Practical guidance for those who steward a mission

Most accounting software is designed for businesses — where money comes in, money goes out, and the goal is profit. Churches operate under a fundamentally different model: stewardship. You're not maximizing shareholder value; you're managing resources entrusted to you by donors, congregants, and God's mission. That's where fund accounting comes in.

What Is Fund Accounting?

Fund accounting tracks money based on the purpose it's designated for, not just whether it came in or went out. Instead of a single general ledger, you maintain separate "funds" — each with its own budget, balance, and activity. When a donor gives specifically to your building project, those dollars are tracked separately from general operating revenue from the first moment they're recorded.

This approach is the standard for nonprofits and is fundamentally distinct from for-profit accounting. It prioritizes accountability over profitability — which is exactly as it should be.

How GAAP Classifies Net Assets

Under GAAP (specifically FASB ASC 958, the accounting standard for nonprofit organizations), your net assets fall into two classifications:

• Net Assets Without Donor Restrictions — Money your organization can use for any purpose at its discretion: operating expenses, staff salaries, utilities, and discretionary ministry costs.
• Net Assets With Donor Restrictions — Money given with a specific condition attached, either a purpose restriction ("this gift funds the new playground") or a time restriction (an endowment whose principal must be maintained permanently).

A 2016 GAAP update (ASU 2016-14) simplified the previous three-class model — which divided funds into unrestricted, temporarily restricted, and permanently restricted — into these two categories. If your organization still reports under the old model, the update is worth addressing with your CPA.

Common Church Funds

Most churches maintain several distinct funds within their accounting system:

• General Fund — Day-to-day operations: staff, utilities, programs, and administration
• Building / Capital Fund — Facility purchases, renovations, and major equipment
• Benevolence Fund — Financial assistance for individuals in need (requires a formal written policy)
• Missions Fund — Support for missionaries and global outreach initiatives
• Memorial Funds — Gifts given in memory of a church member, designated by the family
• Endowment Funds — Permanently restricted principal; only earnings are available to spend

Why It Matters for Your Church

Commingling restricted funds with your general operating account is one of the most common — and most serious — financial mistakes churches make. Beyond the audit risk, it's an ethical problem: you may be spending money in ways your donors never intended. Courts have found churches legally liable for misusing restricted gifts.

Proper fund accounting also gives your board a truthful financial picture. Knowing you have $80,000 in the bank means very little if $72,000 of it is restricted for the building project and cannot legally be used to pay staff. Reporting net assets without disclosing restriction balances is misleading — even if unintentional.

Common Mistakes to Avoid

• Treating all giving as unrestricted unless explicitly told otherwise (if a donor writes "building fund" on their check, it's restricted)
• Releasing restrictions without documentation that the restriction has been fulfilled
• Assuming you must open separate bank accounts for every fund — good accounting software tracks funds independently of bank accounts
• Reporting a single total balance to donors without disclosing how much is restricted and unavailable for general use
• Allowing the senior pastor or executive director to unilaterally redirect restricted funds without board approval

Few tax provisions are as significant — or as frequently mishandled — as the clergy housing allowance. When managed correctly, it can substantially reduce a minister's taxable income and meaningfully improve their compensation package. When mismanaged, it creates real liability for both the pastor and the church. Here's what every church administrator needs to know.

What Is the Clergy Housing Allowance?

Under Section 107 of the Internal Revenue Code, a duly ordained, licensed, or commissioned minister can exclude a designated portion of their compensation from federal gross income — the amount their employing church officially designates as a "housing allowance" (sometimes called a "parsonage allowance"). This is not a deduction the minister claims on their return; it's an exclusion, meaning that amount is never reported as gross income for federal income tax purposes.

Who Qualifies?

