Nonprofits may be exempt from most taxes, but they certainly aren’t exempt from the dreaded IRS audit. Your organization may have a red flag on the 990 that indicates something is potentially wrong or it could be a completely random selection. Either way, the IRS will want to make sure your organization is properly serving an exempt purpose and is in compliance with tax filings, including payroll and 1099s. While IRS exams can be time-consuming and stressful (not unlike a financial audit or grant monitoring visit), most organizations survive with minimal or no adjustments. Here are a few ways you can make sure your IRS visit goes smoothly:
Call your CPA
The IRS expects your CPA to participate in the exam and tends to prefer having a CPA involved. The CPA understands what the IRS wants to see, speaks the same financial/tax language as the IRS agent and generally inspires confidence from the IRS agent. Since your CPA knows more about your nonprofit than the IRS, they can help answer questions and interpret what the IRS is asking so the nonprofit representative can give an appropriate response. Taxpayers (including nonprofit representatives) often get emotional during an IRS exam and say things they regret. Your CPA can act as a buffer with the IRS agent and stop you from talking too much.
Don’t get chatty
Be friendly and accommodating to your IRS agent, but there’s no need to offer information that’s not requested unless you’re sure it improves the IRS agent’s opinion of your organization. If you’re not sure, don’t say it. Answer their questions completely and honestly, but don’t feel compelled to share every detail of your organization with the IRS. Focus on confirming that your activities support your exempt purpose when asked open-ended questions.
Know your rights
The IRS will give you a list of your rights as a taxpayer, but people often don’t realize they have the right to make the exam a little more convenient for them. If the exam is scheduled during your planned vacation, ask the IRS agent if you can adjust the timeline. Be reasonable, of course. In addition to timing, you can often modify the location as well. Some small nonprofits don’t have a physical location and the main address is the home of the Executive Director or a board member. The IRS will initially suggest a meeting at the address listed on the 990, but you can simply explain that it’s a home office and the IRS will generally allow you to come to their office instead. The IRS wants to see the organization’s operations, but they generally understand that a home office doesn’t offer much opportunity to confirm exempt activities.
Get organized
Provide information requested by the IRS in an organized fashion so they can easily identify which information corresponds to each request. A numbering system or detailed labels are both great options. Be sure to provide information that will serve as supporting evidence – a cancelled check is much better proof of payment than an internal list prepared by your bookkeeper or a printout from your accounting system. Keep copies of checks received so you can prove where the money came from and maintain check stubs with paid invoices as documentation of payments made. Keep copies of 1099s and W2s as well.
Locate your organizational documents (Articles of Organization, Bylaws) and IRS determination letter now and keep them in a permanent file. While it seems like the IRS should have this on file (from when you applied for exemption), they will ask for copies from the nonprofit.
Know your organization’s weaknesses
No one is perfect. Maybe your organization was paying the Executive Director as a contractor instead of an employee for a while or forgot to send out 1099s one year. It’s best to know what the IRS will point out and be prepared with your explanation (or apology and assurance that the issue has been resolved). The IRS definitely likes to see that issues in the past have been corrected now.
Remain calm
An IRS audit is survivable and often enlightening for organizations. Even if the IRS has some adjustments, your organization’s issues have to be really egregious to lose exempt status. You may have to amend some prior year payroll tax returns or make some changes to your board of directors, but it’s all in the best interest of the organization and maintaining exempt status.
