When a donor promises to make a contribution at a later date, your not-for-profit likely welcomes it. But such pledges can come with complicated accounting issues.
Conditional vs. unconditional
Let’s say a donor makes a pledge in April 2018 to contribute $10,000 in January 2019. You generally will create a pledge receivable and recognize the revenue for the April 2018 financial period. When the payment is received in January 2019, you’ll apply it to the receivable. No new revenue will result in January because the revenue already was recorded.
Of course, you can’t recognize the revenue unless the donor has made a firm commitment and the pledge is unconditional. Several factors might indicate an unconditional pledge. For example:
• The promise includes a fixed payment schedule.
• The promise includes words such as “pledge,” “binding” and “agree.”
• The amount of the promise can be determined.
Conditional promises, on the other hand, could include a requirement that your organization complete a particular project before receiving the contribution or that you send a representative to an event to receive the check in person. Matching pledges are conditional until the matching requirement is satisfied, and bequests are conditional until after the donor’s death.
You generally shouldn’t recognize revenue on conditional promises until the conditions have been met. Your accounting department will require written documentation to support a pledge before recording it, such as a signed agreement that clearly details all of the terms of the pledge, including the amount and timing.
Pledges must be recognized at their present value, as opposed to the amount you expect to receive in the future. For a pledge that you’ll receive within a year, you can recognize the pledged amount as the present value.
If the pledge will be received further in the future, though, your accounting department will need to calculate present value by applying a discount rate to the amount you expect to receive. The discount rate is usually the market interest rate, or the interest rate a bank would charge you to borrow the amount of the pledge. Additional entries will be required to remove the discount as time elapses.
Word of caution
Proper accounting for pledge receivables can be tricky. But if you don’t record them in the right financial period, you could run into audit issues and even put your funding in jeopardy. Contact us for help. © 2018
Tax planning is a juggling act for business owners. You have to keep your eye on your company’s income and expenses and applicable tax breaks (especially if you own a pass-through entity). But you also must look out for your own financial future. For example, you need to develop an exit strategy so that taxes don’t trip you up when you retire or leave the business for some other reason. An exit strategy is a plan for passing on responsibility for running the company, transferring ownership, and extracting your money from the business.
When a business has more than one owner, a buy-sell agreement can be a powerful tool. The agreement controls what happens to the business when a specified event occurs, such as an owner’s retirement, disability or death.
Among other benefits, a well-drafted agreement:
- Provides a ready market for the departing owner’s shares,
- Prescribes a method for setting a price for the shares, and
- Allows business continuity by preventing disagreements caused by new owners.
A key issue with any buy-sell agreement is providing the buyer(s) with a means of funding the purchase. Life or disability insurance often helps fulfill this need and can give rise to several tax issues and opportunities. One of the biggest advantages of life insurance as a funding method is that proceeds generally are excluded from the beneficiary’s taxable income.
Succession within the family
You can pass your business on to family members by giving them interests, selling them interests, or doing some of each. Be sure to consider your income needs, the tax consequences, and how family members will feel about your choice.
Under the annual gift tax exclusion, you can gift up to $15,000 of ownership interests without using up any of your lifetime gift and estate tax exemption. Valuation discounts may further reduce the taxable value of the gift. With the gift and estate tax exemption approximately doubled through 2025 ($11.4 million for 2019), gift and estate taxes may be less of a concern for some business owners. But others may want to make substantial transfers now to take maximum advantage of the high exemption. What’s right for you will depend on the value of your business and your timeline for transferring ownership.
If you don’t have co-owners or want to pass the business to family members, other options include a management buyout, an employee stock ownership plan (ESOP) or a sale to an outsider. Each involves a variety of tax and nontax considerations. Please contact us to discuss your exit strategy. To be successful, your strategy will require planning well in advance of the transition. © 2018