What Bookkeeping Mistakes Should Private Foundations Be Most Concerned About? (and How to Prevent Them)

Bookkeeping may not make headlines, but it plays a central role in the health and credibility of any private foundation. Financial records do more than just track numbers; they reflect how responsibly your foundation stewards its charitable mission. One grant check that goes uncashed, one mistaken payment to a disqualified person, and your foundation’s compliance status and reputation can quickly be placed at risk.

Private foundations operate under a unique set of tax laws and fiduciary obligations. They must distribute at least five percent of their assets each year for charitable purposes, pay excise tax on net investment income, and avoid acts of self-dealing. Every one of these rules depends on accurate, complete, and timely financial reporting.

Done well, sound bookkeeping ensures your foundation meets its distribution requirements, avoids IRS penalties, files a clean Form 990-PF, and builds trust with regulators, board members, and donors. Just as importantly, strong financial practices help identify and correct problems early, before they escalate.

Below are seven of the most common and damaging bookkeeping and financial compliance mistakes private foundations make, along with practical steps to avoid them.

Treating the 5 Percent Payout Like a December To-Do

“We only realized in mid December we were 2 % short, and had to rush a big grant just to avoid a penalty.”

Too often, foundations wait until the final weeks of the year to tally up their qualifying charitable expenses, only to discover they have fallen short of the minimum distribution requirement. The 5 percent payout amount itself is calculated on the prior year’s Form 990-PF, but it is up to the foundation to ensure that it makes enough qualifying distributions during the current year to satisfy that obligation.

Leaving this calculation until year-end creates unnecessary stress and increases the chance of errors. Missing the minimum by even a small amount can trigger excise tax penalties. On the other hand, making unplanned grants simply to meet the deadline can lead to rushed decisions or draw down assets that might have been better invested for long-term impact.

The best approach is to monitor your qualifying distributions throughout the year. Keep a running tally that compares current-year grantmaking and charitable expenses against the required minimum. Many foundations tag each disbursement in their accounting system as either “qualifies” or “does not qualify,” making it easy to assess progress at a glance. Sharing these figures with the board quarterly ensures that decisions about grant timing and size are based on accurate, timely data, not year-end scrambling.

Ignoring the Difference Between Restricted and Unrestricted Funds

“We spent part of our donor‐restricted scholarship fund on employee salaries, now we’re refunding $15,000 to the donor.”

Mixing up donor-restricted and unrestricted funds can have serious consequences. Restricted gifts come with legal strings attached. Misusing these funds not only breaches donor intent but may also constitute a violation of fiduciary duties by foundation officers or directors. In more serious cases, such misuse could result in legal claims brought by the donor or by a state attorney general overseeing charitable trust enforcement. The reputational fallout alone can deter future contributions and undermine donor confidence.

To avoid this, foundations should ensure that restrictions are recorded the moment a gift is received. Notes about purpose, timing, and any special conditions should be included in the accounting record and donor files. Using accounting software that supports fund tracking is essential, especially for foundations that manage multiple restricted pools. In cases where the restriction is especially long-term or tightly defined, holding those funds in a separate bank account may further protect against inadvertent misuse. On a regular basis, reconcile your accounting balances with donor agreements to confirm that restricted dollars are being held and used appropriately.

Understanding (and Avoiding) Payments to Disqualified Persons

“We thought we were doing the foundation a favor by letting it use our building at a steep discount. No one realized that below-market rent to a disqualified person still counted as self-dealing, until the IRS hit us with penalties.”

While not strictly a bookkeeping task, tracking payments to disqualified persons is a vital compliance responsibility that often overlaps with accounting. Disqualified persons include substantial contributors, officers, directors, foundation managers, their family members, and any entities they control. Under the Self-Dealing rules, certain transactions with these individuals, no matter how well-intentioned, can be deemed infractions and result in stiff excise tax penalties.

Self-dealing encompasses more than just blatant conflicts of interest. It can include leasing property to the foundation, even at below-market rates, providing goods or services, making loans, or using foundation assets for personal benefit. Even routine transactions, such as purchasing office supplies from a board member’s business, are generally prohibited and can constitute self-dealing, regardless of whether the price is fair or the product is needed. These types of arrangements are not allowed simply because they appear beneficial; the rules are intentionally strict to prevent any use of charitable assets for private gain.

That said, some exceptions do exist. For instance, a disqualified person may receive reasonable compensation for personal services that are necessary to carry out the foundation’s exempt purpose, such as serving as executive director, accountant, or investment advisor, provided the payments are fair, well-documented, and not excessive. But these exceptions are narrow, and the burden of proof lies with the foundation.

To reduce risk, foundations should maintain a current list of all disqualified persons and implement procedures to identify and flag related-party transactions in their accounting systems. Before entering into any transaction that could involve a disqualified person, the foundation should seek legal guidance or formal board review to determine whether the arrangement is permissible. Educating board members and staff about what constitutes self-dealing, and when to pause and ask questions, is one of the most effective tools in maintaining compliance.

