Are You Misappropriating Your Nonprofit’s Funds?

robberOne of the things that you learn quickly when starting and operating a 501(c)(3) organization is that you have to handle money wisely.  A nonprofit is no different than any other business in that you must make ends meet.  Otherwise, your charity will cease to exist.  The current economic difficulties make this task even more challenging as we all are stretching dollars until they are see-through.

But here’s a question you probably haven’t considered:  In all of your efforts to keep the lights on, could it be that you are misappropriating funds without knowing it?  Is it possible that you are even committing a crime?  If you do not understand what the IRS requires regarding designated funds, you might be.

I cannot begin to tell you how many times we see this situation messed up.  Most of the time, it is an innocent attempt by a board or executive director to just be good stewards of the money people have donated.

For example, suppose things are tight at the ole soup kitchen.  There is not enough cash in the general operating fund to buy all the food that is needed for the upcoming Christmas season.  There is, however, a pretty good chunk of cash sitting in the fund designated for building a new facility.  And, in truth, the food shortage is a far more pressing need.  It is unlikely a building project will be started for at least two years.  Is it OK to divert some of the building fund money to the food fund?

Maybe…or maybe not.

Two Types of Designated Funds

Understanding that there are two types of designated funds (or donations), solicited and unsolicited, is the first step in getting this right.  Let’s take a look at each:

Solicited designations. A solicitation means that your organization asked for donations for a particular cause.  Maybe it was by letter, email, website, radio spot…it doesn’t really matter.  What matters is that donations given in response to a direct solicitation are to be permanently dedicated to that purpose.  In our soup kitchen example, the board cannot move that money around, no matter how dire the circumstances, if those funds are the result of a solicitation.  Just last week, many of you may have read the story of the director of a large, national charity resigning after it was found he did just this very thing.  Was it for a good reason?  Yes.  Was it illegal?  Unfortunately, yes.

Unsolicited designations. These are donated funds that the donor designates without having been solicited by the charity.  For example, Bob decides to donate $100 to the local soup kitchen, but on his own decides to “designate” that those funds be used for future expansion.  In this situation, can the charity legally divert that money to its food fund?  This may surprise you…but the answer is, “Yes!”  To be fair, there are certainly times where it is politically expedient to honor an unsolicited designation, but the key point is that only the charity itself can tie strings to the donation.  This news often comes as a welcome relief to charities that have struggled with how to deal with these situations.

One more point about solicited designations…there are ways to avoid this problem.  First, provide a disclaimer with your solicitation that the organization reserves the right to move money as it sees fit.  Or, that any funds received over and above the budget of the solicited purpose will be put into the general fund.  In a situation where it’s too late for a disclaimer, you can go back to donors and ask permission to retask their donations.  Keep in mind that they have the legal right to say no, though that is unlikely in most legitimate situations of need.

Handling the finances of a nonprofit is always a challenge.  Knowing how to properly address designations is crucial to staying out of trouble with your donors…and the law.

Greg McRay is the founder and CEO of The Foundation Group. He is registered with the IRS as an Enrolled Agent and specializes in 501(c)(3) and other tax exemption issues.

This Post Has 100 Comments

  1. Bob Pangburn

    If there is no recorded action by the Board in setting up a Designated account (Building Fund) but there has been solicitation from the pulpit, can you transfer funds if the organization needs to make rent payments on the facility they are currently using?
    Thanks

    1. Greg McRay, EA

      Wow, Bob. Too many variables here for a straight answer. If the person in the pulpit has authority via the bylaws to so act, action by the board may not be necessary. Even if he doesn’t have proper authority, you’ve got a potential problem with the donors. Even if by the letter of the law the board was able to redirect the funds, it would be wise to communicate with the donors. Also, there are no hard and fast rules as to what expenses are legitimate from what fund. Many orgs pay any facility related expenses from the “building” fund. Not knowing what parameters are set on your building fund prevents me from addressing that properly.

      1. Alonso

        I am currently a volunteer for a nonprofit that conducts most of it’s operations abroad. A serious question of misappropriation of funds has recently come to light and I would greatly appreciate your input. The organization is a bit atypical in that the group has 501-C3 status in the U.S. AND a separate yet similar status in Nicaragua, where 100% of projects are executed and funding is used. The U.S.-based non-profit is strictly used to solicit donations, which are then transferred to the accounts of the separate non-profit in Nicaragua. The organization has recently received large quantities of designated solicitations, which, according to the director, are all placed in a general fund and not separate accounts. It was recently discovered that these designated funds were in fact being used for other projects. When I confronted the director about this seemingly obvious case of misappropriation his argument was, “The designated donations go into the general funding account and is simply tracked and reported differently. So even if we use these designated funds for other projects, the money is still there.” Is there any logic whatsoever to this? When designated donations are received should they not immediately go into a separate account to prevent confusion, or is simply “tracking and reporting” the money as separate sufficient?

        1. Greg McRay, EA

          The answer the director gave you may be innocent and sincere, but sincerely dangerous. What he is talking about is using the legitimate system of restricted equity fund accounting to “track” designated funds while lumping the actual cash into one checking account. That works, but only as long as sufficient cash is present at all times to satisfy the total of all the restricted equity accounts. If the total cash balance ever dips below the total of these accounts, then you’ve got big problems. It is NEVER acceptable to let that happen. Cash flow problems do not justify misappropriation of funds. If your organization cannot faithfully honor solicited designations, stop asking for them. Period. I cannot stress this enough.

          If there was an easy way around this, believe me…the cash-strapped colleges that cannot get to their restricted endowments would have found it. There is no backdoor here.

          1. mandy cole

            I am a board member for a 501c3 animal rescue. If a fundraiser is held for a specific fund, should the monies be deposited into a fund specifically for that purpose? ie. we are attempting to build a sanctuary and we solicited specifically for the “build the sanctuary fund”. Legally, should those monies be kept in a “sanctuary fund” account rather than the general checking?

          2. Greg McRay, EA

            Great question, Mandy. There is no legal requirement to have a truly separate bank account, though it may be easier that way. You certainly must have some way to permanently restrict the use of those funds to the purpose for which they were solicited. You cannot redirect the use of the funds for other purposes unless you gave the donor a clear disclaimer at the time of the gift that the organization reserves the right to redirect when necessary.

