To maintain their tax-exempt status, nonprofits need to manage their expenses according to strict IRS rules. This article covers some information that can help you comply with those regulations while maximizing the impact of your mission. Please refer to the IRS guidelines for access to all applicable rules.
Why understanding your nonprofit's expenses matters
Nonprofit organizations incur expenses that support their operations and mission. These expenses typically fall into three main categories:
- Program expenses: Costs directly related to delivering the nonprofit’s mission and services.
- Administrative expenses: Costs for general operations and management.
- Fundraising expenses: Costs associated with raising funds to support the organization.
Tracking and managing these expenses helps nonprofits comply with IRS regulations, demonstrate accountability to donors, and maximize resources devoted to their mission.
Ultimately, managing expenses for a nonprofit organization requires clear, strategic choices that can support your fundraising while expanding your mission's reach.
IRS rules for nonprofit expenses
The IRS has laid out specific rules, regulations, and guidelines for categorizing and reporting expenses for nonprofit organizations.
Some are fairly obvious, like not using nonprofit funds to line your own pockets. Others might seem less straightforward, at least at first, but they all come down to making sure nonprofits aren't misusing their funds.
Functional expenses: the three categories of nonprofit expenses
The IRS requires nonprofits to categorize their functional costs into three main areas. With standardized reporting on Form 990, these categories help stakeholders understand how organizations are using their resources.
Program expenses
Program expenses are the direct costs of the activities that fulfill the nonprofit's mission, clearly supporting the organization's charitable purpose. The IRS expects organizations to maintain detailed documentation showing how these expenses contribute to their charitable programs.
Management and general expenses
Management and general costs are necessary for the organization's operation but aren't directly tied to programs or fundraising. The IRS allows reasonable administrative costs but expects nonprofits to keep these administrative expenses proportional to their overall budget and mission scope.
Fundraising expenses
Fundraising expenses must be properly identified and reported separately from program and management expenses. The IRS requires clear documentation of costs associated with soliciting contributions, including both direct and indirect expenses related to fundraising activities.
Reasonable compensation rules
The IRS requires that compensation for nonprofit employees and executives be reasonable and not excessive.
Organizations must demonstrate that salaries and benefits are comparable to those of similar positions in their sector and geographic area. This includes documenting how compensation levels were determined and maintaining records of comparable salary data.
Private benefit and inurement prohibitions
The IRS prohibits nonprofits from using funds to benefit anyone connected to the organization, like board members, trustees, employees, or their families.
This rule exists to make sure nonprofit resources go toward charitable purposes, not someone's personal gain. Even small amounts of private benefit can jeopardize your tax-exempt status.
That said, nonprofits can still compensate employees fairly for their work. We recommend keeping records that show the compensation is reasonable and in line with industry standards.
Disclosure requirements
The IRS requires nonprofits to make certain financial information available to the public. This transparency helps maintain public trust and accountability.
You'll need to provide copies of your three most recent Form 990s to anyone who asks. Many nonprofits simply post these forms on their websites to make them easily accessible.
Documentation and record-keeping requirements
Good documentation isn't just about satisfying IRS requirements—it's about protecting your organization and maintaining donor trust.
Keep detailed records of all expenses—including receipts, invoices, and documentation showing why each expense was necessary. For major expenses, maintain records of the decision-making process, including any board approvals.
The IRS requires you to keep these records for at least three years, but many organizations keep them longer for grant compliance or historical reference.
A complete list of nonprofit expenses
Let's break down common expenses by category, so you can see how to classify each type of cost your organization might incur.
Program expenses
This is the money you spend on your mission. All of these specific program costs relate directly to your organization's charitable purpose. Below are some of the most common examples.
1. Direct service costs: If your nonprofit is providing a service, like tutoring for underprivileged kids, the cost of that service is a program expense. These costs include any services that are specifically being provided as part of your mission.
2. Program-specific personnel: This includes salaries and benefits for the staff who directly deliver your programs, like teachers, social workers, or medical professionals.
