Nonprofits can be exempt from certain taxes, specifically federal income and state sales tax. However, IRS has established rules, similar to the for profit business, relative to accounting and bookkeeping practices.
A 501(c)(3) organization must keep its books and records on an annual accounting period called a tax year. This is the base period for compliance in annual reporting requirements.
The tax year
There are two types of tax years. Both consist of 12 consecutive months in length. The calendar year is a period of 12 consecutive months beginning on Jan. 1 of a year and ending on Dec. 31 of that same year.
A fiscal year is a period of 12 consecutive months ending on the last day of any month except December. As an example, if a nonprofit begins its tax year on July 1 of any year, the last day of that fiscal year is June 30 of the next year.
There are two forms of accounting methods. One method is called the cash basis and the other the accrual method. Both record transactions in the tax year they chose to use. The entries document when and how income and expenses occur.
After one year of existence a nonprofit must file an Annual Information Return known as the 990. At that time the organization must choose the accounting method they will use.
There are some variations in information reporting in either method. The differences are usually based on the source and amount of revenue received during the first year.
Cash basis versus accrual
If the cash basis is selected, income is recorded on the date it is deposited in a checking or other bank account. Expenses are recorded on the date they are paid. In some cases, a bill could be received in one month and paid in the next month.
This method does not lend itself well to matching income with the expense expended to generate the income.
Should the organization decide on the Accrual method, income is recorded when earned even if not yet received. As an example: when a pledge, donation or grant is made (via written notice) but not yet (realized) received.
Expenses are recorded on the date a bill is received, but not yet paid. Even if the bills are not paid during the same month received, they are matched against the income that created the expense in the same period. The practice of matching income to related expenses provides the margin (profit) of income over expense or the reverse (loss) of expense over income.
Best choice and practice
As a general rule and suggestion, IRS prefers the Calendar Year on the 990 Annual Information Return. And this works well using the cash basis of accounting and bookkeeping. Keeping the books on an accrual basis and a fiscal tax year will require more entry work and can lead to errors issues.
Also, nonprofits can use more simple bookkeeping practice to match costs of and revenue received for an event or program that is part of mission and purpose.
Saving transactions & documentation
All financial matters should have documents describing and supporting each transaction. On the income/revenue side there will be donations, awards, gifts, grants, functions that earn revenue supported by checks, deposit receipts, written pledges and grants. All must be saved.
On the expense side canceled checks, receipts, paid invoices and bills should be saved. These documents represent the flow of income and expense. They should be entered into a journal so that all transactions are recorded, backed up in detail and ready for the reporting process.
There are charts of account unique to nonprofits that can be used to organize all transactions. It is best to always keep records in a safe place so if IRS comes calling they are readily available.
Few IRS agents will accept thinly veiled excuses as to why documentation is not available, especially during an audit. If and when a nonprofit is audited, you can be sure there is a justifiable reason that something may not look right on the annual returns.
Bookkeeping and Accounting rules and practices have had a wide range of changes due to the age of digital reporting and especially accounting programs. Nonprofit officers best choice is to have trained a professionals recommend the which way to go.
Dr. Frederick J. Herzog is the founder/executive director of the NonProfit Resource Center in Citrus County. He can be reached at 847-899-9000 or via email to firstname.lastname@example.org. Need help with your nonprofit? Visit www.TheNonProfitResourceCenter.com.