skip to Main Content
America's First Choice Provider of Formation and Compliance Services for Nonprofits

What Are Restricted Funds?

Last modified: December 7, 2018
You are here:
Estimated reading time: 3 min

Definition

Restricted funds are monies set aside for a particular purpose as a result of designated giving.  They are permanently restricted to that purpose and cannot be used for other expenses of the nonprofit.  By contrast, unrestricted funds may be used for any legal purpose appropriate to the organization.

Only Donors Can Restrict Funds

One of the most important points to understand about restricted funds is that they can only come about through designated giving.  A nonprofit is free to set aside a portion of general operating revenue for any number of reasons, and may even create policies to make it difficult for those funds to be used for any other purpose.  But even if that happens, those funds are not truly restricted in the legal sense.  Real restricted funds are the result of a donor giving with specific strings attached as to what the donation may be used for.  It may be the result of the nonprofit soliciting or fundraising for that purpose.  Donors can also designate that a gift be used for a purpose they choose, completely independent of any fundraising campaign.  It may or may not be for a legitimate purpose.  These gifts can be a challenge to deal with.

What To Do About Unsolicited Designations

In that last scenario, if a donor designates a contribution that isn’t a result of an “ask” for that purpose, the nonprofit has a choice to make.  If it accepts the gift with the strings attached, that money becomes restricted to that purpose.  Sometimes that’s fine.  If a church, for example, has a facilities fund that it uses to pay mortgage payments and building-related expenses, the church may be happy to accept donor-designated gifts for that purpose, even if they weren’t directly solicited.

But what about designations that don’t fall into that situation? The good news is that a charity is not obligated to accept designated gifts.  If a donor gives a donation with a designation that doesn’t make sense for the organization at that time, it can always ask the donor if the money can be used for other purposes.  Most donors are trying to help the organization, and such a request is usually granted.  If the donor is gracious enough to agree, the money isn’t restricted.  Rarely, a donor may have a personal agenda, or is seeking some type of influence, and is not willing to lift the designation.  At this point, the nonprofit can accept the donation and agree to the restriction, or it can refuse the gift altogether.

Restrictions Are Permanent (Usually)

Once money is restricted, that restriction is permanent.  The funds cannot be redirected to other purposes, even if the budget picture becomes bleak.  It is a difficult situation to be facing unpaid rent and utility bills, or an upcoming payroll, with nothing in the organization’s operating account, but you have $50,000 sitting unused in a Scholarship Fund.  It seems logical that the money could be moved in an emergency.  But, the IRS is serious about restricted funds.  Improper use can result in severe penalties, or even loss of exempt status.  Boards can be sued by donors for misuse of such funds.

There is a possible way out, but it isn’t always easy.  If a situation arises that is serious enough to necessitate re-purposing restricted funds, it is necessary to obtain permission from the original donor(s) to remove the restriction.  It’s best practice to get that permission in writing.  That is the only legal way to use the money for purposes other than the original restriction.

Avoiding Headaches When Fundraising

There are a few things you can do to keep from getting caught in these situations.  When it comes to soliciting donations for a particular purpose, it is often wise to provide the donor with some caveats prior to the gift.  You can set a budget for the campaign and inform donors that any money received above a predetermined cap will be redirected to the general fund.  You could also publicize a time limit after which unused money in the restricted account becomes available to the general fund.  And finally, you can always provide a general disclaimer that all donations received through a campaign are subject to redirection at the discretion of the organization.

Be careful with blanket disclaimers like that last one, however.  If donors don’t have confidence that their donation is really for the purpose advertised, you may handicap your campaign.  The important thing to understand is that if you use a disclaimer or caveat, it needs to be very clear to the donor prior to the gift.

Tags:
Was this article helpful?
Views: 35640

This Post Has 49 Comments

  1. Our development director wants to encourage a major donor to give to our scholarship programme by promising a match – we will ringfence $1 of reserves for every $1 given up to an agreed amount. I’ve explained to our development director that we cannot create restricted reserves from unrestricted reserves but I’m concerned that if he makes a promise to the donor then those reserves would effectively be restricted. Setting aside whether the ask is a compelling one, what would our obligation be in terms of honouring a match once promised?

    1. I get what your development director is trying to do, but it can create a conflict. A charity cannot legally restrict unrestricted funds it is already in possession of. Only donors can restrict funds. Now, you could offer to allocate a dollar-for-dollar match out of general funds, but it still doesn’t legally restrict it. It does, however, create an awkward obligation to honor the pitch, even though the charity must retain the right to spend those matched funds in other ways, if needed. Matched funds cannot be moved into the restricted category of assets, no matter what was promised. My suggestion is find another way to incentivize your donor!

