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.