Leading a nonprofit organization requires leaders and Board members to wear many hats. Some of the challenges that small to medium organizations face every day range from funding to budgeting, compliance, and maintaining relationships with donors and volunteers, just to name a few.
Sometimes, it’s important to narrow the focus to the ultimate goal: maintaining tax-exempt status so the organization can continue to fulfill its mission. Unless nonprofit leadership is compliant with the IRS, it cannot begin to address other issues like donor retention, creating a culture of philanthropy, or being seen in the community.
Luckily, there are resources to help nonprofit leaders navigate the maze of nonprofit management and compliance. The IRS has resources and information to help nonprofit leadership and Board members understand their responsibilities.
Documentation and Recordkeeping
Nonprofits will need to keep original records of their articles of incorporation or the charter, a copy of the Form 1023, their IRS determination letter, and copies of tax returns with any attachments.
There are four basic types of financial records to keep related to money coming in or out of the organization as well as employment tax and asset records. Examples of these records are as follows.
Accounts receivable records:
- Cash register receipts
- Bank deposit slips
- Receipt books
- Credit card slips
- Forms 1099
Accounts payable records:
- Account statements
- Canceled checks
- Cash register receipts
- Credit card sales slips
- Petty cash slips
If the organization produces and sells items, records of the materials should also be kept.
Keep financial records for at least three years after the return for that year is filed.
Employment tax records:
- Any records that show salaries, wages, benefits paid, and taxes withheld
Keep employment records for at least four years.
- Purchase and sales invoices
- Real estate closing statements
- Canceled checks or certain financial account statements
- Financing documents
These records should show several items about how the asset is or was used, like how and when it was acquired, if any debt was used, the purchase or sale price (and expense of the sale), cost of any improvements, deductions, and when or how it was disposed of.
Asset records should be kept for as long as the organization owns or uses the asset plus three years after its disposal.
Organizations can choose whatever type of recordkeeping system makes sense to them, as long as it’s consistent, clear, and tracks income and expenses separately. Online software like QuickBooks can be a quick and effective way to manage records and bookkeeping in one place.
Some actions can jeopardize an organization’s tax-exempt status, and leaders may not always be aware of the risk. A quick example is that most of the organization’s activities must relate to its exempt purpose. Other actions that can put the tax-exempt status at risk include:
- Political activity
- “Participating in a political campaign on behalf of, or in opposition to, a candidate for public office” is completely prohibited for 501(c)3 organizations.
- Defined as “any activity designed to influence legislation,” lobbying activities are limited to legislation that directly affects the organization, and leaders should only engage in a small amount of it.
- Unrelated business income
- Any income from business activities are subject to taxes. Organizations need to ensure they don’t have too much unrelated business income, otherwise the IRS could determine the tax-exempt status is unnecessary.
- Private benefit or inurement
- “Any activity that substantially benefits the private interest of an individual or organization” is prohibited. Inurement, in which an insider – someone who has a personal and private interest in the organization – would receive substantial benefit from the organization’s accumulated income or assets, is also not allowed.
- Worker classification
- Organizations need to know the rules for worker classification versus independent contractors, and also be careful not to blur the lines between volunteer and paid employee.
- Public information and disclosures
- According to the IRS, “Tax-exempt organizations must make their exemption application, their determination letter and the three most recently-filed annual information returns available to the public, upon request and without charge (except for a reasonable charge for copying).”
There can be gray areas in some of these prohibited activities. For example, while organizations cannot operate for the private benefit of a few, that doesn’t mean they can’t pay employees fair and competitive wages. And organizations can incur unrelated business income or lightly participate in lobbying activities – to a small degree. The key is to understand the thresholds and nuances and work with an advisor to help keep documentation in check.
Knowing the charitable solicitation rules of the state the nonprofit operates in is also important. Each state requires tax-exempt organizations to register before fundraising activities can occur. Any state in which the organization will be soliciting funds must have its own registration, which may also involve different financial report requirements.
Further, it’s important to understand the benefits, limitations, and expectations of a tax-exempt organization.
Other business and tax-related items that nonprofit leaders should be familiar with include:
- Required filings, including Form 990 options
- Significant events, like audits, private letter rulings, and termination proceedings
Other resources for nonprofits are available on the IRS’s Stay Exempt website.
Tips for Good Governance Practices
Establishing a culture of transparency and compliance starts at the top: with the executive director, finance executive, and the Board. Strong governance practices begin with documented policies and processes.
There should be updated job descriptions for board members, officers, the board chair, and staff, for example. The Board should also ensure there’s a clear succession plan for the executive director and board members. A key component of governance is aligning all programs and activities to the organization’s mission. When the mission and message are clear, knowing which programs or activities could run in violation of either becomes easier to discern.
It’s also a given that the organization’s finances should be completely transparent. Discussion and participation in board meetings should be encouraged, and board members should stay on top of changing regulations and legislation. Annual strategic planning can help to direct current activities toward longer-term goals.
There are several models for Board governance, like the voluntary model where members work in the community alongside paid employees and volunteers. This is the most common for smaller organizations. Other governance models are:
- Advisory Board: Helps to fill in gaps in specialty knowledge areas, like accounting or law
- Patron: The Board’s purpose is mainly fundraising and networking
- Cooperative: The Board is a collective group where everyone holds equal ranking
- Policy Governance: Like the Voluntary model except there are management committees that oversee different areas with an organization CEO or executive director
- Community Engagement Governance: The Board serves the community and stakeholders assume governance responsibilities
- Hybrid: A mix of two or more governance models that’s customized to fit the unique needs of the organization and Board
Nonprofit organizations with questions about how to best maintain their ongoing compliance and governance can reach out to Bo Garner, CPA, MBA, who leads the Not-for-Profit group at PBMares.