An audit is an examination by an outside party, conducted to ensure that an organization’s financial records are accurate and in accordance with the law. You may not think of non-profit organizations in the same way that you think of corporations, but nonetheless they are a major part of the United States economy.
Between corporations, foundations, and individual contributions, Americans donated $471.44 billion to non-profit organizations in 2020—that’s 2.3% of the country’s gross domestic product. Despite minor dips during periods of recession, and factoring in inflation, the trend line for annual charitable donations has been heading uphill for decades. There are over 1.5 million non-profit organizations, or charities, in the United States supporting a wide variety of causes from medical research to ending homelessness. With all the money streaming into these organizations, it makes sense that they are audited. There are a variety of reasons that a non-profit may be forced to undergo an audit and there are a number of reasons that a non-profit might choose to get an audit.
Non-Profit Audits Required by Federal Law
Federal law does not require most non-profit organizations to undergo an audit. However, if an organization spends more than $750,000 federal grant dollars in a year, the federal government will require them to do so. The Single Audit Act was put into place in 1984 (and amended in 1986) to hold qualifying non-profits accountable by requiring them to prove that they are using federal grant money in accordance with the federal government’s requirements. The specific requirements that a non-profit must meet are laid out in the federal grant agreement or reward letter.
What is a Single Audit?
Single audits are more extensive than a typical independent audit. The government does not audit these non-profits themselves; they are performed by independent auditing companies. Single audits were created for non-profits as a more affordable option. A single audit combines covers every aspect of the organization at one time instead of conducting multiple audits to cover each program and separate audits for compliance and financial records.
State Required Non-Profit Audits
Like the federal government, some state governments require that non-profits are audited periodically. States also provide non-profits with grant money and auditing may be a stipulation of the grant. Requirements for non-profit audits vary by state, some do not require audits at all while others require them for some organizations based on certain conditions. States including Alabama, Idaho, and Ohio do not require any non-profits within their state to obtain an audit. Other states have certain criteria that requires the non-profit to obtain and submit audited financial statements prepared by an independent CPA. For example, Tennessee requires an audited financial statement from non-profits with a gross annual income over $500,000. Some states require audits from charities that rely on volunteers for fundraising or based on annual contribution amount.
Why would the IRS audit a non-profit organization?
The main objective of the IRS is to collect taxes and ensure that businesses, individuals, and non-profits comply with tax laws. If a non-profit organization is taking advantage of their tax-exempt status, they are breaking the law, violating a moral construct, and in some cases, they are making or using money that is unrelated to their cause without paying taxes. It is also an issue for the IRS if a non-profit fails to report required information because they will be unable to monitor their activity and ensure that the organization is worthy of tax-exempt status.
Referrals From Concerned Parties
There is referral program in place for non-profit organizations where groups, individuals, and states can raise a red flag about a tax-exempt non-profit if they have reason to believe that they are not abiding by laws that tax-exempt organizations must follow. A referral prompts the IRS to investigate the organization and determine whether an audit is appropriate.
Incomplete, Inconsistent, or Suspicious 990
While non-profits are exempt from paying taxes, the government still keeps tabs on them. Non-profit organizations are required to fill out a 990 form each year. These forms collect information about tax-exempt organizations to ensure that they are not taking advantage of their tax-exempt status. Information on a 990 includes a summary of their activities, the structure of their administration and governance, financial information, and an overview of their accomplishments to justify their tax-exempt status. Additionally, these forms are available to the public upon request, allowing potential donors and anyone else who is interested to see how the organization operates and uses their money. The IRS may require a review if a 990 form has suspicious information, is incomplete or contains inconsistent information.
Monitoring Unrelated Business Income
Many non-profit organizations operate a business that is not directly related to the charitable cause that they support. Unrelated business income (UBI) is the term for the income that these businesses bring in. The non-profit uses this income to support the organization’s cause, however, these businesses are not exempt from paying taxes. An example would be if a non-profit animal shelter sold t-shirts. The profits from the t-shirt sales are used to fund shelter operations but the IRS views the t-shirt sales in the same way they view a for-profit clothing store. Non-profits that generate UBI must fill out an additional 990 form and file taxes on the income they generate like any other business. Failure to do so is likely to result in an audit. If UBI becomes a substantial amount of the non-profit’s overall income (roughly 20% or more), the IRS might require an audit to determine if the organization should have tax-exempt status.
When should a non-profit choose to undergo an audit?
A non-profit may choose to hire an independent CPA to audit their organizations due to suspicion of fraudulent activity, to ensure that their financial records are complete and accurate, or to apply for a grant or donation from a foundation that requires the recipients of their contributions to be audited.
Suspicion of Fraud
The nature of non-profits makes them susceptible to fraud. It is easier for a fraudster to take advantage of a non-profit than a corporation because they are not watched as closely by the IRS and typically undergo fewer audits. According to the Association of Certified Fraud Examiners, the average non-profit organization loses 5% of its annual revenue to fraud. Non-profits are susceptible to many of the same types of fraud as corporations, including embezzlement, misappropriation of funds, ghost employees and check fraud. These are all examples of criminal acts committed from within the organization, non-profits are also at risk of being taken advantage of by people outside of their organization—non-profits do not tend to be suspicious of volunteers or the people whom they are trying to help which leaves them vulnerable to those who may take advantage of their generosity and trust. In addition to the money that is lost, a non-profit’s reputation can be damaged by fraud—driving away donors and grantors. A non-profit should be suspicious of fraud and schedule an audit with an independent CPA if there are suspicious vendor billings, especially if they are too frequent, the vendor is unfamiliar, or the address is residential or a P.O. box. If there is an inadequate separation of duties allowing one person to control the organization’s finances without being monitored by other employees, there is a greater risk of fraud. If an employee is unwilling to share financial duties or documents with other employees, this is a red flag.
Eligibility for Grants and Donations from Foundations
Like the government, some grants require that the non-profits who receive their grant money are audited annually. Some foundations also require audits prior to donation. A non-profit may choose to be audited by an independent CPA in order to be eligible to apply for grants or donations or to maintain funding from a source.
Count on Baird Audit Group for your Auditing Needs
Choosing the right auditor to audit your non-profit is just as important and knowing when to do so. Baird Audit Group has been a trusted name in the audit business since 1927, helping individuals, businesses, and non-profit organizations operate legally and successfully. Their team of talented and experienced CPAs will evaluate your organization to help improve internal control systems, efficiencies, and confidence in the accuracy of your financial records.
Contact Baird Audit Group online or call (706)855-9500 for more information.