  2. Nelson Horton

    Regardless of the technical legal aspect. It is generally deemed unethical to accept a donation designated by the donor and then use it for another purpose than the purpose the donor intended. The charity should communicate with the donor and receive the donor’s written approval to drop the unsolicited designation or if the donor doesn’t agree the money should either be returned with a “thanks but no thanks”, or booked and held in a designated fund account until used for the designated purpose. It is perfectly fine to turn down designated gifts for projects or purchases which do not fit the purposes or plans of the nonprofit. However, to accept a designated gift and ignore the donor’s intent is not ethical.

    Nelson Horton

    1. Greg McRay, EA

      Thanks for the input, Nelson…I couldn’t agree more. The ethics involved in accepting the donation matters greatly. Let me add another wrinkle: A board finds itself dealing with an unsolicited designation accepted by prior boards. The money is desperately needed for operating expenses…and the donor is dead. Sounds crazy, but it is very common. So many in nonprofit leadership are hamstrung by misinformation that the funds are untouchable. I’ve seen some take their orgs to the brink when they had cash all along. Of course, if the same situation involved a solicited donation, the problem still exists. All the more reason to use disclaimers up-front!

  3. Robert Weston

    Great article. I know a California non-profit theatre production company which solicits funds for their free children’s classes. However, their classes are stop/start at best and most of the funds seem to go to the rent of their offices and sushi dinners for their board members. How and to whom do report such a thing so that it can be investigated?

    1. Greg McRay, EA

      Tough question…tougher answer. You can always tip off the IRS Tax Exemption Division in Cincinnati or (better) the state Department of Charitable Solicitations. But, keep in mind that overhead is a legitimate expense. The organization you mention may be operating outside the bounds, but not necessarily. Technicalities matter a lot. A 501(c)(3) that solicits donations to support its program(s) has not necessarily violated the rules just because some of that is used for overhead. I know this sounds contradictory to the article, but it isn’t. It’s just complicated.

      The dividing line is often drawn based on a combination of the level of specificity in the solicitation, the degree of disclaimers employed and/or the diversity of programs. In your example, if the theatre company specifically asks for donations to fund their classes, but they also have another distinct program (let’s pretend) that produces arts-related PSAs on television, then donations designated for the classes can only be used for that program and directly related overhead (barring any disclaimers regarding the right to redirect funds). But here is where it gets really complicated…If the theatre company has only one distinct program and solicitation is made asking for support of that program, then practically all organizational expenses can be considered fair game. That does not mean that the organization is being a good steward. Some nonprofits operate between the lines legally, but outside the lines ethically. That is why donors need to know how their funds are being used. Go to Guidestar.org and review the organization’s Form 990. If you don’t like what you see, don’t contribute. If you think it rises to the level of fraud, report it. But before blowing a whistle, make sure you’ve got good reason. Claiming misappropriation of funds is a serious charge. “Legally OK but ethically challenged” tends to self-correct over time. If a 501(c)(3) habitually violates the trust of its donors, it’s only a matter of time before it implodes.

  4. Ben

    Quick question, here’s the situation: What if donations are made as a memorial for someone that has passed away but the obituary listed the charitable foundation’s “general scholarship fund” as the destination for the money.

    Later, the family of the deceased reveals that they intended the money to be appropriated as a “specific scholarship” (named after the deceased) but managed by the foundation. Is it misappropriation of funds if the donated memorial money is not used for a general scholarship, rather a new memorial scholarship that is created in honor of the person that died?

    Help!

  5. Gayle

    What is a board member’s responsibility if s/he discovers that a misappropriation of funds has occurred in his/her organization? Could that board member and the other board members (all of whom were unaware of the misappropriation) be held accountable or would it only be the ones who carried out the transactions?

    1. Greg McRay, EA

      All board members could be liable if they do not correct the situation. The best solution is a timely response by all. Have a specially called board meeting, discuss the problem openly, determine a path to fixing the problem, then fix it. Record everything in minutes. It is up to the board to determine if the misappropriation rises to the level of needing to go public with it. Keep in mind that secrecy, even if you fix the problem, can be perceived as worse than the infraction itself. Be very smart about this…

  6. questioning

    Who would one contact anonymously if they believe funds are being spent or allocated inappropriately? The desired outcome would be for internal investigation to happen within the non-profit agency.

    1. Greg McRay, EA

      I guess the answer depends upon who you believe is doing this. If you can trust one or more board members, take it to them first. They have a vested interest in correcting the problem. That would hopefully result in the internal investigation you would prefer. If the board is the problem, you could still try contacting them via an anonymous letter informing them of your concerns…and maybe even your intention to take your concerns to the state charity board or the IRS if the situation remains unresolved. As an absolute last resort, you can always follow through with the threat. Just keep in mind that if you are wrong and your actions result in headaches for the organization, you better be prepared to live with that.

  7. Cindy

    The non-profit I am consulting for is researching treatment for a terminal disease. Assuming the research leads to a successful treatment, the founder of the non-profit intends to license the drug/treatment/therapy to a for-profit entity. The for-profit entity is also being formed by the founder. He has spent money to form the legal for-profit corporation and has paid people to develop the business plan. The money has come from the non-profit’s funds.
    My gut check says this is not ethical and probably not legal.
    Even if he intends to pay back the money to the non-profit, I have read that in some states loans to boards members are also illegal.

    1. Greg McRay, EA

      Your gut check is correct. This is way out of bounds. If the organization was approved as a medical research 501(c)(3), that usually entails the findings of such research being publicly available. To license the result to a for-profit is unlikely to work regardless of the scenario. The license the result to the founder’s for-profit is insane…and will likely result in the organization’s tax exempt status being revoked and the board members subject to intermediate sanctions penalties. If that is their determined intent, and you cannot persuade them otherwise, you are consulting to no avail. They’re doomed.

  8. Kelly

    I am the treasurer of a 501(c)(3) with a 509(a)(1) status. Our board was recently approached by a member and asked open a new bank account that another non-501(c)(3) group could contribute to and then pay expenses for that group. In other words, to be able to use our 501(c)(3) status only. I do not think that, when formed, there was anything stated in the groups purpose, to help other groups, I believe it was set up for a singular purpose. Can this be done legally?

