Part 4. Examining Process

Chapter 75. Exempt Organizations Examination Procedures

Section 11. On-Site Audit Guidelines

4.75.11 On-Site Audit Guidelines

Manual Transmittal

January 18, 2017

Purpose

(1) This transmits revised IRM 4.75.11, Exempt Organizations Examination Procedures, On-Site Audit Guidelines.

Material Changes

(1) Renamed IRM 4.75.11 from On-Site Examination Guidelines to On-Site Audit Guidelines.

(2) IRM 4.75.11 has been converted to plain language to comply with the Plain Writing Act of 2010, P.L. 111-274.

(3) Combined information from IRM 4.75.11.4 into IRM 4.75.11.3, resulting in the renumbering of subsequent subsections respectively.

(4) Retitled IRM 4.75.11.5 from Initial Interview to Interview.

(5) Rearranged information contained in IRM 4.75.11.5, IRM 4.75.11.5.1, and IRM 4.75.11.5.1.1. This information is now contained in IRM 4.75.11.4.

(6) Added IRM 4.75.11.20, Concluding the On-Site Visit, to emphasize the importance of conducting an exit interview with the organization at the conclusion of the field visit.

(7) Removed Exhibit 4.75.11-2, Exempt Organizations Examinations Appeals Process Flowchart, as information didn’t reflect the purpose of this IRM.

Effect on Other Documents

This manual supersedes IRM 4.75.11, On Site Examination Guidelines, dated August 30, 2010.

Audience

Tax Exempt and Government Entities
Exempt Organizations
Examinations

Effective Date

(01-18-2017)

Margaret Von Lienen
Acting Director, Exempt Organizations
Tax Exempt and Government Entities

4.75.11.1 (01-18-2017)

Introduction

  1. The purpose of this chapter is to provide guidelines and techniques for EO Examinations agents to use when conducting audits.

  2. The agent should use his/her professional judgment and manager’s guidance and approval to determine the scope and depth of the audit.

  3. See the table below listing IRM sections containing additional guidelines for a particular Code section/topic.

    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 Local 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 – IRC 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 or 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 (01-18-2017)

After First Contact

  1. IRM 4.75.10, Pre-audit Guidelines and Procedures, provides steps to take before issuing the appointment letter.

  2. During the first phone contact with the organization or power of attorney (POA) (after the appointment letter has been issued) you should:

    • Verify they received the initial Form 4564, Information Document Request, (IDR).

    • Verify the organization has the records requested.

    • Arrive at a mutually agreeable date and time for the audit appointment.

    • Answer any question they have about the items requested.

  3. If travel is required (e.g., airline, train, personally-owned vehicle) prepare a travel authorization on ConcurGov in advance of the trip. After your field visitation, select the authorization and prepare a travel voucher from it.

    1. When flying, check the airline’s website to confirm reservations and flight times.

    2. Store the government-owned laptop in the space beneath the seat in front of you.

    3. Charge applicable baggage fees to the government travel card.

  4. Take these items with you to the field audit:

    • Laptop, with power cable

    • Air card

    • Smart ID

    • Cable lock

    • Printer (optional)

    • Blank printer paper

    • Case file

    • Pocket commission

    • Business cards

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

    • Driving directions

    • Hotel/airline/train reservations (if applicable)

    • Government travel card

    Note:

    Leave any referral information in a locked cabinet in the office or at your telework location. Make electronic notes you may need in the field of the referral’s key information from the referral package.

  5. Most field audits take a minimum of two days to complete all audit procedures and work papers. Higher graded cases (i.e., grade 12 or 13) may require a minimum of a week. Make travel plans appropriately.

4.75.11.3 (01-18-2017)

Start of Field Audit

  1. Agents participating in the audit must present their pocket commission for inspection to the organization’s officers and/or POA at the initial meeting.

    Note:

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

  2. Request Form 2848, Power of Attorney and Declaration of Representative, or Form 8821, Tax Information Authorization, at the beginning of the initial interview if not previously secured. Verify all entries, including signatures, are valid. See Exhibit 4.75.11-1 for a sample Form 2848, and a list of acceptable entries.

  3. Pub. 1, Your Rights as a Taxpayer, is a two-sided document that informs taxpayers of their rights. It also explains:

    • The audit process

    • The collection process

    • The appeals process

    • Refund claim procedures

    • Potential third-party contacts

  4. Discuss both sides of Pub. 1 at the beginning of the initial interview with all persons present and document your discussion on one of the following:

    • Form 5464, Case Chronology Record

    • Form 5773, EO Work paper Summary Continuation Sheet

    • Initial interview work paper

      Note:

      Use of Pub. 1 eliminates the need to issue notices of intent to contact third parties. If you mail Pub. 1 with the appointment letter and initial IDR, you must wait 10 calendar days before making third-party contacts. If you hand Pub. 1 to the taxpayer or POA, you can make a third-party contact the same day. See IRM 25.27, Third Party Contacts for additional information on third-party contacts.

      Note:

      Generally, you’d only contact a third party when: i) you’re unable to obtain the information from the organization/representative or ii) you need to verify the information the organization provided. Attempt to obtain information first from the organization/representative.

4.75.11.4 (01-18-2017)

Interview

  1. During an interview you obtain information needed to reach informed judgments about:

    • Audit scope and depth.

    • Resolution of issues.

    Note:

    IRC 7602 authorizes the Secretary or a delegate to audit books and records and to take testimony under oath.

  2. The goals of an interview are to:

    • Gather information about the taxpayer that isn’t available from other sources (e.g., financial history, business operations, books and records).

    • Obtain information needed to make informed judgments about the scope and depth of the audit.

    • Correctly resolve issues.

    • Obtain leads.

    • Develop information.

    • Establish evidence.

  3. During an interview, it’s important to create an environment where the taxpayer feels comfortable. Be friendly and professional. Establish rapport by:

    1. Introducing yourself.

    2. Explaining what to expect during the audit process.

    3. Recognizing that an IRS audit is often a once in a lifetime experience; the taxpayer may be nervous.

    4. Being open, honest, and showing integrity.

    5. Remaining calm.

  4. During the interview:

    1. Listen carefully to all details.

    2. Be receptive to all information volunteered, regardless of its nature.

    3. Be patient, yet persistent in gathering the facts necessary to achieve your interview goals.

  5. Conduct the interview with an individual who has sufficient knowledge of the organization’s day-to-day activities and operations.