To claim the housing allowance exclusion, a minister must:

• Be ordained, licensed, or commissioned by a recognized church or religious organization
• Be performing services in the exercise of ministry — preaching, administering sacraments, conducting worship, providing spiritual care
• Have received a formal housing allowance designation from their employing church

The IRS has recognized that "ministers" for this purpose can include chaplains, worship leaders, and other church employees who perform ministerial functions — not only senior pastors. Determinations are fact-specific, and a tax professional familiar with clergy tax law can help in ambiguous situations.

The Three-Prong Test: How Much Can Be Excluded?

The exclusion is limited to the lesser of three amounts:

• The amount officially designated as housing allowance by the church's governing body
• The amount actually spent on housing during the year (rent or mortgage, utilities, furnishings, repairs, insurance)
• The fair rental value of the home, furnished, including utilities

A designation that's too low is just as costly as one that's too high. Best practice: designate a generous amount at the start of the year. The minister will only exclude what they actually spend, but having room in the designation prevents lost tax benefit that can't be recovered after the fact.

The Designation Requirement — The Most Common Mistake

The designation must be made in advance — before the start of the calendar year, or before the minister's first paycheck if they begin employment mid-year. A church cannot retroactively designate a housing allowance for a period that has already passed. The IRS is unambiguous on this point, and it has been affirmed repeatedly in tax court.

The designation must be formally recorded — typically in board or session minutes, or in a governing body resolution. A standing annual resolution passed at the first meeting of each year is standard practice. This documentation must be retained by the church.

What Counts as a Housing Expense?

The IRS allows a broad range of costs to count toward the amount actually spent on housing:

• Rent payments or mortgage principal and interest
• Real estate taxes and property or renter's insurance
• Utilities — electricity, gas, water, trash collection, internet
• Furniture, appliances, and household furnishings
• Home maintenance and repairs
• Lawn care and landscaping
• Down payment on a home purchase (in the year paid — widely accepted in practice, though the IRS has not issued explicit written guidance on this item; consult your tax advisor)

Self-Employment Tax

Ministers are generally treated as self-employed for Social Security and Medicare purposes, even when they receive a W-2 from a church. The housing allowance exclusion applies to federal income tax only — the housing allowance is still included in net earnings from self-employment and is subject to self-employment tax (15.3% as of 2024). Many ministers are surprised by this, and it's worth addressing proactively in financial planning conversations, particularly when structuring compensation packages.

State income tax treatment varies significantly. Some states conform to the federal exclusion; others do not recognize it at all and require the full housing allowance to be included in state taxable income. Ministers should confirm their specific state's treatment with a tax professional — this is one area where the federal rule does not automatically carry over.

W-2 Reporting

The housing allowance is not included in Box 1 of the W-2 (federal taxable wages). Many churches note the designated amount in Box 14 (Other) as a practical courtesy to the minister, making tax preparation easier — though this is not technically required by the IRS. What is required is that the church retain documentation of the official designation in its own records, available for review in the event of an audit.

A financial audit — or the less intensive financial review — is one of the most valuable accountability tools a church can use. Far from being something to dread, it's an opportunity to verify that your financial systems are sound, your records are accurate, and your congregation's trust is well placed. Here's how to make the process go smoothly.

Audit vs. Review vs. Compilation

Many smaller churches don't require a full audit. CPAs offer three levels of financial statement engagement, each providing a different degree of assurance:

• Compilation — The CPA presents financial information you provide without verification or testing. Lowest cost, zero independent assurance. Useful for internal planning or board reporting.
• Review — The CPA performs analytical procedures and inquiries to provide limited assurance that no material modifications are needed. A middle ground for cost and credibility.
• Audit — The CPA performs detailed testing of transactions, third-party confirmations, and physical inspection, providing the highest level of assurance. Required by most lenders, many grantors, and some state charitable registration laws.

Check your church's bylaws, loan covenants, and major grant agreements to determine which level is required. Lenders and large foundations frequently specify a full audit.

