Nonprofit Agendas - February, 2017By Michael McNee
February 14, 2017
Follow the rules and this fundraising tool could be a winner
Raffles have long been a popular fundraiser for nonprofits. They’re easy to produce, affordable for participants and reliable revenue generators.
But they’re also subject to strict rules, particularly in the area of tax law. State laws on nonprofit-sponsored raffles can vary significantly, but every nonprofit that holds a raffle must comply with federal income tax requirements linked to unrelated business income, reporting and withholding.
Unrelated business income
Nonprofits are required to pay income tax on unrelated business income (UBI). It’s defined as income from a trade or business, regularly carried on, that isn’t substantially related to the organization’s exempt purpose. The IRS considers raffles to be a form of gaming, which is a trade or business. If you routinely hold raffles, it’s possible they could be “regularly carried on,” and raffles likely aren’t related to your exempt purpose. The main problem related to UBI is frequency. One raffle is clearly not a regular occurrence, while five raffles a year would be considered as having regularly occurred. The problem rests with the lack of guidance as to what would be considered ‘regular’.
But, raffle income can be exempted from UBI tax, if the raffle is conducted with “substantially all” volunteer labor. The term “substantially all” hasn’t been formally defined, but the IRS’s “unofficial guideline” is that 85% or more of the labor should be volunteer. If relying on this exemption, make sure you keep records to demonstrate your level of volunteer support.
Winnings must be reported when the amount is $600 or more and at least 300 times the amount of the winner’s wager (the raffle ticket price). You can deduct the amount of the wager when determining if the $600 threshold is met.
For example, you sell $2 tickets, and your winner receives $1,000. Because the winnings ($998) are more than $600 and more than 300 times the amount of the $2 wager, you must report them to the IRS.
Form W-2G, “Certain Gambling Winnings,” must be filed with the IRS and provided to the winner to show reportable winnings along with the related income tax withheld. The winner should provide you with his or her name, address and Social Security number to include on the filing.
If you report using a paper form, you must file copy “A” with the IRS by February 28 following the calendar year of the payment. If you file electronically, you have until March 31. The winner must receive copies “B” and “C” by January 31.
Income tax must be withheld from the winnings if the proceeds (the difference between the amount of the winnings and the amount of the wager) are more than $5,000, and remitted to the IRS. If the winnings are in the form of a noncash payment (for example, an automobile or artwork), the proceeds are the difference between the fair market value of the item won and the wager amount. When the value of a noncash prize isn’t obvious, it’s wise to obtain a valuation before the drawing.
You must withhold 28% (the third lowest tax rate for single individuals) in tax from the winnings. Note that the 28% rate applies to the total amount of the proceeds from the wager, not just the amount that exceeds $5,000. Say that you hold a raffle with $1 tickets. The winner nominally wins $6,000. But, because the proceeds ($5,999) exceed $5,000, you must withhold $1,680 ($5,999 × 28%).
For a noncash prize with a fair market value (FMV) of more than $5,000 after deducting the wager, you have two options: Taxes withheld from raffle winnings are nonpayroll withheld taxes and must be reported on Form 945, “Annual Return of Withheld Federal Income Tax.” The amounts you report must include the total amount of tax withheld that you reported on all the Forms W-2G filed for the year.
- The winner reimburses you the amount of withholding tax that you must pay to the IRS.
- You pay the withholding tax on behalf of the winner, calculated at 33.3% of the FMV less the wager.
The payments, if under $2,500 in total, are due with Form 945 by January 31 following the close of the tax reporting year or, if greater than $2,500, on a monthly or semiweekly basis.
Handle with care
Raffles can pay off for nonprofit organizations of all kinds. But if you want to come out a true winner, you also need to satisfy the tax and filing requirements.