  6. Without an administrative summons, you can’t require a taxpayer to accompany his/her authorized representative to an audit interview (IRC 7521(c)). However, you can request the taxpayer’s voluntary presence at the interview to expedite the audit process.

  7. Use the following questioning techniques for an effective interview:

    1. Plan the interview to address the items specific to the taxpayer under audit.

    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 didn’t fully answer your 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. At a minimum, discuss the following items with the taxpayer:

    • Availability of requested books and records, if not already determined during the pre-audit phase

    • Explanation of the accounting system

    • Internal controls

    • Description of activities and operations during the year under audit to the present

    • Issues identified during pre-audit planning

    • Items that come up during the interview that you didn’t previously identify but may lead to audit issues if pursued

  9. Suspend the interview if the taxpayer clearly states that he/she wishes to consult with a qualified representative (IRC 7521(b)(2)).

    Exception:

    IRC 7521(b)(2) doesn’t apply to an interview initiated by administrative summons and can’t be used to repeatedly delay or hinder the audit process.

4.75.11.4.1 (01-18-2017)

Types of Interviews

  1. Initial Interview — Hold the initial interview as soon as possible after you open a case. Your pre-contact analysis should include the preparation for the interview. See IRM 4.10.2, Examination of Returns - Pre-Contact Responsibilities, for details on the pre-contact analysis.

  2. Subsequent Interview — Hold subsequent interviews if:

    • The taxpayer doesn’t provide all the information requested.

    • You need more detailed explanations.

    • You need to review the audit progress. Your review should address information provided to date as well as outstanding information needed to complete the audit.

  3. Third-Party Interview — You may need to interview third-parties when the taxpayer doesn’t or can’t provide documentation about a transaction, deduction, or income item.

  4. Closing Conference — You must hold a closing conference at the audit’s conclusion:

    1. Discuss final conclusions with the taxpayer.

    2. Solicit agreement to any proposed adjustments.

    Note:

    At the conclusion of the audit, you must advise the taxpayer and/or representative of all appeal rights, including the option of Fast Track Settlement, if available. (See IRM 4.75.15.14, Fast Track Settlement, for more details.)

4.75.11.4.2 (01-18-2017)

Documenting Interviews

  1. Equally important to asking sufficient questions during the interview is your fully documenting this information. Many other employees review the case file after you close it, especially if the audit is unagreed. Document the interview(s) so that an employee subsequently reviewing the file doesn’t have questions. An adequately documented interview includes:

    • An audit pre-plan addressing items specific to the taxpayer under audit.

    • Documentation giving a clear understanding of the nature of the taxpayer's history and day-to-day operations.

    • Explanations of large, unusual or questionable (LUQ) items and a conclusion as to whether such explanations resolve the potential issues.

    • Description of books and records maintained and their availability.

    • Complete explanation of the taxpayer's accounting system and methods, including any changes.

    • Explanation of the taxpayer's internal controls.

4.75.11.4.2.1 (01-18-2017)
Documenting Interview Techniques

  1. Use these five methods to document your interview:

    1. Take informal notes

    2. Memorandum of interview

    3. Affidavit

    4. Question and answer

    5. Deposition

  2. Taking informal notes is a commonly used method of recording an interview. This may consist of:

    • An interview outline

    • Notes you make immediately after an interview or conversation

    • Notes you make on the case chronology record after a phone call with the taxpayer

    Note:

    Prepare informal notes with sufficient detail soon after a conversation to refresh your memory as to what happened during the interview. Any format suffices as long as it shows the date, place, persons present and what happened.

  3. A memorandum of interview is an informal statement about the facts you obtained during an interview.

    • Show the date, place, persons present, and what happened during the interview.

    • Use the exact words of the taxpayer, if possible. Don’t assume or interpret meanings. Just record the facts.

    • Promptly prepare, sign, and date it.

  4. An affidavit is a written statement of facts, made voluntarily and confirmed by oath. Affidavits are used to:

    • Record the testimony of a taxpayer.

    • Refresh the memory of a taxpayer.

    • Deter a taxpayer from changing their testimony.

    • Gather complete and accurate information.

    Advantages of Using Affidavits Disadvantages of Using Affidavits
    It is a statement made under oath that can be used to establish or impeach the testimony of the individual. The statement may not follow the exact sequence of the interview.
    It can be limited to contain only pertinent information. It doesn’t always reflect all the questions asked.
    The affidavit can be obtained during the interview. Taking a written statement under oath may decrease the willingness of the individual to speak freely.
    When the affiant writes the affidavit, it tends to be unbiased.

    Use Form 2311, Affidavit, when securing an affidavit; plain paper can also be used. The agent or affiant can hand-write or type the affidavit. It’s permissible for one person to conduct an interview involving an affidavit, but ideally two IRS representatives should be present. At a minimum, an affidavit should contain the following information:

    • The current full name of the person giving the affidavit as well as any current or prior aliases.

    • The most current address of the person giving the affidavit.

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

    • A listing of documents submitted as part of the affidavit.

    • The date on which the affidavit was prepared, the person who prepared it, and any source from which it was prepared.

  5. After filling out the affidavit, one IRS representative will swear in the affiant by asking: "do you swear or affirm that the foregoing facts are true to the best of your knowledge?" The affiant must have his/her right hand raised when he/she replies to this statement.

  6. A question and answer statement is a transcript of questions, answers, and statements each participant makes at an interview. This form has the advantage of following the exact sequence of the questions asked in the interview. If confirmed by an oath, this form of recording an interview can become an affidavit by doing the following:

    • At the bottom of the interview, add on 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."

    • Provide two lines at the bottom underneath the perjury statement (jurat) for the individual’s signature and a typed or printed name and title.

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

    • Once signed, the interview transcript is considered an affidavit.

  7. 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 (01-18-2017)

Internal Controls

  1. Internal controls are the policies and procedures a taxpayer has in place to identify, measure, and protect business operations.

  2. A lack of good internal controls may indicate the potential for:

    • Diverted receipts

    • Diverted assets

    • Other significant problems

    Note:

    A lack of internal controls doesn’t necessarily jeopardize exemption, but it may affect the scope of the audit. The scope is the amount of time and documents involved in an audit. The group manager must approve any changes to the audit scope.

4.75.11.5.1 (01-18-2017)

Evaluation of Internal Controls

  1. Evaluate the existence and effectiveness of an organization’s internal controls. Based on this evaluation, expand or contract the scope accordingly.

  2. Discuss internal controls with the organization’s officers or management early in the audit, ideally during the initial interview. Explain the significance of internal controls to the organization.

