Industries Archives

Nonprofit refresher course: Excess benefit transactions

Non-Profits|October 8, 2024

Most not-for-profit leaders are familiar with the concept of excess benefit transactions and the need to avoid them. But a refresher course may be in order, particularly when you consider that 501(c)(3) organizations determined by the IRS to have violated the rules can be liable for penalties of 25% to 200% of the value of the benefit in question. They may also risk a revocation of their tax-exempt status — and, as a result, the loss of donor and community support.

Private inurement

To understand excess benefit transactions, you also need to comprehend the concept of private inurement. A private benefit is any payment or transfer of assets made, directly or indirectly, by your nonprofit that is:

Beyond reasonable compensation for the services provided or goods sold to your organization, or
For services or products that don’t further your tax-exempt purpose.

If any of your net earnings inure to the private benefit of an individual, the IRS won’t view your nonprofit as operating primarily to further its tax-exempt purpose.

Private inurement rules extend the private benefit prohibition to “insiders” or “disqualified persons” — generally any officer, director, individual or organization (including major donors and donor advised funds) in a position to exert significant influence over your nonprofit’s activities and finances. The rules also cover their family members and organizations they control. A violation occurs when a transaction that ultimately benefits the insider is approved.

Be reasonable

The rules don’t prohibit all payments, such as salaries and wages, to an insider. You simply need to make sure that any payment is reasonable relative to the services or goods provided. In other words, the payment must be made with your nonprofit’s tax-exempt purpose in mind.

To ensure you can later prove that any transaction was reasonable and made for a valid exempt purpose, formally document all payments made to insiders. Also ensure that board members understand their duty of care. This refers to a board member’s responsibility to act in good faith; in your organization’s best interest; and with such care that proper inquiry, skill and diligence has been exercised in the performance of duties. One best practice is to ask all board members to review and sign a conflict-of-interest policy.

Appearance matters

Some states prohibit nonprofits from making loans to insiders (such as officers and directors) while others allow it. In general, you’re safer to avoid such transactions — regardless of your state’s law — because they often trigger IRS scrutiny. Contact us to discuss the best ways to avoid both excess benefit transactions and the appearance of them in your organization.

Planning an event? Don’t neglect sponsorships

|October 1, 2024

There are many ways to evaluate the success of a not-for-profit event. But for most nonprofit leaders, financial success — how much did we raise? — is the metric that ultimately matters. To be financially fruitful, nonprofit events need sponsors (companies and individuals) to cover a portion of expenses. Be sure to make securing sponsorships central to planning your organization’s events.

Best practices

Depending on your organization, your special event might be a dinner gala, a conference, an auction, a golf tournament, a concert or a combination (or none) of these. But finding solid sponsorship largely follows the same process, regardless of the event’s format.

For example, you want time on your side. Nonprofits often compete with peer organizations for the same philanthropic dollars, so start early. It’s not overly ambitious to have a fundraising plan in place a year in advance. And it’s a good practice to lock in sponsors four to six months before your special event.

To develop a list of supporters most likely to step up as sponsors, hold a magnifying glass to your organization’s mission statement. Think in terms of appropriateness and quality. For example, an athletic clothing manufacturer could be an excellent sponsor for a youth soccer league tournament. A local grocer might be just the right target for a food bank’s silent auction.

Using teamwork

You’re more likely to be successful if you assemble a team with strong community connections. Ask your executives, board members and volunteers to reach out to members of their personal and professional networks to solicit sponsorship help. These ambassadors should be well prepared with information about the benefits each sponsor will receive.

This includes the event’s likely attendees. You’ll want to convince potential sponsors that your attendees belong to the same demographic they target for their products and services. Include data on where attendees live, along with their age, sex and buying power. Be factual in your approach — don’t exaggerate.

Exposure opportunities

Sponsors generally help finance nonprofit events in exchange for exposure to your audience. What does such exposure look like? You might offer to put the sponsor’s name on event materials — including signs, banners, brochures, tickets, newsletters and program books — and to recognize the sponsor verbally at the event. To help obtain the greatest amount of support from both large and small sponsors, develop multiple sponsorship options. In general, those companies paying the most should receive the most visibility at your event.

