Choosing Your Year-End
Many business entities are required by the IRS to use a calendar year-end for their fiscal year. Nonprofit organizations are free to choose their fiscal year end, and should do so with great care. Although there is nothing wrong with using a calendar year-end – using a calendar year-end can reduce confusion in many cases – there are several important factors to consider before defaulting to 12/31.
Factors Impacting Year-End Selection:
Business Cycle
Seasonal/programmatic timing – your nonprofit may have certain funding cycles and sources that would be best reported on a year-end other than 12/31. For example, if you hold your biggest fundraiser at the end of the summer, it might be best to set your year-end at September 30 so that the next round of funding and expenses are booked in the most appropriate fiscal year.
Funding cycle – many significant grants come with significant reporting responsibilities. If you receive a large grant from an organization working on a fiscal year other than calendar, it may be easiest to align your reporting with theirs by adopting the same year-end. This is especially true for government funding.
Legal Factors
Debt covenants – although it probably shouldn’t be your most driving factor, in the absence of other long-term factors consider any debt covenants your organization has in place. Lender-imposed requirements usually include certain reporting, which may be easier to fulfill with a year-end aligning with the covenant’s requirements.
Miscellaneous Factors
Industry norms – organizations within certain industries in the nonprofit sector tend to have the same year-end. For example, after-school care organizations may tend to align with schools’ year-end (typically June 30). Conservancy nonprofits may tend to follow a September 30 year-end, to align with the US government year-end. Even if the nonprofit is not receiving grants or funding from schools or governments, keeping the year-end aligned with that of the entities with whom they work closely makes reporting a little easier.
By carefully choosing a year-end that closely aligns with your nonprofit’s operations and adjacent organizations, you minimize reporting misalignments, and provide the most complete picture for your nonprofit’s fiscal cycle.
Changing Your Year-End
Perhaps even more than other business models, nonprofit organizations evolve over time. Your organization may experience a shift in funding sources, a change in the business cycle, or even a major shift in mission focus that would be better served by a different year-end. In cases where such evolution is so drastic that the year-end selected no longer functionally serves the organization, consider changing the fiscal year-end.
1. Assess the need to change the year-end
Changing your year-end is a process, and should not be undertaken frequently or for the hope of obtaining more lucrative grant funding. All financial decision-makers should be included in the discussion to understand why the change is necessary, and all the pros and cons of shifting the year-end.
2. Present to the Board and obtain approval
Because the Board is ultimately responsible of ensuring proper management of their nonprofit, the Board needs to agree with the change in year-end and sign off on making the change. The effects will trickle through all aspects of financial reporting for about 2 years, so they need to be aware and watching for those effects.
3. Notify the IRS and State Agencies
Because the IRS grants a nonprofit their tax-exempt status, the IRS also ratifies a change in year-end. To notify the IRS, file Form 1128 “Application to Adopt, Change, or Retain a Tax Year” to request approval for the change. The principal officer or other person legally authorized must sign this form, so make sure that is the correct person. Often, this is the same person named during the organization’s incorporation, and is a signatory on the bank account(s).
Be careful of when you complete and file this form, to ensure it is effective in the correct period. Per the IRS, “to request a ruling to adopt, change, or retain a tax year, file Form 1128 byt the due date (not including extensions) of the federal income tax return for the first effective year. Do not file earlier than the day following the end of the first effective year. In the case of a change in tax year, the first effective year is the short period required to effect the change.” Let’s look at an example.
Say you have a current year-end of 9/30, and you determine that it would be best to move that year-end to 6/30. For your first effective (6/30) year, the 990 is due – before extensions – 5 ½ months after your year-end, at December 15. The timing will look like this:
Last year-end on old fiscal year: 9/30/20X1
Short year (aka effective year): 10/1/20X1 – 6/30/X2
Earliest day to file Form 1128:7/1/20X2
Last day to file Form 1128: 12/15/20X2
New year-end on new fiscal year: 6/30/20X2
When you file Form 1128, you should also follow whatever procedures are appropriate for your nonprofit’s incorporated state. These procedures vary by state.
Depending on your organization, state charitable registrations may be affected by the short year, and/or the new year-end. Examine the requirements and filings for each state, and follow up on any additional filings needed to remain in compliance as a nonprofit in those states.
4. Update internal documents, accounting systems, and any financial tracking systems
Any bylaws and policies which identify your year-end by date need to be updated, and the year-end for financial reporting purposes needs to be updated across all relevant systems (QBO, LGL, etc). If you have budgets entered into your accounting system, you’ll also need to create/prorate and upload a budget for the short year.
5. Carryforward with the short year, and subsequent new year-end
You will see ripple effects from the year-end change through the end of the first complete year (7/1/20X2 through 6/30/20X3, from the example above). You’ll likely have to include a disclaimer or footnote for most financial reporting to explain the reason for the short year, any proration, and address how the change in year-end affects year-to-year comparisons. You’ll need to ensure this change is communicated effectively to all team members, donors/grantors, and financial statement users. There will be discussion of this short year in your annual audit, and a special “short year” notation will be added to your 990 for that transition year. You’ll need to temporarily change your short-year budgeting to accommodate the smaller time frame, and ensure any strategic projections take this into account.