Nonprofit Sector
Treatment and Reimbursement of Indirect Costs Vary among Grants, and Depend Significantly on Federal, State, and Local Government Practices Gao ID: GAO-10-477 May 18, 2010Nonprofits are key partners in delivering federal services yet reportedly often struggle to cover their indirect costs (costs not readily identifiable with particular programs or projects). This raises concerns about fiscal strain on the sector. To provide information on nonprofits' indirect cost reimbursement, especially when funding flows through entities such as state and local governments, GAO was asked to review, for selected grants and nonprofits, (1) how indirect cost terminology and classification vary, (2) how indirect costs are reimbursed, and (3) if gaps occur between indirect costs incurred and reimbursed, steps taken to bridge gaps. GAO selected six Departments of Health and Human Services and Housing and Urban Development grants and 17 nonprofits in Louisiana, Maryland, and Wisconsin. GAO selected these agencies for their historical relationship with nonprofits. GAO reviewed policies and documents governing indirect costs and interviewed relevant officials. GAO also reviewed research on nonprofits' indirect costs.
Depending on the grant program, nonprofits may be reimbursed for indirect costs (generally costs such as rent or utilities), administrative costs (generally cost activities such as accounting or personnel), both, or neither. OMB officials said costs can be classified as either indirect or direct, and administrative cost activities are usually, but not always, classified as indirect costs. However, inconsistencies in the use and meaning of the terms indirect and administrative, and their relationship to each other, has made it difficult for state and local governments and nonprofits to classify costs consistently. This has resulted in varying interpretations of what activity costs are indirect versus administrative. As OMB guidance on cost principles for nonprofits recognizes (2 CFR Part 230), because nonprofit organizations have diverse characteristics and accounting practices, it is not possible to specify the types of costs that may be classified as indirect in all situations. This increases the challenges of administering federal grants and, in some cases, makes it difficult for recipients to determine those activities eligible for indirect cost reimbursement under a particular federal grant and those that are not. GAO found differences in the rate in which state and local governments reimburse nonprofits for indirect costs. These differences, including whether nonprofits are reimbursed at all, largely depend on the policies and practices of the state and local governments that award federal funds to nonprofits. Federal grants often provide wide latitude in setting cost reimbursement policies and practices, and some state and local governments do not reimburse these costs at all. Those that do can often choose the reimbursement rate. As a result, GAO found that variations in indirect cost reimbursement exist not only among different grants, but also within the same grant across different states. GAO found that nonprofits fund indirect costs with a variety of federal and nonfederal funding sources, and that when indirect cost reimbursement is less than the amount of indirect costs nonprofits determine they have incurred, most nonprofits GAO interviewed take steps to bridge the gap. They may reduce the population served or the scope of services offered, and may forgo or delay physical infrastructure and technology improvements and staffing needs. Because many nonprofits view cuts in clients served or services offered as unpalatable, they reported that they often compromise vital "back-office" functions, which over time can affect their ability to meet their missions. Further, nonprofits' strained resources limit their ability to build a financial safety net, which can create a precarious financial situation for them. Absent a sufficient safety net, nonprofits that experience delays in receiving their federal funding may be inhibited in their ability to bridge funding gaps. When funding is delayed, some nonprofits said they either borrow funds on a line of credit or use cash reserves to provide services and pay bills until their grant awards are received. Collectively, these issues place stress on the nonprofit sector, diminishing its ability to continue to effectively partner with the federal government to provide services to vulnerable populations.
RecommendationsOur recommendations from this work are listed below with a Contact for more information. Status will change from "In process" to "Open," "Closed - implemented," or "Closed - not implemented" based on our follow up work.
Director: Stanley J. Czerwinski Team: Government Accountability Office: Strategic Issues Phone: (202) 512-6520GAO-10-477, Nonprofit Sector: Treatment and Reimbursement of Indirect Costs Vary among Grants, and Depend Significantly on Federal, State, and Local Government Practices
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Report to the Chairman, Committee on the Budget, House of
Representatives:
United States Government Accountability Office:
GAO:
May 2010:
Nonprofit Sector:
Treatment and Reimbursement of Indirect Costs Vary among Grants, and
Depend Significantly on Federal, State, and Local Government Practices:
GAO-10-477:
GAO Highlights:
Highlights of GAO-10-477, a report to the Chairman, Committee on the
Budget, House of Representatives.
Why GAO Did This Study:
Nonprofits are key partners in delivering federal services yet
reportedly often struggle to cover their indirect costs (costs not
readily identifiable with particular programs or projects). This
raises concerns about fiscal strain on the sector. To provide
information on nonprofits‘ indirect cost reimbursement, especially
when funding flows through entities such as state and local
governments, GAO was asked to review, for selected grants and
nonprofits, (1) how indirect cost terminology and classification vary,
(2) how indirect costs are reimbursed, and (3) if gaps occur between
indirect costs incurred and reimbursed, steps taken to bridge gaps.
GAO selected six Departments of Health and Human Services and Housing
and Urban Development grants and 17 nonprofits in Louisiana, Maryland,
and Wisconsin. GAO selected these agencies for their historical
relationship with nonprofits. GAO reviewed policies and documents
governing indirect costs and interviewed relevant officials. GAO also
reviewed research on nonprofits‘ indirect costs.
