4.75.11  On Site Examination Guidelines

4.75.11.1  (08-30-2010)
Introduction

  1. The purpose of this chapter is to provide guidelines and techniques for examiners to utilize in all audits, regardless of Internal Revenue Code section examined. Procedures for examinations conducted under Office Correspondence Examination Procedures are found in IRM 4.75.27.

  2. These guidelines and techniques are only meant to assist the examiner in conducting an examination. The examiner is expected to use their professional judgment, in conjunction with management approval, to establish and modify the appropriate scope and depth of the examination.

  3. For additional specific guidelines with respect to a particular Code section, please reference the chart below for the appropriate IRM section for guidance.

    Chapter Title
    4.76.1 Single Parent Title Holding Corporations IRC §501(c)(2)
    4.76.2 Special Features of IRC §501(c)(3) Organizations
    4.76.3 Public Charities
    4.76.4 Private Foundations
    4.76.5 Non-Exempt Charitable Trusts
    4.76.13 Civic Leagues, Social Welfare Organizations, and Location Association of Employees – IRC §501(c)(4)
    4.76.14 Labor, Agricultural, and Horticulture Organizations – IRC §501(c)(5)
    4.76.15 Business Leagues – IRC §501(c)(6)
    4.76.16 Social and Recreational Clubs – §501(c)(7)
    4.76.17 Fraternal Beneficiary Societies exempt under IRC §501(c)(8) and §501(c)(10)
    4.76.18 Voluntary Employees’ Beneficiary Associations – IRC §501(c)(9)
    4.76.19 Teachers’ Retirement Fund Associations – IRC §501(c)(11)
    4.76.20 Local Benevolent Life Insurance Associations, Mutual Ditch of Irrigation Companies, Mutual or Cooperative Telephone or Electric Companies, and Like Organizations – IRC §501(c)(12)
    4.76.21 Cemetery Companies – IRC §501(c)(13)
    4.76.22 Credit Unions – IRC §501(c)(14)
    4.76.23. Small Insurance Companies or Associations – IRC §501(c)(15)
    4.76.25 Supplemental Unemployment Benefit Trusts – IRC §501(c)(17)
    4.76.26 Veterans Organizations
    4.76.27 Black Lung Benefit Trusts – IRC §501(c)(21)
    4.76.28 Multiple Parent Title Holding Corporations or Trusts – IRC §501(c)(25)
    4.76.29 Apostolic Organizations – IRC §501(d)
    4.76.30 Political Organizations – IRC §527
    4.76.31 Health Maintenance Organizations
    4.76.50 Examinations of Organizations Conducting Gaming Activities
    4.76.51 Fundraising Activities

4.75.11.2  (08-30-2010)
After First Contact

  1. In IRM 4.75.10, Pre-examination Guidelines and Procedures, directions were provided as to the initial determination of the scope of examination, making initial contact, scheduling the initial appointment, issuance of the first information document, and formulating the interview questions.

  2. Prior to arriving at the audit site, a follow up call should be made to the organization’s officer/contact person or power of attorney. The examiner should verify receipt of the initial information document request, verify that the organization has the records requested, reconfirm the audit appointment, and answer any questions the individual has with respect to items asked for in the document request. This call should be performed in the week after the issuance of the initial information document request.

  3. If travel is required to arrive at the audit site (such as via an airline, train, ship, or by personally owned vehicle,) prepare a travel authorization on Govtrip in advance of the trip. Upon completion of the field visitation, a travel voucher will be prepared from the authorization, in order for the examiner to be reimbursed for the travel expenses.

    1. Completion of the travel authorization will frequently assist in determining the length of time that will be spent in traveling to the audit destination, ensuring that the examiner should be able to arrive at the audit site on time.

    2. Travelers who are flying to their audit appointments should utilize the website of the airline to check in 24 hours in advance of the flight to ensure that their ticket has not been cancelled by Govtrip.

    3. When traveling by plane, the laptop is to be stored in the space beneath the seat in front of the examiner. The examiner’s bags can be stored in the storage area above the seat, and any luggage can be checked in. Baggage fees should be charged to the government travel card, and will be reimbursed.

  4. When departing for the field examination, examiners should take the following items with them:

    • Laptop, with power cable

    • Air card

    • Cable lock

    • Printer

    • Blank printer paper

    • Case file (optional)

    • Pocket commission

    • Business cards

    • Printed copies of Publication 1, Your Rights as a Taxpayer

    • Driving directions, and

    • Hotel/airline/train reservations (if applicable).

    Note:

    Examiners are to leave any referral information in the office or at their flexiplace location in a locked cabinet. Electronic notes should be made of any key information in the referral package that will need to be referenced during the field examination.

4.75.11.3  (08-30-2010)
Start of Field Audit

  1. Most examinations will take a minimum of two days to complete all examination procedures and the accompanying paperwork. Cases that are higher graded (such as grade 12 or grade 13) may require a minimum of a week of field examination time to complete the review of the taxpayer’s records and prepare the workpapers documenting the review.

  2. Each agent participating in the examination is to present their pocket commission for inspection to the organization’s officers and/or power(s) of attorney at the initial meeting.

    Note:

    Title 18 U.S.C. §701 prohibits anyone copying or duplicating the employee’s credentials, causing such person to be fined under Title 18 or imprisoned not more than six months, or both.

  3. If not previously secured prior to the field visitation, request any Forms 2848 or 8821 to be provided prior to the beginning of the initial interview. Verify that all entries, including signatures, are valid and acceptable. Exhibit 4.75.11-1 provides a sample Form 2848, and a list of acceptable entries.

  4. Before starting the initial interview, Publication 1 is to be discussed with all persons present (even if the only person present is a power of attorney.) Documentation of the discussion can be recorded in the Form 5464, the Form 5773, or the initial interview workpaper.

  5. After completion of the discussion of Publication 1, the examiner is to start the initial interview with the officers. The discussion of internal controls can be either incorporated into the interview, or held as a separate interview after conclusion of the initial interview. A tour of the facility would be taken after the interview(s), if applicable.

4.75.11.4  (08-30-2010)
Publication 1

  1. Publication 1 is a two-sided document that encapsulates eight specific rights, as well as explanations of the examination, collections, appeals process, and refund claims. The May 2005 revision contains information about potential third party contacts.

  2. Examiners are to discuss both sides of the document, and specifically point out the section on potential third party contacts. Use of the May 2005 revision eliminates the need to issue notices of intent to contact third parties.

  3. When Publication 1 is enclosed with the initial information document request, contacts to third parties for information not in the possession of the taxpayer can occur ten calendar days after the letter was sent.

  4. If Publication 1 is handed in person to the taxpayer (officer representing the organization, or the power of attorney,) a third party contact can be made that same day. For additional information on third party contacts, see IRM 4.75.21.14 Third Party Contacts.

    Note:

    The Service's policy is to obtain information relating to a liability or collectibles determination directly from the organization whenever possible.

  5. Generally, an examiner would only contact a third party when he/she is unable to obtain the information from the organization/representative or to verify information provided by the organization/representative. Examiners must make every effort to obtain information first from the organization/representative.

  6. At the conclusion of the field examination, the examiner must advise the taxpayer and/or representative of all appeal rights, including the option of Fast Track Settlement, if available.

    Note:

    A flowchart of the Appeals process is included as IRM Exhibit 4.75.11-2.

4.75.11.5  (08-30-2010)
Initial Interview

  1. Under IRC §7602(a)(3), examiners are authorized to take testimony from persons concerned, under oath, as may be relevant or material to the inquiry. Interviews provide information about the taxpayer's financial history, business operations, and books and records that are not available from other sources.

  2. Interviews should be used to obtain information needed to make informed judgments about the scope and depth of the examination and correctly resolve issues. Interviews are used to obtain leads, develop information, and establish evidence.

  3. It is important to create an environment where the taxpayer feels comfortable. Examiners should maintain a friendly and professional demeanor. Suggestions for establishing rapport include:

    1. Examiners should introduce themselves.

    2. Examiners should explain what will happen during the examination.

    3. Examiners should be prepared to explain return selection procedures, rights to representation, and appeal rights. See Publication 3498.

    4. Examiners should recognize that an IRS audit is often a once-in-a lifetime experience for the organization and therefore the officers may be tense or nervous.

    5. Examiners should exhibit openness, honesty, and integrity and be calm and objective.

  4. Examiners should listen carefully to all details, be receptive to all information volunteered, regardless of its nature, and be patient and persistent in extracting the facts necessary to achieve the goals of the interview.

  5. Interviews should be conducted with an individual having sufficient knowledge of the organization's activities and operations.

  6. IRC §7521(c) states that an examiner cannot require a taxpayer to accompany an authorized representative to an examination interview in the absence of an administrative summons. The examiner can request the taxpayer’s voluntary presence at the interview as a means to expedite the examination process.

  7. The following are some important points in effective questioning techniques:

    1. Plan the interview to address the items specific to the taxpayer being examined;

    2. Ask clear, relevant and objective questions;

    3. Be direct, while maintaining a courteous, professional image;

    4. Listen to responses and ask further questions about any responses that were inconsistent, vague or did not adequately answer the question;

    5. Use open-ended questions, so the taxpayer has to answer using full sentences rather than a mere “yes” or “no” response.

