Your nonprofit probably won’t be audited by the IRS, but if it is … | tax preparation in baltimore md | Weyrich, Cronin & Sorra

Your nonprofit probably won’t be audited by the IRS, but if it is …

Despite recent accusations that the IRS targets certain types of tax-exempt organizations for audit, not-for-profit audits generally are rare. That’s because most nonprofits owe no or very little tax. However, as the IRS receives funding as part of the Inflation Reduction Act, it’s expected to hire new agents for all divisions, including the Tax Exempt and Government Entities Division. So nonprofit compliance checks and audits potentially could become more common.

What should you do if your nonprofit hears from the IRS?

Initial letter and call

If your organization is chosen, most likely it will be subject to a correspondence (not an in-person) audit. An IRS agent will send you — and, if applicable, anyone with a power of attorney — contact letters via the U.S. Postal Service. The agent will then wait at least 10 business days before making phone contact.

The initial phone call will include discussion of the issue (or issues) being examined, for example, an incomplete Form 990 or a complaint the IRS received about your nonprofit. The agent will ask you to provide items listed on an Information Document Request (IDR), such as:

  • Filed Form 990s and other tax documents,
  • Payroll tax records,
  • Records of transactions with donors or business partners, and
  • Unrelated business income documents.

The phone discussion may lead the IRS auditor to modify the IDR before sending it to you. If the request seeks more than one item, the auditor will group the items on a single IDR.

Communicate and meet deadlines

Before the auditor sends the IDR, you and the auditor should agree on the deadline for your response. If you can’t agree on a date, the auditor will assign one.

The IDR also will identify the date that the auditor plans to review your responses for completeness. Deliver everything by the deadline. If the auditor determines your response is complete, you’ll be informed by phone. If, on the other hand, the auditor decides your response isn’t complete — or if you didn’t respond — you might be granted one or more extensions to comply.

If upon reviewing the IDR documents, the IRS decides you’re in compliance, the agent will contact you via phone and mail you a closing letter. Otherwise, the auditor will propose a tax adjustment, tax status change or even a revocation of tax-exempt status. If you agree to the proposal, you can typically close your case by fulfilling any requirements. Or you can request an appeal with the IRS or via the court system.

Get help if you need it

If your nonprofit is audited, comply with all requests on time and remain calm and professional when talking with IRS agents. If you need assistance communicating with the agency or assembling information and documentation, we can help. Or contact us with your questions about best practices for avoiding an IRS audit.

© 2023

 

Make a fraud recovery plan now, before your nonprofit is defrauded | tax preparation in hunt valley md | Weyrich, Cronin & Sorra

Make a fraud recovery plan now, before your nonprofit is defrauded

According to the Association of Certified Fraud Examiners (ACFE), not-for-profit organizations make up 9% of all defrauded organizations. Such attacks — and losses — can be enough to destroy a nonprofit. Although the best defense against fraud is a strong offense in the form of internal controls, you should also have a recovery plan should fraud occur. Here are some best practices to consider.

Quick action

Let’s say you discover that a trusted staffer has embezzled money from your nonprofit. Act quickly and contact an attorney and forensic accountant. Although there’s no guarantee that the stolen funds will be recovered, a forensic accountant can dig into the matter, interview staffers and preserve any evidence that might be used in court. Your advisors can also help you decide whether to pursue legal action against the perpetrator.

To help mitigate reputational damage, address any significant incident head-on with a press release and formal apology. If you try to bury the incident, you could encourage rumors that turn off donors and other supporters. And to show you’re taking the incident seriously, engage an auditor to perform a complete audit and upgrade any weak internal controls.

Management matters

Also, depending on the size of the loss, consider terminating your executive director or other members of management who could be considered responsible because they allowed lax oversight or didn’t promote an antifraud culture. Although weak internal controls are the No. 1 factor that enables nonprofit fraud to occur, lack of management review and internal control overrides are second and third.

Improving board oversight is critical, too. To signal improved board oversight to stakeholders, start requiring members to be completely independent from your nonprofit’s management (if they aren’t already) and bar employees from serving on the board. You might also increase the number of voting members and mandate that at least one member have a financial or accounting background. The board should review financial statements at least monthly.

Comply with regulations

If your nonprofit loses funds to fraud, it must comply with federal and state reporting obligations. You’re generally required to report any “significant diversion” of assets on IRS Form 990. A significant diversion happens when the gross amount of all diversions discovered during the tax year exceeds the lesser of:

  • 5% of gross receipts for the year,
  • 5% of total assets at year end, or
  • $250,000.

Check with your state (or ask your CPA) for other required reporting.

