Many nonprofits are poised to grow, but recognize risks

More than three-quarters of nonprofits are at least “somewhat likely” to pursue growth through expanded fundraising efforts during the next 12 to 18 months, according to a recent study. Nonprofit Finance Study: Managing Growth, conducted by nonprofit software firm Abila, also found that 84% of the financial professional respondents expect to seek new grant funding opportunities. Nonprofits are at least “somewhat likely” to pursue partnerships with other organizations (72%), provide new services that will bring in new revenue (69%) and seek corporate sponsorships (67%).

The results don’t only highlight a desire to grow among nonprofits. They also reflect the respondents’ recognition that growth makes risk management more challenging. More than 60% indicated that, as their organization grows, their ability to manage risk becomes somewhat or much harder.

If your organization is poised for growth, the report suggests a number of risk management activities. Among them: creating contingency plans for future funding uncertainty, maintaining compliance with funding requirements, assessing internal controls and training employees.

Your 990-EZ filings get easier

One out of three nonprofits that file paper Forms 990-EZ make a mistake. That’s according to the IRS, which is attempting to reduce errors with an updated form. The form has 29 “help” icons to help small and midsize nonprofits avoid common missteps.

The icons describe key information you need to complete many of the form’s fields, and provide links to useful information on the IRS website. Once organizations complete their forms, they can print them for mailing to the IRS. SKR+CO can work with you to ensure your 990 EZ is filed properly.

Gamers raise funds for hurricane victims

When natural disasters hit, many people look for ways to help the survivors get back on their feet. And some nonprofits have found particularly innovative approaches to compound the efforts they make and donations they receive. The Los Angeles Times reports, for example, that one charity, Direct Relief, received over $500,000 from thousands of online gamers in the wake of the 2017 hurricanes.

Gamers also raised more than $5 million for Save the Children over the last five years by holding marathon gaming sessions on live-stream platforms such as Twitch and Gaming for Good. The platforms let viewers watch and talk to their favorite players. The resulting donations — largely from young, male first-time donors — have prompted more nonprofits to reach out to the gaming community to build alliances.

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.

When President Trump signed the massive federal income tax overhaul into law on December 22, 2017, much was made of nonprofits’ understandable concern that the higher standard deduction would reduce incentives for charitable giving. The concern is, of course, extremely important, but the new law also includes several other provisions that may affect nonprofits.

Calculating unrelated business taxable income

The Tax Cuts and Jobs Act (TCJA) has substantially lowered the corporate tax rate to 21%, a significant benefit to any nonprofits already paying unrelated business income tax, which is imposed at the corporate rate. But when it comes to calculating the income that is subject to this tax, the new law brings a significant change for nonprofits.

The TCJA requires nonprofits to compute unrelated business taxable income (UBTI) separately for each unrelated business activity and pay tax on any activity with net income. That means nonprofits cannot use a loss from one unrelated business to offset income from a different unrelated business for the same tax year.

They may, however, use one year’s losses on an unrelated business to offset profits in a different year for that business, subject to certain restrictions. For example, if your nonprofit incurred a loss in its bookstore business in 2018, it can use that loss to offset bookstore profits in 2019.

The TCJA also makes certain fringe benefits includable in UBTI. These include qualified transportation benefits (for example, transit passes), qualified parking benefits and access to any on-site athletic facility.

Compensating executives

The TCJA also imposes a 21% excise tax on “excessive” executive compensation. The tax applies to the sum of any compensation (including most benefits) in excess of $1 million paid in the tax year to a covered employee plus certain large payments to that employee upon his or her departure from the organization (known as “excess parachute payments”).

A “covered employee” means a current or former employee reported as one of the five highest paid employees for any taxable year beginning after 2016. Licensed medical professionals are not covered employees for this tax.

But what is an “excess parachute payment?” A payment generally is considered an excess parachute payment if two conditions are met:

  1. It is contingent on the employee’s departure
  2. The present value of the payments equals or exceeds three times the base amount, which is the employee’s average annual compensation for the preceding five years.

The excess parachute payment subject to the excise tax is the amount of the parachute payment less the base amount.

Discouraging donations?

The increase in the standard deduction — it is expected to reduce the number of taxpayers who itemize and, thus, can deduct charitable contributions — is not the only change that may affect giving.

For example, the TCJA doubles the estate tax exemption to $10 million (indexed for inflation) through 2025. With fewer wealthy individuals at risk of paying this tax, fewer people may make the generous donations that have been partly motivated by a desire to shrink their taxable estates. Plus, the TCJA eliminates any deduction for donations made in exchange for the right to buy season tickets to college athletic events.

The TCJA does raise the limit on cash donation deductions from 50% of adjusted gross income to 60%. But cash donations at this level are uncommon, so the higher limit may not stimulate much additional giving.