What GAO Found:
Depending on the grant program, nonprofits may be reimbursed for
indirect costs (generally costs such as rent or utilities),
administrative costs (generally cost activities such as accounting or
personnel), both, or neither. OMB officials said costs can be
classified as either indirect or direct, and administrative cost
activities are usually, but not always, classified as indirect costs.
However, inconsistencies in the use and meaning of the terms indirect
and administrative, and their relationship to each other, has made it
difficult for state and local governments and nonprofits to classify
costs consistently. This has resulted in varying interpretations of
what activity costs are indirect versus administrative. As OMB
guidance on cost principles for nonprofits recognizes (2 CFR Part
230), because nonprofit organizations have diverse characteristics and
accounting practices, it is not possible to specify the types of costs
that may be classified as indirect in all situations. This increases
the challenges of administering federal grants and, in some cases,
makes it difficult for recipients to determine those activities
eligible for indirect cost reimbursement under a particular federal
grant and those that are not.
GAO found differences in the rate in which state and local governments
reimburse nonprofits for indirect costs. These differences, including
whether nonprofits are reimbursed at all, largely depend on the
policies and practices of the state and local governments that award
federal funds to nonprofits. Federal grants often provide wide
latitude in setting cost reimbursement policies and practices, and
some state and local governments do not reimburse these costs at all.
Those that do can often choose the reimbursement rate. As a result,
GAO found that variations in indirect cost reimbursement exist not
only among different grants, but also within the same grant across
different states.
GAO found that nonprofits fund indirect costs with a variety of
federal and nonfederal funding sources, and that when indirect cost
reimbursement is less than the amount of indirect costs nonprofits
determine they have incurred, most nonprofits GAO interviewed take
steps to bridge the gap. They may reduce the population served or the
scope of services offered, and may forgo or delay physical
infrastructure and technology improvements and staffing needs. Because
many nonprofits view cuts in clients served or services offered as
unpalatable, they reported that they often compromise vital "back-
office" functions, which over time can affect their ability to meet
their missions. Further, nonprofits‘ strained resources limit their
ability to build a financial safety net, which can create a precarious
financial situation for them. Absent a sufficient safety net,
nonprofits that experience delays in receiving their federal funding
may be inhibited in their ability to bridge funding gaps. When funding
is delayed, some nonprofits said they either borrow funds on a line of
credit or use cash reserves to provide services and pay bills until
their grant awards are received. Collectively, these issues place
stress on the nonprofit sector, diminishing its ability to continue to
effectively partner with the federal government to provide services to
vulnerable populations.
What GAO Recommends:
GAO recommends that the Director of the Office of Management and
Budget (OMB) bring together federal, state, local, and nonprofit
representatives to help clarify and improve understanding of how
nonprofits‘ indirect costs should be treated, particularly for grants
passed through state and local governments to nonprofits. OMB agreed
with GAO‘s recommendation.
View [hyperlink, http://www.gao.gov/products/GAO-10-477] or key
components. For more information, contact Stanley J. Czerwinski at
(202) 512-6806 or czerwinskis@gao.gov.
[End of section]
Contents:
Letter:
Background:
Inconsistencies in Terminology Lead to Challenges in Cost
Classification, Which Can Result in Uneven Treatment of Costs:
Nonprofits' Reimbursement for Indirect Costs Largely Depends on
Federal, State, and Local Government Practices:
When Nonprofits Report Differences between Indirect Costs Incurred and
Reimbursed, They Take a Variety of Steps to Bridge Gaps:
Conclusions:
Recommendation for Executive Action:
Agency Comments and Our Evaluation:
Appendix I: Objectives, Scope, and Methodology:
Appendix II: GAO Contact and Staff Acknowledgments:
Tables:
Table 1: Statutory Limits on Administrative Costs for Selected HHS and
HUD Grants:
Table 2: Description of Selected Grants for Our Study:
Figures:
Figure 1: Examples of How Federal Funds Flow to Nonprofit
Organizations:
Figure 2: Examples of How Reimbursement for Nonprofits' Indirect and
Administrative Costs for the Promoting Safe and Stable Families Grant
(PSSF) Varies across States:
Abbreviations:
ACF: Administration for Children and Families:
CPD: Office of Community Planning and Development:
CRS: Congressional Research Service:
ESG: Emergency Shelter Grants:
HHS: Department of Health and Human Services:
HOPWA: Housing Opportunities for Persons with AIDS:
IRS: Internal Revenue Service:
HUD: Department of Housing and Urban Development:
NCCS: National Center for Charitable Statistics:
NTEE: National Taxonomy of Exempt Entities:
OMB: Office of Management and Budget:
PSSF: Promoting Safe and Stable Families:
Recovery Act: American Recovery and Reinvestment Act of 2009:
SAMHSA: Substance Abuse and Mental Health Services Administration:
[End of section]
United States Government Accountability Office:
Washington, DC 20548:
May 18, 2010:
The Honorable John M. Spratt, Jr.
