Many nonprofit organizations engage in some type of gaming activity on a regular basis, whether it’s through annual fundraising events or social events for their members. The main purpose behind these types of activities is to raise funds that are then used to further the organization’s exempt purpose (see Insights volume 1, issue 3 “Understanding a Charitable Organization’s Exempt Purpose” for discussion of “exempt purpose”). It’s important to note that gaming activities in and of themselves do not further the exempt purpose of most organizations, and therefore could be treated as taxable unrelated business income. Gaming Activities Examples of gaming activities include, but are not limited to, raffles, bingo, casino, and card games, scratch-offs, slot machines, and other games of chance. Although the IRS does not define all gaming activities, it does generally distinguish between games of chance and games of skill:

• Raffles are games of chance where the participant is required to give something of value in order to participate: cash or a required purchase of goods or services. Raffles are also referred to as lotteries.
• Contests are games of skill, where chance doesn’t determine a winner. Generally, contests aren’t considered gaming activities, even if those who participate are required to pay to play.
• Sweepstakes are games of chance where a participant isn’t required to give anything of value in order to participate (i.e., no purchase necessary) and are generally not considered gaming activities.

In all cases, wagers and similar payments aren’t considered to be charitable contributions, regardless of whether the participant wins or not. The entire purchase price of the raffle ticket or wager placed is deemed to be payment for goods and services. Not all states define gaming the same. Before engaging in any activity you believe could be considered gaming, be sure to check how the state where you’re holding the activity defines gaming and whether special licenses or permits are required to conduct gaming activities. As well, avoid online gaming activities if at all possible, as they can easily be considered interstate gambling activity, which is a violation of both federal and state gaming laws. 501(c)(3) Organizations and Gaming To qualify as a 501(c)(3) organization, the nonprofit has to operate exclusively for religious, charitable, scientific, literary, or educational purposes. Gaming activities are commonly thought of as charitable if run by a nonprofit organization. The proceeds from those activities may be used to cover expenses related to its charitable programs, but gaming activities themselves do not further any charitable purpose, and therefore must be an insubstantial part of a 501(c)(3) organization’s operations. There are no specific quantitative factors explicitly stated by the IRS to determine whether an activity is substantial or not, but all aspects of the activity will be taken into consideration when evaluating it: amounts raised, expenses paid, time spent, resources devoted. Section 501(c)(3) public charities must also be cognizant of their public support test and how their gaming and unrelated business activities might negatively impact their public support percentage. Funds raised from unrelated business income like gaming are not considered part of the “public” portion of the support test. If a public charity receives too much of their financial support from these non-public sources, they risk failing their public support test and could be classified as a private foundation. Private foundations also cannot have substantial financial support from activities classified as unrelated trade or business. Gaming activities could also be subject to unrelated business income tax, and the organization would need to report the unrelated business income from gaming activities on Form 990-T. Sections 501(c)(3) organizations also must not be organized or operated for the benefit of private interests or inure profits for the benefit of any private shareholder or individual. Any profits received from gaming activities must support the organization. Other Organizations and Gaming Social clubs and fraternal organizations classified as 501(c)(7), 501(c)(8), or 501(c)(10), as well as 501(c)(19) veterans’ organizations are exempt as providers of social and recreational activities for members and their guests. Those organizations are permitted to engage in gaming activities that involve only their members without risking their tax-exempt status. If such an organization opens its activities to the public, then its tax-exempt status would be at risk, and the income generated from those public gaming activities could also be subject to the unrelated business income tax. Social welfare organizations classified as 501(c) (4), and 501(c)(5) and 501(c)(6) labor and agriculture organizations and business leagues are treated similarly to 501(c)(3) organizations in that gaming activity cannot be a substantial portion of the organization’s activities, or it will jeopardize its tax-exempt status. Unrelated Business Income Tax As a general rule, gaming is considered unrelated to an organization’s exempt purpose and, therefore, should be subject to unrelated business income tax. There are exceptions and exclusions for certain types of gaming activities conducted by certain types of tax-exempt organizations, as outlined above. Three conditions must be met before an activity is classified as an unrelated trade or business activity: 1. The activity must be considered a trade or business. 2. The activity must be regularly carried on. 3. The activity must not be substantially related to the organization’s exempt purpose. Read the full Winter issue of Insights, the HBK Nonprofit Solutions quarterly newsletter.

A Q&A with Brooke Spencer, Executive Director, Wellfit Girls Program SWFL, Inc., and Ashlyn Reeder, HBK Nonprofit Solutions

Founded in 2014 to inspire teen girls to climb high in all areas of life, Wellfit Girls Program SWFL, Inc. is a unique and meaningful leadership, fitness, and empowerment nonprofit organization specifically designed to empower teen girls to believe they can do anything; to believe in themselves. The curriculum challenges teen girls to step out of their comfort zone and become confident and empowered leaders, teaching them interpersonal communication, conflict resolution, vision and goals, body positivity, and bold leadership.

