A fun thing about practicing law is to observe changes to governmental agencies. The last few years at the IRS’ EO Division- the section of the federal government responsible for overseeing tax-exempt organizations- has been quite a rollercoaster. The IRS’ EO Division came under intense congressional and public scrutiny in 2013, under allegations that the agency intentionally discriminated against conservative, pro-life, and pro-Israel organizations.
The scandal’s effect on the IRS’ EO Division was monumental. The Service today is different on so many levels from 2013. Moreover, 2017 brings a new sheriff to 1600 Pennsylvania, and the IRS is certain to undergo further changes under Trump’s administration. How have these changes impacted nonprofits, and what’s in store for 2017? Here are some selected observations on audits, the Form 1023-EZ, and what might be ahead for the IRS under President Trump’s administration.
- Audits are Back but Slow, Painfully Slow. In the scandal’s wake (2013-2015), there seemed to be far less audits than in prior years. The year 2016 appeared to be a turning point, as a recognizable increase emerged in the number of nonprofit IRS audits. The agency has reassigned at least thirty employees from EO determinations to examinations and has stated that staffing will be prioritized for audits. As Congress continues to trim the IRS’ EO Division’s budget, the agency is forced to regulate record numbers of nonprofits with far less staff and resources. IRS examinations have never been a quick experience. But, they appear now to be proceeding slower than ever. Regular hot topics for audits include Form 1099 reporting compliance, employee status and filings; contracts with for-profit entities or insiders; and unreported unrelated business income. Nonprofits should be prepared in these areas and allocate the resources necessary to do everything possible to keep the IRS’ examination process moving as quickly as possible.
- Increased Reliance on Data Analytics for Selecting Audits. The IRS selects some audits based on referrals from various sources while others are based on an organization’s Form 990. One of the major pushes over the last few years is the development and use of machine-readable Form 990s so that the large amounts of data reported in 990s can be better analyzed. The IRS now provides the public with access to machine-readable Form 990s, which is a shift from the previous image-only files. This transition enables the IRs to develop and rely on diverse algorithms that can preselect Form 990s for potential noncompliance. Resulting information is limited, but new algorithm-based audit system is expected to be in place for 2017. Accordingly, the IRS will continue to push for electronically-filed Form 990s and be positioned to statistically target potential noncompliance issues based on the Form 990 filings. How should nonprofits prepare? The Form 990 is an “information return”, not an annual reporting of finances, and the so information reported is intended to collectively communicates much information about a nonprofit. Accountants and attorneys well-versed in exempt organization law should review 990s prior to the nonprofit’s board review and identify potential concerns. A reasonable explanation often exists for what may appear as noncompliance. Nonprofits do well to proactively address these issues in the Form 990.
- 1023-EZs. The use of IRS Form 1023-EZ streamlined application continues to increase, as many small nonprofits seek to quickly secure tax-exempt status. Concerns over the sufficiency of this review process and the impact to the nonprofit sector remain, and many resulting problems continue to surface. The IRS now provides the public with a quarterly update of all organizations receiving exemption through the IRS Form 1023-EZ. The temporary regulations governing the Form 1023-EZ expire in 2017, and we’ll see whether any changes are made per the permanent regulations. The IRS’ release of denial letters over the last few months shows that the IRS is vetting at least some of the 100,000 applicants that have sought exemption through filing the 1023-EZ. Our law firm’s anecdotal experience is that many organizations are missing important aspects of corporate development and IRS compliance, due to the 1023-EZ’s oversimplification, with implications ranging from mildly problematic to catastrophic. Nonprofits and donors should also understand the distinctions between the IRS’ approval of Form 1023 Applications and 1023-EZs and potential implications this may have. Additional due diligence in grant-making, joint-ventures, or even for volunteer directors serving on the board is advisable.
Changes Thus Far under the Trump Administration. One significant campaign promise from President Trump was to dramatically reduce federal regulations. To this end, on January 20, 2017, after taking office, President Trump signed an executive order freezing regulations. Thus, any new regulations affecting nonprofits are- absent special circumstances – are on an indefinite hold. Moreover, a second executive order issued ten days later established a rule whereby for every new regulation issued, two regulations must be eliminated and that the incremental cost for the new regulation be $0. How these specific orders impact the Treasury’s oversight of nonprofits is unknown. Presumably the regulatory framework for nonprofits, at least at the federal level, could simplify. At the same time, the amount of federal funding for nonprofits is likely to decrease. Moreover, since enacting major tax reforms is at least verbally a high priority for the Administration, significant changes to the IRS’ oversight of the nonprofit sector could still likely occur.