Almost all charitable organizations have one thing in common. They rely on donor support to carry out their tax-exempt purposes. However, attracting donors and receiving sufficient funds to continue operations year-to-year is often challenging and timeconsuming, requiring valuable resources that an organization might or might not have. Following is a guide for charitable organizations that want to elevate their pitch to potential donors by highlighting the tax planning benefits available to your charitable organization and the donor.

Income Tax vs. Estate Tax

It is important to understand which type of tax most concerns the donor. In most instances, it will be the immediate benefits: “Will I get an income tax deduction from this donation, and how much will it save me in income taxes?” But focusing solely on the immediate benefits ignores the value of a proper charitable giving provision within an estate plan.

The donors most sought after, those with significant assets, likely have an estate that is or will be subject to estate tax. With the current estate tax rate at 40 percent and the estate tax exclusion (the amount that can pass to a decedent’s heirs free of estate tax) set to be cut in half in 2026, these high net worth individuals are likely to consider charitable planning as a means of mitigating or eliminating future estate taxes.

Understanding the Assets

Not all assets are equal when it comes to charitable giving. For example, donating a minority interest in a closely held corporation may not provide the same charitable deduction benefits as a gift of publicly traded securities. In addition, the gift of the closely held corporation generally results in greater complexity for the charitable organization, often leading to compliance issues that a nonprofit might not have the resources to address properly.

Donors often are willing to use retirement funds for charitable giving. Retirement fund distributions are taxable at ordinary income tax rates, whether received by the original owner of the fund or a beneficiary. Retirement plans are also subject to estate tax if the owner has a taxable estate. The ultimate tax rate on inherited retirement funds can exceed 40 percent. As such, the donor can generate significant tax savings by leaving retirement funds to a charity, generally higher than tax savings achieved by donating other estate assets.

During life, a donor meeting the age requirements can also make a qualified charitable distribution from their retirement plan directly to a charity and exclude the distribution from income. Because those distributions will count as part of their required minimum distribution, donors can get a greater overall tax benefit by using this strategy for their charitable giving.

Nonprofits that understand and can discuss the tax consequences of donating different kinds of assets to both the donor and the charitable organization will go a long way to protecting the organization and impressing the donor. Organizations should have a written policy that addresses the types of donations they can and will receive. This will help guide discussions with potential donors and provide guidelines for minimizing risk to the organization.

Charitable Trust Strategies

Many high-net-worth individuals explore using trusts to accomplish some of their charitable giving. These types of trusts can provide both income tax and estate tax savings to the donor and can also provide a significant benefit to the charitable organization beneficiary if structured and funded correctly. Two types of charitable trusts are generally used; a Charitable Remainder Trust (CRT) or a Charitable Lead Trust (CLT). A CRT has a non-charitable beneficiary during the term of the trust, with the remainder payable to a charitable beneficiary. A CLT is the reverse, with a charitable beneficiary during the term of the trust and the remainder payable to a noncharitable beneficiary.

Other Considerations

Many, if not most of the families we work with who are charitably inclined, want a charitable legacy that will carry on through the generations. They are often provided with the option of creating their own private foundation or contributing to a donoradvised fund, allowing all family members to plan for charitable giving together. While these recommendations will provide them with a method for maintaining their charitable giving into the future, they are not the only options that can and should be provided to donors. One often overlooked option is to find a charitable organization whose exempt purpose resonates with the family and help fund an endowment that can provide a lasting income stream to the organization. If fundraising for an endowment is done properly, and the organization can speak to the family’s desire to have a charitable legacy that will continue for years, then both the donor and the organization benefit.

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

An endowment allows a nonprofit to manage a financial instrument that generates earnings it can use to forward its mission, helping to fund future operations and promote the organization’s long-term financial stability. Donations to an endowment tend to be larger than regular contributions—an endowment fund can be comprised of cash, securities, and other income-producing assets—due in part by the donor’s ability to create an enduring legacy by funding the organization long-term. But nonprofits must consider several key factors before creating an endowment, including the type of endowment, compliance with laws surrounding the endowment, and management of the endowment funds.

There are three different types of endowments – true, quasi, or term:

Regulation

Endowments are created to support a nonprofit, and spending or distribution policies apply to the amount of annual support an organization can obtain from its endowment. The Uniform Prudent Management of Institutional Funds Act (UPMIFA), a uniform law governing donor-restricted endowment funds, guides organizations and stipulates the management and investment of endowment funds. The UPMIFA is designed to protect donors and organizations related to contributions and ensure the funds are managed efficiently.

Organizations may disclose the adoption of UPMIFA in their financial statement footnotes. Suppose a nonprofit organization chooses not to adopt UPMIFA. In that case, it still must be aware that it is subject to disclosure requirements, regardless of whether it implements or is subject to UPMIFA. In their financial statements, organizations must provide detailed information on the following:

1. Return objectives and risk paraments that include the organization’s endowment composition and accounting policies


2. Strategies employed for achieving objectives that disclose the organization’s investment policies


3. Spending policy and investment objectives


4. Summary and changes in endowment


5. Interpretations of the relevant law


6. Underwater endowments, if applicable

An underwater endowment occurs when the fair value of the endowment fund is either less than the principal balance of the original gift or less than the amount that is required to be maintained as required by the donor or by law. In the event the endowment is underwater, the financial statements must disclose:

1. The value of the original gift


2. The fair value of the original gift


3. The number of underwater funds


4. The organization’s spending policy for underwater endowments

Underwater endowments are required to be classified within net assets with donor restrictions. They may be included in the aggregate amount of the net assets with donor restrictions on the face of the financial statements or shown separately within the net asset classification.

Before establishing an endowment fund

Nonprofits should consider whether establishing an endowment fund is an activity they can take on in addition to running and maintaining their programs. Managing endowments can take significant time, which could otherwise be spent on the organization’s mission. Organizations should ensure they have the appropriate personnel managing their endowments to relieve the unforeseen administrative burden.

Organizations must clearly understand what is involved in building and maintaining an endowment fund. Making an endowment fund large enough to where investment earnings are enough to sufficiently support an organization should also be a consideration.

Community foundations

Nonprofits may maintain their own endowment funds if they have the expertise, or they can place the funds with a community foundation that can provide financial expertise, access to planned giving, and access to financial resources they don’t have. Additionally, maintaining an endowment with a community foundation can help the organization focus on its mission, while the community foundation helps them stay compliant with the investment and spending policies.

