Although the title of the Government Accountability Office (GAO) report released in December 2014  TAX-EXEMPT ORGANIZATIONS: Better Compliance Indicators and Data, and More Collaboration with State Regulators Would Strengthen Oversight of Charitable Organizationswill not win any awards for elegance, its 66 pages do provide some interesting insights on the IRS review of charities using the Form 990 data.

The Exempt Organization (EO) division of the IRS initiated 8,413 exams of tax-exempt organization returns in 2013, including 4,495 (about 53%) of charities, exempt under IRC Section 501c3.

Most of these organizations were chosen for a review because of the following:

  • An IRS National Research Program project on employment taxes (41%)
  • Form 990 data analytics (22%)
  • Referrals (including news items) received by EO from internal and external sources alleging potential noncompliance with the tax law (14%)

When the IRS redesigned the Form 990 in 2008, the purpose was to promote compliance and increase transparency. Using the new form, a team of EO specialists developed data-mining queries to identify suspected inaccuracies or anomalies.  Also, with the redesign, the Form 990 compensation reporting period was coordinated with other federal reporting periods so that what was reported to different agencies could be cross-checked for consistency, hence the ability to check the payment of employment taxes.

That said, the IRS examines only a small percentage of charitable organizations that file returns. The examination rate was about 0.7% in 2013, compared to 1% for individual and 1.4% for corporate tax returns. From fiscal year 2011 to 2013, the EO exam rate decreased by about 12%, from 0.81% to 0.71%.

Over the past several years, as IRS budget has declined, the number of full-time equivalents (FTEs) within EO has fallen, leading to a steady decrease in the number of charitable organizations examined.

But, even with decreased staff, increasing use of technology will make it easier to target organizations for an examination.  GAO is recommending that Congress expand the mandate for charities to electronically file their tax returns, and IRS agreed with GAO’s recommendations.  The expectation is that expanded e-filing will result in more accurate and complete data available in a timely manner, also allowing IRS to more easily identify areas of noncompliance.  Now further action on e-filing is up to Congress.

In the meantime, charities are likely to avoid investigations if they follow these guidelines:

  • Set executive compensation according to IRS requirements, using data from comparable organizations.
  • Make sure that what is reported in compensation on Form 990 matches what is reported to other federal agencies.
  • Correctly report and transmit income taxes and other payments related to employees, such as Social Security and unemployment compensation (if required).
  • File the Form 990 completely, accurately, and on time.  Also, e-file to eliminate the most common mistakes the software will not allow math errors, omitting attachments or  required schedules, or failing to sign the return.