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GuideStar Blog

From the President's Office, May 2007

Dear Friend:

Nothing makes me madder than hearing about phony charities or those unscrupulous actors who take advantage of the nonprofit sector for personal gain. They hurt all of the hard-working nonprofits doing amazing good work and lessen the public's—including well-meaning donors'—confidence in the entire sector. But it's not always easy to determine what is a legitimate charity. With more than 1.5 million tax-exempt organizations in the United States and the number growing at nearly 5 percent a year, there's a lot to research and consider.

In an effort to streamline this important responsibility, GuideStar created Charity Check, an on-line service that enables grantmakers to perform their due diligence quickly and efficiently by providing instant access to different kinds of IRS data in a single report. Due diligence—determining whether a nonprofit qualifies to receive a grant or contribution—has always been an essential part of grantmaking. Like all donors, grantmakers want to ensure that their organizations' funds are going to nonprofits that will make good use of them. Grantors also must ensure that recipients qualify to receive grants under the law and according to each grantor's guidelines.

Last summer, the Pension Protection Act of 2006 added a new wrinkle to grantmaking due diligence: private foundations and sponsors of donor-advised funds must now determine whether potential recipients of grants and contributions are supporting organizations under section 509(a)(3) of the tax code. Grantmakers who make a grant or contribution without doing this research may have to pay excise taxes.

The IRS has advised grantmakers that they can rely on Business Master File (BMF) data to determine whether or not a charity is a supporting organization. (See more information.) In late March, the IRS issued guidance allowing grantmakers to rely on a third-party source of BMF data, as long as it meets certain criteria. Read the guidance

Although Charity Check already met most of the criteria for a third-party source of BMF data, we needed to change how the information displayed and to add the date of the most recent BMF update to every Charity Check report. The IRS guidance on obtaining BMF data through a third-party source was posted March 23; we launched the Charity Check upgrade April 6. The upgrades were provided to all Charity Check subscribers at no additional cost.

It was an intense two weeks for GuideStar's staff, but the results were worth it. The changes made a valuable, time-saving tool even more useful. Grantmakers can use Charity Check with full confidence that it meets all IRS criteria for a third-party source of BMF data.

Charity Check is a simple solution for an increasingly complex process. As 2007 continues, we will refine other services and introduce new ones. Some of these tools will be available at no cost to users; others, like Charity Check, will be subscription services. All will share one goal: to make it easier for you to find the information you need, when you need it.


Bob Ottenhoff
President and CEO

IRS Updates, May 2007

Note: The following discussion is provided for informational purposes only and is not intended to serve as legal or tax advice. For specific information about Form 990-N and provisions of the Pension Protection Act of 2006 mandating the revocation of exempt status, consult your attorney or tax advisor.
The IRS has announced the next round of changes required by the Pension Protection Act of 2006:

  • Smaller nonprofits will be required to file Form 990-N starting in 2008.
  • Organizations that fail to file Form 990, 990-EZ, 990-PF, or 990-N for three consecutive years will lose their tax exemptions.

Do Your Homework, Do Your Duty: Ten Ways to Protect Your Organization When Engaging Outside Services

Whether you're hiring a consultant to advise your organization on a major restructuring effort, looking for an IT solution from an outside source, or even just considering accepting a service for free, it pays in the long run to do your due diligence, i.e., to research the service provider. It's not a matter of doubting your potential business partner but of protecting yourself in the event of any unforeseen difficulties or misunderstandings. Especially with the fluctuations in legislation regarding nonprofit funding and finances, it's essential to cover all your bases to make sure a transaction will go smoothly for all involved.

Beyond the Checkbook: Accounting Systems in Growing Organizations

Nothing makes me sadder than getting called in at year-end to help an organization with its accounting and reporting, only to discover entrenched systems that have created convoluted records and failed to protect the organization's assets. It can take hours to unravel transactions so that reports required by auditors or the IRS can be prepared.

To avoid this frustrating and expensive situation and to benefit from accurate and useful reporting all year long, here are some standards for transaction processing and accounting that your system should meet:

  • Ensure that cash and checks coming into the office are deposited in the organization's bank accounts
  • Ensure that money is spent appropriately
  • Ensure that consistent recording of transactions is easy
  • Account for temporarily restricted support separately from unrestricted support
  • Distinguish between employees and contractors
  • Ensure that salaries and taxes are paid in accordance with local, state, and federal laws
  • Monitor performance against your plan (that is, against budget)
  • Report to management, the board, funders, donors, and regulatory agencies on time and accurately
If you expect your organization to grow to the point where you're filing a 990-EZ, hiring employees, receiving grants, or charging program service fees, you'd be wise to set up your accounting processes and systems in advance of these benchmark events.

Incoming Cash and Checks

A basic principle of internal control—i.e., the steps you take to ensure that your organization's finances are handled properly—is that people who record and otherwise account for transactions should not execute or authorize them. Thus, your bookkeeper should not open the mail or accept money from clients or donors, and the person who does accept the money should not write checks for the organization. Any person accepting money should prepare receipts, and those receipts should be pre-numbered so that all of them can be accounted for. If you plan to accept cash and checks from individuals in person or through the mail, have receipts printed before the first payment arrives.

You'll need to document these transactions, but if you decide to copy checks or keep credit card numbers, treat them as confidential and make sure that they are kept secure, to protect your donors, clients, and members. Most banks offer a record-keeping service for a minimal fee: they provide a CD containing images of both the front and back of all checks you've deposited, so there's no longer a need to keep paper copies. Ask your bank about this service.

