Windes Nonprofit Advisor

Transcription

1 Nonprofit Advisor Summer 2015 Windes Nonprofit Advisor The Windes Nonprofit Advisor is a periodic technical publication focusing on the tax, regulatory, and accounting issues that nonprofit organizations routinely confront. On the tax side, the Windes Nonprofit Group ( Group ) possesses experience in preparing and reviewing Forms 990, 990-T, 990-PF, and state tax-exempt forms, in addition to having experience in the preparation and filing of both federal and state tax exemption applications for public charities, private foundations, and other exempt organizations. Additionally, the Group can assist in providing valuable guidance (governance / reasonable compensation documentation / public support test / special events / lobbying / transactions with related parties) to nonprofit organizations. On the audit side, the Windes Nonprofit Group prepares audited financial statements and ERISA audits for over 80 nonprofit organizations. For retirement plans, Windes has experts on staff for 403(b) plan administration and compliance, including plan document issues, Form 5500 preparation and filing, non-discrimination testing and government compliance programs. The Windes Nonprofit Group is composed of the following individuals who are dedicated to providing nonprofit organizations with high-level tax, regulatory and accounting consulting, tax compliance services, and financial statement audit and assurance services: Ron Kulek, CPA Lance Adams, CPA Michael Barloewen, CPA, CGMA Tom Huey, CPA Richard Green, CPC, APA Donita Joseph, CPA, MBT Amy Vaughn, JD, CPA, LLM Ryan Fischer, JD Cherie Williams Audit Partner Audit Partner Audit Partner Audit Senior Manager Employee Benefit Services Partner Tax Partner Tax Senior Manager Tax Senior Manager Tax Staff Please do not hesitate to contact any member of the Windes Nonprofit Group toll free at 844.4WINDES ( ) or via at nonprofit@windes.com. 1

2 The Less Obvious Advantages of Donor- Advised Funds Donor-advised funds (DAFs) have taken their place among oft-used vehicles to promote one s charitable interests. DAFs are often described as having the deduction benefits of a public charity but the control benefits of a private foundation. While this is true to some extent, there are many reasons why one should carefully consider the different ways in which one can give. This article will point out a few more subtle advantages of DAFs DAF tactics, if you will. DAFs can be used to prevent tipping a public charity s support percentage below the 33% threshold. A nonprofit will be able to count a DAF contribution as 100% public support, thus not subjecting the gift to the 2% limitation. This can be especially helpful to young organizations where a few unexpected or large gifts inadvertently put an organization in private foundation territory. I, for one, would rather avoid the facts and circumstances test if possible. DAFs can be set up by private foundations. In fact, some advisors think that every private foundation should have a DAF. Contributions to a DAF by a private foundation will count toward the private foundation s minimum distribution requirement. This is a fantastic pressure release valve for large private foundations or those that are subject to large swings in investment income. And, of course, it is great insurance for those private foundations that file their returns 10.5 months after year end and are notified by their tax preparers that an additional $100,000 must be paid out within 45 days. Anonymity Many donors are not confident that the IRS or their respective state will ensure anonymity with respect to contributors. Certainly, a contribution coming from DAF #54321 is less obvious than the Fischer Family Foundation (no relation)! From an individual donor s perspective, the DAF can offer certain timing advantages. If you know you will be itemizing in the current year but not itemizing in a subsequent year, front-loading your charitable giving via a DAF is tax-advantaged. You may maintain a steady flow of giving but not lose the charitable contribution in the non-itemizing year. This concept can be applied over a longer period of time where you are likely to stop itemizing in later years. Similarly, a DAF may be used to offset tax during a Roth conversion. Roth conversions can produce large tax bills, albeit for a short amount of time. Funding a DAF during the conversion for future giving will lessen the conversion tax bite and secure your giving for some time going forward. If you have questions regarding your organization s activities in connection with any of the topics discussed above, please contact Ryan Fischer at rfischer@windes.com or toll free at 844.4WINDES ( ). Ryan Fischer, JD Senior Manager 2