Obtaining financing

Some nonprofits issue tax-exempt bonds to finance construction and other capital activities. These bonds typically pay lower interest rates than other bonds. But investors are willing to accept the lower rates because they are not required to pay income taxes on the interest.

The TCJA, however, repeals the tax-exempt treatment for interest paid on a bond issued to refinance another tax-exempt bond. An “advance refunding bond” is used to pay principal, interest or redemption price on a prior bond issued more than 90 days before redemption of the refinanced (refunded) bond.

Let’s say you issue tax-exempt bonds at 4% interest but later discover you can refinance the bonds at 3% interest. Under the TCJA, the interest payments on the 3% advance refunding bonds will not be tax-exempt for investors — that means you will need to pay a higher interest rate because of the new bonds not being tax-exempt as recompense for the investors’ increased tax liability.

Charting the course ahead

Despite the advantage of a lower tax rate on unrelated business income, the new income tax law may reduce overall charitable giving while simultaneously increasing some nonprofits’ costs. Your CPA may help identify the potential impact of charitable giving on your nonprofit as well as chart the best course forward.

Nonprofits nationwide are increasingly considering shared workspace arrangements to lower rising facility costs. These arrangements are particularly appealing in areas where nonprofits are being priced out of the real estate market and to those determined to cut operating costs. In the Pikes Peak region, the “health care” desert of services is in the 80916/10 area.

Options to choose from

The term “shared space” refers to workspaces shared by small businesses, freelancers, consultants, start-ups and others. Depending on their needs, tenants can pay for short- or long-term access to private offices, conference rooms and common areas. Office equipment and services, such as high-speed Internet; photocopiers, printers and scanners; and coffee and office supplies, are shared among the tenants.

The shared space trend in recent years has led to the development of several options. For example, you could rent space in a dedicated shared workspace facility that also might provide “back-office” services such as HR. Many of these arrangements welcome a variety of businesses, but some cater primarily to nonprofits.

Similarly, some private foundations, with more space than they require, lease out the excess to nonprofits. As tax-exempt organizations, they avoid steep property taxes and pass the savings along to their tenants in the form of reduced rent.

When two or more nonprofits serve the same population, they may rent a shared facility and slice the cost in half. You may also rent out unused space to other organizations, generating revenue to offset your rent obligations.

Potential perks

The most obvious benefit of sharing space lies in potential cost savings. Why, for example, pay annual rent on space that includes a conference room you only use for semiannual board meetings? Organizations of all sizes benefit by efficient use of supplies and equipment, utilities and maintenance expenses.

Flexibility is especially valuable for nonprofits in the early stages of development or entry into a new market. Organizations usually do not want to commit to long-term leases before they have a handle on how much space they will need in the future.

Additional cost sharing opportunities

Workspace is not the only expense you can share with other organizations to reap impressive savings. You also can cut your costs by:

Sharing staff. Your organization may, for instance, be too small to justify a full-time IT person — you might not have the need or the budget. But perhaps you and another organization together have sufficient need and funding for such support.

Sharing equipment. You probably have equipment that goes unused or is used below capacity. Think about sharing it with another organization whose needs for such equipment complement yours. (For example, a summer music program could share instruments with a program that operates during the school year.)

Sharing buying power. Consolidate your buying power with that of other nonprofits to obtain lower rates, discounts and possibly even improved service.

Not all rainbows and unicorns

Shared space is not all rainbows and unicorns, though. Organizations need to take a variety of factors into consideration before taking the plunge. Some nonprofits, for example, may not want to share space with “competing” organizations that serve the same population or pursue similar funding sources.

You also should think about:

You can assess many of these issues by making site visits, both scheduled (to get the sales pitch) and unscheduled (to get a more realistic lay of the land).

Is it right for you?

As nonprofit budgets get tighter and come under more scrutiny, cutting your space-related costs may provide some peace of mind and pave the way to sustainability. Your CPA can help you determine whether moving your operations to shared space is a solid financial decision.

 

Under the pre-Act rules, you could deduct interest on up to a total of $1 million of mortgage debt used to acquire your principal residence and a second home, i.e., acquisition debt. For a married taxpayer filing separately, the limit was $500,000. You could also deduct interest on home equity debt, i.e., debt secured by the qualifying homes. Qualifying home equity debt was limited to the lesser of $100,000 ($50,000 for a married taxpayer filing separately), or the taxpayer’s equity in the home or homes (the excess of the value of the home over the acquisition debt). The funds obtained via a home equity loan did not have to be used to acquire or improve the homes. So you could use home equity debt to pay for education, travel, health care, etc.

Under the TCJA, starting in 2018, the limit on qualifying acquisition debt is reduced to $750,000 ($375,000 for a married taxpayer filing separately). However, for acquisition debt incurred before Dec. 15, 2017, the higher pre-Act limit applies. The higher pre-Act limit also applies to debt arising from refinancing pre-Dec. 15, 2017 acquisition debt, to the extent the debt resulting from the refinancing does not exceed the original debt amount. This means you can refinance up to $1 million of pre-Dec. 15, 2017 acquisition debt in the future and not be subject to the reduced limitation.

