The latest report on the activities and plans for the Exempt Organizations (EO) Division of the Tax Exempt and Government Entities section of the IRS sends a clear message to nonprofits, summarized succinctly on page 22:
The IRS uses the Form 990 responses to select returns for examination, so a complete and accurate return is in your best interest.
EO Director Lois Lerner outlines accomplishments in Fiscal Year (FY) 2012 and provides a work plan for FY 2013 in the 24-page report. The report is expanding—twice as long as LINKlast year's—but the focus throughout is on EO's efforts to develop and use indicators of noncompliance gleaned from analyzing Form 990 data. Below are some highlights.
IRS EO Accomplishments in FY 2012
Monitoring Level Remained Steady
The report emphasizes that data from the redesigned Form 990 are being used to identify patterns of noncompliance so that the IRS can better target potential offenders. Again, there is a warning that inaccurate or incomplete reporting may look like noncompliance and thus lead to unnecessary examinations.
The total number of organizations reviewed again dropped in FY 2012, continuing its trend over the last three years (15,342 in FY 2010, 14,893 in FY 2011, and 14,020 in FY 2012). Roughly three-quarters of these reviews are audits (full examinations, usually on-site, where IRS staff determine if an organization should retain its tax-exempt status) and one-quarter are compliance checks (EO asks in a letter about a specific item on a Form 990 that appears to be reported in error or sends a questionnaire as part of a research study on a specific type of tax-exempt organization).
A breakout by type of review reveals:
- Examinations (full audits) were stepped up somewhat in recent years (10,187 in FY 2009, 11,449 in FY 2010, 11,699 in FY 2011), but the number for FY 2012 dropped to only 10,743, a decline of over 8 percent.
- The number of compliance checks peaked at 6,773 in FY 2009 but then dropped significantly to only 3,893 in FY 2010 and 3,194 in FY 2011. The number rose modestly to 3,277 in FY 2012.
When the IRS first developed the concept of these two types of enforcement reviews, the idea was to emphasize the compliance checks more than the full audits, as they were less resource intensive. In fact, over the past four years, the number of organizations examined has declined somewhat, and the proportion of compliance checks compared to audits has not changed much.
Decrease in EO Staff
Total staff levels continue to shrink, from 910 in FY 2009 to 900 in FY 2010, 889 in FY 2011, and 876 in FY 2012, with almost 60 percent of the staff working in the Examinations area. Most of the drop in staff, however, was in Examinations—from 538 in FY 2010 to 531 in FY 2011 and 516 in FY 2012. The other functional areas (Rulings and Agreements, Customer Education and Outreach, and Director's Office/Program Management) remained at about the same levels of staffing.
EO added a series of governance questions to the Form 990 when the 2008 revisions were completed and in FY 2012 completed some research on which practices reported on the 990 were associated with compliance and which were associated with noncompliance. The sample of organizations used included only those that already had been selected for review (that is, something already looked wrong on their returns), but the IRS found that compliance was associated with:
- a written mission statement;
- use of comparability data for compensation decisions;
- controls in place to protect charitable assets; and
- review of the Form 990 by the entire board before filing.
The characteristic associated with noncompliance was the concentration of control of an organization in one or a small number of individuals.
EO will be repeating this research using a statistically representative sample of charities to confirm these findings and see if other factors are also predictive.
- EO's Customer Education and Outreach continued to focus on reaching more of its nonprofit audience without travel and conference expenses, with more webinars and virtual workshops, as well as expanding the subscriber base for EO Update, a free periodic newsletter covering EO activities and issues of interest to the nonprofit community.
- Improved cooperation and information sharing between regulators at the federal and state levels is slowly occurring. State charity regulators referred more than 100 issues to EO, reporting organizations that did not file, failed to pay employment taxes, and who had high-paid employees. Eight state charity and tax agencies have met the necessary disclosure eligibility requirements, and the IRS has made 27,000 disclosures to these agencies.
- EO continued to work on the Form 990 reporting revisions and other changes and regulations required by the Affordable Care Act of 2010. These alterations affect charitable hospitals, exempt organizations as small employers, and the tax practitioner community.