Also offer free attendance to at least one representative (and a guest) of any sponsoring company so the sponsor will get a chance to mingle with attendees, gather information and build connections. If you’re hosting an annual conference or meeting, you might want to provide the sponsor a speaking opportunity.

Long-term relationship

Don’t forget that sponsorships ideally mark the start of a long-term relationship between your nonprofit and the sponsor. After your event, for example, you may want to get your sponsor’s employees involved in your organization’s work by hosting a company volunteer day. And, of course, you should solicit the sponsor’s support again when you plan your next event.

Finally, be careful: In some circumstances, the IRS may consider corporate sponsorships paid advertising. In such cases, nonprofits can be liable for unrelated business income tax (UBIT). Contact us for information about finding sponsors while navigating complex UBIT rules.

Update on a possible universal charitable deduction

Non-Profits|September 19, 2024

During the COVID-19 pandemic, Congress temporarily enabled individual charitable donors who didn’t itemize federal income tax deductions to deduct up to $300 in contributions in both 2020 and 2021. This universal charitable deduction galvanized many donors who might not otherwise have supported charities in those years. However, the deduction expired after 2021. A bipartisan group of U.S. senators, with support from many in the not-for-profit sector, are attempting to revive this tax break.

Donations drop, then rise

The approximate doubling of the standard deduction under the Tax Cuts and Jobs Act encouraged many donors who previously had itemized deductions and deducted charitable gifts to instead take the standard deduction. Researchers at Indiana University and the University of Notre Dame have found that this change resulted in a $20 billion drop in donations to charity in 2018, the year the higher standard deduction went into effect. Many nonprofits suffered from this pullback.

Although pandemic disruptions generally made giving data less reliable starting in 2020, the temporary universal charitable deduction appears to have motivated donors in middle and lower income brackets to give. According to the National Conference of State Legislatures, over 47 million U.S. households used the tax incentive in 2021 — and more than 21% of these donors had adjusted gross incomes under $30,000.

Potential congressional action

In early 2023, a bipartisan group of U.S. senators introduced the Charitable Act. (A similar bill was introduced in the U.S. House in May 2023.) This bill would expand and extend the nonitemized deduction for charitable giving by reviving and increasing the $300 deduction permitted in 2020 and 2021 ($600 for married couples filing jointly in 2021). Nonitemizing individual taxpayers would potentially be able to deduct about $4,500 (double that for joint filers) in donations annually.

Not surprisingly, many nonprofits and sector advocacy groups, including the National Council of Nonprofits and Charitable Giving Coalition, support the legislation. The most recent Giving USA survey (released by The Giving Institute) reported that charitable donations dropped by an inflation-adjusted 2.1% in 2023, which researchers believe is part of a longer-term trend toward donating less to charity.

Future of the bill

Although the Charitable Act was referred to the Senate Finance Committee, it hasn’t been taken up and its future in its current incarnation is in doubt. Organizations such as the Association of Fundraising Professionals are encouraging members to contact their legislators to revive the bill. And the nonprofit sector is likely to continue to lobby for legislation it believes will raise charitable giving levels.

How your board should evolve over your nonprofit’s life

Non-Profits |August 27, 2024

One thing every new not-for-profit organization can count on is change. Ideally, the changes you experience will be for the better — expanded programming, increased staffing, more clients served and greater overall impact in your community.

Your board of directors will be critical in keeping your nonprofit focused as it grows. But how do nonprofit boards change over time? In part, it depends on the organization and its mission. Its life stage will also help determine your board’s priorities, responsibilities and composition.

Early years

Founders or early volunteers are likely to populate an initially small board that primarily focuses on running the organization day-to-day. Young boards tend to be more entrepreneurial and risk-taking than more established ones. Even with a small board, however, critical decisions should be made by formal votes recorded in written minutes, rather than by casual consensus.

Within the first few years, you’re likely to add paid staffers capable of taking over daily operations. At this point, begin to create a formal governance structure for your board and try to add members with more diverse backgrounds. Look for candidates with at least two of the “three W’s”:

Work. Seek people who can be counted on to reliably and enthusiastically pitch in wherever and whenever needed. These individuals do more than attend board meetings, they also volunteer, organize events and interact with clients.
Wealth. Those with wealth, or connections to wealth, can generate funds, whether by donating from their own pockets or tapping others.
Wisdom. Wisdom refers to necessary expertise. These candidates may have nonprofit sector experience, deep knowledge about your constituency, or professional credentials in accounting, law, marketing, public relations, IT or another field.

