Nonprofit Organization Tax Filings: Building the Accounting System to Capture the Right Information

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It is not uncommon to see Section 501(c)(3) nonprofit organizations, especially smaller 501(c)(3) nonprofits, not have in place the elements needed within their accounting systems to track various items needed to comply with their tax filing obligations. Building these elements in systems on the frontend rather than attempting to produce or reconstruct the tracked information on the backend makes tax compliance much easier and leads to better results.

The major tax filings of nonprofits are public information and are frequently scrutinized by other nonprofit and philanthropic organizations, government agencies, journalists, academics, and others. Lower quality tax filings can quickly end up becoming a major problem and hurt a nonprofit organization’s growth, public relations, fundraising efforts, and ability to fulfill its mission. A few items that may be noted in lower quality filings are:

  • Filings where it appears many of the items required to be tracked and disclosed have not been properly tracked and disclosed
  • Minimal or generic program descriptions without detail on the activities and accomplishments of the organization 
  • Minimal disclosures regarding the governance structure of the organization, including how compliance with the conflict of interest policy is enforced, compensation is determined, grants are awarded, and the nature of board policies and practices.
  • Financial information presentation that doesn’t make sense or is internally inconsistent

As a brief sampling, five examples of some of the items that nonprofit organizations need to account for to fully comply with their tax filing obligations along with considerations as to how to account for the items are:

  • Nonprofit organizations will need to track and report program service revenue and expenses by program. Program service revenue is revenue received in connection with the basis for the organization’s exemption from income tax. Examples would be tuition received by a school, ticket sales, and registration fees for certain types of programs and services provided. Program service revenue does not include contributions and investment income. Program service expenses are expenses associated with the programs of the organization rather than management, administrative, or fundraising expenses.

Defining what the programs of the organization are and building in a way to track revenue and expenses by program is critical. Often the use of the “class” or similar feature within accounting software can be used to track this.

  • Nonprofit organizations need to track contributions by specific donor. One of the reasons for this is certain types of 501(c)(3) organizations are required to show that they are supported by a sufficiently broad base of the public as opposed to just one or a few individuals in order to be considered a “public charity” as opposed to a “private foundation.” For purposes of certain tests donors will have to be combined and treated as a single donor, such as when the organization receives donations from someone who is a family member of another donor or a corporation or another form of business entity that the donor has an interest in. 

Another reason is that 501(c)(3) organizations are required to disclose contributions from a single donor over a certain amount each year.

Organizations should build the capability to track donations by donor into their accounting systems – this will of course also be useful in terms of future fundraising and donor acknowledgement and outreach.

  • Nonprofit organizations are required to carefully track and disclose certain details regarding transactions with a specific group of individuals defined as “interested persons”, which include persons who have made substantial donations to the organization and their family members and businesses in which they have an interest, board members, officers, certain employees, and others. Loans, grants, certain forms of compensation, and other types of transactions are required to be reported.

Accounting systems may make special identification of these transactions so they can be easily extracted or examined as needed.

  • Nonprofit organizations report revenue in tax filings with more detailed classifications than most other forms of organizations. Revenue needs to be broken down by source between dues, fundraising events, government grants, and “federated” campaigns (donations received from organizations such as The United Way).

Tracking revenue on this basis can be accomplished by ensuring the chart of accounts contains accounts for each of these sources of revenue and ensuring that when a new contributor makes a donation the contributor is correctly classified.

  • Nonprofit organizations are generally required to disclose grants made. Disclosed information includes the for-profit/not-for-profit status of the grantee, the employer identification number of the grantee, and the purpose of the grant.

A best practice is to ensure all the needed information is collected at the time the grant is made or shortly thereafter.

A trained accountant can provide value to nonprofit organizations by addressing these challenges and others – for example, by ensuring accounting systems are well-designed to efficiently capture necessary information to produce reports and required filings, consulting on accounting policies and practices, budgeting, forecasting, and other matters. 

Pease CPA’s has a team of certified public accountants and consultants who specialize in accounting for nonprofit organizations.

If you are interested in learning more about how Pease CPA’s can help you with your nonprofit organization’s accounting and finances, please contact Brian Spencer at bspencer@peasecpa.com or 216-472-3852.

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