Tiplines help

Most nonprofit fraud is discovered because an employee or other person submits a tip or complaint. So if your organization doesn’t already provide an anonymous tipline or webform, put one in place as soon as possible. Study after study has found that the earlier a fraud scheme is discovered, the less the defrauded organization loses. Contact us for help preventing or investigating fraud.

© 2023

 

Passing the public support test | quickbooks consulting in cecil county md | Weyrich, Cronin & Sorra

Passing the public support test

Unless 501(c)(3) organizations prove they’re publicly supported, the IRS assumes they’re private foundations. The distinction is important, because publicly supported charities enjoy higher tax-deductible donation limits and generally are exempt from excise taxes and related penalties.

The tax code recognizes several types of publicly supported organizations, but most 501(c)(3) charities fall into one of two categories. The first, Sec. 509(a)(1) organizations, primarily rely on donations from the general public, governmental units and other public charities. The second category, Sec. 509(a)(2) organizations, have significant program revenue. The IRS has established tests for each type of organization. If your nonprofit doesn’t pass the 509(a)(1) test, it may qualify under Sec. 509(a)(2).

First test

The Sec. 509(a)(1) test requires that:

  1. You have at least one third of your total support from the public, governmental agencies or other public charities, or
  2. You have at least 10% of your total support from such sources and that the “facts and circumstances” indicate you’re a publicly supported organization.

Several facts and circumstances help determine whether your organization is publicly supported — for example, whether you have actual sources of support above the 10% threshold, answer to a representative governing body and serve the general public on a continuing basis. Such tests measure public support over a five-year period, including the current and four prior tax years.

The public support percentage excludes certain types of contributions, program revenue fees from related activities, unrelated business income, investment income and “unusual grants.” Net income from unrelated activities and gross investment returns are included in total support, though unusual grants aren’t.

Second test

Under the Sec. 509(a)(2) test, your organization must receive at least one-third of its support from contributions from the public and gross receipts from activities related to its tax-exempt purpose. No more than one-third of its support may be from investment income and unrelated business taxable income. Public support is measured over a five-year period.

This test is subject to limitations. When calculating public support, you can count only the greater of $5,000 or 1% of your total exempt-purpose-related revenue from a single individual, corporation or governmental unit in the numerator. Receipts of any type or amount from disqualified persons, such as board members, aren’t considered public support either.

Be careful about misclassifying gross receipts that are subject to the limits. IRS auditors will look for payments that should be deemed gross receipts but instead are classified as, for example, contributions, gross investment income or unrelated business taxable activity.

Mission critical

It’s critical to maintain your nonprofit’s publicly supported status. Certain organizations, including universities and churches, automatically qualify as public charities. For other nonprofits, we can help determine whether you pass one of the two tests.

© 2023

 

A refresher on nonprofit endowment management | accounting firm in washington dc | Weyrich, Cronin & Sorra

A refresher on nonprofit endowment management

If your not-for-profit has an endowment, you probably know it’s a major responsibility. Endowment investments generally need to be managed by a financial expert, and your organization must adhere to certain regulations, particularly when it comes to spending. As a refresher — or primer for new employees or board members — here are the basics of endowment management.

Prudent decisions

First, it’s important to distinguish endowments from operating reserves. Endowments generally are designed to provide steady income to a nonprofit while its core investments grow untouched. That steady income can be a financial safeguard in times of crisis.

A significant portion of most nonprofit endowment assets are restricted funds. For funds that aren’t restricted, organizations generally must conform to provisions of the Uniform Prudent Management of Institutional Funds Act (UPMIFA). Among other things, the UPMIFA allows nonprofits to include appreciation of invested funds as part of what is “spendable” in addition to realized gains, interest and dividends.

The act also provides guidance for “prudent” decisions, suggesting that spending more than 7% of an endowment in any one year generally isn’t fiscally responsible. And the UPMIFA makes it easier for nonprofits to identify new uses for older and smaller endowments that may be dedicated to obsolete or impractical purposes.

Spending income

Your spending policy will need to define how much of your endowment fund’s income can be spent on operations each year. Usually, this is defined as a percentage (between 4% and 7%) of a rolling average of endowment investments. A rolling average helps even out the ups and downs of market returns and prevents the endowment’s contribution to any one budget year from being significantly lower than contributions to other years.

However, this approach doesn’t address whether your endowment fund will be able to maintain a similar level of funding for future operations. Also, because investment returns usually don’t correspond to the inflation rates that affect your operating budget, your spending policy should be based on more than recent returns. To factor inflation into your spending policy, you might start with a relatively conservative, inflation-free investment rate of return. Then adjust it for inflation to arrive at a spending rate you can apply on a year-by-year basis.