Sidebar: You may need to do “backup” withholding on raffle prizes
Your organization might be required to withhold 28% of raffle prizes for federal income tax backup withholding. Specifically, backup withholding applies when: For example, you hold a raffle, selling tickets for $2 apiece. One of the participants wins $1,200 but refuses to provide you with his Social Security number. You’ll pay this winner $865 ($1,200 less $335, or 28% of $1,198), rather than the entire amount of winnings, since your organization must pay the IRS the $335. If you mistakenly pay out the entire amount to the winner, without any withholding, your organization still owes the IRS the backup withholding amount.
- The winner doesn’t furnish a correct Social Security number
- The regular income tax hasn’t been withheld
- The winnings are at least $600 and at least 300 times the wager
State, rather than federal, issues are often a more critical factor. Raffles fall under the control of the state gaming commission and in most states are subject to a stringent set of rules. For example, if you conduct a raffle you may be subject to the gaming laws in all 50 states and the District of Columbia. In addition, many states have strict rules regarding the banking and use of proceeds. State gaming laws should be reviewed before any raffle is held. Most states require the charity concerned to register prior to the commencement of the raffle.
Having a policy can thwart misuse
When it comes to fraud in any organization, credit cards are frequently a fraudster’s tool. Because the use of credit cards is so commonplace today, there’s always the risk of improper charges to your account. Credit card misuse could hurt your organization financially and jeopardize its reputation in the community.
But there are ways to protect your organization against credit card fraud. Developing a credit card use policy is an important first step.
Certain components make sense
While each organization’s policy will vary according to its circumstances and priorities, certain components are both commonsense and essential. It’s important, for example, to address eligibility by setting restrictions on which employees may have or use your organization’s credit cards. You might, for example, want to limit cards to full-time employees who: You also should require written approval from a supervisor prior to having a credit card issued to an employee.
- Travel regularly for their jobs
- Purchase large volumes of goods and services for the organization’s use
- Otherwise incur regular business expenses of a kind appropriately paid by credit card
In addition, your policy should clearly identify prohibited uses for the cards, such as cash advances, bank checks, traveler’s checks and electronic cash transfers — and explicitly state that the credit cards may not be used for personal expenses. You also might bar using the card for purchases of alcohol or other items inconsistent with your organization’s mission and values. Additionally, you may want to prohibit capital purchases, which often need to go through a more layered approval process.
Finally, your policy should specify that reimbursement for returns of goods or services must be credited directly to the card account. The employee should receive no cash or refunds directly.
Spending limits should be specified, preapproval required
In addition to restricting the types of purchases, your policy should set a spending limit. Or you can rely on the specific limit set with the issuer for each card if that limit is in sync with the user’s needs.
Many nonprofits require all employees to seek preapproval (usually in writing) prior to incurring any credit card charge as a proper internal control. Clearly state in your policy that unauthorized credit card purchases and charges without appropriate documentation are the responsibility of the employee, including any related late fees or interest.
Documentation and statement reconciliation are key
Employees must provide documentation — usually the original itemized receipt — to support all charges. For meal purchases, require employees to provide the names of everyone in attendance and a description of the meal’s business purpose to comply with IRS regulations. The concept of the “Five W’s” should be adhered to for purposes of substantiating the expense incurred 1) Who 2) What 3) Where 4) Why and 5) When.
Request that all original receipts be submitted to the accounting department in an organized manner, and provide users with a standardized format to expedite processing by requiring department coding and descriptions of each charge. Supervisors should indicate their review and approval of the charges by a signature and date on the receipt or on the required form. Your accounting department should reconcile monthly credit card statements, and the statements should be reviewed by an executive or board member.
Enforcement should be mentioned
A policy without an enforcement mechanism is simply a piece of paper. Your policy should state that violations will result in disciplinary action, up to and including termination of employment and, where appropriate, criminal prosecution.
Once you communicate your credit card policy, require the employee to sign an acknowledgment stating that he or she has read and understands the policy and procedures governing credit card use before receiving the card.