3 403(b) Plans: Correction for Universal Availability Errors 403(b) plans sponsored by nonprofit entities must offer salary deferrals to substantially all employees in order to maintain their qualified status. The plan can exclude certain employees from this requirement if they meet any of the following criteria: employees covered under another employer plan, non-resident aliens, student employees performing specific services, and employees who work less than 20 hours per week. The universal availability requirements were detailed in our Spring 2014 Nonprofit Advisor. From time to time, errors will occur and an eligible employee will not be provided an effective opportunity to participate in the plan. Fortunately, there is a prescribed fix for such an error. Under Revenue Procedure , an employer can contribute an amount equal to 50% of the salary deferral the employee could have made to the plan. For this purpose, the amount of the assumed salary deferral is 3% of compensation (with an override for some matching formulas). Example: Foundation XYZ s 403(b) plan employed several students who were excluded under the above exception. These individuals converted to full-time status after graduation, but were not provided with an opportunity to defer salary to the plan. The Foundation must make a contribution equal to 1.5% (3% of compensation x 50%) of their pay for the period of the exclusion, adjusted for lost earnings through the date of the correction. The oversight may be eligible for self-correction or may need to be submitted to the IRS depending on the significance of the error and the timing of the correction. Corrections are available under the IRS Employee Plans Correction Resolution System (EPCRS). The IRS has provided detailed guidance on this issue at: For more information or questions, please contact Richard Green at rgreen@windes.com or by phone at 844.4WINDES ( ). Richard Green, CPC, APA Partner 3

4 Nonprofit Overhead and its Importance How much of your donation goes to program expenses? Nonprofit organizations are all too familiar with this question and the high stakes involved in its answer. A key metric that is front and center on the minds of all nonprofit organizations is program expense ratio. This ratio is primarily measured by how much money an organization spends on programs compared to its total overall expenses. A concern often raised is that program expense can be an imprecise measurement of impact of an organization. It is a known fact that donors tend to avoid charities that dedicate a high percentage of expenses to administrative and fundraising costs. This can reduce the amount of donations for organizations that have lower program ratios, which can limit their ability to be effective. On the face of it, this seems an understandable position for donors and is one of the primary factors used in nonprofit watchdog groups to grade nonprofits. Other key metrics include total fundraising costs, governance policies and financial reserves. All of these appear to be reasonable metrics, but some would argue that it is missing consideration on the most important metric of all, total impact. Total impact is something that more and more stakeholders in financial statements want to see quantified, but how? Is it total program expense? Is that a truly accurate measurement of the quality of services provided by an organization? At the moment, program expense ratio is given priority over program expense totals by oversight agencies. As a result, watchdog organizations would potentially rank a nonprofit organization that is providing $10,000 of program services and has 10% total fundraising administration expenses over a nonprofit that is providing $100,000 of program services and has 30% total fundraising and administration expenses. Which is the charity that is doing the most good? Moreover, what is the quality of those program expenses? Consider this example from Dan Pallotta, author of Uncharitable and Charity Case: As for making donations "go as far as possible," consider two soup kitchens. Soup kitchen A reports that 90% of every donation goes to the cause. Soup Kitchen B reports 70%.You should donate to A, right? No-brainer. Unless you actually visited the two and found that the so-called more "efficient" Soup Kitchen A serves rancid soup in a dilapidated building with an unpleasant staff and is closed half the time, while Soup Kitchen B is open 24/7, and has a super-friendly staff that serves nutritious soup in a state-of-the-art facility. Now which looks better? The administration program ratio would have failed you completely. It betrays your trust. Itʼs utterly deficient in data about which soup kitchen is better at serving soup. It undermines your compassion and insults your contribution. And yet, we praise it as a yardstick of morality and trustworthiness. Itʼs the exact opposite. Perhaps recognizing that the primary nonprofit oversight agencies were over-emphasizing overhead, the heads of the Better Business Bureau Wise Giving Alliance, Guidestar and Charity Navigator (the big three watchdogs) put out a joint letter in 2013 urging the donors of America to look beyond overhead in evaluating where to make their donations. 4

5 Nonprofit Overhead and its Importance (continued) However, despite examples like the above and outreach from the watchdog agencies, there is no denying that program efficiency is a primary factor of consideration for donors. This may simply be due to human psychology rather than over-reliance on any flawed watchdog agency. A recent study in Science magazine titled "Avoiding Overhead Aversion in Charity" examined the science behind how we, the public, give to charity. In the report, the researchers performed a field study (real people in the real world) and found that having an organization's 'overhead' costs covered by other sources almost tripled the total funds raised when compared to a standard 'ask' from the same organization. The 'overhead' covered appeal also outperformed asks with seed funding (by 75%) and matching funds (by 90%). This leads one to the conclusion that the feeling of a donor is more important than any rational assessment of how much good their donation would do. The fact that an amount was 100% going to the cause was more important to a donor than actually giving a larger amount to the cause (when considering the matching funds) would lead to the conclusion that human emotion in charitable giving decisions is the most powerful force at play. As a result, nonprofits need to ensure their requests for donations are hitting the right emotional notes. The American Institute of Certified Public Accountants (AICPA) knows that watchdog agencies evaluate key ratios, such as the ratio of program expenses to total expenses. This ratio is also used by donors, foundations, financial institutions, and other important constituencies. The higher the percentage of program expenses to total expenses, the better. Some watchdog agencies would find a program expense ratio below 65 or 75 percent to be unsatisfactory. Organizations that can support a program expense ratio of 85 or 90 percent can make the claim that 85 cents or 90 cents of every contributed dollar goes directly into program services. These issues around overhead, and the public s perception of it, continue to impact and cause evolution in financial reporting and the auditing profession. Accordingly, in April of 2015, the Financial Accounting Standards Board (FASB) released new guidance intended to improve existing standards for financial statement presentation by nonprofit organizations. The new guidance, in part, is an attempt to help organization s tell their stories and convey their impact. Please see the article on page seven, FASB Proposes Changes to Nonprofit Reporting, which outlines this new guidance. In addition, an AICPA Nonprofit Audit Risk Alert provides guidance for auditors to focus on functional expenses in order to report them correctly. Organizations should be aware of the guidance provided to auditors so they can ensure their policies in this area are appropriate. The advice guides auditors to: Obtain or update an understanding of the allocation methodology of expenses by functional classification. Consider whether payroll and related costs are a significant part of total expenses and then specifically review the nonprofit s methodology for allocating payroll and related costs to the functional classifications. Verify the consistent application of the allocation methodology. 5

