by Cynthia Harrington

CPAs who volunteer their financial expertise to nonprofits increasingly find themselves dealing with profit-making ventures.

Since regular funding sources are down, organizations that serve the social good are scrambling for new ways to acquire capital. More and more turn to selling goods or services. Creating profits while serving a philanthropic mission raises tax issues and can strain the resources of an unprepared organization.

“The past few years, nonprofits have needed to look for ways to enhance dwindling foundation grants and capped government funding,” said Gayle M. Whittemore, CPA, MBT, of Green, Hasson & Janks LP, in Los Angeles. In addition to her large nonprofit practice, Whittemore serves as a board member of the Los Angeles-based Center for Nonprofit Management. “More and more, I see nonprofits looking to increase funding through the earned-income area,” she said.

An early question that the organization faces is whether the new profits will be taxed. Some risk encountering tax liability on unrelated business income, while others do not. “I’ve got a client now with advertising revenue that’s unrelated business income tax, and a senior center with a travel program that’s a problem,” said Whittemore. “But defining UBIT is a judgment call and always entails walking a fine line.”

Organizations and their advisors who are looking for help on tax and other issues have a resource in the Social Enterprise Alliance. Its Web site, www.se-alliance.org, has research, references and contacts to help organizations and their advisors. The alliance also sponsors an annual meeting. “The issue of unrelated business income is a red herring that nonprofits hold on to,” said Beth Bubis, president of the Columbus, Ohio-based SEA. “If you talk to them two and three years out, they will say they wasted their time worrying about it.”

Structural questions
The legal structure of the profit-making venture is another important decision. Organizations structure the moneymaking ventures in different ways. Some establish a separate subsidiary or a joint venture with a for-profit company. Others maintain the new efforts as internal programs or divisions. “Those that may be more successful are setting up alternative legal structures,” said Bubis.

In addition to advising on the tax issues, the board may look to their accountant members to navigate other issues in the quest to raise funds. Nonprofits need to evaluate the skills of staff and the board to see if a for-profit venture would overtax the current organization.

Since the CPA is often the financial and business expert, their experience with for-profit clients may be tapped. Karen Rosen has a bird’s eye view of changes in the nonprofit sector. Rosen is director of the Chicago-based CPAs for the Public Interest of the Illinois CPA Society, which matches financial experts with Illinois nonprofit organizations and community service projects, as well as providing direct educational and consulting help to tax-exempt organizations in the state. “The CPA can play a pivotal role in helping nonprofits in the transition to some earned-income strategies,” said Rosen.
In addition to assessing staff skills, the organization must consider whether the proposed for-profit fits the purpose of the nonprofit. A successful example is Pioneer Industries, in Seattle.

Profiled in the 1999 Harvard Business Press book, “Common Interest, Common Good,” Pioneer started as a service organization to help people coming out of prison and drug rehab programs to gain employment skills. Through a contact at local giant Boeing, Pioneer established a “sheltered workshop” in which the Pioneer people made simple parts for the airplane manufacturer. Profits from this program now support Pioneer’s human services efforts. “Lots of nonprofits try to reach out to too many different places,” said Whittemore. “Organizations have a core practice that they’re good at, and should fit any profitable strategy to that expertise.”

Just like any other business
In the transition to earned income, nonprofits encounter the full range of business issues. Organizations considering profitable ventures need to undertake a marketing analysis to understand who the competitors are and what market share is available. “The nonprofit would have to answer the question of whether the new venture can be run in a profitable manner,” Whittemore said.

From the CPA’s point of view, a big stumbling block could be guiding the organization in understanding a common language. “Earned income” in the nonprofit world means “payments received in direct exchange for a product, service or privilege” according to the Social Enterprise Alliance. Whether or not the earned income becomes UBIT seems to depend on how well the earned-income business or strategy undertaken by a nonprofit to generate revenue supports of its charitable mission.

Interest in understanding the distinction is high. The session at the SEA’s last meeting on how to use financial reports to do good planning for social enterprise had to be run twice to accommodate demand. Participants engaged in a live interactive game of a model situation. Session leader Marty Lasker, MPA and president of HLC Inc., in Valley Village, Calif., runs the Profitability Business Simulation primarily for large multinational companies. “Nonprofits usually think in social terms,” said Lasker. “This challenges them to think in another arena with both their hearts and heads.”

A consistent problem with nonprofit clients is the definition of terms. Lasker gives the example of the word “profit.” To a financial person, the implications of whether the term refers to gross or net profit are clear. But a non-financial person might think the term refers to cash on hand and sometimes to revenue. “The different use of words lays a trap for all kinds of misunderstandings,” Lasker said. “In the simulation, people come to understand a common meaning of the business terms.”

Increased scrutiny puts additional focus on the nonprofit’s financial expert. Bills have been introduced in more than a dozen states to enforce components of Sarbanes-Oxley on the tax-exempt world. In California for instance, the legislation proposes mandatory audits for all organizations with budgets greater than $500,000.

The Internal Revenue Service is also sampling the financials of nonprofits to formulate a plan for how to better police tax-exempt groups. “One thing the IRS is carefully examining is how the organization filled out the tax-exempt purpose form,” said Whittemore. “This all goes back to the call for increased accountability in every sector.”

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