Tax-exempt organizations should be aware that the Internal Revenue Service plans to add more focus—and more personnel—toward its examination efforts, including new strategies to address potential noncompliance.
The new year has brought new hires to the Internal Revenue Service (IRS), including additional personnel to conduct more tax-exempt organization examinations. As Maria Hooke, director of exempt organizations examinations at the IRS, explained to attendees of the TE/GE Exempt Organizations Council meeting in Washington, DC, on February 21, the IRS has added 40 additional revenue agents for exempt organization examinations, with even more hires expected throughout 2020. Exempt organizations should understand these increased enforcement efforts and consider proactive steps to address any potential noncompliance.
For context, IRS exempt organization examiners conducted more than 3,800 examinations in 2019 and closed 3,675 of those. These numbers may well increase in future years. And the IRS’s hiring announcement follows recent tax litigation involving exempt organizations—such as Mayo Clinic v. United States,[1] Giving Hearts, Inc. v. Commissioner,[2] Abovo Foundation v. Commissioner,[3] and Association for Honest Attorneys v. Commissioner[4]—as well as a Senate Finance Committee inquiry into the practices of various nonprofit, tax-exempt hospitals, and the public revelation of an IRS whistleblower complaint against a prominent church regarding its use of tax-exempt investment funds.
The IRS is also rolling out new strategies to address potential noncompliance. These strategies address issues such as Section 4947(a)(1) nonexempt charitable trusts that have underreported income or overreported charitable contributions, investments and nonmember income of Section 501(c)(7) social clubs, organizations that were previously for-profit entities, and organizations that show signs of private benefit or inurement.
These new compliance strategies are data driven and cover various issues, including unrelated business income, operational issues, foundation status, filing requirements, and self-dealing transactions. The IRS recently closed 1,982 examinations initiated from data-driven approaches, which resulted in audit adjustments 85% of the time. Closed examinations also uncovered issues regarding unrelated business income, filing requirements, employee classification, and organizational requirements.
The IRS continues to examine a statistical sample of smaller exempt organizations that filed a Form 1023-EZ, Streamlined Application for Recognition for Exemption. That includes organizations ineligible to use the form, filers operating bingo or other gambling activities, and filers who donate to or pay expenses for individuals.
The increase in examiners, while significant, may not result in as robust an IRS audit program as existed a decade or two ago. Nevertheless, tax-exempt organizations should not become complacent because of the reduction in audit activity over the last several years. As tax-exempt organizations prepare their Forms 990 for last year, now would be a good time to ask whether there are any areas warranting further review and, if so, to seek to address those issues in a timely fashion.
Morgan Lewis extern Meghan Holjes contributed to this LawFlash.
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Washington, DC
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[1] 412 F. Supp. 3d 1038 (D. Minn. 2019).
[2] T.C. Memo. 2019-94.
[3] T.C. Memo. 2018-57.
[4] T.C. Memo. 2018-41.