Chairman:
Committee on the Budget:
House of Representatives:
Dear Mr. Chairman:
Nonprofit organizations have increasingly become key partners with the
federal government in delivering important federal services throughout
the nation, including health care, education, housing, and human
services. One study estimates that nonprofits received approximately
$317 billion from the federal government in fiscal year 2004 for
service delivery.[Footnote 1] The Congressional Research Service (CRS)
estimates that government grants and payments to the nonprofit sector
increased almost 53 percent from 1995 to 2005,[Footnote 2]
demonstrating governments' increased reliance on this sector to
deliver public services. The breadth and diversity of nonprofits allow
them to tailor services to the specific needs of communities and
individuals. However, funding is often limited for the indirect costs
associated with providing these services (indirect costs are generally
costs such as rent or utilities that cannot be readily identified with
a particular service or product). Sometimes costs that would normally
be classified as indirect costs are covered in other ways; other times
they are not covered at all. As such, we have reported that nonprofits
often struggle to cover the costs of doing business, which raises
concerns about the long-term financial health and durability of the
sector and its ability to effectively deliver federal services and
programs.[Footnote 3]
Congress recently took steps toward addressing these challenges. For
example, the Serve America Act[Footnote 4] increases the limit on
nonprofits' use of program funds for administrative costs from 5 to 6
percent for some federal education grant programs, and the American
Recovery and Reinvestment Act of 2009 (Recovery Act)[Footnote 5] makes
$50 million available through the Department of Health and Human
Services' Strengthening Communities Fund to help build the capacity of
nonprofit organizations. Further, if enacted, the Nonprofit Capacity
Building Act of 2009[Footnote 6] would establish a nonprofit capacity-
building program to award grants for organizational development
assistance to small and midsize nonprofit organizations facing
resource hardship challenges.
Our prior work identified the need for more information on various
aspects of the federal-nonprofit relationship, particularly funding
received from federal sources.[Footnote 7] Responding to your request
for more information on indirect cost reimbursement, especially when
federal funding is passed through to nonprofits from other entities
such as state and local governments, we reviewed, for selected federal
grant programs and nonprofits, (1) how indirect cost terminology and
classification vary, (2) how indirect costs are reimbursed, and (3) if
gaps occur between indirect costs incurred and reimbursed, steps
nonprofits take to bridge the gaps.
To achieve our objectives, we selected six federal social services and
housing grants from two federal agencies: the Department of Health and
Human Services (HHS) and the Department of Housing and Urban
Development (HUD). We selected HHS and HUD as our two primary agencies
of focus because of their familiarity and historical relationship with
nonprofit organizations. Within these agencies, we selected grants
based on their design to fulfill a range of housing and social service
needs. The selected grants are:
* Promoting Safe and Stable Families (PSSF) grant and Family Violence
Prevention and Services/Grants for Battered Women's Shelters
administered by HHS's Administration for Children and Families (ACF),
* Block Grants for Community Mental Health Services and Block Grants
for Prevention and Treatment of Substance Abuse administered by HHS's
Substance Abuse and Mental Health Services Administration (SAMHSA),
and:
* Emergency Shelter Grants[Footnote 8] (ESG) and Housing Opportunities
for Persons with AIDS Grant (HOPWA) administered by HUD's Office of
Community Planning and Development (CPD).
We reviewed federal statutes for the six grants we studied, as well as
Office of Management and Budget (OMB), HHS, and HUD documents,
guidance, and policies governing the treatment of indirect costs. We
also interviewed budget and program officials at these agencies. We
selected three states--Louisiana, Maryland, and Wisconsin--and more
than 20 local government and nonprofit organizations to which these
states award federal funding under some or all of the six grants.
These states and nonprofits were selected based on criteria such as
amount of HHS and HUD funding received, population, and geographic
dispersion. We reviewed documents, guidance, and policies governing
the treatment of indirect costs from these states, local governments,
and nonprofits, and interviewed budget and program officials in these
organizations. Further, we interviewed officials from nonprofit
associations, such as the National Council of Nonprofits and the
Nonprofit Finance Fund. We also conducted a literature review of
research on nonprofits' indirect costs, and determined that the
studies we included in our work are methodologically sound. This
research is referenced throughout our report, where applicable.
We conducted this performance audit from October 2008 to May 2010 in
accordance with generally accepted government auditing standards.
Those standards require that we plan and perform the audit to obtain
sufficient, appropriate evidence to provide a reasonable basis for our
findings and conclusions based on our audit objectives. We believe
that the evidence obtained provides a reasonable basis for our
findings and conclusions based on our audit objectives. Although the
illustrative examples in this review cannot be generalized to all
federal grant programs, state and local governments, or nonprofit
organizations, we believe they provide valuable insight into the
challenges of indirect cost classification and the funding
relationship between the federal government and the nonprofit sector.
Appendix I contains more details on our scope and methodology.
Background:
Federal grants are forms of financial assistance from the government
to a recipient for a particular public purpose that is authorized by
law. Federal grant funds flow to the nonprofit sector in various ways,
as shown in figure 1. Some grant funds are awarded directly to
nonprofits, while others are first awarded to states, local
governments, or other entities and then awarded to nonprofit service
providers.[Footnote 9] Federal laws, policies, regulations, and
guidance associated with federal grants apply regardless of how
federal grant funding reaches the final recipients.
Figure 1: Examples of How Federal Funds Flow to Nonprofit
Organizations:
[Refer to PDF for image: illustrated]
From Federal government: to:
Directly to Nonprofit Organizations.
State government, to Nonprofit Organizations;
Local government, to Nonprofit Organizations;
Nonprofit Organizations, to Nonprofit Organizations.
Source: GAO.
[End of figure]
Some federal grant programs contain statutory limits on administrative
cost reimbursement for state and local government grantees.
Additionally, some federal grant programs predetermine a limit for
subgrantees (see table 1 for the statutory limits on the six grants we
reviewed).
