Commentary on ECFA Standard 4

Fiduciary responsibility.  Fiduciary responsibility extends to all exempt resources:

• Assets—including their use and disposition
• Support (contributions)—including cash and noncash gifts, donated goods and materials, the use of facilities, and legacies and bequests (whether from individuals, corporations, partnerships, trusts and estates, foundations, or other nonprofit organizations)
• Revenue (earned income)—including sales, fees, rentals, tuition, investment income, government grants, and royalties

Charitable contributions.  Charitable contributions are only deductible under U.S. tax law if given "to and for the use" of a "qualified" tax-exempt organization to be used under its control to accomplish its exempt purposes. “Qualified” organizations are domestic 501(c)(3) organizations.

To be deductible, charitable contributions must be unconditional and without personal benefit to the donor.

Charitable contributions are commonly provided as either:

• Unrestricted gifts—Gifts received with no restriction on use or purpose.
• Donor-restricted gifts—Gifts that are donor restricted for a stated period of time or until a stated event has occurred. The stated event must be more specific than the broad limits imposed by the charity's purpose or nature.

The terms "unrestricted" and "donor restricted" are used by nonprofit organizations in conformity with generally accepted accounting principles. The IRS indicates concern about excessive donor control if that control is directed toward a particular individual.

Gifts that are given in support of an organization's exempt purposes and programs are generally tax deductible within the limits prescribed by the law. To be tax deductible, the organization must exercise full administrative control over the funds to ensure that they fulfill its exempt purposes and programs. While exercising full control over the funds, the organization must also fulfill its responsibility to honor donor stipulations for particular exempt purposes, if the stipulation does not represent earmarking for a specific individual.

With few exceptions, gifts that are earmarked for a specific individual are not deductible as charitable contributions. This is true whenever the donor has specified, by name, the person to receive the gift. Among the exceptions is the support of an orphan or needy child selected by the organization rather than the donor.

Gifts in support of the ministry activities of a specific worker, such as missionary support, are tax-deductible contributions to an organization if they are not earmarked for personal use. The funds must be under the control of the organization, to be expended only as needed for reasonable compensation and business expenses of the worker or related ministry costs.

Due to international mail and currency transmittal difficulties, foreign missionary organizations frequently handle personal gifts transmitted from one individual to another as a convenience. In other cases it is not advisable for personal gifts to be handled by the organization. Personal gifts are not deductible for tax purposes and donors should be clearly advised of this in any receipt or acknowledgement.

Furthermore, exempt organizations should not use exempt resources for personal gifts because this violates exempt-purpose use and represents either private benefit or inurement.

Use of resources.  Exempt resources must be used exclusively for exempt purposes. This is a fundamental provision of tax law, as well as state law, that should be set forth in an exempt organization’s articles of incorporation and bylaws. Any part of an organization’s resources inuring to the benefit of private individuals is absolutely prohibited.

Private benefit ordinarily pertains to activities or resources that benefit individuals outside of an organization but which do not further the organization’s charitable purposes. On the other hand, private inurement occurs when an insider receives a benefit that does not further or is incidental to the organization’s 501(c)(3) purposes. Private inurement may also result from compensation that is not properly reported for tax purposes or from unreasonable compensation.

1. Compensation of workers.  Compensation of workers, whether employees or independent contractors, must be reasonable for the services rendered and must be properly reported for tax purposes.
   
   Documentation should be maintained to verify reasonable control over all domestic and international workers. This includes personnel files, job descriptions, employment agreements, supervision information, progress reports, and performance evaluations.
    
2. Business expense.  Payment of ministry expenses should be supported by adequate accounting records. Such substantiation demonstrates how these expenses fulfill the organization’s exempt purposes.
    
3. Benevolence.  Any payments made directly to and in support of the poor and needy qualify only if benevolence is a program and purpose of the organization.
   
   Organizations should maintain policies under which the benevolence program is administered. These include: adequate criteria to determine individual need; documentation of need, including external verification; assignment of personnel or a committee to approve requests; reasonable limits of support per person during a specified time period; and coordination with other organizations providing aid.
    
4. Grants.  As contrasted with programs conducted directly by an organization and its personnel, grants may be made to other recipients to further the organization’s exempt purposes. Grant recipients may be related or unrelated charities and may be domestic or foreign organizations.
   
   Grant administration and control procedures will vary based upon grant materiality (amount and significance), the nature of the grant recipient's operations, and the nature of the relationship between the granting organization and the grant recipient.