And, importantly, starting in 2018, there is no longer a deduction for interest on home equity debt. This applies regardless of when the home equity debt was incurred. Accordingly, if you are considering incurring home equity debt in the future, you should take this factor into consideration. And if you currently have outstanding home equity debt, be prepared to lose the interest deduction for it, starting in 2018. (You will still be able to deduct it on your 2017 tax return, filed in 2018.)

Lastly, both of these changes last for eight years, through 2025. In 2026, the pre-Act rules come back into effect. So beginning in 2026, interest on home equity loans will be deductible again, and the limit on qualifying acquisition debt will be raised back to $1 million ($500,000 for married separate filers).

Before the Tax Cuts and Jobs Act, a second tax system called the alternative minimum tax (AMT) applied to both corporate and noncorporate taxpayers. The AMT was designed to reduce a taxpayer’s ability to avoid taxes by using certain deductions and other tax benefit items. The taxpayer’s tax liability for the year was equal to the sum of (i) the regular tax liability, plus (ii) the AMT liability for the year.

A corporation’s tentative minimum tax equalled 20% of the corporation’s “alternative minimum taxable income” (AMTI) in excess of a $40,000 exemption amount, minus the corporation’s AMT foreign tax credit. AMTI was figured by subtracting various AMT adjustments and adding back AMT preferences. The $40,000 exemption amount gradually phased out at a rate of 25% of AMTI above $150,000. “Small” corporations-those whose average annual gross receipts for the prior three years didn’t exceed $7.5 million ($5 million for startups)-were exempt from the AMT. A taxpayer’s net operating loss (NOL) deduction, generally, couldn’t reduce a taxpayer’s AMTI by more than 90% of the AMTI (determined without regard to the NOL deduction). Very complex rules applied to the deductibility of minimum tax credits (MTCs). All-in-all, the AMT was a very complicated system that added greatly to corporate tax compliance chores.

Corporate AMT repeal

The Tax Cuts and Jobs Act repealed the AMT on corporations. Conforming changes also simplified dozens of other tax code sections that were related to the corporate AMT. The TCJA also allows corporations to offset regular tax liability by any minimum tax credit they may have for any tax year. And, a corporation’s MTC is refundable for any tax year beginning after 2017 and before 2022 in an amount equal to 50% (100% for tax years beginning in 2021) of the excess MTC for the tax year, over the amount of the credit allowable for the year against regular tax liability. Thus, the full amount of the corporation’s MTC will be allowed in tax years beginning before 2022.

The Tax Cuts and Jobs Act (TCJA) should provide a substantial tax benefit to individuals with “qualified business income” from a partnership, S corporation, LLC or sole proprietorship. This income is sometimes referred to as “pass-through” income. The deduction is 20% of your “qualified business income (QBI)” from a partnership, S corporation, or sole proprietorship, defined as the net amount of items of income, gain, deduction, and loss with respect to your trade or business.

The business must be conducted within the U.S. to qualify, and specified investment-related items are not included, e.g., capital gains or losses, dividends, and interest income (unless the interest is properly allocable to the business). The trade or business of being an employee does not qualify. Also, QBI does not include reasonable compensation received from an S corporation, or a guaranteed payment received from a partnership for services provided to a partnership’s business.

The deduction is taken “below the line,” i.e., it reduces your taxable income but not your adjusted gross income. It is available regardless of whether you itemize deductions or take the standard deduction. The deduction cannot exceed 20% of the excess of your taxable income over net capital gain. Current QBI losses will be carried forward to offset future QBI income years.

For taxpayers with taxable income above $157,500 ($315,000 for joint filers), an exclusion from QBI of income from “specified service” trades or businesses is phased in. These are trades or businesses involving the performance of services in the fields of health, law, consulting, athletics, financial or brokerage services, or where the principal asset is the reputation or skill of one or more employees or owners. Here’s how the phase-in works: If your taxable income is at least $50,000 above the threshold, i.e., $207,500 ($157,500 + $50,000), all of the net income from the specified service trade or business is excluded from QBI. (Joint filers would use an amount $100,000 above the $315,000 threshold, or $415,000.)

Additionally, for taxpayers with taxable income more than the thresholds ($157,000/$315,000), the deduction is limited by either wages paid or wages paid plus a capital element. Here’s how it works: If your taxable income is at least $50,000 above the threshold, i.e., $207,500 ($157,500 + $50,000), your deduction for QBI cannot exceed the greater of (1) 50% of taxpayer’s allocable share of the W-2 wages paid with respect to the qualified trade or business, or (2) the sum of 25% of such wages plus 2.5% of the unadjusted basis immediately after acquisition of tangible depreciable property used in the business (including real estate). So if your QBI were $100,000, leading to a deduction of $20,000 (20% of $100,000), but the greater of (1) or (2) above were only $16,000, your deduction would be limited to $16,000, i.e., it would be reduced by $4,000.

