Armanino Nonprofit Blog

Armanino Nonprofit Blog

Welcome to the Nonprofit Blog hosted by the professionals at Armanino, CPAs & Consultants. This blog is set up to inform nonprofit organizations of trends, rule changes, best practices and free educational offerings that we have built to support nonprofit organizations. Our professionals bring you their insights from an accounting and organization perspective to help nonprofits reach their goals. We support our clients with advice, direction and best practices.

Tuesday, March 31, 2015

A Lesson in Status: Learn from Insurer’s Tax Woes

The Los Angeles Times reports that the nonprofit Blue Shield of California—the state's third-largest health insurer—has been stripped of its state tax-exempt status, and may be on the hook for tens of millions in state taxes each year moving forward. The insurer’s California status was revoked in August of last year (it’s just now becoming public) and it lost its federal exempt status in the 1990s.

Trouble for the California “Blue” started with a state audit investigating the insurer’s justification for its tax-exempt status. In the past, Blue Shield has been criticized for rate increases, executive compensation and large financial reserves.

And it’s not just the Golden State.

Community advocates, state and municipal tax commissions, and state attorneys general across the country are crying foul, saying that modern not-for-profit hospitals and health systems have violated their "explicit or implicit contract" to serve uninsured patients in return for significant tax breaks.

A number of hospitals and health systems have received letters from the IRS requesting documentation on executive compensation and benefits, deferred compensation plans and charitable care. In some circumstances, these soft audits have led to full-blown IRS scrutiny.

Could Your Organization be Next?

The battle being waged over the legal status of not-for-profit hospitals and health systems underscores just how important it is for nonprofits of every stripe to actively maintain their tax-exempt status. Here are a few things to watch:
  • Compensation: If executive compensation is too high relative to the job performed, an organization can find itself caught up in the web of “intermediate sanctions”—special punitive taxes created by Congress.
  • Inurement: The area that poses the greatest risk of inadvertent noncompliance is what the IRS calls “private inurement.” Here, regulations prohibit any part of the organization’s net earnings (or operations) from accruing to the benefit of private shareholders or individuals.
  • Political activities: While 501(c)(3) organizations are legally entitled to lobby and advocate for the causes and constituents they represent, they are prohibited from participating in partisan politics—working directly for a political party or candidate, for example. In addition to revoking nonprofit status, the IRS can assess a special excise tax against the organization and its managers, which includes board members.
  • Mission: To ensure adherence to your organization’s mission, board members should regularly review the mission statement, organizing documents and programs. If your 501(c)(3) organization decides it wants to change its mission, you must make sure that your new activities are, in fact, a permitted purpose under your home state’s nonprofit corporation statute and, if so, amend your articles of incorporation. You would also need to amend the registration(s) you have on file with state charitable solicitations officials as well as notify the Internal Revenue Service through a letter specifying the changes from your original application, Form 1023.
In this era of increased scrutiny, nonprofits must take steps every day to protect their tax-exempt status. Start by reviewing the IRS’ informative online training tools at www.stayexempt.org.

Monday, January 12, 2015

Five Executive Directors Went for a Walk

At a recent retreat of the Alliance of Arizona Nonprofits, an apocryphal tale made the rounds and helped frame the discussion. Here’s the way Mark Rosenman, a professor emeritus at the Union Institute & University, tells the tale: 
During a break at a nonprofit leadership retreat, five executive directors went for a walk beside a small river near the conference center. Suddenly, they noticed a group of toddlers being swept downstream. As they looked on in horror, the number of babies in peril grew.
One of the EDs jumped into the river and started to grab kids, throwing them one-by-one up onto the dry riverbank to save them. A second ED also jumped in and steered some of the babies toward a section of the river that was calmer, where she began to teach them how to swim.
Then a third ED jumped in and began to organize the now-swimming toddlers to teach their non-swimming peers how to help themselves. The fourth ED turned and started to run back to the conference center, telling the others he would round up some volunteers, solicit donations of dry clothes, raise as much money as he could to support rescue efforts, and secure technical assistance with the goal of making those efforts more efficient and effective.