Endowments that are transferred to a community foundation have special accounting considerations. The nonprofit will have access to future distributions from the transferred funds, and therefore the funds remain an asset of the nonprofit.

When the endowment gift is received by the organization, the entry recorded to show the receipt of the donation, and the applicable restriction would be such as:

Dr. Cash

Cr. Restricted Contributions

The initial entry for the transfer and creation of an endowment fund at the community foundation would then be:

Dr. Beneficial interest in assets held by the community foundation

Cr. Cash

As the community foundation distributes funds from the endowment to the organization— understanding that the distributions are in compliance with the spending policy—the organization receives cash and investment income. When changes in the endowment fund occur, the organization records any unrealized gains or losses, realized gains or losses, and interest and dividend income. When recording this activity, the organization would adjust the beneficial interest in assets held at the community foundation and other applicable income accounts.

Community and donor perceptions

If an endowment is very large, the organization could face scrutiny and have difficulty attracting donors and raising annual gifts; they could be perceived as not having a need. But an endowment does not address current needs. There are also administrative considerations. For example, each endowment should have separate accounting, even when they are pooled for investment purposes. Another consideration is the annual audit. The auditors will likely want to obtain copies of any applicable grant engagements related to the endowment, the organization’s spending, and its investment policy. Audit procedures performed can include:

1. Reviewing the organization’s investment roll forward for the year under audit


2. Sampling investments in the endowment fund portfolio and calculating fair market values subsequent to year-end


3. Testing compliance with the spending and investment policy for the endowment


4. Determining if there are any underwater endowment funds to disclose in the footnotes


5. Reviewing board minutes for board discussions about the endowment fund


6. Confirming investment balances


7. Considerations on how the endowment affects the liquidity and availability of resources

After all these factors have been considered, the board of directors will play an important role in determining if the organization moves forward with an endowment. If it accepts or sets up the endowment, it will require educating management, the board, and future donors on an ongoing basis.

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

You’ve decided to form a nonprofit. Just like forming a for-profit business, you have a lot of decisions to make upfront, many of which will require outside counsel from an accountant, a consultant, or an attorney. Without experienced counsel, your startup will face difficult challenges and could be doomed to failure.

First Step: Create Your Legal Entity.

For the IRS to recognize a nonprofit’s exemption from taxation, it must be organized as a trust, a corporation, or an association. (An unincorporated association can gain recognition as a tax-exempt organization, but this form of organization is not typically recommended for various reasons). Nonprofit incorporation or formation creates your nonprofit entity in your chosen home state. Your Articles of Incorporation/Formation will be required when applying for exempt status. This is also the first place where you will identify your nonprofit’s purpose.

Write Your Bylaws

Bylaws are legal documents, which means there are legal requirements for what should be included. These requirements vary depending on the state in which your nonprofit operates. To ensure your bylaws are in accordance with state laws, get assistance in drafting or amending your bylaws from a qualified professional experienced in nonprofit matters.

As a governing document, your bylaws need to be included in your exemption application. The IRS looks for two key provisions to be included in either your Incorporation/ Formation Document or your bylaws:

If you anticipate filing for 501c3 status, the IRS has specific requirements that apply to your purpose and dissolution clauses.

The bylaws may be quite different depending on the organization. Is the goal to gain status as a public charity, a private foundation, or some other type of exempt organization such as a membership organization?

Even with counsel, it’s still the board’s responsibility to provide input throughout the process and to vote to adopt the final product. Although bylaws are not considered public documents, making them public and easily available increases the organization’s accountability and transparency to donors, beneficiaries, and the general public.

Develop a Business Plan

Every nonprofit seeking tax-exempt status must have an Employer Identification Number (EIN), whether or not it has employees. File a Form SS-4 with the IRS to obtain your EIN.

This is the time for the organization to act like a business and develop its business plan. The business plan should address/include the following:

Besides being a business best practice, gathering much of this information will be necessary if you are required to complete a full Form 1023 or 1024 for exempt status.

Seek Exempt Status

Incorporating a nonprofit in the state of formation only establishes it as a legal business entity. Creating a nonprofit corporation does not guarantee the organization will be granted tax-exempt status by the Internal Revenue Service (IRS). You must apply for tax-exempt status with the IRS and be approved. There are currently 40 different types of exempt organizations in the Internal Revenue Code. Only organizations that meet the requirements of Internal Revenue Code Section 501(a) are exempt from federal income taxation. And charitable contributions made to some Section 501(a) organizations by individuals and corporations are deductible under Section 170.

Other benefits may include access to certain grant monies and income and property tax exemptions.

Determining the correct exempt status for the organization will depend heavily on who will benefit from the mission or its purpose, whether the assets will be dedicated to the mission, and where funding will come from.

Public Charities and Private Foundations

Every exempt charitable organization is classified as either a public charity or a private foundation. Generally, organizations classified as public charities are:

Private foundations usually have a single major source of funding, typically a gift from one family or a corporation, and most have as their primary activity the making of grants to other charitable organizations and individuals rather than the direct operation of charitable programs. Some private foundations, called private operating foundations, do directly operate their own charitable programs.

Political Organizations

A political organization subject to Section 527 is a party, committee, association, fund, or other entity (whether or not incorporated) organized and operated primarily for the purpose of directly or indirectly accepting contributions or making expenditures, or both, for an exempt function.

Other Organizations

Organizations that meet certain requirements may qualify for exemption under subsections other than 501(c)(3). These include social welfare organizations, civic leagues, social clubs, labor organizations, and business leagues.

Application for Exemption

Certain types of organizations are automatically considered exempt without actually filing an application with the IRS, most notably, churches, their integrated auxiliaries, and conventions or associations of churches. Others must file either Form 1023, 1023-EZ, 1024, or 1024-A with the IRS seeking status. All applications are now filed online.

Organizations seeking status under 501c(3) apply using a 1023 or 1023-EZ form. Others seek status by filing Form 1024 or 1024-A.

When filing for a 501c3 determination, smaller organizations may file the simpler EZ Form— Streamlined Application, 1023-EZ. These applications are much easier and take less time complete, and the filing fee is smaller. Larger organizations will file full 1023 or 1024 forms and require much of the information in your “business plan.”

