Small Nonprofit Bookkeeping: Restricted Funds and Form 990

How is bookkeeping for a small nonprofit different from a business's?

A nonprofit has no owners and no profit to distribute. Its books track net assets, the nonprofit version of owner's equity, in two groups, without donor restrictions and with donor restrictions, and the change in each. Form 990 asks for the same split in Part X, lines 27 and 28, for a group that follows the not-for-profit accounting standard (ASC 958); a group that does not follows lines 29 through 31 instead (Form 990 instructions). Which applies is a question for whoever prepares the financial statements.

The return should generally use the same accounting method the books regularly use. Many states that accept Form 990 in place of their own report require the accrual method, so check your state before choosing (instructions).

A case is not simple when a restricted grant was spent without a tag, costs were never split by function, the books are behind, a funder, bank or board is asking for statements, or a return was missed and the exemption may be at risk. Reports to funders and the IRS draw on the books, so gaps there usually have to be closed first. Gather these first:

• The IRS determination letter and the group's filed returns.
• Grant agreements and award letters.
• Bank and card statements for every account.
• Donor records and any acknowledgments sent.
• The board-approved budget.

To set up the books:

1. Give each kind of money its own income account: contributions, grants, membership dues, program fees, event income.
2. Keep expense accounts by type, and tag every expense with its function: program, management and general, or fundraising.
3. Tag every receipt as with or without donor restrictions.

How do I tell whether a gift or grant is restricted, and how do I track it?

A gift or grant is restricted when the donor, which includes the maker of certain grants, sets a limit more specific than the group's own purposes in its articles or bylaws: a purpose, a time, or a requirement to preserve the gift, as with an endowment. A board vote to set money aside is a board designation, not a restriction, and the money stays in net assets without donor restrictions (Form 990 instructions).

A gift for something the group already does under its general purposes may carry no restriction. If the wording is unclear, ask the donor and keep the answer in writing. If a grant pays only after the group spends, or must be repaid if a target is missed, the question is when it counts as revenue. That is an accounting-standard question the IRS instructions do not settle; settle it with whoever prepares the financial statements.

To track a restricted gift or grant:

1. Keep the agreement or letter with the donor's wording. The IRS lists grant applications and awards among the supporting documents to keep (Publication 4221-PC).
2. Add one row per gift or grant to a grant list: donor, purpose, amount, date received, spend-by date, spent to date, balance.
3. Tag each restricted receipt with its class in the books, so the "with donor restrictions" balance can be printed whether or not the money sits in its own bank account.
4. Tag each expense to the grant it was paid from and to its function. The IRS says that with more than one program, the records should identify the income and expenses of each (Publication 4221-PC).
5. Each month, match the grant list to the "with donor restrictions" balance.

What happens in the books when a restricted grant is spent?

Once the money is spent as the donor directed and any time limit has passed, it is no longer subject to the restriction, so the amount moves from net assets with donor restrictions to net assets without. If the agreement also says the group must keep using or hold what it bought, that part stays restricted. The expense is recorded as usual. The move does not change total net assets; the expense does.

• Record the move in the period the restrictions are met, usually when the money is spent, with a note naming the grant.
• A restriction that is only about time ends when the donor's date arrives, with no spending needed.
• If a payment falls outside the donor's terms, do not release the money. Read the agreement or ask the funder first; that is a decision, not an entry.
• A restricted balance left at year end carries forward; on Form 990 it is reported on Part X, line 28 by a group that follows ASC 958.

If the grant was spent before it was tagged

1. Pull the agreement and list what it allows.
2. List every payment from that grant's money, by date, and mark each as inside or outside the donor's terms.
3. Record the release for the inside payments in the period each restriction was met, usually when they were spent. Payments outside the terms are a question for the funder, not an entry.

If a funder's report or an audit is due before this is done, a professional can help sort which payments fit the terms.

What are functional expenses, and how do I split shared costs?

Functional expenses sort every cost by its job: program services, management and general, or fundraising. A 501(c)(3) or 501(c)(4) filing Form 990 completes all three columns in Part IX; other organizations must complete the total column and may complete the rest (Form 990 instructions).

A cost that serves more than one function is split. If the accounting system does not allocate, any reasonable method works, but the amounts must be accurate and the method written down. An employee who spends part of the time on fundraising and part on programs has the salary split by that time; the whole salary cannot go to programs because most of the time was program work (Form 990 instructions).

Pick the basis once, write it down and use it every month. Time records for pay and floor space for rent are common bases. A group filing the short form should still split costs: a state may ask for a complete analysis of functional expenses (Form 990-EZ instructions).

What must I record for donors?

