Church audit

Is an audit required for your church?

The answer mostly depends on your denomination, and sometimes on a lender if your church has a loan. Under the United Methodist Book of Discipline, every local church must be audited each year, and each Episcopal congregation must have its books audited yearly too, although that doesn't have to mean a costly CPA audit.

If your church borrows money, the bank may insist on an outside audit as a condition of a loan. Apart from requirements, church leaders may also consider an audit during a leadership change or as annual income grows. One Baptist state convention recommends auditing every year for churches taking in over $1 million annually and during leadership transitions, and bigger churches, typically those above $3 million a year, often bring in outside auditors.

Church audit committee

Quite a few churches hand the review, or the supervision of it, to a small team of members. A solid committee includes at least 3 people, mostly non-staff, and the chair should not be a church employee. Independence is the whole idea: the people whose work is under review shouldn't be reviewing it.

For that reason, neither the treasurer nor the financial secretary belongs on the committee. For the same reason, nobody who handles church money should do the audit. That includes the pastor and the treasurer's family.

What the auditor actually looks at

The central task is verifying the treasurer's reports independently, tracing where funds went and confirming that donations were used the way donors stipulated. Auditors also check the safeguards for church money, including how financial tasks are divided among people. They review insurance coverage, meeting minutes about financial decisions and records of any limits donors placed on their gifts.

Expect to pull together documents before the work begins. Gather 14 months of monthly financial statements, bank statements and records showing how the bank figures match the church's books, plus payroll files, including Forms 941, W-2 and 1099. These records help the auditor check the treasurer's reports and trace how church money was used.

Less expensive alternatives to a full audit

A full audit is generally the priciest service a CPA offers, which is why churches frequently weigh its value against the price. If a full audit is more than you need, a CPA can offer one of three lighter options:

• A review, in which the auditor studies the financial statements without testing internal controls, and offers only limited assurance. Assurance means how confident the accountant is that the figures are correct.
• A compilation, which just organizes your numbers into tidy statements without any checking or testing, and usually with no assurance at all.
• An agreed-upon procedures engagement, in which a CPA examines only the areas you select, like payroll or designated giving, rather than auditing everything.

By law, professional audit or assurance services on financial statements can be offered only by a CPA or a CPA firm. A committee of members can still examine the books, but it must not present the outcome as a CPA audit.

IRS church tax inquiries

When the IRS looks into a church, that's a different thing from a financial audit. The question is whether the church still qualifies as tax-exempt, or whether it owes tax. Section 7611 of the tax code says the IRS can open a church tax inquiry only when a senior Treasury official states in writing a reasonable belief that the church might be ineligible for its tax status or might owe tax.

Ordinary correspondence doesn't get this protection. Standard IRS questions about filing returns or about withholding Social Security, Medicare, and income taxes from employees' wages lie outside the special church rules.

If a genuine inquiry does open and your reply doesn't resolve it, the IRS may generally issue a second notice within 90 days stating it must examine the books. That examination generally has to wrap up within 2 years of the second notice. After that, the IRS generally can't examine the same church again for 5 years, unless the first examination led to revocation of the church's tax status, an assessment of tax, or a change the church was required to make.