To get the most out of your tax-exempt status, file your Application Form within 27 months of the date you file your nonprofit Articles of Incorporation. If you file within this time period, your nonprofit’s tax exemption when granted takes effect on the date you filed your Articles of Incorporation, and all donations received from the point of incorporation forward will be tax-deductible. If you file later and can’t show “reasonable cause” for your delay, your tax-exempt status will begin as of the date on your IRS Application.

Once You File

Once you submit your application, you will receive an acknowledgment notice from the IRS confirming receipt of your application. If the IRS needs more information, an Exempt Organization specialist may request further information and will contact you and/or your power of attorney. If you have counsel or another representative assisting you with your application, contact them immediately regarding the additional information being requested. Do not try to answer their questions without their assistance.

Once the IRS completes its review of the exempt application, they will send you a determination letter, which will either grant your federal tax exemption or issue a proposed adverse determination, a denial of tax exemption that becomes effective 30 days from the date of issuance. If you receive a proposed denial of tax-exempt status, you have the right to appeal and should seek expert advice immediately. Do not delay; waiting to reply will risk the denial of your exemption.

The IRS review process typically takes several months or longer. Be prepared to wait. The IRS is currently processing 95,000 applications annually. Applicants can review current wait times by going to the IRS website: https://www.irs.gov/charities-non-profits/charitableorganizations/wheres-my-application-for-tax-exempt-status. You can also contact the IRS by phone at 877-829-5500; by fax at 855-204-6184; or by regular mail at:

Internal Revenue Service

EO Determinations; Attn: Manager, EO Correspondence;

P.O. Box 2508; Room 6-403; Cincinnati, OH 45202.

Compliance Begins Immediately

Unless you qualify for an exception from the requirement to file an annual return or notice, your filing obligations begin as soon as you are formed. If you have an annual information return or tax return due while your application is pending, complete the return by checking the “Application Pending” box in the heading Item B, and submit the return as indicated in those instructions. You should also determine when you are required to begin your state’s compliance filings, as each state has its own set of requirements.

Setting up an exempt organization can be confusing, to say the least. The HBK Nonprofit Solutions team is here to help.

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

Boards are legally liable for the actions of their organizations, and there are generally three “duties” that board members must adhere to: care, loyalty, and obedience.

• Duty of care: Board members are expected to exercise the care that a prudent person would exercise in a like situation.
• Duty of loyalty: Board members must act in the best interest of the organization, even if it conflicts with their own self-interests.
• Duty of obedience: Board members must uphold the mission of the organization. Often a nonprofit board will create various committees to demonstrate its commitment to these duties.

Accountability and governance

Large or small, all nonprofit organizations should be built on a firm foundation of fiscal accountability and good governance. While the audit and finance committees both are designed and intended to help a board fulfill the related fiduciary responsibilities, the duties of each are quite different.

The Finance Committee: Tends to be more operational and is typically a standing committee of the board, meaning it functions throughout the year. Committee members work closely with management and the finance staff. Their duties often include:

• Providing oversight in the preparation of annual operating and capital budgets and monitoring budgets to actual results regularly throughout the year
• Reviewing internal financial statements on a regular basis
• Overseeing the handling of all financial resources as well as any policies and procedures related to those resources
• Advising the board on significant financial decisions, including borrowing and investing
• Protecting the organization when a conflict of interest occurs
• Ensuring that good governance policies referenced in Form 990 are implemented
• Often participating in the hiring of finance and accounting team members
• Ensuring that financial reporting requirements, including tax return filings, are fulfilled
• Overseeing long-term financial planning
• Monitoring cash reserves
• Ensuring that financial activities of the organization align with its vision, mission, and strategic plan
• Reporting to the board and/or executive committee about the financial condition of the organization

This committee may have audit responsibilities as well, including:

• Participating in corrective action plans for problems identified in the annual audit
• Monitoring the corrective action plans
• Meeting with the audit team to identify financial trends identified during the audit
• Evaluating the performance of the audit team.

• Who should serve on the finance committee? While members should all have some expertise in financial matters, they need not all be accountants. A diverse group of financial experts—accountants, attorneys, bankers, investment advisors, insurance professionals, even directors of other nonprofits—can provide perspectives that collectively serve the committee well. As well, not all committee members need to be board members. Non-board members can be recruited based on their areas of financial expertise. In addition to financial acumen, committee members should be:

• Independent, that is, able to make decisions without risk of conflict of interest
• Dedicated to the mission of the organization
• Available and willing to meet the time requirements of the committee

• A finance committee charter is often used to clearly define the roles and responsibilities of potential committee members, and will include practical policies and procedures, such as:

• A clear statement of the committee’s purpose and scope of responsibility
• The committee’s relationship to the board and other committees, such as the audit committee
• The committee’s size and the time members are allowed to serve
• Meeting schedules
• Reporting requirements
• Committee governance procedures

The Audit Committee: Usually works in partnership with the finance committee, but their duties are more related to governance than operations. In high performing organizations, the audit committee helps management review and maintain the effectiveness of internal controls and external financial reporting. Audit committee duties may include:

• Reviewing the financial statements and any other information provided to the public
• Overseeing the organization’s internal controls and compliance with policies and procedures
• Possibly overseeing the annual audit process, usually to ensure the objectives of financial reporting and auditing are achieved
• Reviewing compliance documents such as Form 990 and charity filings, and recommending approval by the appropriate officer
• Reviewing any and all fraud prevention practices and policies
• Working with internal auditors throughout the year

• The members of the audit committee must be independent and have financial expertise. While it is not a requirement of nonprofits, at least one member should have the skills, knowledge, and expertise to fully understand the required financial reporting of the organization. Such a “financial expert” is generally defined as someone with considerable experience analyzing, preparing, or auditing financial statements.

Since many nonprofit board members may not fully understand the nuances of the financial reports, often a member of the audit or finance committee will be relied on to interpret these reports for the board.

Like the finance committee, the duties and responsibilities of the audit committee are outlined in its
charter. The charter will outline the objectives of the committee, the steps to achieve each objective, deliverables, and the frequency of each action item. Many charters include calendars that specify guidelines and establish timelines and due dates for their duties. A committee charter should be action oriented, not merely a document on a shelf.