Table 1: Statutory Limits on Administrative Costs for Selected HHS and
HUD Grants:
Federal agency: HHS;
Operational division/subcomponent: SAMHSA;
Grant: Block Grants for Substance Abuse Prevention and Treatment;
Percentage limit: Five percent limitation on reimbursement for
administrative expenses for states;
Federal statute - authorization: Part B of Title XIX of the Public
Health Service Act, 42 U.S.C. § 300x-31.
Federal agency: HHS;
Operational division/subcomponent: SAMHSA;
Grant: Block Grants for Community Mental Health Services;
Percentage limit: Five percent limitation on reimbursement for
administrative expenses for states;
Federal statute - authorization: Part B of Title XIX of the Public
Health Service Act, 42 U.S.C. § 300x-5.
Federal agency: HHS;
Operational division/subcomponent: ACF;
Grant: Promoting Safe & Stable Families Grant;
Percentage limit: Ten percent limitation on reimbursement for
administrative costs for states;
Federal statute - authorization: Promoting Safe and Stable Families
Act, 42 U.S.C. § 629-629e.
Federal agency: HHS;
Operational division/subcomponent: ACF;
Grant: Family Violence Prevention Services/Battered Women's Shelters
Grant;
Percentage limit: Five percent limitation on reimbursement for
administrative costs for states;
Federal statute - authorization: Family Violence Prevention and
Services Act 42 U.S.C. § 10401.
Federal agency: HUD;
Operational division/subcomponent: CPD;
Grant: Emergency Shelter Grants (ESG);
Percentage limit: A recipient may use up to 5 percent[A] for
administrative purposes; a recipient state shall share this amount
with local governments funded by the state;
Federal statute - authorization: McKinney-Vento Homeless Assistance
Act, Title IV, Subtitle B, 42 U.S.C. § 11378.
Federal agency: HUD;
Operational division/subcomponent: CPD;
Grant: Housing Opportunities for Persons with AIDS Grant (HOPWA);
Percentage limit: Grantees can receive up to 3 percent for
administrative costs; Project sponsors[B] can receive up to 7 percent
for administrative costs;
Federal statute - authorization: AIDS Housing Opportunity Act, 42
U.S.C. § 12901.
Source: GAO analysis of applicable program statutes and regulations.
[A] The Homeless Emergency Assistance and Rapid Transition to Housing
Act of 2009 increased the percentage limit for administrative purposes
from 5 percent to 7.5 percent effective November 20, 2010, or 3 months
after the Secretary of HUD issues final regulations implementing the
act. Pub. L. No. 111-22 (2009).
[B] Project sponsors are nonprofit organizations or state or local
government housing agencies that contract with a grantee to provide
HOPWA assistance.
[End of table]
OMB circulars A-87 and A-122[Footnote 10] provide guidance to state
and local governments and nonprofits on classifying costs as direct or
indirect and direct state and local governments to employ the
necessary management techniques in order to efficiently and
effectively administer federal awards. OMB circulars A-87 and A-122
generally define direct and indirect costs as follows:
* Direct costs are those that can be identified specifically with a
particular final cost objective, that is, a particular award, project,
service, or other direct activity of an organization.
* Indirect costs are those that have been incurred for common or joint
objectives and are not readily assignable to the cost objectives
specifically benefited, without effort disproportionate to the results
received. A cost may not be allocated to an award as an indirect cost
if any other cost incurred for the same purpose, in like
circumstances, has been assigned to an award as a direct cost. Direct
costs of minor amounts may be treated as indirect costs under certain
conditions. Recognizing that nonprofit organizations have diverse
characteristics and accounting practices, the guidance states that it
is not possible to specify the types of cost that may be classified as
indirect costs in all situations. Whether a nonprofit classifies costs
as direct or indirect is often a result of the organization's ability
to link costs to a particular program.
OMB Circular A-122 guidance to nonprofits further divides indirect
costs into two broad categories: facilities and administration.
* Facilities costs generally include costs related to the
"depreciation and use allowances on buildings and equipment, as well
as operations and maintenance expenses."
* Administration costs generally include "general administration and
expenses such as the director's office, accounting, personnel, library
services and all other expenses not listed under facilities."
OMB Circular A-133 provides general guidance on the roles and
responsibilities of the federal awarding agencies and primary
recipients of government funds regarding audit requirements of
grantees.[Footnote 11] It sets forth standards for obtaining
consistency and uniformity among federal agencies for the audit of
states, local governments, and nonprofit organizations expending
federal awards totaling $500,000 or more annually. Among other
responsibilities, it gives:
* federal awarding agencies the responsibility to advise recipients of
requirements imposed on them by federal laws, regulations, and the
provisions of contracts or grants and:
* primary recipients the responsibility to identify grant awards;
advise subrecipients of requirements imposed on them by federal laws,
regulations, and the provisions of contracts or grant agreements as
well as any supplemental requirements; and monitor the implementation
of the grants.
Awarding agencies and all recipients and subrecipients of federal
grant funds must comply with certain data collection, record-keeping,
and reporting requirements to help monitor grant implementation. These
requirements differ across grants and are determined by the federal
awarding agency, federal law, or both. State and local governments
sometimes impose additional requirements on their subgrantees.