Some programs conclude with a life-changing expedition where the participants are challenged physically and mentally while hiking with heavy packs in a changing alpine environment. Wellfit Girls follows a curriculum that guides teens through a combination of physical, mental, and interpersonal challenges designed to prepare them for the final expedition and the rest of their life. The struggles they experience on the mountain correlate to life struggles they may currently have or may have in future years and learn they can accomplish anything they put their mind to. The goal is to inspire and empower each girl while nurturing and developing each girl’s individual leadership style. They are building strong women to be our future leaders.

Reeder. The organization is still relatively young, having been founded in 2014. What has been the biggest challenge to date?

Spencer. I would say our biggest challenge is showing the community what we do and clearly defining who we are and the impact we have. Most people are accustomed to seeing quantitative data on the impact of an organization, whereas we have qualitative data on how our programs impact the girls we serve in the long term. We’re an organization that offers programs for all girls who want to learn leadership skills, gain confidence, and learn more about themselves. We believe all girls are “at-risk” to meet their full potential, and girls from all backgrounds have proven to benefit from the programs we offer. Our core philosophy has always been to serve one girl for an extended period so that we can make a sustainable, lifelong impact in that girl’s life. Wellfit Girls takes that core philosophy and expands it so we can operate on a larger scale.

There are also so many different aspects to what we do that defining it in one sentence is difficult to do. We have a holistic approach to wellbeing and reflect that in our programs and really aim to fill in all the gaps in these girls’ education and life.

Reeder. It is a more difficult mission to communicate, but as you said, the impact of the organization is more qualitative than quantitative. What are some of the longlasting impacts of the organization on the girls who go through the programs?

Spencer. When I’m asked this, I think about individual stories. One girl, for example, just went through yoga teacher training with myself and other facilitators and had been getting straight A’s in college. Before joining Wellfit Girls a few years ago, she never thought she’d even go to college as she had little to no support, was in the foster care system, and was a very shy and insecure Wellfit Girls follows a curriculum that guides teens through a combination of physical, mental, and interpersonal challenges that prepare them for the hiking expedition and ultimately the rest of their lives. teenager. She took the tools she acquired from our program and is now financially independent, succeeding in college and teaching yoga classes as a 20-year-old.

Another example that comes to mind is quite the opposite; where this girl came who to us from a stable family, was more of a “cool” kid and wasn’t sure what her goals were in life. Now she’s graduated from cosmetology school, is considering going to a four-year college, is very sure about what does and doesn’t serve her, and goes after what she wants.

There are so many other examples of girls who benefit in completely different ways; some graduate high school when they are at risk not to, some go to more challenging colleges than they originally considered, some enter male-dominated career fields, some become personal trainers and health advocates building upon what they learned during our programs, and many become active in the community and the nonprofit industry as volunteers or employees. I can share that most teen girls we serve ultimately build trust, confidence, resilience, optimism, and self-reflection as a result of the program. They have more positive and deeper relationships with peers and adults and believe they can do more than they ever thought they could. We aren’t a one-size-fits-all organization. Every girl will take something different away, which is what makes Wellfit Girls so special.

Reeder. These are all great examples and such moving individual stories. Now that the programs have been running for seven years, do Alumni play a role in how the organization operates?

Spencer. Yes, we have Alumni who are now serving as facilitators to our programs and as peer mentors. We recently established an Alumni Advisory Council, which operates similar to other youth boards, where a group of Alumni has been established as a council and has regular meetings. A representative of the council sits in at every Board of Directors meeting and gives a participant perspective to the issues the board discusses. Already the Alumni Advisory Council has established a $1,000 scholarship fund, performed fundraising, is assisting with recruiting, and doing what they can to support the organization in the capacity they’re able to.

Reeder. You recently went through and restructured your program operations, making the programs more accessible to a larger group of girls. Can you explain that process? What did you find to be your biggest hurdle in achieving this change?

Spencer. One of my strengths is strategic planning, and I think it’s really important for an executive director to think about the long-term sustainability of an organization and make decisions that inform that sustainability.

We’ve always struggled to get people to see the sustainability of our pinnacle five-month program because we focus all of our energy on making a lifelong transformational impact on a small number of students. What we’ve realized is that we now have the capability for accessing more girls and have started working with them at a younger age, for shorter periods of time, which leads them into our larger five-month program option.

I spent a lot of time creating a plan for the organization through evaluating our challenges and strengths that would allow us to continue to offer the five-month program while also offering shorter, less expensive, focused programs for girls to choose from. This also serves to fill in the gap of those girls who may not be able to commit to our full five-month program.

I think it’s important for an organization to regularly evaluate how they’re operating and whether it’s still sustainable, and to also seek out and bring in those with fresh perspectives into the organization.

Reeder. HBK is excited to see the next chapter of your organization. Wellfit Girls has been working with us since its inception. How has your experience with our firm impacted the organization and its goals?

