Most nonprofits are understandably laser-focused on their mission, and other, seemingly less-critical matters may fall between the cracks. But if the finance function does not receive the attention it deserves, you run the risk of IRS penalties, reputational damage and lost revenue.
Here are four common mistakes related to managing the finance function:
1. Failure to report unrelated business income
According to the IRS, unreported business income ranks as one of the most common tax filing errors made by nonprofits. Revenue generated from a trade or business that your organization regularly engages in, but that is not substantially related to furthering its tax-exempt purpose (other than the need for funding), may well be subject to the unrelated business income tax (UBIT).
Generally, an exempt organization with $1,000 or more of gross income from an unrelated business activity must file Form 990-T. The nonprofit must also pay estimated tax if it expects its tax for the year to be $500 or more.
2. Misclassification of employees
Nonprofits have long turned to independent contractors in the face of tight budgets and small staffs. Contractors can provide valuable flexibility, reduce administrative work and cut your costs and potential liability.
The IRS, however, has strict tests for determining whether an individual is indeed an independent contractor or is actually an employee for whom you must withhold, and pay, payroll taxes. If the IRS reclassifies any of your contractors as employees, you will likely find yourself on the hook for back payroll taxes, interest and penalties. You also may be subject to minimum wage and overtime laws, Social Security and Medicare contributions, and unemployment and workers’ compensation premiums.
3. Overreliance on software
Nonprofits sport plenty of choices when it comes to off-the-shelf accounting software packages. Although these products can improve efficiency, you can rely on them too much. The fact is that accounting software is not fail-safe; it may not flag a mistake or spot possible fraud.
Even with the most expensive and sophisticated software, garbage in means garbage out — the output, in other words, is only as reliable as the input. For example, if an employee enters cash receipts for the wrong amounts or dates, or simply fails to enter them at all, that may have a domino effect. Everything from financial statements to tax filings potentially may be impacted. You need a knowledgeable individual (someone other than the person who makes the entries) to review journal entries, reconcile account balances and perform other checks and balances.
4. Failure to invest in expertise
An overreliance on software also may lead to inadequate investment in accounting resources. Some organizations may count on volunteers to serve as their accountants. Think about the critical role your financial reporting plays in obtaining funding, though. Can you really afford to leave it to underinformed volunteers or one-size-fits-all software?
An option some nonprofits are turning to is to hire part-time or interim CFO and controller contractors. By design, this service is performed by an independent, c-suite level executive at a fraction of the budget.
The bottom line
Mistakes in the oversight of the finance function can get in the way of accomplishing your organization’s mission. By allocating sufficient resources to this area, you can fortify your financial footing, protect your reputation and arm your leadership with vital information for decision-making.