Inconsistencies in Terminology Lead to Challenges in Cost
Classification, Which Can Result in Uneven Treatment of Costs:
Understanding OMB guidance regarding the relationship between indirect
and administrative costs is particularly challenging for state and
local governments and nonprofits. According to OMB officials, the
terms "direct" and "indirect" can be thought of as ways to classify
costs; that is, they are "cost buckets." In contrast, the term
"administrative" refers to a cost function or activity--such as
accounting, procurement, personnel, or budgeting. On the one hand, OMB
Circular A-122 cost guidance to nonprofits indicates that
administrative costs are usually but not always indirect costs; on the
other hand, that same guidance lists "administration" costs as one of
two categories of indirect costs. Further, OMB Circular A-87 cost
guidance to state and local governments uses the terms indirect and
administrative interchangeably in certain places. Taken together, the
OMB guidance can be viewed as ambiguous. Guidance is most useful when
it is clear and well understood. OMB officials told us that given the
uncertainty and confusion with respect to these definitions and their
application, it may be helpful to bring federal, state, and local
officials together with representatives from nonprofit organizations
to discuss these issues. Doing so, they acknowledge, could help
clarify and improve understanding of how indirect costs should be
treated.
Classifying similar costs differently can make it difficult to
determine how much money grantees receive for cost activities
typically thought of as indirect, and at what rate. For example, the
ESG program provides states or local government grantees up to 5
percent for administrative costs. As the primary recipients of ESG
funds, states are required to share at least a portion of this funding
with local government subgrantees; however, there is no such
requirement for cost sharing with nonprofits. Thus, on its face it may
appear as if ESG provides no administrative cost reimbursement for
nonprofits. However, the ESG statute allows some emergency shelter
costs, such as rent and utilities, which are typically thought of as
indirect costs, to be claimed as a direct cost under ESG's "operating
costs" activity--one of five direct program activities for which
subgrantees may be reimbursed.[Footnote 12] In another example, the
statute for the HOPWA grant program limits administrative cost
reimbursement for project sponsors to 7 percent. Because
administrative costs can either be charged as direct or indirect costs
depending on the circumstance, and because HOPWA has no explicit limit
on indirect costs, it is difficult to accurately characterize cost
reimbursement for activities commonly thought of as indirect.
When grants and grantees classify similar costs differently it can
also result in the same cost activity being covered for some
nonprofits but not others, and can increase the complexity of
administering the grants. Nonprofit association officials told us that
because grant award packages and federal guidance contain unclear or
conflicting information on how to allocate costs, nonprofits sometimes
unknowingly exclude eligible expenses in their calculation of
administrative costs and, as a result, limit their own reimbursement
potential.[Footnote 13] Further, some of the nonprofit and association
officials we spoke with said that because grant programs have
different definitions of indirect costs, they must take care to
reconcile their own accounting systems with the requirements of each
grant they receive to ensure that they properly account for the funds.
They also said that this is time consuming and resource intensive, and
that more consistent classifications and treatment across federal
grants would simplify grant administration and may reduce costs.
We and others have previously reported that federal grant programs
sometimes classify similar or identical costs differently. In 2006, we
reviewed seven programs from HHS, and the Departments of Agriculture
and Labor, and found that the legal definitions of and the federal
funding rules for administrative costs varied even though many of the
same activities were performed to administer the programs.[Footnote
14] The report noted that the statutes and regulations that define
administrative costs for these programs differ in part because the
programs evolved separately over time and have different missions,
priorities, services, and clients. Further, the report noted that a
number of state budget officials said that varying definitions of
administrative costs create challenges for them. For example, one said
that it can be difficult to develop coding for accounting and
budgeting that can be used across programs and, as a result, it can be
difficult to monitor costs accurately; another shared this concern and
said that consistent definitions of and caps for administrative costs
would make it easier to allocate costs across programs and, therefore,
might reduce costs. This concern is not new; in a 2002 report on tax-
exempt organizations, we reported that different approaches for
charging expenses, as well as different allocation methods, can result
in charities with similar types of expenses allocating them
differently.[Footnote 15]
Even though the terms indirect costs and administrative costs are not
synonymous, we found that some nonprofit, state, and local government
officials we spoke with use them interchangeably. A national nonprofit
association official made a similar observation, noting that
terminology varies throughout the nonprofit sector. State and local
government and nonprofit officials we spoke with also reported using
other terms, such as overhead, general operating expenses, or
management and general expenses, synonymously with indirect and
administrative costs.
A 2007 report on nonprofits' overhead costs also discussed widespread
confusion about indirect costs throughout the sector, and identified
"variations in definitions of overhead and the overhead cost rate" as
areas of concern among nonprofit researchers and practitioners.
[Footnote 16] The report also concluded that there is a substantial
difference between indirect costs and administrative costs, noting
that not all indirect costs are administrative, such as the costs of a
telemarketing campaign, which is a programmatic or fundraising
function. The report also said that there are administrative costs
that are direct costs, such as those for the computers and office
supplies used by the finance department.[Footnote 17]
Inconsistencies in guidance in grant award packages and across federal
programs add to the challenge of administering federal grants. For
example, officials from a Louisiana nonprofit said that one federal
contract may allow them to charge rent as a direct cost, while another
federal contract states that it is to be charged as an indirect cost.
These officials told us that they should be able to "call an apple, an
apple...every time." In another example, HUD's supplemental guidance
for HOPWA recipients advises that in reviewing administrative and
indirect costs, recipients should keep in mind that "all
administrative costs are indirect costs, but not all indirect costs
are administrative costs." Conversely, in describing HHS's PSSF grant
and the Family Violence Prevention Services/Battered Women's Shelter
grant, ACF officials explained that administrative costs can be either
direct or indirect costs.