  2. Our fund development officer keeps restricting all our contributions based on conversations she has had with funders. She doesn’t have documentation but says the donor “expects” of “assumes” we will use funds a certain way. She says the donor will be offended to be asked to put their request in writing. How do I classify the funds with no documentation? Also, she says community foundation funds received are automatically restricted to that community use, even though there is again no documentation on restriction.

    1. That’s a tough question. For the most part, there are no set rules on what constitutes notice of restriction. While it is obviously best for that to be in writing by the donor, verbal agreements are legally valid. In the case of a verbal restriction, notes should be made in the records as to the nature of the restriction. As to the community foundation, I would have to know more about the restrictions inherent in their grantmaking to give insight there.

      A good way to address this situation is to draft a gift receipt policy that outlines criteria for receiving donations, including what constitutes a restriction. Following a board approved standard operating procedure (SOP) will eliminate what now feels a little ad hoc. Good luck with it!

  3. Our non-profit collected funds for a specific project last year. There was no language to detail how those funds would be used beyond “support our effort”. Now that the project is over and the need is fulfilled, we still have over $10k in the account. Can this legally be used to retroactively rent space in our building, where the project used rooms for storage? Or tool improvements for the areas that were most taxed by the project? How much flexibility is there when there was no clear definition of how the funds would be used to support the project?

    1. You should have some pretty decent flexibility. As long as the use of the funds is within the overall expenditures needed to fully support the initiative, then you should be fine…especially since it sounds like you were pretty broad in describing the program on the front end. If in doubt, you can always go back to your donors and request input as to your intended expenditure. It doesn’t sound like that will be necessary, however.

  4. If a donor has given a non-profit an unrestricted donation, can the donor subsequently state that it should be rested ? Does the non-profit have to honor that request ? If so, and they do honor it, is the contribution now classified as “With Donor Restrictions” ? or would that be considered a “Board Designation” ?

    1. I’m not sure what you mean by “rested”. But under your scenario, if a donor gives an unrestricted gift, then comes back and requests that it be allocated to a specific purpose, it totally up the organization whether or not to honor the request. If they do…and for good donor relations, it may be necessary…I would argue that it is a board designation and that the donor should be informed of that. I think it also depends somewhat on how much time has gone by. If the donor comes back the next day, it’s a lot easier to make the restricted argument than it would be if they came back the next month. It’s frankly a gray area, but I would err on the side of original intent.

  5. The article is quite helpful. Thank you.
    I want clarity on this. My institution experience in recent times is that the donors informed us of having some funding available to fund projects and activities to help achieve certain development objectives either at national or subnational levels. We identify projects and request approvals from the donor. Once approved, we spend accordingly. This kind of funding qualifies under which category, restricted or unrestricted?

    1. I would say that in absence of any qualifier that would give your nonprofit wiggle room regarding ultimate spending decisions, those donations would be restricted. There appears to be a mutual agreement on purpose tied to the gift.

  6. A contribution of $25,000 was solicited and received in 2013 restricted to the purchase of property. The purchase did not go through. There are no prospects for purchase of property in the next 2 to 3 years, yet we have needs for preservation of historical properties that we already own. How long is reasonable to hold on to restricted funds before we contact the donor to request their consideration of reallocating it to current institutional needs?

    1. Sorry for the delayed reply. There is no expiration date on restricted funds unless it was established up-front with the donor’s agreement. If you need to redirect funds, you must get the donor’s permission to the extent it is possible, no matter how many years have gone by.

  7. Can a donor retroactively change the restrictions on their donation or does the organization have the right to make the decision whether to allow the change or hold them to the original restriction?

    1. Great question. No, once a donor makes a gift, whether restricted or unrestricted, they no longer have any say over the use of the funds. That doesn’t mean, however, that a nonprofit has to refuse a request for change. It just means they’re not obligated.

  8. I’m a new ED for a small community arts center. I’ve worked with a city-run arts center for the past 14 years, so some of the nonprofit restrictions are new to me. A board member said that our unrestricted funds have to be “used up” by the end of the fiscal year, but that restricted funds can remain year-to-year. Is this correct?

    1. Not only “no”, but HECK NO! This is a top-10 nonprofit myth that needs to be killed off for good. It’s not true, and has never been true. In fact, it a sure-fire way to ensure an organization starts off the new fiscal year in financial distress. The only way your board member could be somewhat correct would be if your nonprofit has that as an internal policy. Surely not, and if it does, change it. If it’s not an internal policy, it’s just a well-meaning, but horribly misinformed board member. Hope that helps!

