August 28, 2025
With federal funding restrictions and the new tax law affecting nonprofits’ ability to secure the resources they need to pursue their missions, individual and corporate donations have never been more important. However, securing donors’ support requires first securing their trust.
Only 57% of U.S. adults have high trust in nonprofits, and 61% say that the most important accountability factor is how nonprofits spend their money.
One surefire way to promote donor trust (and comply with legal requirements) is to properly manage and uphold donor restrictions. Donor-restricted funds are contributions donors have designated for a specific purpose, program, or time frame. This guide will explain common types of donor restrictions, why they’re so important to uphold, and how your organization can manage them.
Understanding Donor Restrictions
The presence or lack of donor-imposed restrictions on contributed funds is critical for nonprofits to distinguish and track. Let’s explore how your organization should use funds without and with donor restrictions:
- Funds without donor restrictions (formerly unrestricted funds). Most individual donors (particularly those who make small and mid-sized gifts) will contribute unrestricted funds. Your nonprofit can use these contributions for any purpose related to its mission or operations, including overhead, making them the most flexible type of funding. For example, YPTC explains that “nonprofits can often use membership fee revenue and general fundraising event donations however they see fit.”
- Funds with donor restrictions (formerly temporarily restricted and permanently restricted funds). Your organization must use these funds (which typically come from major and planned gifts, grants, or sponsorships) according to the donor’s stipulations. Some restrictions are temporary in nature, such as those that limit fund use for a specific purpose or within a specific timeframe. Other restrictions may be permanent. The most common example of a permanently restricted fund is an endowment, which is a large donation that nonprofits or universities are given to invest. Then, they leave the principal invested in perpetuity and use the investment earnings to support donors’ interests over the long term. For instance, a college alumnus may contribute to their alma mater’s endowment to fund the scholarship that they received when they attended the school.
Inform your team about these different categories of contributed funds so they can better understand them. Include examples to make the information more tangible.
Importance of Upholding Donor Restrictions
First and foremost, upholding donor restrictions is important because it’s a legal obligation. Donor restrictions are binding, and ignoring them or misappropriating funds is considered fraud. Nonprofits that don’t uphold donor restrictions may be subject to IRS penalties, lose their tax-exempt status, or face legal action from donors or state regulators.
In addition to your obligation to adhere to donor restrictions, respecting donors’ wishes is important because it:
- Maintains donor trust. Gaining and keeping donors’ trust is the key to a thriving nonprofit. If you ignore donor restrictions, those donors likely won’t give again and may even warn others not to support your organization either. By upholding donor restrictions, you show that your organization is worthy of support and strengthen your relationships with donors.
- Protects your reputation. Failing to follow donor restrictions will impact the public’s perception of your organization, potentially resulting in negative press coverage, loss of accreditations, board resignations, and funder exits. When you uphold donor restrictions and prove your organization is trustworthy, it’ll be easier to secure donations, grants, and corporate partnerships.
- Supports audit preparation. Within your nonprofit financial statements, you’ll report on restricted funds, most notably in your Statement of Financial Position, where you’ll include refundable advance (a liability representing cash or other assets subject to donor-imposed conditions), if you have any, and net assets with and without donor restrictions. You’ll also include revenue and the change in net assets with and without donor restrictions in your Statement of Activities and cash flows associated with donor-restricted funds in your Statement of Cash Flows. Reporting on restricted funds properly shows you use them as intended and can prove so during a financial statement audit.
While donor restrictions can limit your use of funds, upholding these wishes is vital for your organization’s compliance, longevity, and reputation. Proper management is crucial, especially because many of your nonprofit’s largest, most impactful donations likely come with restrictions.
How to Manage Donor-Restricted Funds
Follow these steps to manage donor restrictions appropriately:
1. Develop restricted fund guidelines.
Align your team on how to handle donor-restricted funds. Create a policy that defines the different types of restricted funds, indicates how and when staff members should record restrictions (typically immediately after receiving restricted contributions), and informs staff members about how to record, track, report, and reallocate restricted funds properly.
2. Set up separate accounts.
Accounting for restricted and unrestricted funds separately ensures you uphold donor restrictions. Within your chart of accounts, you’ll create separate categories for restricted and unrestricted funds. You may also develop subcategories for permanently restricted, purpose-restricted, and time-restricted funds to better track each type.
3. Track restricted fund use.
Track expenditures in real time to monitor how your nonprofit uses restricted funds. Regularly reviewing spending reports and conducting budget-to-actual reporting both help ensure spending aligns with donor restrictions. Additionally, maintain transaction records, such as receipts, invoices, and proof of expenditure, to stay accountable to donors and prove responsible fund use.
4. Communicate with donors.
Donors want to know that you’re using their funds as they intended. Remain transparent by updating donors with regular reports that show how you’ve used funds and indicating the remaining balance you have left to allocate.
You should also inform donors about the impact their gifts are making to reinforce that you’re using their contributions to further your mission as they had hoped. For example, you may explain that a donor’s contribution to your animal rescue program has already helped rehabilitate and send five pets off to loving homes.
If there are any changes in fund use, explain them clearly and reassure donors that you’ll continue to allocate their funds accordingly. For instance, let’s say a donor contributed to a scholarship fund, but your school didn’t award the scholarship this year. You may explain why you didn’t make the award this year and assure the donor that their funds will go toward that scholarship next year instead.
5. Create a plan for any unused restricted funds.
There may be situations in which you have leftover restricted funds. Develop guidelines on how and when to follow up with donors who contributed these funds. Then, if the situation allows, ask donors for approval to reallocate funds.
Try to align the ask with their original conditions as much as possible. For example, if a donor originally contributed to a program to support children in grades K-4 that your nonprofit no longer runs, see if they’d like to support your program for high school-aged children instead.
Securing donors’ trust allows supporters to confidently contribute to your cause. By upholding donor restrictions and managing them properly, you can demonstrate your organization’s trustworthiness and build strong supporter relationships that fuel your efforts for years to come.
Jennifer Alleva
Jennifer Alleva is the Chief Executive Officer at Your Part-Time Controller, LLC (YPTC), a leading provider of nonprofit accounting services and #65 on Accounting Today’s list of Top 100 accounting firms. Jennifer brings over three decades of expertise in accounting and leadership to her role as CEO of YPTC.
When Jennifer joined YPTC in 2003, the firm consisted of just over 10 staff members. Since then, she has helped grow YPTC into one of the fastest-growing accounting firms in the country.
Jennifer’s accomplishments include her tenure as an adjunct professor at the University of Pennsylvania Fels Institute, her frequent speaking engagements on nonprofit financial management issues, her role as the founder of the Women in Nonprofit Leadership Conference in Philadelphia, and her launch of the Mission Business Podcast in 2021, which spotlights professionals and narratives from the nonprofit sector.