By Laura Kalick, JD, LLM in Taxation
The Tax Exempt and Government Entities division of the IRS issued its FY 2017 Work Plan at the end of September 2016, which 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 provide more information to organizations so they can be compliant. The work plan can also serve as a helpful resource for nonprofits as they begin planning for the new fiscal year. Nonprofits can review the work plan to determine key strategic actions they should take now to prepare for the possibility of an IRS audit.
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 its audits identified a discrepancy, and as a result, the organization had to change a position it took on its initial return, which often resulted 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.
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 a large portion of those exams encompassed the tax gap items listed above. So, as organizations look at their tax positions, they need 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 continuing professional education 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, in hopes that more organizations use the short form.
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 resulting from 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. But with the new notification the IRS may be taking a closer look at the new organizations.
Now that the IRS work plan is out, it gives organizations insight on how they can prepare for the year ahead. 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—it’s 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 three-year open tax period. Under certain circumstances, organizations 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.
This article originally appeared in BDO USA, LLP’s “Nonprofit Standard” newsletter (Winter 2017). Copyright © 2016 BDO USA, LLP. All rights reserved. www.bdo.com