Many nonprofits prefer that the audit firm also prepare the tax return. Because the audit represents ten times the hours of the tax work (and ten times the fee), selections are often based on the audit personnel without much consideration of the tax department. For this reason, many firms won’t even bring a member of the tax team to the interview. If they do, it indicates that the tax person presents very well or will give them some advantage.
Audit firms vary in how they handle tax returns for audit clients. In smaller firms, the auditors themselves may prepare and sign the tax returns. In most firms, there is a separate tax department that is largely independent of the audit department. In a few cases, nonprofit audit teams will have dedicated tax personnel who work closely with them during the audit to do the tax return contemporaneously, if not simultaneously.
Every audit firm will tell you that there is “seamless integration” and “tremendous efficiency” in having them prepare your tax returns. However, there are several reasons why your audit firm should not automatically be engaged to do your tax work:
- Quality – Auditors pride themselves in promising that you will have ‘no surprises.’ That means they will communicate with you throughout the audit and that if anything significant comes up, they will discuss it with you early in the process rather than surprising you at a Board meeting. It also means that they are determined that no issues will be uncovered that should have been caught in a prior year (an unpleasant surprise for everyone). That attitude can spill over into the tax return. “We did it that way last year” is the enemy of continuous improvement, and nobody wants to be told, “we’ve been doing this for years, and nothing was ever said before!” Therefore, audit personnel can be inclined to minimize new tax findings in an effort to preserve the client relationship. They may discourage or even forbid tax personnel from bringing controversial findings to light. After all, if it doesn’t affect the tax due, and the IRS accepted it that way last year, why rock the boat?
- Materiality – An essential concept in auditing, materiality has no relevance to tax work, especially for nonprofit organizations that pay little or no tax. The auditor may ask, “If there is no material effect on the tax liability, what does it matter?” A nonprofit tax professional realizes that “tax due” is usually irrelevant to a tax-exempt organization. Instead, the focus must be on accuracy, completeness, transparency, and protecting the organization’s exempt status. They recognize that the IRS isn’t the only audience; the public disclosure copy of the federal tax return can be even more important to the organization’s reputation.
- Efficiency – There is useful information in your audit report that can be used to complete the Form 990. However, almost all of it is in the audit report and the trial balance. Surprisingly, few of the auditors’ supporting workpapers are of any use in preparing the tax return. An audit is not designed to gather the type of information required by Form 990, such as the names and addresses of donors, names and addresses of grantees, descriptions of programs, individual compensation, independent contractors, lobbying activities, and disqualified persons, to name a few. Your audit firm may promise to gather the tax information contemporaneously, but while conducting the audit, they are naturally focused on that function alone. Most nonprofit organizations will be asked to fill out separate information requests for the 990, and that information is of secondary importance to the audit team. Once your tax preparer has a copy of the audit report and trial balance, there is virtually no efficiency to having the audit firm prepare and sign the tax return.
- Cost – You will be told that there are significant savings to the firm when combining the audit and tax services, and that those cost savings ‘will be passed on to you.’ However, every firm tracks its audit and tax services separately. Even in cases where the same individuals are performing both services, they record their time into distinct charge codes. Separate engagement letters are usually required, separate invoices are generated, and income is determined independently. There is no mechanism whereby the firm charges audit clients a lower fee than non-audit clients. In fact, you can usually find a lower price by shopping around and utilizing a firm specializing in nonprofit tax.
When interviewing candidates to provide tax compliance and consulting services, try to determine if they are tax generalists who have experience with a variety of tax forms or nonprofit specialists who focus exclusively on tax-exempt organizations. Generalists are familiar with tax laws and regulations that relate to corporations, individuals, partnerships, trusts, and nonprofits. Their prices will usually be lower, and they will complete the forms quickly with minimal inquiry or discussion. In contrast, nonprofit tax specialists will understand the unique reporting requirements imposed on exempt organizations. They ask more probing questions and will work with you to improve the disclosures on the form each year. They will be alert to potential taxable unrelated business income or lobbying disclosures, keep you informed of recent legal or regulatory developments, and leverage their experience representing nonprofits that have undergone an IRS examination.
A trusted tax advisor must be:
- Responsive: Tax questions are often time-sensitive. The best tax accountant in the world isn’t much use if they don’t return your phone calls or respond to your emails.
- Understandable: Tax accountants tend to be highly technical people who explain things in a way that is difficult for those without a strong legal and financial background to understand. Your tax advisor should demonstrate the ability to explain things in “plain English” so that the instructions are clear and easy to follow. They should be willing to walk you through the tax returns and anticipate the areas of interest to you.
- Reasonable: Tax reporting isn’t always black and white, particularly with nonprofit organizations. There may be numerous ways to accurately and transparently complete a tax return, and nonprofits have a certain amount of “good faith” flexibility. Avoid working with professional advisors who insist that their way is the only way.