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IRS Audit Survival: Is Your Nonprofit Ready for the Public Support Test?
Running a nonprofit can be challenging, and the last thing you want is to worry about an IRS audit. With the focus on making a positive impact, managing donor relations, and ensuring smooth operations, it’s easy to overlook the importance of meeting IRS requirements. One key area that can raise concerns is the Public Support Test. So, how do you ensure that your nonprofit is fully prepared if the IRS decides to audit your organization?
What is the Public Support Test?
The Public Support Test is a critical IRS measure that checks whether your nonprofit is primarily supported by the public. To maintain your status as a public charity, your organization must meet the threshold where at least one-third of your funding comes from public contributions (as per Code Sec. 509(a)(1)).
If your nonprofit generates most of its income through programs or sales—such as museums or performing arts centers—there’s a second test (509(a)(2)) that balances both public donations and program revenue. Passing either test ensures you keep your public charity status. However, failing the test could lead to your nonprofit being reclassified as a private foundation, which comes with stricter regulations and higher tax liabilities.
The IRS doesn’t audit nonprofits without reason, but certain factors can raise red flags:
Inaccurate Reporting: Errors or discrepancies in your Form 990 can attract attention.
Over-reliance on Major Donors: Relying too heavily on a small group of large donors may lead to failure of the Public Support Test.
Funding Changes: Sudden shifts in funding sources may also raise suspicion.
Incorrect Calculations: Miscalculating public support, including the improper handling of unusual grants or excess contributors, can be a problem.
Key Areas the IRS Will Focus On During an Audit
If your nonprofit is audited, here are the areas the IRS will likely scrutinize:
Public Support Percentage: Did your nonprofit meet the one-third public support threshold?
Source of Income: Were all income sources—donations, grants, and sales—accurately reported?
Handling of Unusual Grants: Were any one-time large grants excluded from your public support calculations, and was it done correctly?
Failing to meet these requirements can lead to serious consequences for your organization.
How to Prepare for an IRS Audit
Now that you understand what might trigger an audit and what the IRS will be examining, here are some tips to ensure your nonprofit is always audit-ready:
Keep Detailed Records: Maintaining accurate records of donations, grants, and income sources for at least five years is crucial. This way, if an audit occurs, you can easily demonstrate where your funding comes from.
Double-Check Your Public Support Percentage: If your public support percentage is close to the 33.3% threshold, double-check your calculations. Even minor errors can cause big issues.
Review Schedule A of Form 990: Schedule A is where you provide details about your public support percentage. Ensure this is filled out correctly every year.
Seek Professional Help: Nonprofit tax compliance can be tricky. Consulting with experts like G&S Accountancy can help you avoid mistakes and keep your organization compliant.
Consequences of Failing an IRS Audit
If your nonprofit fails the Public Support Test during an IRS audit, the consequences can be severe:
Reclassification as a Private Foundation: This reclassification brings stricter rules, more reporting requirements, and higher taxes.
Excise Taxes: As a private foundation, your organization may face excise taxes on investment income.
Administrative Burdens: Private foundations are required to distribute a percentage of their income yearly, and conflicts of interest rules are much stricter.
At G&S Accountancy, we specialize in helping nonprofits stay IRS-compliant. Our services include:
Audit-Ready Recordkeeping: We’ll ensure your records are clear, detailed, and compliant with IRS standards.
Public Support Test Calculations: We’ll manage your public support percentage calculations to ensure your nonprofit meets IRS criteria.
Form 990 Preparation: Let us take the stress out of preparing your annual tax forms. We’ll ensure your Schedule A is accurate and complete.
IRS Audit Representation: If you ever face an audit, we’ll represent you and guide you through the process.
Frequently Asked Questions
1. What is the Public Support Test, and why is it important?
The Public Support Test ensures that your nonprofit is funded by a broad base of donors and the public. If your organization meets the requirement, you can continue operating as a public charity, avoiding reclassification as a private foundation, which has stricter rules and taxes.
2. What might trigger an IRS audit for nonprofits?
Common triggers for audits include discrepancies in Form 990, over-reliance on a few major donors, and incorrect public support calculations.
3. How can we avoid mistakes in public support calculations?
Partnering with G&S Accountancy can help. We ensure accurate, compliant calculations and handle the complexity of donations, grants, and unusual contributions.
4. What should we do if we are audited?
If you’re audited, don’t panic. G&S Accountancy will help you gather necessary records, review your financials, and represent your nonprofit in front of the IRS.
5. How can G&S Accountancy help keep us compliant year-round?
We offer year-round support beyond tax season. Our services include detailed recordkeeping, ongoing reviews, and assistance with Form 990 and public support calculations to keep your nonprofit compliant.
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