What to do During an IRS Audit of Your Nonprofit

May 18, 2022

Nothing seems to strike as much fear and anxiety as receiving the dreaded notice that your organization is under audit from the IRS. IRS audits of nonprofit organizations are fairly commonplace, and can go very smoothly if you know what to expect and how to proceed.

Compliance Check v. Examination

The first thing to do when you receive a letter from the IRS is to determine whether it is merely a compliance check or an examination ( more commonly referred to as an audit).

Compliance Check

A compliance check is done to determine whether an organization is complying with recordkeeping and information reporting requirements. It may look at whether the activities the organization is engaged in are consistent with the stated exempt purpose of the organization. This is a limited scope, voluntary check. The IRS can do a compliance check multiple times in any given tax year. The IRS agent could recommend an examination based on the findings.

Examination (or Audit)

An examination is authorized under Section 7602 of the IRC. Once notified by the IRS that you are under examination, participation is mandatory. An examination will include a thorough review of the organization’s books and records. The IRS could determine that there are additional tax liabilities. The IRS could delve in to the organization’s qualification for exempt status.  An examination typically involves the IRS sending a lengthy Information Document Request (“IDR”). An examination also normally includes an interview of someone at the organization that has an understanding of the organization’s books and records.

The IRS is only permitted to audit a tax year once. After the IRS has an onsite visit, an organization can expect to receive a written report in 6-8 weeks. This written report could propose adjustments which can be discussed with the agent in the closing conference. If an agreement on the adjustments cannot be made in the closing conference, then the organization can appeal.

Preparing for an IRS Audit

Another way to determine if an IRS audit is merely a compliance check or a full examination, is to read any correspondence they send closely. If it is an examination, the letter will let you know whether the agent expects to handle it remotely or if they are going to be onsite at your location for part of the time.

The letter may also hold clues as to why you are under audit. For instance, if there are a lot of questions about a rental property you own, the IRS may assume there is a UBI issue.  If there are questions about specific job functions of some individuals you treat as independent contractors the IRS may be looking at a working classification issue.

As you put together your IDR responses, it is important that you stay organized and provide a full response to each of the questions in order for the audit to go as smoothly as possible. We typically recommend having your tax professional review the IDR and your responses before sending them to the IRS.

If there is a field examination, i.e. the IRS agent is on site, there are some additional tips that can ensure a successful audit process.  If possible, provide the IRS agent with a private room. All of the documentation you are providing should be in the room and clearly labeled before the agent arrives.  Once your IRS agent arrives, try to make a personal connection with them. Be civil and remember that just as you are trying to do your job, they are trying to do their job. Know who you are going to have available to the agent to interview and be sure that person is prepared.

Once you are chosen for an examination, there are a number of standard questions that the IRS agent will have to ask.  If you would like to have your accountant present during the field examination to assist you with the interview process, it is important to have the Power of Attorney completed before the interview gets underway. If you know you have taken a position that the IRS is likely going to challenge, have the support for your position available and printed out so that the IRS agent can review it in depth while they are preparing the report.

Properly preparing for your IRS examination can make the process run smoothly. Rely on the expertise of your tax professionals to help you through the examination. Whereas you may only go through a couple of audits during your career, your tax professionals routinely assist nonprofit organizations with their audits. If you have questions regarding an IRS audit of your nonprofit organization, send me a note.