Growing pains

Perhaps the most common marker of a nonprofit in the growth stage is a change in its board’s focus from operations to governance. Although your board likely will continue to be active in operations, it must start pivoting to strategic matters — the policies, planning and evaluations necessary to pave the path to sustainability.

You may want to enlarge your board at this stage to accommodate a wider range of skills, talents and backgrounds. Propelled by their passions for the cause, former or current volunteers or clients may ascend to board positions.

As your organization grows you may also want to establish board committees. However, it’s important to resist the urge to form too many committees. Some organizations implement a three-committee structure, with committees for internal affairs (for example, finance, HR and facilities), external affairs (such as fundraising, PR and marketing) and governance.

Maturity and stability

A mature nonprofit’s brand identity may enable it to attract more wealthy, prestigious and well-connected members. Ideally, these members will have more to offer than simply money, such as industry expertise or a strong personal commitment to your mission. Adding such board members may increase your nonprofit’s financial stability.

Mature organizations usually have a greater wall between paid staffers and board members, with the executive director serving as a bridge between the two groups. At this stage, the board assumes a greater leadership role by setting direction and strategic policy. It may be tasked with difficult decisions involving funding, tax compliance and even legal matters.

Welcome new ideas and perspectives

Note that nonprofit boards tend to become more conservative — in terms of openness to change and risk — over time. This isn’t necessarily a problem unless you have board members who are stubbornly stuck in positions that no longer work. To maintain a board that welcomes new ideas and perspectives, you might want to ask board members to agree to serve time-limited terms. Contact us for more information.

Gather information from clients without triggering survey fatigue

Non-Profits|August 15, 2024

To administer productive programs worthy of your not-for-profit’s budget, you need to determine whether they’re meeting clients’ needs. In general, the best way to assess this is by surveying participants. But survey fatigue — frustration or disinterest when asked to take yet another online survey or one that’s overly complicated or takes too long to complete — is a real and growing problem.

Multiple studies have found that survey fatigue results in low response rates as well as inaccurate or low-quality responses from those who do complete them. Survey participants may doubt that your organization will even review their responses or make meaningful changes based on them. Given such challenges, how can you effectively gather client opinions?

Go “old school”

Each encounter with a client is an opportunity to solicit feedback. So while you’ll want to include online surveys with your email newsletters and request feedback on your website and social media platforms, don’t neglect “old school” techniques. Pull aside clients while working in the field or call them on the phone to ask how they’re doing and what, if anything, they’d change about your programs. When you receive verbal feedback, follow up in writing so you have a record of the conversation and can easily share it with others in your organization.

Platforms such as Facebook and Instagram are free and likely frequent destinations for many of your clients. You can use their survey tools to regularly invite viewers to leave comments about your posts — or even ask them to recommend or write a review of your nonprofit. But also provide an email address or SMS number for texts so that clients can contact you directly if they want to discuss issues in depth.

Also keep in mind that, depending on the population you serve (for example, lower-income or elderly people), not all clients may have easy internet access or use social media accounts. You might want to offer them paper surveys, or even an old-fashioned suggestion box.

Show appreciation and act

Thank your clients for every communication and, when possible, let them know how you’re using their feedback to address shortcomings and make improvements. In some cases, you may want to schedule one-on-one meetings or focus groups where you can discuss plans in greater detail and let clients know how valuable they are to the decision-making process.

Also be sure to follow up on any problems surveys unearth. For example, if clients complain about staffers acting unprofessionally or hint at potential legal issues (such as fraud or discrimination), investigate and address those issues immediately. You should also consult your nonprofit’s attorney if surveys uncover any potential legal problems.

Deliver superior outcomes

Ultimately, gathering meaningful feedback from clients and acting on it allows you to fund programs that deliver superior outcomes. Online surveys can be useful, but keep in mind that you may get better and more insightful feedback by talking to clients one-on-one. Contact us if you have questions about budgeting and spending.

