The Overhead Myth and a Call to Action for Nonprofits

By now you’ve probably seen the letter to donors – written and issued by the BBB Wise Giving Alliance, GuideStar, and Charity Navigator – imploring them to consider results rather than overhead expenses when funding nonprofits. It’s powerful and important.

The trio just released a second letter – this time to the nonprofit organizations themselves – in which they ask three things of NPOs to help squash the Overhead Myth. Here’s the gist of how they suggest doing so:

  • Share data about your performance in order to demonstrate why donors should trust you.
  • Manage towards results and understand your true costs.
  • Educate funders on what it costs to achieve results.

The letter notes that, “As a field, we can move beyond the Overhead Myth to an Overhead Solution, but we need your help.” You can read the entire letter, find a list of great resources, and download a toolkit to help you navigate this process on the Overhead Myth website.

Common State Tax Misconceptions about Non-profit Organizations

By Kim Hunwardsen

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Many non-profit organizations, and companies that do business with them, make innocent mistakes that affect their state tax liability.

In recent years, non-profit organizations have found themselves to be recipients of state sales and use tax audits. In many instances, the resulting assessment was large and caught these organizations by surprise. This current trend has not only affected these non-profit organizations, but also their vendors, suppliers, service providers and any others that deal with them. Generally, the large assessment is not the result of impropriety or intentional disregard of the law, but a misperception of the rules as they apply in the tax arena to non-profit organizations.

Misconception # 1: All non-profit and 501(c)(3) entities are tax exempt, thus, THAT MEANS ALL taxes.

The terms “non-profit” and “tax exempt” are not necessarily interchangeable. A non-profit organization is one that conducts business for the benefit of the general public without shareholders and without a profit motive. But, just because an organization does not have a profit motive, does not mean that legislatures have exempted them from all taxes.

Generally, 501(c)(3) entities are exempt from federal income tax under the Internal Revenue Code. Although most states follow the exemption from income tax for 501(c)(3) entities, NOT all states unilaterally exempt 501(c)(3) entities from income tax. Additionally, even though an entity is exempt from state income taxes it may still be subject to a litany of other types of taxes such as sales and use, fuel, property, payroll and a variety of other state and locally imposed taxes.

First, a non-profit organization must meet specific tax exemption requirements as outlined in the laws for each specific state. One common non-profit error is assuming that an exemption from state income taxes ALSO includes state sales taxes. This is not the case. Most states require a separate application for exemption from state sales taxes, and the tests are very different from those allowed for income tax exemptions. Typically, it’s harder to obtain a state sales tax exemption than it is to obtain a federal income tax exemption because state requirements are more stringent.

For example, if a non-profit has a retail store, or if it has lost its tax exempt status, the non-profit’s activities will be taxable. Further, it is important to be aware of the many exceptions that apply to non-profit entities. Well-established case law denotes that the burden of exemption is on the entity, NOT on the government or tax enforcement agency. Exemptions are a matter of legislative grace, thus, they are rigidly enforced.

Misconception # 2: Every state treats non-profit organizations the same.

This misconception usually is the result of businesses being familiar with the laws of one state and assuming that they can apply those general principles to the laws of other states. Although there are similarities, entities and transactions are not treated the same in every state. For example, Texas is quite generous with 501(c)(3) entities and gives large latitude for exemptions amongst non-profit entities. South Dakota, on the other hand, is much less generous and has strict guidelines on entities in order to allow certain tax exemptions. Thus, assuming that Texas exempt non-profit laws apply to a transaction with a South Dakota non-profit could result in a significant misunderstanding; and, possibly, large tax assessments, if the non-profit were ever audited.

Misconception # 3: A copy of the IRS determination letter is all that is needed to show that an organization is tax-exempt.

As mentioned above, most states require a separate application to establish tax exempt status. To evidence the tax exempt status, many states and cities have entirely different exemption certificate letters or permits which are different than that received by the IRS. The specific state or local exemption certificate must be provided to a seller to execute an exempt transaction. In some states, even the timing of the receipt of the exemption certificate can determine if the exemption is valid.

