IRS Audits of Non-Profit Organizations – Get Ready for Increased Scrutiny
By Mark Helland

Mark Helland, CPA is a partner with the public accounting firm of Elliott, Dozier and Helland, PC which is located in Tulsa, Oklahoma. Mark specializes in audit and tax related issues for non-profits, churches and ministries across the United States. Mark’s firm works with hundreds of churches and ministries and is available for assistance on any issues you might have. To contact Mark on this topic or for assistance on any other tax, accounting or church audit and compliance need, Mark can be contacted via email at [email protected] or by phone at (888) 893-1259 or (918) 488-0880.

The words “IRS” and “audit” are not a combination that any of us wants to hear as they pertain to ourselves or our organizations. The very words conjure up images of a very unpleasant and potentially expensive situation which we hope to avoid. Unfortunately, given the poor state of the U.S. government’s finances, IRS audits are projected to become much more frequent in nature over the coming years. This is primarily an expectation for individual and business taxpayers, but non-profits are not completely out of the woods in this regard. In our office, we are seeing an increase in the number of our non-profit organizations that are being audited, including even small churches and ministries. Whereas churches and ministries used to escape scrutiny in all but the most egregious situations, this is no longer the case.

The IRS is somewhat limited in its ability to audit a church, as opposed to its nearly unlimited ability to audit individuals, for-businesses, non-profit organizations or ministries. Section 7611 of the Internal Revenue Code details how and when the IRS may conduct civil tax inquiries and examinations of churches. As per the IRS website, “The IRS may only initiate a tax inquiry or examination of a church if a high-ranking IRS official reasonably believes, based on a written statement of the facts and circumstances, that the organization: (a) may not qualify for the exemption; or (b) may not be paying tax on unrelated business or other taxable activity.” However, there are certain situations where the restrictions noted above do not apply which include but are not limited to the following:

• Routine requests or inquiries on matters that do not concern the organization’s tax status
• Criminal investigations
• Any case involving the organization’s knowing failure to file a return or willful attempt to defeat or evade tax (including failure to withhold or pay social security or other employment or income tax required to be withheld from wages), or
• Any inquiry or examination relating to the tax status or liability of persons or organizations other than the church (including contributors).

So, as you can see from the above list, despite the tax-exempt status of churches, the IRS still has fairly wide latitude to conduct audits and inquiries. Also, the term “tax-exempt” is somewhat of a misnomer for all non-profit organizations as they still have many forms of tax requirements to stay in compliance with. The most pertinent and critical form of tax compliance that non-profit organizations have to deal with are payroll taxes. In general, payroll taxes give the IRS the widest and easiest “doorway” with which to enter your church or ministry.

One of our firm’s clients (a church) is currently undergoing a “payroll tax” audit by the IRS and I thought it would be informative to provide the list of all the items that they have requested from this particular church. Take a look at this list and decide for yourself if your church could easily produce all of this information in a short period of time:

1. Copies of all employees benefit packages and/or policies. The packages are requested for all classes of employees (rank & file, management, upper management, executive, etc.).
2. Copies of any employee manuals, including any literature or other information provided to employees regarding participation in the entity’s deferred compensation, cafeteria, or other optional plans.
3. Copies of any independent or outside financial audit reports.
4. Copies of all employment contracts for administrators, department heads, and all other employees with employment contracts.
5. Directory of accounts for your accounting system.
6. Disbursement/accounts payable records with directory of fields. If possible, please provide a paid invoice report (or equivalent) by vendor number and name that identifies each vendor and payments made to each during calendar year 2009.
7. Calendar year (2009) end payroll records with directory of fields. If possible, please provide a summary of types of payroll deductions and whether each deduction was subject to federal income tax, social security tax and medicare tax.
8. If possible, please provide a report summarizing all payments to employees in 2009 for allowances, reimbursements, or benefits that were paid through accounts payable and not payroll.
9. Forms W-9 for all current vendors or contractors.
10. Copies of any “B” Notices sent to payees regarding missing or incorrect taxpayer identification numbers for calendar years 2008 and/or 2009.
11. Copies of all employee’s W-4’s.
12. Copies of any correspondence received from Internal Revenue Service or the Social Security Administration regarding the filing of information returns such as Forms 1099 or W-2 for 2008.
13. Copies of your internal control procedures for preparing and transmitting Forms W-2 and 1099.
14. Copies of written plan documents for all deferred compensation (including tax sheltered annuities), cafeteria, flexible spending, and other employee benefits plans (retired health savings plans, health reimbursement plans, etc.).
15. Copies of all written policies for the following:

• Accountable and Non-Accountable Plans
• Automobile Allowances and/or Reimbursements
• Travel Allowances and/or Reimburseme
• Entertainment Allowances and/or Reimbursements
• Employer Provided Automobiles
• Meal Allowances and/or Reimbursements
• Educational Assistance
• Cell Phones provided to Employees
• Employer Provided Housing to Employees

So, at this point, I hope you are still reading this article because it is likely that you have either (a) fallen asleep or (b) you are scared to death! The thing that amazed me about this list was how extensive it was and how it requested items that are seemingly unrelated to a payroll tax audit. I personally find items #3, #5 and #6 particularly troubling as there is a definite potential to expand the scope of the audit with these items.

The best advice that we can give to churches and ministries is to review this list NOW and to first make sure that your organization could even provide these items if called upon. More importantly, all of these items need to be reviewed to make sure that you don’t have any “issues” that could create problems if you were to be examined – i.e. poor documentation, employees incorrectly classified, independent contractors utilized, etc. We help churches and ministries all the time with these issues, so give us a call now to make sure that you are in compliance.

 

This article is designed to provide accurate and authoritative information in regard to the subject matter covered. It is shared with the understanding that neither the author nor Tony Cooke Ministries is engaged in rendering legal, accounting, psychological, medical or other professional services. Laws and regulations are continually changing, and can vary according to location and time. No representation is made that the information herein is applicable for all locations and times. If legal advice or other expert assistance is required, the services of a competent professional person should be sought.

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