3. Program supplies and materials: These are the ongoing supplies needed to run your programs, from educational materials to food for meals to medical supplies, depending on your mission.
4. Program-specific technology: This covers software, equipment, or other technology used specifically for program delivery, like case management software or specialized medical equipment.
5. Direct travel for program delivery: Travel expenses that are directly related to delivering services, like mileage reimbursement for delivering meals, are also included in program service expenses.
Management and general expenses
These operational costs are necessary to run your nonprofit organization, but they aren't tied directly to your programs or fundraising. Here are some common examples.
1. Administrative personnel: This covers salaries and benefits for staff who handle your organization's general operations, but who aren't directly delivering your programs, such as your executive director, finance team, public relations, and HR staff.
2. Professional services: These operating expenses include nonprofit accounting, legal fees, and any consulting services that are needed to ensure compliance with federal regulations and run your organization effectively.
3. Facilities expenses: This category includes rent, utilities, and other costs incurred to maintain your headquarters or office space independent of your program operations.
4. Office supplies, equipment, and technology: This covers general office technology and equipment for day-to-day operations that aren't specific to program delivery, like computers, phones, and general-purpose software.
5. Insurance and risk management: This includes liability insurance, property insurance, and other coverage needed to protect your entire organization generally.
6. Marketing and communications: These costs are related to general organizational communications, like your website, annual report, and general marketing materials, not tied to any specific fundraising or program delivery.
Fundraising expenses
These are the fundraising costs associated with raising money for your organization. While they're necessary for sustainability, you'll want to keep them reasonable compared to the funds you raise.
1. Fundraising events and campaigns: This includes all costs associated directly with fundraising activities, from venue rentals and catering for events to online campaign costs and printed materials specifically for fundraising.
2. Development staff: This covers salaries and benefits for employees who focus on fundraising and donor relations, including your development director and grant writers.
3. Donor management systems: These are the tools and software you use to track donations, manage donor relationships, and run fundraising campaigns.
4. Grant writing costs: This includes not just the staff time spent writing grants, but also any consulting fees, grant-specific research costs, and resources dedicated to grant reporting.
Allocating mixed expenses
Some expenses don't fit neatly into a single category. Here's how to handle functional expense allocation for costs that span multiple areas.
1. Shared personnel time: When staff members split their time between different functions, you'll need to allocate their costs accordingly. For example, if your executive director spends 60% of their time on management, 30% on programs, and 10% on fundraising, their salary should be split the same way.
2. Facility usage: Similarly, if you use your main building for multiple purposes, allocate those costs based on usage.
These allocations might be based on space—maybe your administrative offices make up 20% of the floor space and the other 80% is used for the people who run your nonprofit hotline. Or they could be based on time, like a community center that's occasionally used for fundraising. Or both—if 20% is admin space and the other 80% is sometimes used for programs and sometimes for fundraising.
The key is to allocate expenses using a meaningful accounting system that you can easily validate and to make sure you're documenting that system.
Manage your nonprofit expenses with BILL Spend & Expense
Managing these different expense categories—and making sure they're properly allocated—can be challenging.
BILL Spend & Expense can help you:
- Set budgets by category—code expenses and enforce budgets automatically
- Maintain proper documentation for each expense
- Create financial reports for your board and the IRS
- Set approval rules and workflows for different types of expenses
- Sync your data to your accounting software to keep everything up to date
What our nonprofit customers say about BILL
“The impact of adding BILL was immediate and dramatic. What used to take 20 hours a week in manual payment processing has been cut to less than a couple hours.” — Network of Community Ministries
“I appreciate the robust user controls in BILL. Some team members can just enter bills, others can be approvers, and only the leadership team can make changes once approved. It’s easy to show that to auditors or print the audit history and cashed checks.” — Hidden Villa
“My desk was the most disgusting thing with paper up to here. Now my auditors come and I don’t have to stay up all night wondering what happened to one bill.” — The Life Link