Spencer. Working with HBK, and you specifically, has been one of the more consistent things we’ve had as an organization. You’ve consistently been the professional support we need, from helping us through financial challenges to making sure that we’re staying compliant as a nonprofit organization. We know that if we need your help, you’ll be there for us and that what you take on is one less thing we have to worry about because we know you’ll get it done, and you’ll get it done right. It’s such a huge value for us to have that kind of support and guidance; we couldn’t do what we do without it.

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As a nonprofit organization approaches the end of its life cycle, there are items to consider and filings to prepare that are inherently different from their for-profit counterparts. Nonprofits may cease operations for numerous reasons whether it be that they have fulfilled their mission or that they decide to merge with another tax-exempt organization. In either scenario, the board and management should be aware of the complexities involved, and should work with advisors that are familiar with nonprofit dissolutions. Many of the items discussed below should be accomplished under the guidance of an experienced nonprofit attorney. First, nonprofit organizations need board approval in order to dissolve the organization and there should be a consensus among board members that dissolution is the best path forward. When voting on dissolution, the board of directors should be mindful of what the bylaws dictate about dissolution and the time needed for complete dissolution of an organization. Even if operations have ceased for the organization, it must maintain at least the minimum number board members allowable as described in the bylaws. Moreover, if dissolution is indeed determined to be the best option for the organization, a plan of dissolution should be drafted detailing how assets will be distributed, and liabilities will be paid off. The board should maintain transparency throughout this process and inform donors of their plans. These organizations will also need to file articles of dissolution in all the states they operate in. Not all states have the same procedures with regard to dissolution of a nonprofit organization, therefore, it is imperative that the organization understand the specific procedures for the applicable states. Tax-exempt organizations that are ceasing operations must distribute their assets to another tax-exempt organization or to a governmental entity. Even during its dissolution, no individuals can inure to the earnings of a tax-exempt organization. It’s important to read the bylaws carefully to ensure that the assets of the organization are distributed to previously approved nonprofit and governmental organizations in the approved amounts or allocations. Other considerations include notifying any other applicable agencies to alert them to the dissolution of the organization. On the final Form 990-series filing, organizations that are dissolving, liquidating, terminating, or reducing their operations by more than 25% are required to complete Schedule N. These organizations would mark yes to either line 31 or 32 on the Checklist of Required Schedules on the main Form 990 (or line 36 on Form 990-EZ) and complete the corresponding part on Schedule N. The articles of dissolution or merger should be attached with Schedule N for filing. If not available, then the organization should attach a resolution from the board approving its termination or merger. Organization’s that have been fully liquidated, dissolved, or terminated should answer yes to line 31 and complete Part I of Schedule N, list the assts transferred out of the organization and complete the checklist. If all assets and liabilities were transferred out during the tax year, the balance sheet on the Form 990 should also reflect that there are no assets or liabilities at the end of the year. If the organization is in the process of disposing its assets during the year and disposed more than 25% but not 100% of its net assets, organizations should answer yes to line 32 instead and complete Part II on Schedule N. The final Form 990 or Form 990-EZ should be marked final. Please reach out to the Nonprofit Solutions Group for more information. We work closely with nonprofit attorneys who are experienced in the legal complexities associated with the dissolution of a nonprofit organization, and we can help you navigate the required financial disclosures and tax filings.

As the year draws to a close, many of our client conversations are about gifts—not so much about Christmas presents, but gifting to charities and other philanthropic organizations. The subject arises as we discuss year-end deadlines and planning. Considering the strong stock market performance of 2021, most of my clients are dealing with capital gains and how to plan around them, which is where gift-giving conversations begin.

Donating is one of the few options to decrease your tax responsibilities. Giving money to a charity also corresponds nicely with the season and the spirit of doing good for others. However, when I ask customers about their favorite organizations and programs to support, I discover that many of them have reservations. They are concerned about how some charities use their donations, particularly put off by the seven-figure salaries of some nonprofit organization executives. My interactions with my nonprofit foundation and charity clients, on the other hand, frequently revolve around annual receipts that fall short of income predictions and strategies to increase their donation receivables.

This is where taxpayers looking for deductions and nonprofits looking for donations can come together for their mutual benefit. An endowment can be the solution to both concerns.

The endowment double solution

For the donor, an endowment can perpetuate their gift by producing gifts for many years. In addition, an endowment can provide assurance the donated funds are used for programs they specify. For example, a donor might endow a certain position within an organization, like a chaplain in an assisted living facility who helped the donor’s mother adjust to her new way of life. Or an endowment could be used to fund educational scholarships for the donor’s field of study that allowed him to earn money during his career that he can now use to help others.

As an endowment is a way to ensure the funds gifted will be used only as the donor intends, it is also a powerful tool for charitable organizations looking to increase their donation receivables. The endowment is a permanently invested pool of money that provides a reliable source of income in perpetuity. The organization can count on the distributions annually to support its charitable work. The value of endowments was particularly evident in 2020 when making donations and supporting local charities was challenged by local lockdowns and the COVID- 19-related financial uncertainties, when the pandemic prevented charities from staging events and gathering people together to raise money. As the needs served by charitable organizations didn’t diminish with the pandemic—in fact, they increased—endowment income was for many organizations a lifesaver.