  9. Our church (located in Pennsylvania) merged with another church this past year. Our new church “adopted” a dying older congregation. We legally merged and are operating as one entity. We are finishing consolidating our financials and one of the last remaining items is the designated funds.

    There are two designated funds for which we have no documentation. These were memorial funds in honor of people who passed away that had been connected to the church.

    The intent of the funds and the restrictions on the fund principle (one fund had a restriction on the principle and another fund did not) has been communicated through the collective memory of the members of the former church to which the gifts were made. We have attempted to contact the families connected to the funds but have been unsuccessful.

    What obligation do we have to maintain the oral tradition regarding the purpose and restrictions on these funds? May we transfer them to unrestricted funds?

    1. Tricky situation, and may depend on the surviving entity. If New-Church is the survivor legally, then all assets of Old-Church should belong to New-Church. Any restrictions would most likely die with Old-Church. Even if Old-Church is the surviving entity, it doesn’t sound like any records have been adequately maintained as to the actual restriction. That’s improper, but it is what it is. If there isn’t clarity, then there is likely little recourse to redirecting the funds for current use. Oral history doesn’t replace legal documentation, but is does matter relationally. Get the buy-in of the remaining Old-Church people if you choose to redirect, else friction is sure to be the outcome.

  10. Would there ever be a problem with using a portion of completely unrestricted funds to create a separate designated account? For example, I would like to move 500$ from an unrestricted account to establish an separate gift account for a designated purpose.

    1. Yes, you absolutely can do that. Nonprofits, as well as businesses, frequently set aside funds into project accounts to keep track of transactions separately from general operations. The key point to remember, though, is that these are not restricted funds by definition, meaning they can be moved again for other purposes should the organization find it necessary.

  11. GAAP and the FASB have very detailed requirements that seem to consider large public nonprofits with professional accountants. After all, they are professional accountant groups.
    Are there actual codes that require compliance to these burdens, particularly for small nonprofits and churches?

    1. Yes, actually. The GAAP and FASB requirements are not dependent upon organization size. Even small nonprofits and churches are expected to use the current methodology for tracking such.

  12. Is a Facebook birthday fundraiser sponsored by an individual and advertised as supporting a specific project for a nonprofit organization considered a restricted fund?

    1. It depends on whether or not the nonprofit agrees to accept the gift with those strings attached. Many larger nonprofits do not allow outsiders to fundraise for it without explicit prior permission of the organization in order to prevent such misunderstandings and misrepresentations. I think that is a great policy. It’s great if people believe in your mission so much they want to raise money for you, but it comes with many problems if the plans are not authorized in advance. The last thing you want is for a well-meaning supporter to unintentionally conducting themselves in a way that reflects badly on your nonprofit.

  13. We have a donor who created a restricted fund with our organization for a specific type of field of education, donating a set amount each year for five years. Can the nonprofit add money to the restricted fund to cover the amount of grant dollars not covered by the balance of the restricted fund? For example, the restricted fund received $10,000 in grant requests, but the restricted fund’s balance is $7,000, with no other money scheduled to come in. Can the nonprofit organization use $3,000 of its own funds to cover the restricted fund’s grant requests?

    1. Absolutely, yes. The money you supplement with will not be restricted, so it shouldn’t be tracked as restricted funds. But that won’t likely matter, as it sounds like you’re going to be distributing it as soon as it gets added to the donor’s funds. There is never any problem adding more money to restricted money, just remember you’re not actually adding to the restricted balance. In your case, your budget for grants just became $10,000, but your restricted funds balance is still $7,000. I hope that makes sense.

      1. Yes, it does. Does it matter that the restricted grant is for a specific purpose and the organization doesn’t have a grant for that exact purpose?

        1. Therein lies the potential problem with restricted gifts. It really does matter. If you don’t have a grant that matches the designated purpose, you cannot unilaterally repurpose the funds. This may require you to seek out the original donor to get permission to repurpose it. Even if your grant is similar, it’s probably best to get the donor’s blessing. In the future, it’s always best to match expectations on the front end. If a donor wishes to give a restricted gift, and that restriction doesn’t mesh with existing programs, you’re not obligated to accept the gift. You can refuse it, or better yet, talk with the donor about what would better match your nonprofit’s needs. Gifts that require you to spend money on something that isn’t part of your existing mission is often not a gift at all, but rather a distracting burden. Maybe your situation doesn’t rise to that level, but it is something to keep in mind.

  14. The Q&A resulting from this article was really helpful. However, I also have a question.

    Are disclosures such as “The Board reserves the right to direct use of these funds to other areas as needed” on church offertory envelopes legal?
    if so, what is the regulation number that gives the church Boards this right?

