Six Common Nonprofit IRS Audit Triggers

The Inflation Reduction Act has provided the IRS with an additional $80 billion in funds, of which $46.5 billion is allocated explicitly for enforcement activities. As a result, the IRS, known for its regular audits of exempt organizations to verify compliance with federal tax regulations, will experience a substantial increase in funding specifically for conducting audits.

Understanding common IRS audit triggers can help nonprofits identify potential compliance concerns and prepare if their organization is selected for an audit.

What Are the Types of IRS Audits?

There are three primary types of IRS audits that individuals and organizations may encounter:

1. Mail Audit: The taxpayer receives a letter from the IRS requesting specific information to be faxed or mailed back.
2. In-person Office Audit: The taxpayer must visit an IRS office and meet with the designated agent conducting the audit.
3. In-person Field Audit: The assigned IRS agent visits the taxpayer’s place of business or their accountant’s office to conduct the audit.

Each type of audit may have its own unique requirements and procedures. Understanding the specifics of the audit type described in the IRS notice can help organizations prepare.

What Are Common IRS Audit Triggers for Nonprofits?

While an audit can occur randomly, there are common factors the IRS looks for. Understanding the six nonprofit IRS audit triggers below can help organizations establish procedures that address these triggers and minimize the likelihood of selection.

1. Incomplete or Inaccurate Form 990 Information

The IRS uses aggregate Form 990 data to target areas of concern or noncompliance, assuming forms are completed accurately. When Form 990 is submitted with incomplete or inaccurate information, it gives the appearance of a noncompliant organization. The IRS has stated that this conclusion may lead to an examination (audit). The IRS also uses Form 990 to identify governance issues that it feels can lead to noncompliance. The numerous questions in the 990 related to board and management governance provide the IRS with insight into organizations that may be more likely to have issues warranting examination.

2. Referrals About Potential Noncompliance

The IRS has a robust referral program that allows individuals, groups, other government agencies, and other sources to refer exempt organizations. When the IRS receives a referral, the agency reviews the relevant information and then decides whether an audit is warranted. While most people may consider a referral “whistleblowing,” many referrals to the IRS come from state agencies coordinating information with the IRS. These state referrals may arise from non-filing in a state, payroll issues, or other tax-exempt issues related to the states where the nonprofit operates.

3. Foreign Activities and Overseas Expenditures

Currently, the IRS is focusing significantly on large foreign grant activities due to concerns that money sent overseas could be diverted away from charitable purposes. Previously, areas of noncompliance regarding the control of overseas expenditures, the reporting of foreign bank accounts, and inadequate recordkeeping have been identified.

4. Discrepancies Between Fundraising Income and Expenses

If there are large amounts of fundraising income, the IRS generally expects to see related amounts of fundraising expenses. The IRS may initiate an audit if it feels fundraising expenses are not in proper proportion to fundraising income.

5. Compensation Issues

Most nonprofit organizations are aware that the IRS frowns on unusually high executive compensation. However, it also focuses on unusually low compensation amounts reported relative to the organization’s size. In this scenario, the IRS may be concerned about a lack of reporting transparency and may decide to open an audit.

6. Substantial Unrelated Business Income Without Tax Payments

The IRS seriously reviews organizations with a history of substantial unrelated business income (UBI) —income unrelated to the organization’s exempt function — that have not paid any taxes, since these organizations may be allocating too many expenses to UBI. A recent program that the IRS conducted with universities confirmed the need to expand efforts in this area.

CRI's nonprofit advisors can help your organization address compliance concerns in these common audit trigger areas. If your organization is selected for an IRS audit, our team can assist you in preparing for and navigating the process.