  3. In evaluating internal controls, consider the extent to which the organization uses the following control checks:

    1. Transactions promptly recorded in the books and records

    2. Return reconciles to the books

    3. Organization reconciles bank statement balances to the books

    4. Segregation of duties

    5. Active board of directors, with members independent of one another

    6. Outside third parties such as a governmental agency overseeing the organization

    7. Annual independent audit

  4. An organization may have these other examples of internal controls in place:

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

    • Indemnification of officers and directors

    • Establishment of reserve funds

    • Physical safeguarding of assets

    • 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)

    • Mandatory vacations of those responsible for record keeping

4.75.11.5.2 (01-18-2017)

Segregation of Duties

  1. Segregation of duties is fundamental to a system of internal controls. Ask questions during the initial interview to determine the extent to which the organization has segregated duties.

  2. The key to the proper segregation of duties, with respect to transactions, is to have separate, independent individuals perform:

    • Authorizations

    • Executions

    • Recordings

  3. Ask these questions aimed at evaluating segregation of duties for expenditure handling:

    • "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?"

  4. Ask these questions aimed at evaluating segregation of duties for income:

    • "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?"

4.75.11.5.3 (01-18-2017)

Addressing Poor Internal Controls

  1. When you find significant weaknesses in an organization’s internal controls it may indicate an increased risk of diverted funds for personal interests which could result in loss of exempt status. If you find this, but the audit otherwise results in a no-change, consider issuing a written advisory. See IRM 4.75.15.6, Issues Under Tolerance (Written Advisory).

  2. When considering internal controls, always be aware of the possibility of fraud. Weak internal controls increase the risk of possible fraud.

  3. Discuss any findings of affirmative acts or indications of fraud with your group manager and the TE/GE Fraud Specialist. See IRM 4.75.35.7, Civil Fraud.

4.75.11.6 (01-18-2017)

Tour of Facilities

  1. CFR 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 tour of the organization’s facilities is an integral part of the audit process. When you see the organization’s facilities and observe business activities, you have an opportunity to:

    1. Get 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.

    5. Identify potential audit issues.

  3. Conduct a tour of business during all field audits. Generally, you should visit the main location and any other locations acquired during the period under audit. However, weigh the cost effectiveness and practicality of conducting the tour. Consider alternatives when appropriate.

    Example:

    An IRC 501(c)(14) state chartered credit union operates branch offices in 23 cities in the state and 150 ATMs not located at branch offices. You tour the main headquarters and a nearby branch office. To be practical, you opt to view randomly sampled security footage of the other branch offices.

  4. Tours can clarify items discussed during the interview and provide a frame of reference when interpreting information in the books and records. This helps you to correctly refine the scope and depth of the audit.

  5. Conduct tours with knowledgeable individuals. Officers, directors, trustees, employees, or the representatives, can often explain practices that appear unusual to you.

  6. Plan tours to address large, unusual, or questionable (LUQ) items identified during the pre-contact analysis or interviews.

    Caution:

    Tours shouldn’t disrupt business operations or interfere with the organization’s interactions with customers.

  7. During the tour, determine whether others use the organization's facility. You may need further documentation for space used:

    1. By other entities.

    2. By officers or other individuals for their own personal or business use.

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

  8. Observe and be alert to the physical surroundings. Confirm assets listed on the tax return are physically present. Identify assets that are physically present but aren’t listed on the return.

    Example:

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

  9. Ask questions to confirm understanding of what you observed.

4.75.11.7 (01-18-2017)

Contemporaneous Documentation

  1. After you complete the tour document actions taken. Complete and edit work papers generated from the interview, internal controls assessment, and tour of facility.

  2. Record an entry on the Form 5464, Case Chronology Record, noting that you conducted the interview, questioned internal controls, and toured the facility.

  3. Complete sections C-1 Initial Interview, C-2 Tour of Facility, and D-1 Method of Accounting/Internal Controls, on the Form 5773, EO Work paper Summary Continuation Sheet. Entries should briefly summarize your findings or determinations you made during the interview, internal controls questioning, and tour.

  4. Index completed work papers and upload to Reporting Compliance Case Management System (RCCMS).

  5. During the remainder of the audit:

    • Complete the relevant portions of the Form 5773 as you complete a work paper.

    • Update the Form 5464 as you complete procedures.

    • Index all work papers (see IRM 4.75.16.7, Case File Assembly).

    • Upload all documents to RCCMS prior to case closing.

4.75.11.8 (01-18-2017)

Audit of Books and Records

  1. An audit of books and records will establish whether:

    1. An organization is both organized and operated for tax-exempt purposes.

    2. Any related returns have been or need to be filed by the organization.

    3. Any tax reported is reasonably correct.

  2. Review the books and records to:

    1. Verify that any changes made to organizing documents don’t 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 are filed and taxes are paid.

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

  3. While reviewing books and records, keep in mind the Protecting Americans from Tax Hikes Act of 2015 (PATH Act), P.L. 114-113 requirements:

    1. The PATH Act requires all revocations to be treated the same.

    2. All revoked exempt organization now have declaratory judgment rights. Therefore, you are strongly encouraged to create an administrative record file or folder at the beginning of every 501(c) and (d) audit and to keep it up to date as the audit develops.

    3. While you aren’t required to create an administrative record file or folder until there are indications of a proposed revocation or an adverse change in foundation status, it works to your benefit to start one early. See IRM 4.75.32.4.1, Preparation of the Administrative Record, and IRM 4.75.32.6 Examiner’s Responsibility.

  4. Review the following books and records as 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.)

    • Other filed federal returns

  5. If you have requested and received any of these documents during the pre-audit, review them before the initial appointment. For pre-audit procedures, see IRM 4.75.10, Exempt Organizations Pre-Audit Procedures.

  6. You have the discretion as to the order in which you audit these records. The following sections outline a suggested order of action.

  7. When two or more EO Examinations agents are involved in an audit, the agent assigned to the case decides the order of procedures to follow.

4.75.11.8.1 (01-18-2017)

Governing Instruments

  1. Review the organization’s governing instruments to identify:

    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.

    4. Duties of officers (i.e., who is authorized to disburse funds, who makes decisions affecting the operations of the organization).

  2. Prepare separate work papers for the articles and bylaws and make corresponding entries on Form 5773. Address any amendments to these documents in the specific work papers, and summarize them on the Form 5773, section B-5, Amendments [Organizational Documents and Rulings].