What Auditors Want to See

Well-organized records dramatically reduce the time — and therefore the cost — of any CPA engagement. Have the following prepared before fieldwork begins:

• Bank statements and reconciliations — All accounts reconciled monthly, with no unexplained outstanding items older than 60 days
• Transaction documentation — Receipts and invoices for all expenditures, organized by month or general ledger account
• Payroll records — Quarterly 941 filings, annual W-2s, payroll registers, and documentation of all compensation changes
• Fund activity documentation — Evidence that restricted fund balances match donor intent and that releases of restrictions were properly authorized and documented
• Board minutes — Particularly resolutions approving the annual budget, major expenditures, salary changes, and housing allowance designations
• Prior-year financial statements — For analytical comparison

Key Internal Controls Auditors Evaluate

Auditors assess not only whether your numbers are accurate, but whether you have adequate controls in place to prevent and detect errors or misappropriation. The most critical controls for churches:

• Dual custody for offering counting — Offering collections should always be counted by at least two unrelated individuals, with a documented count sheet retained
• Segregation of duties — The person who authorizes purchases should not also record them or sign the checks. These functions must be separated.
• Check signing authority and limits — Dual signatures for checks above a defined threshold; board approval for major expenditures
• Regular financial reporting to the governing board — The board should review actuals against budget monthly, not merely quarterly
• Background checks — For all staff and volunteers with access to financial systems or cash

A Practical Preparation Timeline

For calendar-year organizations, a useful audit preparation calendar:

• November — Review open items, confirm housing allowance designations for next year, clear any outstanding vendor issues
• December — Year-end journal entries: depreciation, prepaid amortization, accruals
• January — Final bank reconciliations, payroll year-end close, W-2s issued by January 31
• February — Prepare draft financial statements, organize document packages for the CPA
• March–April — CPA fieldwork. Respond to information requests promptly — slow responses are the most common cause of cost overruns

If your organization holds tax-exempt status under IRC Section 501(c)(3) and is not a church, you're required to file an annual information return with the IRS. This isn't a tax return in the traditional sense — you don't owe tax. It's a public accountability document that tells the IRS and the general public how your organization received and used its resources.

Which Version of the 990 Do You File?

The version you file depends on your organization's size:

Form	Who Files
990-N (e-Postcard)	Gross receipts normally ≤ $50,000. Filed electronically only; takes minutes to complete.
990-EZ	Gross receipts < $200,000 AND total assets < $500,000. A shorter version of the full 990.
Form 990	All other public charities. Gross receipts ≥ $200,000 OR total assets ≥ $500,000.
Form 990-PF	Private foundations, regardless of size.

Filing Deadlines — Don't Miss Them

The 990 is due on the 15th day of the 5th month after your fiscal year ends. For calendar-year organizations, that's May 15. An automatic 6-month extension is available by filing Form 8868, moving the deadline to November 15. No reason is required for the extension — file it proactively if there's any doubt you'll meet the original deadline.

The consequences of missing the deadline escalate quickly. Late filing penalties apply for larger organizations. More critically, organizations that fail to file for three consecutive years automatically lose their tax-exempt status — with no warning from the IRS. The revocation appears in the IRS's online database, and reinstatement requires a new application and can involve penalty abatement requests that take months to resolve.

The 990 Is a Public Document

Every 990 filed is publicly available. Donors, journalists, watchdog organizations, major grantors, and prospective board members routinely search nonprofits on ProPublica Nonprofit Explorer and Candid (formerly GuideStar). This means your 990 is not just a compliance document — it's a communications document that represents your organization to the world.

Your compensation disclosures, program descriptions, governance policies, and major revenue sources are all visible to anyone who looks. Organizations that treat the 990 strategically — writing clear, compelling program descriptions and ensuring compensation is defensible — are better positioned with donors and grantors than those that file the bare minimum.

What About Churches?

Churches as defined under IRC Section 508(c)(1)(A) are generally exempt from 990 filing requirements. However, this exemption applies specifically to the church itself — not necessarily to separately organized entities controlled by or affiliated with the church. A church's separately incorporated food pantry, school, or camp operating under its own EIN may still be required to file. If your situation involves related entities, consult a CPA or nonprofit attorney familiar with the IRS's 14-factor test for defining a "church."