The last of the EDs ran off in the other direction. When her confused colleagues asked where she was going, she said she was headed upstream to see why so many babies were falling or, worse, being thrown into the river.
In his blog, Rosenman wrote, “We know that nonprofit organizations, to be successful, need to use all five of those strategies—and more—but that even the best-run charity is doomed to a Sisyphean future unless its leaders think about what's happening upstream. It's not enough for a nonprofit to provide services; it must always be thinking about the factors that created the problem in the first place, and what it can do to address and ameliorate the problem.”

This seems a good time for the nonprofit community—executives, donors and staff, and even recipients—to look in the mirror. The goal of being all things to all people clearly isn’t sustainable. But neither is business as usual.

In the private sector, cooperation in the form of partnerships are ‘in.’ Perhaps the same should be true among nonprofits. That way, we can rescue more babies from the river, teach them survival skills, stop the underlying cause at the source and achieve broad financial support for our efforts.

Now that’s a story with a happy ending.

Click here to read the complete post from Rosenman’s blog post "How the Charitable Sector Keeps Us All Afloat" on Philanthropy News Digest.

Monday, December 15, 2014

5% of Total Revenue: The Cost of Fraud

Whether it’s misappropriation of funds, corruption, kickbacks or filing misleading financial statements, fraud is costing businesses 5% of total revenue, new figures suggest. That’s $3.7 trillion, with a median loss of $142,000 per incident. And businesses recover some of the losses in only half the cases. In virtually none of the cases is restitution complete.

The picture is even worse for nonprofits, where disclosure of fraud can raise questions about management controls and sap the enthusiasm of donors.

Yet just 19% of private companies are taking the single most effective step to deter fraud, Armanino Partner Jeff Stegner and Natalie McFarlin, Manager in Armanino’s forensic and valuation services practice, said in a recent webinar. That tool?  A simple employee hotline for reporting tips.

“Red Flag” systems allow employees to call a toll-free hotline or log into a website 24/7. Tipsters can remain anonymous. Tips are routed through independent third parties who then turn over the details to the appropriate company officials for investigation and action.

The Sarbanes-Oxley Act requires such hotlines for public companies, but private companies and nonprofits have been slower to adapt the simple measures. Statistics offered by the Association of Certified Fraud Examiners show 43% of fraud cases come to light because of an employee tip. That’s by far the most effective counter-measure available. Fraud cut off by hotline tips are also 41% less costly and are detected 50% more quickly than those uncovered by other techniques from surprise internal audits to management controls. 
Fellow employees are best positioned to spot some of the behaviors that should cause concern:
  • Employees who like to work early or late, when they are alone in the office
  • Employees who never take time off and resist training anyone else in their duties
  • Employees who live above their means
  • Employees who are unusually close to vendors or customers
There are certain patterns that characterize most fraud:
  • Pressure on the employee, from family emergencies to simply a need to keep up with the Joneses
  • Opportunity, usually a combination of misplaced trust and substandard controls
  • Rationalization, a belief that the actions are justified for some reason—from a feeling their efforts are undervalued to a belief they funds can be repaid before anyone notices
There are a lot of steps nonprofit management can take to reduce the risk. But none is as inexpensive or as effective as the employee hotline. It sends a clear message management cares and is setting an expectation of ethical behavior. And it works.

To learn more about fraud prevention and Armanino’s new fraud hotline, visit Armanino's events page, click on "archived" tab, and select the webinar recording titled Fraud - What Every Nonprofit Needs to Guard Against.

Saturday, November 22, 2014

New Reports Show Foundations Lead the Way as Nonprofit Sector Continues to Grow

Back in 2012, America was slowly climbing out of the Great Recession, and foundations were leading the way by distributing a then record $52 billion. A year later, foundations again broke the record by distributing $54.7 billion. The numbers come from a new report—Key Facts on U.S. Foundations—released by the Foundation Center in New York City, and they paint an encouraging portrait of a nonprofit industry that continues to move forward.

