When does a not for profit need an audit?

When does a not for profit need an audit? In this blog, we will discuss the triggers for an audit of a nonprofit organization and the benefits they bring.

Audits, good or bad?

When does a not for profit need an audit? For most of us, the word “audit” brings up a sense of dread and anxiety. Audits are commonly associated with long and arduous back-and-forth conversations with the IRS that usually lead to a fine on someone’s personal tax return. For Not-for-profits, however, the experience is quite different. Nonprofit organizations are usually not audited by the IRS, as the IRS handles taxation, which nonprofits are exempt from. There are, however, certain triggers for nonprofits that can justify an audit of the organization’s finances. Let’s look at a few potential triggers that could justify an audit of your organization, and our nonprofit audit-ready checklist.

When does a not for profit need an audit? – State Regulation

The state your organization is based in will obviously have a say in whether your organization needs to be audited or not. Whether or not an audit needs to take place in the state’s eyes is usually related to a nonprofit’s income, however, this can vary. 

For example: Let’s imagine setting up the same nonprofit in two different states, Arizona and California. There is no state law requirement for nonprofit audits in Arizona, so that organization can continue to grow and make as much income as it wants until a federal-level audit is triggered. Meanwhile, for California nonprofits, any charitable organization with gross annual revenue of over two million dollars is required to go through an audit of their financial statements by an independent certified public accountant. Quite different regulations for two states that are so close to each other!

Each state’s regulations are different, though many use the 500,000 mark for annual gross revenue as the point that an audit must occur. It’s important to know what your state’s rules are, and you can find a list of state law audit nonprofit requirements here provided by the National Council of Nonprofits. Ignorance is no excuse in the government’s eyes, so read up!

When does a not for profit need an audit? – Federal funding 

The Federal Government disperses huge amounts of its annual budget to supporting nonprofits that better the lives of US citizens. Because this money comes out of the taxpayer’s wallets, what it’s used for is heavily scrutinized, and misallocation of provided federal funds has serious consequences. An organization could face massive penalties, the revocation of its nonprofit status, and in the case of serious offenses jail time could be involved for the related organization’s members. All of this is the worst-case scenario, and a federal audit will not be triggered until the organization in question has received a minimum of 750,000 dollars in federal funding over a single fiscal year. Once that number is surpassed, the organization is required to obtain a “Single audit”, which is significantly more extensive and in-depth than a standard independent audit.

A single audit looks to review the entirety of an organization’s financial operations to assure compliance with every element of governmental regulation of nonprofit organizations. A single audit is going to review any grants, loans, donations, and subsidies provided by the government to assure that whatever has been provided has been used properly. Pass-through entities aren’t excused from this process, as a single audit is required for those qualifying entities as well, and all information must be made publicly available.

When does a not for profit need an audit? – Grant application

Nonprofits are almost never able to obtain enough revenue from the services they provide alone. Very often, the doors of nonprofit organizations stay open due to generous philanthropic donors and grant money. We’ve touched on federal grants, which are broken into four different categories (competitive, formula, pass-through, and continuation) but there are countless other non-federal entities that support nonprofits through grant money. Many of the large companies that are household names provide grant opportunities as well. Companies like GE, Google, Disney, and more provide hundreds of millions of dollars alone for nonprofits all over the country. With money like that, however, there are rules that have to be followed in order to qualify for these grants. 

Each company is going to have different rules surrounding the requirements for obtaining grant money, but many donors are going to need to see proof of strong financial management to feel certain that an organization is going to use the provided money in the way they say they will. For many companies like this, an audit is an obvious and simple way to prove the legitimacy of an organization’s finances. It’s about financial transparency, as a nonprofit trying to hide its finances is one that probably isn’t following through on its decided mission.

When does a not for profit need an audit? – Honoring the mission

When someone sets out to create a not for profit, it’s because they believe in a mission so strongly that they are willing to give up potential profits in order to see the mission through to its fullest extent. It cannot be understated the importance of the nonprofit industry, and that bylaws are developed to keep a nonprofit true to its mission. The process of developing bylaws is a lengthy and carefully considered process for most organizations. Within this process is the opportunity to introduce checks and balances to prevent fraud or misdirection of external funding, and one of these checks and balances could be the introduction of a required third-party audit every year, regardless of funding of government regulation.

But why would you voluntarily put your organization through the arduous process of an audit?

If a nonprofit never triggers state or federal audits, then it is possible that the organization won’t have to go through the audit process. This leaves a lot of room for misdirection and dealignment of the organization’s mission to occur. Leaders of organizations come and go, changing the narrative and approach to a nonprofit’s programming. Numbers, however, don’t lie, and audits are a fantastic way to confirm that your finances reflect the goals of your organization. Audits also keep fraud from running rampant in an organization, as misallocated funds are easier to catch on an annual basis than several years later. 

Audits, a necessary evil.

No one enjoys the process of auditing (besides perhaps, the individual being paid to audit an organization), but the benefit they provide in the nonprofit sector are majorly important to the financial health of those who qualify as a 501C. The process offers a form of protection and justification for the funding received by the government or grant-providing for-profit companies. 

It’s essential to be informed about the audit process before going through one with a third party. You want to work with a company that can explain to you the elements behind the process, keeping you informed and up to date on what is required to complete the audit successfully. Need help with an audit or have additional questions? Let’s chat.