Nonprofit audit requirementsIs your nonprofit facing an IRS audit? Don't panic. Make the best of the situation — and be careful to learn from past mistakes to avoid repeating them in the future.
Understand the type of audit
In general, the IRS conducts two types of audits:
- Field audit. With a field audit, an IRS agent visits your facility, interviews staff and reviews documents. Your notification letter from the IRS will include details about an appointment with an agent.
- Office or correspondence audit. With an office or correspondence audit, you'll be asked to submit key documents to the IRS by mail. You won't meet with an IRS agent.
The IRS also conducts compliance checks, which aren't considered audits. If your organization is selected for a compliance check, you may be asked to complete a questionnaire to help the IRS better understand how your organization meets federal tax law requirements.
Consider what triggered the audit
If you're not sure why you're being audited, give it some thought. For example:
- Look for irregularities in your tax forms. Anything "off" in your 990-N, 990-EZ or 990 — or failure to file the form — could trigger an audit.
- Review your fiscal practices. A whistleblower may report perceived financial mismanagement to the IRS.
- Check for financial discrepancies. Fundraising income, compensation and fee-for-service income should be in balance. If not, the IRS might investigate.
- Review routine activities. Distributing large amounts of money internationally or running programs in other countries (such as college alumni tours) can be a red flag for the IRS. You might also be more likely to be audited if you run gambling fundraisers, engage in commercial co-ventures with for-profit companies, offer credit counseling or other financial services, or engage in political activities.
- Be aware of activities that might subject your organization to taxation. As a general rule, your finance staff should be familiar with IRS rules about what constitutes unrelated business income and whether your organization's activities could be subject to Unrelated Business Income Tax (UBIT).
Prepare the required documents
The IRS will send a letter listing the documents and records to be reviewed. You'll likely need to gather:
- Your incorporating documents, including any amendments or bylaws, your 501(c)(3) application and the letter from the IRS granting nonprofit status
- Copies of all 990 forms and supporting documents
- Relevant board meeting minutes (to help establish the level of fiscal oversight)
- Fundraising literature, including newsletters and brochures
- Accounting records, such as your chart of accounts, general ledgers (beginning of the year trial balance as well as a year-end summary and trial balance), cash receipts and cash disbursements journal, cancelled checks, invoices, bank statements, credit card statements and expense reports
- Tax records, such as W-2s, W-4s and 1099s
- Records of donations and grants (including any restrictions on use of the funds)
- Investment records
- Records for assets and liabilities
- Conflict of interest policy
- Written disclosures of any relationships between directors, officers and key employees
Know what the IRS will be looking for
Whether you meet with an IRS agent in person or submit the requested documents by mail, the IRS will be looking for:
- Signs that your nonprofit is enriching the private interests of its staff, board or leaders
- Excessive income (which may be subject to unrelated business income tax)
- Inappropriate lobbying or other prohibited political activity
- Excessive compensation of executives or consultants
- Disorganized or irresponsible record keeping
Know what to expect after the audit
After the audit, be prepared for instructions about compliance or correction of minor errors in tax forms — even if the IRS finds no evidence of wrongdoing.
Regardless of the outcome of the IRS audit, consider implementing internal financial audits of your own. Although it's unlikely that a law-abiding nonprofit will be audited by the IRS routinely, regular internal audits can be helpful in the case of a future IRS audit.
IRS: Charity and nonprofit audits (2016)
Carr, Riggs and Ingram: These six common IRS audit triggers are no laughing matter
LinkedIn: The "dreaded" IRS audit explained: A survival guide for non-profits by Adam Davidson (2015)
Blue Avocado: I survived an IRS audit by Steve Zimmerman
Nolo: Avoiding IRS tax audits of your nonprofit by Stephen Fishman