    1. Greg McRay, EA

      Be very careful, here. Being a fiscal agent is a program in itself. At a minimum, the IRS would need to be notified in detail via your next Form 990 filing. It is possible that your organization could receive follow up from the IRS to determine whether or not this new program qualifies. Also understand that your nonprofit is liable for their activity if you do this.

  9. Nancy Barkman

    I am a volunteer for a small 501 (c) 3 social service agency affiliated with my church that gives aid and assistance for short terms to people in need. A local corporation has been making donations to us and designating particular people in need to whom specific gifts should be given. Is this ethical and legal?

    1. Greg McRay, EA

      No, it is not considered ethical at all. In fact, such a donation would not be considered tax deductible to the donor. The only time a designation can be legally made and honored is when a specific solicitation has been made by the charity.

  10. John Ayers

    Dear Mr. McRay,
    I am the treasure of a small church on the east coast. In 2008, the church received a lump sum donation from a parishioner estate who passed away. There was not a designation or stipulation from the estate or family regarding this donation. Those funds where placed into the General Funds. In 2009, we were in a building program for our church when the family of this same parishioner made another donation. However, this donation was requested to be designated for a Memorial Fund to honor their loved one. The parishioner owned property that receives yearly profits which the family donates a percentage to the Memorial Fund each year. To date, we have received 3 lump sums which have been placed into a separate designated Memorial Fund for the requested purpose. As you have mentioned in previous correspondences, the financial restraints surrounding our countries economic troubles have placed sever concerns and struggles on the General Fund for our church. So much that we have problems meeting the weekly budget.
    The Church Council Chairperson instructed me as the treasurer to take funds out of the Memorial Fund to cover the immediate budget needs. I did as I was instructed however, I have not allowed any of those funds to be used until I received confirmation of our legal obligations and law concerning this situation.
    So, my questions are as follows:
    1. Does a governing body of a non-profit organization (ie: Church Council, Church
    Board, Deacons, etc.) have the right to reassign monies from a designated fund
    for General Fund deficiencies?
    (I believe I know the answer to this one, but would appreciate your response.)

    2. As the treasurer, am I legally / personally responsible should any misappropriation of
    funds be inadvertently (as directed by any church governing body) or intentionally
    made?

    I appreciate your articles and the information that I receive from them. I would greatly appreciate your response to this very sensitive situation as I feel that I must uphold the integrity of the office for which I elected. And regardless of the fallout regarding this decision, I will stand firm in doing what is right!

    Sincerely,
    John
    Cumberland, MD

    1. Greg McRay, EA

      Sorry for the delay in response, John. I hope I’m not too late.

      As for question #1, the governing body does NOT have the right to reassign monies if the either 1) the designation was solicited for that purpose by the church (which it sounds like it was not), or 2) the unsolicited designation was honored without disclaimer of right to redirect. The only thing that can be done is to go back to the donor and request permission from them to redirect the funds. Hopefully, if survival of the church is at stake, the donor would be eager to help.

      On question #2, you would not likely be liable from an IRS perspective assuming you are not a board member, officer or trustee. However, if your title of treasurer is that of an officer, you do have liability. From a fiduciary perspective, you owe it to the church to do the right thing.

      I am very sorry to hear about your unfortunate predicament. I sincerely hope you get it worked out satisfactorily.

  11. Donna

    Greg,
    Thank you for all of this valuable information! I am the bookkeeper for a church where we have been in the middle of a building campaign. Therefore, we have solicited, designated funds for a Family Life Center to be built with in the future. These monies have been deposited over the past 3-4 years in a money market account that has earned interest.
    As other churches these days, money has become more scarce and some in the church have suggested using the “interest earned” on these designated monies for pet projects and church maintenance. Two questions:

    1.) Is the “interest earned” on these designated funds considered designated as well? Or can it be “legally” used for other purposes?

    2.) Some members are leaving our church. Can they ask for their donations to this building fund to be refunded? If so, what is the process?

    Thank you again and God bless,
    Donna

    1. Greg McRay, EA

      Great questions, Donna. Interest earned can be used however you wish…no restrictions. As to the departing members, no they cannot ask for refunds. Donations are forever. The only exception would be if you wished to move solicited funds to another purpose. In this case, donors must be asked for permission to redirect the funds with the option of being refunded. That is rare. Hope that helps.

  12. Sharon

    A board voted to restrict specific funds of a local sports booster club to future large improvements. The intention was to be able to save for several years for very large projects that no single board (which turns over frequently as their kids leave the sports program) could raise the cash for on its own. This board created a special committee to convene for the disbursement of their specific restricted funds. This board also created by-laws to govern the creation and disbursement of such restricted funds. A couple years later, a new board changed these by-laws, and co-mingled the restricted fund previously established with the general fund and spent it a.) without convening the special committee, and b.) not on one of the large improvements for which the fund was intended (i.e. they used it in normal operations). I believe they have the power to change by-laws on a go-forward basis, but can they really re-designate an established restricted fund’s purpose?

    1. Greg McRay, EA

      They have no legal basis from which to re-purpose restricted funds if these funds were truly restricted based on the original solicitation appeal. However, if the set-aside was made from general fund monies in the first place, that money could be re-purposed by a future board. Restricted funds are not permanently restricted in the legal sense unless they result from targeted solicitations.

  13. Rachel

    I serve as treasurer for a sports association in my town. Recently our president has, in my opinion, misappropriated funds. We have always run our sport as a Spring league. However, this fall we were asked to join a neighboring cities Fall league. We decided to do so as a board and paid entrance fees for each of our 3 teams to join as well as purchased new uniforms for the 3 teams. We solicited donations from sponsors for our Fall teams with a question on the sponsor form of “which age division would you like to sponsor?” There are 2 twelve year old teams and 1 ten year old team. Four sponsors chose the 12 yr olds and one chose the 10 yr olds. Our league president then decided that the sponsor monies would be used for such things as team socks, jackets, headbands and a banner for HER daughters 12 yr old team WITHOUT any discussion or approval from the board. Our by-laws clearly state that all uses of funds must be approved by 3 board members. She “justifies” this by saying that her team parents raised the money and they can spend it how they want to. Parents and coaches of the other teams in our league are furious about this and are coming to me as the league treasurer for answers as to why this has happened. When I try to discuss the situation with the president she adamently defends her posistion saying that her team parents raised the money and they can spend it how they see fit. Our other 12 yr old team got NO extras, not even a banner to thank the sponsors…but her team did. We are also now being asked to hold extra fund raisers to get ready for our Spring league season expenses…many people are seeing this as not fair considering we could have had nearly all of the unexpected expense of Fall league covered by our sponsor donations. So my questions are this, was this a true misappropriation of funds considering the money was spent on the presidents daughters team? Can I be held liable as treasurer? What can we do now that the money is spent? I appreciate any help and direction you can offer.

    1. Greg McRay, EA

      Sorry to hear about your troubles, Rachel. Your president certainly violated the spirit of the law, if not the letter as well (I would have to have more details to know that for sure). Worse yet, she has lost the trust of others and put you in a difficult situation. Her logic makes sense to her…but she is wrong. When those funds are raised in the name of the organization, she has no discretion whatsoever to go outside established bylaws or policy and procedures. As treasurer, you do have some potential liability. But as long as you are on record as opposing this action and actively working to right wrongs, your liability is quite limited.

  14. Athletic Bobert

    I run an athletic contest within a festival run by a 501c3 organization. For participants to compete in this contest, they pay a registration fee. The web page for this festival states that for the registration fee, the contestant will receive a t-shirt and lunch. The festival lost money this year as it rained enough to keep people away but not enough to trigger weather insurance. Now there is a scramble to pay bills. Some say the registration fees are earmarked funds that have to first be used to pay the expenses of the contest within the festival. If so, is using the registration fee to pay other bills misappropriation of funds? Others say the registration fee is general revenue and can be used to pay any bill without restriction. Since the registration fee is not a donation to the 501c3, is there earmarking of the funds? Is registration a Fee for service? Any advice or help on the accounting treatment of the registration fee would be wonderful.

    1. Greg McRay, EA

      Tough question. I’m making the assumption that registration fees were non-refundable. Those fees are considered program revenue, not donations. Therefore, I would come down on the side of it being general revenue available to be used for whatever purpose. Program revenue is almost never restricted funds unless very obvious strings are attached by the organization. As long as you do not owe the registrants anything back, my opinion is to use the money however it needs to be used. Whatever you do, consider the public image ramifications. Good luck.

  15. Grieving widow

    Hi Mr. McRay – Please help.
    I recently made a large, unsolicited donation to my child’s preschool to be used to create a memorial playground in memory of my late husband. The non-profit that runs the school cashed the check and subsequently advised me that another family previously donated funds for a similar effort (a playground built in memory of his mother). Because another family approached the organization first, I was advised my wishes for a memorial playground in memory of my late husband could not be honored. I was given the option to get a full refund of my money, but it seems ugly to take back something you donate. Still, I am upset the organization cashed my check and apparently has decided to use a portion of the money to fix the existing playground until the new playground can be built. Is this an improper application of an unsolicited donation?
    In my view, I believe it may be improper because I did not intend for my donation to be used to fix an existing problem – but to be applied for the replacement playground. Do I have a right to say how this money should be used?
    Please advise me on this complex matter as soon as possible.
    Thank you for your time and attention to this matter.

    1. Greg McRay, EA

      Dear Grieving – I am sorry to hear about the loss of your husband. The situation you describe is delicate to say the least. It is best to discuss things both from a technical perspective and a best practice perspective.

      From a technical perspective, the school did nothing wrong. You really do not have a say in the matter since the designation was not solicited. The school can legally use the money for whatever purpose they choose. All that being said, the best practice perspective says that the school should have discussed this with you prior to cashing the check. I give them credit for offering the refund…too many nonprofits would not have done that. But, a tension now exists because of the way this was handled.

      Let me add one more thought…and this is not to suggest you did anything wrong. It is a good idea for donors themselves to communicate with a charity before giving a significant, unsolicited, designated gift, particularly one so wrapped in emotion. Getting on the same page before money changes hands is a lot easier on both parties. I hope you all can work this out to everyone’s satisfaction and come to peace about all of this.

  16. Ted Campbell

    I sit on the board of directors for a 501c3. We do an annual benefit which advertises (solicits?) funds for projects. Participants pay an entrance fee and get food and beverage. In addition to this, we auction off donated items to raise money for our projects. Are these considered general funds or designated funds? The funds for one of the projects are no longer needed for that purpose and I am wondering if we can re-direct those funds. If so, will we need to get permission from the participants to re-direct the funds?

    1. Greg McRay, EA

      It all depends upon the solicitation. If a donor was contributing to a pool for the benefit of any of the projects, then money could easily be redirected from one project to another. It gets a little dicey if the donor was giving toward a specific project based on a direct solicitation by the charity. If the latter is the case…and no disclaimer was made about the charity having the right to move monies…you should notify the donors of your intent and get their buy-in. It really does matter.

  17. Joe

    We are a 501c3 church. Is it wrong to give money to the poor from the Poor Fund. Isn't the person receiving the Poor Fund money privately benefiting from contributions?

    1. Greg McRay, EA

      Great question, Joe. While it is not necessarily wrong to give money directly to individuals in need, it is not a best practice. It is much better to pay a utility bill or rent on behalf of the person, buy them groceries, give them a grocery gift card…you get the idea. Also, have a consistent method of vetting those who receive help.

  18. Patrice

    Hello Greg. Great article – really eye-opening! I work for a private Christian school that is 501c3 but operates under the church's umbrella. We do not have a separate tax id #. Each year in our enrollment packets, we list the cost of tuition and all of the fees that the parents will incur for the upcoming school year. Any money that we collect from parents or donors (tuition, money from fundraisers, book fees, supply fees, graduation fees, sports fees, etc.,), has to be turned over to the church. All accounts payable and receivable goes through the church and is handled by ONE person. When we need to purchase supplies or books or ANYTHING for the school wherein funds have been pre-collected, we have to put in a request to the church. Sometimes it takes months to get an approval, even though the funds have already been designated and collected. My question is this – if we have collected and turned in over $45,000 in books fees from parents this year to the church, should we be getting 90+ days late notices from the 6-8 curriculum vendors that we use stating that they have not received payment as of yet? We had parents pay for graduation caps and gowns for their students in January of 2010. The actual bill for caps and gowns was half of the total amount of money that was collected from the parents. The company is calling wondering why they have not received payment as of yet! The funds have been collected and have been designated for these purposes, but have been used to pay church expenses. Wouldn't this be considered misappropriaton of funds? I would love to hear your thoughts!

    1. Greg McRay, EA

      Sounds like a disaster, Patrice. It makes my head hurt just reading it. Unfortunately, this is all too common in church-controlled private schools. At a minimum, it is exceptionally poor stewardship. It may or may not rise to the level of misappropriation. The best thing that could ever happen to that school is to separate the money. Given that it is the same corporate entity, a consolidated set of books will be required. But, if the school is making enough money to cover it own expenses, it should keep itself current and only then should the church use left-over funds to pay church expenses. Just my $0.02!

  19. Rodney R Reece

    Recently a memorial fund was set up for my nephews burial, over 3000 dollars was collected through different benefits for his family through BOK. But come to find out they never received any funds, He died in Mexico and the family he was with paid to have him brought back to the USA and kept almost all of the funds raised for funeral expenses. What is the best way for them to have this investigated for fraud. The memorial site created stated it would go to the family of the deceased but did not.

    1. Greg McRay, EA

      A fraud investigation is unlikely because very few memorial funds are tax exempt organizations. Most are nothing more than a bank account. It might make for a good investigative reporter-type story on your local news, but that's probably as far as it would ever go.

  20. Amanda

    Hi Greg! Fantastic article! I was hoping to get your opinion if you don't mind providing it. I am a member of a national 501(c)3 organization that operates multiple chapters (primarily connecting members via online forums) in almost every state without a separate EIN#. Those chapters then arrange local group activities for its members and holds local fundraisers to support their group functions. This fundraising is conducted on behalf of their locally recognized chapter name, not the parent organization. Up until recently, the parent group has been fully supportive of the local groups retaining most of the funds (aside from a 10% "fee" that goes to pay for overhead expenses – like network/technology expenses) to pay for their local group activities and has even stated, in writing, that those funds/fundraisers were intended to support the chapters, not support the general fund of the organization. That changed recently and they now claim that they have revised their policies so that those designated funds have been retroactively claimed by the parent organization to be placed in a general pool fund to support all operational expenditures of the organization. We've asked that the policy change be made for all future fundraising events and exclude our current chapter balance, since those funds were specifically solicited to support the local chapter. Am I correct that by the chapter soliciting donations from its local area for the purposes of supporting the local chapter and NOT the organization-at-large, that those funds will be at risk of misappropriation if they do, indeed, go to support the organization as a whole and aren't restricted to paying for activities/expenditures/administrative costs of the local group? We've also discovered that the board failed to register to solicit funds in any state other than the state of origin, claiming that since the funds come back to a general bank account there, multiple state registrations are not required. Please advise! Thank you.

    1. Greg McRay, EA

      Based on what you've shared, it sounds like it would be improper to retroactively commit those funds to the parent unless there was a disclaimer advising the possibility of such when the funds were solicited. Also, the board is very, very wrong about the liability for multi-state registration. If solicitations are happening in a state that requires registration, then registration is mandatory. The ultimate destination of the funds makes no difference at all.

  21. Amanda

    I work for a non-profit school…I handle their E-rate applications and always used an anonymous National School Lunch Program form to show proof that we qualify for a high percent of free & reduced lunch. We are an urban school and for those reasons we are at a 90% discount rate. We recently adapted a new lunch program to our school and the director of the program is over protective of the forms and refuses to give me a copy so that I can submit for discounts. She claims "it is illegal" for her to give me any copies even though I white-out all personal information. I consulted with an E-rate personel and he says he's never heard of such thing. I'm very concerned that there might be something she is doing that makes it suspicious and the vice principal is backing her up. Before she came with the new lunch program we had a different program and had no problem submitting anything USAC requested on our behalf and I've been doing this for 7 years. My questions are: How do I know she isn't doing something illegal herself? Where do I report her or to who if the Diocese and my principal are definitely not options? Should I worry about the misappropriations of funds that could be happening in my school by administrators?

    1. Greg McRay, EA

      If you have such concerns, the best thing to do is to follow the proper chain of command. Maybe you've done this, already. Start with your manager and work up to board members as necessary. Just be careful. If you are wrong about this, you could wind up losing your job if your employer thinks you are a liability. I am always in favor of "doing the right thing". Just make sure it is the right thing.

  22. Nicole

    I have a question.Can the church refuse to give a copy of the financial report to a member?

    1. Greg McRay, EA

      Short answer is "no". You must give the church sufficient time to honor your request by giving you a copy of the most recent P & L and balance sheet. But, they cannot legally refuse. Keep in mind that you do not necessarily have the right to see payroll records, but standard financial info is required to be open record.

  23. Bryan

    If a church solicited funds for a project overseas and the donation were made as a direct result of and to that solicitation, can the church then go and change the use of those funds to a building repair project..even through was a direct solicitation for use elsewhere?

    1. Greg McRay, EA

      Only under one of the following circumstances: 1) The solicitation clearly included a disclaimer that the funds could be used as needed, regardless of solicitation or 2) Permission for redirection was secured from the donor. If neither of these happened, then the redirection was not done legally and the board members responsible could be held liable for fraud. Sorry to be so blunt, but that is the law.

  24. Karen

    This is exactly the type of information I'm looking for – thanks! I recently resigned from a 501(c)(3) nonprofit after attempts to correct what I – and other members of the staff – perceive as misuse of restricted funds that were explicitly solicited for and intentionally donated for specific projects. In the last 6 months, the executive director and board president have transferred more than $600K and $300K from two accounts that contained these funds to pay for operational expenses well beyond a 7-10% allocation for administrative costs of the project. Included are expensive travel and dinners, event tickets for staff on a "business trip" with no business meetings, etc. Staff appeals to the board have gone unanswered as the director and president have misrepresented our finances and restricted the flow of accurate information. Example: the board hasn't seen a financial summary (even a P&L) since Aug. 2010. While an external financial audit is planned for 2011 for 2010 finances, the director has now pushed it to August 2011, at which point the organization will no longer be able to keep its doors open. I'm not sure if one more written letter to the board will do any good, but perhaps the threat of reporting them to the FTC or state attorney general would do the trick. Even with multiple attempts by different staff members, they seem to stick to the current course. As I no longer work there, what would be the best evidence to have on hand if/when I file a complaint? The lack of financial reporting makes it hard to form a case, but is also so indicative of the problem! The organization does employ a C.P.A. that shares these ethical concerns but worries about being sued.

    1. Greg McRay, EA

      This is an unfortunate situation and one that is all too common, unfortunately. Your idea of the contacting the AG's office is probably the most likely to result in action. Complaints to the IRS can occasionally get some traction, but not always.

  25. Jan Hubbard

    So glad I found this blog. The NFP organization that I work for does re-hab for affordable housing. We had a donor give our re-hab crew a check for $200 and then said, "Take your crew out for dinner on us". Our Executive Director said the money had to go into the operating funds. The rehab crew said it was designated funds and was to be used for the expressed purpose. Also, we have many people give money at Christmas time to buy gifts for children in our poverty area. Truth is, Christmas time is when we get more than enough toys for kids. We could use the money more to help subsidize the housing. However, is this also a designated gift that must be used for toys?

    1. Greg McRay, EA

      Go back and study the part of the article that deals with solicited vs. non-solicited designations. I think the answer to both scenarios is there. With non-solicited designations, the money can be used however needed; solicited designations must be honored.

  26. Dan Clum

    Our Church approved a budget. Once the mortgage was paid off, the cash used for the monthly mortgage was put into a saving account for future porjects. Since last month's offerings were low, can the Church use the amount in the savings account for general operations to pay bills?

    1. Greg McRay, EA

      The funds are restricted only if your church specifically solicited the donations for the building fund. If the money going into the account is simply what is not now going to your mortgage, then use the money however it's needed.

  27. Tashe

    My group puts on an annual event in which an international spiritual person visits our city as part of his national tour to 25 or so cities across the US. We solicit donations to pay for this annual event in our city, as do all the other cities on the tour. We are not legally organized, just a group of people who put on the event, but there is a national organization that is a registered 501c3 non-profit. Our local group does not fall under the umbrella of the 501c3, so in order for donors to receive tax receipts for their donations, we either collect donations and deposit them with the national organization, or we direct donors to send their donations directly to the national organization. In both cases, we insist and make certain that any and all donations are tagged to be used for our local event and for no other purposes.
    We have been operating with the understanding that our donation money was being held in good faith by the national organization and that they would honor the donations as being tagged to be used only for our local event. And when we solicited donations we made it clear to donors and potential donors that the funds were to be used only for our local event (to make it clear that they weren't donating to the national organization).
    Recently, however, the national organization has been making statements to the effect that it expects all the local event groups to donate at least $1000 to the national organization's projects and charities. In the past this $1000 donation had been optional, but it seems that now the national organization is considering making it mandatory, to the extent that it is talking about automatically withdrawing the $1000 from our funds that were deposited with them (to my knowledge they don't have a separate acct for each city). These funds, however, are all from the donations that we solicited and which were earmarked to be used solely for our local event. So we are thinking that the national can't appropriate the money without asking permission from each and every donor; in fact, it is our understanding that we, the local group, can't do anything like give permission for the funds to be used for anything other than our local event. Are we understanding this correctly? Can the national organization actually, legally do what it's proposing? If not, is there any way to stop this action short of reporting the national organization to the IRS? Can individual donors ask for an accounting of where their funds went, what they were used for, and actually expect an answer?
    We would appreciate any help and advice you can give us. The way things are going now, we are seriously considering canceling our local event in protest, but we really don't want to go down that road unless we have to.

    1. Greg McRay, EA

      This is a tough situation, but the national organization may well be within its rights to exact a percentage. You don't have an actual nonprofit. Donors are (in effect) giving to the national organization, which has the ability to spend its money however it deems appropriate…so long as it does so legally. Unless you are acting as a soliciting agent of the national group, these designations have not been solicited by national. It sounds like they are simply doing you a favor. If that's true, you do not really have a case. You have a problem, no doubt…but not an actionable case. You will simply have to decide whether to stay hooked up with this group or not.

  28. Terry

    Hello my wife is treasurer for the local youth football league and has been for 3 years. The president last year decided to use funds to fix a needy parents vehicle ( a loan which han not been repaid) without board knowledge. Simply directing my wife to co-sign a check to pay for such. He then decided he was going to start his own charitage foundation and use league funds to finace his foundation. he borrowed $2000 to buy a very large amount of football player cards. He has repaid $600 but has taken a year to repay even that amount. She feels that the loan to the parent was inappropriate and his use of funds totally wrong for his foundation. Her problem is that the board consists of the president and his wife and his best friend and my wife is the odd one out and has a constant feeling when dealing with him of berratment. Also his action are without board approval just undertaken with omnipotent authority.
    If you would please provide advise as to what she should do

    1. Greg McRay, EA

      If she has no practical way to influence the behavior of this board, she needs to get out. The president's actions are totally inappropriate and could result in IRS sanctions against all board members for allowing it to happen. If she resigns, make sure her resignation letter spells out in detail her reasons for leaving. As treasurer, anything she has cooperated with, even if she disapproved, could blow up in her face. Good luck to you. I hope it works out.

  29. Dawn

    Greg I thank you so much for this site and the work you've done here. As a board member on a non-profit it is beyond helpful in times of "confusion" :)

    So Greg, here's my question…I sit on the board of a large charity (501c3). In a recent meeting it came to my attention for the first time that the entity has been "borrowing" from temporarily restricted funds. These funds come from two sources. One is a specific solicitation held during an auction to fund scholarships for programs. The solicitation is very specific to the scholarship fund (ie raise your paddle if you want to donate $5000 to the fund a dream fund…the scholarship fund). Folks raised their paddle to the tune of almost 70 thousand which is considered restricted funds by the entity and tracked as such. The entity "borrowed" from these funds to meet operating expenses with the intent to pay back by year end (which they did) with the blessing of our auditor's firm. They plan on doing this again to avoid paying interest on our line of credit this year which is why it came up in the meeting. I had a small stroke listening to the conversation and left in shock. Reputationally OUCH but legally….Greg isn't this action against the law, even if the funds will be paid back by year end?

    Two other restricted funds were borrowed from. One is quasi solicited (a call for funds for a specific festival for which a large chunk of change was received by a donor) and the other was non-solicited but donated with a specific purpose stated by the donor. These funds are both tapped into on occasion as well with the intent to pay back by year end so the books will be clean. Someone on the finance committee even was kind enough to develop a tracking system so we can see how many times we dip into the funds and ensure repayment prior to submitting the statements to the auditor at year end….

