I’ve just taken over as the Executive Director of a small nonprofit after an extended transition with my predecessor, during which she could never quite get around to handing me the checkbook. Now that I’ve got it, I can see why: there’s a record of the checks we’ve written but no balance. When I called the bank in a panic, the bank officer said, "Oh, yeah, you’ve got plenty of cash" and cited a number in the $10,000 range–whereas if we had $10,000 to spare I sure wouldn’t keep it in a non-interest-bearing checking account! Meanwhile, there seems to be some trouble with the IRS, though I haven’t yet figured out the meaning of the letters I’m receiving. What can you advise? Signed, Befuddled Without Balance
What you’re describing is a frighteningly common "game" among small nonprofits: the practice of (1) failing to pay withholding taxes so the cash can be used for general operating purposes, and (2) failing to keep a tally of the condition of the checking account to conceal #1. The reason you have so much money in your checking account is that your predecessor took money out of your employees’ checks for Social Security and income taxes, just as they instructed her to do; but then failed to remit that money to the IRS. This is called "stealing."
But many nonprofit executives don’t think of it as stealing–they think of it as borrowing. Executives of agencies with erratic cashflow (which is to say, most of us) sometimes imagine it’s okay to delay payment of the withholding taxes, just to make sure that checks written during the lean times to landlords, utilities, printers, and, oh, yeah, employees, actually clear. They figure the government will never notice as long as it gets its money eventually.
But they also figure that somebody (the Board’s treasurer, perhaps? or the company’s auditor?) might notice if they never actually wrote the checks for the withholding taxes–so every two weeks or month they write a check for the required amount, and then throw it in a drawer, a file, the trash can, the paper shredder. Thus, they always have a lot more money in the checking account than it appears, because they have these huge volumes of uncashed withholding checks. It would be needlessly alarming as well as confusing to show a balance that deducted all these checks (because they’re not actually outstanding–they’re in the trash); but it would inaccurate as well as criminal to show a balance that DIDN’T deduct all these checks. So, our hero(ine) simply shows no balance at all.
The first thing you should do is bring in an outside bookkeeper (doesn’t need to be a CPA but must be someone utterly trustworthy) to reconcile your bank statements as far back as necessary to ascertain how much money you actually have, and how many checks (surprise! most of them to the IRS and your state government) are actually outstanding. If your agency has an outside financial firm conduct your annual audit, DON’T use them–because they should have picked up on this little manuever, and alerted your Board to it, a long time ago.
As soon as you know how much you haven’t paid the IRS and the state, void or stop payment on all those checks (most likely they’re in the trash, but you never know) and write a fresh check for the total. Then call the number that appears on your latest threatening letter from the IRS and make a clean breast of it: you’re new, you’ve just discovered an underpayment of withholding taxes, you want to pay the balance, where and how should it be submitted? This is worth asking because regular payments of withholding taxes are made at the bank, but back taxes are usually paid by mail. Find out which the IRS prefers this week. Lather, rinse and repeat with state taxing authorities.
NOW you only have one small problem: the IRS assesses something close to 20% in interest and penalties on unpaid withholding taxes. Why? Because they weren’t born yesterday and they know that nonprofits and small businesses often find the temptation of their employees’ money just irresistible. So, go to your Board of Directors–after forewarning your Board Treasurer and President–and tell them that they are individually and personally liable for that 20% in interest and penalties (which they are). See how quickly they form a committee of all the lawyers and accountants on the Board to begin an appeal process with the IRS for remission of that interest and those penalties.
Then grab an accountant–ideally a Board member but if not, again, someone you can trust utterly–and have her set up a system of internal oversight of the check-writing function. This may include having two people sign every check; it should certainly include a regular review of expenditures and revenue by a member of the Board working with a member of the staff. (Someday, when the current craze for CSI-like shows has truly run its course, we’ll have CSI: Forensic Accounting, in which a fighting bookkeeper in a green eyeshade battles embezzlement and overdraft fees.)
All of the foregoing assumes paper bookkeeping on your part, but is equally applicable if you’re keeping the books on a computer. You must make sure there’s no one who has access to the computerized books who’s capable of juggling them, and again a system of internal oversight is essential. The Nonprofiteer is neither bookkeeper nor accountant, but she knows that there are well-established standards for preventing the kind of debacle you inherited.
You may also wish to discuss with your Board appropriate action to be taken against the previous Executive Director. Boards rarely do take such action, preferring cleaning up the mess in private and letting the malefactor go unpunished to taking the whole thing public and having donors and potential donors know of you as "that place where they embezzle." Good luck!