The good news, I suppose, is that there is almost no chance your non-profit organization will ever face an IRS audit. This is not my opinion. The numbers don't lie.
In 2009 the IRS audited approximately 1,723 of the existing 800,000 tax-exempt organizations. The arithmetic is pretty straightforward: The chances of any single organization facing an audit during any year are about two in a thousand. When you consider that lately the IRS has tended to focus its audits on specific categories of non-profits (e.g. universities, credit counseling groups, etc.), your risk of an audit diminishes to infinitesimal if you aren't in one of the categories.
Consider also that the already thinly staffed IRS simply can't keep up with the workload. In one recent three-year period, the number of charities increased by 38 percent even as the IRS staff available for audits actually declined. By one calculation, there is only one IRS enforcement agent available for every 4,000 tax-exempt entities. The prospect that this ratio will change for the better is highly unlikely with a proposed federal employee wage freeze and a new Congress looking to cut the size of the government.
These numbers may be good news for in-house non-profit lawyers like us, but they aren't good for the common good. Non-profits now employ 12.9 million people, which means the sector accounts for fully 10 percent of the jobs in this economy. That is greater than the combined employment of the finance, insurance and real estate industries. And, the sector's total annual revenue is nearing $2 trillion. If just the sector's investment income were taxed, it would produce at least $60 billion for the U.S. Treasury. These numbers are evidence of just how important non-profit organizations are to the economy and to society as a whole.
Yet, we are doing precious little to protect the non-profit sector from itself. The situation is not unlike the village that made a big show of lowering speed limits to reduce accidents, but spent nothing on enforcement (except for new signs). Guess what happened? People felt safer for a while, until drivers realized the signs didn't mean a thing. With no enforcement from the IRS, the non-profit sector amounts to a legal free-fire zone where ne'er-do-wells can, and do, exploit the government, other non-profits and the public. The stories of outlandish executive compensation are well known to the point they got the attention of Sen. Charles Grassley of Iowa. But the effect of his strong intervention is ephemeral at best without significant and sustained enforcement. Since 2003, the IRS has imposed fines for excessive pay and benefits only about 10 times a year.
The audit of the legitimate-sounding U.S. Navy Veterans Association illustrates the weakness of the enforcement mechanisms the IRS is able to mount. According to independent reporting by the St. Petersburg Times, the IRS gave the charity a clean bill of health two years ago, which allowed it to raise another $27.6 million from the public to help vets and troops overseas. But the audit did not uncover the fact that the founder was a fake Navy veteran who used "his elaborately constructed but phony [charity] to swindle the gift-giving public" and had been doing so for years, in part to funnel donated money into political campaigns. That's not even like giving a reckless driver a warning instead of a ticket--it's more like giving him a free tank of gas and a pat on the back. The IRS has to do better.
The truth is, we need better enforcement across the board. First, we will catch some bad guys. But second, and more important, the deterrent effect of regular enforcement will improve compliance. When that happens the public will not think their donations are misused, and the government may allow us to keep our tax exemptions a while longer.