Today’s difficult climate

The current high inflation, market volatility and recession worries make planning for your organization’s future challenging. If you aren’t sure whether your endowment’s spending policy has kept up with economic realities or developments within your organization, contact us for help.

© 2023

 

Tips to help prevent accounting and tax errors | quickbooks consulting in washington dc | Weyrich, Cronin & Sorra

Tips to help prevent accounting and tax errors

Although failing to file a Form 990 with the IRS when required to do so is probably a more serious mistake, filing it with data errors isn’t recommended. Similarly, your not-for-profit should strive to be as accurate as possible when preparing accounting and other tax documents. Carelessness can cost you support from donors and grant makers and, in extreme cases, threaten your exempt status. Here’s how to avoid financial errors.

Follow processes and procedures

First, make sure your nonprofit has formally documented its accounting processes. All aspects of managing your nonprofit’s money should be reflected in a detailed, written accounting manual. This should include how to accept and deposit donations and pay bills.

Your organization may depend on accounting software for daily functioning. But even with the assistance of technology, mistakes happen. Your staff should follow certain procedures, such as double-checking entries and reconciling bank accounts, to ensure transactions entered into accounting software are complete and accurate.

Avoid common pitfalls

Next, keep an eye on unrelated business income (UBI). IRS officials have cited “failing to consider obvious and subtle” UBI tax issues as the biggest tax mistake nonprofits make. Organizations commonly fail to report UBI — or they underreport it. Be sure to follow guidance in IRS Publication 598, Tax on Unrelated Business Income of Exempt Organizations. And if you need more help, contact us.

Correctly classifying workers as employees (vs. independent contractors) is another area where nonprofits commonly make errors in judgment and practice. You’re required to withhold and pay various payroll taxes on employee earnings but don’t have the same obligation for contractors. If the IRS can successfully argue that one or more of your contractors meet the criteria for being classified as employees, both you and the contractor possibly face financial consequences.

For peace of mind

Finally, if your nonprofit doesn’t already regularly back up accounting and tax information, start doing so. Otherwise, your data may not be safe in the event of a fire, natural disaster or cyberattack. Back up data automatically using cloud-based or other offsite storage solutions.

For extra peace of mind, contact us. We can help prepare your organization’s tax filings and review financial statements for accuracy and adherence to Generally Accepted Accounting Principles.

© 2023

 

A financial dashboard can take your nonprofit where it wants to go | quickbooks consulting in bel air md | Weyrich, Cronin & Sorra

A financial dashboard can take your nonprofit where it wants to go

Does your board have a quick and easy way to assess your not-for-profit’s financial performance? It does if it has a dashboard with carefully chosen and up-to-date key performance indicators (KPIs). Dashboards can also be set up to provide critical information to multiple audiences regarding specific goals and fundraising campaigns. Here’s how you can get started.

Your nonprofit’s “business” drivers

To facilitate informed, timely decisions, you must first select the right KPIs. For a financial dashboard, these will depend largely on factors such as your organization’s revenue streams, key expense factors, budget and strategic goals. To include the most useful metrics, identify your nonprofit’s “business” drivers.

Additionally, determine which factors affect the reliability of your revenue streams — and which influence expense levels. Then create KPIs that monitor those factors. Think, too, about the level at which you want to track your KPIs. You could monitor them by individual program or function, or at the organizational level.

Staging financial stability

Say that a nonprofit theater company’s board is concerned about financial stability and liquidity. The theater’s primary business drivers are proper pricing and maximum attendance. Its dashboard might include such KPIs as:

  • Operating results,
  • The level of liquid unrestricted net assets,
  • Current debt ratio (total liabilities / total assets),
  • Progress toward a desired number of months’ cash on hand (cash on hand + current unrestricted investments / average monthly expenses),
  • Number of tickets sold, and
  • Average revenue per performance.

Over time, this nonprofit likely would need to adjust its KPIs as its strategies, priorities or programs change. What was “key” last year isn’t necessarily key in today’s challenging environment.

Other important metrics

Certain KPIs are popular among a variety of nonprofits, including:

Current ratio. This reflects your organization’s ability to satisfy debts coming due within the year. Divide current assets by current liabilities. A ratio of “1” or more generally means you can meet those obligations.

Projected year-end cash. Based on the current cash position plus budgeted cash flows through the end of the fiscal year, this projects liquidity and ability to satisfy upcoming commitments.

Year-to-date revenue and expense. This measures actual results against a budget and reveals whether revenues and expenses are in line with expectations or within a reasonable range.