The endowment can hedge inflation and increase future spending power by implementing sound investment and spending practices. An endowment can generate a pipeline of gifts. Many endowment gifts are intended to be used at a later date, usually after the donor’s death. We frequently use life insurance to make small gifts during a donor’s lifetime and a substantial gift after they pass away. As a result, the endowment provides long-term financial security to the organization through delayed gifts. It can also position the organization for larger gifts in the future, as endowments frequently attract new contributors who want to support the endowment’s mission. Because of their long-term and future focus, endowments can attract committed visionaries, which can add to the endowment other assets, like real estate and cash. Their commitment to the project’s future often makes them annual donors.

In summary, the endowment is a powerful, donor-centered fundraising tool for givers and charitable organizations:

• As the gift is controlled by the donor and limits the use of the assets, the endowment solves concerns over the mishandling of donations.
• By assuring donors that their gifts will be used as they designate, an endowment can attract new donors and donations by specifically targeting projects or programs as well as by giving them the opportunity to designate the use of the funds.
• An endowment can provide perpetual income to help flatten gifting curves during economic downturns by reliably providing ongoing income.

An endowment can solve many concerns for both givers and receiving organizations this time of year when gift-giving and helping others is top of mind.

Read the full Winter issue of Insights, the HBK Nonprofit Solutions quarterly newsletter.

IMPORTANT DISCLOSURES

The information included in this document is for general, informational purposes only. It does not contain any investment advice and does not address any individual facts and circumstances. As such, it cannot be relied on as providing any investment advice. If you would like investment advice regarding your specific facts and circumstances, please contact a qualified financial advisor.

Any investment involves some degree of risk, and different types of investments involve varying degrees of risk, including loss of principal. It should not be assumed that future performance of any specific investment, strategy or allocation (including those recommended by HBKS® Wealth Advisors) will be profitable or equal the corresponding indicated or intended results or performance level(s). Past performance of any security, indices, strategy or allocation may not be indicative of future results.

The historical and current information as to rules, laws, guidelines or benefits contained in this document is a summary of information obtained from or prepared by other sources. It has not been independently verified, but was obtained from sources believed to be reliable. HBKS® Wealth Advisors does not guarantee the accuracy of this information and does not assume liability for any errors in information obtained from or prepared by these other sources.

HBKS® Wealth Advisors is not a legal or accounting firm, and does not render legal, accounting or tax advice. You should contact an attorney or CPA if you wish to receive legal, accounting or tax advice.

Mutual funds and ETFs are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.

You have engaged independent auditors to perform an audit of your financial statements, which is required by one or more of your funding sources. The auditors have provided you with the audited financial statements and have issued an unmodified opinion, meaning that your financial statements are not materially misstated, which is what you expected.

However, they also provide you with a management letter on internal control (internal control letter) that appears to list in detail everything they found wrong with your internal control during the audit. You do a great job making sure all of the accounting transactions are properly recorded and immediately become defensive; you did not ask for this letter, so why was it prepared? What will your funding sources think if they receive this letter? Will they stop funding your organization? What does this letter mean? What is the difference between a material weakness and a significant deficiency? What do you need to do to make sure that you do not receive another letter in the future?

This article will address these questions and hopefully, show you the benefits of the internal control letter to your organization.

Why did the auditor prepare this letter? Auditing standards require auditors to communicate in writing to management about material weaknesses and or significant deficiencies in internal controls discovered in an audit. The auditor is required to gain an understanding of internal control as part of the planning process; however, that does not mean that internal control is required to be tested in all audits. In most cases, auditors use walkthrough procedures to gain this understanding. They will review the organization’s procedures, noting the internal controls that are implemented, and then follow specific transactions through the process to make sure that it appears that the internal controls are working properly.

What will your funding sources think if they receive this letter? Will they stop funding your organization? This letter is prepared for and intended for management and those charged with governance, i.e., the board of directors, the audit committee, etc. This is a tool to assist management in improving the organization’s internal control and should not be provided to anyone other than these specified parties. This letter is not intended to and should not play a role in the future funding of your organization by those requesting the audit.

What does this letter mean? What is the difference between a material weakness and a significant deficiency? As mentioned previously, the auditor is required to communicate to management about material weaknesses and/or significant deficiencies identified during the audit. In addition, the auditor may also include “other matters” in the letter. Here are some definitions to assist with this question:

Deficiencies in internal control – these exist when the design or operation of a control does not allow management or employees, in the normal course of performing their work, to prevent, or detect and correct misstatements on a timely basis. For example, an employee electronically submits an electronic payment to a vendor for $15,000, but mistakenly records an entry for $1,500 and bank accounts were not required to be reconciled, this error would not be detected or corrected, and is therefore considered a deficiency in internal control, depending on the potential impact to the financial statement it could be a significant deficiency or a material weakness.

Significant Deficiencies in internal control – this is a deficiency, or a combination of deficiencies, in internal control that is less severe than a material weakness, yet important enough to merit attention by those charged with governance. For example, the organization’s accounts payable clerk prints all checks and provides them to the Executive Director to be signed without proper supporting documentation, i.e., approved invoices. One of the checks was mistakenly written for $3,500 instead of $2,500, the vendor was overpaid by $1,000, and since the difference was not significant, it was not questioned by the Executive Director.

Material Weakness in internal control – this is a deficiency, or a combination of deficiencies, in internal control, such that there is a reasonable possibility that a material misstatement of the entity’s financial statement will not be prevented or detected and corrected on a timely basis. For example, a new capital lease agreement is executed by the Executive Director for 20 new copiers and requested payments to be made electronically by automatic withdrawal, but mistakenly forgot to provide this information to the accountant. The organization does not perform bank reconciliation; these transactions will not be captured in the accounting records. In addition, the capital lease asset and obligation under the capital lease would not be recorded, which would result in a material misstatement to the organization’s financial statement.

“Other matters” in internal control – this could be a deficiency or simply another matter that the auditor wants to bring to the attention of management and those charged with governance. For example, the organization does not have formal job descriptions for the accountant that has been employed by the organization for more than ten years. If the accountant becomes ill and is unable to work for several weeks, it is likely that some of the accountant’s job responsibilities will not be done that could result in late tax filings, noncompliance with grants, etc. The auditor may want to inform management and those charged with governance of the matter.

The internal control letter breaks the deficiencies in internal control into the different types, material weaknesses, significant deficiencies, and other matters, as noted above. The internal control letter means that during the audit, it was noted that an internal control did not exist or the internal control was not working properly and did or could result in errors. The letter is a tool provided to management and those charged with governance to assist them in improving the internal control of the organization.

In addition to identifying the internal control deficiency, the auditor provides a recommendation to the organization to improve its internal control in order to eliminate those deficiencies. The auditor recommendations can vary in resources needed to implement the recommendation. It is the responsibility of management and those charged with governance to analyze the recommendation and determine if it is feasible to implement them, if another internal control could accomplish the same result at a lower cost, or if nothing should be changed and they are willing to accept the risk.

What do you need to do to make sure that you do not receive another letter in the future? The obvious answer would be to correct all of the deficiencies in internal controls that are provided by the auditor and make sure all existing internal controls are followed. The auditors are required to report on material weaknesses and significant deficiencies; if they do not exist, a letter is not required. However, with many small to medium-sized organizations, the costs to implement proper internal controls could be very costly. Therefore, I recommend that you start with eliminating the material weaknesses, those that have the greatest risk of a material misstatement. When analyzing the recommendations, try to find other lower-cost ways to improve the internal control.

However, should you be trying to avoid another internal control letter next year? The auditors have already done the work as required by professional standards; don’t you want to know what they have found and documented in their audit files? The letter should be used as a tool for ways to improve the internal controls within the organization. The organizations that are constantly analyzing and improving their internal controls are typically those that have fewer errors and misstatements noted during the audit.

You may think that the organization’s internal control is finally perfect, but then changes occur, you have accounting staff turnover, the organization changes their accounting software, the organization goes paperless, etc. When significant changes like this occur, typically, the organization is trying to quickly adapt to the change but forgets to adapt its internal controls. For example, an organization has decided to implement a paperless work environment. The organization’s accountant previously took the bank statement that was received by the bank, performed a reconciliation, printed it, and provided it to a supervisor to review and approve, which was done by initialing the reconciliation.

In the paperless environment, the bank statement is obtained online, an electronic reconciliation process is done, and then the supervisor is emailed that it has been completed and is ready for review. The supervisor opens the file, reviews it, and then closes it. Now, there is no documentation that the reconciliation has been reviewed. You may think that the review has been performed; therefore, internal control still exists.

However, how do you know that it has been done? Now, let us assume that the supervisor got behind on work after taking a few days off and forgot about reviewing the bank reconciliation. Now the control procedure has not been performed. If it is not documented, are we sure that it was done? It is important to include some form of sign-off procedure, even if it is in an electronic format. Therefore, an internal control letter is extremely important in years in which changes have occurred in the accounting or finance department or the organization itself to make sure that internal control procedures are adapted for those changes.

As you can see, if used properly, a management letter on internal control is a great tool to ensure that your internal control procedures are properly working and assist you in making improvements to prevent, detect, and correct misstatements that may occur.

Read the full Fall issue of Insights, the HBK Nonprofit Solutions quarterly newsletter.

