Special to the Philanthropy Journal
By Laura Kalick
The Tax Exempt and Government Entities division of the IRS just issued its FY 2017 Work Plan, which outlines tax and audit initiatives for the fiscal year ahead. As nonprofits structure their financial planning for 2017, the work plan is an essential resource. Nonprofits can review this document to determine key strategic actions they can take now to prepare for the possibility of an IRS audit. The work plan has useful insights for all nonprofit organizations, with specific provisions for 501(c)(3), 501(c)(4), 501(c)(7) and 501 (c)(12) organizations and nonprofit hospitals.
The IRS Work Plan builds upon the agency’s 2016 priorities and its mission to work smarter with fewer resources. This idea of “working smarter” includes targeting audit initiatives so the IRS can focus on organizations where they will be more likely to find noncompliance, as well as providing more information to organizations to ease the compliance burden.
Form 990s, which nonprofits file annually, will continue to be a critical touchpoint between nonprofit organizations and the IRS. In 2016, the IRS launched an effort to use data gathered from the Form 990 series to identify existing and emerging high risk areas of noncompliance. With this initiative, the IRS achieved a change rate of 90 percent when conducting audits in 2016. In other words, 90 percent of the IRS’ audits identified a discrepancy, and as a result, the organization had to change a position it took on its initial return, often times resulting in additional tax dollars paid to the IRS. Based on the 2016 results, the IRS will continue to utilize data analytics from Form 990 in fiscal year 2017.
IRS Examination Focus
The 2016 priorities put forward five key issues of examination focus, which will continue in FY 2017. They are:
- Exemption: Non-exempt purpose activity and private inurement
- Protection of Assets: Self-dealing, excess benefit transactions, and loans to disqualified persons
- Tax Gap: Employment tax and unrelated business income tax (UBIT) liability
- International Operations: Oversight on funds spent outside of the U.S., exempt organizations operating as foreign conduits and requirements under the Report of Foreign Bank and Financial Accounts (FBAR)
- Emerging Issues: Non-exempt charitable trusts and IRC 501(r)
Of those five key issue areas, the tax gap was one of the most prevalent in the past year. In 2016, the IRS conducted almost 5,000 exams and their statistics show that a large portion of those exams encompassed the tax gap items listed above. So as organizations look at their tax positions, they should be sure to examine tax gap concerns such as:
- Unrelated Business Income: Gaming, non-member income, expense allocation issues, net operating loss adjustments, rental activity, advertising, debt financed property rentals and investment income
- Employment Tax Issues: Unreported compensation, tips, accountable plans, worker reclassifications and noncompliance with FICA, FUTA and backup withholding requirements
In addition to tax gap concerns, there are several issue areas which are always under scrutiny for section 501(c)(3) organizations such as private inurement, private benefit, political activity and more than insubstantial lobbying activities.
Other potential audit triggers include:
- Inconsistent or incomplete information on a filed return
- Diversion of assets
- A claim for refund or a request for abatement that requires further review
In addition, the IRS also relies on public sources of information including complaints or referrals from a federal or state regulatory agency or referrals from the public. Form 13909 is the referral form for exempt organizations and Form 211 is the Application for Reward for Original Information form. Informants can keep their anonymity.
FY 2017 Initiatives
In FY 2017, the IRS will continue to build its knowledge base for its agents and the public by hosting CPE events and preparing issue snapshots. Streamlining processes also remains a key priority for the IRS, for example, making the determination letter process more efficient by returning applications that do not have the required documentation. The IRS lowered the user fee for organizations to apply for section 501(c)(3) status using Form 1023-EZ, hoping more and more organizations use the short form.
In order to prevent surprise revocations for an organization’s failure to file a return for three years in a row, the IRS has implemented a warning system prior to revocation. This should also reduce the determination letter inventories that are due to automatic revocations.
The IRS has also introduced Form 8976, which 501(c)(4) organizations will now be required to file to indicate their intent to operate as a 501(c)(4). These organizations are also still required to file Form 990. The new form is not a substitute for filing a Form 1024, Application for Exemption; however, the application is still not required as 501(c)(4) organizations may be “self-declared” as exempt. With the new notification, however, the IRS may be taking a closer look at the new organizations.
With the IRS’ 2017 priorities in mind, organizations can take key steps now to prepare for compliance. As part of an organization’s annual financial audit, it should determine whether or not there are any material uncertain income tax positions. Even if your organization goes through this exercise annually, it may be good to get a fresh look and even conduct a “mock” IRS audit. Better to identify any potential issues in the mock audit rather than a real one.
After the analysis of tax positions, organizations would be wise to document, document, document. In a routine audit, the IRS typically examines the 3-year open tax period. However, in certain circumstances organizations would need to produce documentation for years prior. For example, net operating losses can be carried forward 20 years. If an organization is using a loss that was generated two decades ago to offset current income, the IRS can request documentation from the year the loss was incurred. If an organization does not have documentation to support its position, it may be difficult to prevail on an issue.
Nonprofit organizations and their finances are currently under heightened scrutiny, with controversies garnering attention from the media and donors alike. Proactively addressing potential compliance issues now, before the IRS identifies them, can minimize complications, costs and reputational risks in the long run. All nonprofit organizations can tap the IRS Work Plan as a resource to plan for the year ahead, and would be wise to do so.
Laura Kalick is the Tax Consulting Director for BDO USA’s National Healthcare and Nonprofit and Education Practices. Laura’s areas of focus include private inurement and benefit, intermediate sanctions, unrelated business income and allocation of expenses, taxable subsidiaries, private use of tax-exempt bonds, charitable contributions, joint ventures, royalty, affinity, and sponsorship agreements, debt-financed income, lobbying and political activity, and compensation arrangements. Laura also works with nonprofit clients on applications for exemption, ASC 740-10(FIN 48) documentation, IRS audits, and the Form 990. She can be reached at email@example.com.