The Foundation Center’s report showed there were 86,192 foundations with an aggregate $715 billion in assets. Here is how that breaks down:
  • Independent foundations control 82% of the assets ($584 billion) and gave 68% of the 2012 $52 billion total, or $35.4 billion.
  • Community foundations made up only 1% of the total number of foundations but had 9% of the assets and gave 10% of the total dollars. 
  • Health and education led the way as the top focuses for grants, at $5 billion and 22% of total giving each. Grants for human services accounted for the highest number of grants, at 42,037. The median grant amount was $30,000. Some 58,000 organizations worldwide received these grants, but nearly half of the $22.4 billion went to 1%of the recipients.
  • Internationally, health was the greatest focus for grants, with $2.2 billion going overseas for health causes. International development and disaster relief organizations received $1.2 billion. The Gates Foundation, which gave $2.6 billion internationally in 2012, has been the top international funder since 2004. The Switzerland-based World Health Organization was the top recipient of international grant dollars in 2012.
The Foundation Center’s report comes on the heels of the Nonprofit Times’ recent 25th annual snapshot of the nation’s largest charitable organizations. The 2014 NPT Top 100 reported total revenue of $70.067 billion, up 3.19% compared to last year while public support was up 5.6%, to $34.931 billion.

Those gains were posted against strong headwinds. Government support declined 5.6% and investment income was down 6.26%. Nonprofits compensated by leveraging “other revenue”—that which comes from sources outside the nonprofits core mission—to post a 20.5% gain. The larger category of ‘program revenue’ was up 2.19% for the same period.

Download the Reports

You can download a PDF version of Foundation Center’s Key Facts on U.S. Foundations report here. A copy of the Nonprofit Times’ 2014 NPT Top 100  report can be found here.

Monday, November 10, 2014

Not All States Are Equal: Fundraising Campaigns and Professional Solicitors

Many of America’s largest and best-known nonprofits trace their success, at least in part, to fundraising campaigns handled by professional solicitors. But in an era when states, and even some localities, are busily trying to register and regulate fundraising activities, what happens when something goes wrong?

A new case in South Carolina puts a sharp point on the question with a $1.054 million fine levied against Strategic Fundraising, a well-established firm based in St. Paul, Minn. According to various media reports, Secretary of State Mark Hammond cited the fundraising firm on Oct. 22 for a series of violations involving misrepresentation and failure to register individual solicitors as required by state law.

The charges are based on state officials monitoring 350 calls after receiving citizen complaints. What they found, according to a report in The Nonprofit Times, involved failure to disclose that the fundraisers were paid professionals, failure to disclose the name and location of the soliciting firm, and misrepresentation of the percentage of donations going to the nonprofit’s programs.

“What makes this case so egregious is that these were ‘robo-calls’ in which the individual solicitors were using pre-recorded scripts,” Hammond said in a statement. “This wasn’t a situation in which an individual caller made a mistake and went off script, these disclosure violations were a result of deliberate choices made by a professional fundraiser.”

And this isn’t Strategic Fundraising’s first brush with South Carolina law. In 2009, it signed a voluntary agreement of compliance promising to toe the line. Instead, it is now facing the largest fine of its type in a decade. Often in such cases, fines are reduced after negotiation. But that can’t undo the black eye suffered by the charities involved.

The takeaway here is the responsibility doesn’t end when the contract is signed. Your name, your reputation rests on every interaction with a potential donor. Due diligence extends to reviewing the script and asking about compliance procedures. Anything less has the potential to backfire with disastrous repercussions that may take years to undo.

Friday, October 31, 2014

Benchmark your way to donors

Nonprofit CFOs have a responsibility to be their organization’s fiscal educator. In fact, an estimated 75%  of the staff at any nonprofit doesn’t understand the financial side of the operation, and that’s a missed opportunity.

