IRS audit issues for exempt organizations.

• Author: Mulcahy, Timothy W.

The primary objective of an IRS audit of an exempt organization is to determine whether the organization is organized and operated in accordance with its exempt function.

Maintaining Charitable Purpose

An entity's organizational articles or governing documents must state its charitable purpose; a deficiency cannot be cured by the entity's activities. Also, the entity must operate in accordance with its exempt purpose. It must comply with reporting and disclosure requirements, including filing annual information returns and other documents and making them available for public inspection. IRS examiners perform in-depth reviews of activities and operations to ensure that an entity continues to meet the statutory exemption requirements.

If an entity materially changes its activities and, thus, becomes inconsistent with its charitable purpose, it may not be able to rely on a new determination letter recognizing exempt stares.

Any such changes must be reported to the IRS immediately, so that a determination can be made as to stares. By not reporting a material change, an organization may lose exempt status and be required to file retroactive returns.

UBIT

Another issue under IRS scrutiny is unrelated trade or business income (UBI). Under Sec. 512 and 513, UBI is income derived from any trade or business regularly carried on by an exempt organization that is not substantially related to its exempt purpose or function (except that the organization uses the profits derived from that activity). Examples of UBI include debt-financed rental income (under Sec. 514) and sales of merchandise unrelated to its exempt purpose. An organization with more than $1,000 in gross income from UBI must file Form 990-T, Exempt Organization Business Income Tax Return (and proxy tax under section...