Ultimately, a strong system for identifying, documenting, and reviewing related-party transactions not only helps avoid costly missteps but also reinforces a culture of integrity, transparency, and trust.

Missing or Incomplete Documentation

“Our auditor found six grants with no board approvals or signed award letters and we had no way to show those grants were ever formally approved!”

No paper trail means no proof. Even the best-intentioned grant can become a problem if the paperwork is incomplete. From an IRS perspective, no documentation can sometimes mean no deduction. Missing receipts, unsigned contracts, or vague records can lead to disallowed expenses, restated returns, and added tax liabilities.

Foundations should centralize documentation into a well-organized digital archive. Every invoice, grant agreement, board resolution, and payment confirmation should be scanned, stored by date and transaction ID, and easily retrievable. A good system will also include a checklist that staff must complete before any funds are disbursed. These small steps protect the foundation not only during audits but also during leadership transitions or staff turnover. Finally, set up a regular review of your records retention policies to ensure that required documents are kept for the appropriate number of years.

Overlooking or Misreporting Investment Income and Activity

“We counted dividends net of fees and our net investment income was understated by $25,000, so we under paid our excise tax.”

Investment income must be reported in gross terms, not net. Yet many foundations mistakenly record only the amount deposited into their bank account, often already reduced by investment management fees, and consider the job done. The IRS requires private foundations to report all interest, dividends, and realized gains before subtracting any related expenses. If you report only what shows up after fees, you will understate your gross income and potentially miscalculate your excise tax.

One of the most common areas for errors involves partnerships and other alternative investments that issue a Schedule K-1. For tax reporting purposes, what matters is not the cash distributed from the fund, but rather the partnership’s underlying results as reported on the K-1. These may include interest, dividends, capital gains, foreign income, and even unrelated business income, all of which must be analyzed and reported appropriately, regardless of whether the foundation received any cash. It is easy to muck this up, especially if the K-1 arrives late or if no one is carefully extracting and categorizing the tax-relevant information.

The solution begins with a clear separation between income and expenses in your general ledger. Create separate accounts for gross dividends, realized gains, and investment advisory fees. Clearly distinguish between realized and unrealized gains to avoid accidental overreporting. Reconcile monthly investment statements from your custodians against your accounting records to confirm that all activity is complete and properly classified. For partnerships and alternative investments, create a process for reviewing each K-1 in detail, ensuring that all reportable items are captured, even if no cash changed hands. When in doubt, consult a tax advisor familiar with Form 990-PF and the nuances of private foundation investment reporting.

Misclassifying Expenses (and Misleading Stakeholders)

“We mistakenly treated investment fees as qualifying charitable distributions. When the IRS reviewed our 990-PF, we got hit with a penalty for underpaying the required payout.”

Misclassifying investment, administrative, and program expenses can make the foundation’s financial reports unreliable. This distortion often affects the calculation of qualifying charitable distributions, which can lead to underpayment and trigger excise tax penalties. Beyond compliance risks, it can mislead the board or grant reviewers, resulting in flawed internal decisions based on inaccurate reports. Significant year-to-year swings in expense ratios, caused by misclassification, can also draw unwanted attention during audits or external reviews. What begins as a simple bookkeeping error can quickly become a broader compliance and governance problem.

To prevent this, foundations should design a thoughtful chart of accounts that separates program, administrative, investment, and (if applicable) fundraising expenses. Every transaction should be tagged at the time it is recorded, assigning it to the correct category. On a quarterly basis, it is also helpful to conduct internal reviews, pulling a sample of entries and comparing them to supporting documents like invoices and board meeting minutes. This kind of oversight strengthens both accuracy and accountability.

Failing to Segregate Financial Duties

“The foundation president handled everything--deposits, disbursements, even bank reconciliations. No one questioned it until we discovered he had been embezzling funds while going through a divorce.”

The most dangerous bookkeeping mistake is concentrating too much financial authority in one person’s hands. Every foundation, regardless of size, should implement some level of separation of duties. No one person should initiate, approve, make the payment, and reconcile the same transaction. If there is no paid staff, board members must step in to provide oversight. For instance, one person might enter bills, while another signs the checks and a third reconciles the bank accounts.

Large payments, especially grants and wire transfers, should require dual authorization, with supporting documentation reviewed before the funds are released. Foundations should also rotate duties or assign peer review tasks, so that a second set of eyes periodically reviews the books. Even simple spot checks can catch errors and prevent fraud.

And while trust is important, internal controls are not about distrust, they are about protecting everyone involved. Even honest people can make mistakes or fall prey to temptation when under pressure. Systems that create accountability help ensure integrity, not just compliance.

Closing Thoughts

Bookkeeping may not be the most visible part of a foundation’s work, but it underpins everything else. Your financial records form the framework of accountability to regulators, donors, board members, and the communities you aim to serve. By proactively addressing these seven common pitfalls, your foundation strengthens not only its compliance standing but also its operational integrity. That foundation of trust leads to better decision-making, stronger partnerships, and greater philanthropic impact. In the end, diligent financial stewardship doesn’t just prevent problems; it empowers your foundation to focus more fully on its mission and deliver lasting change.

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