So, do you really need both? It is important to check state requirements, as some states require a nonprofit to have an audit committee once they have raised a certain amount of revenue. While it is considered an industry best practice to have both a finance and an audit committee, many smaller organizations do not have enough expertise available to have two separate committees. In that case, finance committee members typically assume the duties of both. Where both committees exist, detailed charters should be reviewed and updated regularly to clearly define the roles and responsibilities of each.

Board Orientation and Training

Since board members will have different skill sets, it may be advisable to conduct ongoing training as well as training for new members at orientation. Many board members will not have financial skills, and if they do, they might not have the financial acumen specific to a nonprofit organization. A training agenda might include:

• A review of each committee’s policies, procedures and responsibilities
• A review of the organization’s budget process
• An overview of the state laws governing nonprofit finances
• A review of terminology unique to nonprofits
• A review of basic nonprofit financial statements
• A review of other information a member might be asked to cast a vote on

• Organizations can look to paid consultants, their attorneys, or their auditors to provide board training.

Board committees play important roles in both financial oversight and governance. Highly functioning board committees are key to helping a board fulfill its fiduciary responsibility.

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

I continue to be amazed reading about nonprofits as victims of fraud or theft. Girl scout cookie money stolen, church collections under deposited, prom and wedding dresses and a fedora purchased from corporate accounts: the incidents just keep coming.

Nonprofits, particularly smaller ones, face a great number of challenges. They often operate with limited resources, have fewer financial controls, tend to be more trusting of staff and volunteers, have ongoing staff turnover, and many are not well versed in financial matters. The Center for Audit Quality noted, “Fraud cannot occur unless and an opportunity is present.”

Some red flags often ignored:

• An employee living beyond their means
• An employee unwilling to share job duties or take a vacation
• Vendors who are not “recognizable” outside the accounting department
• Bank accounts not reconciled timely and reviewed by a second responsible party
• Thinking the auditor will catch it
• Volunteers having access to confidential data, such as banking information
• Missing documents

A recent report indicated that 34.5 percent of fraud involves cash. How is the fraudster operating? Some usual schemes:

• Stealing from cash on hand: petty cash funds, cash register banks, church collections, and donation cans are all subject to cash theft.
• Creating fake vendors or fake employees and writing checks to them
• Creating fake or duplicate checks, then writing, cashing,and recording them in accounting records as vendor payments
• Falsifying financial reports and documents: altering or back-dating documents
• Submitting false expense reimbursement requests
• Paying personal expenses from organization accounts

The list is not all-inclusive, and, perhaps even more shocking, in a large number of reported frauds, the fraudster has been with the organization for years. Seniority didn’t matter.

Self-defense

So how can a nonprofit defend itself? Fraud prevention does not necessarily require a large budget or a full-time risk manager. Smaller organizations can follow some simple steps to create an anti-fraud environment:

• Establish an anonymous reporting system.
• Create a culture of compliance, where nothing gets overlooked and no one gets ignored or criticized for coming forward.
• Require supporting documents for EVERYTHING!
• Control the use and access to credit and debit cards.
• Segregate duties as much as possible; require vacations be taken and those duties be handled by another staff member or volunteer.
• Rotate duties, particularly for volunteers.
• Establish and train a board audit committee to review safeguards throughout the organization on a regular basis.
• Train board members who may be less savvy. Someone on the board should have the skills, knowledge, and expertise to handle financial issues.
• Reconcile bank accounts immediately each month. Understand that “uncleared” anything may be a problem that should be addressed immediately.
• And my personal favorite: four eyes on everything. Require two signatures on checks and two people counting all cash being handled.

A recent report indicates that about 40 percent of nonprofit frauds do not get reported to law enforcement. Nonprofits fear damage to their reputations, negative publicity, and the resulting loss of funding. So what should be the protocol when a fraud or theft is discovered? The organization should have a standard response plan that should address:

• Who gets notified of the situation: the board, the attorney, the insurance agent, the bank?
• How is an investigation handled?
• Who addresses the other employees and volunteers?
• Who addresses the public, donors, and the media?

Planning ahead and documenting the process should be a standard practice for every nonprofit. Good, consistent internal control systems can help to provide reasonable, if not absolute, assurance to the organization. Still, no organization is immune.

If you have any questions regarding nonprofits as victims of fraud or theft, please reach out to your HBK Adviser.

If you were to randomly poll a hundred people about the difference between a sponsorship and advertising, most would probably say they’re the same. But in the world of nonprofit accounting, the difference could end up costing—or saving—an organization thousands of dollars in taxes.

Sponsorship vs. advertising

If a business pays a nonprofit to have its logo, slogan, or other information displayed throughout the nonprofit organization’s event, that money could be considered either sponsorship or advertising. There are several qualitative factors to consider, key of which is the concept of “substantial benefit.” Did the business receive a substantial benefit for having its logo on display throughout the event? If the answer is “no,” the organization would recognize sponsorship income, which is not subject to an unrelated business income tax (UBIT). If the answer is “yes,” the organization would recognize advertising income, which is subject to UBIT.

So what qualifies as a substantial benefit? Like most tax-related questions, the IRS’s answer is, “It depends.” Some qualitative factors provide a substantial benefit, which renders the contribution of advertising-income subject to UBIT. If the message contains comparative price information, endorsements, or persuasive language to buy products, the IRS considers that a substantial benefit has been provided. On the other hand, payment to post only the business’s logo, slogan, location, and/or contact information will most likely be considered as sponsorship income not subject to UBIT.

Real world example

Consider the following hypothetical example:

If DEF is looking to maximize sponsorship income without being subject to tax, the nonprofit should seek more sponsors like KMC LLC and fewer like AMS Inc.

Know the difference

Management of a nonprofit organization should be cognizant of these nuances when it comes to planning their sponsored events. Knowing the subtle differences between sponsorships and advertising can save your nonprofit thousands of dollars in UBIT, allowing you to use those funds to support your mission and purpose.

Increasingly, investors are incorporating cryptocurrencies into their portfolios. Cryptocurrency
has graduated from the fringes of the dark web, where it resided for most of the last decade, to gain acceptance by mainstream institutions and investors. In February, Superbowl LVI featured three advertisements for cryptocurrency companies, one of which generated so much traffic that it crashed the company’s website. Considering the widespread adoption of cryptocurrency and the tax benefits of in-kind charitable contributions of appreciated property, charitable organizations should expect to see an increased number of donors seeking to make in-kind donations of cryptocurrency.