    My understanding from reading your comments above is that at least one of the funds issues are not legal and the other is problematic on an IRS standpoint? But I'm also wondering if all of these funds issues run afoul of UPMIFA (which is enacted in our state). The fund feels UPMIFA only applies to endowment funds but I'm given to understand that UPMIFA basically covers all funds held by an entity that qualifies under UPMIFA when a donor specifies an intent which is not followed by the entity….

    Help? :) Your opinion would be greatly appreciated. My husband and I are withholding all donations to this entity as well as our support for the line of credit until we know how bad this issue is….

    1. Greg McRay, EA

      Your situation is not uncommon, unfortunately. But the fact that it is common does not make it a best practice. So-called "borrowing" from restricted funds is called an intraorganizational loan and should be avoided. I'm a big fan of the Evangelical Counsel for Financial Accountability's (ECFA) take on this. They have a great article on this subject, http://www.ecfa.org/Content/Borrowing-Restricted-…. The gist of it is, don't do it. Even if it's legal, it is not considered ethical.

  30. Joe

    Greg, excellent stuff. I am on the Board on a Baseball Travel team open to the Public. A few questions arose. Can the officers collect a small salary?

    Also fundraising. Two part question. Leys say you live in Chicago and there is a tournament in Texas. Can you fundraise for the tournament – specifically state you are raising money for airfare and hotel stay/along with tournament fees, would this be a problem with the IRS and the 501c3 designation?

    Lets say you fund raised for your General Fund and were not specific as to what the monies would be spent on. Could you use those monies for the Tournament(and travel) and would this be a problem with the Irs and the 501c3 designation.

    Thanks

  31. Rita

    I work with several non-profits. One of them has a donor who gives to the organization and designates the funds to go directly to a family member who is having financial problems. I think this is illegal use of a non-profit and could cause us to lose our non-profit status. Am I right and where can find the answer so I can prove it to the directors.

    1. Greg McRay

      “Illegal” is a strong word, but what is going on is certainly a very bad practice. The donor is essentially laundering money by running a personal gift through the nonprofit. Usually this is done for the sake of anonymity, but it’s still a problem. If the nonprofit is giving a tax deductible receipt, it is potential fraud. The only exception would be if the nonprofit was already helping the recipient and the relative was merely assisting the effort. Proving this via the IRS code is more difficult than a chapter and verse approach. The prohibition is the result of several rules put together. Suffice it to say that nonprofits should never approve such a request.

  32. S Walden

    I am the bookkeeper for a very small non profit ministry. Is it legal for the director to use the non profits funds for covering personal expenses such as medical insurance, home equity loan, personal residence utilities?

  33. S Walden

    Additional information for above question: The director (pastor) is not currently receiving a salary from the ministry, they simply write checks out of the non-profit’s checking account for personal bills.

    1. Greg McRay

      If the ministry is a 501(c)(3), then it is NOT OK. Many small ministry organizations are actually sole proprietorships that have never formalized into a real nonprofit and are, in effect, a virtual extension of the individual. Assuming this is not the case, the pastor’s practice of using ministry funds for personal expenses is illegal and could subject him, the ministry and its board to a world of hurt.

  34. Myrtie

    We are a small committee that aids a university with its elder education program. We receive money for educational purposes from a 501C3 earmarked for the purchase of books. Can we ignore this desire by the donor? Can we embed this money into the general fund? Are we legally required to account for the spending of these funds?

    1. Greg McRay

      I would need to know more detail before giving specific advice, but this can be a fine line. If the earmark was solicited for that purpose by the 501c3, then using the money for another purpose is not legal. If the money was only earmarked by the donor, then it gets trickier. Did the 501c3 communicate intent to honor the earmark? If so, retasking the funds may not be illegal, but it is certainly bad for PR.

  35. Jon

    Can a non-profit 501(c)(3) organization (Party A) accept donations solicited by a church (Party B) for a Senior Center (Party C). Party A and Party B worked together on an event held at the church and the pastor took up a cash offering for Party C but asked that any checks be made out to Party A and those funds would be donated to Party C. Party A has no problem depositing the checks into Party A’s account and making a donation to Party C in the amount of those checks. Do you see any issues with doing so?

    1. Greg McRay

      Assuming I didn’t get lost in the alphabet soup, it sounds OK as long as all parties are 501c3 organizations.

  36. Brian

    My church has a pledge drive each year for the national denominations missions fund. During the drive we are encouraged both from the pulpit and via video provided by the denomination to pledge a yearly amount of giving. The donations are collected at the local church then sent to the national office. I recently learned that the pastor has taken those funds to help with operational expenses for the actual church. The way I understand the above information is that not illegal since the fund is nationally solicited?

    1. Greg McRay

      Obviously I do not know all the details of your situation, but it sounds outside the bounds. Unless a disclaimer was given at the time of the solicitation that the funds could be redirected at the discretion of the church, then this is a textbook example of misappropriation. It is both unethical and illegal.

  37. Chris

    This was an incredibly helpful article. I am struggling, however, to find this info on the IRS website. Where would I find the actual law/code so that I can keep it for reference?

    1. Greg McRay

      Like many legal issues, it is not always chapter and verse. It is often an extrapolation of broader principles. An example is the IRS prohibition against private benefit, which specifically leads to boards that must be a majority unrelated by blood, marriage and outside business ownership. The latter is not an articulated rule, but is nevertheless prohibited based on the broader prohibition. Start with IRS Publication 557 for a primer.

  38. Lance Geiger

    I am the treasurer for a school booster organization. Recently there was a family in need that used to be part of our organization (still is in spirit). Some wanted to take some money raised from our organization to help this family. I said we couldn’t for the reasons you described in your article. Was I correct due to the fact the money was not going to what we solicited it for?

  39. Alice Martin

    Can a 501 C3 church refuse to give you a annual donors statement (tithes/offerings) of the cash contributions that you gave through out the year? And also, can they suggest to you, instead of giving your cash donations directly to the church, open up a personal checking account and put your tithes in it, and if the church needs to access it you have to let them. The account is suppose to be to help out if someone in the church has a need?