The right steps
Credit card use is sometimes a convenient way to handle expenses, particularly for event planning and travel. So if your not-for-profit permits credit card use, make sure that you have controls in place to deter and guard against misuse.
Occupational fraud is an unfortunate reality for just about every employer, nonprofit organization or otherwise. But you might be able to reduce the risk of costly losses if you understand some of the common traits of fraud perpetrators. The 2016 Report to the Nations on Occupational Fraud and Abuse from the Association of Certified Fraud Examiners (ACFE) provides some useful insights on these characteristics.
How old are the perpetrators?
The ACFE found that 55% of the fraudsters in its study were between the ages of 31 and 45, and the size of the losses generally rose with the age of the perpetrator. It identified a “line of demarcation” around the age of 40: In all age ranges at or below that age, the highest median loss was $100,000, while the median loss in the ranges above age 40 was $250,000 or higher.
Fraud losses also tend to increase the longer a fraudster has worked for the victim organization. Those with six to 10 years’ tenure caused a median loss of $210,000, and those with more than 10 years’ tenure caused a median loss of $250,000. People who remain with an organization for a long time often move up to higher levels of authority, the ACFE notes, and that gives them the opportunity to commit larger misdeeds.
Which gender are they?
Fraud isn’t, of course, limited to one gender, but 69% of perpetrators in the ACFE study were male. This is consistent with gender distributions in previous studies.
Moreover, men generally cause larger losses. The median loss caused by a male perpetrator was $187,000, while the median loss caused by a female was $100,000. This disparity also is consistent with earlier studies.
What about educational level?
Perpetrators with a college degree caused a median loss of $200,000, and those with postgraduate degrees rang up a median loss of $300,000. These losses were significantly higher than the losses caused by less educated fraudsters.
The ACFE theorizes that the discrepancy may be heavily influenced by the perpetrator’s department and position of authority. The perpetrators with degrees were more likely to be managers or owner-executives. And higher-level fraudsters generally are better positioned to override or circumvent antifraud measures. So, their schemes are harder to detect, run longer and generate more losses.
What should you look for?
Perpetrators tend to exhibit some red flags that may indicate fraud. In the study, of the 17 traits identified, the most common warning signs were: At least one of the six indicators listed above was displayed in 79% of the cases.
- Living beyond their means
- Financial difficulties
- Unusually close association with a vendor or customer
- Excessive control issues
- A general “wheeler-dealer” attitude involving unscrupulous behavior
- Recent divorce or family problems
It’s important to remember that the behaviors described above are merely signs of fraud — they aren’t conclusive. Further investigation is required before you take any action, particularly suspension or termination.
The ACFE estimates that organizations lose 5% of their annual revenues to occupational fraud. That’s a significant chunk of change for budget-conscious nonprofits. If you suspect your not-for-profit might have fallen prey to a fraud perpetrator, or just want to do everything you can to help combat it, your CPA can help.
Is your next board chair prepared to lead?
Only half of board chairpersons are prepared for their leadership role when they take on the post, according to a recent survey by the Alliance for Nonprofit Management. The Voices of Board Chairs: A National Study on the Perspectives of Nonprofit Board Chairs surveyed 635 board chairs across the country. For those who considered themselves ready for the position, the chairs’ primary source of training was the observation of prior chairs, regardless of whether they were effective leaders. Less than half of the respondents received formal training; used the Internet for resources; or used books, magazines or libraries to help them learn how to be effective chairs. The results underscore the need for succession planning and board chairperson training.
Jargon plagues some nonprofits
Nonprofits are just like their for-profit counterparts when it comes to using sometimes head-scratching jargon. The Chronicle of Philanthropy recently compiled a list of some of the most bothersome jargon used in the nonprofit world, including sustainable, scalable, leverage, deep dive, capacity building, giving levels, ask amounts and outcome. Jargon can prove especially damaging in fundraising efforts and communicating the importance of your work, the Chronicle noted. It’s difficult for potential donors, volunteers and others to become invested when they feel they’re hearing the language of an exclusive group.
