Be an Informed Donor!

| April 3, 2012 More

It seems every few months we hear news of a nonprofit organization that mishandled donated funds. With more than a million registered charities in the United States, how can you as a donor be sure your contributions are being put to good use?

First, let’s have a little lesson on charitable donations. In order for your donation to be tax-deductible, it must go to a qualified tax-exempt organization. This means that the charity has received tax-exempt status under Section 501(c)(3) of the Internal Revenue Code. If someone shows up on your door soliciting funds for a charity but you’re not sure if the charity is registered, ask for proof of 501(c)(3) status. This is not the same as simply having a tax ID number! Read the beginning of the letter to see if it indeed says the charity is exempt.  This statement should be in the first paragraph of the letter. Alternatively, you can look in the top right corner of the letter to find the “Effective Date of Exemption.” The letter issued by the IRS to assign a tax ID number will not contain this information, so don’t be fooled by an unscrupulous solicitor.

Most 501(c)(3) organizations must file an annual tax return, just like any business or individual. The tax return for a nonprofit organization is called Form 990. There are a few different variations on Form 990 depending upon the size or type of organization, but viewing a charity’s tax return can give you great insight into how the organization uses its funds.

The law requires all 501(c)(3) tax-exempt organizations to make their financial statements available to the public. Additionally, the IRS and the organization must make public the information they disclose on Form 990. Organizations often post this information on their website for public viewing, or you can locate a tax return on such websites as If a charity refuses to provide you with a financial statement, you may want to think twice before donating.

Deciphering Form 990

Now that you know where to find Form 990 for a particular organization, you may be asking yourself, “how on earth do I read this thing?” The remainder of this post will review a few key areas of Form 990 that can provide insight into the organization’s finances. While a more thorough review of the tax return is advised, this post simply hits a few areas that may be potential red flags for a donor. (A blank copy of Form 990 can be downloaded here. Please note that the IRS revamped Form 990 in 2008, and all line numbers I mention in this article reference the current form.)

The first thing to check on Form 990 is the organization’s tax-exempt status, which can be found in Item I on page one. If the organization is exempt under a section of the tax code other than 501(c)(3), your donation is most likely not tax-deductible. 

In Part I, you can see a summary of total revenues and expenses for the organization. This information will be repeated in greater detail elsewhere in the return. Skipping to Part III, the form asks the organization to state its mission. Does this mission seem compatible with how you wish to spend your money? If the answer is “yes,” read through the rest of the page for more details on specific programs and their costs.

Now I like to skip ahead to Part VII – the meat of Form 990. In this section, a nonprofit organization must disclose compensation to any directors, officers, trustees, key employees, and independent contractors. The donor can draw his or her own conclusions about salary levels to the highest paid employees, whether these levels are appropriate, and/or whether amounts may have been omitted. It is very unusual for board members to be paid for their service. Reimbursement for travel expenses or other costs incurred on behalf of the organization are not considered compensation and should not be reported in this section.

Part IX of Form 990 is the section I find to be the most relevant. This is the Statement of Functional Expenses. This is typically the first section of Form 990 I review, and depending on what I find it may be the only section that matters. Every dollar spent by a 501(c)(3) organization must be recorded as a management/administrative expense, fundraising expense, or program expense. Ideally, the majority of an organization’s expenses should be spent on the programs or services it provides. Please note that the form clearly states that all 501(c)(3) and 501(c)(4) organizations must complete columns B, C, and D to disclose their functional expenses. If a 501(c)(3) charity fails to disclose this information and only completes column A, they will not get a donation from me – but they can certainly expect some communication from the IRS to correct this error.

Moving back to Part IV, organizations are asked about specific activities. Questions 3 and 4 ask if the organization engaged in lobbying activities or political campaign activities. A “yes” answer to either question should prompt you to flip to Schedule C for additional information.  Questions 25-28 deal with financial transactions with officers, directors, and key employees. A “yes” answer to any of these questions requires additional information to be provided in Schedule L.

Part VI examines governance and management. Question 2 on this section asks if any officer, director, trustee, or key employee had a family relationship or a business relationship with any other officer, director, trustee, or key employee. If the answer is “yes,” further research into the organization’s management may be appropriate before donating. An organization whose board of directors includes multiple members of the same family may be quite different than an organization with more diverse leadership. Question 5 asks: “Did the organization become aware during the year of a significant diversion of the organization’s assets?” This is another question where a “yes” response warrants further research before I choose to donate.

Question 8 and its subparts ask if the organization documented in writing its board meetings and actions taken at those meetings. An answer of “no” is a big red flag to me. The remainder of the Part VI is worth reviewing, as it can give the donor an idea of how the organization is managed.

In Part VIII we can see more detailed information about the sources of the organization’s income for the year being reported. This section is quite helpful if you can compare the data from multiple years, to get a sense of how the organization may be growing or declining.

It is important to note that not all salaries and wages are administrative. A nonprofit organization that provides free medical services to the homeless would include wages paid to a nurse in Column B, as this expense is incurred to directly further the mission of the organization. However, wages paid by the same nonprofit to a bookkeeper, receptionist, or grant writer would be considered administrative or fundraising expenses. I also like to compare lines 5, 7, and 10. Salaries paid to staff should be treated as payroll costs, and as such the organization must pay applicable federal and state payroll taxes. A charity that pays all staff as independent contractors may be trying to avoid payroll tax expenses, although this certainly is not always the case. I only consider this a red flag if it appears to reflect a pattern of irregularities on Form 990 for that particular nonprofit.

Continuing with Part IX, take a look at Legal Fees (Line 11b). It is not uncommon for a nonprofit organization to incur legal fees as part of normal operations. Quite simply, once in a while you just need a lawyer to help with writing a contract or answering some questions. This line is a red flag if costs are excessive, as this may indicate that the organization is involved in a lawsuit of some sort.

Line 25 provides the totals for all expenses in each column. As stated before, a nonprofit organization should be spending the majority of its dollars on the programs that support its mission. By dividing the total of Column B by the total of Column A, we can see the percentage being spent on program services. A donor can use this information to determine whether the organization is spending funds wisely. If exorbitant amounts are being spent on fundraising and administrative costs, I typically will not donate to the organization. It is important to note that organizations in their first years of operation may incur higher fundraising costs as they develop a funding base. However, if an organization consistently spends a high percentage of funds on fundraising and administrative expenses, I will likely move on to find a charity that is a better steward of its money.

Part X of Form 990 is the balance sheet, which details the organization’s assets, liabilities, and changes in net assets over the year. If Line 26 (Total Liabilities) is greater than Line 16 (Total Assets), this may be indicative of an organization in financial difficulty. However, if Unrestricted Net Assets (Line 27) are sufficient to cover the liabilities, the difference may simply be a matter of timing in paying bills at year-end. This is another situation where having access to Form 990 for multiple years may be helpful, as you can determine if the deficit seems to be increasing over time. If so, the organization may be in poor financial health. A significant jump in liabilities from one year to the next without a corresponding increase in assets may also be cause for concern.

These points provide merely a cursory review of Form 990 for those who may otherwise be unfamiliar with the document. A review of Form 990 should not be relied upon for a complete picture of a nonprofit organization, but it can provide general insights into an otherwise unfamiliar organization which is vying for your charitable contributions. Do your homework, and then give generously to the nonprofit organization of your choice.


Category: Accounting, Apex, Bookkeeping, Cary, Nonprofit, Payroll, QuickBooks, Small Business, Uncategorized

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  1. Hi just wanted to say that I like your article very much. Please keep up the good posts Thanks a ton! and Have a good day