Other limitations may apply in certain circumstances, e.g., for taxpayers with qualified cooperative dividends, qualified real estate investment trust (REIT) dividends, or income from publicly traded partnerships.

The complexities surrounding this substantial new deduction can be formidable, especially if your taxable income exceeds the threshold discussed above.

The Tax Cuts and Jobs Act makes changes to the general business credit by adding a new component credit for paid family and medical leave, and changing two current component credits, i.e., the rehabilitation credit and the orphan drug credit.

First, the Act introduces a new component credit for paid family and medical leave, i.e. the paid family and medical leave credit, which is available to eligible employers for wages paid to qualifying employees on family and medical leave. The credit is available as long as the amount paid to employees on leave is at least 50% of their normal wages and the leave payments are made in employer tax years beginning in 2018 and 2019. That is, under the Act, the new credit is temporary and won’t be available for employer tax years beginning in 2020 or later unless Congress extends it further.

For leave payments of 50% of normal wage payments, the credit amount is 12.5% of wages paid on leave. If the leave payment is more than 50% of normal wages, then the credit is raised by .25% for each 1% by which the rate is more than 50% of normal wages. So, if the leave payment rate is 100% of the normal rate, i.e. is equal to the normal rate, then the credit is raised to 25% of the on leave payment rate. The maximum leave allowed for any employee for any tax year is 12 weeks.

Eligible employers are those with a written policy in place allowing (1) qualifying full-time employees at least two weeks of paid family and medical leave a year, and (2) less than full-time employees a pro-rated amount of leave. On that note, qualifying employees are those who have (1) been employed by the employer for one year or more, and (2) who, in the preceding year, had compensation not above 60% of the compensation threshold for highly compensated employees. Paid leave provided as vacation leave, personal leave, or other medical or sick leave is not considered family and medical leave.

Second, the Act changes the rehabilitation credit for qualified rehabilitation expenditures paid or incurred starting in 2018, by eliminating the 10% credit for expenditures for qualified rehabilitation buildings placed in service before 1936, and retaining the 20% credit for expenditures for certified historic structures, but reducing its value by requiring taxpayers to take the credit ratably over five years starting with the date the structure is placed in service. Formerly, a taxpayer could take the entire credit in the year the structure was placed in service. The Act also provides for a transition rule for buildings owned or leased at all times on and after Jan. 1, 2018.

Third, the Act also makes significant changes to another component credit of the general business credit, i.e., the orphan drug credit for clinical testing expenses for certain drugs for rare diseases or conditions. For clinical testing expense amounts paid or incurred in tax years beginning in 2018, the former 50% credit is cut in half to 25%. Taxpayers that claim the full credit have to reduce the amount of any otherwise allowable deduction for the expenses regardless of limitations under the general business credit. Similarly, taxpayers that capitalize, rather than deduct, their expenses have to reduce the amount charged to a capital account. The credit has been reduced and now equals 25 percent of qualifying clinical testing expenses. However, the Act gives taxpayers the option of taking a reduced orphan drug credit that if elected allows taxpayers to avoid reducing otherwise allowable deductions or charges to their capital account. The election for the reduced credit for any tax year must be made on a tax return no later than the time for filing the return for that year (including extensions) and in a manner prescribed by IRS. Once the reduced credit election is made, it is irrevocable.

A 529 plan distribution is tax-free if it is used to pay “qualified higher education expenses” of the beneficiary (student). Before the TCJA made these changes, tuition for elementary or secondary schools wasn’t a “qualified higher education expense,” so students/529 beneficiaries who had to pay such tuition couldn’t receive tax-free 529 plan distributions.

The TCJA provides that qualified higher education expenses now include expenses for tuition in connection with enrollment or attendance at an elementary or secondary public, private, or religious school. Thus, tax-free distributions from 529 plans can now be received by beneficiaries who pay these expenses, effective for distributions from 529 plans after 2017.

There is a limit to how much of a distribution can be taken from a 529 plan for these expenses. The amount of cash distributions from all 529 plans per single beneficiary during any tax year can’t, when combined, include more than $10,000 for elementary school and secondary school tuition incurred during the tax year.

Before Tax Rerfom changes were effective, individuals were permitted to claim the following types of taxes as itemized deductions, even if they were not business related:

Taxpayers could elect to deduct state and local general sales taxes in lieu of the itemized deduction for state and local income taxes.

New SALT Deduction Limits

For tax years 2018 through 2025, new tax reform laws limit deductions for taxes paid by individual taxpayers in the following ways: