When IRS scrutinizes nonprofits -- How to protect your organization from an audit

What makes the IRS hone in on a nonprofit organization? It can be as small as a simple mistake made while filling out the annual 990 or as large as management collusion. For those who fall in the former category, here is a list of a few issues the IRS may target in an audit:

Internet

Be careful about using the Web. The IRS watches Internet activity related to politics, lobbying, and income received from advertisements. Virtual charities and Web-based fundraising are also under increasing scrutiny.

Worker Classification

Employee or independent contractor? Use caution when classifying workers. Nearly half of past nonprofit audits have faced headaches due to independent contractors. Organizations tend to classify workers as independent contractors, when in fact, they should be classified as employees. This misclassification can lead to back taxes, penalties and interest.

Joint Ventures

This area has always been highly scrutinized by IRS audits. When nonprofits and for profits combine, the line separating charity and profit becomes skewed. The most examined joint venture tends to be between nonprofits and for profit health care organizations.

Fringe Benefits

Make sure to include fringe benefits in the taxable compensation of managers. Employers often forget to include onsite parking, employer provided automobiles, and employer provided living accommodations in taxable pay.

Gambling fundraisers

Fundraisers are a common way for nonprofits to raise money. Gambling fundraisers, in particular, are a well-known way to bring in some quick cash. However, hosting a bingo night or casino night can sometimes lead to taxable income known as unrelated business income. Hosting too many of these events can even cause an organization to lose their tax exempt status.

Be cautious, be smart, and don’t gamble with the IRS.

--LeAnn Carlson

Changes start in the head

I recently took some time off. I needed to clear my head. I needed to refocus. I needed to re-energize. So I packed my bags and spent a week at the College World Series in Omaha. What a wonderful experience!



"Everyone thinks of changing the world, but no one thinks of changing himself,."

Tolstoy.

The early summer days in Omaha are long. The ballpark is filled with sunshine, raw energy and college kids - tomorrow's leaders. Wow. No wonder my parents were scared when I was that age. College students are delightfully detached from the universe. A combination of raging energy and delightful innocence. The perfect atmosphere to recharge one's batteries.

As I sat through a two and a-half hour rain delay, I made a number of observations:

How soothing is a gentle rain? I observed a man sitting at a picnic table, sound asleep, with the rain softly tapping on him.

Are you looking for a career for your child? Consider podiatry. Every woman and virtually every young man wore "flip-flops". Fallen arches and flat feet is sure to be a growth industry.

Are people really so different? Not when there is a common cause. People from all over the countrywearing every imaginable team shirt, visited as if long lost friends.

Why do people wearing "flip-flops" avoid stepping in pools of water? I'm still searching for the answer.

And now, the rest of the story: We all need to recharge periodically. Whether we are building a new business from the ground up or simply maintaining an existing business, we need to be motivated. We need to be positive. We need to be energetic. We are the leaders. The organization gathers its energy and direction from us. We are guided by our head.

-- Steve Cook

How to help avoid increasing audit fees

Time.

It all comes down to the amount of time a firm and its employees must spend gathering support and documentation.

The use of an hourly rate is standard in the industry. Overall audit costs rise as audit hours go up. Why the increased support and documentation? Two words: "new standards."

These new accounting and auditing standards imposed by government regulators are often difficult to interpret. They can be even harder to apply. Some of the more well-known changes include:

• Greater responsibility related to the detection of material fraud
• Gaining a better understanding of the design and operation of a client’s internal controls
• Obtaining specialized knowledge regarding fair value measurements
• Determining the best answer when presented with conflicting guidance in professional literature

What can firms facing audits do to assist the auditors and decrease audit costs? The following list provides a few basic rules to follow to make an audit as smooth as butter. Butter? Well, maybe crunchy peanut butter.

• Ask your auditors for a list outlining what documents they will need. He will probably ask for:
  • Articles of incorporation
  • Debt agreements
  • Significant leases
  • Minutes of the Board of Directors
  • IRS filings
  
  
• A company should designate sufficient personnel to the audit. For example, your chief financial officer, controller, accounts receivable manager, accounts payable manager and internal auditor should be available, when needed. During an audit, a company should hold a meeting to introduce the audit form and also develop a joint audit plan that identifies deadlines and materials needed to meet them.

-- LeAnn Carlson

The Coming Storm – How to Deal with IRS’ Increased Efforts in Tax Enforcement and Compliance

In recent years, we have seen the number of audits conducted by the IRS decrease significantly. For calendar year 2007, the IRS’ overall audit percentage was 0.8% of returns filed. That means that only one in about 120 returns was audited, and many of those were high-income individuals and businesses. Comparing this to 2006 data (when the audit rate was 1.6%) shows us that IRS is auditing only about half as many returns as in the past. This has led to a taxpaying public that is less and less concerned with the risk of an IRS audit.

That’s all about to change if IRS has anything to say about it.

The IRS recently announced an initiative to increase staffing for audit and compliance staff. They also announced a renewed effort to close the “tax gap” – the hypothetical difference between what the tax people should pay and what they do pay. Finally, IRS announced that it will devote more resources to collecting past due balances from taxpayers. So what does this mean for the average taxpayer? There are three main points we at Cook & Associates are advising our clients to be aware of in a time of increasing IRS scrutiny:

• First, we make sure our clients know to keep adequate records of their reported income and expenses. In our experience, the biggest reason taxpayers lose deductions under audit is a lack of proper substantiation. Expense reports, business receipts, sales slips, and any other document that supports a taxpayer’s deductions should be kept for a minimum of seven years.
• Second, we advise clients to be sure to consider the risks they take when filing their tax return. This might not be the best time to try a hyper-aggressive tax strategy or to venture too far into a grey area when it comes to taking tax deductions. The tax code does have some room for interpretation, but there are many areas where the rules are “black and white”.
• Finally, in the event that a taxpayer is unable to pay their tax liability in full, we advise that they deal with the situation proactively. Many people choose to wait and see what IRS will do about a past due tax bill – we can promise that they will try to collect – with interest and penalties. There are several programs available to delinquent taxpayers. These programs work best when a liability is addressed immediately, not when IRS has already placed tax liens or levies on a taxpayer’s assets.

If you have any questions about dealing with a potentially more aggressive IRS, or how to keep your tax records “audit proof”, please contact our offices.

-- Dan Musick

CEOs who develop realistic business plans are more likely to succeed than those who don't have one

“Concentrate on solving the problem that makes all the other problems soluble,” said Holman Jenkins, Jr in the Wall Street Journal.

Gary Harpst, the author of Six Disciplines-Execution Revolution, makes the claim that the biggest and toughest challenge in business is to build an organization that has the ability to plan and execute while at the same time overcoming the inevitable surprises in business. He goes on to say that building an organization that executes each and every time is the greatest challenge of the CEO and the Organization.

So, how do you do it? How do you build an organization with a realistic business plan that becomes executable each and every time? How do you build an executable business model that adjusts for changes without veering off course?

A blog does not allow us to explore a topic in massive detail, but let’s take a look at the most critical questions: First, as the CEO/Owner, what is the highest and best use of my time? And, secondly, if I put myself in the position of routinely performing my highest and best uses, how can I be assured that the organization will perform the remaining functions in a predictably executable fashion time after time?

The solution that we practice and recommend is two-fold. First, systematize as many functions as possible. Systematize routine functions to the extent that someone with the lowest possible level of training can successfully perform the operation. Next, we suggest that you outsource all those non-essential functions that require time and money but that don’t fall under “the highest, but best use” label.

Why this approach? The blatant, cold truth is that we as CEOs always spend more time in our highest/best use area than in the other areas of the business because it is within our comfort zone. As a result, we typically don’t end up doing a very good job in either area, leaving the Company exposed. As a wise man once said, “We usually know what to do. It’s just that we don’t always do it.”

-- Steve Cook

When accelerated depreciation on a business asset makes sense

A commonly used tax planning device is the ability to take accelerated depreciation on business assets. Normally, an asset is purchased and the business deducts (depreciates) its cost over a time period of several years. This time period is mandated by IRS based on the type of asset that is purchased. The IRS has enacted several provisions that allow businesses to accelerate the depreciation that they deduct on an asset and take most (or all) of it in the year of purchase. This is an important decision because taking accelerated depreciation can greatly reduce the amount of tax that the business owes - and paying less tax is generally thought of as a good thing. There are, however, several reasons why accelerated depreciation might not be right for every business.

For example, when a businessperson takes accelerated depreciation on an asset, she might not be matching her cash flow to her deductions. If she finances a piece of equipment for five years, but takes the entire depreciation allowance in year one, it will mean that she is spending money for four years without being able to deduct any of that expenditure. This could leave her with profit on the books (and thus a tax liability) but no cash in the bank to pay the taxes. From a management standpoint, it might be a better idea to match her depreciation deduction with the length of the note to avoid this situation.

Another time that taking accelerated depreciation might be a bad idea is when a business is growing. In this case, it’s likely that income will be larger in future years than it is right now – and that could mean paying taxes in a higher bracket. In cases like this, we often advise our clients to save the depreciation deduction for future years when they can receive a greater benefit for their deduction. A deduction of $10,000 when you are in the 20-percent tax bracket would save a taxpayer $2,000, but timing that same deduction two years later when they are in the 28-percent bracket could save them $2,800.

Finally, taking accelerated depreciation might not make sense if the businessman is likely to sell the asset in the near future. Any time an asset is depreciated, it reduces the book value for that asset. If a businessman purchases an asset and immediately takes 100 percent depreciation, he now has zero book value (basis) in that asset – he's used it all up in depreciation. Now, if he sells that asset in two years, he will have to pay tax on whatever the sale price of the asset was in the form of capital gains. This is called “depreciation recapture” and it can be a costly tax trap.

In the end, the decision to take accelerated depreciation on a major asset purchase is one that should be made carefully and with the advice of a qualified financial professional. If you have any questions about whether accelerated depreciation can benefit your business, please call our office.

-- Dan Musick

In these difficult times, CPAs are needed to help address inefficiencies in a business' operations

As a group, certified public accountants and other financial officers are pretty conservative.
So the news that the American Institute of Certified Public Accountants is releasing information from a recent survey that we believe our national economy is improving should serve as a sign that things are looking up.

According to the Portland Business Journal: "For the first time in a year, sentiment is improving in our quarterly economic outlook survey," Arleen Thomas, AICPA’s senior vice president for member competency and development, said in the news release announcing the survey results. “We see a significant shift from pessimistic to neutral on the economy which suggests a leveling of confidence. At the same time, CFOs and CPAs are remaining cautious as they continue to grapple with difficult decisions within their organizations.”

In these difficult times, it's important that business owners engage their CPA to help them address the financial performance of their company. A professional accountant brings an independent review of data and trends that most businesses can't see as they focus on their daily operations.

-- Steve Cook