    Note:

    For an unincorporated organization, trust, or an organization chartered by a parent organization, analyze the articles of association, trust instrument, or charter respectively. Then make corresponding entries on Form 5773, section B-1, Articles of Incorporation.

  3. If an organization (e.g., IRC 501(c)(3), 501(c)(4), 501(c)(19)) fails the organizational test, discuss the issue with your group manager via secure email or phone call while in the field. The manager, agent, and Area Counsel, if necessary, will discuss possible remedies.

    Note:

    Propose revocation only after consideration of all other facts in the case (e.g., abusive transactions, failure to operate in an exempt manner, inurement).

  4. Organizations exempt under IRC 501(c)(3), 501(c)(9), and 501(c)(17) are required to file a determination application that includes the organizing documents before receiving a determination letter. Organizations exempt under all other code sections don't have to file an application for exemption before filing the Form 990, Return of Organization Exempt From Income Tax. Procedures for closing cases where a determination application wasn’t filed (nor required to be filed), are found in IRM 4.75.16.5.9, Status 36 Cases.

    Note:

    There are no determination files for the specific entities exempt under a group ruling (identified by the group exemption number (GEN) on INOLES/BMFOLO).

4.75.11.8.2 (01-18-2017)

Determination Letter and Application

  1. The determination letter and application are parts of the EO microfiche file kept at the Cincinnati offices. Request the microfiche file before you visit the organization:

    1. If received, review the determination letter and application during the pre-audit phase to help you identify any large, unusual, or questionable items.

    2. If unavailable, review the determination letter and application at the organization.

  2. Determination letters may vary depending on which office issued them and when:

    1. Determination letters issued before 1954 reference IRC sections that predate IRC 501.

    2. Determination letters issued from National Office Rulings and Agreements may differ in language from those issued from the Tax Examination Determination Systems/Exempt Determination System (TEDS/EDS) system used by determination groups in Rulings and Agreements.

    3. See IRM 7.21.5, Exempt Organizations Determinations Processing, Determination Case Processing Assistance, for the various types of letters issued by determination groups.

  3. Reviewing the determination file may identify:

    • Earlier legal names of the organization.

    • Prior addresses.

    • Return filing requirements.

  4. Attached addendum address issues the determination specialist identified.

    Example:

    An addendum attached to a determination letter sent to a 501(c)(3) public charity discusses the possibility of Unrelated Business Income Tax (UBIT) generated by a proposed activity.

  5. Reviewing the determination application identifies the activities conducted or proposed at the time of the application. Organizations however, frequently change activities over time. 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 audit finds that the only children benefiting are those of the founder and other substantial contributors.

  6. Organizations are required to provide copies of their determination application (including determination letter), and their three most recently filed Forms 990, upon request from the general public (IRC 6104(d)). Form 990-T, Exempt Organization Business Income Tax Return, of organizations exempt under IRC 501(c)(3) is a required publicly disclosed form (Pension Protection Act of 2006). For further information, see Pub 557, Tax-Exempt Status for Your Organization.

  7. IRS may apply penalties under IRC 6685 for failure to make the documents available for public inspection. See IRM 20.1.8.2.3, IRC 6685 - Failure to Comply with the Public Inspection Requirements for Certain Tax Exempt Organizations for guidance in assessing the penalty.

4.75.11.8.3 (01-18-2017)

Minutes

  1. Review minutes for the year under audit, prior years, and subsequent years. At a minimum, review at least the year before and the year after the return under audit. Expand the review as circumstances warrant.

    Note:

    The organization may challenge your request to review the minutes of a year not under audit. If so, explain that you’re concerned about any activities of the audit year that started, carried on, or concluded in a prior/subsequent year. Or, obtain managerial approval to expand the audit to prior and subsequent years.

  2. Consider appropriate follow-up discussions about:

    1. Proposed or past activities, which may violate requirements for exempt status or constitute unrelated trade or businesses.

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

    3. Transactions with related entities.

  3. Review the minutes of any subcommittees (e.g., executive, audit, finance, and compensation committees).

    Note:

    In cases involving IRC 4958, excess compensation determinations, make copies of the meeting minutes of the board, executive, and compensation committees, for use in the audit report.

  4. Consider all attachments, exhibits, and reports as part of the minutes. If the organization doesn’t provide these with the minute book, request them as an integral part of the minutes. This also includes correspondence referred to in the minutes.

    Example:

    The organization’s set of minutes mention a written report provided during a meeting. The minutes however don’t include the report. When you ask for the report and read it, you find details of a questionable transaction with an insider that isn’t mentioned in the minutes.

  5. Use dates listed in the minutes to identify time frames for document sampling.

    Example:

    The organization’s minutes mention the awarding of a scholarship in the minutes as occurring on August 5th. You request the ledger and journal entries for that date and find the scholarship check written to the individual and not to the college. You then decide to request copies of the college transcript and/or other reports that the granting organization should keep.

4.75.11.8.4 (01-18-2017)

Publications

  1. Review any websites maintained by the taxpayer:

    1. Review the current and past website due to the ever-changing content of websites.

    2. Review a printout of the taxpayer’s website as it appeared during the period(s) under audit, if possible.

  2. If the organization has no printouts of the website as it appeared during the year(s) of audit, log onto web.archive.org. This website captures and presents various websites as they appeared at different times in the past. Although this website doesn’t provide a 100 percent recapture, it’s substantial.

    Note:

    Links in the old archives won’t work because they’re no longer active.

  3. Links to other websites may indicate:

    • Advertising

    • For-profit ventures

    • Other sources of UBI

    • Signs of inurement

    Note:

    If these links exist, request documentation of any emails, correspondence, contracts, and agreements entered into for 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.

    3. Includes indications of legislative or political activity.

  5. Discuss any issues arising from reviewing publications to determine if there’s additional supporting documentation, including:

    1. Advertisement pricing charts

    2. Advertising contracts

    3. Lobbyist contracts

    4. Other pertinent documents

    .

4.75.11.8.5 (01-18-2017)

Operating Manuals

  1. Review the following, if pertinent:

    • Any operating manual

    • Employee handbooks

    • Instruction booklets

    • Other materials outlining procedures performed in the course of business

  2. Certain issues, (e.g., worker classification, tip reporting, and UBI),require an in-depth review of any manuals. You may need to photocopy relevant portions.

    Example:

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

  3. Consider requesting copies of relevant section of operating manuals in electronic format. If available, use a scanner to scan the portions into an OCR (optical character recognition) format, and insert it into a Word document.

