Fundraising is an essential activity for nonprofits, generating valuable income that organizations rely on to advance their mission and improve their communities. From an accounting and tax perspective, it’s a complex field, with a multitude of different types of fundraising events, transactions, and reporting requirements.
Getting the accounting details right is crucial, but it’s important not to lose sight of the key goals of the fundraising activities either. That’s why we sat down with two leaders in our nonprofit accounting team, Paul Atkinson and Sabre Linahan, to discuss some key reminders that nonprofits should bear in mind as they manage their fundraising activities.
Paul Atkinson is a Partner in Smith + Howard’s Assurance practice and a member of our nonprofit team. He has spent significant time in his public accounting career leading audits and reviews of many nonprofit organizations.
Sabre Linahan is a Partner in Smith + Howard’s Tax practice and specializes in tax services for nonprofits. Sabre is regarded as an influential leader in the nonprofit accounting industry and has spoken at events including the American Alliance of Museums, the Georgia Society of CPAs’ Nonprofit Conference and the Institute of Continuing Legal Education’s Nonprofit Law Seminar, as well at Connect+, Smith + Howard’s nonprofit workshop series.
Categories of Nonprofit Fundraising
Q: Let’s start with the big picture. What are the key categories of nonprofit fundraising?
Paul Atkinson (PA): There are several buckets: sponsorships, events, and capital campaigns. Larger nonprofits are typically primarily focused on capital campaigns that raise money for a specific cause, like a new building. Capital campaigns typically have an endowment component where a certain percentage of the money donated to the campaign is allocated toward the organization’s endowment.
We also see a lot of annual fund contributions. That’s particularly common among our independent school clients where families of students commit additional contributions towards the school, over and above their standard tuition payments.
Of course, there are also one-off fundraising events, like galas, which can often include additional components such as auctions. And lastly, there is the planned giving component, where nonprofits receive funds from estates, wills, and things of that nature.
Sabre Linahan (SL): Usually with the one-off fundraising events Paul is talking about, nonprofits aim to attract sponsors: corporations that give high-value donations for specific events. When the nonprofit acknowledges that type of support in connection with the event, they must be careful that it’s just a thank you or an acknowledgment that they participated and not a message that would encourage others to purchase the sponsor’s products or services. Otherwise, the nonprofit risks having the sponsor donation being classed as advertising, and the income could be subject to Unrelated Business Income Tax (UBIT).
From a tax perspective, the auctions that Paul mentioned are pretty complex also. There are two transactions there: the donation of the item and the purchase of the item at the auction.
Let’s say I donate a painting I want a museum to auction off at a fundraising event. As the donor, I get a deduction for that donation. The organization acknowledges the donation, but it’s up to me, as the donor, to decide on the value of the painting: for this example, let’s say it’s $1,000.
At the event, Paul falls in love with the painting and purchases it at the auction for $3,000. For him, this transaction would be in part a purchase and a charitable contribution. The museum would send a letter to thank Paul for his support and inform him that he could deduct the excess above the fair market value of the painting as a charitable contribution: in this case, $2,000.
Revenue Recognition from Fundraising Campaigns
Q: One key issue for nonprofits when it comes to fundraising is revenue recognition. What best practices do you recommend nonprofits follow when recognizing revenue from fundraising campaigns?
PA: It’s important to look at transactions, or groups of transactions, and identify whether the transactions are exchange transactions or non-exchange transactions. People get confused between those two concepts and often fail to recognize exchange transactions.
If a donor is receiving a service or something of value in exchange for their donation, that’s an exchange transaction. But if they’re just providing funds with no expectation of receiving any benefit in return, that’s a non-exchange transaction. Transactions often have both an exchange and a non-exchange component and nonprofits need to bifurcate these components.
For exchange transactions, nonprofits should calculate the value of the exchange by establishing what the fair market value of the items that have been exchanged would be in an arms-length transaction. Having a consistently applied approach to how you calculate these amounts is key to making sure you’re getting a reasonable value when determining these amounts.
SL: When you’re offering corporate sponsors benefits, like a table at a fundraising gala, you want to make sure that this return benefit is de minimis or “too trivial or minor to merit consideration.” In this case, it means that the value of the benefits you’re offering do not exceed certain thresholds.
The other side of this is when the participants in a fundraising event are individuals, rather than corporate. If an individual buys two tickets for $500 for a gala dinner, the development office must write a letter thanking the individual for their support. This letter should also contain a couple of disclosures: the amount the donor paid, which is $500, and the fair market value they received, which might be $200 for dinner and entertainment. The donor only gets to deduct $300 as a charitable contribution – the difference between the payment and the fair market value – since they received $200 worth of benefits. As Paul explained, this is an exchange transaction, and nonprofits should recognize it as such.
Those kinds of things can easily be missed, especially when there’s a lot of turnover in a development function at a nonprofit, because it is a relatively small component of the event as a whole. But it’s important for tax reporting for the individual donor, as well as for disclosures on the organization’s Form 990. Best practices include having a checklist for events that ensures the organization is doing everything that’s required from a tax perspective.
Restricted and Unrestricted Contributions
Q: Another key distinction nonprofits need to be aware of is the difference between restricted contributions and unrestricted contributions. Could you talk about that a little?
PA: Often, campaign contributions are given for a purpose, such as a specific building or program activity, and so those are considered restricted. Contributions can also be restricted by time. For instance, an individual might pledge $1 million to an organization but specify that they only want the organization to spend $100,000 a year for the next 10 years.
