Every tax-exempt organization relies on its ability to carry out its mission without incurring unnecessary financial burdens. Maintaining that status requires careful attention to IRS rules and reporting standards. In 2025, IRS oversight continues to shape the environment in which not-for-profits operate.
Why IRS scrutiny matters
When an organization is granted tax-exempt status, it gains the ability to devote more funding to mission-based work. That designation comes with clear responsibilities. The IRS may review an organization’s activities if filings are inconsistent, financial records raise concerns, or governance procedures are unclear. Being proactive about compliance helps organizations maintain their exemption and avoid unnecessary challenges.
Common areas of focus
The IRS typically looks at several areas when reviewing tax-exempt organizations:
- Organizational and operational purpose: An organization must be both structured and operated exclusively for exempt purposes such as charitable, educational, or religious activities.
- Private inurement and private benefit: A tax-exempt entity cannot use its resources to provide excessive benefits to insiders (like officers or directors) or to confer undue advantage on private individuals or businesses.
- Unrelated business income (UBI): Generating revenue from activities that are not substantially related to the exempt purpose is permitted, but excessive or improperly reported UBI can raise red flags.
- Political activity and lobbying: While some organizations may engage in limited lobbying depending on their tax-exempt classification, 501(c)(3) organizations are prohibited from participating in campaign activities. They must keep lobbying activity within allowable limits.
- Recordkeeping and reporting: Incomplete Form 990 filings, missing documentation, or weak financial controls often draw the attention of the IRS.
- Significant diversion of assets: Answering “Yes” to the question on Form 990 about a diversion of assets will trigger an investigation.
- Foreign activities: The IRS focuses on foreign grants, investments, and fundraising, particularly for organizations operating internationally.
- Other matching discrepancies: The IRS matches information from third-party payors, such as Forms 1099, against what an organization reports.
What to expect in an IRS review
When the IRS examines a tax-exempt organization, the process usually follows a series of steps:
- Examination: This may be conducted by correspondence or through an on-site (field) audit.
- Possible outcomes: Many examinations conclude without changes or with advisory comments. In some cases, the IRS may propose corrective action or adjustments.
- Revocation process: If the IRS determines an organization no longer qualifies for exemption, it issues a proposed revocation letter. The organization has the right to appeal within the IRS and, if necessary, to seek judicial review.
- Impact of revocation: If the exemption is revoked, the organization will continue to exist but become taxable and must file corporate tax returns. Reinstatement is possible through a new application process.
Best practices for compliance
One of the best ways to avoid IRS concerns is to approach compliance as an ongoing practice rather than a one-time task:
- Review operations regularly to be sure they continue to support the organization’s exempt mission.
- Document governance decisions carefully, including board minutes, compensation approvals, and conflict-of-interest policies.
- Track unrelated business activities and report them properly on Form 990-T when required.
- Submit complete and timely Form 990 filings, making sure schedules and disclosures are accurate.
- Seek professional guidance before entering into complex transactions, expanding into new activities, or making significant governance changes.
- Stay informed about IRS guidance and updates that affect exempt organizations.
Conclusion
Compliance goes beyond satisfying IRS requirements—it safeguards the mission and strengthens credibility with donors, members, and the community. By prioritizing sound governance and maintaining vigilance in reporting, not-for-profits can confidently navigate IRS expectations throughout 2025 and in the years ahead.
Article Prepared By:
Lila Leno, CPA, MBA | Partner
