A charitable organization should spend a significant percentage of its annual budget on programs that pursue its mission. The budget should also provide sufficient resources for effective administration of the organization, and, if it solicits contributions, for appropriate fundraising activities.
Charitable organizations have an obligation to devote their resources to the charitable purposes for which they were granted tax exemption, and to spend donated funds on the programs and activities for which the funds were contributed. At the same time, the successful operation of any business or organization—including the responsible pursuit of nearly any kind of charitable purpose—requires effective management and administration. Administrative activities include financial and investment management, personnel services, recordkeeping, soliciting and managing contracts, legal services, and supporting the governing body of the organization. Not only do these elements ensure that the organization complies with all legal requirements, but they also help provide complete, accurate, and timely information to donors, the public, and government regulators.
Charitable organizations rely on other supporting services to carry out their missions. Most public charities have fundraising operations to encourage potential donors to contribute money, materials and other assets and to ensure that donors receive necessary reports about how their contributions were used. Some public charities also rely on membership development activities to solicit prospective members, collect membership dues, and ensure that members receive promised benefits. Private foundations and some public charities also have expenses associated with making grants and contributions to other organizations and individuals.
Qualified personnel are crucial for providing programs, recruiting and managing volunteers, raising funds, and ensuring proper administration. The costs of compensating personnel, including salaries and benefits, must be allocated to the particular functions they perform for the organization based on appropriate records.
Some self-regulation systems and “watchdog” organizations recommend that public charities
spend at least 65 percent of their total expenses on program activities. This standard is reasonable for most organizations, but there can be extenuating circumstances that require an organization to devote more resources to administrative and fundraising activities. The board should review the budget and financial reports to determine whether the organization is allocating its funds appropriately.
Both private foundations and public charities are permitted to incur reasonable and necessary
“administrative expenses” to further their charitable missions. Congress has never placed a general limitation on the amount of administrative expenses public charities can incur. Public charities that are required to file Form 990 must disclose their total expenditures for administration or what the instructions to the form calls “management and general” expenses. The IRS defines management and general expenses as the organization’s expenses for overall function and management, rather than for its direct conduct of fundraising activities or program services. Overall management usually includes the salaries and expenses of the chief officer of the organization and that officer’s staff. If part of a manager’s time is spent directly supervising program services and fundraising activities, the appropriate portion of his or her salary and expenses should be allocated to those functions.1
Rental income expenses and program-related income expenses are not included in management and general expenses. Administrative expenses are further distinguished from “indirect expenses” such as rent, reception services, etc. which can be allocated to various program cost centers and to management and general. There is no comparable definition of administrative expenses for private foundations in the instructions to the Form 990-PF. Private foundations are permitted to count all “reasonable and necessary” administrative expenses against their five percent payout requirement.2 Federal law does not permit expenses for ongoing investment management, such as investment consultant fees, custodial fees, attending investment conferences, etc., to be counted as qualifying distributions.
These questions – from the Principles Workbook (PDF) – are intended to prompt discussion about the principle, assess the polices and practices of your organization, and encourage your organization to take steps to identify where improvements should be made.