Larger audiences may lead to fewer contributions
A study of arts and cultural nonprofits published in the journal Public Performance & Management Review finds that organizations that are more successful — in terms of attracting larger audiences to their programs — tend to receive fewer contributions. Despite a growing environment of performance measurement, the researchers say, the evidence doesn’t point to increased support from donors. They theorize that better performance results create the image of success, making organizations appear less needy.
Marketing agency deploys clickbait to help nonprofits
A digital marketing agency is working to turn clickbait (sensational or provocative online content intended to drive traffic to a particular website) from a nuisance to a tool for good, according to a Wall Street Journal report. RXM Creative has set up a website (http://www.clickbaitforgood.org) where people can get links to share on their social profiles. Those who click on them are steered to charities, including World Wildlife Fund; charity: water; Stop Hunger Now and others. The agency searches online daily for content by or about charities it believes advocate worthy causes and writes clickbait headlines associated with that content. Charities also can submit their content for consideration through the “Submit Charity” link on the website.
John D’Amico, CPA, is a Director with the Professional Standards Group at Marks Paneth LLP and provides quality control services to the firm’s Nonprofit, Government & Healthcare Group. He specializes in quality reviews of nonprofit organizations’ audits and is part of a team that reviews all attest engagements, provides consultation on accounting and attestation matters, tests and monitors the firm’s quality review policies and procedures. He also develops and delivers training material related to accounting and auditing standards and ethics.
John has over 20 years’ experience providing accounting and auditing services to nonprofit organizations and higher education and governmental entities. He brings extensive knowledge of nonprofit accounting and auditing and expertise in the performance of Single Audits under OMB Circular A-133 and, now, under the new Uniform Guidance.
As a sought-after thought leader in his areas of expertise, he is an instructor for the American Institute of Certified Public Accountants (AICPA) and is also an adjunct professor at St. John’s University. John is dedicated volunteer who sits on the audit committees of two non-profit organizations. When he’s not working John loves being out in the great outdoors, enjoying such activities as boating, bicycling, hiking up mountain trials, and fishing. John is also an avid American history buff and loves astronomy.
Marks Paneth LLP is the 35th largest accounting firm in the US and 9th largest in the mid-Atlantic region. We have a long history of serving the not-for-profit community. Today, we work with more than 150 tax-exempt clients and proudly serve 20% of New York’s 25 largest charitable organizations, as ranked by Crain’s New York Business. Our firm is ranked in the top 1% nationally in pension plan audits and is the 8th largest preparer of Form 990 PFs in the US.
Our Nonprofit, Government & Healthcare Group consists of approximately 45 people in New York, New Jersey, Pennsylvania and Washington DC, including our six Partners and four Directors listed below. If you have questions, please contact one of us. More information can also be found at markspaneth.com.
Nonprofit, Government & Healthcare Leadership Team Michael McNee, Co-Partner-in-Charge of the Nonprofit, Government & Healthcare Group Hope Goldstein, Co-Partner-in-Charge of the Nonprofit, Government & Healthcare Group Joseph J. Kanjamala, Partner Sibi Thomas, Partner Warren Ruppel, Partner Anthony J. Tempesta, Partner-in-Charge of the Westchester Office Alan Becker, Director Howard Becker, Director John D’Amico , Director Robert Lyons, Tax Director, Exempt Organizations
© Marks Paneth LLP 2017 | markspaneth.com
About Michael McNee
Michael McNee, CPA, is the Partner-in-Charge of Attest Services and Co-Partner-in-Charge the Nonprofit, Government & Healthcare Group at Marks Paneth LLP. He is also a member of the firm’s Executive and Management Committees. In these roles, Mr. McNee is responsible for overseeing the execution of the firm’s audit and attest services and directing the operations of the Nonprofit, Government & Healthcare Group. He develops strategy, sets policy and acquires and develops talent. In addition to his managerial... READ MORE +