Program efficiency ratio. The ratio assesses mission efficiency by showing how much funding goes to programs vs. administrative or other expenses. Calculate it by dividing program expenses by overall expenses.

Multiple uses

Once you successfully establish a financial dashboard, you may want to use the tool for other purposes. Some nonprofits create dashboards to monitor hiring stats, board “accountability,” risk management and social media use. Contact us for more information.

© 2022

 

The audit is over. Now what? | cpa in washington dc | Weyrich, Cronin & Sorra

The audit is over. Now what?

Whew! That’s probably your reaction when outside experts announce that their audit of your not-for-profit is complete. But even if auditors have left your premises and returned the documents they’ve reviewed, the work isn’t really over. Not only do your executive director and board need to review the audit report, but it may be necessary to address auditor concerns by making changes to your organization.

Review the draft

Once outside auditors complete their work, they typically present a draft report to an organization’s audit committee, executive director and senior financial staffers. Those individuals should take the time to review the draft before it’s presented to the board of directors.

Your audit committee and management also need to meet with the auditors before the board presentation. Often auditors will provide a management letter (also called “communication with those charged with governance”) highlighting operational areas and controls that need improvement. Your nonprofit’s team can respond to these comments, indicating ways they plan to improve operations and controls, to be included in the final letter. The audit committee also can use the meeting to ensure the audit is properly comprehensive.

Assess internal controls

The final audit report will state whether your nonprofit’s financial statements present its financial position in accordance with U.S. Generally Accepted Accounting Principles. The statements must be presented without any inaccuracies or “material” — meaning significant — misrepresentation.

The auditors also will identify, in a separate 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. If the auditors have found your internal controls to be weak, promptly shore them up.

Gather feedback

One important audit committee task is to obtain your executive director’s impression of the auditors and audit process. Were the auditors efficient, or did they perform or require redundant work? Did they demonstrate the requisite expertise, skills and understanding? Were they disruptive to operations? Consider this input when deciding whether to retain the same firm for the next audit.

The committee also might want to seek feedback from employees who worked most closely with the auditors. In addition to feedback on the auditors, they may have suggestions on how to streamline the process for the next audit.

Fiscal responsibility

Your donors, grantmakers and other supporters expect your organization to do everything in its power to ensure funds are used appropriately and responsibly. If you fail to act on issues identified in an audit, it could lead to asset misappropriation and seriously damage your nonprofit’s reputation and viability. Contact us if you have questions, require an audit or need help improving internal controls.

© 2022

 

Why your nonprofit might want to compensate board members | tax preparation in alexandria va | Weyrich, Cronin & Sorra

Why your nonprofit might want to compensate board members

Because most not-for-profit board members serve voluntarily, you may not have known compensating them was an option. But depending on the type of organization, the expertise and experience expected of board members, and the required time commitment, it may make sense to compensate these hardworking individuals.

Pros and cons

There are advantages and drawbacks to compensating board members. Your organization might, for example, find it worthwhile to offer compensation to attract individuals who are prominent or bring highly specialized expertise — or are expected to invest significant time and effort. Also, if you’re trying to build a more diverse board, it may be easier to recruit new members if you offer a financial incentive.

Some organizations, such as nonprofit hospitals, may have business models that compete with those of for-profit companies. In such cases, board compensation often is appropriate. In general, providing compensation can improve board member performance and promote professionalism. And it may incentivize meeting attendance and accountability.

But there are drawbacks to paying board members. First, it can look bad. Donors expect their funds to go to program services, and board compensation represents resources diverted from your organization’s mission. Further, there are legal and IRS implications. For example, in some states volunteer board members are protected from legal liability, while compensated members may not be.

Avoiding taxes and penalties

If you decide to compensate board members, make sure your arrangement complies with the Internal Revenue Code’s private inurement and excess benefit regulations, as well as IRS rules about “reasonable compensation.” Failure to do so can result in excise taxes, penalties and even the loss of your tax-exempt status.

Independent directors, an independent governance or compensation committee, or an independent consultant should set the amount of (or formula for) compensation. Whoever sets the amount should be guided by a written compensation policy and make the amount comparable to that paid by similar nonprofits.

Your compensation policy should cover:

  • How compensating board members benefits your organization,
  • Which members are eligible, and
  • How compensation is structured (for instance, flat or per-meeting fee).

It should also spell out expectations for board members in exchange for compensation, such as qualifications and meeting attendance.

Document everything

Whether or not your organization ultimately decides to compensate board members, be sure to document all compensation discussions, including any votes your board takes. If you’re still unsure, contact us. We can help walk you through the decision, including how to determine appropriate amounts.