4.75.11.8.6 (01-18-2017)

Contracts

  1. Consider reviewing contracts, particularly those with officers, directors, trustees, and key employees. Determine whether:

    1. Private individuals are receiving any form of inurement.

    2. The organization has executed any agreements not in furtherance of its exempt purpose.

    or whether.

    Example:

    An IRC 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:

    An IRC 527 political organization, established by an IRC 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 whether payments are at fair market value and at arm’s length.

    Example:

    The president/executive director of an IRC 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. Obtain and review contracts for any such agreements for consideration of whether UBI may be present. 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.

    Example:

    An IRC 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.

4.75.11.8.7 (01-18-2017)

Leases, Mortgages, and Loans

  1. Consider reviewing questionable leases, mortgages and loans, particularly those with officers or other related parties, to determine whether:

    1. Private individuals are receiving any form of inurement.

    2. The organization has executed any agreements not in furtherance of its exempt purpose.

    Example:

    An IRC 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 these documents to determine if payments received represent fair market/rental value and whether the transaction was made at an arm’s length:

    • Mortgages

    • Notes payable

    • Notes receivable

    • Loans

    • Leases

    Example:

    An IRC 501(c)(5) labor union has a note receivable from the organization’s treasurer for a 5-year $25,000 note. The note doesn’t require monthly payments and interest is determined by the current savings rate offered by a local bank.

    Example:

    An IRC 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.

4.75.11.8.8 (01-18-2017)

Deeds or Other Title Documents

  1. Review the organization’s title documents to verify:

    1. Ownership of any real property by the organization

    2. From whom the property was acquired

    3. The date of acquisition

    Example:

    An IRC 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. Obtain copies of the purchase and sale agreements, or other contracts if you have questions after reviewing the title documents. Review the agreements for:

    1. Details on the terms of the purchase and sale

    2. The financing arrangements

    3. Any additional considerations provided for the property

    4. Information to determine if the purchase was at fair market value

    Example:

    An IRC 501(c)(21) black lung trust purchased a building to house its administrative services. The coal mine operator who established the trust previously owned the building. The trust paid for the building in-full at the time of purchase, resulting in no mortgage.

4.75.11.8.9 (01-18-2017)

Correspondence Files

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

    1. Letters soliciting funds for projects

    2. Correspondence that identifies the type of organizations or activities supported by the funds solicited

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

    4. Correspondence with the IRS

    Example:

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

    Example:

    A series of emails 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. The VP then had the tickets converted to coach class and received half of the refunded amount from the travel agent.

    Example:

    The website for an IRC 501(c)(3) religious organization offers certificates of ordination for a $35 fee. The website generates a letter that is emailed to the purchaser thanking them for their tax-deductible contribution.

  2. Review current correspondence with the IRS. Help the organization resolve any outstanding notices or other problems with the IRS.

4.75.11.8.10 (01-18-2017)

Financial Records

  1. A review of the financial information:

    • Reveals important information about the organization’s activities.

    • Verifies information reported on the tax return is correct.

    • Determines the strength or weakness of the internal controls.

  2. Consider following these procedures:

    • Reconcile the books to the return

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

    • Review chart of accounts

    • Review year-end trial balance

    • Review auditor's report

    • Review audited financial statements and management reports

    • Analyze income and expenses

    • Analyze the balance sheet,

    • Test sample transactions for LUQs

    • Ensure an accurate return is filed

    Note:

    Consider requesting financial records during the pre-audit phase and analyzing them before the audit. This helps reduce the case cycle time.

4.75.11.8.11 (01-18-2017)

Definitions

  1. Tax reconciliation work papers - work papers used in preparing a return, such as the trial balance. You can frequently use these work papers to trace financial information to the return.

  2. Audit work papers - work papers kept by an independent accountant with details of the following items used in his/her audit:

    • Procedures followed

    • Tests performed

    • Information obtained

    • Conclusions reached

    Examples of audit work papers:

    • Work programs

    • Analyses

    • Memorandums

    • Letters of confirmation and representation

    • Abstracts of organization/plan documents

    • Schedule or commentaries prepared or obtained by the auditor

    Note:

    These work papers ensure the audit work was done in conformity with generally accepted accounting principles and demonstrate compliance with the generally accepted auditing standards.

4.75.11.9 (01-18-2017)

Reconciliation of Books and Records

  1. The burden is on the organization to arrange books and records, as well as prepare summaries and reconciliations.

  2. Reconcile the return to the organization’s books ensuring all transactions recorded in the books were reported on the return.

  3. Prepare a work paper showing the reconciliation and index it to section D-3 of the Form 5773.

    Note:

    If you can’t reconcile the books and records to the return, this may indicate a lack of internal controls or the use of improper accounting procedures. Carefully consider the amount of deviation; a small percentage may mean the difference is immaterial.

  4. For larger organizations reconciliation can be time-consuming, especially if the organization doesn’t give you tax return preparation work papers. For these cases, consider reconciling only those accounts identified as LUQ. Prepare a work paper showing this reconciliation and index to Form 5773 section D-3.

    Note:

    If you’re unable to reconcile the return to the books and records, this is a red flag and warrants a more in-depth financial audit.

    Example:

    The organization provides a trial balance that shows $3 million more in income and expenses. The organization doesn’t provide any other tax reconciliation work papers. Your quick reconciliations of the LUQ accounts show deviations of less than 0.1 percent; no other issues exist. It wouldn’t be an efficient use of government resources to do a full reconciliation of the return.

  5. Review the return reconciliation work papers. These generally consist of year-end trial balances after any adjusting (and consolidating, if applicable) entries.

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

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

    Example:

    The trial balance reflects $2 million of in-kind revenues and expenses, $0.5 million in refunds of membership dues, and $0.5 million in allowances for doubtful accounts, none of which was reported on the return.

4.75.11.10 (01-18-2017)

Comparison of Prior and Subsequent Year Financial Information

  1. Compare the year under audit with prior and subsequent year income and expense statements. Identify any large or questionable differences between years (e.g., amounts reported in only one year but not others).

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

  3. Obtain copies of the Forms 990 from On-Line Statistics of Income EO Image Net (SEIN) or by requesting a copy of the return from the organization. Once received, analyze the prior and subsequent years before the field visit in order to shorten the cycle time.

    Note:

    Access to On-Line SEIN may be restricted due to the number of site licenses available. If restricted, ask your group manager to send your request to an individual with access.

    Note:

    Request copies of a filed return from the organization only after you’ve tried unsuccessfully to get a copy of the return internally, or elsewhere (unless your purpose is to verify IRC 6104(d)).

