Ann K. Batlle Morgan Lewis

How to Prepare for & Survivean IRS Mini-AuditFinance & Administration RoundtableNovember 15, 2006 Ann K. Batlle Morgan Lewis

IRS Enforcement in EO Sector The IRS EO Work Plan for FY2007 states that it will continue to focus on “enhanced enforcement of the tax laws” in the sector. Other regulators also have taken an interest in exempt organizations: • Senate Finance Committee Investigations • House Ways and Means Investigations • State Attorney General Investigations • Increase in investigative reporting about real or perceived abuses in the EO sector

IRS Enforcement in EO Sector The IRS has increased its audit presence in the tax-exempt community, augmenting its traditional audit methods with some alternatives: • Correspondence examinations • Targeted compliance requests • Limited scope examinations • Follow-up letters or phone calls regarding information reported on Forms 990.

IRS Enforcement in EO Sector Exempt Organizations Compliance Area (EOCA) • Sends compliance checks and educational letters to selected organizations to monitor compliance within the sector Review of Operations (ROO) • Monitors organizations previously found to be non-compliant, as well as newly exempt entities

IRS Selection of Organizations to Audit • Team Examination Program • General Program • Targeted exam initiatives • Compliance Program • Market Segment Studies • Targeted compliance initiatives • Returns Inventory and Classification System (RICS) • Referrals

Types of IRS Examinations • Office/Correspondence Examination Program (OCEP) • limited scope; typically involves no more than three issues • focus on smaller organizations (<$100,000 in revenues) • Field Audit • examination of entity’s business records, usually on premises • Team Examination Program • intensive audits covering a range of tax areas, not just exemption and income tax • Used with large organizations (>$100 million in revenues) • Church Audit

The Examination Stage - Commencement • Initial phone call and letter from the revenue agent • Initial document request list; typically includes: • Corporate documents: Articles of incorporation, bylaws, resolutions of the board, minutes of board meetings for the past several years; • Director transactions: list directors and any transactions between the organization and directors; • IRS application for recognition for exemption and subsequent IRS correspondence; • Accounting records: financial statements, chart of accounts, accounting manual • Business documents: correspondence files, contracts, donor lists • Tax records: reconciliation workpapers, employment tax returns, returns of affiliated individuals or organizations • Entity publications (IRS will also review web-site) • Payroll and pension plan records

The Examination Stage - Commencement • Tax advisor should attend and present power of attorney • Assess potential scope and length of audit • Identify areas of revenue agent interest (UBIT, political activity, etc.) • Set ground rules for procedural issues • Identify to the IRS one contact person within organization who will be the clearinghouse for documents and information

The Examination Stage –During the Audit • Maximize control over audit • Keep examination moving quickly • No IRS “fishing expeditions” – require agent to concretely identify documents for review

The Examination Stage –During the Audit • Closely review all documents to be turned over • Remove and separate privileged documents to determine whether they should be provided • Collate files and records in good order • Produce documents without explanation or editorializing unless absolutely necessary • Keep good records of documents that the agent has seen; provide only copies - no open access to records and photocopier

The Examination Stage –During the Audit • Close review of documents can provide clues as to agent’s area(s) of interest • Issues can be resolved during the exam stage • Entity may proffer corrective action, if necessary, which can demonstrate its good faith

The Examination Stage –Concluding the Audit • Request a final meeting or phone call with revenue agent(s) to narrow any remaining issues to be resolved • May involve Group Manager or someone even more senior if relationship with agent has been difficult

The Examination Stage –Concluding the Audit • Agent issues 30-day letter with Revenue Agent Report • Appeal Rights • 30 days to protest to the IRS Appeals Office • If entity does not file a timely protest, the IRS issues a statutory notice of deficiency • Closing Agreements • Petition to Tax Court or Suit for Refund • Fast-track Mediation • Technical Advice

EO Work Plan for FY 2007 –An Ambitious IRS New Projects • Gaming organizations – at least 50 new audits in 10 states • Employment tax compliance • Community foundations • College and university-related UBIT issues • Outreach on implementing PPA and obtaining the telephone excise tax refund

EO Work Plan for FY 2007 –An Ambitious IRS “Critical Initiatives” • Political Activity Compliance Initiative (PACI) • contact at least 300 organizations that may have violated political activity rules; follow-up on referrals from 2006 elections • Continuing audits of: • Credit Counseling Organizations • Down-Payment Assistance Organizations

EO Work Plan for FY 2007 –An Ambitious IRS “Critical Initiatives” • Executive compensation • Forthcoming report on results of 1200 compliance letter responses and 800 single-issue exams • Audits focusing on loans to officers and excess benefit transactions • Tax-exempt hospitals – 500 compliance letters • Community benefit • Executive compensation

EO Work Plan for FY 2007 –An Ambitious IRS “Critical Initiatives” • Ongoing audits, internal IRS studies and issuance of new guidance about the PPA for: • Donor Advised Funds • 509(a)(3) Supporting Organizations • Tax Shelter Accommodation Parties • New disclosure and excise tax rules

EO Work Plan for FY 2007 –An Ambitious IRS Other Projects • 527 organizations – verification of status as qualified state or local political organizations • EOCA educational letters on new e-filing obligations • Risk Modeling Project • 200 new audits of organizations with “highly scored” returns from risk modeling for non-compliance • 50 new audits of gaming organizations

Preparing for an IRS Audit Periodically conduct an in-house audit • Particularly important for organizations appearing on the current EO Work Plan • Can be conducted in connection with preparation of annual Form 990 • Also review publicly available compliance letters and Congressional investigation requests to see what type of information is being requested by regulators

Preparing for an IRS Audit • Are the organization’s activities conducted in compliance with its governing documents and its IRS determination letter? • Has the organization kept the IRS informed as to any material changes in operations since the original exemption letter? • Do the corporate minutes clearly document the relationship of program activities to the fulfillment of exempt purposes?

Preparing for an IRS Audit • Are the organization’s financial books and records adequate to document clearly the nature of revenues and expenses? • Is there an appropriate and well‑documented basis for allocations of expenditures among related entities? • Are income‑producing activities conducted and reported in compliance with UBIT rules?

Preparing for an IRS Audit • Has the organization considered making the lobbying election? Is it in compliance with lobbying and political activity restrictions? • Are arrangements with independent contractors in compliance with employment tax rules, and are all required Forms 1099 filed?

Preparing for an IRS Audit • Does the organization have salary surveys or other information to justify executive compensation? Is there a strong conflict of interest policy which provides guidance for transactions with insiders? • Are fund‑raising activities conducted in compliance with donor disclosure rules? • Does the organization have a policy of making its exemption materials and Forms 990 available for public inspection?

Ann K. Batlle Morgan Lewis