© 2022

 

Lost your tax-exempt status? Here’s how to regain it | cpa in alexandria va | Weyrich, Cronin & Sorra

Lost your tax-exempt status? Here’s how to regain it

So you forgot to file your not-for-profit’s Form 990, 990-EZ or 990-N with the IRS. It can happen — particularly with newer organizations that are still trying to get a handle on all the financial and regulatory requirements of running a nonprofit. However, if you forget to file three years in a row, you could face an automatic revocation of your tax-exempt status. This is serious because it means your donors can’t deduct their contributions. But it doesn’t have to be final.

Essential forms and dates

Assuming you lost your exempt status for failing to file, you can regain it with another filing. Talk to your tax advisor about submitting either Form 1023, “Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code” or Form 1024, “Application for Recognition of Exemption Under Section 501(a) or Section 521 of the Internal Revenue Code,” based on your type of nonprofit.

Smaller organizations that were eligible to file either Form 990-EZ or 990-N for each of the three consecutive years and that hadn’t previously had their tax-exempt status automatically revoked, can apply to have their status retroactively reinstated effective from the revocation date. To apply for this retroactive reinstatement, file the applicable form within 15 months or the later of 1) the date of the IRS revocation letter, or 2) the date the IRS posted your organization’s name on its website.

If you aren’t eligible for retroactive reinstatement, your organization’s activities between the revocation date and the reinstatement date will be considered taxable. This includes donors’ contributions.

Required documentation

When you file for recognition of exemption, attach a detailed statement that provides reasonable cause for failing to file required returns in each of the three consecutive years. You should state the facts that led to each failure and the continual failure, discovery of the failures and steps taken to avoid or mitigate them.

You’ll need to attach a statement that describes safeguards put in place and steps taken to avoid future failures as well as evidence to support all material aspects of those two statements. In addition, include properly completed and executed tax returns for all taxable years during and after the three-year period your organization failed to file.

Also submit an original declaration dated and signed by an authorized person in your organization such as an officer or director. (See IRS Notice 2011-44 for the required wording.)

All’s well

Assuming you file correctly and submit all required paperwork that shows your organization qualifies as a nonprofit, it’s likely to regain its tax-exempt status. At that point, the IRS will issue a new determination letter and update its records that confirm your eligibility to receive tax-deductible contributions. Generally, the effective date of reinstatement is the date your exemption application was submitted.

If you’re having trouble keeping up with IRS filings or have questions about nonprofit regulations, contact us for help.

© 2022

 

What revenue numbers can reveal about your nonprofit’s financial health | accounting firm in baltimore county md | Weyrich, Cronin & Sorra

What revenue numbers can reveal about your nonprofit’s financial health

When professional auditors review a not-for-profit’s books, they usually spend significant time on revenue. Inadequate revenue — or revenue trending in the wrong direction — can provide an early warning of future trouble. But you don’t have to wait for your next audit to assess revenue. You can employ the same techniques an auditor uses to monitor your organization’s financial health.

Contributions and grants

Start by comparing the donation dollars raised in past periods to pinpoint trends. For example, have individual contributions been increasing over the past five years? What campaigns have you implemented during that period? You might go beyond the totals and determine if the number of major donors has grown.

Also estimate what portion of contributions is restricted. If a large percentage of donations are tied up in restricted funds, you might want to re-evaluate your gift acceptance policy or fundraising materials.

Pay attention to grant trends, too. Grants can vary dramatically in size and purpose — from covering operational costs, to launching a program, to funding client services. Did one funder supply 50% of total revenue in 2019, 75% in 2020, and 80% last year? A growing reliance on a single funding source is a red flag to auditors and it should be to you, too. In this case, if funding stopped, your organization might be forced to close its doors.

Fees and dues

Fees collected from clients, joint venture partners or other third parties can be similar to fees that for-profit organizations collect. They’re generally considered exchange transactions because the client receives a product or service of value in exchange for payment. Sometimes fees are charged on a sliding scale based on income or ability to pay. In other cases, fees are subject to legal limitations set by government agencies. You’ll need to assess whether these services are paying for themselves.

Also, if your nonprofit is a membership organization and charges dues, determine whether membership has grown or declined in recent years. How does this compare with your peers? Do you suspect that dues income will decline? You might consider dropping dues altogether and restructuring. If so, examine other income sources for growth potential.

Handling anomalous data

As you make year-by-year comparisons, keep in mind that numbers from 2020 and 2021 — or the height of the COVID-19 pandemic — may be less useful or reliable. If, for example, you closed your doors and discontinued fundraising for several months in 2020, figures from 2019 and before may make better comparisons with current numbers. For help interpreting such data and for answers to your revenue questions, contact us.

© 2022