When Is an Audit Required for a Nonprofit?
Many nonprofit organizations are considered tax-exempt, which makes it seem strange that they would have to submit a yearly return. Charities and nonprofit organizations are public entities, and to make sure they are being financially responsible, the IRS requires charitable organizations to file a Form 990. While this return isn’t for tax purposes, it’s a way for the IRS and the public to evaluate how nonprofit organizations use donations and federal money to advance their mission.
Nonprofit audits are required for all public charities, private foundations, and supporting organizations with annual gross receipts of more than $500,000 or total assets (net worth) of more than $250,000 at the end of a fiscal year. Federal, state, and local governments may request a copy of the nonprofit’s audited financial records, especially if a large proportion comes from public sources.
Nonprofit organizations can be audited for a number of reasons:
- To make sure the organization and board members are operating legally and ethically
- To verify the accuracy of financial statements
- To make sure that Form 990 has been filed on time and for each fiscal year
- To determine if the organization has complied with laws and regulations
The IRS Nonprofit Audit Preparation Checklist
When your organization has been selected to receive a review of its returns, you will receive a letter informing you one of the following will happen:
A field audit where an IRS agent visits your premises to conduct the audit
An office or correspondence audit where your organization either visits a local revenue service office or mails in documents
Typically, an organization’s board or designated audit committee will review and approve yearly Form 990 filings. This audit readiness checklist will cover the relevant sections of Form 990 so you understand the kind of information the IRS and donors require.
Part I – Summary
This is a snapshot of the organization’s mission, governance, financial, and operational information.
- Is the mission clearly communicated?
- Do the organization’s goals include the mission?
- How do the current year’s financials compare to the previous year’s?
Part III – Statement of Program Service Accomplishments
The financial system of a nonprofit is to fund programs, and this section details their results and all related costs.
- Does the information here explain who the organization serves, and do the programs directly benefit them?
- Are the programs described in enough detail?
Part IV – Checklist of Required Schedules
The IRS uses this section to evaluate the likelihood of inaccuracies or incomplete information as it determines whether or not the return needs to include more detailed information.
Part V – Statements Regarding Other IRS Filings and Tax Compliance
Not all compliance requirements are financial, and this section is intended to alert organizations and the IRS about other potential issues.
- Are personnel properly classified as employees or independent contractors?
- Did the organization provide receipts for donations over $250?
Part VI – Governance, Management, and Disclosure
This section covers visibility and transparency by asking questions about who is in charge and the policies within the organization about how they report information.
- Does the organization have written policies?
- If not, should they?
- If so, how accessible are they?
- If the organization operates in multiple states, is it properly registered in those states?
Part VII – Compensation of Officers, Directors, Trustees, Key Employees, Highest Compensated Employees, and Independent Contractors
Compensation is a tricky issue for nonprofits, and this section makes sure their compensation and benefits are justifiable.
Part VIII – Statement of Revenue
This is a detailed list of the organization’s sources of income.
- Does the organization rely too much on one source of income?
- Is any listed income potentially taxable?
Part IX – Statement of Functional Expenses
All activities have a related cost, and the IRS and donors use this section to make sure that money spent is going toward specific purposes.
- How much of the organization’s expenditures are toward compensation?
- Are all expenses justifiable?
Part X – Balance Sheet
Balance sheets are a snapshot of financial positions and determine financial stability by comparing assets to liabilities.
- Does the organization carry a lot of debt?
- Does the organization carry an excessive amount of cash?
- Are liabilities monitored for timely payment?
- Is there excessive credit card debt that would indicate cash flow issues?
Part XII – Financial Statements and Reporting
If an organization uses an independent accountant, this section details their level of involvement and the reporting required for organizations that receive federal grants.
- Who do auditors report to?
- How often are independent audits completed?
- How long should nonprofits keep financial records?
- Does the organization have an internal oversight committee to review and act upon the results of independent audits?
Schedule A – Public Charity Status and Public Support
This part details the organization’s distinction between a public charity and a private foundation and provides evidence about sources of financial support.
Schedule C – Political Campaigns and Lobbying Activities
Nonprofits have to be careful when they support political campaigns, and this section details any lobbying activities that could jeopardize their tax-exempt status.
Schedule J – Compensation Information
This is more detailed information than what is found in Part VII. Schedule J is important to find evidence of waste, overcompensation, extravagance, and financial abuse.
Schedule L – Transactions with Interested Persons
As a public entity, the organization must disclose direct or indirect transactions and arrangements with interested persons. This goes so far as to have the organization describe the relationship they have with the party and the purpose behind it.
Schedule O – Supplemental Information
An organization would use this section to explain responses to specific questions related to Form 990.