Practical Tips for 990 Preparation

• Begin gathering data in January — don't wait until April to start assembling information for a May deadline
• Ensure your chart of accounts aligns with 990 reporting categories so financial data flows into the form without manual reclassification
• Review your program descriptions annually — they should reflect your current work, not boilerplate from five years ago
• If any individual is paid more than $100,000, their compensation must be disclosed; plan board conversations accordingly
• Board members should review a draft 990 before filing; the form includes a governance question asking whether they did
• Retain signed copies of your 990s for at least three years — you're required to provide copies to anyone who requests them

Grants are one of the most powerful funding tools available to nonprofits and faith-based organizations — but grant money is not free money. It comes with conditions, and failing to document proper use can require you to return funds, disqualify you from future awards, and damage relationships with funders you've spent years building. Solid grant accounting starts before the money arrives.

The Basics of Grant Restrictions

Every grant comes with a grant agreement that specifies what the funds can and cannot be spent on. From the moment grant funds arrive, your job as a bookkeeper is to ensure:

• Grant funds are recorded as net assets with donor restrictions in the appropriate fund or project code
• Every expenditure charged to the grant is allowable under the grant agreement
• Personnel time charged to the grant is supported by contemporaneous timesheets documenting the actual hours worked on grant-funded activities
• Restrictions are formally "released" when qualifying expenses are incurred — and this release is documented in the accounting system

Each grant-funded program should have its own fund or project code. This makes financial reporting to funders straightforward and makes your records auditable if questions arise.

Federal Grants and the Uniform Guidance

If your organization receives federal funds — directly or as a pass-through from a state or local agency — you must comply with 2 CFR Part 200, commonly called the Uniform Guidance. This federal framework governs allowable costs, procurement requirements, financial management standards, and reporting. Key requirements include:

• Allowable costs: Costs must be necessary, reasonable, allocable to the grant, and not prohibited by the award or federal regulations
• Time and effort reporting: Personnel costs charged to federal grants must be supported by after-the-fact time records reflecting actual activity — "budget estimates" are not sufficient
• Procurement standards: Purchases above certain thresholds require competitive quotes or formal bidding; sole-source purchases must be justified in writing
• Single Audit: Organizations expending $1 million or more in federal awards in a fiscal year are subject to a Single Audit under the Uniform Guidance (this threshold was raised from $750,000 effective for fiscal years beginning on or after October 1, 2024; the prior $750,000 threshold applies to earlier periods)

Indirect Costs: Don't Leave Money on the Table

Many nonprofits fail to recover overhead costs — rent, accounting, administration — from grants that would permit it. For federal awards, you have two options:

• Negotiate a rate with your federal cognizant agency. This allows for full cost recovery and remains in effect until renegotiated, but requires cost analysis documentation.
• Use the de minimis rate — 10% of Modified Total Direct Costs (MTDC), available to organizations that have never had a negotiated rate. No documentation required beyond the election in the grant application.

Many private foundations also allow indirect cost recovery at 10–15%. Always review the grant agreement carefully, and ask if you don't see it addressed — funders generally cannot retroactively add indirect cost recovery after the award is made.

Reporting to Funders

Most grants require periodic financial reports — commonly quarterly and annually — showing spending against the approved grant budget. These reports are often the primary basis on which funders evaluate whether to renew or expand your award. Build your reports to match your grant budget line items exactly, and ensure every figure reconciles directly to your accounting system. Discrepancies between what you report to a funder and what appears in your books is an immediate audit flag.