Donors of property are entitled to a charitable deduction equal to the appreciated fair market
value of such property at the time of the transfer —so long as the property has been held for more than one year¹. At the same time, it is well established that unrealized gains are generally not recognized when a donor makes an in-kind transfer for no consideration². The meteoric rise in the use of cryptocurrency in the last year presents an opportunity for charitably inclined taxpayers to maximize this double tax benefit. In some cases, donors have almost no basis in their cryptocurrency holdings, putting the after-tax value of nonrecognition on equal footing with the charitable deduction.

While current economic conditions present a unique fundraising opportunity for charitable organizations to solicit cryptocurrency donations, the opportunity carries compliance risk requiring careful consideration and planning.

The Uniform Prudent Management of
Institutional Funds Act

The Uniform Prudent Management of Institutional Funds Act (the “Act”) has been enacted in 49 states, the District of Columbia, and the U.S. Virgin Islands. The only state that has not adopted the Act is Pennsylvania, which imposes substantially similar requirements through its own law. In making
investment decisions for endowment funds, the Act requires the charitable organization to (1) act in good faith and with the care an ordinarily prudent person in a like position would exercise under similar circumstances (the “prudence standard”),³ and (2) consider its charitable purposes and the purposes of the endowment⁴.

The Act sets forth eight factors to guide investment decisions, which require the charitable organization to consider:

• general economic conditions

• the possible effect of inflation or deflation

• the expected tax consequences, if any, of investment decisions or strategies

• the role each investment or course of action plays within the overall investment portfolio of the fund

• the expected total return from income and the appreciation of investments other resources of the organization

• the needs of the organization and the fund to make distributions and to preserve capital, and

• an asset’s special relationship or special value, if any, to the organization’s charitable purposes⁵.

The Act specifically permits charitable organizations to invest in any kind of property or type of investment consistent with its terms.⁶ There is no reason to believe that this blanket permission excludes cryptocurrency, but the prudence standard—guided by the factors listed above—will likely preclude a charitable organization from allocating sizable portions of its endowed funds to
most cryptocurrencies due to their inherent volatility.⁷ Investment decisions about individual assets are not made in isolation but rather in the context of the portfolio as a whole and as a part of an overall investment strategy having risk and return objectives reasonably suited to the endowment and the charitable organization.⁸ Additionally, a charitable organization is required to diversify its
portfolio unless special circumstances dictate otherwise.⁹ Accordingly, cryptocurrency may find a home as a small allocation within a diversified portfolio.

The big caveat to the requirements above is that they are all subject to the donor’s expression of contrary intent.¹⁰ While the emphasis on donor intent does not mean that the donor can or should control the management of the charitable organization, the drafters’ comments to the Act provide that a charitable organization has an overarching duty to comply with donor intent, which is primary to the charitable purposes of the organization or endowment.¹¹ Accordingly, if the donor of a gift instructs the charitable organization to invest the gift in cryptocurrency by the gift instrument, the organization will not fall out of compliance with the Act by abiding by the donor’s instructions.

As mentioned previously, charitable organizations are likely to see an increased prevalence of in-kind donations of cryptocurrency by tax-motivated donors. An organization that accepts such a donation must then decide whether to retain the cryptocurrency or dispose of it. The Act
requires that an organization make and carry out decisions concerning the retention or disposition of property or to rebalance a portfolio to bring it into compliance with the purposes, terms, and distribution requirements of the organization as necessary to meet other circumstances and the requirements of the Act.¹²

While an organization that accepts such a donation will generally prefer to liquidate cryptocurrency immediately upon receipt to raise cash for their charitable purposes or convert it to a more suitable investment, the donor may prefer the organization to retain the cryptocurrency for a period or
indefinitely. If the donor fails to express this intent in the gift instrument, the organization will have to decide whether it will retain the cryptocurrency at the expense of its organizational goals or dispose of the property and jeopardize the likelihood of receiving gifts from the donor in the future.

Notably, the Act does not require the organization to arrive at a particular outcome – the organization may consider a variety of factors in deciding whether to retain or dispose of the cryptocurrency, and a decision to retain it for a period or indefinitely may be a prudent decision.¹³ The drafters’ comments to the Act explain that the potential for developing additional contributions by retaining property contributed to the organization is among the “other circumstances” that the organization may consider in deciding whether to retain or dispose of the property. Accordingly, the organization might be able to justify the retention of a position in a cryptocurrency that is otherwise unsuitable for its investment portfolio on the grounds that the donor i a prospect for future donations. While the organization will likely be able to justify retention with documented discussion and analysis, this gray area is an uncomfortable place to be.

Federal tax reporting obligations

If the donor is claiming a tax deduction of more than $5,000 with respect to a charitable contribution of cryptocurrency, the donee organization is generally required to sign
the donor’s Form 8283, if requested, to substantiate the deduction. The signature of the donee organization does not represent agreement with the appraised value of the cryptocurrency but merely acknowledges its receipt and that the organization understands its own reporting obligations if the cryptocurrency is disposed of within three years of receipt.¹⁴ If the organization disposes of the donated cryptocurrency within the three-year window, it must file Form 8282 to report information about the disposition to the IRS and provide a copy of the form to the original donor.

Remaining compliant through adequate risk management

Charitable organizations must be deliberate in their compliance efforts, establishing robust risk management procedures setting forth detailed instructions for organizational personnel to follow whenever cryptocurrency comes through the door. Risk management procedures may be
different for each organization but should include common-sense measures such as requiring any
donor making an in-kind gift of cryptocurrency or establishing a fund to hold cryptocurrency to sign an approved gift instrument stating, in no uncertain terms, the donor’s intent for the gift; requiring any donation of cryptocurrency with a value exceeding $5,000 to be disposed of only with the approval of a specific individual responsible for federal tax reporting; and requiring that any purchase of cryptocurrency be accompanied by documentation of the discussion and analysis justifying the purchase.

