UPMIFA to Impact Nonprofits

“Currently, there is no specific guidance on how these changes will be reflected and disclosed in a nonprofit’s financial statement; however, we feel it’s important to start conversations now to help tax-exempt organizations prepare for possible scenarios,” states Jennifer Foley, nonprofit and government manager with LarsonAllen.

In the first quarter of 2008, the Financial Accounting Standards Board (FASB) intends to issue comments on the potential effects of UPMIFA. At this time, there are a lot of questions about how the act will impact nonprofit organizations. People are asking what “prudent” means under the new act and some say a 7 percent spending limit will be enacted. According to Foley, “Nonprofits should consider engaging legal counsel to fully deal with the effects of UPMIFA.”

Per October 2007 data, 13 states have already enacted a variation of the new act, and other states have announced legislation. In the next two to three years, it is believed the remaining states currently following UMIFA will also enact a variation of UPMIFA.

What we do know about UPMIFA

• Considered a modernized version of UMIFA, the new act focuses on managing funds as a whole and prudent investor would.
• Under UPMIFA, the transparency of tax-exempt organizations will increase.
• The concept of historical value will go away and be replaced with more flexible spending policies.
• The act does not change your organization’s obligation to meet donors’ wishes and the intent of the endowed funds.
• The act does allow nonprofits to invest and spend from their endowments in the manner of a prudent investor.
• Endowments may still be created in which the principal cannot be spent under UPMIFA.
• Other states have announced legislation to enact UPMIFA.

Historical dollar value
Under UMIFA, the concept of historical dollar value was commonly considered a floor when determining the amount of permanently restricted net assets. In addition, organizations often adopted accounting policies where permanently restricted net assets would normally only be affected by contributions into the fund. Under this accounting policy, financial statements presented earnings on permanently restricted funds as unrestricted or temporarily restricted, unless the donor explicitly stipulated otherwise.

Under UPMIFA, nonprofits will be allowed to spend the principals plus any earnings as a prudent investor would, keeping in mind the original intent of the fund, the intended duration of the fund, and anticipated market conditions. Therefore, it will be important for organizations with endowments to develop a formal spending rate policy that includes all of these factors. This step will determine what amount can be spent from the endowment in accordance with the organization’s policy, which will also allow more flexibility to spend those funds—even when market returns are down or if the fund is regarded as “below-water.” Organizations must still retain the purchasing power of the fund.

Endowments where the principal cannot be spent under UPMIFA
Endowments may still be created in which the principal cannot be spent under UPMIFA. To do this, organizations must have the donor’s explicit written intent. Even without the explicit stipulations, nonprofits should continue to classify a portion of these funds as permanently restricted under UPMIFA. But based on the investment and spending rate policies, the fund should be evaluated and adjusted if necessary. And nonprofits will still need to understand the original intent of the fund and ensure they are doing what is in the best interests of the beneficiaries.

UPMIFA’s effect on funds older than 20 years
There is a provision in the new act that allows organizations with funds older than 20 years (and for amounts less than $25,000) to change the restriction. Although they must give notice to the attorney general before this is done, court approval is not needed to change this restriction (as it was under UMIFA). This should be reviewed by the governance of the organization to determine if it is prudent.

Some nonprofits may feel it is necessary to communicate this decision to donors in order to maintain good relations, but it is not required. However, development and fundraising departments should be aware of this change when creating endowed funds because it will impact how the organization invests and accounts for the funds.

Contact us
For more information, contact Jennifer Foley at jfoley@larsonallen.com or 888-529-2648.