A recent question came from a relatively large church that is considering raising funds to cover legal support related to property. Are these types of contributions allowable and deductible?

Allowable and deductible can mean 2 different things?  First to the donee and then to the donor.

As long as the qualified charitable entity maintains control or “use of the funds” and uses these to further their exempt purpose, the contributions are allowable for the organization and deductible by the donor.

Donors may designate a program, ministry, event, project, endowment etc., of the qualified charitable entity as long as the church controls the funding. Be careful in not designating a specific individual as the recipient, this often disallows the deduction for the donor and the church is then required to report the funds as an “agency” transaction.

So the church can solicit contributions for general, administrative and fundraising functions? Yes, as long as the church retains control or “use of the funds” and the church is operating within its exempt purpose, as designated by its IRS code.

Questions? Give me a call or post a comment.

At times the line between related exempt income and unrelated income can be narrow and gray. Because exempt organizations are not required to pay income taxes on “exempt earnings”, there are perceived advantages for developing diverse revenue streams that support the operations of the entity. However because these activities are competing with for-profit (tax paying) organizations, the IRS attempts to impose equality by assessing a tax on unrelated activities.

What is program related and what is unrelated? Here’s an example – A substance abuse center offers educational and counseling services to individuals based on need and income levels, helping them understand the signs of addiction. Because the center’s exempt purpose is rehabilitating individuals with addictions, this revenue stream is directly related to the exempt purpose. However, suppose the center operates a donut shop selling baked goods to the public. Is the donut shop related to the center’s exempt purpose? Probably not.

In order to qualify as unrelated income, the activity must meet all of the following characteristics:
1. Performance of a trade or business (profit motive in the selling of goods or services).
2. Regular activity (based on frequency and continuity, compared to commercial enterprises).
3. Not related to exempt purpose (does not significantly advance the exempt purpose of the organization).

If the activity meets all three requirements, there may be exceptions that eliminate the potential tax. Read the rest of this entry »

Starting in 2009, exempt organizations must adopt Fin 48 – Accounting for Uncertainty in Income Taxes. According to FASB, adopting FIN 48 is supposed to enhance the transparency of the exempt organization’s activities, much like the IRS’s intentions with the new Form 990. Implementing FIN 48 means exempt organizations are expected to analyze various areas of their operations and disclose any potential tax that may be assessed on uncertain tax positions. FIN 48 analyses may be necessary in many different areas such as state taxation and asset transactions, but a few target areas for all organizations are the purpose and activities, generation of unrelated business income, and excessive compensation arrangements.

FIN 48 will force a closer look at the source of the organization’s funds and the organization’s tax exempt purpose. Analysis in this area is necessary because if the organization strays from its exempt purpose, the income generated could become taxable. FIN 48 implementation requires that the risk of this happening be analyzed and any potential taxes be disclosed. 

This goes along with the second target area, classification of unrelated business income and management’s devotion of time to raising funds unrelated to the exempt purpose. Income unrelated to the exempt purpose of the organization should be taxable and whether or not income is classified as “unrelated” is a tax position. The potential tax liability arising from classifying income as unrelated business income requires a FIN 48 disclosure. 

The last generally applicable target area for exempt organizations is excessive compensation arrangements. If a compensation arrangement is found to be excessive it can result in excise taxes or jeopardize the tax exempt status of the organization. Compensation policies and practices will require analysis and possibly a FIN 48 disclosure of potential tax liability. 

Posted by Jamye Shaffer
RCO – Tax Senior

FIN 48 is an accounting standard that publicly traded companies have been complying with since 2007. Due to many comments and concerns about the standard, the implementation was delayed for nonpublic entities. FIN48 is an interpretation that clarifies accounting for uncertainties in income taxes, but more importantly, it changes the way that resulting liabilities are recognized, measured, presented and disclosed in the financial statements. When a tax return is completed, every answer or number is really a tax position. FIN48 asks the theoretical question, “would that tax position (either taken on a return or expected to be taken on a future return) stand up to examination by the IRS if they have full knowledge of the facts?”. 

Ok that is a bunch of tax talk. How can this standard affect tax-exempt organizations? The Financial Accounting Standards Board actually addressed that issue specifically, in a staff position paper issued last year. There are several FIN48 issues that can affect tax exempt agencies, but the most common are (1) performing services that are not consistent with the organization’s tax exempt purpose and (2) unrelated business income.

The first assessment of any tax position is whether or not the position is more likely than not to be upheld during an IRS examination. If the position would be upheld, then it is NOT an uncertain tax position and there is NO liability.  If the position cannot be upheld, then FIN48 requires a liability to be recorded and disclosed. The calculation of the liability is prescribed but allows some judgement. The recorded liability is the difference between the benefit recorded (full amount) and the amount that would be 50% or more likely to be allowed after the examination. The disclosure will identify this as an uncertain tax position, and will raise red flags for an IRS audit. As reported in the Journal of Accountancy, the IRS is currently proposing companies with more than $10 million of assets to disclose uncertain tax positions on their annual returns. 

Need help in determining what is considered an “uncertain tax position”? See our next post.

Organizations comprised of property owners can be classified into the following four groups:

1. Condominium Associations - comprised of unit owners owning their individual living quarters, having an undivided percentage interest in the common property.

2. Homeowners’ Associations - comprised of members who own their dwellings and the land on which the dwelling sits however the common area/property is owned by the Association.

3. Cooperative Housing Corporations - comprised of residents owning shares of stock or membership certificates, giving them the right to occupy a unit in the cooperative. The Corporation has title to the property (individual units and common area) within the development.

