Going once, going twice
If you’re holding an auction, learn the rules of tax compliance Investment income
Recognize UBI when you see it What’s the difference between nonprofit and for-profit financial reporting? News for Nonprofits
NONPROFIT AGENDAS JUNE/JULY 2017
Sechler CPA, P.C. Carolyn Sechler
carolyn@azcpa.com 921 East Orange Drive, Phoenix, AZ 85014 Tel: 602.230.2700/Fax: 602.230.2705 www.azcpa.com
Going once, going twice If you’re holding an auction, learn the rules of tax compliance
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haritable auctions have long been lucrative fundraising and stakeholder engagement events. And the option of cost-effectively conducting online auctions has only made these activities more popular. But auctions also come with some tax compliance responsibilities, largely related to substantiating donations.
Acknowledging donations of auction items If you use an auction to sell merchandise or services donated to your charity, you should provide written acknowledgments to the donors of the auctioned items valued at $250 or more. You won’t incur a penalty for failing to acknowledge the donation, but the donor can’t claim a deduction without such substantiation. You can assist your auction item donors by providing a timely, written statement containing the name of your organization and a description — but not the value — of the donated item. The statement also should include: u A description and good faith estimate of the value
of any goods or services that your organization provided in return for the contribution,
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u A statement that any goods or services that
your organization provided in return for the contribution consisted entirely of intangible religious benefits, or
u A statement that no goods or services were
provided by your organization in return for the contribution.
Remember, it’s the donor’s responsibility to substantiate the value of a donated auction item.
Other rules for auction item donors Donors of services (for example, legal, beauty or personal chef services) may be surprised to learn that their donations aren’t tax-deductible. So make sure you alert them to this in advance. The same goes for the donation of the use of a vacation home or other property, including goods, equipment and facilities. You also may want to inform donors of property, such as artwork or fine jewelry, that tax law generally limits their deduction to their tax basis in the property (typically what they paid for it) — they can’t deduct the current fair market value (FMV) of the donated property if it’s higher.
How to satisfy sales tax obligations It’s important to remember that your organization’s exemption from paying sales tax when purchasing items isn’t an exemption from collecting sales tax when selling items. Charitable auctions are basically sales, and most states will require nonprofits to collect sales tax on the items sold. If your organization doesn’t normally engage in merchandise sales, you may need to register with the state to collect sales tax. Some states allow exemptions for “occasional sales,” though. Research the state and local sales tax implications before you hold your event to ensure compliance. Your CPA can help, if needed.
If you receive an item for auction valued at greater than $500 — and within three years sell the property — you must file Form 8282, “Donee Information Return.” You also must provide a copy of the form to the donor of the item. Form 8282 must be filed within 125 days of the sale. If you fail to file the form, penalties may apply. And if you receive a motor vehicle as a donation, you must provide Form 1098-C to the donor reporting the actual amount received for the vehicle within 30 days of the sale. The donor’s charitable deduction is limited to this amount.
Substantiation requirements for winning bidders A contribution made by a donor who also receives substantial goods and services in exchange (such as the item won in the auction) is known as a quid pro quo contribution. Under the IRS’s quid pro quo rules, nonprofits must provide a written disclosure statement to a donor who makes a payment of more than $75 that’s partly a contribution and partly for goods and services received. These disclosures are often required in the context of charitable auctions where the bids exceed $75. To take a charitable deduction, a donor must be able to show that he or she knew the value of
the item was less than the amount paid. So it’s a good idea to provide bidders with a good faith estimate of the FMV of each available item in the auction catalog. In the absence of a catalog, you can provide the FMV in the descriptions posted at the time of bidding. Include language notifying bidders that only the amount paid in excess of the FMV is deductible as a charitable donation. This will satisfy the written disclosure requirements.
To take a charitable deduction, a donor must be able to show that he or she knew the value of the item was less than the amount paid. The failure to provide the written disclosures can result in penalties of $10 per contribution, not to exceed $5,000 per auction. You can avoid the penalty if you can show your failure was due to “reasonable cause.”
Plan ahead As with most tax matters, you’ll be best off planning ahead to tackle issues related to a charitable auction. While the rules aren’t new, they are specific to each circumstance. n
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Investment income
Recognize UBI when you see it
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ost nonprofit leaders understand a principal truth of their tax-exempt status: The IRS generally considers any revenue they take in that’s not related to their mission to be unrelated business income (UBI), and that income is subject to tax. Nonprofits that don’t pay tax on that income face the possibility of back taxes, penalties and interest — and, in extreme cases, the loss of their tax-exempt status. When it comes to investment income, your organization must comply with some rather complex rules. The following provides information to help you identify UBI and stay on the right side of the law.
Debt-financed income is generally taxable While dividends, interest, rents, annuities and other investment income are generally excluded when calculating UBI, that’s not the case for income from debt-financed property. The income produced from a property that is debtfinanced will be taxable UBI in the same percentage as the debt is to the full acquisition cost. So 75% of any income or gain from a property with a loan for 75% of its cost will be taxable UBI. Such assets are typically real estate — for example, an office building with income from rents unrelated to the nonprofit’s mission. But the assets also could be stocks, or other investments purchased with borrowed funds. Income-producing property is debt-financed if, at any time during the tax year, it had outstanding “acquisition indebtedness” — debt incurred before, during or shortly after the acquisition (or improvement) of property if the indebtedness wouldn’t have been incurred but for the acquisition.
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Exemptions apply Some types of debt-financed property aren’t considered debt-financed property when calculating UBI. One type is property related to exempt purposes. If 85% or more of the use of the property is substantially related to a not-for-profit’s exempt purposes, it won’t be considered debt-financed property. And, thus, income from the property won’t be taxable. Simply using the income to support the organization’s programs doesn’t make the property related to the exempt purpose. The property must actually be used in providing program services. For the purposes of the UBI rules, debt-financed property also doesn’t include property used in certain excluded activities. This is property used in a trade or business that’s excluded from the definition of “unrelated trade or business.” That’s
either because it’s used in research activities or because the activity has a volunteer workforce, is conducted for the convenience of members, or operates to sell donated merchandise.
a for-profit or nonprofit. Such payments are included in the parent organization’s taxable UBI to the extent they reduce the subsidiary organization’s net taxable income or UBI.
Real property covered by the neighborhood land rule also isn’t considered debt-financed property for UBI purposes. The not-for-profit must acquire the real estate intending to use it for exempt purposes within 10 years and the property must usually be connected to other property the organization uses for exempt purposes. This favorable treatment will no longer apply, however, if the nonprofit abandons its intent to use the land for exempt purposes.
The IRS generally considers an organization to be “controlled” if the other organization owns more than 50% of the “beneficial interest” — either stock in a for-profit or voting board positions in a nonprofit. For instance, if a for-profit leases space from an organization that owns more than 50% of its stock, the lease payments are valid deductions from taxable income. But when these lease payments are received by the controlling nonprofit, they are included in UBI.
Payments from subsidiaries may be taxable Another situation where dividends, interest, rents, annuities and other investment income may be taxable is when that income is paid directly from a nonprofit’s “controlled” organization, whether
Increased scrutiny The IRS has increased its scrutiny of UBI in recent years. If you have any uncertainties about which investment income at your organization counts as UBI, talk to your CPA. n
What’s the difference between nonprofit and for-profit financial reporting?
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oard members and new staff from a for-profit background don’t always grasp the differences between the for-profit and nonprofit worlds. One area of significant variation is their financial reporting approach, including both goals and practices.
Chasing different goals As the term suggests, for-profit companies are driven by the quest to maximize profits for their owners. Nonprofits, on the other hand, are generally
motivated by a charitable purpose. From a financial perspective, they just want their revenue to cover the costs of fulfilling their mission now and in the future. Their respective financial statements reflect this difference. For-profits report mainly on profitability and increasing assets, which correlate with future dividends and return on investment to owners and shareholders. Nonprofits report on their financial position, stability and how their funds are used to funders, board members and the community.
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Reporting assets and liabilities For-profits and nonprofits use different financial statements for their reporting of assets and liabilities. For-profit companies prepare a balance sheet that lists the owner’s or shareholders’ equity, which is based on the company’s assets, liabilities and prior profits. The equity determines the value of a company’s common and preferred stock. Nonprofits, which have no owners, prepare a statement of financial position, which also looks at assets, liabilities and prior earnings. The resulting net assets are classified as: 1) unrestricted, 2) temporarily restricted and 3) permanently restricted, based on the presence of donor restrictions. The classes will soon be reduced to two: 1) net assets without donor restrictions and 2) net assets with donor restrictions. This change will take place when adherence to the new Accounting Standards Update (ASU) No. 2016-14, Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities, is required for fiscal years beginning after December 15, 2017. Another key difference: Nonprofits are generally more focused on transparency than are for-profit companies. Thus, their financial statements and footnotes include disclosures about the nature and amount of donor-imposed restrictions on net assets. The new standard will require more disclosures on the amount, purpose and type of board designations of net assets. Additional disclosures will be required to outline the availability and liquidity of assets to cover operations in the coming year.
Reporting revenues and expenses For-profits and nonprofits also take different reporting approaches to revenues and expenses. For-profits produce an income statement (also known as a profit and loss statement), listing their revenues, gains, expenses and losses to evaluate financial performance.
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Nonprofits often rely on grants and donations in addition to fees for service income. So they prepare a statement of activities, which lists all revenue less expenses, and classifies the impact on each net asset class. Many nonprofits currently produce a statement of functional expenses. But when the new accounting standard kicks in, organizations will be required to classify expenses by both nature (meaning categories such as salaries and wages, rent, employee benefits and utilities) and function (mainly program services and supporting activities). This information will need to be expressed in a grid format that shows the amount of each natural category spent on each function.
Similarities remain Despite their different approaches, for-profit and nonprofit organizations share some financial reporting similarities, too. Both must carefully track all of their transactions; maintain supporting documentation; and produce accurate, timely financial statements. And both can benefit from the services of qualified financial professionals with knowledge in areas specific to their organizations. n
NEWS FOR NONPROFITS Nonprofits running deficits The latest edition of an Urban Institute report has good news and worrisome news about the finances of the nonprofit sector. According to the 2016 edition of The Nonprofit Almanac: The Essential Facts and Figures for Managers, Researchers, and Volunteers, nonprofit revenues and expenses both increased from 2004 to 2014. And the sector’s size and growth were healthy even during the recession. In fact, the nonprofit sector has seen positive growth every year since 2000. But the report also highlights the gap between total revenue and expenses. Since 2008, the sector has seen deficits of 4%–8% of total revenue every year, suggesting that nonprofits have drawn down savings or opened lines of credit to sustain their operations. The report notes one highly significant expense area: wages. In 2003, nonprofits paid an estimated $425 billion for wages; by 2013, the figure had grown to $634 billion. Even accounting for inflation, this represents an 18% increase. But it’s worth noting that, between 2000 and 2013, nonprofit employment grew at an estimated 22%, faster than the overall workforce. n
GoFundMe touts donation-raising capabilities GoFundMe, the “do-it-yourself ” fundraising website, announced it’s helped campaigns raise more than $3 billion since it started in 2010, with a majority of those funds amassed in the past two years. For example, $11.2 million was raised through the site after the 2016 flooding in
Louisiana and $9 million after the nightclub shooting in Orlando, Fla. On the one hand, it’s possible that these campaigns are eating into donations that would otherwise go to more traditional nonprofits. On the other, nonprofits might be able to make better use of the platform, although they’d have to share about 8% of every donation with GoFundMe. n
Governments target nonprofits’ property tax exemptions As state and local governments struggle to deal with budget deficits, they’re increasingly aiming their sights at large nonprofits that have long been exempt from property taxes. Earlier this year, for example, the Illinois Supreme Court heard a case challenging a law that exempts the state’s nonprofit hospitals from property taxes. And in 2015, the New Jersey Tax Court determined that a nonprofit hospital in the state wasn’t entitled to a property tax exemption, leading various cities to challenge the property tax exemptions of 35 other New Jersey hospitals. Legislative changes are possible. Oregon, for instance, has several bills in circulation — one would create a study on ad valorem property taxation, which would tax nonprofits on a percentage of the assessed value or sales price of their property. And Massachusetts has considered several bills calling for “payments in lieu of taxation” by organizations exempt from property tax. n
This publication is distributed with the understanding that the author, publisher and distributor are not rendering legal, accounting or other professional advice or opinions on specific facts or matters, and, accordingly, assume no liability whatsoever in connection with its use. ©2017 NPAjj17
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The support you need. The service you’re looking for. Succeeding in the not-for-profit sector today requires more than a strong commitment to your mission. It takes shrewd fiscal management, careful regulatory compliance, skillful use of technology and the assistance of advisors who know the issues nonprofit organizations face and how to address them. This is where Sechler CPA comes in. Our team of experienced professionals cherishes the opportunity to support nonprofit organizations, meet their management challenges and fulfill their missions. We offer a variety of specialized accounting, tax and consulting services including:
k Audit intermediary services
k Tax form preparation (990, etc.)
k Budget and policy design
k Strategic and management consulting
k Financial statement preparation
k Speaking on financial literacy and other topics
k Outsourced accounting/bookkeeping
k Technology and virtual system design
RESPONSIVE QUALITY We are committed to providing responsive, personalized service to the highest quality. We take time to truly understand your Organization so that we can customize our recommendations to your specific situation. Our goal is to make your processes easier, streamline your operations and ensure your success in reaching your goals. We welcome the opportunity to discuss your mission and vision so that we may assist you with our expertise. Please call us at 602-230-2700 or e-mail carolyn@azcpa.com and let us know how we may support you. Be sure to visit our website at www.azcpa.com for additional tools and information, as well as our archive of this newsletter.
Sechler CPA, P.C. 921 East Orange Drive Phoenix, AZ 85014 www.azcpa.com