One 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. And, as many nonprofits soon learn, it doesn’t really matter whether the economy is in recession or is booming…being wise about your organization’s financial resources is essential.
But here’s a question you probably haven’t considered: In all of your efforts to keep your program running strong, 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 restricted 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 of directors or an executive director to just be good stewards of the money people have donated. With completely innocent and positive intent, they proceed to act in a manner that is totally against the rules.
For example, suppose things are tight at the 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 Funds
Understanding that there are two types (or buckets) of funds, restricted and unrestricted, is the first step in getting this right. Let’s take a look at each:
Restricted Funds: These are funds that are set aside for a particular purpose. Sometimes it’s temporarily restricted, meaning that the restriction could end due to a specified time limit, or more likely, by the completion of a project, such as the construction of a facility. Funds that are permanently restricted are usually meant to be saved or invested in an endowment fund, the interest earnings of which can be used for a particular activity or general operations.
And, restricted means RESTRICTED! This is not a trivial matter. Donors can take legal action against a nonprofit that it believes is misusing restricted donations. The last thing your charity wants is to be in the cross-hairs of the Attorney General’s office.
Unrestricted Funds: As the name suggests, unrestricted funds don’t have strings attached and may be used by the nonprofit for whatever purpose it deems necessary. This money typically goes toward normal operating costs.
So, how does money get restricted? It is critical to point out that only a donor can restrict funds. For that reason, it is absolutely essential that a nonprofit understand how soliciting donations impacts whether money is restricted or unrestricted.
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 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.
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 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? The answer depends on the actions of the nonprofit at the time of the gift. If Bob is notified of that possibility at the time of the gift, and agrees to it, then the restriction may be avoided. If not, the donation will likely be considered restricted.
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 use 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. Make sure your donation receipt reiterates that point. In a situation where it’s too late for a disclaimer, you can go back to donors and ask permission to re-purpose 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.