Dr. David Lovett
May 1, 2025
The start of 2025 brings important audit and tax updates that nonprofit leaders should be aware of. From managing operating reserves to navigating new donor-advised fund rules, these insights are essential for long-term financial sustainability and compliance.
At Florida Business Consultants, we stay ahead of the evolving regulatory landscape so you can focus on advancing your mission. The start of 2025 brings important audit and tax updates that nonprofit leaders should be aware of. From managing operating reserves to navigating new donor-advised fund rules, these insights are essential for long-term financial sustainability and compliance.
Strengthening Your Financial Foundation: The Importance of Operating Reserves
Operating reserves are more than just a financial buffer—they are essential to the resilience and longevity of your nonprofit. Unlike restricted funds or endowments, operating reserves consist of liquid, unrestricted net assets that are available to stabilize operations, seize strategic opportunities, and respond to unexpected challenges.
Why Operating Reserves Matter:
Provide a safeguard during periods of revenue disruption
Support continuity during economic or political shifts
Enable strategic investment in programs, staff, or infrastructure
Allow flexibility to pursue new funding opportunities
Enhance organizational credibility and borrowing capacity
Developing a reserve strategy should begin with an internal review of existing policies and financial practices. This includes collecting relevant financial data, engaging leadership in policy discussions, and modeling target reserve levels. Final policies should clearly define the purpose of the reserves, funding thresholds, use parameters, and review cycles. Oversight should be shared across board committees, executive leadership, and investment advisors to ensure reserves are managed prudently and consistently aligned with the organization's mission.
Expense Allocation: A Strategic and Compliance Imperative
Expense allocations help nonprofits provide an accurate picture of how resources are used. This is not only an accounting requirement but a tool for transparency, donor confidence, and informed decision-making.
Nonprofits are required to allocate expenses across three functional categories: program services, management and general, and fundraising. A well-developed allocation method can:
Ensure accurate reporting in audits and Form 990
Comply with grant requirements, especially federal awards
Reflect the true cost of operating each program
There are three primary expense allocation models:
Functional Allocation (Required): Based on accounting standards and reported on the Form 990; often uses staff time as a driver.
Indirect Cost Rate Allocation (Required for federal contracts): Calculates a rate based on indirect expenses divided by a direct cost base; used for reimbursement grant agreements.
Fully-Loaded Allocation (Optional): Allocates all indirect and overhead expenses across program areas to understand total costs and support strategic decision-making.
Organizations should review and document their methodology, regularly validate cost assumptions, and ensure staff are trained in accurate time and resource tracking.
Going Concern: Recognizing and Responding to Financial Red Flags
Auditors are required to assess whether an organization can continue operating for at least one year from the audit report date. If “substantial doubt” exists about the organization’s ability to continue as a going concern, management must provide plans and supporting evidence to address these risks.
Common warning signs include:
Ongoing operating deficits or negative cash flows
Expiring or withdrawn grant funding without replacement
Delays in accounts payable or reliance on short-term borrowing
Repeated use of endowment funds for operations
Negative trends in giving or fundraising
Organizations must prepare realistic plans and financial forecasts, which may include cost reductions, new revenue sources, debt restructuring, or asset liquidation. Auditors will evaluate the feasibility of these plans and whether they are likely to mitigate risk. Depending on the outcome, the audit report may include a statement disclosing the going concern issue or note management’s plan to resolve it.
Public Support Test: Maintaining Public Charity Status
To qualify and remain as a public charity under IRS rules, nonprofits must meet the public support test. This test ensures that a significant portion of the organization’s revenue comes from the general public or government sources.
The IRS evaluates this using Schedule A of Form 990, specifically Parts II or III depending on the organization’s classification. Failing to meet the public support test over a five-year rolling period can result in reclassification as a private foundation, which carries stricter rules and tax obligations.
Best practices include:
Broadening your donor base and avoiding reliance on a few major contributors
Tracking contributions from disqualified persons, including board members
Properly categorizing grants and earned revenue
Documenting any unusual or one-time grants for IRS reporting purposes
Donor Advised Funds: Benefits and Limitations
Donor Advised Funds (DAFs) have become increasingly popular for philanthropic giving. They allow donors to make a charitable contribution, receive an immediate tax benefit, and recommend grants over time. While DAFs offer flexibility, nonprofits must be mindful of the restrictions surrounding their use.
Key limitations:
DAFs cannot fulfill personal pledges or provide more than incidental benefits to donors
Grants cannot be earmarked for individuals
Funds may not be used for ticket purchases, auction items, or membership fees if they are not fully deductible
Grants to private non-operating foundations are prohibited
International grants require additional compliance such as expenditure responsibility or equivalency determinations
In 2025, the IRS issued new proposed regulations to tighten oversight on DAFs. These include expanded definitions of related parties and new excise tax rules for both sponsoring organizations and donors. These regulations are expected to apply retroactively once finalized, making it critical for nonprofits to review how they accept and use DAF contributions.
How FBC Can Support You
Navigating audit and tax compliance as a nonprofit requires more than annual checkboxes—it requires a strategic, informed approach year-round. FBC Accounting Services is dedicated to helping mission-driven organizations achieve financial clarity and regulatory confidence.
Our team can assist with:
Reserve policy design and implementation
Functional and fully-loaded expense allocation models
Going concern risk mitigation planning
Public support test compliance and Schedule A reviews
Donor Advised Fund strategy and documentation
As your nonprofit continues to grow, FBC is here to provide the accounting insights and strategic support you need to thrive. Contact us to schedule a consultation and learn how we can help you stay compliant, agile, and mission-ready in 2025 and beyond.
Dr. Lovett has 30+ years experience in the accounting and finance fields. He is a noted author, columnist, speaker, and contributor to the financial success of multiple businesses and nonprofit organizations. Dr. Lovett can be contacted at dr.lovett@fl-business-consultants.com.