4.75.11.11 (01-18-2017)

Review of Chart of Accounts

  1. Review the chart of accounts for unusual accounts or accounts that should appear but are absent.

    Example:

    An IRC 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 corresponding account titled raffle sales, or other similar name.

  2. The chart of accounts also helps you to review the general ledger. The chart of accounts associates identifying numbers with account titles, and classifies accounts as revenue, expense, asset, and liability.

4.75.11.12 (01-18-2017)

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 internal report provides useful information on internal controls and the organization’s accounting procedures.

    Note:

    See IRM 4.75.11.14 for a discussion of privileges that the organization’s officer may assert.

  2. Due to the revisions made to the Form 990 for tax years ending in 2008 and later, organizations must disclose in Part XII, Financial Statements and Reporting, whether:

    1. An independent accountant prepared or reviewed the compilation of financial statements.

    2. An independent accountant performed an audit of the organization’s financial statements.

    3. An audit committee 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 the receipt of a federal contract award.

    Note:

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

  3. Also review the organization’s annual report. This report usually discusses major accomplishments for the year and planned accomplishments for the future. It may be issued to management, the public, and/or members.

  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.

4.75.11.13 (01-18-2017)

Accountant’s Work Papers

  1. Request and review the accountant’s tax reconciliation work papers. They give you a good starting point for reconciling the return to the books.

  2. Request tax reconciliation work papers at the beginning of the audit 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 work papers are prepared and provided by the organization. However, if these work papers are unavailable from the organization, you can request them from the accountant.

  4. Limit any requests for audit work papers to only those material and relevant to the audit. Determine whether an item is material based on your judgment and evaluation of the case’s facts and circumstances.

4.75.11.14 (01-18-2017)

Protected Privileges

  1. An officer, director, trustee, or representative may attempt to hinder or halt an audit by various methods including:

    1. Invoking the Fifth Amendment privilege against self-incrimination

    2. Assertion of an attorney-client privilege

    3. Claiming documents are covered by the work product doctrine

    4. Asserting a federal tax practitioner-client privilege under IRC 7525

  2. The person can assert these privileges orally or in writing.

  3. A person can’t successfully refuse to testify or provide information solely based on the facts that he/she stands in a confidential relationship with another person. The burden is on the witness to:

    1. Establish the facts on which the asserted privilege is based.

    2. Demonstrate how, and the extent to which, the requested information is covered by the privilege.

  4. If a person asserts one of these privileges during an interview or in response to a request for records, consult Area Counsel.

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

  6. See IRM 4.10.1.6, Taxpayer Rights, and IRM 5.17.6, Legal Reference Guide for Revenue Officers, Summonses for additional information, including court case citations and additional analyses.

4.75.11.14.1 (01-18-2017)

Fifth Amendment

  1. An individual can’t 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. The courts, not the agent, will determine the protection of oral testimony or written records by a Fifth Amendment privilege.

  3. Fifth Amendment protections don’t 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. Suspend any interview during which an individual asserts a Fifth Amendment privilege.

4.75.11.14.2 (01-18-2017)

Attorney-Client Privilege

  1. In general, communications from a taxpayer to an attorney made in confidence while obtaining legal advice are privileged. The attorney can’t be compelled to disclose that information to the IRS. 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 IRS 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 isn’t all-inclusive and doesn’t protect everything an attorney may do for a client. The privilege is limited to communications the client made in confidence to obtain legal advice from an attorney.

  4. The client in an exempt organization setting may be any officer or employee of the exempt organization. You can obtain underlying factual information from the employees whether they’ve communicated this same information to the organization’s attorney.

  5. An attorney’s possession of a taxpayer’s books and records doesn’t grant an attorney-client privilege. You may compel production of the records via a summons.

  6. These 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

    • 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. The attorney-client privilege doesn’t cover:

    • Work papers produced while preparing the returns or the tax records used.

    • Communications between the client and the attorney about the return being prepared

4.75.11.14.3 (01-18-2017)

Work Product Doctrine

  1. The work product privilege protects documents an attorney prepares for his client anticipating legal action. This doctrine applies to IRS summonses.

  2. The courts typically determine whether the work product doctrine applies in a hearing concerning summons enforcement.

  3. The work product doctrine doesn’t cover accountant-prepared documents, unless produced for the attorney in anticipation of or for use in litigation.

4.75.11.14.4 (01-18-2017)

Federal Tax Practitioner-Client Privilege

  1. IRC 7525(RRA 1998), extended the attorney-client privilege 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 doesn’t change the attorney-client privilege of confidentiality. Therefore, as with the attorney-client privilege, information an individual discloses to an authorized practitioner acting beyond his capacity isn’t privileged.

  3. The American Jobs Creation Act of 2004 amended IRC 7525(b) by stating that the tax practitioner privilege doesn’t 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.

  4. "Federally authorized tax practitioner" means any individual authorized under federal law to practice before the IRS (Circular 230). The term includes

    • Attorneys

    • Certified Public Accountants

    • Enrolled agents

    • Enrolled actuaries

  5. The term "tax advice" means advice an individual gives with on matters within the scope of that individual’s authority to practice before the IRS.IRC 7525(a)(3).

  6. The privilege may only be asserted in:

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

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

  7. The privilege may not be asserted to prevent disclosing of information to any regulatory body (i.e., the Securities and Exchange Commission) other than the IRS, including in an administrative or court proceeding.

4.75.11.15 (01-18-2017)

Analysis of Accounts

  1. You can perform the following procedures either during the pre-audit phase or in the field. Request the general ledger and chart of accounts in the initial information document. Request the organization to send these items before the audit if you plan to review them before the initial interview.

  2. An organization’s use of its resources is an important indicator of its programs and activities. During your review of the general ledger and chart of accounts, identify certain accounts to analyze to determine the source of the revenue or expenditures.

  3. Look for any unusual (by amount, source or nature) or nonrecurring items. 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; investigate any deviations from the norm (e.g., a payroll entry in the office supplies account).

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

  4. Use these audit steps to review accounts:

    1. Review year-end adjusting trial balance or similar summary of year-end general ledger account balances. Select LUQ accounts for further analysis.

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

    3. Select samples of detailed transactions 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) you need to determine the impact of a large or unusual transaction on the organization's exempt status or tax liability.