Endowments are another area where restrictions often exist. If funds are given for an endowment purpose, it’s often the case that the corpus cannot be spent; only the earnings associated with it can be spent. So those funds would be permanently restricted. Nonprofits need to understand the restrictions on all of the funds they have at their disposal and ensure they are well documented for others to refer back to at a later date.
Within a Statement of Financial Position, nonprofits have to delineate between restricted and unrestricted funds. But in addition to that, they would also want to include disclosures that break out the detail of the different types of restrictions (i.e. time and purpose) and additional information related to endowments that specifies how endowment funds are spent and tracked.
SL: From a tax perspective for the donor (not the nonprofit), the restrictions do not impact the timing of the donor’s deduction. Once the contribution is completed on the donor side, the amount given is deductible by the donor, regardless of any restricted reporting required by the nonprofit.
Key Reporting Requirements
Q: For those financial statements, and also for Form 990, what are the key reporting requirements that nonprofits should be aware of?
PA: All tax-exempt organizations, except for religious organizations, have to file a Form 990 each year, which is a public document. Anyone can access it and read it to get a sense of the organization and how it’s allocating its funds.
SL: Nonprofits report fundraising revenue and expenses on Schedule G of Form 990. It’s a separate schedule that details the top events the nonprofit hosted. There are a few intricacies within Schedule G that it’s important to be aware of.
All expenses associated with the event are recorded in Schedule G, so it often looks like the fundraising event was run at a loss since “net income” is calculated using revenue that excludes the charitable component of funds raised at the event. If you consider the charitable contributions, it’s often a much better picture – that’s something I’d encourage nonprofit leaders to keep in mind. It’s important to have the frameworks in place to track these different forms of income – it makes the reporting process much easier.
Schedule G has three parts. The first part reports paid fundraisers, the second part reports special events, which we mentioned earlier, and the third part reports gaming activities – events like raffles and bingo that are too specific to get into here.
The role of paid fundraisers is important. Many nonprofit organizations pay third-party consultants for certain fundraising services: grant writing, calling donors, and other tasks. If the organization pays these third parties over $15,000 per year, they need to disclose some details about their relationship with the third-party. That includes the name of the contractor(s), the activities they performed, the amount they were paid, and the revenue that’s attributable to their activities.
PA: While there’s a lot of information in Form 990, as Sabre just described, the detailed financial statements have even more information. There are often detailed footnotes that explain the items on the financial statement in more detail. One of the more important things that people look at is the Statement of Functional Expenses.
Within that statement, there’s a breakdown of how a nonprofit spends its funds. Generally speaking, it’s best practice to see an allocation of around 80% of your expenses toward program costs. The remaining 20% is split between management and general expenses and fundraising expenses, with the majority of that remainder going towards management and general expenses.
What qualifies as fundraising expenses?
Q: When fundraising, sometimes nonprofits have to spend money to raise money. What types of expenses would fall under that fundraising expenses category?
PA: Any expense where the attendee of a fundraising event derives benefit would be a program expense, not a fundraising expense. The costs that Sabre mentioned earlier, including the food and entertainment at a gala dinner, are program expenses. Anything donors do not receive benefit from is classed as a fundraising expense: facility rentals, signage, permits, marketing collateral for the event, and so on.
With these types of expenses, it’s important to have good documentation that outlines the policies that determine how these expenses are allocated.
Most Common Nonprofit Fundraising Issues
Q: What issues do you see nonprofits encounter most often when it comes to fundraising?
PA: Not understanding the different types of fundraising expenses is one. Another big one is failing to correctly record in-kind contributions. We see that a lot with auction-style events held at galas. Individuals donate items to the organization to auction off, and these items often have significant value. Recognizing them as in-kind contributions is an important step.
Another thing to note is that nonprofits don’t have to accept every type of donation. One example would be an endowment: nonprofits should consider having a minimum threshold. Otherwise, the cost of managing the endowment and remaining compliant with restrictions could outweigh the potential financial benefits.
In addition, a common issue we see is the lack of communication between the development and accounting departments of an organization that ultimately could lead to financial misstatements. Most of the time, development departments are leading the initiatives to receive fundraising dollars; however, sometimes the communication of pledges received (verbal or written) isn’t always properly communicated and/or provided to the accounting department to record these pledges in the correct period or for the correct amount. We highly recommend that as part of the monthly reconciliation process those departments should meet to ensure the accuracy and completeness of outstanding pledges.
SL: Failing to properly disclose fundraising events on Form 990 is an error I see. That can range from not filling out Schedule G at all to not filling it out completely. They might not show any charitable contributions from an event, or show that all revenue from the event was a charitable contribution, when in fact a significant portion was program revenue. Not considering this interplay between return benefits and charitable contributions is really the biggest error I encounter.
I think it’s important for nonprofits to understand that documents like their Form 990 aren’t just an informational tax filing: they’re a marketing opportunity. Donors will look at Form 990 to assess how effectively your organization raises and spends funds, and they want to see real detail in there––not just the minimum required by the IRS.
That underscores the importance of partnering with an accounting partner that truly understands the nonprofit industry. At Smith + Howard, our nonprofit accounting team provides a range of services catered to the needs of nonprofits in the arts and culture space, including assurance, advisory, and more.
To learn more about how Smith + Howard can support the accounting needs of your nonprofit organization, contact an advisor today.
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