6 Nonprofit Overhead and its Importance (continued) Verify that the nonprofit has updated its allocation methodology in a timely manner for any changes in its cost structure. Triggering events could include: office space being added or given up; new debt being entered into; a significant new program being started or discontinued; or staff positions being added or removed. Reviewing and testing management's policies and procedures for allocating costs to the various functional categories that they support, including the allocation of joint costs. Performing an analytical review of functional classifications. Verifying that the nonprofit s presentation of program services in the statement of activities or notes to the financial statements is appropriate, consistent, and includes the appropriate costs. Verifying that the number of programs reported for program expenses is adequate based on the complexity of the nonprofit and its activities. Verifying that the nonprofit s presentation of supporting services in the statement of activities or notes to the financial statements is appropriate, consistent, and includes the appropriate categories, such as fund-raising and management and general. In conclusion, because the ratio is scrutinized by charity watchdog groups, the media, and donors, organizations need to ensure they have appropriate and thoughtful controls and policies in place around the reporting of functional expenses. In addition, stakeholders should maintain focus on this evolving area of nonprofit accounting. For questions or more information, please contact Michael Barloewen at mbarloewen@windes.com or toll free at 844.4WINDES ( ). Michael Barloewen, CPA Partner 6

7 FASB Proposes Changes to Nonprofit Reporting The Financial Accounting Standards Board (FASB) issued a proposed Accounting Standards Update (ASU) in April 2015 intended to improve the financial statement presentation on nonprofit organizations. The proposed ASU seeks to improve: complexity of having three classes of net assets and current accounting for underwater endowments; inconsistent reporting of intermediate measures of operations in the statement of activities; lack of consistency in the type of information provided about expenses of a period; and misunderstanding about-and opportunities to enhance-the utility of the statement of cash flows. The proposed ASU will change nonprofit financial statement reporting as follows: Under current standards, nonprofit organizations are required to report three classes of net assets based on the absence or presence of donor restrictions (unrestricted, temporarily restricted, and permanently restricted) in their statement of financial position. The proposed ASU will require nonprofit organizations to report two classes of net assets in their statement of financial position: net assets with donor restrictions and net assets without donor restrictions. Information about the nature and amounts of the different types of donor restrictions and governing board designations will be required to be disclosed, including the details of how those restrictions and designations affect the use of resources and their liquidity. An underwater endowment fund is one which the fair value is below its original gift amount. Under current rules, the endowment net assets are maintained at the original gift amount as permanently restricted net assets and the underwater amount (amount fair value is below original gift amount) is reported in unrestricted net assets, which confuses users of nonprofit financial statements. The proposed ASU will also change how underwater endowment funds are reported. Endowments would be classified as net assets with donor restrictions and disclosure of the aggregate amount by which the funds are underwater, the original gift amount, and any governing board policy or decisions to spend, or not spend, from such funds would be required. The ASU attempts to improve the financial statement user s ability to assess an organization s liquidity and how it is being managed. Disclosure will be required of quantitative and qualitative information about liquidity of assets and near-term demands for cash as of the reporting date, to include the amount of financial assets at the end of each period; the amount, because of restrictions or limitations on their use, is not available to meet the cash needs in the near term; the amount of financial liabilities that require cash in the near term; and the way an organization manages its liquidity and the organizations time horizon it uses in the management of liquidity. 7