    Note:

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

4.75.11.15.1 (01-18-2017)

Sampling Techniques

  1. Sampling of the records provides:

    • An element of confidence in the amounts recorded in the books

    • Helps to identify issues to be addressed

    • Aids in recognizing fraud

    Note:

    With certain small organizations, you may not have to sample documents because you 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 spent at an audit site.

  2. The two basic types of sampling are:

    1. Judgment

    2. Statistical

4.75.11.15.1.1 (01-18-2017)
Judgment Sampling

  1. Judgment sampling requires you to use professional judgment to:

    1. Perform the sampling procedure.

    2. Evaluate the results of the sample.

    Note:

    Judgment samples aren’t statistically valid. If you find errors in a sampled set of records, consider expanding the sample size.

  2. Judgment sampling methods include:

    1. Block sampling - uses groups of continuous items selected from an account balance or class of transactions. The sample may include selecting all items in a selected numerical or alphabetical sequence.

      Example:

      You select one month of travel expenses to reach a conclusion about the travel expenses for the entire year. You look at each voucher filed for the month, the attached receipts, and compare them to the entries in the general ledger.

      Example:

      You sample gross receipts on the 5th, 15th, and 25th of each month. You review and compare the general ledger, cash receipts journal, bank statements, and deposit slips for those specific dates.

    2. Dollar limitation (or cut-off) sampling selects a minimum dollar amount and creates a sample by selecting all items exceeding that dollar amount. This type of sampling prevents you from wasting time examining small, insignificant amounts.

      Example:

      You choose to review pull-tab prize payouts of $1,000 or more. You review all Forms W-2G, Certain Gambling Winnings, issued by the organization and the daily prize journal maintained for the state gambling commission.

      Caution:

      Perform dollar limitation sampling in conjunction with block sampling. Individuals who 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:

      You review an expense account for meals purchased by the employees and officers. The records show an expense of $100 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.

4.75.11.15.1.2 (01-18-2017)
Statistical Sampling

  1. Statistical sampling is a procedure used to choose a portion of the whole to make a statement about the entire body of information. Statistical sampling allows each sampling unit to stand an equal chance of selection, eliminating your judgment on which items to sample.

  2. Before performing a statistical sampling application discuss the facts and circumstances with your manager. Together you will determine whether to request a Computer Audit Specialist (CAS). Refer to IRM 4.47.3.2.4, Computer Audit Specialist, Statistical Sampling Audit Techniques, for instructions on requesting CAS assistance.

  3. The burden of proof is placed on the IRS in any court proceeding when the IRS reconstructs any item of income by using statistical information only on unrelated taxpayers (IRC 7491(b)).

4.75.11.15.2 (01-18-2017)

Income Analysis

  1. By reviewing the organization’s income you can determine its accuracy, extent, and nature.

  2. There are several purposes for analyzing income, including determining 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.

      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:

      An organization erroneously classified receipts from "social members" of a veterans post as member dues, when the bylaws explicitly prohibit social members.

  3. Using the LUQ items you originally selected on the return during the pre-audit, 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 selected will primarily depend on the type of organization audited.

    Example:

    The investment income of an IRC 501(c)(7) organization is taxable, whereas the investment income of an IRC 501(c)(4) organization isn’t.

  5. See the appropriate IRM 4.76 chapters for guidance on specific types of income to consider auditing.

  6. Review the bank statements, bank reconciliations, and 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:

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

    Note:

    Most bank imaging systems eliminated the need for deposit slips and deposit envelopes. Many banks also request clients to opt for online bank statements, in lieu of receiving printed materials. A taxpayer doesn’t comply with the record keeping requirements under IRC 6001 and associated regulations if their electronic storage system doesn’t meet the requirement of Rev. Proc. 97-22.

  8. Select specific days for sampling sales of inventory, contributions, and program service revenues.

    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), you should find all of the days’ receipts totaled. Trace these to a deposit slip for later that night or during the week, which should show up on a bank statement, as well as the general ledger and cash receipts journal.

4.75.11.15.3 (01-18-2017)

Expense Analysis

  1. Review an organization’s expenses to:

    • Determine the size, extent and nature of the expenses.

    • Verify the amount reported is reasonably accurate.

    • Verify the amount reported is correctly classified as an expense and not an asset (such as a prepaid expense).

  2. When analyzing an expense, determine whether the expense:

    1. Is in furtherance of exempt purposes.

      Example:

      An IRC 501(c)(19) veterans organization purchases 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:

      An IRC 501(c)(3) private foundation spends $3,000 per person 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:

      An IRC 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 isn’t a political expenditure, but is a legislative expenditure. It isn’t expended for exempt purposes under IRC 527.)

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

      Example:

      An IRC 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 percent. 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.

      Example:

      An IRC 501(c)(10) organization employs a favorite band four times in a 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 UBI.

      Example:

      Form 990-T for an IRC 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 LUQ items you identified during the pre-audit, 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, you track the entry on the general ledger to the travel account and from there to the travel voucher, and then match 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, 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. The Form 990 should list most of these individuals. Carefully analyze any business relationships or other dealings with these individuals to determine if they provide inappropriate benefits.

  8. Determine the reasonableness of total compensation paid or accrued to principal officers. Consider any compensation claimed under a heading other than officers' salaries (e.g., contributions to pension plans, payments of personal expenses, year-end bonuses, use of company car).

    Note:

    Look for multiple entity situations that split compensation between two or more related corporations. The aggregate amount paid may be excessive.

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

    • Advertising

    • Printing

    • Promotion

    • Outside services

    • Legal and professional fees

    • Miscellaneous expenses

  10. If auditing a membership organization (other than an IRC 501(c)(3) organization), review the following aspects of the 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 dues and other general funds or special assessments financed the lobbying activities.

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

  11. Review contract labor, repairs and maintenance, legal, consulting, and similar accounts for potential Form 1099 filing requirements. Consider the following:

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

    2. Additional compensation in the form of expense accounts

  12. Analyze travel and other expense allowances. If the organization doesn’t require the employee to file an expense account, the payments should be included in the recipient’s gross income.

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

  14. When reviewing UBI and expenses, verify:

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

    2. That expenses are allocated on a reasonable basis.

    3. The deductibility of any losses.

  15. Organizations aren’t 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 method 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. You determine 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.

4.75.11.15.4 (01-18-2017)

Balance Sheet Analysis

  1. Analyze the balance sheet to identify:

    1. Potential inurement, private benefit, or excess benefit transactions.

    2. Assets generating UBI.

  2. Analyze the changes in net assets/fund balances and in net worth. 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 personal use of automobiles, houses and other assets.