Grant administration and control procedures should include:

• Pre-grant due diligence—including documentation of 501(c)(3) status for U.S. charities, information about the recipient’s operations and personnel, information about the project or work and proposed use of funds, and information about how the proposed grant will further the grantor’s exempt purposes
• Determination of grant recipients—including determining eligibility of recipients if funds are granted to an organization which, in turn, makes disbursements to other individuals or entities
• Written grant agreements—including specific terms, expected results, timing of funds remittances, consequences of noncompliance with grant terms (including cessation of future funding and/or the return of grant funds), and specified accountability (including appropriate provisions such as written progress reports, required accounting or financial statements, provision for internal or independent audit and inspection of records, and on-site inspection of programs by grantor personnel)
• Approval of grants and grant budgets by the governing board or through board policy—including the subsequent comparison of actual financial results with the budget
• Authorization of funds expenditure—including board-delegated control over the receipt and disbursement of funds for activities having prior approval and budgetary authorization
• Determination of compliance with administration policies and grant agreement specifications (supervision and evaluation)
  
  When an organization receives significant donor-restricted funding for international grants, it is better for the organization to include at least some grant funds from its general operating budget. This demonstrates control over the grants and participation in the exempt-purpose expenditures.

International grant-making.  U.S. tax law does not prohibit the making of grants by a U.S. tax-exempt organization to recipients in other countries if they further the U.S. organization’s tax-exempt purposes. However, the IRS has articulated some parameters as to when contributions may or may not be deductible for tax purposes, if they are made to a U.S. charity and subsequently distributed in the form of a grant to a foreign recipient.

The reason for the IRS’s scrutiny of such grants is the general rule that only donations to a U.S. tax-exempt organization are deductible as charitable contributions. Contributions by a U.S. taxpayer to a foreign organization are not tax deductible. Therefore, the IRS looks carefully at pass-through gifts.

A U.S. charity may not act merely as a conduit of funds for a foreign recipient. This would result in treating these indirect contributions to a foreign organization as tax-deductible contributions, something that would not happen if the funds were made directly to the foreign entity.

However, if a grant is made by a U.S. charity to further its exempt purposes, and if the grant funds are clearly under the control and discretion of the U.S. charity rather than the donor, it is not likely that the IRS would challenge the deductibility of the gift.

Organizations should seek professional counsel concerning operations that result in grants to foreign recipients. Various rulings and tax cases stipulate certain characteristics in evaluating whether grants to foreign recipients are proper, exempt-purpose expenditures of the U.S. charity and, therefore, if any supporting gifts are deductible by donors of those funds.

Impact of international operations on the financial statements.  It is important for organizations to properly control, adequately account for, responsibly audit, and fully disclose in their financial statements the nature and scope of their operations, both within the U.S. and internationally. Organizations and their auditors should consider the impact of worldwide operations on the scope of the audit, and the financial statements should report on all organizational assets, liabilities, revenue, and expenses.

The scope of an organization extends to activities conducted under its control (internationally) when expenditures are made in furtherance of its exempt purposes to compensate workers, pay business expenses, provide benevolence to the poor and needy, or to make exempt-purpose grants.

To be "unqualified" or "clean," an independent auditor's report must reflect no restriction on the scope of the audit.

In order for financial statements to be in conformity with generally accepted accounting principles, they must accurately portray the full scope of the organization's operations internationally. Accounting standards issued by the Financial Accounting Standards Board (FASB) No. 117 set forth that such statements must focus on the organization as a whole, including its total assets, liabilities, net assets, revenue, expenses, and changes in net assets. In addition, the American Institute of Certified Public Accountants in its Statement of Position 94-3 provides guidance on when a reporting organization must consolidate another not-for-profit organization in which it has a controlling financial interest.

Significant granting activities should be properly disclosed in an organization's financial statements, including a description of the nature and purpose of the grants and the grant administration policies.

Grant administration policies must be well developed and approved by the governing board, while adaptable to a wide range of circumstances. The following are possible controls and accountability measures:

1. Written progress reports
2. Required accounting or financial statements
3. Required internal or independent audits and inspections
4. On-site program inspections by grantor personnel
5. Retention of discretion as to when funds will be remitted based on administration policies and grant agreements, including the policy and practice of refusing conditional or earmarked gifts that create an obligation to remit the funds immediately
6. Adequate oversight (supervision) and review (program evaluation) or compliance with administration policies by the governing board and/or the organization’s independent auditors