There are many ways organizations can secure funding for capital projects, including cash reserves, tax-exempt debt, taxable debt and donations. Nonprofit senior living communities that use tax-exempt bonds to fund capital projects should keep in mind that they must adhere to the applicable tax regulations upon the initial issuance of the tax-exempt bonds and during the life of the bond issue and that the applicable tax regulations also impact fundraising campaigns for the tax-exempt financed capital project. Accordingly, if organizations plan to use tax-exempt debt and donations to fund their capital projects, they should consider how both forms of funding impact each other to ensure compliance with tax regulations and fundraising rules to maximize the organization’s long-term goals.
The main tax regulation at the intersection of tax-exempt debt and fundraising are the anti-abuse rules of the Internal Revenue Code. The rules prohibit the overburdening of the tax-exempt bond market, which generally means one of three things: (1) issuing tax-exempt bonds in amount more than necessary, (2) issuing bonds earlier than necessary or (3) allowing bonds to remain outstanding longer than otherwise reasonably necessary to accomplish the purpose of the bonds. Fundraising campaigns can implicate each of the three main limitations of the anti-abuse rules because they limit an organization’s ability to use tax-exempt bonds when the organization has other resources available to pay for the project to be financed. When enforcing the rules, the Internal Revenue Service requires that funds with a direct nexus to the financed project be spent before bond proceeds are used.
Fundraising campaigns and other fundraising dollars are a common source of funds for paying for a capital project. Donors typically contribute gifts for a particular purpose designated by the donor or by the organization. Donors make gifts with or without restrictions. Restricted gifts are permanently restricted to a specifically designated purpose while unrestricted gifts may be used by the organization as it determines is best.
When issuing tax-exempt bonds, restricted gifts must be spent on the applicable project. The requirement to spend restricted gifts toward the costs of the financed project influences the maximum allowable issuance of tax-exempt bonds for the project. But since not all gifts are received by an organization prior to the issuance of tax-exempt bonds, the bonds are required to be sized or structured in a manner that takes future gifts into consideration.
Organizations will receive restricted and unrestricted gifts. They would prefer unrestricted gifts, as they provide maximum flexibility, enabling organizations to optimize the combination of gifts and tax-exempt bond proceeds for capital project financing.
At the outset of a fundraising campaign, or even in the middle of one, organizations should strive to maximize their unrestricted gifts by using one or more of the following strategies:
Broad Campaign Objectives and Visionary Purpose
When setting the objectives and vision for a fundraising campaign, organizations are well served by adopting broad goals to optimize their use of gifts. A broad goal and vision for the campaign will help the organization maximize the receipt of unrestricted gifts, which can be allocated to various purposes such as operations, benevolent care or establishing an endowment. Setting more specific goals and vision for the fundraising campaign increases the likelihood of receiving restricted gifts.
Communicating With Donors
The next step in launching a fundraising campaign is creating impactful and effective written and verbal communications that will inspire donations. Professional fundraisers strive to tell engaging stories and present donors with a concrete vision of how their contributions will be used. But this process can sometimes inadvertently limit the purpose of the gifts. Whether the organization has hired a fundraising consultant or is overseeing the campaign internally, all communications, written and spoken, should consistently and clearly convey the campaign’s goals and vision.
Bond counsel should review written materials such as brochures, social media posts, newsletters and presentations before dissemination. While these materials may highlight the capital projects benefiting from the campaign, they must explicitly state that fundraising amounts may serve various purposes and should not guarantee funds for a specific objective.
Individuals soliciting donations for the organization must align their verbal communications with the campaign’s goals, vision and written materials. While discussions may revolve around tangible plans such as a new expansion project, solicitors must emphasize that fundraising dollars are versatile and may support other initiatives as well.
If a donor wishes to restrict a sizable gift to a specific purpose, the organization can engage in a dialogue with the donor to explain the advantages and benefits of providing an unrestricted gift, including the organization’s ability to leverage tax-exempt bond proceeds. By discussing these advantages, the organization may encourage the donor to consider the broader impact of an unrestricted gift on the organization’s financial flexibility and long-term sustainability.
Donor Cards and Acknowledgements
Donor cards and thank you acknowledgement cards are the direct communications between the organization and the donor; therefore, it is important that these materials use clear messaging to reiterate the goals and mission of the fundraising campaign and the unrestricted nature of their gift. Organizations should carefully review donor cards to ensure that donors have not specified a restricted purpose for their gift. The donor card essentially serves as the agreement or contract between the organization and the donor regarding the utilization of the gift. Here are some examples.
Donor Card Messaging: “This is an unrestricted gift to support the community’s vision for the future.”
Acknowledgement Card: “Thank you for gift. Your financial support is important to the furtherance of the community’s mission.”
Accounting for Gifts Upon Receipt
Once an organization receives a gift, it will need to appropriately account for such a gift as “unrestricted” or “restricted” on the organization’s financial statements.
An organization is not obligated to place gifts, restricted or unrestricted, into a segregated bank account but if the organization chooses to do so, it should not be earmarked for a specific purpose such as “project fund,” “debt service fund” or “expansion project account.” Doing so could establish a nexus between the gift and a particular project. Instead, unrestricted funds should be deposited into an unrestricted account.
Organizations should steer clear of creating “board-designated restricted funds” where the board imposes restrictions on a gift’s use without the donor’s explicit instruction to do so. Such a practice can lead to confusion, especially during management changes or record loss, as it may blur the distinction between donor-restricted funds and board-designated ones. If a board wishes to proceed with designating gifts for specific purposes, the organization should consult its accountants and bond counsel to discuss the implications of such designation. Board-designated restricted funds will be treated in the same manner as donor-restricted funds when analyzing the sources and uses of project financed with tax-exempt bonds.
Leveraging Restricted Gifts
The code imposes restrictions on the types of expenses that can be financed with tax-exempt bonds. Consequently, an organization must utilize alternative funds to cover costs ineligible for tax-exempt financing. Allocating restricted gifts to cover these expenses is a practical strategy, for example using restricted gifts to build a chapel or space leased to a for-profit company.
When a donor earmarks a gift for a capital project, it may be allocated toward servicing the debt on tax-exempt bonds, unless such use contradicts the donor’s specific restriction.
If a capital project’s funding sources include restricted gifts and tax-exempt proceeds, the code typically allows these restricted gifts to be freely invested for up to 13 months. After this period, however, the funds must be invested at yield-restricted rates, which means the rates cannot exceed the yield on the tax-exempt bonds. Nonetheless, organizations should seek guidance from their bond counsel to determine the relevance of different exceptions and conduct a thorough analysis of the specific facts and circumstances.
