Nonprofit organizations face unique financial and compliance risks that differ from those of for-profit entities. In this blog, we’ll discuss four of the most common finance and accounting compliance risks that nonprofits face and some practical tips for overcoming them:
#1 Fundraising risks
A significant risk for nonprofits is that they may be overdependent on a few large donors or government funding. If you then consider the restrictions that donors often place on grants or donations and the impact of economic downturns on an organization’s ability to raise funds, it’s easy to see how external factors can negatively impact a nonprofit.
While developing a broader donor base is a necessary first step for nonprofits, organizations can also help mitigate the impact of funding disruptions with strong financial controls and contingency plans.
#2 Grant compliance and donor regulations risk
As noted above, donor and grant restrictions can increase the risk for nonprofits. It’s a complicated area, and many nonprofit organizations inadvertently fall foul of donor and grant requirements that limit funding to specific programs, specific types of expenses, or a defined period. Often, donors or grant providers will also require regular feedback, including financial reporting and impact assessment, which can be difficult for nonprofits whose employees are already stretched thin.
Developing detailed budgets and financial plans, supported by effective monitoring and reporting systems, is an effective way to help nonprofits track and report on exactly how funds are being used.
#3 Financial reporting risk
One of the most critical areas where nonprofits differ from for-profit organizations and must take special care is financial accounting. Nonprofits must adhere to accounting standard ASC 958, which includes:
• Financial statement presentation and disclosure requirements
• Revenue recognition, including contributions and grants
• Expenses, including program and administrative expenses
• Net assets, including classification and donor restrictions
• Investments and endowments
• Tax considerations for nonprofits, including unrelated business income tax (UBIT)
• Nonprofit mergers and acquisitions
Compliance with ASC 958 is essential for maintaining transparency and accountability with donors, stakeholders, and regulatory bodies. Expert professional advice can help you ensure your financial statements meet the standards.
#4 Tax Compliance Risks:
To maintain tax-exempt status, nonprofits have to comply with IRS regulations requiring them to:
• File annual information returns (Form 990, 990-EZ, or 990-N): The required form depends on the nonprofit’s gross receipts and assets. Failing to file for three consecutive years can result in the revocation of your tax-exempt status.
• Report any changes in activities: This includes changes in mission, activities, or structure, as well as changes in your organization’s name, address, or leadership.
• Comply with public disclosure requirements: Nonprofits must make certain information available to the public upon request, including annual information returns (Form 990), exemption application (Form 1023), and certain financial statements.
• Avoid private benefit ( Private Inurement):. If the IRS determines that a nonprofit has engaged in private inurement–excessive benefits to insiders, such as officers, directors, and key employees– it may revoke its tax-exempt status and impose penalties.
• Follow the rules for unrelated business income (UBIT): Your nonprofit may be subject to UBIT if you engage in activities unrelated to the organization’s tax-exempt purpose. UBIT is calculated on the net income from such activities and can result in a significant tax liability if not properly accounted for and reported to the IRS.
• Maintain accurate records: You must keep accurate records of the nonprofit’s activities, finances, and governance. This includes maintaining records of donations, expenses, and board meetings.
• Renew tax-exempt status: Don’t forget to renew your tax-exempt status by filing the appropriate forms and paying any required fees every year.
Keeping up with all the potential changes and maintaining the right kind of records in an acceptable format can be challenging. Nonprofits can mitigate this risk by deploying effective tax compliance policies and procedures.
Despite the challenges, your nonprofit’s financial and compliance risks can be managed and mitigated by paying attention to accounting infrastructure. That means strengthening internal controls and policies and deploying technology and software to track and manage cash flows, donations, and expenses. Bringing in professional accounting expertise is also highly recommended.
How Scrubbed can help
Outsourcing your accounting and finance to Scrubbed is a cost-effective way to help your nonprofit maintain legal and regulatory compliance, ensure tax compliance, and avoid conflicts of interest or self-dealing. We can support you in everyday bookkeeping as well as more complex activities like reading and interpreting contracts, monitoring grant funds, and providing reporting that complies with ASC 958 and the specific grant requirements.
We’re also experienced in nonprofit financial management, forecasting, fraud prevention, audit support, and the latest software and technology you need.
Let us take on your accounting and finance needs while you focus on your organization’s mission.