Organizations that are organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary or educational purposes, foster national or international amateur sports competitions, or for the prevention of cruelty to children or animals are eligible to be exempt from federal income tax under section 501(c)(3) of the Internal Revenue Code. Unless the organization is a church, or a related-type entity, or  the organization has annual gross receipts less $5,000, the organization is required to file Form 1023 with the IRS. These charitable organizations must be organized and operated exclusively for one or more exempt purposes (as listed above).

Based on Form 1023, the IRS will classify the entity as either a public or private charity. What are the major differences?

A public charity has a broad base of support (contributions typically exceeding 33 1/3% of total support). A private charity has a small base of public support and the majority of the support is derived primarily from the investment earnings of the organization.  For recent legislative information for private foundations, see this post.

So what type of organization are you? Look at the composition of the organization’s support.

Organizations disburse funds in order to pay for costs incurred by the entity. An operating expense is an on-going cost to run the organization. Operating expenses can be broken out into program services expenses and supporting services expenses. Program service expenses are expenses of an organization which are directly related to the organization’s non-profit purposes. Supporting services include management and fundraising expenses. Operating expenses can include salaries and wages, communications or telephone, and rent. Non-operating expenses are expenses not directly related to the main business, such as insurance, interest, repairs and maintenance, special events, fundraising and depreciation.

Expenses are incurred, for cash basis purposes, when a check is written or cash is paid by an organization to another organization or person for services or goods. To record an expense, you debit the expense account related to the purpose for which a disbursement is made and credit the cash account from which the cash is paid or check is written.

Recording expenses properly and keeping detailed records of the types of disbursements an organization makes is very important. Expenses are used in determining how the funds received by the organization are being used and whether those funds are being used for the entity’s exempt purpose. It is also important to monitor restricted contributions to determine that the donor’s restriction has been met. The way an organization spends the money received can impact future fundraising efforts.

Written by Lauren McComic, senior auditor

In 1984 Congress enacted the Church Audit Procedures Act providing churches with important protection and guidelines relating to an IRS audit. Section 7602 of the tax code provides the authority under which IRS may examine individuals and organizations. Section 7611 of the tax code provides important protection for churches regarding IRS inquiries and tax examinations.

What is a church tax inquiry? An IRS inquiry determines:

1. Does the church qualify for tax exemption?

2. Is the church involved in an unrelated business or trade?

3. Is the church involved in other activities subject to tax?

If the IRS believes that the church may have activities that jeopardize the tax-exempt status, or involved in unreported taxes, then the IRS may proceed with certain inquiries.

How does the IRS proceed with an inquiry?  Read the rest of this entry »

Cash and cash equivalents are reported on the balance sheet of an organization. Cash generally consists of cash on hand (petty cash), available funds at financial institutions, and other items such as negotiable money orders and checks. Cash equivalents consist of highly liquid investments such as certificates of deposit and money market accounts. These accounts are considered to be highly liquid if they have an initial maturity of three months or less.

To be classified as a current asset, cash and cash equivalents must be readily available to pay current obligations and free from any contractual restrictions. Cash that is restricted should be segregated from the general cash and cash equivalents category. Cash is considered to be restricted if it is designated (by donor or the Board of Directors) to be used for a specific purpose. For example, if you have entered into a capital campaign to raise money for a new building, any cash received for that purpose would be restricted. This means that this cash can only be spent on costs incurred for the new building and cannot be spent for any other purpose. 

The restricted cash is classified on the balance sheet either as a current asset or a noncurrent asset – depending on the relationship to the asset for which the funds are restricted. If the cash is restricted for property and equipment, the restricted portion is classified as a long-term asset.

Restrictions on cash must also be disclosed in the notes to the financial statements. You must disclose the amount of restricted cash and the purpose for which it is restricted. The following example shows the balance sheet presentation and the disclosure for cash restricted for current and noncurrent purposes.

At December 31, 2008, the Company has $1,500,000 of restricted cash of which $900,000 is classified as a noncurrent asset. The restricted cash serves as collateral for an irrevocable standby letter of credit that provides financial assurance that the Company will fulfill its obligations with respect to a litigation settlement discussed in Note [X]. The cash is held in custody by the issuing bank, is restricted as to withdrawal or use, and is currently invested in money market funds. Income from these investments is paid to the Company. The current portion of restricted cash of $600,000 represents the amount of current liability for amounts billed to the Company for certain repairs agreed to be made under the settlement agreement.