    6. Research questionable items on the return to know what questions to ask.

  8. The following items should be discussed with the organization:

    1. Availability of requested books and records, if not already determined during the pre-examination phase;

    2. Explanation of the accounting system;

    3. Description of activities and current operations; and

    4. Issues identified during pre-examination planning.

  9. IRC §7521(b)(2) requires the examiner to suspend the interview if the official clearly states that he/she wishes to consult with a qualified representative.

    Note:

    This above provision does not apply to an interview initiated by administrative summons and cannot be used to repeatedly delay or hinder the examination process. Publication 1 advises the organization of this right.

4.75.11.5.1  (08-30-2010)
Interview Techniques

  1. There are five methods of interview that may be used during an examination:

    • Taking notes,

    • Memorandum of interview,

    • Affidavit,

    • Question and answer, and

    • Deposition.

  2. Taking informal notes is a commonly used method of recording an interview. This may consist of an interview outline, notes made immediately after an interview or conversation or a notation on an activity record made after a telephone conversation with the taxpayer.

    1. The informal notes should be prepared timely and contain sufficient detail to permit you to refresh your memory as to what happened during the interview.

    2. Any format is suitable provided it shows the date, place, persons present and what occurred.

  3. A memorandum of interview is an informal statement concerning facts obtained during an interview.

    1. The memorandum should show the date, time, place, and persons present, as well as what transpired during the interview.

    2. If possible, use the exact words of the taxpayer. Do not assume or interpret meanings. Just record the facts.

    3. It should be promptly prepared, signed, and dated by the agent present.

  4. An affidavit is a written statement of facts, made voluntarily and confirmed by oath.

    1. While the average individual cannot quote the law, he/she generally knows that the preparation or giving of a false statement is a criminal offense. Therefore, an affidavit has great validity when properly prepared and voluntarily given.

    2. An affidavit should be taken when an affiant (taxpayer, representative, or informant) presents information (written or oral) relating to his/her, or other income/excise tax liability. The Service provides Form 2311 and 2311-B for this purpose, however, affidavits may be taken on plain paper. Affidavits can be written or typed by the affiant or the agent. All words in the affidavit must be correctly spelled.

    3. Ideally, two representatives of the Service should be present, although it is permissible for one person to conduct an interview involving an affidavit. One representative will swear in the affiant after the affidavit is filled out. The affiant must have his or her hand raised at the time of swearing in.

  5. A question and answer statement is a transcript of questions, answers, and statements made by each participant at an interview. This form of recording an interview can become an affidavit provided it is confirmed by an oath. This form of recordation has the advantage of following the exact sequence of the questions that are asked in the interview.

    1. The interview transcript will be considered an affidavit once it has been signed.

    2. At the bottom of the interview, append the statement, "Under penalties of perjury, I declare that I have reviewed the above interview information, and to the best of my knowledge and belief, it is true, correct, and complete."

    3. Provide two lines at the bottom underneath the perjury statement for the individual's signature and a typed or printed name or title.

    4. After signing, the individual should also date their signature.

  6. Depositions are formal interviews primarily conducted during criminal investigations, where the agent, Counsel, and a stenographer are present during the interview. For further information, see IRM 9, Criminal Investigation.

4.75.11.5.1.1  (08-30-2010)
Affidavits

  1. At a minimum, an affidavit should contain the following information:

    1. Name: This should be the current full name as well as any current or prior alias.

    2. Address: The most current.

    3. Occupation: The present occupation of the person giving the affidavit. If the information relates to a prior occupation, then that occupation should be added.

    4. The identity of documents being submitted as part of the affidavit. The date on which it was prepared must be noted, the person who prepared it and the source from which it was prepared.

  2. If it is expected that an affidavit will be necessary, take several Forms 2311 to the interview, listen to the statements made, hand the form to the affiant to complete in their own handwriting, and then have the affiant sign and date the Form 2311.

  3. After the affidavit is filled out, the examiner will swear in the affiant by asking the following:

    1. "Do you swear or affirm that the foregoing facts are true to the best of your knowledge?"

    2. The affiant must have his/her right hand raised at the time of reply to this statement.

  4. The advantages of securing an affidavit are as follows:

    • It is a statement made under oath and can be used to establish or impeach the testimony of the individual.

    • It can be limited to contain only pertinent information.

    • The affidavit can be obtained during the interview. When the affidavit is written by the affiant, it tends to be unbiased.

  5. The disadvantages in securing an affidavit are as follows:

    • The statement may not follow the exact sequence of the interview.

    • It does not always reflect all the questions asked.

    • Taking a written statement under oath may decrease the willingness of the individual to speak freely.

    • If the affidavit is written by the agent, there is a tendency for the statement to be in the words of the examiner rather than the words of the affiant.

4.75.11.6  (08-30-2010)
Internal Controls

  1. Internal controls are defined as the taxpayer’s policies and procedures to identify, measure, and safeguard business operations, to avoid material misstatements of financial information.

  2. The lack of good internal controls may indicate the potential for diverted receipts, diverted assets, or other significant problems.

    Note:

    The lack of internal controls does not necessarily jeopardize exemption, but it may affect the scope of the examination. Any changes to the scope of the examination need to be communicated to and approved by the group manager.

  3. The scope of the examination is defined as the range of activities that are the focus of an audit. The scope includes all areas of importance in an audit.

4.75.11.6.1  (08-30-2010)
Evaluation of Internal Controls

  1. Examiners should evaluate the existence and effectiveness of an organization's internal controls and expand or contract the scope of the examination accordingly.

  2. Examiners should discuss internal controls with the organization’s officers or management early in the examination. This should generally be done during the initial interview. Examiners should explain the significance of internal controls in the context of tax-exempt organizations. In doing so, the examiner should emphasize the importance of proper stewardship of the tax subsidy afforded by the rest of the tax-paying public.

  3. In evaluating internal controls, the examiner should consider the extent to which the following control checks are utilized by the organization:

    1. Transactions are recorded in the books and records in a timely manner;

    2. The return reconciles to the books;

    3. The organization reconciles its bank statement balances to the books;

    4. There is segregation of duties;

    5. The organization has an active board of directors, consisting of members who are independent of one another;

    6. There are outside third parties such as a governmental agency overseeing the organization; and

    7. The organization has an annual independent audit.

  4. Additional considerations to be evaluated by the examiner are:

    • Insurance policies (property, directors and officers, etc.),

    • Indemnification of officers and directors,

    • Establishment of reserve funds,

    • Physical safeguarding of assets,

    • Separation of duties,

    • Required executive approval for adjusting journal entries,

    • Independent reconciliations (outside auditors),

    • Dual signatures on checks,

    • Non-use of signature stamps,

    • Bonding employees who have access to cash,

    • Modern computerized accounting systems,

    • Conflict of interest and whistleblower policies,

    • Written employee job descriptions,

    • Mandatory rotations of accounting employees (e.g. A/P to A/R to Payroll), and

    • Mandatory vacations of those responsible for record keeping.

4.75.11.6.2  (08-30-2010)
Segregation of Duties

  1. Segregation of duties is fundamental to a system of internal controls. The examiner should ask questions during the initial interview to determine whether the organization is observing this control.

  2. Questions aimed at evaluating segregation of duties with respect to expenditures may include:

    • "Walk me through (the process of) how expenditures are made and recorded."

    • "Who makes / writes the checks?"

    • "Who signs the checks?"

    • "Who records the expenditures in your accounting system?"

  3. Questions aimed at evaluating segregation of duties with respect to income may include:

    • "Walk me through (the process of ) how income is received and recorded."

    • "Who opens the mail?"

    • "Who makes deposits?"

    • "Who records the income in your accounting system?"

  4. The key to the proper segregation of duties is to have authorizations, executions, and recordings of transactions performed by separate, independent individuals.

4.75.11.6.3  (08-30-2010)
Addressing Poor Internal Controls

  1. Where significant weaknesses in an organization’s internal controls are found, but the examination otherwise results in a no-change, the examiner should consider issuing a written advisory as a closing letter addendum upon closing the examination. See IRM 4.75.15 for No Change with Written Advisory procedures.

  2. In any consideration of internal controls, examiners should be aware of the possibility of fraud. Weak internal controls can be a sign of possible fraud.

  3. Traditionally, fraud has been found to be more likely to happen when an individual has an incentive or is perceiving a financial pressure to commit fraud, where weak internal controls or operational oversight provide an opening or opportunity for the individual to commit fraud, and that the person is able to rationalize their behavior. This is referred to as the fraud triangle.

  4. Several accounts have added an additional consideration, that of capability, where the traits, education, and abilities of an individual can come into play when the other three factors are present.

  5. Any findings of affirmative acts or indications of fraud should be discussed with the TE/GE Fraud Specialist. Procedures are outlined in IRM 4.75.21.

4.75.11.7  (08-30-2010)
Tour of Facilities

  1. Regulation §301.7605-1(d)(3)(iii) states: “regardless of where an examination takes place, the Service may visit the taxpayer’s place of business or residence to establish facts that can only be established by direct visit, such as inventory or asset verification. The Service generally will visit for these purposes on a normal workday of the Service during the Service’s normal tour of duty hours.”