8 FASB Proposes Changes to Nonprofit Reporting (continued) The statement of activities would present on the face the amount of the change in each of the two classes of net assets noted above. The proposed ASU would also require the presentation of two measures (subtotals) of operating activities associated with the changes in net assets without donor restrictions. The measures reflect operating activities for the period, distinguished from other activities on the basis of whether the resource inflows and outflows are from or focused at carrying out the organization s purpose and available for current-period activities. The first measure would summarize operating revenues, support, expenses, gains and losses that are without donor restrictions and before internal transfers. The second measure includes the effects of internal transfers from governing board designations, appropriations, and similar actions that place or remove self-imposed limits on the use of resources and that make resources unavailable or available for current-period operating activities. The ASU will require all nonprofit organizations to report operating expenses by nature and function on the face of the statement of activities, as a separate statement, or in the notes to the financial statements. Additional disclosure will be required about the methods used to allocate expenses among the functions. Currently, only voluntary health and welfare organizations are required to present a statement of functional expenses. In addition, the new ASU requires the investment return to be presented net of related external and direct internal expenses in the statement of activities. The proposed ASU will also change the presentation within the statement of cash flows as follows: 1. Require use of the direct method of reporting cash flows from operating activities instead of the indirect method. 2. Cash flows from purchases of long-lived assets, from contributions restricted to acquire long-lived assets, and from sales of long-lived assets would be classified as operating cash flows instead of investing cash flows. 3. Cash flows from payments from payments of interest on borrowings and cash management activities would be classified as financing activities instead of operating cash flows. 4. Cash flows from receipts of interest and dividends on loans and investments, other than those made for program purposes, would be classified as investing activities instead of operating cash flows. The above changes are intended to improve financial reporting as follows: Net Asset Classifications The reduction of classes of net assets to two rather than three on the face of the financial statements along with enhanced disclosure providing information about limits placed on net assets by governing boards and donors is expected to reduce complexity in financial reporting and increase the readers understanding of limits placed on net assets by governing boards and donors. Statement of Activities The presentation of the standardized intermediate measures of operations is expected to help communicate financial performance in ways that are more comparable and more understandable to creditors, donors and other outside users. The proposed requirement to subtotal before internal transfers from governing board 8

9 FASB Proposes Changes to Nonprofit Reporting (continued) actions is expected to provide greater comparability across the many types of nonprofit organizations and will be more useful internally to governing boards and managers in benchmarking their financial performance to peers within their industries. The reporting of internal transfers after that subtotal and within operations enables nonprofit organizations to help tell their financial story by providing important information on how the organization is managed. Functional Expenses Reporting expenses by function and nature is expected to add information useful to creditors, donors, grantors and others in understanding nonprofit organization s expenses by assessing the degree they are fixed or discretionary, how the related resources are being allocated and the costs of the services provided. Reporting investment return net of related expenses is expected to provide a more comparable measure of investment return across all nonprofit organizations. Cash Flows Requiring the direct method for presenting operating cash flows is expected to increase the understandability of information about cash flows and its usefulness to the nonprofit organization s creditors, donors, and other users, including members of its governing board. Enhanced Disclosures Requiring enhanced disclosures is expected to improve the usefulness of information helpful in assessing: effects of limits placed on the use of resources by a governing board and by its donors, especially limits that bear upon the organization s liquidity, financial flexibility, and ability to allocate resources toward needed services; methods governing boards and their designees use to manage liquidity to meet near-term demands for cash; and types of resources used (expenses by nature) and how they are allocated (expenses by function) in carrying out operating activities, including about the methods used for allocating expenses. Feedback The FASB invites individuals and organizations to review and comment on all matters in the proposed ASU. Instructions on how to submit comments are contained in the proposed ASU. All written comments are requested by August 20, For more information or questions, please contact Ron Kulek at rkulek@windes.com or toll free at 844.4WINDES ( ). Ron Kulek, CPA Partner 9

10 Windes is a recognized leader in the field of accounting, assurance, tax, and business consulting services. Our goal is to exceed your expectations by providing timely, high-quality, and personalized service that is directed at improving your bottom-line results. Quality and value-added solutions from your accounting firm are essential steps toward success in today s marketplace. You can depend on Windes to deliver exceptional client service in each engagement. Since 1926, we have gone beyond traditional services to provide proactive solutions and the highest level of capabilities and experience. The Windes team approach allows you to benefit from a wealth of technical expertise and extensive resources. We service a broad range of clients, from high-net-worth individuals and nonprofit organizations to privately held businesses and publicly traded companies. We act as business advisors, working with you to set strategies, maximize efficiencies, minimize taxes, and elevate your business to the next level. Headquarters 111 West Ocean Boulevard Twenty-Second Floor Long Beach, CA Orange County Office Von Karman Avenue Suite 1060 Irvine, CA Los Angeles Office 601 South Figueroa Street Suite 4950 Los Angeles, CA Windes, Inc. All rights reserved.