For example, think of a child trying to raise money as part of a school project. The child can turn to relatives and achieve one level of results. But if the child can take the message to everyone in the social media contact list of all of those family members, the results rise exponentially.

The same can be true for nonprofits, if they can successfully arm their staff and even their volunteers to tell the nonprofit’s story. The only way that can happen is if the CFO can use the numbers to validate the nonprofit’s position and give this army of new fundraisers a compelling story to tell.

Building that story starts by benchmarking your nonprofit’s performance in the key areas of financial stability, operational efficiency and areas of focus.  Identifying your peers isn’t as simple as it sounds. Perfect matches are rare and smart nonprofit CFOs look for similarities first before considering differences. Look at mission and size. Turn to your sector’s associations for ideas, help and in some cases data. Dig into the numbers from 990 forms, annual reports and Charity Navigator.

When identifying metrics, don’t identify more than 10 that tell your story best. Then, list the most important key performance indicators (KPIs) for nonprofits as:
  • Liquiity
  • Cash flow
  • Operating reliance
  • Program efficiencies
  • Fundraising efficiency

Armed with a story that uses benchmarked numbers that validate the nonprofit’s performance, an organization’s staff can be energized to share that story with their network, opening a whole new realm of potential donors. 

Of course, there are many other good reasons to benchmark your nonprofit’s performance. Executives and the board need the information to set policy and steer the ship. And talking with others who may have mastered a particular area can provide important insights that can improve your performance.

Wednesday, September 24, 2014

Treasury report shows nonprofits face back tax scrutiny

A new report from the Treasury Department’s inspector general paints a clear target on nonprofit organizations that haven’t been paying their taxes.

The feds found more than 64,000 tax-exempt organizations owed nearly $875 million in back taxes as of June 2012. Most of the unpaid bill  (69%) represented unpaid payroll taxes but unrelated business income and excise taxes were also a factor.

All in all, Treasury found about 1,200 tax-exempt organizations owed more than $100,000 each. Drilling down on what the inspectors considered the 25 worst offenders, the feds found $25 million in tax delinquencies, some dating back a decade.

As a result, the IRS imposed the Trust Fund Recovery Penalty on several officers of those organizations, all of which are 501(c)(3) entities. That levy is imposed on the “responsible person” in an organization that hasn’t paid its taxes. And the penalty is huge—100% of the unpaid amount levied against the individual.

Think you’re immune because you’re ‘just’ a volunteer? There is an exception in the law for unpaid volunteers serving in an honorary position. But that exception doesn’t hold if the feds can’t identify another “responsible person” within the delinquent organization.

The silver lining here is that the feds found more than 96% of nonprofits have been doing the right thing. While that’s encouraging, the report fires the kind of warning shot that should prompt nonprofit executives to take a close look at their practices.

Start by reviewing your records to make sure your organization is current on all its tax bills. Pay particular attention to those payroll taxes. Then take a close look at your internal controls to identify that “responsible person.” Ask yourself if the finding is what you intend and whether the person knows they could be on the hook if anything goes wrong. This is also a good time to check your directors and business officers insurance coverage.

While the Treasury and IRS disagree on next steps, this is the kind of issue that likely won’t go away. Uncle Sam has a long arm and an $875 million unpaid bill is enough to get his attention. Read the full report to learn more: http://www.treasury.gov/tigta/auditreports/2014reports/201410012fr.pdf.

Wednesday, September 17, 2014

Fraud takes a bite out of nonprofit revenue

A new report puts some important detail on an unfortunate truth: Fraud is a major drag on business.

Overall, fraud is costing business 5% of gross revenue, according to the biennial Report to the Nations on Occupational Fraud and Abuse authored by the Association of Certified Fraud Examiners. The media loss is $145,000, and in 58% of cases, there is no recovery. Small or large. Private, public or nonprofit. It doesn’t matter. Dishonest employees don’t discriminate.