Thinking ahead to your next Form 990

Non-Profits|August 6, 2024

The deadline for most not-for-profits to file Form 990 with the IRS (May 15, 2024) has come and gone. Assuming your organization operates on a calendar-year tax basis and filed its Form 990 on time, you probably don’t want to think about tax reporting again until next spring. However, it’s important to keep your future Form 990 in mind as your organization carries out its programs and events this year.

4 overlooked issues

You’re probably already alert to issues such as unrelated business income and the risks potentially posed by political participation, excess benefit transactions and excessive compensation (and the need to report some of them). But you may not be paying as much attention to the following four:

1. Fundraising expenses. Your not-for-profit must report its income from fundraising activities, as well as its expenses, on Schedule G of Form 990. The IRS is always on the lookout for events that produce a relatively small amount of income compared with claimed expenses. In such situations, make sure you keep good records to withstand any potential IRS challenge.

2. Operations abroad. Nonprofits are permitted to operate outside the United States without penalty. But your organization is required to answer questions on Form 990 relating to foreign bank accounts, activities in foreign countries and grants by foreign entities. The IRS will likely ratchet up its scrutiny if it finds inconsistencies or evidence of activities that don’t measure up to U.S. standards. If you operate abroad, professional tax advice is essential.

3. Diverted assets. Form 990 asks whether there has been any “diversion” of assets during the past year. Essentially, “diversion” means that funds have been misappropriated for personal reasons. If you answer “yes” to this question, you’ll need to provide a detailed explanation of the diversion and its resolution. However, even if you’ve provided a plausible explanation, a “yes” answer to this question may lead to an IRS audit. If you fail to attach an explanation, your audit exposure increases exponentially. To avoid the issue altogether, take every step (including implementing robust internal controls) to prevent fraud and other illegal asset diversions.

4. Loans to disqualified persons. Generally, loans from a tax-exempt organization to a disqualified person are prohibited on the state level. Form 990 asks if your nonprofit has made such loans. In the event your nonprofit has made a prohibited loan, your Form 990 will need to reflect a declining balance. Otherwise, it may look as though the loan isn’t being paid off in time — a certain red flag for the IRS. Again, if you don’t allow this activity, you won’t have anything to report.

Of course, if you engage a professional tax advisor to prepare your Form 990, your advisor will ask about all these subjects to ensure your organization properly reports its activities. But you can help your nonprofit minimize audit risk by keeping possible pitfalls top of mind.

Why private foundations need to avoid self-dealing

Non-Profits |July 25, 2024

If you’re a leader of a private foundation, you’re probably aware of the prohibition against self-dealing transactions between foundations and “disqualified persons.” But what constitutes self-dealing? And who exactly counts as disqualified in this context? It’s important for you to know because financial repercussions for violating the rules can be severe.

Who is disqualified?

The IRS defines disqualified persons as substantial contributors (generally, large donors), foundation managers, owners of more than 20% of certain organizations that are substantial contributors and family members of any of these.

Also disqualified are corporations or partnerships in which any of the previously listed parties hold more than 35% voting power and trusts or estates in which they hold more than a 35% beneficial interest. In addition, persons effectively in control of a foundation are disqualified, as are government officials.

What are they prohibited from doing?

In general, a disqualified person can’t participate in acts of “self-dealing.” According to the IRS, these include selling, exchanging or leasing the foundation’s property. Lending money or extending credit to the foundation as well as furnishing it with goods, services or facilities are also off-limits.

Foundations aren’t allowed to pay compensation or expenses to a disqualified person. Nor can they allow the transfer or use of the foundation’s income or assets by or for the benefit of disqualified persons. Certain payments to government officials and transactions between organizations controlled by a private foundation may also be taxable self-dealing.

What happens if the rules are violated?

Internal Revenue Code Section 4941 imposes a minimum 10% excise tax on most disqualified persons on the amount involved in each self-dealing transaction. Foundation managers — officers, directors or trustees — who knowingly participate in acts of self-dealing face a 5% tax on the amount involved. Notably, participation on the part of foundation managers includes not only affirmative acts, but also silence or inaction where they have a duty to speak or act.