Ensuring That Money Is Spent Appropriately

The most common embezzlement method is to invent a vendor and submit invoices for services that were never authorized or performed or for goods that were never ordered or delivered.

Incoming invoices should go to the bookkeeper, who notes them in a log (in case they languish on the desk of someone who's not good at paying attention to paper) and routes them to the person who ordered the services or goods. That person then initials the invoice (indicating that the invoice is legitimate and presents the correct charges) and codes it for the bookkeeper—that is, specifies the account, program, and grant to which the expense should be assigned. The bookkeeper can then record the invoice and print a check.

Authorized check signers should receive not only the check but all the supporting documentation as well. Before they sign each check, they should—I'd love to say MUST but realistically can only say should—read the documentation carefully. Especially in small organizations, where other controls (such as a process to approve vendors) may be lacking, this step is critical for preventing misappropriation. If the person signing the checks has any doubts at all, he or she should consult the person who authorized the transaction. The person responsible for signing checks must be satisfied that an expenditure is in payment of a legitimate expense before signing a check.

Making Consistent Recording Easy

Nonprofit reporting is complex, and setting up a clear and logical accounting structure in the software you use is critical—you need to record transactions consistently. Natural accounts (e.g., salaries, rent, and travel) need to be logically separate from both activities (e.g., program services and fundraising) and grants. Too often, charts of accounts are designed with activities and natural accounts intermingled, leading to a list of accounts that's too long and includes logical dilemmas.

For example, you hold an event to increase your visibility in the community, and it results in an invoice for rental of a meeting space. If there's an account for "facility rental" and another for "outreach," which one should the manager choose when she's coding the invoice? She needs to be able to select both of them, and she can if "facility rental" is a natural account and "outreach" is an activity.

It's well worth hiring an accountant who's familiar with not-for-profit reporting to design your accounting system. You'll find that your bookkeeper makes fewer errors in the details and that your reports, both during the year and at year-end, are much easier to generate directly from your accounting system, without outside manipulation in a spreadsheet.

Accounting for Temporarily Restricted Support

It's thrilling when you get a sizable grant and can put a big check in the bank! If the grantor has placed any conditions on the grant, such as the period during which you can spend it or the kinds of things you can spend it on, you'll need to be able to track the satisfaction of those restrictions in your accounting system. This is true for temporarily restricted grants whether or not you receive cash in advance.

It's a sad day indeed when an executive director realizes that, although there's plenty of money in the bank, most of it is committed to running programs and therefore still restricted, while the unrestricted fund is actually in debt. Don't let this happen to you; build procedures into your monthly accounting that will enable separate reporting on unrestricted and temporarily restricted funds.

Distinguish between Employees and Contractors

State and federal laws set out guidelines for purchasing services from individuals; these guidelines distinguish between employees and contractors. It's especially tempting for small organizations, often in need of just a little bit of expertise or help when they're getting started, to call an employee a contractor. This mistake can be costly: even if the provider wants to be engaged as a contractor, the law holds sway, and the employer is the one who is fined.

You could be audited by your state employment department, your state department of revenue and taxation, or the IRS. The penalties and fines are stiff and could be high enough to threaten your organization.

The federal guidelines are available on the IRS' Web. Type "independent contractor" in the search field. You may also find good guidance on your state's Web site.

Pay Salaries and Taxes Accurately and on Time

You can choose between paying a bookkeeper to prepare payroll checks and payroll tax returns or hiring an outside service to do it. For most organizations, hiring a service is the better option because the service will guarantee timely filing of returns and timely depositing of your taxes for a minimal fee. Payroll is complex and, unless your bookkeeper is experienced with payroll, you'll get a higher degree of assurance for a lower price with a service.

You don't have to hire a national name; most cities and towns have at least one locally owned service that will do just as fine a job as a national firm.

Internal procedures should include requiring employees to complete and sign time sheets (or use a time clock) indicating the days and times they worked and which programs or activities their work related to.

Supervisors should review and sign the time sheets, authorizing the hours worked and payment of any overtime due or personal leave taken. From these records, the bookkeeper can prepare the payroll for the service to process.

Monitor Performance against Your Plan

Your annual budget is your plan, and your accounting system should be able to produce a report comparing the actual results for a specific period and your budget for that time, and it should be able to do this without exporting to Excel.

All managers should review this report in detail monthly. By that I mean that they should see a report with each natural account presented and each function shown separately. Before giving this information to the managers, the bookkeeper should review it and make sure that any variances are not due to accounting errors. Managers should ask themselves if variances between performance and plan make sense in light of what they know about operations.

In my experience, the most difficult part of instituting this procedure is getting managers to make time for it. The executive director's leadership can be critically important in establishing this habit.

Report to Supporters on Time and Accurately

For the most part, this will be easy if your accounting system is well designed; thoughtful, attentive review occurs monthly; and the development manager who's responsible for reporting to grantors communicates well with the bookkeeper.

If you find that reporting deadlines cause a flurry in your organization, then it's time to review your system.

Nancy Church, CPA, Not-for-Profit Accounting Help
© 2007, Nancy Church

Nancy Church is the founder of Not-for-Profit Accounting Help, a resource for nonprofit bookkeepers and financial managers. She has been licensed as a CPA in Oregon since 1987 and has 20 years' experience working with nonprofits as a board member and finance committee member, independent auditor, part-time accountant, director of finance and administration, and consultant to educational, community, and environmental organizations.