Nonprofits' Reimbursement for Indirect Costs Largely Depends on
Federal, State, and Local Government Practices:
For the majority of grants in our review, we found that state and
local government grantees are allowed to decide whether or not and how
much they reimburse nonprofit subgrantees for their administrative or
indirect costs. In all three states we reviewed, we found differences
in the rates at which state and local governments reimburse nonprofits
for indirect costs. These differences, including whether nonprofits
are reimbursed at all, largely depend on the policies and practices of
the state and local governments that award federal funds to
nonprofits. State and local governments may apply the same indirect
cost limit to all subgrantees or may choose to apply different
indirect cost limits to different subgrantees. For example, for all
subgrantees who receive funds under the Block Grants for Community
Mental Health Services and the Prevention and Treatment of Substance
Abuse, the Louisiana Department of Health and Hospitals limits
indirect cost reimbursement to 12 percent. Other state and local
government agencies, such as the Wisconsin Department of Health
Services, work with individual subgrantees to determine an indirect
cost reimbursement rate. Officials from the department told us that
they often assist subgrantees in determining how to classify costs;
this helps to determine what costs to reimburse as indirect, and at
what rate.
The amount of funding passed through to nonprofits can also be
affected by the amount of funding a state or local government uses for
its own administrative costs. For example, according to a Dane County,
Wisconsin official, Dane County receives 10 percent for administrative
and indirect costs for the PSSF grant from the state of Wisconsin and
passes the entire amount on to its nonprofit service providers; this
increases the amount of funds available to nonprofits. However, some
state and local governments we spoke with interpret statutory
limitations on their own administrative costs as necessarily limiting
the administrative and indirect costs allowable by the grant for all
subgrantees. Although states often enjoy wide latitude in determining
the administrative and indirect reimbursement rates of their
subgrantees, applying a more specific interpretation of federal
statute potentially limits the amount of funds available to nonprofits.
Variations in cost coverage exist not only among different grants
across different states, but also within the same grant across
different states. For example, for the PSSF grant, states may retain
up to 10 percent of the grant award to pay for their own costs to
administer this grant, or they may pass this amount through to the
nonprofit service providers to which they award PSSF grants. In
addition, states may determine the allowable level of indirect cost
reimbursement for the nonprofit service providers to whom they award
PSSF grants. As shown in figure 2, three nonprofits that receive
funding under the PSSF grant in Louisiana, Maryland, and Wisconsin are
reimbursed for their indirect costs, administrative costs, or both at
different rates (9.4 percent, 0 percent, and 14 percent, respectively).
The differences among reimbursement rates for these nonprofits may in
part be due to the presence or absence of an indirect cost rate
agreement. Primary recipients of federal funds are required to have a
federal indirect cost rate agreement in order to be reimbursed for
indirect costs. There is no such requirement for recipients that
receive federal funds that first flow through entities such as state
and local governments. Five of the 17 nonprofits in our sample have
federal agreements. However, state and local governments are not
required to consider or honor federal indirect cost rate agreements
when awarding federal funds. Some state and local governments
negotiate a similar indirect cost rate agreement directly with
subrecipients; others do not.
Figure 2: Examples of How Reimbursement for Nonprofits' Indirect and
Administrative Costs for the Promoting Safe and Stable Families Grant
(PSSF) Varies across States:
[Refer to PDF for image: illustration]
States are allowed to retain 10 percent for their own administrative
costs.
HHS/ACF Promoting Safe and Stable Families grant program:
State of Louisiana Department of Social Services:
State passes majority of its own administrative cost funds through to
nonprofits;
Nonprofit recipient: Federal indirect cost rate honored. Nonprofit
receives 9.4 percent for administrative costs through grant.
HHS/ACF Promoting Safe and Stable Families grant program:
State of Maryland Department of Human Resources:
St. Mary‘s County Government Department of Social Services;
St. Mary‘s County Government acts on behalf of the state. State and
county retain a total of 10 percent for their own administrative costs;
Local Board of Education: No indirect cost funding retained by Board
of Education;
Nonprofit recipient: Nonprofit does not have a federal indirect cost
rate or an agreement with county or local board of education. No
indirect costs allowable through grant.
HHS/ACF Promoting Safe and Stable Families grant program:
State of Wisconsin Department of Children and Families: State retains
10 percent for its own administrative costs;
Dane County Government Department of Human Services: County allowed to
retain 10 percent of grant for administrative and indirect costs, but
it does not. It passes entire amount through to nonprofit;
Nonprofit recipient: Nonprofit does not have a federal indirect cost
rate. Nonprofit receives 14 percent indirect cost reimbursement
through agreement with county.
Source: GAO analysis of HHS, state and local government, and nonprofit
information.
Note: These examples depict how funds flow to the specific nonprofit
subrecipients included in our sample; other pass-through relationships
also exist in these states for this particular grant.