    1. Great question. It’s not really a matter of a specific regulation number. It’s more about the nature of how a gift gets restricted or not, that is, by mutual agreement between the donor and recipient.

      Such envelope disclosures are legal, but it’s not foolproof. Many churches will include various line items on the envelope for specific funds: youth, building, seniors, benevolence, general fund, etc. If a donor puts a check in that envelope, but designates the donation to go to the building fund, she may be upset if she finds out her gift was “redirected” to the youth department without her consent. That said, as long as the disclaimer is clear, use of the envelope should qualify as mutual consent that the gift is ultimately not restricted.

      But, an envelope disclaimer won’t cover donations that come in other ways. If someone mailed a check designated for a particular purpose, and the church didn’t want to honor the designation, that would still require communication with the donor to either redirect, or give the right to refund.

      1. What if you have a clear gift policy on your website that notes the organization will do its best to meet donor designations, but in the event it would cost the organization more to restrict the gift than the gift’s value, the org will repurpose the gift to the fund most closely-aligned with the donor’s intention? Thanks!

        1. I think that is a great approach for online giving scenarios. Make sure the disclaimer is clearly visible. I would also suggest include similar wording on the receipt you send for good measure, whether it is a paper or email receipt. Include a suggestion that they contact you should they have any questions about your gift policy.

  15. We have a situation where a church member left a house for the purpose of housing missionaries. This was 20 years ago and the family has since deceased as well as there are no living relatives. We are now faced with situation where the house is becoming a drain on the budget and we want to sell the house. Can we sell the house? Also, what must be done with the funds? We have two options before us are place the funds in a designated account and continue to help missionaries or use the funds for another need within the community that honors the family as well.

    1. Do what makes the most sense. A tangible asset cannot be considered restricted in the same manner as a monetary gift. The original designation has been honored for 20 years, and now your situation has changed. You’re not bound in any legal sense unless you have a restricted deed. If you need to sell it, sell it. Use the funds in the way that best furthers your mission. Good luck with it.

  16. Our Board President (without the rest of the board’s knowledge) solicited funds for Climbing gear in a state-wide fund raiser, writing that the donations would go into a restricted fund. Problem: our board did not know she was doing this, and as Treasurer I know we do not have a restricted fund set up for this program. Now that we’ve received donations to this non-existent program, what is the best way to deal with this?

    1. Miscommunication among the board doesn’t prevent the President’s actions from creating a restricted funds situation. Just because you don’t have a separate bank account, or even a line item on your books for this, the money raised is restricted as of right now. Donors gave under the pretext of their gifts being restricted…therefore, they are. The only real options are: 1) following through with the climbing gear, 2) getting donor permission to redirect their donation, or 3) offer the donor a refund. Anything other than those 3 options would be considered out of bounds. Good luck with it!

  17. What happens when a person raised funds for their personal support and it is given to the nonprofit, and the person doesn’t fulfill their work commitment and goes to work for another organization?

    What do you do with the designated funds?

    1. Tough situation. Nonprofits that require their staff to raise their own salaries, so to speak, often provide a disclaimer to the donor (prior to the gift being given) that amounts over and above the stated salary, or undistributed portions in the case of someone leaving the organization, will be redirected to other purposes. If no such disclaimer was provided, these are restricted funds, subjecting them to the same treatment explained in the article. The donor must be given the right to refund, or to voluntarily allow the funds to be used elsewhere.

  18. I work for a church and the lead pastor approached me a few day ago with this statement and directive; the money in my designated account that I raised for purposes directly related to my department was not mine. I do not own it. It is money that belongs to the church. I never disagreed with this but here’s the problem I need clarity on. He then directed me to cover the salary of an assist for department using money from this designated account. Are there any legal issues that can come back to haunt us?

    1. He is correct that the money belongs to the church, but you obviously know that. His directive to spend the money for a purpose other than its designation could be a major problem, however. If this money was originally set aside from general donations, then it is not technically restricted. Nonprofits and businesses do that all the time, that is, set money aside for a project or other purpose, only later to realize that they need to use it elsewhere. Not a problem there. However, if the money was given by donors for a specific designated purpose, and assuming the donors were not told at the time of the gift that the money might be spent differently, then that money is cannot be repurposed without permission from the donors. This is a legal issue that could definitely come back to bite you. The IRS doesn’t get too involved in this fight, but state Attorney General offices definitely do. Just because the money is needed somewhere else doesn’t override its restriction. Tread carefully here.

