Expense Allocation for Non-Profit Organizations
Just like a for-profit organization allocates its expenses between different categories like cost of goods sold, general & administrative, and selling expenses, a non-profit organization also needs to be aware of how to correctly classify its expenses. The allocation of expenses in a non-profit organization is important when filing its tax return. A non-profit organization’s expenses can be classified as program expenses, management & general expenses, or fundraising expenses. Knowing the difference between these three classifications can help you with your bookkeeping and tax filings.
Program Service Expenses are the direct and indirect costs related to providing the organization’s exempt programs as described and approved in the organization’s exemption application.
Management and General Expenses are expenses that are not identifiable to a specific program or fundraising activity. Examples of some costs that should be reported as management and general expenses include activities that determine the overall direction of the organization, general liability insurance, office management, staff meetings (unless they involve specific program services), legal services, executive planning, managing investments, mail distribution, telecommunication, accounting, etc.
Fundraising expenses are the expenses incurred in soliciting cash and noncash contributions, gifts and grants. They include the costs of preparing and distributing fundraising materials to solicit or receive contributions.
Some expenses may be related to more than one activity or function. These expenses must be properly allocated for a few important reasons. Donors want to know the extent to which their contributions are being used for charitable purposes. Allocation is important to the IRS and state governments to verify that the organization is operating primarily for an exempt purpose in order to continue to qualify for its tax exempt status. As stated in the IRS instructions to Form 990, the organization should use its normal accounting method to allocate the expenses into the appropriate categories. When an accounting system does not provide for this type of segregation, the organization can use any reasonable method of allocation. Sometimes the return preparer must determine an appropriate allocation method. You may allocate indirect expenses based on how the activity relates to one function verses another or allocate based on the amount of time spent on each separate function within the activity.
How to allocate
When allocating joint activity expenses between program services and fundraising, three criteria must first be satisfied; purpose, audience and content. If any of the three criteria is not met, all the costs of activity must be reported as fundraising costs. In order to satisfy the purpose criteria, accomplishing the organization’s mission must be one of the reasons for joint activity. The audience criterion will be met as long as the selection of the members of the audience was primarily because of their need for the action called for, their ability to help the organization accomplish its program, or their need for the management and the general component of the joint activity. In order to satisfy the content criteria, the need for and the benefits of the action the audience is called upon to undertake is explained in the information presented. This action needs to support the organization’s mission.
Private Foundations and the Allocation of Expenses between Investment and Charitable Purposes
Private Foundations which file Form 990-PF also need to allocate certain expenses between investment and charitable purposes. Deductions allowed against gross investment income include all ordinary and necessary expenses paid or incurred for the production of gross investment income or for the management of such income, with certain exceptions. Deductible expenses include a portion of the foundation’s operating expenses in relation to its investment activities. Disbursements for charitable purposes include expenses incurred directly in carrying out the foundation’s charitable purpose, reasonable and necessary administrative expenses incurred in implementing its charitable purpose, and contributions, gifts, and grants paid to individuals and other organizations to accomplish a charitable purpose.
Operating expenses can be attributable to both investment and charitable activities which would require an allocation. There is no specific method to allocating the expenses, however, the method must be reasonable and used consistently. Administrative expenses can also be attributable to both investment and charitable purposes. An example of an administrative expense that may need to be allocated is audit fees since the typical audit of a foundation’s financial records include an examination of both income and expenses attributable to its investment activities and distributions in furtherance of its charitable purposes.
As you can see, allocation of expenses in a non-profit organization is very important to the donor as well as the federal and state authorities with which the informational tax returns are filed. If you have any questions or concerns, please do not hesitate to contact our office.