Applying for Tax-Exempt Status
When deciding whether or not to apply for 501(c)3 status here are some things to consider.
Tax-Exempt Status Overview: 501(c)(3) Public Charities
Benefits & Responsibilities:
Benefits: Federal income tax exemption, tax-deductible contributions, reduced postal rates.
Responsibilities: Detailed financial and non-financial recordkeeping, annual Form 990 filing, and multiple public disclosures.
The 5-Stage Life Cycle:
Commencement: Establishment as a state non-profit organization. Obtain an EIN, and define the exempt organization type with the Federal Government.
Application for Exemption: Apply to the IRS using Form 1023 or 1023-EZ.
Mandatory Filings: Submit an annual report with the IRS called Form 990. Additional reports that are required, but having completed your 990 simplifies the others.
Sustained Compliance: Continue to fulfill all mandatory requirements at the Federal, State, and local levels.
Noteworthy Events: Events such as Audits are required from time to time. While these may or may not be predictable, they are a part of operating as a Public Charity.
Public Charity Requirement: Must prove broad public support, either by substantial public funding or by limiting investment/unrelated business income and having significant support from contributions, fees, and exempt activities.
Application Prep: Register with your state as a public charity, and then obtain an EIN from the IRS. Having organizing documents, bylaws and a dissolution plan are required to complet a 1023.
Application Process: File Form 1023 with the IRS. Response times from the IRS vary, but application needs to be filed within 27 months of the organization’s inception. The organization will be recognized as exempt from its’ creation.
Exceptions: Group Exemptions are available for smaller, affiliated groups. Churches are automatically exempt, but often file a 1023 just to receive a Determination Letter. Some donors want to see proof of their status as an exempt organization.
Post-Filing: Maintain meticulous records (financial and non-financial, including all application documents). Track status online.
Determination Letter: This is a permanent record required and must be available for public disclosure.
State Compliance: Organizations must also meet state-level nonprofit requirements, especially for fundraising. States also have requirements for specific types of fundraising, such as raffles.
Additional Questions?
If you would like to discuss these items in more detail, schedule a phone call at
https://calendly.com/chuck-simsbookkeeping/
Nonprofit Compliance Navigator: Clarity & Confidence
Tired of compliance headaches? Small nonprofits face overwhelming federal, state, and local regulations (IRS Form 990s, state reports, fundraising registrations). Confusion leads to wasted time and stress. You want to make a difference, not to be a compliance expert.
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Essential Document Templates: Ready-to-use templates (bylaws, policies, etc.).
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Expert Educational Resources: Plain-language modules and webinars.
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Empowering small nonprofits through simplified compliance
The life of a nonprofit organization begins with an idea and continues until a mature organization delivering on its mission statement is established. Here’s a breakdown of these stages:
1. Pre-Formation/Planning Stage
Vision and Mission Development: The initial stage where the founders identify the purpose of the organization, its mission, and its core values.
Feasibility and Planning: Determining the need for the nonprofit’s services, and developing a strategic plan for the organization.
2. Formation Stage
Incorporation: Filing the necessary paperwork.
Establishing Governance: Defining the governance structure.
State and Federal Filings: Submitting IRS Form 1023 to apply for tax-exempt status.
3. Start-Up Stage
Initial Operations: Launching programs, services, or initiatives in line with the organization’s mission.
Fundraising: Identifying initial sources of funding.
4. Growth Stage
Program Expansion: Increasing the scale or number of programs/services the organization provides. These programs/services must align with their Mission Statement and have community support.
Sustainability Efforts: Developing long-term strategies for funding.
5. Maturity Stage
Consolidation: The organization becomes stable and sustainable. Its programs are well-established, and it has an established reputation in its field or community.
Strategic Refinement: Regular reviews of strategic goals and potential adjustments to stay relevant and responsive to changes in the community.
6. Renewal or Transition Stage
Innovation and Adaptation: As the organization matures, it may need to evolve. This may include rebranding, shifting programs, or revising strategies.
Significant Events: A mature organization will occasionally encounter items that are out of their normal processes. An example of this is an Audit. Audits may be requested by governments or donors. These events may impact your exempt status or your funding sources. Additional information about audits will be provided in a future blog.