This section is for a charity eligible to receive tax-deductible gifts, such as a 501(c)(3) group. Other exempt groups, such as clubs and trade associations, follow different donor rules.

For a gift of $250 or more, the group gives the donor a written acknowledgment. For a payment over $75 that is partly a gift and partly a purchase, it gives a written disclosure statement when it asks for the payment or receives it, not at year end. A group that skips an acknowledgment faces no penalty, but the donor cannot deduct the gift without one (Publication 1771).

The acknowledgment must reach the donor by the earlier of the date the donor files or the due date, with extensions, of the donor's return; groups typically send by January 31. One annual summary can cover several gifts of that size, but smaller gifts are not added together. A missing disclosure statement draws $10 per contribution, up to $5,000 per fundraising event or mailing unless there was reasonable cause. Small token items and some low-cost membership benefits are exceptions (Publication 1771).

In the books, record each gift's donor, date, amount, method, any goods or services given and any restriction. Book a payment like a dinner ticket in two parts: the retail value of what the donor received as event revenue, and only the excess as a contribution (Form 990 instructions). Keep samples of fundraising materials and, for each event, what patrons received and its retail value (Form 990 instructions).

Donated goods, such as food or equipment, are noncash gifts: record what was given and its value when received. Donated services and free use of space may not be reported as revenue on Form 990 (Form 990 instructions). For a larger noncash gift, the donor may bring Form 8283, Section B; the group signs the donee acknowledgment and keeps a copy. If it sells or otherwise disposes of that property within 3 years, it generally files Form 8282 within 125 days and gives the donor a copy. Items consumed or given away for the exempt purpose are excepted (Form 8283 instructions; Form 8282).

Which annual return does my nonprofit file, and when is it due?

The return depends on gross receipts and total assets (Form 990 instructions; IRS Form 990-N page).

All three are due on the 15th day of the fifth month after the tax year ends (May 15 for a calendar year), or the next business day. Form 8868 gives an automatic six-month extension for Forms 990 and 990-EZ (Publication 4221-PC). Forms 990 and 990-EZ must be filed electronically (Form 990 instructions; Form 990-EZ instructions).

Gross receipts are everything received in the year from all sources, with no costs subtracted (Form 990 instructions). "Normally" has its own test (IRS Form 990-N page):

• In its first year, a group qualifies if it received, or donors pledged, $75,000 or less.
• Between one and three years old, it must have averaged $60,000 or less in gross receipts during each of its first two tax years.
• At three years or more, it must have averaged $50,000 or less over the preceding three tax years, including the current one.

Churches and some other groups need not file, a private foundation files Form 990-PF instead, and some groups, such as supporting organizations, must file Form 990 or 990-EZ even when small (IRS: who must file). Sponsoring organizations of donor advised funds must use Form 990 and not Form 990-EZ, and so must a controlling organization under section 512(b)(13) when funds moved in either direction between it and a controlled entity during the year (Form 990 instructions). For a church, see church books and giving records. State charity registration, annual reports and state tax exemptions are separate and vary by state; the IRS lists state sites on its State Links page. Some states accept the federal return in place of their own report and may require added detail (Form 990-EZ instructions).

The books supply the figures, but preparing the return is separate work from keeping the books. Settle who prepares it before the due date.

What happens if the return is not filed for three years?

A group that fails to file a required Form 990, 990-EZ or 990-N for three consecutive years loses its tax-exempt status automatically, effective on the original due date of the third missed return or notice (IRS: automatic revocation). Filing the Form 990-N late carries no penalty, but a missed e-Postcard still counts toward the three years (IRS Form 990-N page).

The IRS posts an Automatic Revocation List; check it for the group's name (IRS: automatic revocation).

After revocation:

• The group is no longer exempt from federal income tax, so it may have to file an income tax return and pay tax.
• It is no longer eligible to receive tax-deductible contributions. Donors can still deduct gifts made before its name appears on the IRS revocation list.
• It must apply to the IRS to be reinstated; the law gives no appeal of a proper revocation. State and local law may also treat it differently (IRS: automatic revocation).

Each route is an exemption application with a user fee: Form 1023, 1024 or 1024-A on every route, and Form 1023-EZ only on the first and last. The date the exemption comes back depends on the route (IRS: reinstatement):

The two reasonable-cause routes also require the missed returns, filed on paper, and a statement that every required return is now filed. On the first route the IRS waives the failure-to-file penalty only if the group also files paper Forms 990-EZ for the missed years, except for a year it could have used Form 990-N.

