Top 5 Compliance Problems for 501(c)(3) Organizations

IRS exempt organizations audit manager Joe Kroll spoke at a program for the Bar Association of San Francisco yesterday and discussed five common ways charitable organizations jeopardize their 501(c)(3) tax-exempt status.

  1. Private inurement / private benefit.
  2. Lobbying and political activity. 
  3. Filing requirements.  Small 501(c)(3) organizations that have not previously filed Form 990 or Form 990-EZ may be required to electronically file Form 990-N.  Failure to file for three consecutive years will result in revocation of exempt status.
  4. Unrelated business activities.
  5. Employment issues (particularly the employee-independent contractor-volunteer distinctions).
You can read more about each of these issues in the IRS Compliance Guide for 501(c)(3) Public Charities.

Kroll explained that the IRS no longer conducted random audits except where an industry segment has compliance problems or a single practitioner is involved in the formation of several noncompliant organizations.  Referrals are the number one source for audit investigations.  Media stories are another substantial source.  Because of the recent expansion of the audit group, there are many new hires who will be auditing smaller organizations (e.g., under $1 million annual revenues) as they get experience.

Kroll briefly discussed the new Form 990.  He noted that this is the first time the Form has been substantially revised in 30 years and that 75 percent of the Form related to activities rather than finances.  It is truly an information return and not just a financial return.

The Form now allows no attachments other than Schedule O.  But you can submit as many Schedules O as necessary.  This will help assure that complete returns end up being imaged by Guidestar.  Note, however, that, according to Kroll, it is the IRS position that referring someone to Guidestar does not in and of itself meet the Form 990 public disclosure requirement.

Here are some great IRS resources shared with the audience:
Thanks to Joe for a great presentation!

2 thoughts on “Top 5 Compliance Problems for 501(c)(3) Organizations

  1. Karl Slaughenhaupt

    I have some questions about fund raising and managing 501 (c) (3) contributions. If a person solicits and collects money on behalf of a 501 (c) (3) but does not actually give the money to the 501 (c) (3) what code or statute would this violate? In this scenario the 501 (c) (3) never actually gains possession of the funds. Further, let’s say the donations were deposited into a personal private checking account of a person not officially part of the 501 (c) (3) and disbursed from that account. Also, if the money is solicited and collected to support a specific event but is used for a different event, is that not also a violation of law? Would this be a criminal violation of law or some lesser offense? If so, can you please cite the legal reference?

    • Gene Takagi

      These are state law issues and specific state statutes and regulations regarding fraud and diversion of charitable assets will likely apply to the person raising funds, though there may be instances when a professional fundraiser raises funds for a charity subject an agreement to distribute only amounts over a certain minimum threshold covering the fundraiser’s fees and costs. That may or may not be unlawful too. Money solicited and collected to fund one project but used for another may be a breach of charitable trust but the nature, scope, and extent of such diversion may determine whether it’s a violation that would face enforcement. For example, if a charity raised $1 million with a solicitation stating such monies would be used to help veterans and then uses it to support the opera, that’s more likely to be enforced than the case of a charity raising $100 with a solicitation stating that such monies would be used to fund a holiday gathering but is instead used to fund its general administrative costs because not enough funds were raised to host a gathering this year.

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