Additional information from the IRS is available at this link.
How to make a bookkeeping entry for an item that is donated for an auction, but sells for less than the Fair Market Value (FMV).
The bookkeeping record for an in-kind donation and its subsequent sale at an auction by a Non-Profit Organization (NPO) involves three separate enteries.
In this example, a set of golf clubs is donated with a FMV of $500. At auction the golf clubs sell for $450.
1. Initial Recording of the In-Kind Donation
When the NPO receives an item, it is recorded as a donation at its Fair Market Value (FMV).
Account Debit Credit
Debit: Auction Items Inventory
(This could be Temporarily Restricted or Unrestricted) $500.0
Credit: Auction Contribution Revenue $500.0
To record the receipt of the in-kind donation.
Debit: An asset account, such as Auction Items Inventory for $500..
Credit: Auction Contribution Revenue for $500.00.
2. Recording the Sale at Auction
When the item sells for $450.00 (which is below the FMV/recorded value), the following entries are needed:
Increase Cash and decrease Auction Items Inventory.
Account Debit Credit
Debit: Cash
$450.0
Credit: Auction Items Inventory $450.0
B. Recording $50 the Difference between FMV and Sale Price.
Since the clubs were recorded as revenue of $500 but only generated $450 in cash, the NPO must record the $50 difference as an expense.
Account Debit Credit
Debit: Loss on Auction Inventory
$50.0
Credit: Auction Items Inventory $50.0
Net Effect: The initial revenue was recorded at $500.00, cash increased $450.00, and the difference of $50.00 is recorded as an expense.
Summary of Double Entry Accounting Records
Debit $500 to Auction Items Inventory
Credit $500 to Auction Contribution Revenue
Debit $450 to Cash
Beyond the Bottom Line: A Guide to Nonprofit Accounting
When it comes to managing the finances of a nonprofit, a donation isn't just a donation. It's a key piece of a larger puzzle that, when properly accounted for, tells the story of your organization's financial health and mission impact. At the heart of this process is the distinction between restricted and unrestricted donations.
If you've ever felt overwhelmed by the thought of managing these two categories, you're not alone. But with a solid understanding of proper fund accounting, you can build a system that ensures transparency, earns donor trust, and keeps your organization on solid financial footing.
Nonprofit accounting, frequently referred to as fund accounting, constitutes a specialized system for tracking and managing financial resources based on their designated purpose. Unlike a for-profit entity that primarily focuses on demonstrating profitability, a nonprofit must meticulously illustrate how every dollar was utilized to advance its mission. The following elaborates on the pivotal functions and features essential to this discipline.
1. The Core Principle: Restricted vs. Unrestricted Funds
This concept is unequivocally the most critical in nonprofit accounting.
Unrestricted Funds: These donations are received without specific donor-imposed conditions. The board of directors possesses the discretion to allocate these funds for any purpose that supports the organization's mission, such as staff compensation, operational overhead, or technological investments. This represents the most adaptable form of funding.
Restricted Funds: These donations are accompanied by a precise, donor-imposed stipulation. The funds must be allocated for a particular program, project, or within a defined timeframe. The organization is legally and ethically bound to uphold these restrictions. For instance, a grant designated specifically for a new playground cannot be reallocated to cover utility expenses.
Effective nonprofit accounting software is engineered to facilitate the precise tracking of these two categories, thereby preventing the inadvertent expenditure of restricted funds for unauthorized purposes.
2. The Essential Financial Statements
Nonprofit organizations utilize a distinct set of financial reports. These reports are instrumental in communicating the organization's financial health and demonstrating the utilization of its funds.
Statement of Financial Position (Balance Sheet): This report provides a comprehensive snapshot of the organization's assets (what it owns), liabilities (what it owes), and net assets (the organization's equity). It is imperative for delineating net assets with and without donor restrictions.
Statement of Activities (Income Statement): This document details the organization's revenues and expenses over a specified period. Analogous to the Statement of Financial Position, it must clearly segregate restricted and unrestricted transactions.
Statement of Cash Flows: This statement elucidates the movement of cash into and out of the organization. It serves as a vital instrument for cash flow management and ensuring adequate operational liquidity.
