Earlier this year, the IRS’s Exempt Organization and Government Entities Division (TE/GE), in its FY 2016 Priority Letter , affirmed that it has moved to a data-driven decision-making process in determining examination plans. Among other things, the new audit selection methodology for the most part eliminates subjectivity from how auditees are identified and selected. The most likely outcome? Industry experts surmise that the IRS will cast a wider net with its audits, but not necessarily a deeper one, because the TE/GE’s compliance budget was not increased.
So what, exactly, is changing, and where do we go from here?
The Old Approach
It is helpful to compare the “old” audit selection methodology with the new one. In past years, the TE/GE’s compliance activities were often issue-specific and focused on entities it considered a higher risk for noncompliance. That meant the IRS targeted various types of exempt organizations when deciding whom to audit. For example, after TE/GE conducted a hospital study, they conducted many audits of hospitals. After TE/GE conducted a college/university study, they conducted many audits of colleges/universities. Additionally, in the past, TE/GE conducted many audits of §501(c)(7) social clubs and organizations that conducted “big ticket” raffles.
The New Approach
The IRS’s new approach is to use analytics drawing on data from the Form 990. There are approximately 150 different queries that the IRS now runs for each Form 990 filed by an exempt organization. If an exempt organization “fails” too many of the 150 queries, then it is more likely to be audited by the IRS.
Although the IRS has not publicized the specific content of its 150 queries, industry experts have surmised it is most likely focused on the following aspects of the Form 990:
- Identifying inconsistent information being reported on the Form 990, for example, the total program service expenses reported on Part III, Line 4 not agreeing with the total program service expenses reported on Part IX, Line 25, column (B).
- Reporting amounts in column (C) of Part VIII, but not reporting that a Form 990-T was filed on Part V, Line 3.
- Preparing Schedule L to report an insider transaction, but reporting on Part VI, Line 12 that the organization did not implement a conflict of interest policy.
- Responding affirmatively to a Part IV inquiry, but not completing the applicable Form 990 schedule.
What We Know So Far
The IRS has reported that they have experienced return change rates over 90% since they have implemented the new audit selection methodology for exempt organizations. Previously, the IRS was experiencing return change rates in the 70% range. Additionally, TE/GE has reported that in 2015, it took them an average of 233 days to complete the audit process for an exempt organization, while so far in 2016, it has taken them an average of 213 days to complete the audit process for an exempt organization.
Where Do We Go From Here?
Preparers of the Form 990 should be mindful of the new audit methodology and can focus on both accuracy and completeness. The core form contains a series of yes/no questions, and depending on that response, it may be necessary to furnish additional information that is a required component of a complete return. A common misperception is the schedules that are filed along with the core form are reporting “supplemental” information and, thus, are of lesser importance, or that “immaterial” items are not a priority. However, the concept of immateriality that is applied in a financial statement audit setting does not apply to tax forms.
Allot enough time to Form 990 preparation to avoid errors and omissions. Reviewers of Form 990 can ask questions if anything seems amiss and pay extra attention to ensure something is not inadvertently overlooked. Additionally, an exempt organization should ensure that it does its best to minimize, if not eliminate, the reporting of "red flags” on their Form 990.
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