At the heart of every nonprofit organization is its mission, and a part of the fundamental financial scaffolding that helps an organization achieve its mission is its tax-exempt status. This status not only allows nonprofits to avoid the costly tax obligations of for-profit businesses, but it also incentivizes donors by allowing them to make tax-exempt contributions – meaning less money goes to operational costs and more can go to directly further the organization’s mission. However, there are certain financial activities that can endanger that tax-exempt status such as excess private benefit transactions. Many nonprofits will work with nonprofit audit services to ensure they avoid these critical missteps.
What excess benefit transactions can look like
The IRS states that a nonprofit cannot be organized or operated for the benefit of private interests, but instead must serve the public interest. For nonprofit organizations, there are several scenarios that would violate this provision:
- If a nonprofit makes a payment or transfers assets to a private individual or organization for services or goods in an amount that is excessive or beyond reasonable compensation.
- If a nonprofit makes a payment or transfers assets to a private individual or organization for services or goods that aren’t aligned with the nonprofit’s tax-exempt purpose.
- If a nonprofit’s net earnings benefit the private interests of “insiders” to the detriment of the organization. Insiders include any officer, director, individual or organization (as well as their family members and organizations they control) who is in a position to exert significant influence over a nonprofit’s activities and finances.
Navigating necessary transactions
In order to avoid the pitfalls of excess private benefits, it is important to first ensure that your nonprofit’s payments to individuals and organizations are reasonable and make sense for what your nonprofit received in exchange. For example, many individuals who are considered “insiders” in a nonprofit will receive the benefit of a salary or wage for their work in the organization. When the board considers what payment would be appropriate for this work, they will need to rely on their duty of care as board members for guidance. This means they must act in good faith, in the organization’s best interest, and with such care that proper inquiry, skill, and diligence has been exercised in their decision making.
Audit services can support your status
With the adherence to fiduciary duties like the duty of care, thorough and accurate documentation of all transactions, and an awareness of what excessive private benefits are your nonprofit is well on its way in maintaining its tax-exempt status. And because that status is so important, some nonprofits will get further support from California nonprofit audit services, benefitting from professional insight as they work to avoid excessive benefit transactions.
Ernst Wintter & Associates LLP specialize in California nonprofit audit and tax preparation services. Contact us today for help with your non-profit audit or tax prep needs.
