS and invite a closer look. Inconsistencies in reporting expenses or revenues, or between financial statements and the information on Form 990, are just some of the errors that can trigger an audit. And let's not forget about incomplete forms — missing schedules, parts of schedules or even signatures can bring forth immediate scrutiny.
Nonprofit leaders must also understand that the IRS treats incomplete returns as they do returns that were never filed at all, so corrections must be made before the due date to avoid hefty fines.
Foreign Grant Activity
Operating in foreign countries and granting money to foreign charities can be a great way for US not-for-profits to expand their reach and impact. However, foreign activity is closely examined by the IRS, and for a good reason. Potential risks are associated with sending money overseas, such as diverting funds for non-charitable purposes or the threat of non-compliance, such as inaccurate reporting and record-keeping. There is also the concern of US charities being controlled by foreign entities where the IRS has no jurisdiction.
To avoid these issues, not-for-profits must be transparent and accurate in reporting foreign activity on Form 990, ensuring that their operations and grants align with IRS regulations.
The IRS scrutinizes compensation paid to officers, directors, trustees and key employees of not-for-profit organizations to ensure that it is reasonable and not excessive. If the compensation reported on Form 990 appears excessive or too low, the IRS may launch an audit to investigate.
When determining reasonable compensation for employees of not-for-profit organizations, the IRS offers guidelines that are somewhat open to interpretation. Generally, employee compensation should be comparable to similar organizations paying for similar positions. It should also be based on the employee's job description and be within the organization's financial means.
Unrelated Business Income
Not-for-profits often seek ways to diversify their revenue streams, and unrelated business income (UBI) can be a legitimate opportunity. UBI is any income generated from ongoing activities that aren't directly related to the organization's exempt purpose. It's not illegal, but it must be reported accurately and not make up a significant portion of an organization's revenue; otherwise, it can trigger an audit.
A common area where not-for-profits can fall into trouble is failing to file a required Form 990-T when acknowledging UBI greater than $1,000 on Form 990. Since it is a revenue generator, UBI is a consistent focal point for regulators. Organizations should be prudent in correctly reporting any UBI and working with a professional to minimize exposure and tax liability.
Board Member Independence
The IRS takes the issue of fraud very seriously, and not-for-profit organizations must be diligent in avoiding any appearance of impropriety. Regulators pay close attention to information about an organization's governing body, including any payments made to board members or their family members for services rendered. Such expenses can compromise the board's independence and raise red flags during an audit.
While not all board members need to be independent, a higher proportion of non-independent board members can increase the risk of an audit.
Ways to Keep Form 990 Above Board
There are numerous strategies that not-for-profit organizations can implement to ensure that their Form 990 is above board and in compliance with federal tax laws.
Here are a few suggestions:
- Keep Accurate Records: It is essential to keep detailed records of all financial transactions and other activities, including descriptions of all revenue and expenses and documentation of any charitable activities or programs.
- Use Accounting Software: Automation can help track an organization's finances more efficiently and accurately and can also help generate financial statements and reports compliant with IRS requirements.
- Review Form 990 Regularly: Executives who regularly review their organization's Form 990 can identify any errors or inconsistencies before they become problematic. Ensuring that all information reported on the form is accurate, up-to-date and consistent with the organization's financial statements and other records is essential.
- Ensure Reasonable Compensation: To avoid triggering an audit based on compensation issues, leaders must ensure their organization's compensation practices are reasonable and in line with industry standards. This may include conducting regular salary surveys to ensure the organization's salaries are competitive with similar organizations.
Work With a Professional: If staff is unsure how to complete Form 990 or has questions about the reporting requirements, they should seek professional advice from an accountant or tax professional specializing in not-for-profit organizations.
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