No one wants to go through Internal Revenue Service (IRS) audit. Even an honest error can trigger one and that exacts a cost in time, resources and possibly, reputation.
“The IRS Form 990, Return of Organization Exempt From Income Tax, asks a lot of questions about procedures and activities,” said Dan Romano, Grant Thornton partner-in-charge, Not-for-Profit Tax, from his New York City office. “But often, there’s no black-and-white answer to many of the questions, and it can be easy to trigger an audit.”
High executive compensation levels, especially if they’re beyond industry standards, could arouse the IRS’s suspicions, Romano noted, suggesting that an independent compensation study could be a defense for a nonprofit. “Excessive perquisites, like housing or spousal travel reimbursements could also wave a red flag in front of IRS,” he added. “Smaller organizations might unintentionally skip over a question, leading to a penalty or an audit. We recommend having a board committee or outside auditor review the Form 990 before submitting it.”
The federal Form 990 is very complicated, with one schedule often impacting another, added Kelly Frank a partner in the accounting firm CohnReznick and based in Roseland, N.J. office. “It’s common for nonprofits to mix up their ‘yes-no’ or other answers and unintentionally set off an IRS audit,” she cautioned. “Even if they don’t set off an audit, Form 990s are posted on the Web and if they look out of whack, then independent ratings organizations like Charity Navigator may downgrade their assessment, potentially scaring away donors.
Allocated overhead expenses can also raise questions if they’re not properly segmented, according to Brenda DeCosta, an assurance partner at Marcum LLP’s Boston office.
“In addition to excessive compensation or excessive lobbying costs, neglecting to properly allocate overhead expenses could potentially set off an IRS audit,” DeCosta cautioned. “Let’s say you don’t have a line item for ‘fundraising costs,’ but instead lump the charge into overhead. IRS may wonder how you’re able to raise revenue without spending anything on fundraising to drum up support. It might be an innocent mistake, but it could cost you a lot to explain it.”