Demystifying the Overreliance on Tax Filings as Predictive of Future Results

As we know, nonprofit organizations provide services to the general public. As a result, they have a unique role in society. In short, we trust them to support socially good and positive causes, and, in exchange, the government generally provides them with tax exemptions. However, many nonprofits make a serious error in thinking that the annual reporting of how great the sector’s doing is predictive of the future.

Here's the scoop. It's a mirage on a couple of levels, and it would be best if nonprofit leaders and donors viewed the annual reporting as nice to know. The reality for the vast majority of organizations is that annual tax reporting has nothing to do with them. For one, most nonprofits aren't the institutions where billionaires donate. Also, tax filings are the worst indicators because they rely on tax information that's dated.

Many nonprofits are under the impression that the financial performance of the sector (with reporting nearly two years old by the time it's published) is a good predictor of its future fundraising performance. In today's digital, data-driven environment, it’s increasingly understood that external factors, such as changes in the economy, donor expectations, and the organization's leadership, have a much more significant impact on a nonprofit's future performance.

How Donor-Advised Funds Skew Fundraising

Increasingly, nonprofit fundraisers understand that donor-advised funds (DAFs) are a way for donors to park money with a measure known as assets under management (AUM). No worries. The U.S. government is trying to figure out ways to claw back the money, so they don't have to support social programs. I think it's fair to say that it's no secret that the U.S. prefers not to invest in social safety nets, and everyone has to take care of themselves. That's what happens in an individualistic society.

That said, the largest “nonprofits” are organizations like Fidelity Charitable and Vanguard Charitable. Does that make sense to you? It doesn’t to me, and it doesn’t to the U.S. Congress, which introduced legislation in 2022 to fully enforce the minimum 5% (woefully low) payout to programmatic nonprofits and when donors could get a tax deduction, among other things. More than 1 million DAF accounts exist, with more than $159 billion in assets as stated in Congress’ proposed legislation. That ultimately ends up skewing annual reporting numbers for the sector.

New Strategies Are Needed to Stay Relevant

Again, while it's nice to know, annual reporting about the size and scope of the industry is not something that most nonprofits should ever consider. As the sector grows in terms of the number of organizations in operation, the amount of services provided, and the amount of public interest in service delivery, the need for better predictability has become even more pronounced. This is particularly true for nonprofits looking to attract new funding from donors.

So, to stay relevant to donors in this scenario, future performance must be more predictive than tax filings. Moreover, the industry has grappled with poor financial reporting standards. Therefore, while tax filings have offered some insights into the sector's financial health and future performance, they do not have any predictive power. What does? Plain and simple, predictive data platforms.

Emphasis on Compliance and Auditing as Predictive Measures

It should be no surprise that organizations that depend on compliance and auditing for their survival would place a lot of emphasis on tax returns as a predictive measure of future results. Compliance and auditing are essential elements of the sector, but they’re not measures nonprofits should use to predict an organization's future performance.

Audits have provided reasonably accurate assessments of revenue and compliance with regulations, such as The Sarbanes-Oxley Act, giving good indications of past and current financial health. However, these measures have their limitations. Audits are required by law at certain levels, but they do nothing to truly predict fundraising results for any nonprofit in a dynamic environment where anything can happen at any time.

Leaning Into Data and Predictive Tools

Tax filings don't provide sufficient information on the sector's current and future financial health and performance. And they certainly don’t do it for any specific nonprofit. So, again, nonprofit leaders should steer away from the idea that giving reports showing the sector is an approximately $500 billion industry as having much to do with them. It doesn't.

It's nice to look at the numbers year over year and be amazed at how the industry continues to grow — even through the pandemic. But it belies facts that are too easy to ignore. DAFs make up a portion of those funds, and right now, a lot of it is doing not much more than making money managers wealthy. And more and more nonprofits are being added to the roles each year.  Florida averages an increase of 10,000 nonprofits per year alone.

Also, just because nonprofit fundraising appears to have increased year over year, it means nothing to any specific nonprofit. If you don’t do relational fundraising, make a significant social impact or lean into data and predictive fundraising tools instead of taking educated guesses at future goals, at some point, you’ll experience a fundraising decline.

Most nonprofits spend a lot of time and energy trying to predict the future. Unfortunately, this pursuit is almost always futile if you don't invest in data tools and old-school relationship-building. As a sector, I hope we’re getting past the point of relying on annual reporting of tax filings as a measure of future results as well as the performance of the markets. Once we do, we’ll get back to the serious business of tending to our own fundraising gardens instead of looking at a mirage in a desert.

The preceding blog was provided by an individual unaffiliated with NonProfit PRO. The views expressed within do not directly reflect the thoughts or opinions of NonProfit PRO.