Through the Coronavirus Aid, Relief, and Economic Security (CARES) Act and the Paycheck Protection Program and Health Care Enhancement Act (PPPCHEA), the federal government allocated $178 billion in Provider Relief Fund (PRF) payments to support healthcare providers through the COVID-19 pandemic. Because the money comes from the federal government—it is being distributed by the Department of Health and Human Services (HHS)—those accepting the money, including nonprofits, could be subject to Single Audit requirements, as outlined in the regulations at 45 CFR 75 Subpart F. Requirements for a Single Audit are triggered when an organization expends, in aggregate, $750,000 or more of federal funds in a year.

What you should know about the Single Audit Requirement:

• The federal government specifies that independent auditors should be engaged to determine whether the financial statements, including a schedule of expenditures of federal awards (SEFA), are presented fairly.

• In conducting a Single Audit, auditors look to ensure the entity complied with the terms and conditions of the federal award as well as test the internal controls of the organization relevant to compliance.

• The auditor you select should be specifically trained for and capable of conducting a Single Audit. Not all auditors or auditing firms perform Single Audits.

• The Office of Management and Budget’s (OMB) Compliance Supplement specifies the PRF reporting requirements.

• The entity, with assistance from the auditor, will be required to submit the audit through the Federal Audit Clearinghouse. The data will be analyzed to determine whether the money has been used as intended.

• Until recently, many healthcare providers were uncertain as to how to report their Provider Relief Fund expenditures. Financial statements for calendar-year organizations could not be issued because there was no definitive guidance or mechanism for reporting on their uses of the funds until July 1, 2021.

• The new reporting guidance includes hard deadlines for the use of the funds and reporting through both the PRF reporting portal and on the entity’s SEFA. However, entities are reporting expenditures in a manner they are not accustomed to. Audits for a particular year typically cover expenditures made during that year. But entities spending part or all of their funds in the year they receive them will not report on those expenditures until the following year (see chart below).

• HHS had indicated the deadlines to report are firm; there are no extensions.

What you should do now:

• Start gathering the information you will need, as indicated in the HHS reporting portal, including a wide range of demographic and financial information.

• Draft your SEFA and determine if you require a Single Audit.

• Document key positions regarding the calculations of lost revenue and qualifications of expenses in relation to PRF compliance requirements.

• Engage an independent auditor with the proper training and experience, one who is qualified and practiced at doing a Single Audit.

We are here to help. Call us at 724-934-5300; or email me at dmastropietro@hbkcpa.com.

As the new administration and other constituents are discussing income tax increases for wealthy Americans and lowering the estate tax exemption (currently $11.7 million), many Americans are wondering what planning opportunities are still safe for them to consider. Utilizing trusts as part of a charitable planning strategy could be an answer to some of the income and estate tax concerns that exist. This article will focus on several common charitable giving strategies available using trusts. Charitable Remainder Trusts (CRTs) Charitable Remainder Trusts (CRTs) pay amounts to one or more noncharitable beneficiaries (often the grantor) for their lifetime or over a fixed period of up to 20 years. The remainder is then paid to charitable beneficiaries at the end of the trust term. There are two types of distribution options that can be used when choosing the payment options to the income beneficiary(ies):

• Charitable Remainder Annuity Trusts (CRATs) which pay a fixed amount each year to the noncharitable beneficiaries (donor, donor’s spouse, or children); and
• Charitable Remainder Unitrusts (CRUTs) which pay a fixed percentage of the fair market value of the trust assets, generally valued at the beginning of each year.

The annual income distribution must be a minimum of 5% but no more than 50% of the trust’s assets. State law may impact the required distribution and should be considered when the trust is drafted. CRTs are typically not subject to income tax at the trust level. Instead, tax attributes are passed out to the income beneficiaries based on a calculation that takes into consideration the different tiers of income. Since CRTs are generally tax-exempt, they are a great option if a taxpayer wishes to sell appreciated property on a low basis. The property may be transferred to the trust, then sold while in the trust. If done correctly there should be no income tax on the sale at the trust level, and only a portion of the gain will pass out when distributions are made to the noncharitable beneficiaries. This allows the taxpayer to stretch out the recognition of and resulting tax on, the gain over time. In addition to deferring tax on gains, CRTs allow the donor to take income tax and gift tax charitable deductions in the year the property is contributed to the CRT. The amount of the income tax deduction is limited to 60% of adjusted gross income (AGI) for gifts of cash, 30% of AGI for gifts of long-term capital gain property, and 20% of AGI for gifts of long-term capital gain property if the charity is a private foundation. The deduction amount is based on the actuarial value of the amount that will be paid to the charitable beneficiaries and can be calculated by your HBK Tax Advisor or attorney at the time of contribution. For this reason, CRTs are also a good option for wealthy taxpayers and/or those recognizing unusually high income in one year due to a large capital gain from a sale or significant ordinary income recognition from a Roth IRA conversion. As an estate planning tool, CRTs can also be funded at death by writing them into a will or revocable trust document. If CRTs are funded at death, an income tax deduction would not be available, however, the estate may be eligible for a charitable estate tax deduction. Charitable Lead Trusts (CLTs) CLTs are the opposite of CRTs: amounts are paid to the charitable beneficiaries first and the remainder goes to the noncharitable beneficiaries. CLTs may also be structured as an annuity trust that pays a fixed amount each year to charitable beneficiaries, or a unitrust that pays a fixed percentage of the FMV of the trust’s assets to charitable beneficiaries on an annual basis. CLTs are not tax-exempt, meaning income from trust assets is subject to income tax. CLTs can be structured as non-grantor or grantor trusts. The differences in the income tax treatment and deductibility of the charitable contribution are described below.

