Tax Alert | August 28, 2022

by RSM US LLP

For nonprofit organizations, inflation hits doubly hard, with demand for services rising along with the costs of providing those services. In addition, nonprofits often see donor pools dry up as the economy worsens over time. Nonprofits grapple with these challenges along three lines: budgets, reserves and contributions.

Blown out budgets

Most nonprofits budget on annual cycles; depending on the start of their fiscal years, organizational budgets may have been constructed up to 12 months ago in a very different economic context. When these budgets were approved, it is highly unlikely that current levels of inflation were taken into account. This means that most organizations will face higher-than-planned expenses unless they make significant operational changes, which is often difficult in the middle of a fiscal year. Organizations that rely heavily on travel—such as those that present conferences or distribute food—are paying over a third more for flights and over 40% more for gas. Offsetting these price increases requires some combination of additional revenue, reserve spending or a change in operations to reduce services.

Catch-22 for endowments and reserves

An organization with a healthy endowment or operating reserve might typically cover short-term price increases by drawing from those resources to maintain service levels without sacrificing future operations. However, with both stock and bond markets significantly down year to date, additional draws only hinder the long-term success of those investments by locking in the losses of the past year. Therefore, pulling funds out of the market may be an especially difficult pill for nonprofits to swallow.

Contribution instability

Donors, grantors and association members are the lifeblood of nonprofits of all types, so it is important to consider economic impacts on them and the subsequent impact on their philanthropy. Data show that contributions to nonprofits, on average, decrease 0.5% in down economic years, while they increase 4.7% in up years. Foundations are squeezed to the same degree as nonprofit endowments, but they are required to distribute 5% of their net assets annually. Smaller asset portfolios mean that foundations have less to give. Similarly, associations that have members with squeezed budgets may find that their value propositions are less effective in enticing dues renewals and new members.

There is no doubt that current economic struggles are hitting the nonprofit industry hard. Demand for services is high, while revenue is strained, and expenses have risen faster than planned. During recent good years, many nonprofits built rainy day funds and created operating reserve policies. It may be time to tap those funds or utilize those policies while waiting for the sunshine to reappear.

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This article was written by Matt Haggerty and originally appeared on 2022-08-16.
2022 RSM US LLP. All rights reserved.
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