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

1 Treas. Reg. § 1.170A-1(c)(1).

2 The Humacid Co. v. Comm’r, 42 T.C. 894, 913 (1964).

3 UPMIFA § 3(b).

4 UPMIFA § 3(a).

5 UPMIFA § 3(e)(1).

6 UPMIFA § 3(e)(3).

7 Notwithstanding this observation, it is noted that one of the
largest charities in the country, the Silicon Valley Community
Foundation, is reported to hold $4.5B in digital assets according
to its financial statement, accounting for nearly a third of its
total investments.
https://www.siliconvalleycf.org/sites/default/files/documents/
financial/2017-independent-auditors-report.pdf

8 UPMIFA § 3(e)(2).

9 UPMIFA § 3(e)(4).

10 UPMIFA § 3(a).

11 See drafters’ comment on UPMIFA § 3 and 3(a): “In addition,
subsection (a) of Section 3 reminds the decision-maker that
the intent of a donor expressed in a gift instrument will control
decision making. Further, the decision-maker must consider the
charitable purposes of the institution and the purposes of the
institutional fund for which decisions are being made.”

12 UPMIFA § 3(e)(5).

13 See drafters’ comment on UPMIFA § 3(e)(5).

14 IRC § 6050L(a)(1)-(2). The exception for publicly traded
securities does not apply because cryptocurrency does not
qualify as a “security” for this purpose. See IRS Frequently
Asked Questions on Virtual Currency.

After a series of deferrals, the new lease standard, Topic 842, is here. Your organization may be unsure how this will affect your day-to-day activities, but I can assure you, it is not something to put off or deal with at the end of the year as part of your closing process. Read on for a better understanding of what Topic 842 means for your organization, and how you should be monitoring it throughout the year.

History

FASB accounting standards codification (ASC) 842 was created by ASU No. 16 and issued in February 2016. The standard supersedes FASB ASC 840. Prior to 840, a loophole allowed for financial statement manipulation using off-balance sheet transactions, which led to some well-known accounting scandals in 2000—think Enron.

ASC 840 applied a classification test to determine the accounting for a lease. If substantially all the benefits and risks associated with the asset were transferred to the lessee, the lease would be considered a “capital lease” and recorded as such on the balance sheet. If it did not meet one of four criteria, it was considered an “operating lease” and avoided the balance sheet altogether.

Even after ASC 840 was put in place, off-balance sheet transactions continued. But because operating leases are not included on the balance sheet, the effects of these contracts have been excluded from financial ratios and metrics used to measure an organization’s health. Financial statement users have criticized the prior rules, and rightfully so. Operating leases are contracts in which one party has committed to paying another party for an asset for a specified period of time.

Understanding leases and distinctions

It is important to understand how a lease is defined, and certainly helps if you know the difference between what was a capital lease—now called a “financing lease”—and an operating lease. Historically, a lease was defined as an agreement conveying a right to use property, plant, or equipment, usually for a stated period of time. To be considered a capital lease, the lease had to meet one of four criteria:

1. The asset transferred ownership at the end of the term.

2. There was an option to purchase the asset at a discounted price at the end of the term.

3. The term of the lease was greater than or equal to 75 percent of the useful life of the asset.

4. The present value of the lease payments was greater than or equal to 90 percent of the assets’ fair market value.

If any one of the four conditions was met, the asset was capitalized at its present market value and a corresponding lease liability recorded. Depreciation would be recorded to reduce the asset value and as payments were made, the associated liability would be relieved. If the lease was not capital, then it was classified as operating. No additional accounting was needed for the operating lease; it would be expensed as paid each period.

ASC 842 changes the definition of a lease to a contract, or part of a contract, that conveys the right to control the use of identified property, plant, or equipment (an identified asset) for a period of time in exchange for consideration. This new definition requires, substantially, all leases to be added to the balance sheet.

Whether it’s a building, a vehicle, or another asset being leased, you can expect to see that on your balance sheet as an asset and a corresponding liability for the total lease liability, with some exceptions. The new lease standard freshens up the terms for what we now know as financing leases. Operating leases remain as operating leases. “Short-term” lease is another category.

The finance lease

The ASC 842 standard scrapped the specific percentages associated with tests numbered 3 and 4 above, called “bright-line” tests, and added less specific language and a fifth test. That’s not to say that the organization cannot continue to use 75 percent and 90 percent as guides, but they are not specifically stated as the measurements.

To be a finance lease, the lease must meet at least one of the following criteria:

• The lease transfers ownership of the underlying asset to the lessee by the end of the lease term.

• The lease contains a purchase option that the lessee is reasonably certain to exercise.

• The lease term is for the major part of the the remaining economic life of the asset.

• The present value of the lease payments and residual value guaranteed by the lessee equals or exceeds substantially all the fair value of the underlying asset.

• The asset is specialized and expected to have no alternative use to the lessor at the end of the lease term.

As you might have noticed, the finance lease is similar to the previous capital lease.

The operating lease

Notably, ASC 842 does not change the definition of an operating lease. Instead, it indicates that a lease is operating if it’s not a finance lease. However, even though the definition has not changed, changes in how an operating lease is measured and recognized are dramatic.

Short-term leases

Short-term leases are defined as leases that are less than 12 months and do not include an option to purchase the asset. In these cases, the organization can elect not to apply the new standard. But don’t think you can avoid recognizing leases under the new standard by making them all less than 12 month. If there is an option to extend the lease beyond 12 months, it is not considered a short-term lease.

If you are a lessor, you need not read further. The new standard does not include significant changes to the lessor accounting model.

Recognition, measurement, presentation

If you currently know how to report the different leases, you will be comfortable with finance lease reporting. At the commencement of the lease, an asset and liability are recorded at the “present value” of the lease payments. The present value of the right-of-use (ROU) asset and lease liability are discounted at the rate implicit in the lease, or the incremental borrowing rate if there is no known rate implicit in the lease. The standard calls the asset an ROU asset. Don’t be intimidated by the language; it simply means the organization has a right to use the asset. Each year after initial recognition the organization will make three entries: one entry to amortize the ROU asset on a straightline basis over the life of the lease, one to record interest expense on the lease liability by increasing interest expense and also increasing the lease liability, and a third entry to record the cash payment and reduce the lease liability by the total of the lease payment (principal and interest). The income statement shows the lease activity through interest and amortization expense.

The recognition and measurement of the operating lease are more complicated. As mentioned above, historically this would involve only cash out and lease expense. Under Topic 842, the organization must record the ROU asset and related liability exactly the same as it would under a finance lease using the present value of the lease liability. After initial recognition, the the organization will increase the lease expense for the total of the lease payment (principal and interest), reduce the lease liability by the principal amount, reduce the ROU asset by the amortization amount, and record the cash payment.