  40. Murvyn

    What if a fund-raising program becomes wildly successful and the organization is able to raise more money than expected — or planned for — to meet the monetary needs of the program? Scenario: Board designates a solicitation campaign (via Christmas caroling) to raise money for a medical mission overseas. Initial estimates set the goal at $4,000. The campaign is wildly successful and the organization is able to raise $6,000.

    Is the Board required to spend all the $6,000 raised all at once (towards the designated program). Or can the Board authorize the expenditure of $4,000 towards the program for this year and the remaining $2,000 booked and used for the same program for next year? BTW, this is the first time the Board has undertaken this type of programming but would like to do it on a yearly basis as time and funds allow.

    1. Greg McRay

      Excess donations could be used for the same program next year. A good idea is to let that be known up-front during your solicitations.

      1. Murvyn

        Thanks, Greg! Much appreciated. Will let the Board know that, going forward, potential donors need to be informed beforehand that excess monies will be used to fund future missions. Thanks again!

  41. joe

    SIR,

    I just read a story where a child solicited contributions on the web, and used the funds to pay missed payments, avoiding forclosure. Is this legal? I remember someone doing this a few years ago and was prosecuted for mail fraud by the postal service. Which is legal? If it is legal, what keeps me from having my teen set up a nonprofit, collect money and pay off my house?

    joe

    1. Greg McRay

      Whether or not the solicitation was legal would depend upon local or state solicitation laws. No federal laws would have been broken. That being said, any money “donated” wasn’t tax-deductible to the donor because the gift wasn’t given to a recognized charity.

  42. janet

    I am on the finance committee at our church. We have a general fund(checking account), a building/construction fund(savings), and a Youth/Family Life center building account(savings).
    questions have been raised to the legalities of monies being transferred from the Youth/Family Life Building account into the general fund account. I was told the money could not be transferred because it is in a “Designated account”.

    1. Greg McRay

      It matters more how the money got into the “designated account”. If it was by soliciting donors for that express designation, then the money is restricted and shouldn’t be moved. If any of the money in that account was transferred there or was the result of unsolicited designations, then that money can be retasked as necessary.

  43. Ruth

    I recently became president of a garden club with non-profit status. I am trying to establish a budget and make sure we are doing everything correctly. We have two fund raising events each year to raise funds for a horticulture scholarship and to support other gardening projects in the community. The first event is a plant sale where members contribute plants from their yards. In the past they have been given a receipt to fill out of what they determine the value of the donated plants (from their yards) to be. Should we be giving members a receipt for a plant that came out of their yard and was not purchased? The second fundraising event is based on soliciting plants from nurseries in the community. The nurseries are given a tax receipt with the value stated. I am assuming that is okay.
    Does 100% of monies raised from these two events have to go to the scholarship fund and garden project? Can the costs to hold the events be deducted from the generated funds?Can some of the monies raised go for club costs such as rent, website, newsletter, etc.

    1. Greg McRay

      Lots of questions. I’ll tackle them in order.

      If the members who donate plants aren’t getting the unsold ones back, they should still get a receipt. As to the nurseries, any donation receipt should allow them to fill out a value themselves, but your organization should never value tangible gifts for the donor…even if something clearly has a FMV. Lastly, unless you are telling your donors that 100% of their donation is going to a specific program, some of the funds can certainly go toward overhead.

  44. Africa

    I recently donated to support a friend’s mission trip to Africa. She instructed me to send the check directly to the church, made payable to the church. They said they couldn’t accept the donation because I put “Amy’s Africa Mission Trip” in the subject line (for my own memory purposes). They said there couldn’t be any indication of her name in order for them to accept it. Do you think that is legitimate and why would that matter?

    1. Greg McRay

      They are way off base…probably got some bad advice from someone along the way. Your donation is designated for a distinct purpose, so notating that in the memo is very appropriate.

  45. David

    Good afternoon Greg,

    I am am a new volunteer for a non profit organization 501(c)3. Over the past two years, the organization solicited donors through direct appeal (letters and emails) requesting donatoins for a specific purpose. The organization received contributions from the solicitations and it was later determined that the funds received were used for purposes other than the purpose outlined in the appeal letters and emails. The organization does not have adequate funds to cover the temporary restriction on funds (difference between amount received versus the amount expended for the purpose defined in the solicitation) Organizational management has sent out negative confirmation letters requesting that the donors un-designate their contributions. However, the letter simply stated that it was the intent of the organization to spend the funds where most needed and did not require a “confirmation” of approval from the donor. Is that an acceptable method to un-restrict contributions which were formerly considered temporarly restricted?

    1. Greg McRay

      No it isn’t sufficient. Donor approval must be received to reallocate money based on a specific restricted solicitation. Some nonprofits include a disclaimer in their solicitations that the organization reserves the right to allocate monies as needed in order to avoid the situation you are in now.

  46. Kimberly

    I have a concern. I serve on the Board of a small nonprofit. We had a meet and greet (our first) in January and a few of the people gave checks to the organization. When the Co-Directors (husband and wife) had us send the tax acknowledgement, they changed the wording saying that “every effort would be made to use for the nonprofit but the funds may be used for something else”…. is this misappropriation?

    1. Greg McRay

      It’s OK unless the donors were solicited for a restricted purpose. Such a disclaimer is fair game in the solicitation, but not after the fact in a receipt.

  47. ChristineMM

    I wish you would write a similar post for when designated funds were solicited to buy an object and what happens to that physical object. Also if a person buys the object and donates it for a group to use and what happens if it is being used by others that were not “designated”. I’m talking about after the money is spent, not the cash flows.

  48. Jim T

    Our church had and is still in the midst of a Capital Funds Campaign. We have solicited donations specifically for this building fund with personalized envelopes with the name of our campaign printed on them. For three years the congregation has been giving to this building fund. With the economy being the way it is and offering down for over a year and a half, the staff was told that they have been taking monies that are designated for the building fund and using it to pay for overhead such as staff salaries and bills for over a year. When we approached the pastor about the legality of this, he said that because it all goes into our general offering, even though it is pegged for that fund, so long as we have at least the amount of money in our accounts that our building fund is suppose to have we are not doing anything illegal. Seems like a technicality that rides on the brim of illegal or poor and improper bookkeeping. .

  49. Jim T

    Forgot to mention that the pastor did announce to the congregation from the pulpit one weekend that we were doing this. People complained to each other but no one brought their gripes to him.

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