  2. The physical observation of the organization’s operation, or tour of business site, is an integral part of the examination process. Viewing the organization’s facilities and observing business activities is an opportunity to:

    1. Acquire an overview of the business operation,

    2. Establish that the books and records accurately reflect actual business operations,

    3. Observe and test internal controls,

    4. Clarify information obtained through interviews, and

    5. Identify potential audit issues.

  3. Tours of business sites should be conducted during field examinations of all organizations. Generally, the principal location, and any locations acquired during the period under examination, should be visited. However, consideration should be given to the cost effectiveness and practicality of conducting the tour. When appropriate, alternatives should be considered.

    Example:

    An IRC §501(c)(14) state chartered credit union operates branch offices in 23 cities in the state, as well as 150 ATMs not located at branch offices. The agent tours the main headquarters and a nearby branch office, opting to view randomly sampled security footage of the other branch offices, normally retained for the FBI in the event of a robbery.

  4. Tours can clarify what was said during the interview and provide a frame of reference when interpreting information in the books and records. This assists examiners to correctly refine the scope and depth of the examination and avoid unnecessary audit steps.

  5. Tours should be conducted with knowledgeable individuals. Officers, directors, trustees, employees, or the representatives, can often explain practices that appear unusual to the examiner.

  6. Tours should be planned to address large, unusual, or questionable items identified during the pre-contact analysis or interviews.

  7. Tours should not disrupt business operations or interfere with the organization’s interactions with customers.

  8. During the tour, the examiner should determine utilization of the organization's facility by others. The following situations if identified may require further documentation:

    1. Space used by other entities,

    2. Space used by officers or other individuals for their own personal or business use, and

    3. Space used for other than exempt purposes, such as a food service facility or bar open to the public.

  9. Observe and be alert to the physical surroundings. Confirm that assets identified on the tax return (and identified as having audit potential during the pre-contact analysis) are physically present and identify assets that are physically present but are not represented on the return.

    Example:

    When walking through a parking lot on property owned by the organization, consider asking whether any of the vehicles parked on the lot are owned by the organization. If so, who uses them, and are they used for personal travel, including commuting to and from work?

  10. Use of digital or film cameras are recommended when an issue is encountered for which documentation will be needed. Some organizations may frown on photography while on the tour, so any photos may need to be taken during a break, while departing for the day, or in the morning of the next day, prior to the start of the business day.

    Example:

    Signs posted at a gated entrance to a housing community owned by a homeowner’s organization may state that members of the public are not permitted. Photographs of such signs are a valid piece of factual evidence in a subsequent report proposing revocation.

    Example:

    Signs at a veterans’ organization inviting the public to come in for karaoke nights in the bar are a likely indicator of unrelated business income. Pictures of the signs can be inserted into the fact portion of a Revenue Agent Report.

  11. Ask questions to confirm understanding of what is observed and avoid confusion.

4.75.11.8  (08-30-2010)
Contemporaneous Documentation

  1. At this point of the examination, prior to the start of the examination of the actual books and records, the examiner should document actions taken, and complete and edit the workpapers generated for the interview, internal controls, and tour.

  2. On the Form 5464, Case Chronology Record, examiners will record an entry for the day mentioning that the interview, internal controls questioning, and tour were conducted.

  3. On the Form 5773, EO Workpaper Summary Continuation Sheet, entries should be completed for sections C-1, Initial Interview, C-2, Tour of Facility, and D-1, Method of Accounting/Internal Controls. Entries should summarize briefly any findings or determinations made during the interview, internal controls questioning, and the tour.

  4. Completed workpapers are to be indexed per the RCCMS naming convention and uploaded to RCCMS.

  5. During the remainder of the examination, the examiner should complete the relevant portions of the Form 5773 as a workpaper is completed, and update the Form 5464 as to procedures completed. All workpapers are to be indexed and uploaded to RCCMS prior to the closure of the case.

4.75.11.9  (08-30-2010)
Examination of Books and Records

  1. An examination of books and records will establish whether an organization is both organized and operated for tax-exempt purposes, what related returns have been or need to be filed by the organization, and whether any tax reported is reasonably correct.

  2. The examiner reviews the books and records to:

    1. Verify that any changes made to organizing documents do not jeopardize the exemption,

    2. Substantiate and expand information about the organization's activities,

    3. Verify the accuracy of the return,

    4. Verify that all appropriate returns have been filed and taxes paid, and

    5. Determine whether any taxes (income, employment, excise) are accurately reported.

  3. The following books and other records should be reviewed when appropriate:

    • Governing instruments and amendments,

    • Organization's determination letter and application,

    • Minutes,

    • Publications (websites, newsletters, brochures, pamphlets, etc.),

    • Operating manuals,

    • Contracts,

    • Leases, mortgages, and loans,

    • Deeds or other title documents,

    • Correspondence files,

    • Financial records (chart of accounts, trial balance, income statement, balance sheet, general ledger, transaction journals, etc.),

    • Third party records (bank statements, brokerage statements, invoices, receipts, etc.), and

    • Other filed Federal returns.

  4. Several of these documents should already have been reviewed during the pre-examination phase of the audit (such as the original organizing documents, the determination letter, the determination application, the trial balance, and some of the other financial documents.) For the pre-examination procedures, see IRM 4.75.10.

  5. The order in which these records are reviewed and examined is entirely at the examiner’s discretion. The following IRM sections outline a suggested order of action.

  6. When two or more EO Examinations agents are involved in an audit, examination procedures are to be assigned by the agent to whom the case is assigned.

4.75.11.9.1  (08-30-2010)
Governing Instruments

  1. For organizations exempt under IRC §501(c)(3), §501(c)(9), and §501(c)(17), a determination application that includes the organizing documents is required to be filed prior to the receipt of a determination letter. No other Code sections are required to file an application for exemption prior to filing the Form 990. Procedures for closing cases where no determination application was filed (and was not required) are found in IRM 4.75.21.

    Note:

    For organizations exempt under a group ruling (identified by the GEN (group exemption number) on INOLES/BMFOLO,) there will be no determination file for the specific entity.

  2. The examiner should review the organization's governing instruments to identify the following:

    1. Any amendments or changes that would jeopardize the organization's exempt status;

    2. Any committees with special responsibilities;

    3. Who controls the organization, both ultimately and in day-to-day operations; and

    4. Duties of officers, especially noting which officials are authorized to disburse funds and make decisions affecting the operations of the organization.

  3. The examiner should secure copies of amendments, including name changes, which the organization has not previously sent to the Service. These items need to be forwarded to the Cincinnati Records Unit to update the determination file. Procedures for forwarding the documents are found in IRM 4.75.16.

    Note:

    If no determination file was available on microfiche from Cincinnati, copies of the original and amended organizing documents (if any) need to be obtained for inclusion in the determination file.

  4. If the organization is subject to an organizational test under the Code, such as IRC §501(c)(3), §501(c)(4), §501(c)(6), §501(c)(7), and §501(c)(19), and fails the test, the examiner should consult with their group manager via secure e-mail or phone call while in the field. The manager, agent, and Area Counsel, if necessary, will determine any remedies to be sought.

    Note:

    Revocation of an organization should be proposed only after consideration of all other facts in the case, such as abusive transactions, failure to operate in an exempt manner, or inurement to insiders.

  5. Separate workpapers should be prepared for the articles and bylaws, with corresponding entries on the Form 5773. Any amendments can be addressed within the specific workpapers, and discussed on the Form 5773, section B-5, Amendments [Organizational Documents and Rulings].

    Note:

    If the organization is unincorporated, a trust, or has been chartered by a parent organization, the articles of association, trust instrument, or charter should be analyzed and an entry should be made on the Form 5773, section B-1, Articles of Incorporation.

4.75.11.9.2  (08-30-2010)
Determination Letter and Application

  1. The determination letter and application are parts of the EO microfiche file retained at the Cincinnati offices. By requesting the microfiche file prior to visiting the organization, the determination letter and application can be reviewed as part of the process of identifying large, unusual and questionable items during the pre-examination phase.

  2. If the determination file was not available prior to the audit, or no such file exists, the determination letter and application should be reviewed while at the offices of the organization, and copies obtained for submission to Cincinnati.

  3. Under IRC §6104(d), organizations are to provide copies of their determination application (including determination letter,) and their three most recent Forms 990 to the public upon request. The Pension Protection Act of 2006 included the Forms 990-T of organizations exempt under IRC §501(c)(3) under the public disclosure requirements. For further information, see Publication 557, Tax-Exempt Status for Your Organization.

  4. Penalties may be applied under IRC §6685 for failure to make the documents available for public inspection. Guidance for assessing the penalty can be found at IRM 20.1.8.2.3.

  5. Determination letters may vary depending on when and from which office they were issued. Determination letters issued before 1954 will reference IRC sections that predate IRC §501. Determinations letters issued from National Office Rulings and Agreements may differ in language from those issued via the EDS/TEDS system used by determination groups in Rulings and Agreements.

  6. Standard language and optional paragraphs for determination letters can be found at IRM 7.21.5, which discusses the various types of letters issued by determination groups.

  7. Review of the determination letter may identify earlier legal names of the organization, prior addresses, income/employment/excise tax return filing requirements, and FUTA liability. Any addendums attached will address issues identified by the determination specialist.

    Example:

    An addendum attached to a determination letter sent to a §501(c)(3) public charity discusses the possibility of unrelated business income tax generated by a proposed activity.

  8. Review of the determination application will identify the activities conducted or proposed at the time of the application. Organizations frequently change activities over time, however, a complete change in activities and purposes may indicate a misleading application.

    Example:

    A §501(c)(3) private foundation is established with the intention of giving college scholarships to students for a particular field of study on the basis of merit or financial need. The examination finds that the founder is sending only her own children and those of other substantial contributors to colleges.

    Example:

    An organization was granted exemption as a §501(c)(7) college fraternity. The examiner finds the organization to be a residents association for an off campus apartment building, where there is no common bond aside from living in an apartment, and there is no commingling. Dues are used to pay the utility bills for the apartment building.

4.75.11.9.3  (08-30-2010)
Minutes

  1. The examiner should review minutes for the year under examination, prior years, and subsequent years. At a minimum, coverage should include at least the year before and the year after the return under examination. The examiner will expand the review as circumstances warrant.

    Note:

    When, or if, challenged over the ability to request the minutes of prior and subsequent years when auditing just a single year, notify the organization that the examination concerns any activities conducted in the year under examination that were started, carried on, or concluded in a prior/subsequent year. Alternatively, obtain managerial approval to expand the examination into prior and subsequent years.

  2. The examiner should appropriately consider discussions about the following:

    1. Proposed or past activities, which may violate exempt purposes or constitute unrelated trade or businesses;

    2. Transactions which may serve the private interests of the trustees, directors, officers or private individuals; and

    3. Transactions with related entities.

  3. The examiner should review the minutes of any subcommittees, such as the executive, audit, finance, and compensation committees.

    Note:

    In cases involving §4958 excess compensation determinations, copies of the meeting minutes of the board, executive, and compensation committees should be retained for reference in the examination report.

  4. The examiner should consider all attachments, exhibits, and reports as part of the minutes. If they are not provided with the minute book, they should be requested as an integral part of the minutes. This would also include correspondence referred to in the minutes.

    Example:

    The set of minutes provided to the examiner mention a written report provided during a meeting. The report is not attached to the minutes. The examiner obtains the report after requesting it, and finds that details of a questionable transaction with an insider are included in the report, but not mentioned in the minutes.

  5. Dates listed in the minutes will help to identify possible timeframes to be used for document sampling.

    Example:

    The awarding of a scholarship is mentioned in the minutes as occurring on August 5th. Requesting the ledger and journal entries for that date, the examiner finds the scholarship check written to the individual and not to the college. The examiner decides to request copies of the college transcript or other reports that should have been obtained by the granting organization.

4.75.11.9.4  (08-30-2010)
Publications

  1. Any websites maintained by the taxpayer must be reviewed. A current as well as a past review should be performed due to the ever-changing content of websites. A printout of the taxpayer’s website as it appeared during the period(s) under examination should be reviewed if possible.

  2. If the organization has no print outs of the website as it appeared during the year(s) of examination, agents should log onto web.archive.org. This website captures and presents various websites as they appeared at different junctures in the past. Although this website does not provide a 100% recapture, it is substantial. Dynamic links within the old archives will not function, as they would no longer be active.

  3. Links to other websites may be indicative of advertising, for-profit joint ventures, other sources of unrelated business income, or inurement. If such links are found, request documentation of any e-mails, correspondence, contracts, and agreements entered into with respect to each questionable link.

  4. Review newsletters, pamphlets, brochures, magazines, annual reports, and similar items and determine whether the publication:

    1. Furthers the exempt purpose of the organization,

    2. Contains advertising, and/or

    3. Includes indications of legislative or political activity.

  5. Any issues arising from the review of the publications should be discussed with the organization’s officers to determine if there is additional supporting documentation, such as advertisement pricing charts, advertising contracts, lobbyist contracts, or other documents as come to mind.

4.75.11.9.5  (08-30-2010)
Operating Manuals

  1. If available and pertinent to the examination, the examiner should review any operating manuals, employee handbooks, instruction booklets or other materials outlining procedures to be performed in the course of business.

  2. Certain issues, such as worker classification, tip reporting, and unrelated business income, will require an in depth review of any such manuals, and potentially require photocopies of relevant portions.

    Example:

    An organization treats its workers as independent contractors, issuing Forms 1099-MISC to all individuals, including the corporate officers. The organization provides employee handbooks, operating manuals, training guides, and expense reimbursement instructions for vouchers.

  3. Consider requesting copies of relevant portions of operating manuals to be provided in electronic format, or use a scanner (if available in your post of duty,) to scan the portions into an OCR (optical character recognition) format, so that such material may be inserted directly into a Word document.

4.75.11.9.6  (08-30-2010)
Contracts

  1. Consider reviewing contracts, particularly those with officers, directors, trustees, and key employees. Determine whether private individuals are receiving any form of inurement or whether the organization has executed any agreements not in furtherance of its exempt purpose.

    Example:

    A §501(c)(10) fraternal organization has contracted with an insurance company to provide group term life insurance, at the organization’s expense, to the officers of the lodge.

    Example:

    A §527 political organization, established by a §501(c)(5) agricultural organization, enters into a contract with a registered lobbyist. The contract specifies that the lobbyist will communicate with members of the US Congress on the issue of farm subsidies.

  2. Review copies of contracts and agreements to determine if payments are at fair market value and are at arm's length.

    Example:

    The president/executive director of a §501(c)(6) chamber of commerce executes a contract to purchase property from the chamber. The president signed the contract as both president and as purchaser. The price agreed upon was less than the value shown on the property tax statement.

  3. The organization may act as a tenant/landlord for businesses, individuals, and other exempt organizations, or may have contracts for services provided to the organization. Obtain and review contracts for any such agreements for consideration of whether unrelated business income may be present.

    Example:

    A §501(c)(8) fraternal organization has a contract with a vendor who provides catering services for functions held at the lodge when the lodge is rented out to both members and non-members.

4.75.11.9.7  (08-30-2010)
Leases, Mortgages, and Loans

  1. Consider reviewing questionable leases, mortgages and loans, particularly those with officers or other related parties. Determine whether private individuals are receiving any form of inurement or whether the organization has executed any agreements not in furtherance of its exempt purpose.

    Example:

    A §501(c)(4) social welfare organization leases a bingo hall from one of its board members, who also has a contract to operate the bingo hall on behalf of the organization. The costs of the lease and bingo operation consume 95% of the bingo receipts.

  2. Review copies of mortgages, notes payable, notes receivable, loans, and leases to determine if payments represent fair market/rental value. Also, determine whether the agreements were entered into at arm’s length.

    Example:

    A §501(c)(5) labor union has a note receivable from the organization’s treasurer for a 5 year $25,000 note. The note provides for no monthly payments and interest is determined by the current savings rate offered by a local bank.

    Example:

    A §501(c)(12) mutual irrigation company has a note payable with a director of the organization. The note payable is for services rendered to the organization as a consultant for irrigation planning. The director owns a local farm that is coincidentally located next door to the waterworks building of the company.

4.75.11.9.8  (08-30-2010)
Deeds or Other Title Documents

  1. Review the title documents to verify ownership of any real property by the organization, from whom the property was acquired, and the date of acquisition.

    Example:

    A §501(c)(3) private foundation holds title to a building used as a museum, open to the public. The title document shows that the property was purchased from the founders of the foundation.

  2. Should questions arise from the review of the title documents, obtain copies of the purchase and sale agreements, or other contracts, if constructed by the organization. Examine the agreements for details on the terms of the purchase, the financing arrangements, and any additional considerations provided for the property. Determine if the purchase was at fair market value.

    Example:

    A §501(c)(21) black lung trust purchased a building to house its administrative services. The building was previously owned by the coal mine operator who established the trust. No mortgage was executed by the trust, as payment for the full cost of the building was made at the time of purchase.

4.75.11.9.9  (08-30-2010)
Correspondence Files

  1. Consider reviewing correspondence files. They usually fall into four categories:

    1. Letters soliciting funds that identify the nature of projects to be financed or supported;

    2. Correspondence relating to use of funds which identifies the type of organizations or activities being supported;

    3. General correspondence which identifies other activities carried on for or on behalf of the organization or related parties; and

    4. Correspondence with the Internal Revenue Service.

    Example:

    Letters issued by a §501(c)(6) sport fisherman’s association thank local businesses for their contributions of services rendered during a fishing derby. The letters identify values for the services provided, and state that the contributions are tax deductible.

    Example:

    A series of e-mails provided in a referral package from an inside informant documents transactions in which the vice president of a college purchased airline tickets at first class ticket prices, had the tickets converted to coach class by a travel agent, and then received half of the refunded amount from the travel agent.

    Example:

    The website for a §501(c)(3) religious organization offers certificates of ordination for a fee of $35. The website generates a letter e-mailed to the purchaser thanking them for their tax-deductible contribution.

  2. Request current correspondence the organization has had with the Service. Take appropriate actions to help resolve any outstanding notices or other problems the organization may be having with the Service.

4.75.11.10  (08-30-2010)
Financial Records

  1. A review of the financial information generally reveals important information about the organization's activities. Additionally it verifies that the information reported on the tax return is correct. Sampling of the transactions also determines the strength or weakness of the internal controls.

  2. Consider performing the following procedures:

    • Reconciling the books to the return,

    • Comparing prior and subsequent year income, expenses, assets, and liabilities,

    • Reviewing chart of accounts,

    • Reviewing year-end trial balance,

    • Reviewing auditor's report,

    • Reviewing audited financial statements and management reports,

    • Analyzing income and expenses,

    • Analyzing the balance sheet,

    • Test sampling transactions for amounts identified as large, unusual and questionable, and

    • Ensuring an accurate return is filed

    Note:

    Several of these will have been performed is the records were requested during the pre-examination phase and analyzed prior to arrival at the audit site.

  3. When an organization submits unorganized records, the burden is on the organization to arrange them, as well as prepare summaries and reconciliations.

4.75.11.10.1  (08-30-2010)
Definitions

  1. The term tax reconciliation workpapers means workpapers used in assembling and compiling financial data preparatory to placing it on a return. The trial balance, modified by adjusting entries input by either internal or external accountants, can frequently (but not always) be used to trace financial information to the return.

    Note:

    The tax reconciliation workpapers used by an accountant who prepares the return may use the trial balance as a starting point, but typically will consist of a separate workpaper that groups the income, expenses, assets, and liabilities, frequently netting amounts, and recognizing in-kind contributions.

  2. The term audit workpapers means workpapers retained by the independent accountant as to the procedures followed, the tests performed, the information obtained, and the conclusions reached pertinent to his/her examination.

    • Workpapers may include work programs, analyses, memorandums, letters of confirmation and representation, abstracts of organization/plan documents, and schedules or commentaries prepared or obtained by the auditor.

    • These workpapers provide an important support for the independent certified public accountant's opinion as to the fairness of the presentation of the financial statements, in conformity with generally accepted accounting principles and demonstrate compliance with the generally accepted auditing standards.

4.75.11.10.2  (08-30-2010)
Reconciliation of Books and Records

  1. The examiner should reconcile the return to the organization's books. This is necessary to ensure all transactions reported on the return have been recorded in the books.

    Note:

    If the tax return cannot be reconciled to the organization's books and records, this is a very good indication that internal controls may be inadequate or that proper accounting procedures are not being used.

    Caution:

    Consider the amount of deviation from the amounts recorded in the books and records. An insubstantial percentage of deviation may mean the difference is immaterial.

  2. Reconciliation of a tax return can be a very time consuming process if no tax reconciliation workpaper is provided other than an adjusted trial balance. When faced with such situations, consider reconciling just those accounts that were identified as large, unusual, and questionable.

    Example:

    A trial balance that shows $3 million more in income and expenses is provided, without any other tax reconciliation workpapers. Quick reconciliations of the LUQ accounts show deviations of less than 0.1%. No other issues are identified. Full reconciliation of the return would otherwise be expected to take no less than three weeks.

  3. The return reconciliation workpapers should be reviewed. These generally consist of year-end trial balances after any adjusting (and consolidating, if applicable) entries.

  4. Review the adjusting journal entries, as they often can be important indicators of unusual transactions or expenditures. If explanations of the adjusting entries are not straightforward, request written explanations for the reclassifications and/or adjustments.

  5. Identify and explain any material differences between the books and return.

    Example:

    The trial balance provided in the previous example is later determined to have $2 million of in kind revenues and expenses, $.5 million in refunds of membership dues, and $.5 million in allowances for doubtful accounts, none of which was reported on the return.

4.75.11.10.3  (08-30-2010)
Comparison of Prior and Subsequent Year Financial Information

  1. Compare the year under examination with prior and subsequent year income and expense statements to identify any large or questionable differences between years. Identification of amounts reported in only one year but not other years may indicate unusual, one time transactions.

  2. When comparing pre-2008 Forms 990 to prior Forms 990, amounts reported on the forms will need to be grouped for comparison, as the reporting of certain types of income and expenses were either grouped, eliminated, or reclassified in the post-2007 Forms 990.

  3. Review budget reports prepared by the organization. Large variances between actual and budgeted amounts may indicate diversion of funds or other problems requiring further analysis.

  4. Analysis of prior and subsequent years Forms 990 can be performed prior to the field visit, by obtaining copies of the Forms 990 from On-Line SEIN (http://sein.osc.irs.gov).

    Note:

    Access to On-Line SEIN may be restricted due to the number of site licenses available. If restricted, requests would need to be forwarded by the group manager to those individuals who have access for retrieval. All documents retrieved from On-Line SEIN can be printed directly to Adobe PDF. Access to On-Line SEIN is obtained via the Online 5081 process.

4.75.11.10.4  (08-30-2010)
Review of Chart of Accounts

  1. The examiner should review the chart of accounts for unusual accounts or accounts that should appear but are absent.

    Example:

    A §501(c)(19) auxiliary conducts bingo operations, using the associated post’s hall. The chart of accounts has an expense account titled raffle tickets. There is no account corresponding account titled raffle sales, or other similar name.

  2. The chart of accounts also assists the examiner in the review of the general ledger. The chart of accounts will associated account identifying numbers with account titles, classifying accounts as revenue, expense, asset, and liability.

4.75.11.10.5  (08-30-2010)
Review of Financial and Management Reports

  1. Review audit reports (both external and internal), as well as the management letter from the exempt organization's CPA. The latter report provides useful information on internal controls and the organization's accounting procedures.

    Note:

    See IRM 4.75.11.8 for a discussion of privileges that may be asserted by the organization’s officers.

  2. As part of the revisions made to the Form 990, for tax years ending in 2008 and subsequent years, organizations must disclose in Part XI, Financial Statements and Reporting, whether:

    1. A compilation of financial statements was prepared by an independent accountant.

    2. An audit was performed by an independent accountant.

    3. There is an audit committee that reviews any audits and selects the independent auditor.

    4. The organization is subject to an audit performed under the OMB Circular A-133 procedures due to receipt of a federal contract award.

    Note:

    OMB Circular A-133 audits require additional schedules to be included with the audit report, documenting expenditures of federal awards, audit findings, and corrective actions taken based on the audit findings.

  3. The organization's annual report should also be reviewed. This report may be issued to management, the public, and/or members. It usually discusses major accomplishments for the year and planned accomplishments for the future.

  4. Consider reviewing reports to or prepared by other regulatory groups, such as the Department of Health and Human Services or the Department of Education.

4.75.11.10.6  (08-30-2010)
Accountants Workpapers

  1. Request and review the accountant's tax reconciliation workpapers. They provide a good starting point for reconciling the return to the books.

  2. Tax reconciliation workpapers, unlike audit workpapers, should be requested at the beginning of an examination. There is a need for these workpapers since they include the final balance tying the return to the general ledger and other analyses necessary to complete the return.

  3. Ordinarily tax reconciliation workpapers are prepared and provided by the organization. However, if these workpapers are unavailable from the organization, access should be sought from the accountant.

  4. Requests for access to the audit workpapers can be made in unusual circumstances. Accountant's audit workpapers should normally be used only when such factual data cannot be obtained from the organization's records and then only as a collateral source for factual data.

  5. Limit any requests for audit workpapers to only those portions material and relevant to the examination. Whether an item is considered to be material is based on the examiner's judgment and an evaluation of the facts and circumstances in the case.

4.75.11.11  (08-30-2010)
Protected Privileges

  1. The following section discusses various methods by which an officer, director, trustee, or representative may attempt to hinder or halt an examination of the books and records of an exempt organization, by blocking the giving of testimony and providing of records. The methods include the following:

    1. Invoking the Fifth Amendment privilege against self-incrimination.

    2. Assertion of an attorney-client privilege.

    3. Claiming documents to be covered by the work product doctrine.

    4. Assertion of a federal tax practitioner-client privilege under IRC §7525.

  2. A person cannot successfully refuse to testify or provide information solely on the basis that he/she stands in a confidential relationship with another person. The burden is on the witness first to establish the facts on which the asserted privilege is based and then to demonstrate how, and the extent to which, the requested information is covered by the privilege.

  3. A person may forfeit a privilege by expressly waiving the privilege or failing to assert it.

  4. Assertion of a privilege may be done orally or in writing.

  5. In any situation where one of these privileges is asserted during either an interview or in response to a request for records, Area Counsel is to be consulted, and decisions must be as to whether to contact third parties for information, or to issue a summons to the organization, the individual, or any third parties.

  6. For additional information, including court case citations and additional analyses, see IRM 4.10.1.6 and IRM 5.17.6.

4.75.11.11.1  (08-30-2010)
Fifth Amendment

  1. An individual claiming protection under the Fifth Amendment is not permitted to make a blanket claim of the Fifth Amendment privilege. The person is required to establish a reasonable belief that providing answers to specific questions or producing specific documents would subject him/her to substantial hazards of self-incrimination.

  2. Determinations of whether oral testimony or written records in the possession of the taxpayer are protected by a Fifth Amendment privilege claim are to be made by the courts and not by the examiner.

  3. The protections of the Fifth Amendment do not extend to the books and records of corporations, associations, or trusts. The custodian of corporate records may not be compelled to incriminate themselves by their own testimony.

  4. In any situation where a Fifth Amendment privilege claim is asserted, any interviews with the individual are to be suspended.

4.75.11.11.2  (08-30-2010)
Attorney-Client Privilege

  1. In general, communications from a taxpayer to an attorney made in confidence for the purpose of obtaining legal advice are privileged, and the attorney cannot be compelled to disclose that information to the Service. The privilege is a provision of common law upheld by the courts.

  2. If the taxpayer creates records to facilitate the exchange of privileged communications with the attorney, those records are privileged.

    Note:

    If a taxpayer turns over pre-existing records to an attorney, the Service can obtain those records by summons, unless the records were otherwise privileged from production while in the taxpayer’s possession.

  3. The attorney-client privilege is not all-inclusive and does not protect everything an attorney may do for a client. The privilege is confined to communications made in confidence by the client for the purpose of obtaining legal advice from an attorney.

  4. The client in an exempt organization setting may be any officer or employee of the exempt organization. Underlying factual information can be obtained from the employees whether or not this same information has been communicated to the organization’s attorney.

  5. Books and records of a taxpayer are not privileged merely because they are in the hands of his attorney. If the records were compellable from the taxpayer, the taxpayer cannot cloak them with the privilege by transferring them to an attorney.

  6. The following are also not covered by the attorney-client privilege:

    • Ministerial or clerical services,

    • Records of financial transactions involving monies paid by or on behalf of a client to an attorney,

    • Records of transactions where the attorney acts as the client’s business advisor, or agent for the receipt or disbursement of money or property to or from third parties, and

    • The identity of a client or the fact that a given individual has become a client, absent special circumstances.

  7. The preparation of a tax return is primarily an accounting service. When an attorney prepares his or her client’s tax returns, the workpapers produced by the attorney while preparing the returns and the tax records on which they are based are not shielded by the attorney-client privilege. The same is true of the communications between the client and the attorney about the return being prepared.

4.75.11.11.3  (08-30-2010)
Work Product Doctrine

  1. The work product privilege protects documents prepared by an attorney acting for his client in anticipation of or for use in litigation. This doctrine applies to IRS summonses.

  2. Whether a document is protected by the work product doctrine is to be determined by the courts, typically in a hearing concerning summons enforcement.

  3. The work product doctrine does not cover documents prepared by accountants, unless the document was produced for the attorney in anticipation of or for use in litigation.

4.75.11.11.4  (08-30-2010)
Federal Tax Practitioner-Client Privilege

  1. With the enactment of IRC §7525 by RRA 1998, the attorney-client privilege was extended to include communications between a taxpayer and a tax practitioner, including accountants, to the extent that such communications would be considered privileged communications if they were between a taxpayer and an attorney.

  2. The law merely extends the application of the attorney-client privilege to other individuals, it does not modify the attorney-client privilege of confidentiality. Thus, as with the attorney-client privilege, information disclosed to an authorized practitioner acting beyond his capacity will not be privileged.

  3. The American Jobs Creation Act of 2004 amended IRC §7525(b) by providing that the tax practitioner privilege does not apply to communications regarding tax shelters. The law now provides that the privilege does not apply to written communications in connection with the promotion of the direct or indirect participation of any person in any tax shelter between a federally authorized tax practitioner and any person, director, officer, employee, agent, or representative of the person. The 2004 amendments apply to communications made on or after October 22, 2004.

  4. “Federally authorized tax practitioner” means any individual who is authorized under federal law to practice before the IRS. See Circular 230. The term includes attorneys, certified public accountants, enrolled agents and enrolled actuaries. The term “tax advice” means advice given by an individual with respect to matters within the scope of that individual’s authority to practice before the Service. IRC §7525(a)(3).

  5. The privilege may only be asserted in:

    1. Any noncriminal tax matter before IRS (IRC §7525(a)(2)(A)), and

    2. Any noncriminal tax proceeding in federal court brought by or against the United States. (IRC §7525(a)(2)(B)).

  6. The privilege may not be asserted to prevent the disclosure of information to any regulatory body other than the IRS, such as the Securities and Exchange Commission (SEC), including in an administrative or a court proceeding.

4.75.11.12  (08-30-2010)
Analysis of Accounts

  1. The following procedures can be performed during the pre-examination phase, or in the field. To perform these procedures prior to the field visitation, the general ledger and chart of accounts must be obtained in advance of the audit, requested in the initial information document request.

  2. Identify certain accounts for further analysis to determine the source of the revenue or expenditures. An organization's utilization of its resources and expenditures are important indicators of an organization's programs and activities.

  3. Look for any unusual or nonrecurring items. Items may be unusual by amount, source or nature. Examples include:

    • Unusual in amount - amounts which are much larger or smaller than typical entries to an account

    • Unusual by source - Source, as used here, means the journals from which the account was posted, as indicated in the folio column. There is a normal source pattern for most postings and any deviations from the norm should be investigated, such as a payroll entry in the office supplies account.

    • Unusual by nature - such as credit entries in accounts usually containing only debits or accounts which exist at the beginning of the year but do not exist at the end.

  4. In reviewing accounts, perform the following audit steps:

    1. Review year-end adjusting trial balance or similar summary of year-end general ledger account balances and select large unusual or questionable accounts for further analysis.

    2. Review transaction details in the general ledger for selected accounts.

    3. Select samples of detailed transactions as warranted and trace to journals or other supporting documentation.

    4. Discuss those items needing additional explanation with the organization.

    5. Request any additional documentation, e.g., sales contracts and mortgage documents, as necessary to determine the impact of a particular transaction on the exempt organization's exempt status or tax liability.

    Note:

    Use judgment in deciding which accounts, if any to select for further analysis.

4.75.11.12.1  (08-30-2010)
Sampling Techniques

  1. With certain small organizations, there may be no need to sample documents as the agent can review all of the records in the span of a day or two. All other organizations have far too many records to review in the limited time that an agent spends at an audit site. Sampling of the records provides an element of confidence in the amounts recorded on the books, assists in identifying issues to be addressed, and aids in recognizing fraud.

    Example:

    An examiner requesting to look at the inventory of a museum’s gift shop is shown a room full of sealed boxes, stacked neatly in cubes of boxes, 5 boxes high, wide, and deep. The examiner selects a cube in the back of the room, and asks an officer to open each box in the cube (125 boxes total.) The outer boxes contain the contents specified on the outside of the box but the boxes inside the cube are all empty.

  2. There are two basic types of sampling, judgment and statistical.

  3. Judgment sampling requires examiners to use professional judgment in performing the sampling procedure and in evaluating the results of the sample.

    Note:

    Judgment samples are not statistically valid. If errors are found in a sampled set of records, consider expanding the sample size.

  4. A number of judgment sampling methods include block sampling and dollar limitation (or cut-off) sampling.

    1. Block sampling may use groups of continuous items selected from an account balance or class of transactions.

      Example:

      An examiner selects one month of travel expenses to reach a conclusion about the travel expenses for the entire year. The examiner looks at each voucher filed for the month, the attached receipts, and compares them to the entries in the general ledger.

    2. Block sampling may include selecting all items in a selected numerical or alphabetical sequence.

      Example:

      Gross receipts might be sampled on the 5th, 15th, and 25th of each month. The general ledger, cash receipts journal, bank statements, and deposit slips for those specific dates are reviewed and compared to each other.

    3. Dollar limitation sampling is a method, which selects a minimum dollar amount and creates a sample by selecting all items exceeding that dollar amount.

      Example:

      The examiner opts to review pull-tab prize payouts of $1,000 or more. The examiner reviews all Forms W-2G issued by the organization, and reviews the daily prize journal maintained for the state gambling commission.

    4. This type of sampling prevents the examiner from wasting time examining small, insignificant amounts.

      Caution:

      Dollar limitation sampling should be performed in conjunction with block sampling. Those seeking to embezzle funds frequently do so in smaller amounts. Frequency of the transactions for the same amount may identify all but the most cautious embezzlers.

      Example:

      An examiner reviews an expense account for meals purchased by the employees and officers. The expense of $100 is repeated every seven days for an entire year. Review of the receipts shows a weekly charge at a grocery store for a $50 gift card and $50 in cash back.

  5. Statistical sampling is a procedure used to choose a portion of the whole to make a statement about the entire body of information, eliminating the examiner’s judgment on the items to be sampled.

  6. Examiners should generally seek assistance before performing a statistical sampling application. Examiners should discuss the facts and circumstances with their manager and determine if a request for a Computer Audit Specialist (CAS) is necessary. Refer to IRM 4.47 for instructions on requesting CAS assistance.

  7. IRC §7491(b) places the burden of proof on the Service in any court proceeding when the Service reconstructs any item of the organization's income using solely statistical information on unrelated organizations. This is true whether the organization does or does not cooperate and provides evidence or otherwise meets the requirements of IRC §7491(a).

4.75.11.12.2  (08-30-2010)
Income Analysis

  1. The income of an organization should be reviewed to determine the size, extent, and nature of the income, as well as verifying that the amount reported is reasonably accurate.

  2. There are several purposes for analyzing income, including determinations of whether the income:

    1. Supports the exempt purposes of the organization,

      Example:

      Income from government contracts to provide housing for mentally disabled individuals would support the exempt purposes of an organization formed to support the disabled.