Entities that are organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary or educational purposes may be eligible for federal income tax exemption. What does exempt from federal income tax mean? The organization does not pay federal income tax on the net earnings of the operation. An organization that has applied and received their exemption under Code 501(c)(3) may be receive charitable contributions that are tax deductible by the donor.

So how does an organization receive exempt status? Read the rest of this entry »

If your tax-exempt organization “normally” has gross receipts of $25,000 or less, you should file Form 990-N with the IRS. The following are reminders of the who/how much/when/where and what you need to file:

1. Has been in existence for 1 year or less and received, or donors have pledged to give, $37,500 or less during the organization’s first tax year;
2. Has been in existence between 1 and 3 years and averaged $30,000 or less in gross receipts during each of its first 2 tax years; or
3. Is at least 3 years old and averaged $25,000 or less in gross receipts for the immediately preceding 3 tax years (including the year for which calculations are being made).

Read the rest of this entry »

Program fees are one of several types of cash receipts or income a tax-exempt organizations can receive. These fees can be generated from a myriad of transactions such as registration fees, admission fees, processing fees, application fees or membership fees. To reconcile the account or search for any errors, a non-profit can maintain a cash receipts log. This would record any cash received at the office which would then be compared to the bank statement deposits and deposit receipts. Two separate individuals performing the separate functions provide a stronger internal control environment.

The receipt of program fees falls into the revenue cycle of accounting. The revenue cycle begins with the purchase or service provided and sending of the sales invoice to the customer. The invoice should display the cost and service or product purchased and the due date. Once an item has been invoiced it is added to the sales and accounts receivable journals. Once the fee has been collected, the accounts receivable is reversed and cash is then recorded. At the end of the cycle, the cash or check amount should tie to the deposit slip and/or bank statement and lastly in the sales journal.

On an annual basis, tax-exempt organizations (excluding certain religious, gov’t and political organizations) are required to file an annual return with the IRS. Which form the organization files, depends on the organizational type (public vs private charity) and the amount of gross receipts and assets of the entity.

Public Charities (excluding certain religious, gov’t and political organizations) are requied to file a Form 990, and if your have:

1. Gross receipts greater than $1,000,000 and assets greater than $2,500,000 your organization should complete Form 990.

2. Gross receipts greater than $25,000 and less than $1,000,000 and assets less than $2,500,000 should complete Form 990EZ.

3. Gross receipts less than $25,000 should complete Form 990-N.

Private foundations file Form 990-PF.  Forms 990 and 990-PF are due within 41/2 months after your organization’s year-end (May 15 if your year-end is December 31). Extensions may be filed using Form 8868.

If you fail to file the return on time, the penalties for the 990 are $20/day to a maximum of $10,000 or 5% of gross receipts. The penalities for a 990-PF are $20/day to a maximum of $10,000 (small org) or $50,000 (large org) or 5% of gross receipts.

So…be ready to file or extend as the due date approaches.

Nonprofit organizations may solicit and receive grants from a variety of sources, including federal, state and local governments, corporations and foundations.

The term cash receipts includes currency, checks, etc. received by mail or in person. Good cash-receipt handling contributes to good cash-flow management and the task is most manageable when receipts are posted promptly in the accounting system. Over time, you will begin to see patterns in your organization so that accurate predictions of cash-flow needs can occur.

Keeping detailed records of grant receipts will assist you in the separation of business income from other income, which is crucial when answering questions from the IRS and is beneficial during audits. Further, to facilitate a smooth audit process it is recommended that the original supporting documentation related to grants and their receipts should be maintained at a central office rather than at many different locations within the organization. Read the rest of this entry »

Churches are classified as a charitable organization under the Internal Revenue Service code. Despite a number of references to the word “church”, the tax code provides no definition, primarily because of interfering with the constitutional guaranty of religious freedom or encouraging abuse.

The IRS has attempted to fill this void by developing a list of 14 criteria that characterize a church. In determining whether an organization can be defined as a church, the IRS considers the following operational and organizational activities:

Read the rest of this entry »