Many nonprofit organizations assume that IRS audits are rare or occur at random.
In reality, audits are often the result of data-driven selection processes. The Internal Revenue Service uses a combination of analytics, compliance checks, and targeted reviews to identify organizations that may warrant further examination.
Understanding what the IRS is looking for can help organizations reduce risk, strengthen compliance, and avoid unnecessary scrutiny.
How the IRS Identifies Organizations for Review
The IRS does not review nonprofit filings in isolation. Instead, it analyzes data across multiple sources, including:
- Form 990, 990-EZ, and 990-PF filings
- Form 990-T filings (if applicable)
- Prior-year returns and trends over time
- Publicly available information
This approach allows the IRS to identify patterns, inconsistencies, and anomalies that may indicate potential compliance issues.
Key Areas That May Trigger IRS Scrutiny
Inconsistencies Within the Return
One of the most common triggers is inconsistency across different sections of Form 990.
Examples include:
- Program descriptions that do not align with reported revenue
- Governance responses that conflict with other disclosures
- Missing or incomplete schedules
Even when underlying activities are appropriate, inconsistencies can raise questions about the accuracy of the return.
Significant Year-Over-Year Changes
The IRS frequently reviews changes in an organization’s financial and operational data from one year to the next.
Examples include:
- Sudden increases or decreases in revenue
- Significant changes in compensation
- Shifts in program activities or priorities
Changes are not inherently problematic. However, they should be supported by documentation and, where appropriate, explained within the return.
Missing or Incomplete Information
Incomplete filings are a common compliance issue.
This may include:
- Required schedules that are omitted
- Sections left blank or partially completed
- Limited or unclear narrative disclosures
Because Form 990 is intended to provide a comprehensive view of an organization, missing information can be interpreted as a potential red flag.
Indicators of Unrelated Business Income (UBI)
Certain revenue streams may suggest the presence of unrelated business income.
Examples include:
- Advertising income
- Merchandise sales
- Facility rentals or other commercial activities
If these activities are not properly analyzed or reported, they may increase the likelihood of IRS review.
Governance and Compensation Disclosures
The IRS pays close attention to governance practices and compensation arrangements, including:
- Board independence
- Conflict of interest policies
- Compensation of officers and key employees
- Transactions with related parties
These disclosures provide insight into how the organization is managed and whether appropriate oversight is in place.
The Role of Form 990
Form 990 is more than a compliance requirement. It is a primary tool used by the IRS to evaluate whether an organization is operating in accordance with its tax-exempt purpose.
It is also publicly available, meaning that donors, grantors, and regulators may review the same information.
A well-prepared Form 990 should be:
- Complete
- Consistent
- Clearly explained
A Proactive Approach to Reducing Risk
Organizations can reduce the likelihood of IRS scrutiny by taking a proactive approach to compliance.
This includes:
- Reviewing activities throughout the year—not just at filing time
- Ensuring consistency between financial and narrative reporting
- Maintaining documentation to support key disclosures
- Involving leadership in the review of Form 990 prior to filing
The goal is not simply to file on time, but to ensure that the return accurately reflects the organization’s activities and operations.
Final Thought
IRS audits are often driven by patterns and inconsistencies, not just errors.
By understanding what the IRS is reviewing, nonprofit organizations can identify potential issues early, strengthen compliance, and present a clear and consistent picture of their operations.