Think of fraud as a triangle, Jeff Stegner, Partner with Armanino’s Forensic and Valuation Services Group, and I explained during a recent webinar focusing on fraud prevention in the nonprofit sector. The legs of that triangle are:
  • Pressure – An employee is in need and feeling pressure
  • Rationalization – An employee rationalizes the fraud as justified or an entitlement
  • Opportunity – An employee finds an opportunity to commit fraud
And opportunity is the only one employers can control. Our best advice involves tightening internal controls and putting your firm in a position to detect a crime. The report showed that 42% of fraud is discovered through a tip from an insider. Another 30% is uncovered by internal controls and internal audits. An additional 11% is discovered purely by accident.

At the bottom of the list at 3% is external audits, highlighting a crucial lesson. Don’t count on external auditors as a frontline detection strategy. That’s not what external audits are designed to do. But that doesn’t mean your auditors can’t help. Ask them for suggestions on how to tighten your internal controls to make fraud easier to detect.

Fraud comes in three main forms, the report said:
  1. Fraudulent financial reporting – This category of white-collar crime makes up just 9% of total fraud but carries a median loss of $1 million. As bad as that it, the figure is down from the $4.1 million median chronicled in the 2010 report. Sarbanes-Oxley reporting requirements deserve much of the credit.  
  2. Asset misallocation – This is the largest category, making up 85% of U.S. cases with a median cost of $130,000. The category includes everything from no-show employees to skimming, theft of supplies to fictionalized expense reports. 
  3. Corruption -- This is a larger problem overseas than in the U.S. but represents 37% of reported cases. (Some cases involve more than one category, sending the total over 100%). The median corruption case costs $200,000.
The old school anonymous tip hotline is one of the most effective steps employers can take. Employers with hotlines find 51% of detection comes from tips while that number dips to 30% for employers without hotlines.

Nonprofits aren’t immune from fraud. Almost 11% of cases involve nonprofits and carry a media loss of $108,000. A common factor is lax internal controls. Also, for small nonprofits, a few key employees are often forced to take on incompatible roles that can open the door to fraud. Rotating duties and roles can lessen the opportunity for fraud.

To learn more about fraud and prevention techniques, download the PowerPoint presentation or replay the entire webinar on our website.

Monday, September 8, 2014

Unrelated Business Income: Tax-Exempt Revenue Can Hang By a Thread

The term ‘unrelated business income’ sounds innocuous on the surface, a kind of catchall for items accountants can’t categorize. For the nonprofit community, however, nothing could be further from the truth.

A miscalculation that moves tax-exempt revenue into the taxable realm of unrelated business income (UBI) can be devastating. The nuances are so granular, only a CPA can explain the ins, outs and ramifications. This is why my recent webinar presented more than a dozen case studies to explain the subtleties nonprofits need to master to stay on the right side of IRS rules.

The whole area of UBI stems from concerns raised more than 50 years ago by for-profit entities over what they characterized as unfair competition from tax-exempt entities. To level the playing field, Congress moved from considering the use of the revenue to considering the source.

The test for falling out of tax-exempt status involves three elements, all of which must be present:
  1. The activity must not be substantially related to the tax-exempt purpose
  2. It must be a trade or business
  3. And it must be regularly carried on
Is a hospital cafeteria substantially related to the mission of the hospital? How about a college that leases unused land for a cell phone tower? How about a fundraising gala or that Christmas tree lot on the corner?

These are tricky issues, with lots of variables. In addition, these nuances often have to be sorted out by the courts, resulting in a complex set of exceptions and modifications.

Nonprofits can slip into UBI territory without even knowing it. Watch those hyperlinks. The IRS is on the lookout for links that lead to pages that can be classified as advertising or political content. That’s enough to poison a whole partnership and make any revenues taxable. And that can really hurt at a time when nonprofits are watching every penny.

To hear some additional scenarios and learn more about UBI, click here to access my recent webinar presentation and recording.