Designated and Restricted Giving are the Same, but Different

We’re in the middle of the series How to Establish a Funding Strategy for Your Church.

As mentioned in the first post in the series, The Funding Strategy consists of two parts or steps:

#1. Establish funds to facilitate funding of mission, vision and strategy
#2. Help people excel in the grace of giving

We’ve been talking about the first step in the previous post, but before we can move on to the second step, it’s vitally important for the church leadership to understand the rules and potential pitfalls related to designated funding.

Most everyone knows the church is legally bound to use the funds as designated. To not do so can carry penalties for breach of fiduciary duty or worse, fraud. Aside from the legality of such, it’s the right/moral thing to do. Wanna lose trust in your church? The misappropriation of funds will put you on this road.

Something that may not be as well known is – it may be against state law to borrow against designated funds, intentionally or not. (A quick check that may indicate borrowing has occurred is when Restricted Net Assets > Sum of Cash and Other Restricted Assets).

Now, these two facts above are relatively straightforward and easy to understand.

What I want to bring out today are the types of designated giving, when designated giving is not tax-deductible and how the church may redirect designated giving.

In the church world, Pastors, Staff and Church Members almost exclusively use the term “designated” to describe gifts that are directed towards specific ministries or projects.

I’m not trying to confuse the matter here, but there are two types of gifts that can be directed to ministries and projects that church leaders need to understand.

Designated and Restricted Giving

How they are the same – Designated and Restricted Donations are the same in that churches must use the gifts/offerings as the donor intended. And, from the donors perspective, in that regard, they are the same as well.

How they are different – There is one difference between Designated and Restricted Donations, per the IRS, that church leadership and givers need to know. This difference has to do with who ultimately controls the use of the funds. As such, this difference impacts the deductibility of the gifts.

Designated Gifts are tax deductible, Restricted Gifts are not. Again, the key difference is who has control over the donated funds. If the church has control, then they are tax-deductible. If the donor has control, they are not tax-deductible.

For example, gifts/designations to ministries such as, Benevolence, Children’s Ministry, etc., are designated gifts. Let’s say a donor wished a gift to be used for benevolence, but the church controls the who, what, when, where and how – it’s designated and deductible.

Restricted gifts on the other hand, generally are unsolicited donations that “direct” the funds “specifically” – for example, the donor directs the funds to be used to purchase something specific (a piano, for example) or that are directed to a named individual. In these cases, the donor controls the who, what, when, where and how – it’s restricted and not deductible because the donor, not the 501(c)(3) organization directed the gift’s use.

Again, the church must honor both designated and restricted regardless, it’s just one is not tax-deductible. I suspect there exists a misunderstanding and misapplication of this in a lot of churches.

Hence, to eliminate any misunderstanding, I recommend a statement like this in your funding policy:

This church is a qualified 501(c)(3) organization. All tithes, offerings, or donations of any kind are deductible under IRC section 170(c)(2). Unless otherwise noted and in accordance with IRS regulation, you agree to relinquish control of the donated funds to the discretion of this church.”

Further clarification can be added by including this in your statement as well:

Donors who restrict his/her unsolicited donation(s) to a specific use or person (does not relinquish control of the donated funds), the donation is considered a restricted donation and as such, is not a tax-deductible contribution.”

Solicitation Makes All the Difference

Referring back to the two restricted gift examples above, if the church has a need to purchase something specific, or is aware of an individual that needs help, it’s better for the church to solicit the funds for the specific item, say a piano or playground equipment or a benevolent need (without divulging names) – then the donations fall under “designated” because the church is controlling the donations and therefore are tax deductible.

In other words, any appeal initiated by the church makes the donations designated. This applies to building campaigns, renovation projects, mission trips, ministry needs and so on. Worth noting too, just because the church initiated it and placed the designation, it cannot simply redirect funds elsewhere at any point. Its morally and legally bound to its own designation.

How Designated Funds May Be Redirected

There are times when the church may find it needs to redirect designated or restricted funds to other areas.

First, in absence of a policy stating otherwise, there are only 3 ways to redirect designated funds – by the written permission of the donor(s), by court order, or with the permission of your state Attorney General. In some cases, these may prove difficult or nearly impossible (It’s just not practical, some donors are opposed or are no longer living).

The church can avoid these situations by including a statement like this in their fund policy –

The Board or Finance Team of the church may remove any designations or restrictions on gifts when it is deemed in the best interest of the church to do so.” This policy, once adopted by the church, gives church leadership the discretion to redirect funds.

In addition, state or reference the policy on all giving documents, receipts and fund-raising materials. That way, everyone knows (or is reminded) upfront the church reserves the right to redirect funds. (The donor relinquishes control anyway if they were tax-deductible contributions). However, this still doesn’t give the church carte blanche to do what it wants, when and how it wants. What it does do, is to give the church the ability to redirect funds in certain circumstances without necessarily having to obtain permission from the donors, courts or the state attorney general.

Here are the most common situations where a church needs the ability to redirect funds:

#1. Where there are remaining funds after a construction or debt retirement capital campaign has ended.

#2. Where a project was over-funded. Similar to the above, this could be a renovation project or the purchase of vehicle or new audio system, etc. More was received than needed.

NOTE – I’m really speaking to relatively minor excess or left-over funds here. If something was significantly over-funded, I’d encourage you to consult the donors/church before redirecting the funds.

#3. Where a project was ended due to being woefully underfunded. Again, the best course of action is to consult donors first by offering to return their donations and/or to propose an area to redirect the funds to.

#4. When you need to close an existing fund that’s no longer needed – i.e., when the fund no longer fits into the vision/strategy of the church or that have outlived its purpose.

In Closing

At end of the day, much judgment and discretion is required in each case. You want to honor and maintain the trust of your givers, while recognizing the eventuality of the need to redirect funds. Otherwise, you may end up with funds that can’t be used. That’s not good stewardship.

Finally, the purpose of this post is to stimulate your thinking here. Seek advice from your attorney for specifics.

In my next post, I’ll offer tips you’ll want to consider before finalizing your funding policy.

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