How to Prepare for & Survive
an IRS Mini-Audit
Finance & Administration Roundtable
November 15, 2006
Ann K. Batlle
Morgan Lewis
IRS Enforcement in EO Sector
The IRS EO Work Plan for FY2007 states that it will
continue to focus on “enhanced enforcement of the tax
laws” in the sector. Other regulators also have taken an
interest in exempt organizations:
• Senate Finance Committee Investigations
• House Ways and Means Investigations
• State Attorney General Investigations
• Increase in investigative reporting about real or
perceived abuses in the EO sector
IRS Enforcement in EO Sector
The IRS has increased its audit presence in the taxexempt community, augmenting its traditional audit
methods with some alternatives:
• Correspondence examinations
• Targeted compliance requests
• Limited scope examinations
• Follow-up letters or phone calls regarding information
reported on Forms 990.
IRS Enforcement in EO Sector
Exempt Organizations Compliance Area (EOCA)
• Sends compliance checks and educational
letters to selected organizations to monitor
compliance within the sector
Review of Operations (ROO)
• Monitors organizations previously found to be
non-compliant, as well as newly exempt entities
IRS Selection of Organizations to Audit
• Team Examination Program
• General Program
– Targeted exam initiatives
– Compliance Program
• Market Segment Studies
• Targeted compliance initiatives
• Returns Inventory and Classification System (RICS)
• Referrals
Types of IRS Examinations
• Office/Correspondence Examination Program (OCEP)
– limited scope; typically involves no more than three issues
– focus on smaller organizations (<$100,000 in revenues)
• Field Audit
– examination of entity’s business records, usually on premises
• Team Examination Program
– intensive audits covering a range of tax areas, not just
exemption and income tax
– Used with large organizations (>$100 million in revenues)
• Church Audit
The Examination Stage Commencement
• Initial phone call and letter from the revenue agent
• Initial document request list; typically includes:
– Corporate documents: Articles of incorporation, bylaws, resolutions of the board,
minutes of board meetings for the past several years;
– Director transactions: list directors and any transactions between the organization and
directors;
– IRS application for recognition for exemption and subsequent IRS correspondence;
– Accounting records: financial statements, chart of accounts, accounting manual
– Business documents: correspondence files, contracts, donor lists
– Tax records: reconciliation workpapers, employment tax returns, returns of affiliated
individuals or organizations
– Entity publications (IRS will also review web-site)
– Payroll and pension plan records
The Examination Stage Commencement
• Tax advisor should attend and present power of attorney
• Assess potential scope and length of audit
• Identify areas of revenue agent interest (UBIT, political
activity, etc.)
• Set ground rules for procedural issues
• Identify to the IRS one contact person within
organization who will be the clearinghouse for
documents and information
The Examination Stage –
During the Audit
• Maximize control over audit
• Keep examination moving quickly
• No IRS “fishing expeditions” – require agent to
concretely identify documents for review
The Examination Stage –
During the Audit
• Closely review all documents to be turned over
• Remove and separate privileged documents to
determine whether they should be provided
• Collate files and records in good order
• Produce documents without explanation or editorializing
unless absolutely necessary
• Keep good records of documents that the agent has
seen; provide only copies - no open access to records
and photocopier
The Examination Stage –
During the Audit
• Close review of documents can provide clues
as to agent’s area(s) of interest
• Issues can be resolved during the exam stage
• Entity may proffer corrective action, if
necessary, which can demonstrate its good faith
The Examination Stage –
Concluding the Audit
• Request a final meeting or phone call with
revenue agent(s) to narrow any remaining
issues to be resolved
• May involve Group Manager or someone even
more senior if relationship with agent has been
difficult
The Examination Stage –
Concluding the Audit
• Agent issues 30-day letter with Revenue Agent Report
• Appeal Rights
– 30 days to protest to the IRS Appeals Office
– If entity does not file a timely protest, the IRS issues a statutory
notice of deficiency
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Closing Agreements
Petition to Tax Court or Suit for Refund
Fast-track Mediation
Technical Advice
EO Work Plan for FY 2007 –
An Ambitious IRS
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New Projects
Gaming organizations – at least 50 new audits
in 10 states
Employment tax compliance
Community foundations
College and university-related UBIT issues
Outreach on implementing PPA and obtaining
the telephone excise tax refund
EO Work Plan for FY 2007 –
An Ambitious IRS
“Critical Initiatives”
• Political Activity Compliance Initiative (PACI)
– contact at least 300 organizations that may have
violated political activity rules; follow-up on referrals
from 2006 elections
• Continuing audits of:
– Credit Counseling Organizations
– Down-Payment Assistance Organizations
EO Work Plan for FY 2007 –
An Ambitious IRS
“Critical Initiatives”
• Executive compensation
– Forthcoming report on results of 1200 compliance
letter responses and 800 single-issue exams
– Audits focusing on loans to officers and excess
benefit transactions
• Tax-exempt hospitals – 500 compliance letters
– Community benefit
– Executive compensation
EO Work Plan for FY 2007 –
An Ambitious IRS
“Critical Initiatives”
• Ongoing audits, internal IRS studies and
issuance of new guidance about the PPA for:
– Donor Advised Funds
– 509(a)(3) Supporting Organizations
• Tax Shelter Accommodation Parties
– New disclosure and excise tax rules
EO Work Plan for FY 2007 –
An Ambitious IRS
Other Projects
• 527 organizations – verification of status as
qualified state or local political organizations
• EOCA educational letters on new e-filing
obligations
• Risk Modeling Project
– 200 new audits of organizations with “highly scored”
returns from risk modeling for non-compliance
– 50 new audits of gaming organizations
Preparing for an IRS Audit
Periodically conduct an in-house audit
• Particularly important for organizations appearing on the
current EO Work Plan
• Can be conducted in connection with preparation of
annual Form 990
• Also review publicly available compliance letters and
Congressional investigation requests to see what type
of information is being requested by regulators
Preparing for an IRS Audit
• Are the organization’s activities conducted in
compliance with its governing documents and its
IRS determination letter?
• Has the organization kept the IRS informed as to
any material changes in operations since the
original exemption letter?
• Do the corporate minutes clearly document the
relationship of program activities to the fulfillment of
exempt purposes?
Preparing for an IRS Audit
• Are the organization’s financial books and records
adequate to document clearly the nature of revenues
and expenses?
• Is there an appropriate and well-documented basis for
allocations of expenditures among related entities?
• Are income-producing activities conducted and
reported in compliance with UBIT rules?
Preparing for an IRS Audit
• Has the organization considered making the lobbying
election? Is it in compliance with lobbying and political
activity restrictions?
• Are arrangements with independent contractors in
compliance with employment tax rules, and are all
required Forms 1099 filed?
Preparing for an IRS Audit
• Does the organization have salary surveys or other
information to justify executive compensation? Is there a
strong conflict of interest policy which provides guidance
for transactions with insiders?
• Are fund-raising activities conducted in compliance with
donor disclosure rules?
• Does the organization have a policy of making its
exemption materials and Forms 990 available for public
inspection?