Statement of Functional Expenses: This report is unique to nonprofit entities and is mandated for IRS Form 990. It itemizes how expenses are apportioned across three primary functions: Program, Fundraising, and Administrative. This provides transparency by precisely demonstrating the proportion of each dollar dedicated to the organization's mission.
3. Essential Features of Nonprofit Accounting Software
While a rudimentary spreadsheet may suffice for startups, the majority of nonprofit organizations will derive substantial benefits from dedicated accounting software. When selecting a platform, consider the following key features:
Fund Accounting: The capability to readily establish and monitor various funds, particularly for restricted grants and campaigns.
Detailed Reporting: Tools capable of generating the four requisite financial statements and itemizing expenses by program and function.
Donor Management Integration: Seamless connectivity with the donor database to automatically synchronize donation data and assign appropriate fund and project codes.
User-Friendly Interface: An intuitive design that facilitates ease of use for non-accountants (such as volunteers and program staff) for basic tasks.
The Cornerstone of Trust: Why Nonprofit Accounting Matters
Nonprofit accounting is more than just crunching numbers; it's about building and maintaining trust. Accurate and transparent financial records are essential. They demonstrate an organization's commitment to its community, donors, and board of directors, solidifying its role as a public trust. This meticulous financial management forms the foundation of strong governance and is critical for long-term sustainability.
Statement of Economic Activity
It all begins with an idea.
The Statement of Economic Activity and the Profit and Loss, (aka the P&L) are similar documents, but they serve different purposes.
Here's a detailed comparison of both.
The Profit and Loss
Definition: The P&L summarizes a company’s revenues and expenses during a specific period of time. This period of time is typically a fiscal quarter or year, but it can be whatever time you choose.
Components: The data elements that are used to generate a P&L are:
Revenue: Total income generated from the primary operations.
Cost of Goods Sold (COGS): Direct costs attributable to the production of goods sold.
Gross Profit: Revenue minus COGS.
Net Income: The revenue remaining after all expenses have been subtracted.
Operating Income: Gross profit minus operating expenses.
Purpose: The P&L report is used by management, investors, and analysts to assess the company's financial performance over that time period. This information is critical to making wise decisions about operations, investments, and financing.
Statement of Economic Activity
Definition: The Statement of Economic Activity is basically the same as the P&L, but it provides a slightly broader scope of financial performance. It does this by including additional data elements that are not typically part of the P&L Statement.
Components: The data that is used to generate a Statement of Economic Activity are:
Revenue: Total income generated from its primary sources.
Cost of Goods Sold (COGS): Direct costs required to deliver their programs.
Net Income: This is determined in the same way it is in the P&L.
Other Comprehensive Income (OCI): Includes items not included in net income, such as unrealized gains and losses on investments. Endowments are often a large part of a nonprofit’s revenue, now and in the future. Factors that impact their future value are a big part of making decisions about the present.
Total Comprehensive Income: The sum of net income plus OCI.
Purpose: The Statement of Financial Activity is used to provide stakeholders with information about an organization’s financial health. This information is critical to making wise decisions about current and future programs.
Key Differences
Scope:
The P&L Statement focuses on profitability through revenue and expenses.
The Statement of Economic Activity takes a broader view of revenue by including the OCI.
This helps the organization focus on fulfilling their Mission Statement and not their profitability.
Components:
The P&L Statement includes revenues, expenses, and net income.
The Statement of Economic Activity includes everything in the P&L plus items like unrealized gains/losses, revaluation surpluses, and other items.
Purpose:
The P&L Statement is primarily for assessing operational profitability.
The Statement of Economic Activity is for understanding the overall financial performance and includes non-operational gains and losses.
Users:
P&L Statement is used by management and investors.
The Statement of Economic Activity is used by stakeholders interested in the organization’s financial performance and economic activities.
In summary, both statements are crucial for a financial analysis of the business or organization.
The “P&L Statement” provides detailed insight into a “for-profit” organization’s ability to generate profits.
The “Statement of Economic Activity” gives a detailed insight into a nonprofit’s ability to remain financially sound into the future.