“The charity should be efficient,” says Wade McMullen, partner at Vicenti, Lloyd & Stutzman LLP. “You don’t want your donations to go toward inefficient operations.”
Smart Business spoke with McMullen about how to decide which charities to give to, how to evaluate your contributions and what types of tax implications should be considered.
What criterion should a donor use when deciding which charities to give to?
First, the donor should look at how the charity spends the money that it receives. In terms of a percentage that is spent on the charitable purpose of the organization, it should be 60 percent or greater. You should look at how much money it’s spending for fundraising and how much it’s getting contributed for those fundraising expenses. The other criteria would be looking at that particular organization and seeing if it has large asset reserves or if it is using the money that is being donated. It shouldn’t have more than three to five years worth of operating expenses as reserves.
How do the financial statements of a nonprofit differ from a for-profit enterprise?
It used to be really different than a for-profit enterprise. The financial statements were not organized in such a way that they could be comparable from one to the other. Then in the mid-1990s, the way financial reporting was done changed, and they became more uniform. The biggest difference is that the for-profit financial statements don’t have anything to do with donor-imposed restrictions and they don’t show things on a functional basis (programs, management and general, and fundraising). They show things on a natural classification basis, which includes items like salaries, rent, etc. Some nonprofits also give information about natural classifications as they specifically relate to the functional categories.
How can a donor determine how much of a nonprofit organization’s budget is used for programs that fulfill their mission?
There are three ways to look at that. One, look at its Web site and get information on its budget and the different type of programs that it has. A more concrete way would be to look at its audited financial statements which show how much is spent on programs, how much is spent on management in general and how much is spent on fundraising. The third way would be looking at its federal informational tax return, which is Form 990. That not only gives information about expenses, but also lists who the key officers, directors and employees are and how much money they make.
How should a donor follow-up and evaluate their charitable donations?
One way of doing that is contacting the organizations and asking for reports. If you give a large donation, you can stipulate that you would like to have a report prepared and sent back to you about how the organization spent your money. Big foundations or donors will often ask for that type of information to verify that the entity has spent their money on what they had planned on spending it on.
Another way is to utilize the philanthropic infrastructure that supports donors. There are now organizations that help donors monitor their giving, how it is being spent and even helps them make decisions on which charities to give to.
There are also Web-based services like GuideStar.org and Give.org that give advice on screening.
What are some of the tax implications that should be taken into consideration when donating to charities?
From a business standpoint, there are limitations on the deductibility of charitable gifts. Usually, it’s limited to 10 percent of taxable income so that is a consideration for corporations when they give charitable donations. There is a good chance that, if you’re giving significant amounts to charities, you might be limited on how much you can deduct in one year. You can, however, carry those deductions forward on the corporation’s tax return for up to five years, but after five years you lose the deduction.
Because of the limitations that corporations have on their charitable deductions, we encourage them - whenever they possibly can to make those donations on a personal level rather than on a corporate level so that they can get the full deduction for the tax return. For individual donors, it is important that the organization you’re giving to is a 501(c) organization that is exempt from taxes. Also, you should be asking for acknowledgement letters of your donations so that you can deduct them on your personal tax returns.
WADE McMULLEN is a partner at Vicenti, Lloyd & Stutzman LLP. Reach him at email@example.com.