Separately, a late or incomplete Form 990 or 990-EZ can draw $25 a day, up to the lesser of $13,000 or 5% of gross receipts for a smaller organization, unless there was reasonable cause; an organization with gross receipts above a higher level set in the instructions faces a larger daily amount and cap. The penalty can also fall on a person. If the IRS sends a letter setting a date to file or fix the return and the date passes, each officer, director, trustee, employee or other individual with a duty to file can owe $10 a day, up to $6,500 in total for all persons for one return, and all of them are liable together for it (Form 990 instructions; 26 U.S.C. 6652(c)).

Missed years are a professional-judgment case: which years were required, which form each needed, and which route fits. Every return reports figures from the books, so books that are behind for those years matter too.

Which records do I keep, and for how long?

Keep records that support a return for at least three years from the later of the return's due date or filing date, and keep the exemption papers and board minutes permanently (Form 990 instructions; Publication 4221-PC).

Employment tax and property records follow the general rules in how long to keep business records. Form 990, Part VI, line 14, asks whether the group has a document retention and destruction policy (Form 990 instructions).

Does a nonprofit ever owe tax?

Yes. The usual federal income tax is on unrelated business income: for most organizations, income from a trade or business, regularly carried on, that is not substantially related to the purpose behind the exemption. Income tax can also apply after the exemption is revoked (above), and a group with paid staff has employment taxes (setting up payroll). Two common exceptions can change the answer: a business in which substantially all the work is done without pay, such as a volunteer-run sale, and the sale of merchandise substantially all of which was donated, such as many thrift shops (IRS: exceptions and exclusions). Keep records of who did the work and where the goods came from. A group with $1,000 or more of total gross income from all its unrelated businesses combined files Form 990-T in addition to its annual return (Form 990 instructions; IRS: unrelated business income tax). Gross income here means gross receipts minus cost of goods sold. Form 990-T must be filed electronically and is due on the 15th day of the fifth month after year end, with an extension on Form 8868; tax is due by the original due date (Form 990-T instructions). A group that expects the tax for the year to be $500 or more also pays estimated tax during the year (IRS: unrelated business income tax).

Whether an activity is an unrelated business depends on the facts. In the books, keep income and direct costs of any regular side business apart from donations and program income, so the group can see whether it crosses the line.

What should the treasurer or board see each month?

No IRS rule sets a monthly report. A useful pack mirrors what the annual return asks, so year end draws on the same figures:

1. A balance sheet showing net assets with and without donor restrictions (Part X).
2. Income and expenses for the month and year to date against the budget.
3. The grant list: received, spent, balance and spend-by date for each restricted gift or grant.
4. Expenses by function, year to date (Part IX).
5. Bank and card reconciliations, done and signed off.
6. Acknowledgments sent for every gift of $250 or more.

For the routine behind this pack, see the month-end close checklist and the year-end close checklist.

Example

These examples are illustrative. All figures are in US dollars.

A food pantry spends part of a restricted grant

A food pantry receives a $20,000 grant for a freezer and food purchases. It buys $5,000 of food in March.

The $5,000 expense is covered by the release, and $15,000 stays with donor restrictions for the freezer and later food. The grant list shows the same balance.

A small arts group picks its return

A calendar-year arts group, at least three years old and not a supporting organization, has taken in about $60,000 in each of the last three years and ends the year with $40,000 in assets. Its three-year average is above $50,000, so it cannot use the e-Postcard. It is under the $200,000 and $500,000 tests, so it files Form 990-EZ or Form 990. It confirms which before May 15, or extends with Form 8868.

A donor pays for a dinner

A donor pays $150 for a dinner the group values at $60. The payment is over $75 and buys something in return, so the group gives a written disclosure statement: the deductible amount is limited to $90, the excess over the $60 estimate. In the books, $60 is event revenue and $90 is a contribution. A payment of $300 for the same dinner leaves a $240 contribution, under $250, so it needs the disclosure but not the acknowledgment. At $350, the $290 contribution also needs a written acknowledgment describing the dinner and its $60 value.

Different for you?

• Your nonprofit is a church: use church books, housing allowance and giving records.
• You are a business giving to charity: the donor side is in charitable donations from the business.
• Your nonprofit is Canadian: see non-profit books and information returns.
• A restricted grant was spent without a tag, the books are months or years behind, or a funder, bank or board wants statements: reports to funders and the IRS draw on the books, so gaps there usually have to be closed first. See catching up on overdue books and bookkeeping help.
• Returns were missed, the IRS sent a letter about a return, or the exemption may have ended: the years, forms and reinstatement route turn on the facts. The books for those years can be rebuilt with bookkeeping help; which returns and application fit is for a professional to decide.
• You have paid staff: payroll is its own setup; see setting up payroll.