4. Timeshare Developments - comprised of users having access to certain accommodations annually or other repeating basis.  

These organizations are commonly referred to as Common Interest Realty Associations or “CIRAs”. The principle activities for these organizations include: Read the rest of this entry »

In my previous post we discussed external financial statement audits. Now we will discuss the audit process.

To begin the audit, the accountant (or equivalent) will present the auditor with a listing of all accounts and the related balances that are used to compile the financial statements. Basically, the accountant is saying this is what I believe to be the balances of these accounts. Then the auditor goes through various steps, such as confirming information with third parties, reviewing invoices, contracts, receipts, bank statements, and analytical procedures to prove that the balances are not “materially misstated” and that the statements conform to generally accepted accounting principles.

An audit does not look at every transaction that occurred during the year. Normally this would be cost prohibitive. So the auditor will look at various accounts and take a sample of transactions from those accounts. Because we “test” the account balances and not review 100%, our report is not saying that the financial statements are necessarily 100% accurate, but our report tells the users of the financial statements that we believe there is not a material misstatement that would cause you to alter a decision.

For example, your organization may report to us that they have a balance of accounts receivable of $2 million. Through various means of testing this balance, we have reviewed $1.9 million of this balance and believe it to be accurate. But we have not audited the remaining $100,000. We believe that the users of the financial statements would make the same decision if the actual balance were $2 million or $1.9 million. When errors are found during the audit, the auditors will discuss the issues with management and propose adjustments to the financial statements.

Understanding what an audit of financial statements entails helps management, Board of Directors and others to know what they are paying for and that the statements fairly represent the financial status of the organization. If the accountant uses the same generally accepted accounting principles to compile the monthly financial statements, this will help management and the Board of Directors make consistent, well-informed decisions.

FAS 164 issued in April 2009, sets out the principles and requirements for how a not-for-profit entity should determine whether a combination is in fact a merger or an acquisition. Prior to the issuance of this standard FAS 141 provided guidance on combinations for Business entities (for-profit organizations). There are different motivators for acquiring or merging with another organizations. For-profit entities tend to be motivated by market share, generating revenues and maximizing net income. Nonprofit organizations may merge for different reasons, other than the effect on the bottom line. Enhanced program services and missional outreach while reducing overhead, play important factors in negotiating a combination.

Non-profit organizations exempt status requires continued operational compliance with its exemption. Whether the organization fulfills a religious, educational, scientific, cultural service to the community, any organizational changes have to be focused on continuing or expanding the operational exemption. Many non-profit combinations involve an inherent contribution between the organizations.

When two non-profit organizations are combined – is it a merger or an acquisition? After the combination, who controls the combined entity? Who is in control? A new governance team – the combination is recorded as a merger. If one entity cedes control to another entity – the combination is recorded as an acquisition.

How is the combination recorded? Read the rest of this entry »

When I tell folks that I am an auditor, I immediately get that defensive look as they assume that I am a dreaded IRS auditor (which I am not). When I further explain that I audit financial statements, I usually receive a weak smile and a slight head nod, as if to signal that they are glad I am not with the IRS, but they really don’t have an idea what I do and are a little too embarrassed to ask or don’t really care. For those of you employed at non-profit organizations or serve on their Board of Directors, I thought I would take a few moments and explain what an audit of financial statements really entails. In a later post I will address who may need to have an audit.

So what is an audit of financial statements? Usually on a monthly basis, the controller, CFO, or accountant at your organization prepares financial statements, usually consisting of a balance sheet and income statement. These statements are used by staff, management and the Board of Directors to make decisions about the organization. But all of the information is gathered by and reported by people INTERNAL to the organization. A financial statement audit involves someone EXTERNAL to the organization, an independent certified public accountant.

Audits of financial statements are done according to a set of standards that all CPA’s must adhere to, which are referred to as Generally Accepted Auditing Standards (GAAS). These standards have been developed by the American Institute of Certified Public Accountants and are monitored and revised based on financial circumstances, including failures related to fraud.

So how do we perform an audit? See my post, next month.

RCO recently hosted a breakfast event for tax-exempt executive directors. Good to Great and the Social Sectors provided discussion points for defining the level 5 executive. Someone suggested that a leader is someone people would follow if there were no titles. They set the tone, opinions and functionality for the organization.

Think about it.
Who would you follow into the missional battle? The one who “wore the stars” or the one who knew how to shoot?

It’s year-end and tax-exempt (T-E) organizations are preparing budgets for next year. In fact the budget process relating to expenses has probably been completed, however trying to estimate the revenue stream can be difficult. A number of churches utilize a pledge card to estimate contributions.

During the budget process expenses are reviewed and operations are monitored/analyzed, determining the effectiveness to the mission. Remember, all T-E organizations must continue to be organized and operate in accordance with it’s stated exempt purpose, as approved by the IRS (Form 1023).

Before the end of the fiscal year, department managers are usually asked to submit their budget for next year. Reviewing the current year disbursements, estimated costs for significant capital/program projects, revisions for personnel and related costs are just several of the key factors that must be considered.

To help the finance department and ultimately those charged with governance, churches may ask their congregants to complete a pledge card, indicating their intention to give. During this weekend, First United Methodist Church of Mansfield, accepted the annual “estimates of giving”. An estimate or an “intention to give” allows the church to collect and assess the level of contributions for the next year, without recording an unconditional promise to give. Remember conditional promises to give are recorded when collected (or when the condition has been met). Unconditional promises to give as recorded with the promise has been made by the donor.

So as your church prepares it’s annual budget, it’s o.k. to ask congregants for a giving estimate. This estimate allows management to prioritize capital expenditures and program services.