Restricted Area – Caution Advised
Mark Helland, C.P.A.

Mark Helland, CPA is a partner with the public accounting firm of Elliott, Dozier and Helland, PC (www.edhcpa.com) which is located in Tulsa, Oklahoma. Mark specializes in audit and tax related issues for church and ministry clients across the United States. For further assistance from Mark on this topic or for assistance on any other tax, accounting or church audit and compliance need, Mark can be contacted via email at [email protected] or by phone at (888) 893-1259 or (918) 488-0880.

In the current economic environment, our CPA firm has fielded a lot of questions regarding designated/donor restricted contributions received by non-profit organizations (NPO’s), specifically benevolence donations. While designated contributions for a specific program, such as missions in a church setting or disaster relief for certain NPO’s, are relatively straightforward, contributions designated for a specific individual or family are problematic. I will discuss this issue further in the article, but for now a brief explanation of “designated” contributions is in order.

Donors give designated contributions to an NPO for a specific purpose, in other words the donor “designates” exactly how the contribution will be spent. In contrast a non-designated or regular contribution to an NPO is available for the general operations of the NPO, with no restriction as to its use. Designated contributions must be held in trust by the NPO, to be used solely for the specific purpose defined by the donor. A designated contribution may be either temporarily restricted or permanently restricted. A “temporary” restriction is a designated contribution where the entire amount of the funds can be spent, but solely for the purpose defined by the donor. A “permanent” restriction is a designated contribution in which the entire principal balance of the donation must be held by the NPO as an endowment and only the investment earnings generated by the donation can be used by the NPO for the designated purpose. Here are the basic ground rules set by the IRS for designated contributions:

1. If the designated contribution is for a specific program of the NPO, the contribution will always be considered a tax deductible contribution for the donor.

2. Designated contributions for the benefit of a named individual such as a specific missionary or guest speaker/minister are potentially tax deductible, so long as the NPO exercises full administrative and accounting for the funds and the funds are spent in furtherance of the organization’s tax exempt purpose.

3. If the donor specifies that the contribution be spent for the benefit of a specific individual other than those mentioned in point two, the tax deductibility of the donation is much more complicated, as mentioned previously.

The IRS has consistently taken the stance that designated contributions to named individuals (even if for “benevolence” or financial hardship) are non-deductible donations. Again, I am referring to donations to individuals other than missionaries or guest ministers in a church or ministry setting. The reasoning as to why a donation to a specific individual would not be tax deductible is the concept of a “conduit.” The IRS does not want tax favored non-profit organizations to function as a conduit through which funds can be passed through the organization to specific individuals with the donor receiving a tax benefit. This is common sense as the impact is significant – the donor gets a tax deduction for the transfer of funds and the recipient of the funds gets tax free income. The possibilities for abuse or outright tax fraud between related parties is a significant issue that NPO’s should be aware of when asked by a donor to give the donation to a specific person.

Given the ongoing weak economy, I am seeing more and more of the situation described in the previous paragraph, where an NPO is asked to accept a donation to provide benevolence to a specific family. In these cases, the NPO really has three options:

1. Option 1 – The NPO can return the money to the donor.
2. Option 2 – The NPO can get a signed document from the donor to allow the donation to be allowed for another approved program or for general use. In this case, the NPO can accept the donation and provide a tax donation receipt to the donor.
3. Option 3 – The NPO can accept the donation and pass it through to the designated individual without providing a tax deduction to the donor. This assumes that the individual or family is a valid candidate for benevolence assistance.

One final recommendation on restricted funds that I feel is very helpful from an accounting standpoint is to maintain a separate bank account for designated gifts. By no means is this an IRS requirement and many organizations are able to successfully hold both unrestricted and restricted funds in a combined account. However, in my view it is a potentially dangerous practice to co-mingle restricted funds with unrestricted funds for a variety of reasons. It is easy to lose the history of restricted donations if these funds are not tracked separately. Also, it is easy for management to mistakenly believe that the cash balance for operations is higher than it actually is if restricted funds are combined!  Overall, designated funds require special care and tracking to ensure that the wishes of donors are honored.

 

This article is designed to provide accurate and authoritative information in regard to the subject matter covered. It is shared with the understanding that neither the author nor Tony Cooke Ministries is engaged in rendering legal, accounting, psychological, medical or other professional services. Laws and regulations are continually changing, and can vary according to location and time. No representation is made that the information herein is applicable for all locations and times. If legal advice or other expert assistance is required, the services of a competent professional person should be sought.

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