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IRS Scrutiny of New Nonprofits on the Rise

IRS Scrutiny Of New Nonprofits On The Rise

Applying for tax-exempt, 501(c)(3) status has always been a formidable process for the uninitiated.  From the planning to the paperwork to the IRS follow-up, it has never been a walk in the park.

The Foundation Group has worked with nearly 13,000 nonprofit startup clients since our founding in 1995.  Over the years, we have seen quite an evolution with regard to the IRS review process.  You could throw just about anything at the IRS back in the mid-90s.  Not that we did that, mind you.  We have always been diligent to present our clients in the best and most compliant light possible.  It’s just that the bar was not set all that high, frankly…at least not compared with now.

As the 90s gave way to the 2000s, the IRS began to raise that bar.  Reviewing agents started requiring applicant organizations to adhere much more closely to the letter of the law as opposed to simply the spirit of it.  By the mid-2000s, concerns about conflict-of-interest and private benefit (inurement) emerged as dominant themes of the review process.  It remains that way to this day.  We quickly adapted to the changing landscape and preemptively began to supply supplementary information along with that which was required, in an effort to answer questions before they could even be asked by the IRS.  This foreknowledge of what to expect has contributed greatly to us having such a high percentage of no-questions-asked IRS approvals.

Fast-forward to today.  2012 has certainly continued the long-running trend of escalating IRS scrutiny.  But there are differences in this year’s escalation.  We have noticed a distinct turn toward IRS reviewers seeking extraordinary detail way beyond standard documentation.  An example of this can be seen in this question from a recent IRS letter we received regarding a client’s 501(c)(3) application (edited for clarity):

[quote]You represent (that) you will approve compensation arrangements based on information about compensation paid by similarly situated taxable or tax-exempt organizations for similar services, current compensation surveys compiled by independent firms or actual written offers from similarly situated organizations.  Please explain in detail which of the above you used to determine to pay Person A $XX and provide a copy of all applicable documentation.  Also, provide detail and documentation concerning your decision to pay Person B $XX. [/quote]

This is but one example of several that we have received over the past few months.  What does it mean?  It means that the IRS is leaving no stone unturned in its quest to insure that what a nonprofit says it is doing compliance-wise, it is, in fact, doing.  We have already made significant internal adjustments to our client preparation in response to these changes, so our clients will be just fine.  For those relying on someone who doesn’t know this process like we do, or are maybe doing it themselves, it may prove to be a rough road for them.  We expect a noticeable increase in application denials for those not prepared for what awaits them at the IRS.

Just one more reason to trust the experts at The Foundation Group!

Greg McRay, EA

Greg McRay is the founder and CEO of The Foundation Group. He is registered with the IRS as an Enrolled Agent and specializes in 501(c)(3) and other tax exemption issues.

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