For example, in Colorado, the 501(c)(3) letter is adequate to attain the state exemption, but not for many home rule cities, which administer their own separate set of sales and use tax laws.

Therefore, it is important to know the proper documentation requirements in the states in which a non-profit organization operates and the applicable time frame for obtaining the correct documentation in each jurisdiction. If a non-profit does not follow the appropriate process and documentation to verify tax exempt status, the result could be costly.

Misconception # 4: All transactions with governmental agencies and governmental entities are exempt from all taxes.

While the Federal government itself is typically exempt from state taxation based on the Supremacy Clause of the U.S. Constitution, it is not always the federal government itself that is ACTUALLY making purchases. Instead, entities working under a government contract might make purchases, acting as an agent for the Federal government. Often states view such transactions and the taxation decision quite differently. In addition, each state has its own rules about the taxability of transaction with its own government, quasi-government entities and the governments of other states. Therefore, treating all transactions with governmental entities the same could have costly tax consequences.

South Dakota, for example, exempts the purchases by the other state governments and the District of Columbia if that state provides a similar exemption for South Dakota government entities. This means, one has to look to the other state in order to determine if the South Dakota exemption will apply.

In conclusion, non-profit organizations need to be aware of the following:

  • The laws in your state or applicable states where your non-profit organization is operating, whether on its own or its agents;
  • What types of entities and transactions are subject to sales and use tax; and
  • The proper documentation needed to substantiate a tax exempt transaction.

It is the responsibility of the non-profit organization to understand applicable tax implications. For assistance or to learn more, please contact your tax advisor.

FASB to Develop Draft on the Not-for-Profit Financial Statement Project for External Review

Due to feedback provided by the Not-for-Profit Advisory Committee (NAC), the Financial Accounting Standards Board (FASB) reconsidered in its October meeting two positions

on areas affecting the intermediate measure of operations to be reported in the statement of activities:

  • The treatment of capital gifts
  • The use of board designations and transfers

NAC members previously expressed concern over the cost and complexity of making certain changes in the areas of capital-like transactions and board designations, appropriations, and similar transfers (collectively referred to as transfers).

FASB

FASB

FASB is now proposing that not-for-profit (NFP) entities would report the receipt of gifts of long-lived assets without donor restrictions as operating revenue. When the assets are placed in service (instead of being sold), the NFP would report a transfer out of operations for the entire amount of the gifted long-lived asset. (This is a welcome change that reduces the complexity of FASB’s prior decision, which would have required entities to report a transfer out of current operations for the amount of the gifted long-lived asset expected to be utilized in future periods, and back into current operations in subsequent periods to the extent long-lived assets are utilized during the current reporting period.)

The revised position reflects the view that, when an NFP begins using a capital asset, the revenue generated from the activities related to the asset will be matched with the depreciation recorded on the asset. Both are recorded in current operations.

Gifts of cash that are donor restricted for the acquisition or construction of long-lived assets would initially be reported as revenue that increases net assets with donor restrictions, which is reported outside of operations. When the asset is placed in service, the release of the donor restriction would be reported as an increase in net assets without donor restrictions (within current-year operating activity) and a corresponding decrease in net assets with donor restrictions. This amount would be reported as a transfer from operations to non-operating activities, similar to the treatment of long-lived assets, and there would be no transfers back into operations in subsequent periods.

FASB also addressed concerns about the degree of flexibility regarding board designations, appropriations, and similar transfers. They concluded that several key requirements were necessary:

  1. Present all transfers in a separate, discrete section in the statement of activities.
  2. Include a subtotal of operating revenues and expenses before and after such transfers.
  3. Present the aggregate of transfers out of operating activities separate from of aggregate transfers into operating activities.
  4. When an NFP does not present all transfers as discrete line items in the statement of activities, it should provide details for aggregated transfers in a note to the financial statements.
  5. NFPs must describe the purpose, amounts, and types of transfers incurred, e.g. transfers arising from standing board policies and those arising from one-time decisions.

FASB directed staff to prepare a draft on the Not-for-Profit Financial Statement project for external review, and will wait for the results of this review before voting on issuing a proposal, expected in early 2015.