Setting Up Your Chart of Accounts for Grants

The most important infrastructure investment for grant-funded organizations is a well-designed chart of accounts. Build it before the grants arrive, not after:

• Create a separate fund, class, or project code for each active grant
• Align your account categories with typical grant budget line items: personnel, fringe benefits, travel, supplies, contractual services, indirect costs
• Build grant closing procedures into your monthly close so unexpended balances stay current and aren't discovered only at year-end
• Maintain a grant tracking schedule showing award amount, expenditures to date, balance, reporting due dates, and end date — updated monthly

A budget is not a constraint — it's a plan for living out your mission with the resources entrusted to your congregation. Done well, a church budget is as much a spiritual document as a financial one: it reflects your values, your priorities, and your faith about where God is leading. Here's how to build one that actually guides decisions across the year.

Start With Mission, Not Last Year's Numbers

The most common church budgeting mistake is incrementalism: taking last year's actuals, adding a percentage for inflation, and calling it a budget. This approach preserves the past rather than funding the future. It means your resource allocation is driven by inertia, not intention.

A better approach: begin each budget cycle by reviewing your ministry goals for the coming year. What programs do you want to launch or grow? What community needs is your congregation called to address? What does faithful execution of those goals require? Build your budget from those answers, then test it against your revenue projections. This is a more demanding process — but it produces a budget that actually guides decisions, not just one that describes what happened last year.

Know Your Revenue Patterns

Church giving is highly seasonal, and this has significant cash flow implications that catch many church administrators off guard. Most congregations follow a predictable annual pattern:

• December is typically the highest giving month — often representing 15–25% of annual giving, driven by year-end tax giving
• Summer months (June–August) usually run 15–20% below the monthly average due to travel, irregular attendance, and vacation disruptions
• January tends to be one of the lowest months, as the giving surge from December subsides
• Easter and Christmas offerings can be significant but are variable — they shouldn't be built into regular operating projections

Common Budget Categories and Typical Allocations

While every congregation is different, the following ranges reflect what's seen in financially healthy churches:

• Personnel (45–55%) — Salaries, housing allowances, benefits, and payroll taxes. The largest category for most churches, and the one that requires the most careful stewardship.
• Facilities (10–20%) — Mortgage or rent, utilities, property insurance, and maintenance and repairs.
• Ministry Programs (10–15%) — Children and youth ministry, adult programs, small groups, and worship production.
• Missions & Benevolence (10–15%) — Local outreach, global missions support, and benevolence assistance to individuals in need.
• Administration (5–8%) — Software, office supplies, insurance, accounting and legal fees, and professional development.

If personnel costs have consistently exceeded 60% of your budget, it's worth reviewing whether your staffing model is sustainable relative to the ministry output it produces — not to cut indiscriminately, but to make sure the investment is intentional.

Build a Cash Flow Projection Alongside the Annual Budget

An annual budget tells you whether the year adds up. A cash flow projection tells you whether you can make payroll in July. These are different questions, and both matter.

A month-by-month cash flow model — updated monthly against actual giving and spending — allows leadership to make proactive decisions rather than reactive ones. It's the difference between noticing in April that you'll face a shortfall in August and having three months to address it, versus discovering the problem when you're staring at a negative balance.

Build and Protect an Operating Reserve

Every church should maintain an operating reserve: unrestricted funds set aside in a separate account to weather revenue shortfalls, unexpected equipment failures, or emergency repairs. A reserve target of 3–6 months of operating expenses is the standard recommendation in nonprofit finance.

Keep reserve funds in a separate bank account to reduce the temptation to treat them as available operating cash, and establish a board-approved reserve policy that specifies when draws are permitted and requires a replenishment plan for any funds used. A reserve without a policy is just a second checking account.

Involving Your Congregation

In most healthy churches, the annual budget is presented to the congregation for approval or meaningful review — not just delivered by the board as a fait accompli. Transparency builds trust. When members understand how their giving is deployed, they tend to give more consistently and more generously.

Consider presenting the budget as a story rather than a spreadsheet: here are our ministry goals for the year, and here is the financial plan that makes them possible. Frame it as mission first, money second. That's not just good communication — it's good stewardship.