Completing Form 990 takes a lot of time and effort. Nonprofits deal with this substantial challenge each year, dutifully gathering information on all financial activities and filing the mandatory report with the IRS. While NFP leaders typically strive to ensure the accuracy and timeliness of their 990 returns, mistakes can slip through here and there. That’s a concern, and not just because we all like to think we’re fulfilling our tax obligations correctly.
Making a mistake on Form 990 often brings unwelcome attention from federal and state authorities, leading to further examination of tax-exempt status or audit. It’s not only mistakes that can trigger additional exploration, either. While every return is unique, numbers that fall outside expected ranges for various reporting points can trigger agency actions. Sometimes unusual numbers reflect a rare-though-real situation, but accurate or not, these seven 990 red flags are particularly likely to earn IRS scrutiny.
- Disproportional fundraising expenses. The ratio of fundraising expenses to overall income varies between nonprofits, but most organizations follow a familiar pattern that tax and regulatory agencies have come to expect. If the amount of fundraising expenses is remarkable relative to an organization’s income, NFP leaders should expect curiosity from donors and tax authorities alike.
- Exceptional compensation profiles. Nonprofit leaders work hard, and delivering appropriate compensation for outstanding effort is both reasonable and appropriate. Organizations that report compensation that’s exceptionally high – or unusually low – relative to its size and budget are likely to face questions and requests for explanation about why their expenses in this area don’t adhere to the norm.
- Incorrect allotment of expenses to UBI. Tracking and reporting unrelated business income has long been a thorn in the collective side of nonprofit leaders. This complex issue leads to frequent mistakes and misattributions. But while it’s easy to make a mistake here, the IRS is kind of a stickler for accuracy. If the agency spots something questionable in this portion of Form 990 it won’t hesitate to commence audit proceedings.
- Mismatched reporting. Like other filers, nonprofits are obligated to provide employees, contractors, vendors and others with the appropriate tax documents, either a W-2 or Form 1099. When IRS receives conflicting reports of compensation from the organization and a payee, it starts looking more closely to determine who’s telling the truth and why these figures differ.
- Inadequate documentation of foreign spending and accounts. Reporting responsibilities that stem from foreign spending and assets often extend beyond Form 990. Failing to file a required Report of Foreign Bank Accounts (FBAR) or Schedule F, or to fully meet 990 reporting requirements surrounding activities in other countries is an open invitation to spend some quality time with the IRS.
- Links to taxpayers under audit. Even organizations that scrupulously attend to Form 990’s every detail and submit reporting that’s 100 percent correct can be drawn into extended IRS interaction on occasion. Simply through its association with board members, vendors or others being audited for (hopefully) unrelated reasons, a nonprofit can earn facetime with IRS representatives. This risk is yet one more reason for NFPs to take reasonable precautions to ensure all partners are operating ethically and legally.
- Incomplete or missing Form 990. This red flag is a glaring one, but one that’s completely avoidable. Omitting some required information or failure to file Form 990 entirely for one or more tax year may make things easier in the short term but it will almost certainly create bigger headaches down the line. If you’re not sure how to complete the necessary reporting or need more time, it’s always better to seek professional help and/or file for an extension rather than just ignoring the problem.
Nobody loves preparing tax returns, and getting the job done completely and correctly is an undisputed inconvenience. Still, that annual hassle is far less difficult than dealing with an IRS audit. Being aware of these red flags can help your nonprofit organization avoid unnecessary follow-up activity from the IRS and regulatory bodies. If you need assistance with Form 990 or any critical compliance, contact the knowledgeable tax and nonprofit advisors at HBP.