  19. A donor gave a multimillion $ donation to a 501 c(3) non profit. The only restriction was that the non-profit’s CEO remain “employed” for a minimum of five years.

    A year later, the new CEO terminated the former CEO. Can the SEC or other agencies investigate this abuse of restricted funds. The funds had been invested in a separate “foundation” governed by the SEC.

    What other agencies can be notified for investigation?

    1. Several red flags with this. For one, why would the SEC be involved in a foundation? Secondly, truly restricted funds are restricted by purpose, not by requiring specific actions of a nonprofit. A donor has no right to dictate the employment practices of the charity they give to. It doesn’t sound like an abuse of restricted funds…more like a misunderstanding of what a restricted donation actually is, by one or both parties.

  20. If a church membership establishes a savings account for a specific purpose and it is funded with transfers from the general fund to grow it, is that savings account considered a “restricted” fund or a dedicated fund?

    1. Hi, Mike. Sorry for the response delay. No, that scenario does not create a “restricted account” in the legal sense. Your church may wish to treat it as a protected set-aside, which is perfectly fine. But, restricted funds can only be created at the time of the donation based solely on donor intent.

  21. Why don’t you submit a request with backup invoices for a reimbursement to your organization for the $5k?

    The invoice you paid can be from more than $5k and it should readily be a bonafide expenditure that benefited the intended recipient of the original restriction.

    You don’t have to be short on cash in order to request this and as long as it meets the intended purpose of the original restriction it would be pretty hard to substantiate why they didn’t grant approval.

  22. We are structured in St. Vincent de Paul as a pyramid. Our National Council at the top, District/Diocesan Councils beneath, and local Conferences at the bottom. In most instances Conferences use the EIN/501C3 of the District/Diocesan Council. As a member of an existing Conference a Donor donated $10K to my new Conference. My new Conference had not been established when the donation was made, so no bank account existed for my new Conference. Rather than holding the $10K as the end of the year approached, the Donor and I agreed to identify the donation as a Restricted Donation, and have our Diocesan/District Council hold the funds in a checking account, separate from the general funds of the Diocesan/District Council. The control of the funds were relinquished at that point. Three months later…….. I requested that the Diocesan/District Council release the funds to my new Conference as we has established an EIN, our own 501C3, and a bank account. The Diocesan/District Council refused to do so, stating that the funds were in their bank account, so belonged to them. Through intermediaries from our National Council, we negotiated with the Diocesan/District Council to get $5K of the $10K. We agreed to allow the Diocesan/District Council to have use of the $5K they would not provide for a 6-month period to resolve attorney fees with lawsuits they’re involved with – imagine that! No documentation was created as they refused to sign anything. However I’ve retained emails that cover everything. The time has passed, and they continue to refuse to provide the remaining funds. At what point did the original Donor’s authority to direct the funds end? What IRS laws is the Diocesan/District Council breaking by not providing the $5K in restricted funds? Although, we don’t have need of the funds, at this point, I want to ensure we’ve complied with IRS regulations from our perspective. What recourse might we have ?

    1. This is tricky. From your description, it sounds like the District Council agreed to be a fiscal sponsor until your organization was established. That allows the donor to give immediately and receive donation acknowledgement from an established charity. If the donor explicitly intended all of the $10,000 to go to your organization, the entire $10,000 should be considered restricted to your nonprofit by the District. The question is whether or not the District understood that donor restriction at the time they took custody of the funds. Even if they didn’t fully understand, they’re obligated to the donor as the recipient charity to honor the designation and restrict the funds.

      As for recourse, you need to press your case. If the District won’t acquiesce, your only recourse may be legal. Before filing suit, contact your AG’s office or state Dept of Charities to see what they say.

  23. Where is the actual reference in the IRS code to the requirement to honor (as opposed to “account for”) a donor restriction? I can find it in state codes, but have not seen anyone cite the actual requirement from either the US code or current IRS forms, pubs, etc. What penalties can/will the IRS impose, and where is that documented?

    1. This is one of those issues that is governed more by state law and accounting regulations than by IRS code. Generally Accepting Accounting Principles, GAAP, represents the standards of accounting practice in the US. GAAP details how restricted funds should be accounted for. Also, the Financial Accounting Standards Board (FASB) is the group who establishes the rules recognized under GAAP. State law is the jurisdiction for enforcement of restricted funds rules, as boards of accountancy are governed at the state level. Finally, the IRS follows GAAP/FASB requirements, requiring a breakdown on Form 990 balance sheets of restricted and unrestricted funds. Penalties aren’t generally levied by the IRS for restricted funds violations, but state AG’s offices will aggressively enforce these rules.

Leave a Reply

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.

Back To Top