Various calculations are required in the accounting. The lease expense will be recognized on a straight-line basis. The present value of the ROU asset and lease liability will be discounted at the rate implicit in the lease, or the incremental borrowing rate if there is no known rate implicit in the lease. Additionally, the amortization amount is not a consistent amount year to year, but rather, it is a balancing figure to get the operating lease expense constant over the life of the lease.

In the end, the income statement will look the same as it did under the former rules, with only the lease expense being affected. The full lease expense will be included in operating expenses.

How to prepare

There are many variables to consider in contracts that may affect the treatment and determination of the lease. Additionally, there are accounting policies to review and practical expedients available to alleviate some of your burden of execution. It is important to start analyzing your organization’s leases now, as this standard is in effect in for all organizations with a fiscal year beginning after December 31, 2021.

To get prepared:

• Determine if the organization has qualified internal resources to take this project on. If not, consider hiring a consultant.

• Determine the organization’s lease commitments. Start by analyzing the contracts you have in place. For example, the standard specifies that the asset must be identified in the contract; if the vendor has substitution rights, it might not be a lease.

• Prepare a template or document for calculating the ROU asset and lease liabilities, so you have the support to back up the balance recorded on the balance sheet and the associated amortization and interest expense or lease expense. If you have a significant number of leases, new software may be your best solution.

• Update policies and procedures and get your team trained.

• And, most importantly, call your accountants.

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

Everyone is talking about the “great resignation,” many calling it the “great quit.” Unfortunately, exempt organizations haven’t been exempted from the trend.

The Canby (Oregon) Area Chamber of Commerce’s widely respected Executive Director Kyle Lang announced his resignation in January 2022, saying, “The last two years have taught me a lot about resilience, about the power of staying limber and loose and able to adapt in crises.” Nonprofit Quarterly has reported the average term for small and mid-sized nonprofit organization executive directors is six years. Many say the pandemic will only hasten leadership departures and retirements.

A leadership transition may come as a surprise or as part of a long-term plan. In any case, the job of the board is to move swiftly to make the transition in a smooth and controlled manner. Ideally, the departure of a leader, whether a CEO, executive director, COO, CFO, or other management team leader, should be managed by an existing succession plan. In writing for the Nonprofit Risk Management Center, contributors Melanie Lockwood Herman and Erin Gloeckner identify succession planning as “a critical risk management issue for every board … a planning process that will ensure the health of your nonprofit during and after a leadership change.”

Large and small nonprofits often have some form of a strategic plan, and a best practice is to include succession planning for the CEO and other organization leaders in that plan. Yet fewer than half of nonprofits actually have documented succession plans. Why? Perhaps because the board fears saying to its valuable CEO or executive director, “We’re going to talk about a succession plan for you.” Best-practice strategic planning lessens this anxiety by focusing succession planning not only on one position like the CEO or executive director but on all the management team and the board.

Experts advise that any succession plan is better than none, but multiple plans should be developed based on the circumstances surrounding the leader’s departure. The transition process differs depending on the reason behind the departure, whether it is prompted by an emergency, termination, extended medical leave, resignation, planned retirement, or another reason. The organization should develop transition plans for all leadership positions and all reasons for departures.

The Planned Departure

The planned departure allows for a thoughtful process of saying good-bye to one leader and welcoming a new leader. The entire process should be grounded in keeping the mission at the forefront of all decisions. The governance documents should be reviewed for board policies regarding the approved transition process, assuming there is one. Given that the hiring of a CEO or executive director often takes six months or longer, a timeline for the transition should be outlined and documented, and a transition team formed to manage the process.

It is vital to understand the roles and responsibilities of the outgoing leader. A detailed position description may already be part of the leader’s annual review. Is it complete? Has it changed recently? Is the position description both people- and task-specific? It is also critical to consider a new executive in light of the goals of the organization. Is the organization looking to expand, change direction, adjust priorities, increase fundraising efforts, or change its communication strategies? Does your next leader have the skills to accomplish those goals?

Often missed in leadership changes is the passing on of institutional knowledge, including the contact list of the outgoing leader. Who gets the proverbial Rolodex? If a new leader has been identified and introductions can be made, both the new leader and the contact are likely to feel more comfortable with the transition.

It is important to communicate wisely. Identifying who needs to know, what they should hear, and who should make the announcement of a departure is vital. First, identify spokespeople regarding this news. The circumstances of the departure will control the messaging and its timing. It is important to communicate the planned transition with key stakeholders, including board members, staff members, donors, partners, the community, and the media. The transition team must realize the word will get out, so the organization needs to be upfront with its message, focusing on the organization’s stability, continuity, and sustainability during the transition. Consider how these messages resonate: “The Board of Directors announces and congratulates our outgoing CEO on their outstanding leadership. We are excited to begin our search for a new leader.” That is, we’ve got this covered, and we’re ready.

Or as Kyle Lang said it so eloquently, “I will be sad to no longer fill my role, as I did, but I’m not going far. You will still see me around town on occasion doing community work, so stay tuned.” That is, I’m not abandoning you.

The Unexpected Departure

The unplanned departure can be the result of an emergency, extended medical leave, death, or termination. In these instances, it is the job of the board to move swiftly to make the transition as smooth and controlled as possible. One of the most important objectives in an unexpected departure is to keep the remaining team intact and to keep morale as high as possible. So tell the staff immediately and be professional with the message. And remember, some confidentiality regarding the circumstances of the departure might be needed, especially in the case of a termination. A senior leader’s departure can create uncertainty for the staff, but any accompanying chaos can often be lessened by senior team members. The board should immediately meet with the current staff and identify team members who might be ready and willing to step up, whether in an “acting” role or in a permanent position. The board will need to identify who will fill in and in what capacity. Can the role be shared by more than one existing team member? Depending on which leadership role is being vacated, a variety of experience, skills, and personalities might be needed. Consider the different talents required of a CEO, CFO, or Development Director. Specific responsibilities should be assigned to qualified individuals during the transition. You might hire an outside professional, if temporarily. No one should doubt that the operations of the organization are continuing, the programs are ongoing, and the organization is proceeding confidently into the future.