[End of figure]
When Nonprofits Report Differences between Indirect Costs Incurred and
Reimbursed, They Take a Variety of Steps to Bridge Gaps:
Nonprofits Fund Indirect Costs from a Variety of Sources:
To help cover their indirect costs, nonprofits reported using funding
from a variety of sources in addition to federal funds, such as
capacity-building grants, private donations, fundraising, endowment
funds, and business income generated from services provided.[Footnote
18] For example, some of the nonprofits we spoke with operate fee-for-
service furniture restoration, repair shop, and batterers' treatment
programs. A Wisconsin nonprofit official said that the United Way
recognizes the challenges nonprofits face in receiving reimbursement
for indirect costs and provides unrestricted funding to help cover
them. Other nonprofit officials we spoke with, however, reported that
these grants can be difficult to secure. A November 2009 CRS report
noted, perhaps not surprisingly, that charitable giving declined
during the recent recession.[Footnote 19] For some nonprofits the
decline comes at a time when their services may be in greater demand,
which can further strain resources.
Nonprofits also rely on in-kind donations and volunteer labor to help
cover costs. For example, nonprofits reported receiving food donations
from local restaurants, furniture donations, and facilities repairs by
nonprofit board members. One Louisiana nonprofit official said that in-
kind and volunteer labor is essential for her organization's ability
to provide services, and it received $160,000 in volunteer labor in
2008. However, nonprofit officials also noted that while the use of
volunteer labor is valued, it is not "free," as volunteers may require
additional supervision and training.
Nonprofits Take Steps to Bridge Reported Funding Gaps:
Fifteen of the 17 nonprofits in our sample reported that funding
received for indirect costs does not cover their actual indirect
costs.[Footnote 20] A nonprofit official whose organization receives a
HUD grant from the state of Wisconsin said that his organization is
authorized to claim 5 percent for administrative costs associated with
delivering supportive housing program services, but that amount does
not cover the costs of administering the program. In another example,
recipients of the Family Violence Prevention Services/Grants for
Battered Women's Shelters grants in all three states reported
receiving no indirect cost reimbursement, but their overall
organizational indirect costs ranged from about 8 to 11 percent.
[Footnote 21] Similarly, nonprofit subrecipients of ESG funding across
all three states reported no indirect cost reimbursement from state
and local governments. The overall organizational indirect costs for
these nonprofits ranged from 1.8 to 20 percent. These self-reported
levels are generally in line with an Urban Institute study that
analyzed the 1999 tax returns of approximately 160,000 health-related
and human services nonprofits,[Footnote 22] and reported average
management and general expenses of 17 and 16 percent, respectively.
Although nonprofits' fiscal challenges are not limited to indirect
cost funding, as noted above, funding sources that can be used to
cover indirect costs can be difficult to come by. As such, it is
particularly important to understand steps nonprofits take to bridge
gaps when they report gaps between indirect costs incurred and
reimbursed. We found that nonprofits often respond by reducing service
levels, compromising infrastructure and staff investments, or both,
and that these cost-cutting measures can limit nonprofits' ability to
build a financial safety net.
Reduced Service Levels:
Several nonprofits we spoke with said at the time of our interviews
they had reduced the size of their programs and populations served as
a result of gaps in funding for direct and indirect costs. For
example, a Louisiana nonprofit official said that his organization
scaled back its housing and shelter services 10 to 15 percent even
though its mission is to serve all at-risk youth in need of these
services. As a result, he said, the nonprofit now has a waiting list
for its residential services. A Maryland nonprofit official told us
that the organization's psychiatric rehabilitation program was one of
the largest in the state. However, according to this official, the
level of reimbursement his organization received from government
sources led to the nonprofit reducing the program's size in order to
remain viable. A 2008 study that examined several nonprofits also
discussed negative effects on nonprofits' capacity to provide services
due to funding gaps, noting that as a result of funding gaps in the
short term, staff members struggle to provide more services but with
fewer resources.[Footnote 23]
Nonprofits we spoke with also reported reducing the range of services
they offered. An official from a Maryland nonprofit whose mission
includes providing housing, employment services, and job referrals,
said that the organization once provided a computer lab with a part-
time computer instructor for its clients as part of its General
Education Development services. The official said that in an effort to
more closely align costs incurred with costs reimbursed, the nonprofit
eliminated the instructor position because it was not directly related
to the organization's primary mission of providing supportive housing
and housing placement. Officials from a Maryland drug and alcohol
rehabilitation nonprofit told us that they discontinued a vocational
education program for similar reasons.
Compromised Infrastructure Investments:
Many nonprofits compromise vital facilities maintenance and "back-
office" support functions, such as information technology systems, to
avoid reducing their services. Almost half of the nonprofits we spoke
with reported making such trade-offs. For example, a Louisiana
nonprofit said that it does not have an updated security system that
adequately protects the victims of domestic violence that it serves,
which directly affects the nonprofit's ability to fulfill its mission--
providing a safe space for victims of domestic violence. We also
observed ceilings that were in disrepair when we toured this
nonprofit's facility. An official from a Maryland nonprofit said that
her staff makes personal sacrifices to sustain services, such as
working in dark offices to conserve electricity costs or bringing
supplies from home. Wisconsin nonprofit officials reported that their
medical and dental appointment systems are not integrated, inhibiting
their ability to better serve their patients.
The experiences of these nonprofits are consistent with other studies'
findings that trade-offs in facility maintenance can hinder
nonprofits' ability to effectively carry out their mission in the long
term. A 2007 study on the financial health of the human service
providers in Massachusetts said that providers may defer routine
costs, such as facility maintenance and other critical infrastructure
investments, when they lack indirect cost funding.[Footnote 24] A 2008
study suggested that funders have unrealistic expectations for
nonprofits' indirect costs, which can lead nonprofits to underinvest
in infrastructure that is needed to maintain or improve standards for
service delivery.[Footnote 25] A 2008 study on the administrative
management capacity of 16 select nonprofit programs noted that many
organizations cite a lack of resources for information technology
infrastructure needs and that some organizations in the study reported
that they cannot meet technology needs beyond a basic level of
functionality.[Footnote 26] The study also reported that these
organizations lack sufficient strategic and long-term planning for
future information technology needs and equipment and software updates.