    2. Is subject to unrelated trade or business, and/or excise taxes,

      Example:

      Receipts from pull-tabs sold to the public are subject to UBIT, occupational and wagering excise taxes.

    3. Is from related parties, potentially giving rise to inurement, and

      Example:

      A church sells its parsonage to its pastor for $1,000. The market value of the building is $150,000.

    4. Is properly classified for purposes of various tests.

      Example:

      Receipts from “social members” of a veterans post are erroneously classified as member dues, when the bylaws explicitly prohibit social members.

  3. Using the large, unusual, and questionable items originally selected on the return during the pre-examination phase, select the corresponding accounts from the trial balance for further in depth review. At the same time, review the trial balance for any additional LUQ items not previously identified.

  4. The accounts to be selected will primarily be dependent on the type of organization being examined. No one specific category of income must be examined for all organizations as not all organizations have the same types of income.

    Example:

    The investment income of a §501(c)(7) organization is taxable, whereas the investment income of a §501(c)(4) organization is not.

  5. For guidance as to the specific types of income to consider examining, see the appropriate IRM 4.76 chapters. For a list of IRM chapters, see 4.76.11.1.3.

  6. Review the bank statements, bank reconciliations, and microfiche images of deposited checks, if available. Verify that the ending bank reconciliation balance matches up to the amount(s) reported on the return.

  7. Trace sampled transactions from the general ledger to the bank statement, and vice versa.

    Example:

    A contribution recorded on the general ledger is traced to the cash receipts journal, and in turn traced to a deposit slip, which matches up to the bank statement.

    Note:

    Newer bank imaging systems used at various automated teller machines have eliminated the need for deposit slips and deposit envelopes, instead scanning the deposited check as it is inserted, and verifying the amount for deposit. Many banks are also requesting clients to opt for online bank statements, in lieu of receiving printed materials. Any organizations that have shifted entirely to electronic records should be retrieving and storing the electronic statements as they are made available.

  8. For sales of inventory, contributions, and program service revenues, select specific days for sampling and review the receipts for those days.

    Example:

    A bingo hall is a cash intensive operation. By requesting to look at the Z tape (a summary tape generated by a cash register at the end of the day), all of the days receipts should be totaled. These can then be traced to a deposit slip for later that night or during the week, which should show up on a bank statement, as well as being recorded in the general ledger and cash receipts journal.

4.75.11.12.3  (08-30-2010)
Expense Analysis

  1. The expenses of an organization should be reviewed to determine the size, extent, and nature of the expenses, as well as verifying that the amount reported is not only reasonably accurate but also correctly classified as an expense and not an asset (such as prepaid expenses.)

  2. There are several purposes for analyzing expense, including determinations of whether the expense:

    1. Is in furtherance of exempt purposes,

      Example:

      A §501(c)(19) veterans organization purchases brand new flags. By distributing them to local schools, collecting, and retiring the old flags, the expenditure serves a patriotic purpose.

    2. Gives rise to potential inurement,

      Example:

      A §501(c)(3) private foundation spends $3,000 per director to send the founder, and three other directors on a week long board retreat in Hawaii. The foundation is located in the continental US.

    3. Is for a political and/or legislative expenditure,

      Example:

      A §527 political organization pays for signature gatherers to collect signatures for a ballot measure to repeal a tax voted into law by the state legislature. (This is not a political expenditure, but is a legislative expenditure. This is not expended for exempt purposes under IRC §527.)

    4. Gives rise to additional tax liabilities (Chapters 41 and 42)

      Example:

      A §501(c)(21) black lung trust lends $5,000,000 in a five year loan to the coal mine operator that created the trust, at an interest rate of 1%. The coal mine operator is subject to the IRC §4951 excise tax (computed in the same manner as IRC §4941.)

    5. Triggers other filing requirements, and

      Example:

      A §501(c)(10) organization employs a favorite band four times in the course of the year for holiday dances, paying $1,000 per performance, triggering the Form 1099-MISC filing requirement with the very first payment.

    6. Is properly allocated against any unrelated business income.

      Example:

      The Form 990-T for a §501(c)(3) educational organization that issues a monthly newsletter claims all of the expenses reported on the Form 990 against taxable advertising income, generating an enormous net operating loss deduction.

  3. Using the large, unusual, and questionable items originally selected on the return during the pre-examination phase, select the corresponding accounts from the trial balance for further in depth review. At the same time, review the trial balance for any additional LUQ items not previously identified.

  4. Review the bank statements, bank reconciliations, and cancelled checks, if available. Match the checks/payments to invoices, receipts, or other documentation.

  5. Trace sampled transactions from the general ledger to the bank/brokerage statements, and vice versa.

    Example:

    In reviewing travel expenses, an examiner tracks the entry on the general ledger to the travel account, and from there to the travel voucher, and then matches the expense to the bank statement.

  6. Use credit card statements to trace to/from the general ledger expenses incurred by the organization’s employees. Match those amounts against vouchers or other supporting documentation.

    Note:

    Travel expenditures for which there is no travel log, voucher, or other supporting documentation of a business purpose, may constitute taxable benefits to the employee, and be subject to employment taxes.

  7. To detect possible inurement of income or serving of private interest, identify the board of trustees, directors, officers, and key members of the organization's staff. Most of these individuals should already be listed on the Form 990, if filed. Any business relationships or other dealings with these individuals should be carefully analyzed to determine if they provide inappropriate benefits.

  8. Determine the reasonableness of total compensation paid or accrued to principal officers. Take into consideration any compensation claimed under a heading other than officers' salaries such as contributions to pension plans, payments of personal expenses, year-end bonuses, use of company car etc.

    Note:

    Be alert to multiple entity situations in which compensation is split between two or more related corporations making the aggregate amount paid excessive.

  9. Review the following accounts, as they may disclose lobbying activity

    • Advertising

    • Printing

    • Promotion

    • Outside services

    • Legal and professional fees

    • Miscellaneous expenses

  10. In the case of examinations involving membership organizations other than IRC §501(c)(3) organizations, review the following aspects of an organization's lobbying activities:

    1. The existence and extent of its involvement in "grassroots" lobbying, or lobbying in support of, or opposition to legislation not directly connected with the trade or business of its members.

    2. Whether such activities were financed from dues and other general funds, or by special assessments of organization members.

    3. Whether part or all of the dues or special assessments for the years involved were or were not properly deductible by the member in accordance with IRC §162(e)(2).

  11. Review contract labor, repairs and maintenance, legal, consulting, and similar accounts for potential Form 1099 filing requirements. The following should be considered:

    1. Payments to individuals, e.g., prizes and fees, that may result in a discrepancy adjustment, and

    2. Additional compensation in the form of expense accounts.

  12. Analyze travel and other expense allowances. If the organization does not require the employee to file an expense account, the payments should be included in the gross income of the recipient.

  13. Refer to IRM 4.75.12 Required Filing Checks for additional information on required package audit procedures.

  14. In cases where unrelated business income is identified, verify:

    1. That expenses bear a primary and proximate relationship to the income,

    2. That expenses are allocated on a reasonable basis, and

    3. The deductibility of any losses.

  15. An organization is not required to use any specific allocation method. Rather, the only requirement is that the method reasonably approximate the costs incurred to generate the unrelated income. If the methodology used is unreasonable, identify and use a more accurate method to allocate expenses.

    Example:

    An organization decides to use the margin ((selling price – purchase price)/selling price) to allocate the fixed expenses of property tax and depreciation. The agent determines the method to be unreasonable, and allocates the property taxes and depreciation by the combined percentage of total space used and hours of taxable operation.

4.75.11.12.4  (08-30-2010)
Balance Sheet Analysis

  1. The purposes for analyzing the balance sheet include:

    1. Identifying potential inurement, private benefit, or excess benefit transactions

    2. Identifying assets generating unrelated business income

  2. Analyze the changes in net assets/fund balances and in net worth and reconcile any increases or decreases with the income and expense statements.

  3. In reviewing assets:

    1. Identify and analyze receivables with officers, directors, or other persons in a position of control to determine whether the transactions serve private interests.

    2. Determine if the lack of intent to fulfill the obligations on the part of an officer or director has income tax consequences.

    3. Look for automobiles, houses and other assets that could be used by individuals in control.

    4. Look for rental property or property used in an unrelated trade or business.

    5. Look for investments that may be used to generate unrelated business income.

    6. Determine whether any assets are being used for personal purposes. This may constitute inurement or be taxable income to the user.

    7. Analyze any dispositions for possible inurement to officials.

    8. Identify any loans that became delinquent or foreclosed during the years under examination.

    9. Identify receivables written off to determine if they were from an official. This can also be, in effect, a reimbursement to the official for an illegal payment made on behalf of the organization.

    10. Review payables, loans, or other liabilities involving officers, directors, trustees, or key employees. Such amounts may in fact be disguised compensation amounts or returns of assets to the founders/substantial contributors.