The board should explain the process of identifying the next leader to the team. Will there be a search? Who will be conducting it—the board, a search firm, a consultant? Will internal candidates be considered? Many organizations use a process called “collaborative hiring,” which allows relevant departmental or functional teams to be part of the selection process. Also called “team-based hiring,” the process allows the organization to hear the perspectives of diverse team members and promotes “ownership” among the team. As the process continues, it will be important to stay in touch with all the stakeholders, to be as open and transparent as possible.

Culture Matters

Whether the departure is planned or not, it is extremely important that the transition team consider the culture of the organization and realize much of the current culture may be tied directly to the resigning team member. Where employees are empowered to work and make decisions either on their own or in teams, a domineering leader might negatively and severely impact that culture. On the other hand, if the team is used to the leader making all the decisions, the staff might not be able to make decisions independently. Chaos can ensue and result in significant turnover— culture matters. Unfortunately, most organizations don’t define their culture in their documents, policies, or manuals.

The story of an outgoing leader

A long-time HBK client, a statewide organization, recently lost their CEO to their national organization. The transition needed to be quick, and their active board was ready and moved quickly. The outgoing CEO was confident she had developed a senior leadership team that would effectively manage the organization and was able to step away to her new role. The messages were clear: From the CEO to the board, “They can do this”; and from the management team, “We can do this.” Lucky organization. While the new leader is still being identified, the board, donors, and community can rest assured that the organization is in good hands.

Not all nonprofits are so lucky, but there are some lessons in the story. Develop bench strength. Be ready with a transition process— communication and culture matter. Act swiftly. Look to the future. And always support the mission.

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

The first donor-advised funds appeared back in the 1930s but were not formally recognized in the Internal Revenue Code until the Pension and Protection Act of 2006. Today, these funds are one of the fastest-growing vehicles for making current charitable contributions but are also being incorporated in many tax planning strategies. Exactly, what are donor-advised funds?

A donor-advised fund (DAF) is a separately identified and managed charitable investment account that is operated by a Sec. 501(c)(3) organization, also known as a sponsor or sponsoring organization. Often these sponsoring organizations are affiliated with brokerage houses and community foundations, but more recently with hospitals, universities, charities associated with affiliated corporations and religious institutions. Increasingly more DAFs are being used to facilitate workplace giving and online fundraising. Recent reports indicate that more than 1000 DAFs exist.

How does a DAF operate? Many times, donors have never heard about a DAF before this donation strategy is recommended by an accountant, attorney, tax planner or investment manager. Generally, the donor makes what will become a charitable donation to an existing DAF. The donor benefits by enjoying an immediate tax benefit for the contribution. That contribution is 100% irrevocable and is ultimately destined for distribution to a 501c3 organization, including a foreign equivalent of a 501c3. The final distributions to a grantee are not necessarily immediate, or even in the same tax year, hence the ongoing controversy surrounding DAF giving. Once received, the sponsoring organization has legal control over those funds. The donor retains advisory rights with respect to the investment of those funds and the ultimate distribution of those funds. At some point after the original donation, the donor or the donor’s representative, recommends that the sponsor donates to a public charity. The sponsor is not legally bound to the donor’s request and will usually perform due diligence to verify the grantee’s tax-exempt status and may reject the donor’s request. The great end result, the charity gets its donation.

The donor would be wise to research DAFs before randomly selecting one. Some of the factors to consider:

• Is there a minimum initial contribution?
• Are there minimums for additional contributions?
• What assets will the DAF accept? Cash, stocks, bonds, IRA and 401k funds, cryptocurrencies, life insurance, real property?
• What investment options are available for the account?
• Is there a minimum amount for grants to charities?
• How often can grants be recommended by the donor?
• How much are the annual admin fees, investment fees and maintenance fees? DAFs make money from these fees.
• What is the reporting, performance and governance of the DAF?

Many donors are seeking local impact, so they might be more interested in a community DAF as opposed to a larger sponsoring organization. Some sponsors offer customizable DAFs based on the donor’s impact, geographic and investment preferences.

Donors can make contributions in a variety of ways including induvial giving, supporting charitable special events, creating private foundations or opening a DAF fund, to name a few.

What are the advantages DAF fund donors enjoy:

• DAF funds are relatively simple and cheaper to establish.
• DAF giving works for all levels of wealth.
• Administrative work shifts from the donor to the DAF sponsor.
• Donors may retain investment decisions or allow fund managers to make these decisions.
• Charitable donations can be bundled for tax purposes into one year, while outgoing grants can be spread over time.
• Many sponsoring organizations allow the donor to name a successor of the DAF if the donor should become incapacitated or pass away.
• Multiple donors can contribute to the DAF. Think about bequest and memorial type contributions.
• Allows a donor to reach international charities and other non-governmental organizations while still receiving a federal tax credit.
• Helps a donor create a philanthropic vision, philosophy and legacy.
• Allows for the more beneficial tax treatment of contribution as opposed to donating to a private foundation and finally,
• Protects the privacy of donors, by allowing the individual donors and grants to be kept private.

So, what are some of the disadvantages?

• The contributions to the DAF are irrevocable.
• The donor gives up full control over the funds and relies on the sponsor to approve their recommendations.
• Investment options and contribution amounts might be limited by the sponsor.
• DAF participants cannot receive any personal benefit from a grant request, such as tickets to a charity gala.

The controversy and what to watch for your future giving

The great debate about donor-advised funds is centered around the fact that DAF sponsoring organizations are not getting funds out fast enough to the charities. Not that the DAFs are inefficient, but that there is no required distribution amount or percentage for a DAF like there is for a private foundation.

Introduced in July 2021 a Senate bill, proposes to influence the deductibility of charitable contributions if not disbursed within certain time frames like 15 or 50 years. Under current law, assets can remain in a DAF indefinitely, tax-free. There are great debates on both sides of this discussion, including the impact on sponsoring organizations as well as charitable recipients. In February 2022, the House introduced its version of the legislation on this issue calling the “Accelerating Charitable Efforts Act” the “ACE Act” The House version, which almost mirrors the Senate bill, would place additional restrictions on the deductions for contributions to DAFs, establishes minimum payouts and establishes failure to payout taxes.

No matter, where you fall on this great debate, if you are a DAF donor or a charity recipient of DAF donations, new legislation will impact those contributions.

If you have any questions regarding DAFs, please reach out to an HBK Tax Adviser.