Armanino Blog

The IRS Is Using Data Analytics on Form 990: What This Means for You

by Katy Brown

Nonprofits have been under a new sort of scrutiny lately, as the IRS has begun using data analytics to determine which organizations they should audit each year. The data reveals which nonprofits are more likely to be noncompliant with government regulations, and the IRS is capitalizing on that information by performing more targeted audits than in years past.

The Rise of Big Data

While nonprofits have always been required to make their tax returns available for public inspection, sharing information with the public has become easier than ever before. As filing requirements have changed, more and more nonprofits have begun e-filing their tax returns, making it much less difficult for them to update their public records. Having more current entity information is extremely helpful for charitable givers, and e-filing returns is often the easier option for charitable organizations and their accountants. 

However, e-filing also enables the chronically short-staffed IRS to scrutinize the returns more closely and   discover more about the filing entities than they could before. Their new strategy involves running reports on electronic data provided by charitable organizations to select entities for audit, rather than conducting random samplings, as in the past. This approach should reduce audits that produce no substantive changes, which means that charities have the opportunity to reduce their own audit risk through proactive compliance.

Raising Red Flags

Form 990 requires an organization’s leaders to answer question after question about their operations, programs, board members, funding sources, policies and procedures, along with many other topics. The IRS data mining queries can look at the responses to these questions and estimate which entities may be operating in a way that is inconsistent with nonprofit regulations.

The IRS has best practices for how nonprofits should adhere to governmental guidelines. If any of the answers on a tax return hint that the nonprofit is not following these best practices, the return is more likely to be flagged for examination. Returns with multiple flags will be selected for audit.

Government regulations can be very specific, and even a small deviation from the requirements could cause an entity to lose its 501(c) status. For instance, if a nonprofit shows negative restricted net assets on its Form 990 balance sheet, the organization may be dipping into its restricted funds to cover ongoing operations, in violation of Uniform Prudent Management of Institutional Funds Act (UPMIFA) requirements and the board’s fiduciary responsibilities. Even if the IRS doesn’t find any problems with the originally flagged items, they may question any other items presented on the return selected for audit. 

What You Can Do

Reviewing the details of your tax return with a tax professional will help you identify potential red flags and make the changes needed to bring your organization into alignment with IRS best practices. Not only will this decrease your chances of being audited, it will also help your organization improve its overall business practices.

We also recommend that nonprofits commission a tax compliance review every five years or so, to uncover reporting inconsistencies. This involves a deeper look at your Form 990 reporting than would typically be involved in annual tax preparation, and is designed to enhance and improve your public reporting. Even if your tax reporting is up to IRS standards, this detailed review can reveal other issues that may impact your nonprofit status. Something as simple as your board of directors failing to file board minutes as required can mean losing your 501(c) status, for example. By being proactive, you’ll mitigate these risks and help keep your organization strong.

December 15, 2017

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Katy Brown - Manager, Tax - San Ramon CA | Armanino
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