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Many organizations we have worked with have a vague sense of dread when it comes to IRS, state, and public scrutiny. There's often no specific reason for the nagging concern, just a lingering fear that something might be amiss. Below are some preventive measures to take that can put your organization in a stronger, more informed position in dealing with the IRS, the public, and the media. Although by no means exhaustive, the list should provide a sense of the kinds of internal and public measures available in light of increased nonprofit scrutiny.

  1. Public Relations through Public Reporting. Most government filings are public records. Competitors, local media, legislative offices, and regulatory agencies may be examining your filings, so use them to describe your services to the public. For instance, you can include in IRS Annual Return Form 990, Activities Sections III and VIII, a description of how your organization is fulfilling its mission.
  2. A Conservative Approach to Employee/Independent Contractor Issues. The IRS has long devoted some resources to making sure that employees are not incorrectly classified as independent contractors. Someone on staff should be knowledgeable about the factors that allow for an accurate and good faith determination of whether a worker is an employee or independent contractor. One of the quickest ways to incur back taxes, penalties, interest, and heightened IRS scrutiny, is through the underpayment of employee withholding and social security taxes.
  3. An Aggressive Approach to Unrelated Business Income (UBI) Issues. Unrelated business income must be reported annually to the IRS on Form 990-T and estimated taxes paid quarterly. Rather than determining after the fact if unrelated business income taxes are due, we suggest determining in advance what revenues might constitute unrelated income. Then make your best case for the relatedness of an item. And finally document (as you would any business or personal tax deduction) the good faith reasons for making such determination.
  4. Continued Good Faith Action by Board and Staff. You may have noticed our emphasis in other articles on the importance of good faith action. In general, the IRS and other regulators are on the look-out for intentional wrong-doing and actions taken in bad faith. This may be particularly true in the case of fast-growing organizations, those which "compete" with for-profit companies, and those whose top staff members have dual responsibilities as board members.

    In our estimation, the vast majority of revoked tax exemptions and personal penalties occur not because of good faith mistakes, but because of bad faith actions on the part of officers and directors. Therefore, although it is easy to say and much more difficult to actually affect, make sure that in everything from board recruitment to hiring policies, directors, officers, and managers share the same bottom-line principle: good faith commitment to fulfilling the mission of the organization.
  5. Adoption of Conflict of Interest Policy. Extra caution should be taken in guarding against possible conflicts of interest and perceived conflicts. In order to create internal awareness of potential conflicts and to demonstrate good faith compliance to external audiences, you may wish to add a conflict of interest statement to your bylaws, board manual and personnel policies. The statement, while it might authorize payments to directors and other insiders in many circumstances, would also require defined precautionary measures be taken to ensure impartiality and fairness in such transactions.
  6. Self-Audit. The chances of an IRS audit, while small, are not negligible. It may be worthwhile to address problems before the IRS informs you of its intent to audit by periodically reviewing activities in high profile or higher risk areas.

    There is much confusion, even within the IRS, about exempt organization practices. The chances of an IRS audit for most fall in the range of 0.5%-1%. But it is impossible to predict in advance the degree of familiarity a given IRS auditor might have for certain types of expenditures or revenue producing activities. In the event of IRS audit, one auditor may seriously question issues that another might not even notice. Regardless of the merits of the issue, an organization would still be in the position of having to expend the time and effort to defend its practices.
  7. Improved Documentation and Board Minutes. Documentation establishes good faith. A complete and up-to-date minute book of meetings of the board of directors, containing appropriately recorded board resolutions, shows good faith legal compliance. IRS auditors and state authorities often look at the minutes, so use them to tell your story concisely and accurately. A lack of such records can be perceived not as a sign of an informally operated organization but as intent to circumvent fiduciary obligations.

    Similarly, the bylaws of the organization should reflect the actual organizational and decision-making structure. Accurate bylaws show good faith adherence to the standards of nonprofit governance. They may even help an organization avoid challenges to its corporate and business actions and deflect allegations of impropriety.

    In sum, all of the above factors argue in favor of taking a comprehensive approach to governmental compliance and internal recordkeeping. While unglamorous, it may become pivotal upon audit or other inquiry to be able to fully substantiate the legitimate reasons for past activities and for undertaking certain actions and transactions.