- EO now has 40 staff who conduct Reviews of Operations (ROOs), research that does not involve directly contacting the organizations in question. Instead, sources such as an organization's application for tax exemption, other IRS information, and information from public sources, including Internet searches, are used. This process helps to improve "case selection for compliance projects and individual audits" (see page 12 of the report).
- The Pension Protection Act of 2006 mandated that nonprofits must lose their tax-exempt status for failing to file required returns with the IRS for three consecutive years. The IRS is also required to publish a list of the nonprofits that have lost their federal tax exemption. More than 450,000 organizations have lost tax-exempt status to date, and about 30,000 have applied for reinstatement. Starting March 2013, a more timely list of revocations will be published on the IRS Web site, so that organizations and potential donors and funders will have more current information.
EO is working to reduce the amount of time required to obtain tax-exempt status. The 60,000 new applications for tax-exempt status each year are now sorted into four categories, with different times for EO action:
- Substantially complete—determination letters usually within 90 days
- Not substantially complete—letter stating closed with no action within 60 days
- Minor additional information needed—request for information within 120 days
- Assigned to agent to determine if eligible for tax-exempt status—about 5 months' wait time
About 70 percent of new applications are in the first three categories and dealt within 120 days. Obviously, it is best to stay out of the last category.
IRS Plans for FY 2013
The point of most IRS EO projects discussed in the report is to develop processes and procedures to use EO resources more effectively. Below are some areas of focus for EO that nonprofits should note.
- Once you file, keep filing. Following up on organizations that file in one year and then fail to file the next is now a part of EO's ongoing efforts.
- Pay employment taxes. FY 2013 is the third year of a study that checks employment and compensation data reported on Form 990 with employment taxes paid by the organization, as reported to other divisions of the IRS.
- Be careful with foreign investments and grant expenditures. About half of EO's completed examinations of organizations with foreign investments or grants resulted in taxes and penalties. In the coming year, there will be more examinations with a focus on organizations with foreign activities that appear to have limited charitable activity and excessive compensation.
- Know what to file if you are part of a group. Some central organizations hold group rulings that cover their affiliates, but some of those subordinates lost their tax-exempt status when they failed to file for three years. EO is researching the relationship between the central organizations and their affiliates to ensure that EO has the right information and that affiliates are not dropped. Questionnaires have been sent to 2,000 central organizations, and the data gathered in these instruments will inform the approach to reporting correctly.
- File the right form and only one—990, 990-EZ, 990-PF, or 990-N. With the threat of the loss of tax-exempt status, EO found that a number of organizations filed the wrong form or filed the 990-N in addition to the required form. EO will be looking to see that organizations filed the correct form—and only the correct form—each year.
Report expenses correctly. EO is using Form 990 information to develop indicators of noncompliance and is now in the process of testing them. Of particular interest are organizations with:
- Relatively high fundraising costs and low charitable activity
- High fundraising costs with little income from fundraising
- High annual gross receipts and very low total compensation
- Taxable unrelated business income reported on the 990 but no Form 990-T filed
The message from EO is that organizations must be careful in completing their returns because the data are used to select returns for examinations, now more than ever before.
What Should a Nonprofit Do?
Here are some ideas to lessen the likelihood of receiving an inquiry from the IRS in the coming year:
- Make sure that what's reported in compensation on Form 990 is consistent with what is reported to other federal agencies (Social Security, unemployment compensation, etc.)
- File Form 990 completely, accurately, and on time. Make sure the correct form is filed, since threshold levels have changed over the past few years.
- E-file. It is easy and typically inexpensive. But even more important, it eliminates the possibility of the most common mistakes—the software won't let you make math errors, forget to attach or complete required schedules, or fail to sign the return. Check out http://efile.form990.org/ for easy access to software developed by the National Center for Charitable Statistics at the Urban institute.
Linda M. Lampkin, ERI Economic Research Institute
© 2013, ERI Economic Research Institute
Linda M. Lampkin is research director of ERI Economic Research Institute, a company that provides Form 990 compensation data for use by nonprofits, and former director of the National Center for Charitable Statistics at the Urban Institute. She can be reached at firstname.lastname@example.org or (877) 799-3428.