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. 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 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.