If a violation isn’t corrected, the tax on a self-dealing transaction on disqualified persons other than foundation managers soars to 200%. When this extra tax is imposed, an excise tax of 50% of the amount involved is also imposed on any foundation manager who refuses to agree to part or all of the correction of the self-dealing act.

Are there exceptions?

There are some exceptions to these rules. For example, compensation paid to disqualified persons isn’t an act of self-dealing if the payments are for reasonable and necessary services to carry on the foundation’s exempt purposes. However, you shouldn’t count on self-dealing to be allowed or forgiven.

Are your volunteers risking legal and tax liability?

Non-Profits |July 2, 2024

Comprehensive risk management is one of the primary responsibilities of not-for-profit leaders. You probably regularly consider and act to mitigate risk to your facilities and assets and your staffers and clients. What about your volunteers? Even though the federal Volunteer Protection Act of 1997 provides some protection, volunteers face the real risk of being sued for actions while working for your organization. They also can become subject to tax liabilities.

State by state

The Volunteer Protection Act offers some degree of defense for volunteers acting within the scope of their responsibilities. And many states have passed similar laws to shield volunteers. But liability can vary significantly from state to state, with different limits, conditions and exceptions such as broad coverage in the absence of willful or wanton misconduct vs. coverage only if the nonprofit expressly assumes liability for claims in its articles of incorporation.

Volunteer protection laws, however, don’t preempt the need for your nonprofit to buy appropriate insurance coverage. In fact, some state laws explicitly require nonprofits to carry insurance to limit volunteer liability.

Insurance coverage

To minimize risk, your organization should carry general liability insurance that specifically covers volunteers, as well as directors and officers liability insurance. If volunteers will operate vehicles for your organization, check whether your auto insurance covers them. Larger organizations might consider amending their bylaws to include a broad indemnification clause for volunteers when the claims against them exceed insurance limits.

Also consider implementing processes and procedures to control the risks of harm or injury caused by volunteers. For instance, devote time upfront to screen and train volunteers appropriately and restrict certain client-facing activities to paid staffers.

Inadvertent taxable income

Another risk is that federal or state taxing authorities might come after your volunteers because of their activities. For example, your nonprofit could inadvertently create taxable income for volunteers if it provides them with benefits such as services or compensation beyond reimbursements for actual out-of-pocket expenses incurred. In fact, reimbursements that exceed actual expenses are taxable.

If your volunteers sometimes need to cover costs with their own money that you subsequently reimburse, inform them beforehand — in writing and verbally — that they must provide receipts of their spending on your organization’s behalf. This may seem burdensome to people just trying to do some good, so explain that it’s for both your and their protection.

Protecting everyone

Volunteer risk varies by nonprofit. But it’s particularly significant with nonprofits that provide medical services or work with vulnerable populations. Even such simple tasks as driving can result in litigation. So make sure your hardworking volunteers aren’t a risk to themselves or to your nonprofit’s important mission. Consult an attorney for any legal advice.

Nonprofits: Act thoroughly on audit findings

Non-Profits|June 20, 2024

External audits can help assure your not-for-profit’s stakeholders that your financial statements are fairly presented according to U.S. Generally Accepted Accounting Principles. They can also help prevent occupational fraud. Often, audit reports contain recommendations for organizations to act on. And if you fail to make changes that respond to risks or concerns discovered in an audit, it could threaten your nonprofit’s future.

Discuss the report

When auditors complete an engagement, they typically present a draft report to their subject’s audit committee, executive director and senior financial staff. Those individuals need to review the draft before it’s presented to their full board of directors.

Your audit committee and management should meet with auditors before their board presentation. Often auditors provide a management letter highlighting operational areas and controls that need improvement. Your team should explain how your organization plans to improve operations and controls, and this explanation can be included in the report’s final management letter.

Your audit committee also can use the meeting to ensure the audit is properly comprehensive. Auditors will provide a governance letter, which should confirm cooperation from your nonprofit’s staff and whether the auditors received all requested documentation. The letter also will disclose any difficulties or limitations encountered during the process, accounting adjustments required, and significant audit plan changes (and the reasons for such changes).

Finally, the auditors will list any unresolved matters. Your audit committee should determine whether there were any conflicts of interest between the auditors and your team and how they might have affected the audit’s scope.