• Non-grantor-type CLTs: The income interest is paid to charity and the remainder is paid to a noncharitable beneficiary other than the donor or donor’s spouse. Since the donor and donor’s spouse are not beneficiaries of the trust, income generated from the assets is taxed to the trust, and the trust deducts the payments made to the charity. The donor does not have to pick up any income from the trust assets and is not entitled to an income tax deduction on amounts passing to the charitable beneficiary. Only the remainder interest passing to the noncharitable beneficiary is subject to gift or estate tax when the trust is funded. Gift or estate tax may be due if the value of the remainder interest exceeds the donor’s applicable exclusion amount ($11.7 million for 2021, plus any deceased spouse’s unused exclusion amount if the portability election was made).
• Grantor-type CLTs: The income interest is paid to charity and the donor is the remainder beneficiary in the trust. The donor (grantor) recognizes the trust’s income as it is earned even though the grantor does not legally have access to the income of the trust. The grantor also receives a deduction for the payments made to the charity. Since the charitable contribution is considered “for the use of” the charity, it is subject to the 30% AGI limitation even if the original contribution is cash. If the original contribution was other than cash, it may be subject to a lower AGI limitation. Any charitable deduction is not used in the year it is generated, it can be carried forward for up to five years.

Grantor-type CLTs are often used in income tax planning. Although the grantor is taxed on the income, they receive a charitable deduction on an amount passing to charity at funding. For many, the deduction is driving the decision-making process when transferring assets to a grantor CLT as the grantor would be taxed on any income generated on the trust assets had they not transferred the assets to the trust. Non-grantor type CLTs are more often used in estate planning as they remove appreciation out of the taxpayer’s estate. If an asset is expected to appreciate significantly, a non-grantor CLT may be used as a vehicle to pass the expected appreciation to the noncharitable beneficiaries at the end of the trust term, removing the appreciation from the grantor’s gross estate. Non-grantor CLTs can also be funded at death by including them in the terms of a will or revocable trust document. CLTs funded at death do not receive an income tax deduction but may be eligible for a charitable estate tax deduction. Both CRTs and CLTs are effective planning tools and may provide significant income and estate tax benefits. Please contact your HBK Tax Advisor if you would like to learn more about these charitable trusts and whether or not they fit with your situation.

Corporate reforms in the for-profit sector have prompted nonprofits to also re-evaluate their governance practices to enhance accountability. One way many organizations have responded is by establishing an audit committee or improving how theirs operates. Whether you need to create an audit committee depends on your organization and board.

Smaller nonprofits that don’t conduct outside audits probably don’t need an audit committee. They may have a finance committee instead, which oversees financial matters relating to the organization. Nonprofits that do have an audit committee should separate it from the finance or investment committee to achieve greater independence.

The purpose of the Audit Committee is to assist the Board of Directors in fulfilling its legal and fiduciary obligations and responsibilities with respect to matters involving the accounting, auditing, financial reporting, and internal control functions of the Organization.

Responsibilities and duties

In carrying out its duties and responsibilities, the following should be considered within the authority of the Audit Committee:

Financial Matters

The committee oversees accounting and financial reporting policies and practices, including the resolution of any disagreement between management and the independent auditors regarding financial reporting, to prepare or issue an audit report or related work.

The committee reviews the financial statements of the Organization and the results of the independent audit, including the audit of government grants and awards if any, underlying accounting judgments and estimates and the auditor’s internal control recommendations to management and management’s response.

Some audit committees will also assume responsibility for reviewing the annual Form 990 and Form 990T and any other related federal, state, or local tax returns/filings.

The duties of the committee include a review with management, internal auditors and independent auditors:

• the communications required by professional standards;
• acceptability, appropriateness, and consistency of application of accounting methods;
• unrecorded adjustments and omitted disclosures;
• reasonableness of judgments;
• degree of aggressiveness or conservatism in applying accounting policies;
• completeness and clarity of financial statements and related disclosures;
• review the conformity of the financial statements and generally accepted accounting principles.

Oversight of Internal Control Matters and Functions

The Audit Committee typically reviews and approves the internal audit function, including: (a) purpose, authority, and organizational reporting lines; (b) annual audit plan, budget, and staffing, and any changes thereto; (c) the charter for the internal audit function; and (d) the effectiveness of the internal audit function, including compliance by the internal audit staff with the Institute of Internal Auditors’ Standards for the Professional Practice of Internal Auditing.

