When a nonprofit makes too much money (has a surplus), it must reinvest the excess funds back into its mission, not benefit individuals, or risk losing tax-exempt status; this surplus acts as reserves for future stability, funding new programs, or covering unexpected costs, but it must be clearly documented and justified as mission-related, often requiring transparent reporting to donors and the IRS to avoid accusations of private inurement or hoarding.
The IRS permits nonprofits to generate surplus funds, as long as those funds are then reinvested into activities that support the mission of the organization. The IRS has no issue with profit - rather they have an issue with that profit benefiting individuals, such as your staff or nonprofit board of directors.
Common violations that might get you in this pickle include:
Below are a few different areas where a surplus of nonprofit cash can be applied.
The 80/20 rule (Pareto Principle) for nonprofits suggests that roughly 80% of results come from 20% of causes, most commonly meaning 20% of donors provide 80% of donations, but it also applies to programs, volunteers, and marketing efforts, guiding organizations to focus resources on high-impact areas like major donors or effective programs for greater efficiency and fundraising success. It emphasizes donor stewardship, program evaluation, and targeted communications to maximize impact, though some argue for diversifying away from over-reliance on a small donor base.
What are the most common mistakes nonprofits make? Some of the most common mistakes include unclear missions, weak board engagement, poor donor communication, lack of financial transparency, and neglecting compliance requirements. Many of these issues are fixable with the right tools and support.
There is no legal requirement that nonprofit, tax-exempt organizations spend all their funds and there is no limit on the amount of funds that may be carried over to subsequent years.
Misappropriation of funds: This occurs when an employee or board member uses company funds for personal use, usually by writing checks or stealing cash. Kickbacks: A kickback occurs when a person in a position of power receives money or goods from someone who wants to do business with the nonprofit for personal gain.
Earning too much income generated from unrelated activities can jeopardize an organization's 501(c)(3) tax-exempt status. This income comes from a regularly carried- on trade or business that is not substantially related to the organization's exempt purpose.
One option is reporting directly to law enforcement. Another option is reporting to a state government, which exercises regulatory authority over the nonprofits incorporated within the state.
If the nonprofit is sued and lacks the proper planning and protection, you could lose your savings, your home and other assets. Nearly two out of three nonprofits reported a Directors & Officers liability claim within the past 10 years.
The real data from National Center on Charitable Statistics reveals that approximately 30% of nonprofits fail to exist after 10 years, and according to Forbes, over half of all nonprofits that are chartered are destined to fail or stall within a few years due to leadership issues and the lack of a strategic plan, among ...
The "33% rule" for nonprofits refers to the IRS Public Support Test, requiring most 501(c)(3) public charities to show that at least one-third (33.3%) of their total financial support comes from the general public or government over a rolling five-year period to maintain their public charity status, preventing reclassification as a private foundation. This support must come from diverse sources, not heavily concentrated in a few large donations, with individual gifts generally limited to 2% of total support.
§ 641 makes it a crime to steal "any record, voucher, money, or thing of value of the United States or of any department or agency thereof." If the property stolen is worth less than $1,000, the statute authorizes fines and a maximum prison term of one year.
Nonprofits are held accountable by multiple groups, primarily their Board of Directors (fiduciary duty), government regulators like the IRS and State Attorneys General, and the public/donors who demand transparency and ethical conduct in fulfilling the mission, with tools like the annual IRS Form 990 ensuring financial and operational disclosure.
If excess funds exist, donors should be contacted for permission to reallocate funds. To prevent this bookkeeping quagmire, an organization can indicate on donation materials that excess funds will go to a secondary cause.
The 27-month rule for 501(c)(3) status is an IRS guideline stating that a newly formed organization must file its exemption application (Form 1023) within 27 months from the end of the month it was legally formed to get tax-exempt status retroactive to its date of formation, allowing donors to deduct contributions from that earlier date; missing this window generally limits exemption to the filing date, but relief might be granted if reasonable efforts were made.
The 50/30/20 rule is a budget guideline that allocates 50% of after-tax income to Needs (housing, groceries, utilities), 30% to Wants (dining out, entertainment, shopping), and 20% to Savings & Debt (emergency fund, retirement, loan payments). While not directly a "charity rule," you can incorporate giving by slightly reducing the 30% "Wants" category to free up funds for donations, making charitable contributions a fixed part of your budget rather than an afterthought.
Common Mistakes Non-Profits Make
Failing to File Form 990: The IRS automatically revokes tax-exempt status if you miss three years in a row. Mixing Funds: Using nonprofit funds for personal expenses can trigger investigations.
Nonprofits use fund accounting to organize and allocate their money in accordance with the programs and activities the money was donated to support. Nonprofits can use either accrual- or cash-basis accounting to track the finances of their operation.
No part of the net earnings of a section 501(c)(3) organization may inure to the benefit of any private shareholder or individual. A private shareholder or individual is a person having a personal and private interest in the activities of the organization.