Nonprofit Tax Risk & Strategy Series (Part 1)
Many nonprofit organizations believe they are compliant because they file their annual Form 990 on time.
But compliance goes far beyond filing.
In practice, most IRS issues arise not from missed deadlines—but from misunderstood rules, incomplete processes, and undocumented decisions. These risks often develop gradually through day-to-day operations, making them difficult to identify until they become significant issues.
The reality is that many organizations are exposed to risk without realizing it.
Compliance vs. Risk: Understanding the Difference
Filing Form 990 is only one part of maintaining compliance.
The IRS evaluates whether an organization is:
- Operating in furtherance of its exempt purpose
- Avoiding impermissible private benefit
- Maintaining appropriate governance and oversight
- Reporting activities accurately and consistently
An organization can meet filing requirements and still face material compliance risks if these areas are not properly managed.
Common Hidden Risks Nonprofits Overlook
Unrelated Business Activities
Many organizations generate revenue through activities that may not be substantially related to their exempt purpose.
Examples include:
- Advertising income
- Sponsorship arrangements
- Fee-for-service programs
These activities may create unrelated business taxable income (UBI), which can trigger additional filing requirements and tax liability if not properly evaluated.
Compensation and Private Benefit
Compensation arrangements involving officers, directors, or key employees must be reasonable and properly documented.
Even well-intentioned arrangements can raise concerns if:
- Compensation is not supported by comparability data
- Decisions are not independently reviewed
- Documentation is insufficient
Improperly structured arrangements may result in excess benefit transactions, which carry potential excise taxes and increased scrutiny.
Related Party Transactions
Transactions involving insiders or related entities are not prohibited—but they are closely reviewed.
These transactions must be:
- Conducted at fair market value
- Approved through an independent process
- Fully disclosed on Form 990
A lack of transparency or documentation can create risk, even when the underlying transaction is appropriate.
Governance and Oversight
The IRS uses Form 990 to evaluate governance practices, including:
- Board independence
- Conflict of interest policies
- Documentation of decision-making
Weak governance structures may signal broader compliance issues and increase the likelihood of further review.
Filing and Reporting Gaps
In addition to Form 990, nonprofits may have multiple filing obligations, including:
- Form 990-T for unrelated business income
- Payroll tax filings
- Information returns such as Forms 1099
Missing or incomplete filings can indicate systemic weaknesses in compliance processes.
The Most Common Issue: Lack of Structure
One of the most common risks is not a specific transaction—but the absence of a structured compliance framework.
Without clearly defined processes:
- Responsibilities may be unclear
- Key decisions may not be documented
- Filing requirements may be overlooked
This often results in a reactive approach to compliance, where issues are addressed only after they arise.
A Practical Approach to Managing Risk
Strong organizations treat compliance as an ongoing process, rather than an annual requirement.
This includes:
- Regularly reviewing revenue streams and activities
- Establishing clear governance and approval processes
- Maintaining contemporaneous documentation
- Coordinating between leadership, finance, and advisors
A proactive approach helps identify risks early and ensures consistent compliance.
Why This Matters
Compliance risks can have significant consequences, including:
- IRS inquiries or audits
- Financial penalties
- Reputational concerns
- Potential loss of tax-exempt status
Many of these risks are preventable with proper planning and oversight.
Final Thought
Most nonprofit risks are not obvious.
They arise from everyday decisions—how revenue is generated, how compensation is structured, and how transactions are managed.
Understanding these risks is the first step toward protecting your organization and its mission.
What’s Next
In Part 2 of this series, we’ll explore one of the most misunderstood areas of nonprofit taxation:
Unrelated Business Income (UBI) vs. mission-related revenue—and where organizations often get it wrong.
