When the Cat’s Away, Should You Play?

The chances of an IRS examination of a tax-exempt entity is one in 742, reported the Treasury Inspector General For Tax Administration (TIGTA) in February. For-profit businesses are five times as likely to be examined (one in 156) and individuals are three times as likely to be examined (one in 226). The rate for churches is about one in 5,000.

To better show you how many this is, during FY 2019, there were almost 1.5 million Form 990 series returns and notices filed; however, the EO function examined approximately 2,000 (0.13 percent) Form 990 series returns during the same year. Of those, 13% resulted in no change to the organization’s tax-exempt status or tax liability.

The low rate of examinations is likely due to limited resources, and the in-depth training, experience, and knowledge required due to the complexity of the tax law. Also, some exempt organizations, such as churches, do not have to file annual information returns. This makes it difficult for the IRS to track the activities of these organizations to identify non-compliance. Making it even more difficult for the IRS, special rules imposed by Congress limit the IRS’ authority to conduct certain tax inquiries and examinations of churches.

Thus, it is quite a challenge for the IRS to identify non-compliance by tax-exempt organizations.

Because the Form 990 series often doesn’t provide enough information to raise concerns of non-compliance, the IRS relies heavily on referrals to identify abusive schemes. And although referrals are a valuable source of information, examinations initiated from referrals are more likely to be closed with no changes to the return than those from other sources, such as compliance strategies and data-driven approaches.

What does this mean for tax-exempt organizations? Time to relax and put up your feet?

No.

First, if an organization has been lax in its tax compliance or proper governance, then it will be harder to rectify when the IRS resolves these problems and improves its examinations processes. And we mustn’t forget that the return is still open to public inspection. The ability to receive donations may be compromised because the return portrays a lack of governance and knowledge of the compliance rules. And becoming lax on reporting may trigger flags in the IRS’ system, which may increase the chances of being one of the few examined organizations.

While the IRS is grappling with these problems, many states have taken it upon themselves to enforce some of the charitable compliance rules. Whether or not the IRS improves its examination procedures and expands the number of organizations examined, we may see this trend continue.

So, stay vigilant. It will help your organization in the long run, whether or not the IRS steps up its examinations. If your not-for-profit requires assistance, please contact a Clark Nuber professional.

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