One of the things you quickly learn when starting and operating a 501(c)(3) organization is that you must handle money wisely. A nonprofit organization is no different than any other business in that you have to make ends meet. Otherwise, your charity will cease to exist. The current economic difficulties make this task even more challenging as we are all stretching the dollars until they are transparent.

But here’s a question you probably haven’t considered: In all your efforts to keep the lights on, could you be unknowingly embezzling funds? Is it possible that he is even committing a crime? If you don’t understand what the IRS requires regarding designated funds, you may be.

I can’t begin to tell you how many times we see this situation messed up. Most of the time, it’s an innocent attempt by a board or CEO to be good stewards of the money that people have donated.

For example, suppose things are tight at the old soup kitchen. There is not enough cash in the general operating fund to buy all the food needed for the upcoming holiday season. However, there is a good amount of cash in the fund designated to build a new facility. And, in truth, food shortages are a much more pressing need. It is unlikely that a construction project will start for at least two years. Is it okay to divert some of the money from the construction fund to the food fund?

Maybe or maybe not.

Two Types of Designated Funds Understanding that there are two types of designated funds (or gifts), solicited and unsolicited, is the first step to getting it right. Let’s take a look at each:

Requested designations. A request means that your organization has requested donations for a particular cause. Maybe it was by letter, email, website, radio ad… it doesn’t really matter. What matters is that donations given in response to a direct request are permanently dedicated to that purpose. In our soup kitchen example, the board cannot move that money, no matter what the circumstances say, if those funds are the result of a solicitation. Last week, many of you may have read the story of the director of a large national charity who resigned after it was discovered that he had done exactly this. Was it for a good reason? Yes. Was it illegal? Unfortunately yes.

Unsolicited appointments. These are donated funds that the donor designates without being solicited by the charity. For example, Bob decides to donate $100 to the local soup kitchen, but on his own he decides to “designate” those funds to be used for future expansion. In this situation, can the charity legally divert that money to its food fund? This may surprise you… but the answer is “Yes!” To be fair, there are certainly times when it’s politically expedient to honor an unsolicited designation, but the key point is that only the charity itself can bind the donation. This news is often a welcome relief for charities that have struggled to deal with these situations.

One more point about requested designations…there are ways around this problem. First, provide a disclaimer with your request that the organization reserves the right to move the money as it sees fit. However, any funds received in excess of the requested purpose budget will be put into the general fund. In a situation where it’s too late for a disclaimer, you can go back to the donors and ask for permission to reallocate their donations. Keep in mind that they have a legal right to say no, although that is unlikely in most legitimate situations of need.

Managing the finances of a nonprofit organization is always a challenge. Knowing how to properly approach designations is critical to staying out of trouble with your donors…and the law.