Taking next steps

The final audit report will state whether your organization’s financial statements are fairly presented in accordance with U.S. Generally Accepted Accounting Principles. The statements must be presented without any material — meaning significant — inaccuracies or misrepresentation.

As noted above, the auditors also may identify, in a separate management letter, specific concerns about material internal control issues. Adequate internal controls are critical for preventing, catching and remedying misstatements that could compromise the integrity of financial statements, whether due to error or fraud.

If the auditors find your internal controls weak, your organization must promptly shore them up. You could, for instance, set up new controls, such as segregating financial duties or implementing new accounting practices or software. These measures can reduce the odds of fraud, improve the accuracy of your financial statements and help reduce future audit costs.

Make your audit effective

Audit reports are only as effective as their reception — and the action subject organizations take in response to their findings. Contact us for help implementing new internal controls and addressing other issues.

Disaster relief charities: Know the rules before providing aid

Non-Profits|June 4, 2024

The United States is entering the most natural-disaster-prone time of the year. Tornadoes are most likely to occur in May, and the Atlantic hurricane season starts on June 1. Not-for-profits that provide aid to disaster victims — whether it’s medical care, food, clothing, shelter, cash or rebuilding assistance — are gearing up for potential emergencies. But if your organization operates in this space, know that when dispensing aid you must observe certain IRS rules.

Defining charitable activities

Disaster relief organizations are allowed to provide short-term emergency assistance and long-term aid to help ensure victims have necessities. Relief may also come in the form of cash grants or vouchers. Providing such relief to individuals qualifies as a charitable activity because it aims to relieve human suffering.

However, your nonprofit must assist a “charitable class.” A charitable class should be either large enough that the potential beneficiaries can’t be individually identified or sufficiently indefinite that the community as a whole, rather than a pre-selected group of people, benefits. In addition, you must apply needs-based tests, meaning you can’t distribute aid to individuals just because they’re disaster victims. Decisions about how funds will be distributed must be based on an objective evaluation of needs at the time grants are made.

But practicality and sympathy for victims’ immediate plight can be considered. For example, take a charity that distributes blankets and hot meals to natural disaster victims. In the immediate aftermath of a storm, the charity doesn’t ask victims for proof of financial need. However, as time goes on and victims and their community begin to recover, it may be appropriate to conduct individual financial needs assessments.

Aiding businesses

In addition to helping individuals, your charity generally can provide disaster aid to businesses, so long as two conditions are met:

1. Assistance must be reasonably related to the accomplishment of a tax-exempt purpose. Businesses aren’t members of a charitable class and can’t, therefore, be appropriate charitable objects. However, distributing aid to them can achieve charitable purposes, such as preventing community deterioration or reducing the burden on local government.

2. Any private benefit to businesses must be incidental. An eligible business might not have adequate resources, conventional financing or insurance coverage that would enable it to recover from a disaster. Disaster aid organizations also need to determine that businesses they assist wouldn’t be able to remain in the community without their intervention.

Maintaining records

To prove your organization’s compliance with IRS rules, maintain good records. Document amounts paid, the purpose of payments and evidence that payments were made to meet charitable purposes and victims’ needs. In addition, document:

Your organization’s objective criteria for disbursing assistance,
How specific recipients were selected,
Names and addresses of recipients and the amounts supplied to them,
Any relationship between recipients and your charity’s officers, directors, key employees or substantial donors, and
The composition of the selection committee approving assistance.

Note an exception: Organizations distributing short-term emergency assistance aren’t expected to record the names, addresses and amounts provided. Instead, document the date, place and estimated number of victims assisted.

Other rules may apply

There are other IRS rules that might apply to your nonprofit’s situation. Contact us if you have questions about complying with rules for tax-exempt organizations.

Nonprofit refresher course: Excess benefit transactions

Planning an event? Don’t neglect sponsorships

Update on a possible universal charitable deduction

How your board should evolve over your nonprofit’s life

Gather information from clients without triggering survey fatigue

Thinking ahead to your next Form 990

Why private foundations need to avoid self-dealing

Are your volunteers risking legal and tax liability?

Nonprofits: Act thoroughly on audit findings

Disaster relief charities: Know the rules before providing aid

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