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

    5. Look for investments that generate UBI.

    6. Analyze any disposition of assets for possible inurement to officials.

    7. Identify any loans that became delinquent or foreclosed during the years under audit.

    8. Identify receivables written off to determine if they were from an officer, director, trustee or key employee. This can also, in effect, be a reimbursement to the officer, director, trustee, or key employee for an illegal payment made on behalf of the organization.

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

4.75.11.15.5 (01-18-2017)

Tax Liabilities

  1. You should determine if the organization is liable for certain taxes and determine the correct amount of tax owed relating to:

    Taxes Owed For IRC Section
    Unrelated business taxable income 511-514
    Transactions by private foundations 4940-4945
    Lobbying activities 4911 - 4912
    Political activities 527(f) and 4955
    Excess benefit transactions 4958
    Employment taxes 3101, 3111, 3301, 3402, 3406, and 3509
    Gaming activities 4401 and 4411
    Proxy Tax on Lobbying and Political Expenditures 6033(e)(2)(A)
    Black Lung Trust excise taxes 4951 - 4953

  2. Please refer to the appropriate Knowledge Networks (K-Net), Knowledge Networks site for guidance on computing specific taxes. Also see IRM 4.23, Employment Taxes.

4.75.11.15.6 (01-18-2017)

Accuracy of Return

  1. Many organizations filing Form 990 series returns aren’t subject to the various taxes identified in IRM 4.75.11.15.5. Forms 990 however, are subject to public inspection and relied upon by the public for a variety of purposes. Due to this public scrutiny of the Form 990 series, make sure the return is accurate.

  2. Secure and attach to the return any schedules or other information omitted from the originally filed return. Information commonly omitted from the Form 990 includes:

    • 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

    • Answers to all applicable questions

  3. For returns that have substantial misstatements, secure amended returns if the organization is to retain exemption. These amended returns don’t offer relief from the contemporaneous reporting requirements of IRC 4958.

    Example:

    An IRC 501(c)(3) public charity is involved in gift-in-kind transactions but substantially overstates the amounts of contributions.

4.75.11.16 (01-18-2017)

Fraud Considerations

  1. Properly identify and address potential "badges of fraud" .

  2. IRC 6663 doesn’t 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

    • Carelessness

  3. Since direct proof of a taxpayer’s fraudulent intent is rarely available, you may have to prove fraud with 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)

    • 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 agent.

    8. Concealment of assets.

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

    10. Inadequate records.

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

  5. When initial badges of fraud are uncovered, discuss with your manager. Develop an action plan as soon as possible to document firm indications of fraud. The plan should be a joint effort of you, your manager, and when needed, the TE/GE Fraud Specialist. See IRM 4.75.35.7, Civil Fraud.

4.75.11.17 (01-18-2017)

Other Audit Considerations

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

    Note:

    Make changes to filing requirements involving Form 11-C, Occupational Tax and Registration Return for Wagering, Form 730, Monthly Tax Returns for Wagers, and Form 945, Annual Return of Withheld Federal Income Tax, using Form 2363, Master File Entity Change.

  2. There are certain public disclosure requirements of various returns, applications, etc. of organizations exempt under IRC 501(a) or IRC 527 (IRC 6104). Certain non-IRC 501(c)(3) organizations must disclose in their fund-raising materials that contributions to their organization are nondeductible (IRC 6113).

    1. Discuss the disclosure and/or notification requirements and ensure the organization has met its responsibility.

    2. Review any violations noted in the minutes, correspondence, or through interviews and determine if penalties apply.

4.75.11.18 (01-18-2017)

Follow-Up Information Document Requests

  1. You may need to secure additional records, documents, or other clarifying evidence during the audit. Prepare a Form 4564, Information Document Request (IDR), advising the organization of the information needed.

  2. Request only relevant information you need to resolve the issue(s) or areas you’re considering. This decreases the burden on the organization.

  3. A properly completed IDR:

    • Specifies clearly and concisely the types of documents requested.

    • Briefly explains why the documents are being requested.

    • Is computer generated, either through RCCMS or manually via MS Word.

  4. At a minimum, the request must contain the:

    1. Name of the organization.

    2. Name of the agent.

    3. Agent’s mailing address.

    4. Agent’s phone and fax numbers.

    5. Date of the request.

    6. Due date of requested materials.

    7. Delivery method for the records (in person or by mail).

  5. You may request electronic records (e.g., CD or thumb drive). Always scan any files received electronically for viruses while disconnected from the network before you open them.

4.75.11.19 (01-18-2017)

Organization Delays

  1. ) If you requested additional information and the organization doesn’t provide it within the specified time (e.g., 30 days), call them. If you can’t contact the organization by telephone, send another copy of the previously requested information by certified mail. Include in this request a specific due date for the information.

  2. Always be aware of statute and audit cycle considerations when setting a response date. If the organization fails to respond after two attempts, ask your group manager for help to obtain the requested information.

  3. Schedule a meeting that includes the organization, the group manager, and you to determine if they intend to send the records. If the organization still isn’t cooperative, the group manager consults Area Counsel for advice on issuing a summons.

  4. If a practitioner fails twice to provide documents in response to a single IDR, consider making a referral to the Office of Professional Responsibility for possible sanctions. Consult your group manager before you make a referral, as you must perform POA bypass procedures. See IRM 4.71.1.9.1, Overview of Power of Attorney By-pass Procedures).

4.75.11.20 (01-18-2017)

Concluding the On-Site Visit

  1. Before you leave the audit site on the last day, conduct an "exit conference" with the organization’s representative. During the exit conference, discuss these items:

    • The next steps involved in the audit

    • A date when the organization can reasonably expect to hear from you next

    • Any additional items requested on IDR #2, if issued

    • Any remaining questions the organization may have

4.75.11.21 (01-18-2017)

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. Statute requires the Service to provide this information to the public. These requests are generally not made under the Freedom of Information Act (FOIA), 5 U.S.C. section 522.

  2. You may receive a request at any time during or after the field visit. Within one day of receipt, send any requests for information to the Manager, Compliance Strategies and Critical Initiatives (CSCI).

  3. The CSCI manager reviews the requests to determine if the Director, EO Examinations has the authority to release the information. If so:

    1. The CSCI manager forwards the request to the EO FOIA coordinator for processing.

    2. The requester receives a notice informing them that they’ll receive a response within 15 business days and that fees may apply for searches and copying.

  4. If the information can’t be released, the agent informs the requester 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 any applicable fees.

Exhibit 4.75.11-1

Sample Form 2848

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