Committee members must understand the scope of the review of the Organization’s internal controls and financial reporting by the independent auditors and Director of Internal Audit, and obtain reports on significant findings and recommendations, together with management’s responses.

Communicate with and review the activities and effectiveness of the internal auditors, including the review of internal controls relating to information technology security and controls. The Committee will review the results of internal audits and any significant findings and any difficulties encountered in the course of the internal audits, including any restrictions on the scope of the internal audit function’s work or access to required information.

Oversight of the Relationship with the Independent Auditors

Audit Committee members

• Have the sole authority and responsibility to select, evaluate, compensate, and oversee the work of any accounting firm engaged for preparing or issuing an audit report or performing other audits, review, or attest services for the organization. The independent auditor reports and is accountable directly to the Committee. The Committee has sole authority in its discretion to approve all audit engagement fees and terms and to terminate the independent auditor. The appointment of the independent audit firm and lead audit partner will be considered annually by the Audit Committee. The Audit Committee then advises the Board of Directors of its decision to continue with or terminate the engagement of the independent audit firm. The Audit Committee’s decisions regarding the use of the existing audit firm and lead audit partner versus the selection of a new firm and partner should be summarized in the Audit Committee’s meeting minutes.
• Confirm the independence of the external auditors in compliance with the independence rules of the American Institute of Certified Public Accountants (AICPA) and the U.S. General Accountability Office (GAO) standards via inquiries as to whether any additional relationships with or services provided to the organization, beyond the annual audit engagement, could have an impact on the auditor’s objectivity and independence. The Audit Committee should pre-approve all audit and non-audit services performed by the independent auditor. The Audit Committee may designate its Chair to represent the entire Committee for purposes of approval of non-audit services, subject to review by the full Audit Committee at the next regularly scheduled meeting.
• Obtain and review at least annually a formal written report from the independent auditors delineating the auditing firm’s internal quality-control procedures and any material issues raised within the preceding five years by the auditing firm’s internal quality-control reviews, by peer reviews of the firm, or by any governmental or other inquiry or investigation relating to any audit conducted by the firm. The Committee shall review steps taken by the auditing firm to address any findings in any of the foregoing reviews.
• On a regular basis, meet separately with the independent auditors to discuss any matters that the Committee or the independent auditors believe should be discussed in executive session.

Depending on the composition and size of the Board and organization, the Audit Committee may also provide oversight of corporate risk management and regulatory compliance.

Who should sit on the Committee?

Each member of the Audit Committee must be financially independent of the organization. Our experience has been that nonprofit audit committee members are not paid for their services. Each of the Audit Committee members shall be “financially literate,” which shall include the ability to read and understand fundamental financial statements. In addition, at least one member of the Audit Committee shall qualify as a Financial Expert and be appointed to such designation by the Board of Directors An Audit Committee Financial Expert shall be selected considering the following attributes:

• an understanding of generally accepted accounting principles and financial statements;
• the ability to assess the general application of such principles in connection with the accounting for estimates, accruals, and reserves;
• experience preparing, auditing, analyzing, or evaluating financial statements that present a breadth and level of complexity of accounting issues that are generally comparable to the breadth and complexity of issues that can reasonably be expected to be raised by the organization’s financial statements, or experience actively supervising one or more persons engaged in such activities;
• an understanding of internal controls and procedures for financial reporting;
• an understanding of audit committee functions.

The Annual Process

The Committee usually meets with representatives of the independent auditor at least annually, maybe more often to review and discuss appropriate matters within the scope of the committee’s responsibilities and duties. including, but not limited to:

• the planning, scope, approach, staffing, and identified objectives of the independent audit for the current fiscal year;
• the results of the independent audit and underlying accounting judgments and estimates;
• the auditor’s comments regarding the adequacy of organizations internal accounting controls;
• external auditor’s relationships with the Organization that may impact objectivity and independence;
• management’s representations regarding the integrity of internal controls and financial reporting systems and conformity of financial statements with generally accepted accounting principles;
• other relevant matters noted during the auditor’s examination, along with management’s response regarding such comments;
• assurance that auditors were not subject to undue influence by management during the course of the audit.

Annually, the Committee should meet with the internal auditors to discuss and determine the scope of the internal audit and to review the results of the internal auditor’s examination and management’s response regarding the auditors’ findings and recommendations.

As necessary or desirable, the Audit Committee is empowered to investigate any matter brought to its attention with full access to books, records, facilities, and personnel of the Organization and may request that representatives of the independent auditors, the internal auditors, or legal counsel be present at meetings of the Committee related to such investigation. In addition, the Committee should have the authority to retain, at the Organization’s expense, special legal, accounting, or other consultants or experts it deems necessary or appropriate to carry out its duties and to assist in the fulfillment of its obligations, including the provision of training to the Audit Committee members in order to meet the financial literacy requirements.

Please reach out to the Nonprofit Solutions Group for additional information on Audit Committees or if you would like more information on how HBK can help.