4.75.11.12.5  (08-30-2010)
Tax Liabilities

  1. Determine if an exempt organization is liable for certain taxes and if so, determine the correct amount relating to:

    • Unrelated business taxable income, IRC §§511-514

    • Transactions by private foundations, IRC §§4940-4945

    • Lobbying activities, IRC §§4911-4912

    • Political activities, IRC §§527(f) and 4955

    • Excess benefit transactions, IRC §4958

    • Employment taxes, IRC §§3101, 3111, 3301, 3402, 3406, and 3509

    • Gaming activities, IRC §§4401 and 4411

    • Proxy Tax on Lobbying and Political Expenditures, IRC §6033(e)(2)(A)

    • Black Lung Trust excise taxes, IRC §§4951-4953

  2. For guidance on computing specific taxes, see the appropriate chapter in IRM 7.27. For employment taxes, see IRM 4.23.

4.75.11.12.6  (08-30-2010)
Accuracy of Return

  1. Even though many organizations filing Forms 990-N, 990-EZ, or 990, are not subject to the various taxes identified above, the forms are subject to public inspection, and are relied upon by the public for a variety of purposes.

  2. Due to this public scrutiny of the Form 990 series of returns, considerations must be given to ensuring the correctness and accuracy of the return. Amended returns may be accepted in most situations.

    Note:

    In instances where the organization has incorrectly calculated the proxy tax, resulting in an understatement of tax, no amended return will be accepted, as the period for rolling over additional legislative expenses to the subsequent year tolls when the return is examined.

  3. Secure and attach to the return any schedules or other information omitted from the originally filed return.

  4. Information commonly omitted from the Form 990 are as follows:

    • Schedules (for 2008 and subsequent years, the schedules may include both schedules and statements),

    • Program service accomplishments,

    • Complete list of the names and addresses of all officers, directors and trustees, and

    • Answers to all applicable questions.

  5. For situations of substantial misstatements of amounts reported on the return, amended returns should be secured provided, that the organization is to be retaining exemption. Such amended returns will not provide relief from the contemporaneous reporting requirements of IRC §4958.

    Example:

    A §501(c)(3) public charity is involved in gift in kind transactions, where the amounts of contributions reported are substantially overstated.

4.75.11.13  (08-30-2010)
Fraud Considerations

  1. The examiner must properly identify and address potential "badges of fraud" .

  2. IRC §6663 does not define “fraud.” Courts have long recognized that the essence of the fraud penalty is the taxpayer’s state of mind. The state of mind required has been described in various ways, but most definitions require “intent to evade tax.” Intent is distinguished from inadvertence, reliance on incorrect professional advice, honest difference of opinion, negligence, or carelessness.

  3. Since direct proof of a taxpayer’s fraudulent intent is rarely available, fraud may be proven by circumstantial evidence and reasonable inferences. Fraud will generally involve one or more of the following elements:

    • Deception,

    • Misrepresentation of material facts,

    • False or altered documents,

    • Evasion (i.e., diversion or omission), or

    • Conspiracy.

  4. Some common “badges of fraud” include:

    1. Understatement of income (e.g., by omissions of specific items or entire sources of income, failure to report substantial amounts of income received),

    2. Fictitious or improper deductions (e.g., overstatement of deductions, personal items deducted as business expenses),

    3. Accounting irregularities (e.g., two sets of books, false entries on documents),

    4. Acts of the taxpayer evidencing an intention to evade tax (e.g., false statements, destruction of records, transfer of assets),

    5. A consistent pattern over several years of underreporting taxable income,

    6. Implausible or inconsistent explanations of behavior,

    7. Failure to cooperate with the examining agent,

    8. Concealment of assets,

    9. Engaging in illegal activities (e.g., drug dealing), or attempting to conceal illegal activities,

    10. Inadequate records, and

    11. Dealing in cash, with no records associated with the transactions.

  5. When initial badges of fraud are uncovered, examiners should initiate a discussion with their manager, and develop an action plan as soon as possible to document firm indications of fraud. The plan should be a joint effort of the examiner, manager, and when needed, the TE/GE Fraud Specialist. See IRM 4.75.21.

4.75.11.14  (08-30-2010)
Other Examination Considerations

  1. Resolve any discrepancies between the Exempt Organizations/Business Master File (EO/BMF) and the information developed during the examination. Prepare a Form 2363-A, Request for IDRS Input for BMF/EO Entity Change, to update the Master File, if necessary.

    Note:

    Changes to filing requirements involving Forms 11-C, 730, and 945 are made using Form 2363, Master File Entity Change.

  2. Ensure the organization is complying with the disclosure and notification requirements of IRC §6104 and IRC §6113.

    1. IRC §6104, among other things, sets forth certain requirements for the disclosure of various returns, applications, etc. of organizations exempt under 501(a) or 527 to the public.

    2. IRC §6113 provides that certain non-IRC §501(c)(3) organizations disclose in fund-raising solicitations that contributions are nondeductible.

  3. Discuss the disclosure and/or notification requirements and ensure the organization has met its responsibility. Any violations noted in the minutes, correspondence or through interviews should be reviewed and a determination made as to the applicability of any penalties.

4.75.11.15  (08-30-2010)
Follow-Up Information Document Requests

  1. It may be necessary during the examination to secure additional records, documents, or other clarifying evidence. Prepare a Form 4564, Information Document Request, advising the organization of the information needed.

  2. Request only relevant information necessary to resolve the issue(s) or areas under consideration. This decreases the burden on the organization.

  3. A properly completed information document request:

    • Specifies clearly and concisely the types of documents requested,

    • Explains briefly why such documents are being requested, and

    • Has been computer generated, either through RCCMS or manually via MS Word,

  4. At a minimum, the request must contain:

    1. The name of the organization,

    2. The name of the examining agent,

    3. The examining agent’s mailing address,

    4. Phone and fax numbers for the examining agent,

    5. The date that the request was made,

    6. The date by which the expected materials are due, and

    7. The method by which the records are to be provided (in person or by mail).

  5. Records may be requested in electronic format, and provided by e-mail, on CD, thumb drive, or can be downloaded. Any files received electronically must be scanned for viruses while disconnected from the network prior to opening the file.

4.75.11.16  (08-30-2010)
Organization Delays

  1. When additional information has been requested, and the organization does not provide the information within the specified time (e.g. 7, 10, 14, 21, or 30 days,) attempt to contact the organization by telephone, if feasible. If the organization cannot be reached by telephone, send another document request by certified mail. This request should also include a specific date for the information to be supplied to the examiner.

  2. Always be aware of statute and audit cycle considerations when providing a sufficient amount of time to the organization to respond to the request. If after two attempts at obtaining the information requested the organization does not respond, obtain the group manager's assistance in obtaining the requested information.

  3. Schedule a meeting that includes the organization, examiner, and group manager in order to ascertain if the records will be forthcoming. If the organization still is not cooperative, the group manager should consult Area Counsel for advice on the issuance of a summons.

  4. If a practitioner has twice delayed providing documents in response to a single information document request, consideration must be given to making a referral to the Office of Professional Responsibility for possible sanctions. Consult with the group manager prior to making any such referral, as POA bypass procedures should be performed prior to making any referrals.

4.75.11.17  (08-30-2010)
Guidance on Requests from the General Public for EO Examinations Program and Statistical Data

  1. Historically, EO has received requests from the EO practitioner community for information and statistics on various EO Examinations programs. The Service is required by statute to provide this information to the public. Generally, these requests are not made under the Freedom of Information Act (FOIA), 5 U.S.C. section 522.

  2. A request may be received during the field visitation and at any time subsequent to the field visitation. All requests for such information must be forwarded to the Manager, EO Examinations Programs and Review (EPR) within one day of receipt.

  3. The EPR manager will review the requests to determine if the Director, EO Examinations is authorized to release the information. If the information can be released the request will then be processed as follows:

    1. The request will be forwarded to EPP for processing

    2. The requester will be notified they will receive a response within 15 business days.

    3. The requester informed a fee may be charged for searches and copying, if applicable.

      Note:

      Treasury Regulations §601.702(f) permit the Service to establish an average rate to be used for searches. Presently this fee is $17 for each hour or fraction thereof. Additionally, the current fee for copies is $.20 per copy of each page.

    4. EPP will determine and facilitate communication and receipt of applicable fees in accordance with IRM 11.3.5.

  4. If the information can not be released however, the requester will be informed he/she should submit a FOIA request to their local Disclosure Office as described in 5 U.S.C. section 522. In addition, the requester should know that they may be responsible for fees according to the “category of the requester” and the activities involved in responding to the request.

  5. Fees may be charged for search and review time as well as document duplication. IRM 11.3, "Disclosure of Official Information" , contains information and procedures concerning these issues. IRM 11.3.13.5(4) for example, provides a summary of request requirements. IRM 11.3.5 provides additional guidelines and procedures relating to collecting fees for documents and related services, including "categories of requesters" .

  6. If a request is submitted under FOIA, the Disclosure Office will determine what fees should be charged if the request does not fall under the statutory provision relating to charges for the disclosure of records.

Exhibit 4.75.11-1 
Sample Form 2848

This image is too large to be displayed in the current screen. Please click the link to view the image.
This image is too large to be displayed in the current screen. Please click the link to view the image.
This image is too large to be displayed in the current screen. Please click the link to view the image.

Exhibit 4.75.11-2 
Exempt Organizations Examinations Appeals Process Flowchart

This image is too large to be displayed in the current screen. Please click the link to view the image.
This image is too large to be displayed in the current screen. Please click the link to view the image.

More Internal Revenue Manual