Compromised Staff Investments:
Nonprofits often report that they forgo staff investments or reduce or
freeze salaries to avoid reducing services. Officials from 10 of 17
nonprofits we spoke with said that at the time of our interviews they
had delayed filling vacant positions or have eliminated positions to
cover costs. For example, officials from a Maryland nonprofit
eliminated a development position and trained a receptionist to assume
other responsibilities. As a result, the organization lacked a
dedicated receptionist during business hours, which makes it more
challenging to respond to clients' needs. A Wisconsin nonprofit said
that it has not hired a medical coder--a position that would allow the
doctors in the organization to devote more time to seeing patients
instead of on administrative paperwork. Another Wisconsin nonprofit
official reported instituting a voluntary leave without pay program
during the summer months to reduce salary costs. Another Maryland
nonprofit official explained that because she cannot attract qualified
staff at the salary she is able to offer, she usually hires people
with very little experience who require a significant amount of
training and supervision. Similarly, officials from a third Maryland
nonprofit said that they are unable to provide salary increases or
cost-of-living adjustments for their staff and have had to cut
benefits.
Other studies have shown that nonprofits may also leave positions
vacant to realize savings, which can have adverse quality
implications. A 2008 study found that program staff at the 16
nonprofits in the study often take on administrative tasks, such as
recruitment processes and site maintenance, to bridge gaps in
administrative infrastructure and support; as a result, program staff
devote less time to activities more directly tied to service delivery
and quality programming.[Footnote 27] A 2004 study on nonprofit
overhead costs reported that limited or no staff for administrative
functions limited nonprofits' ability to manage and monitor finance,
development, and other important functions.[Footnote 28] A 2007 study
noted that staff salaries and benefits of the human service providers
in Massachusetts do not appear to keep pace with increases in the
overall cost of living. It further noted that the relatively low wages
can limit the qualifications and level of experience of many direct
care workers and can lead to rapid staff turnover. [Footnote 29] A
2004 study on nonprofit overhead costs discussed how challenges in
recruiting and retaining qualified staff compromised nonprofits'
effectiveness, noting that key positions are filled by individuals
with little relevant experience and training, and once staff gain
relevant experience, they seek employment at organizations with higher
salaries, leading to high turnover for nonprofits.[Footnote 30]
Limited Ability to Build a Financial Safety Net:
Nonprofits' strained resources also limit their ability to build
financial reserves for unanticipated expenses. Officials at a
Louisiana nonprofit said that their ability to build a financial
safety net is limited because they struggle to cover their costs and
do not have money left over to save. A nonprofit association official
said that nonprofits sometimes cannot set aside sufficient cash
reserves to cover unforeseen costs, such as a broken boiler. To
address unexpected costs, nonprofits often draw from their program
costs where possible, which can lead to a decline in program quality.
Other studies also reported on financial sustainability challenges for
nonprofits. Nonprofit financial management experts have recommended
that nonprofits maintain cash reserves sufficient to fund 3 months of
operating expenses. A 2009 study on the operating reserves of over
2,000 Washington, D.C. area nonprofits reported that in 2006, 57
percent of the operating public charities in the Greater Washington
area had operating reserves of less than 3 months; 28 percent of these
organizations reported no operating reserves.[Footnote 31] A 2008
study on the administrative management capacity of select nonprofit
programs reported that half of the nonprofits in the study do not
maintain the recommended level of reserves.[Footnote 32] Finally, a
2007 study reported that one-third of the more than 600 Massachusetts
providers in its sample had less than 15 days' cash at the ends of
their fiscal years; another quarter have only 3 to 4 weeks of cash at
the ends of their fiscal years.[Footnote 33] Given recent economic
conditions, the need for sufficient cash reserves may be particularly
important.
Untimely Reimbursements and High Grant Administration Costs Exacerbate
Nonprofits' Reported Funding Gaps:
A November 2009 CRS report noted that (1) in addition to funding cuts,
states apparently have been delaying payments for services they have
contracted with nonprofits to provide; and that (2) it appears that
governments, particularly state governments, may be contributing to
the financial difficulties of nonprofit organizations.[Footnote 34]
During the course of our work, we spoke with nonprofits that made
similar observations. Factors such as untimely reimbursements and high
grant administration costs can place stress on the nonprofit sector,
diminishing its ability to continue to provide services to vulnerable
populations. OMB officials acknowledged that building nonprofits'
capacity to manage may help nonprofits better contend with these
issues and continue to meet their missions.
Untimely Reimbursements:
Untimely receipt of government grant and contract payments contributes
to financial strain on nonprofits. Six of the 17 nonprofits in our
study reported that their reimbursements from federal, state, and
local governments are delayed at times, which can cause cash flow
problems and undermine their sustainability. For example, an official
from a Maryland nonprofit said that her organization was awarded an
HHS grant from the state of Maryland in October 2008 but did not
actually receive the funding until May 2009. Maryland nonprofit
officials said they sometimes experience 15-to 30-day delays in
reimbursement from the state of Maryland. One Maryland nonprofit
official said delays such as these create a "cash-flow nightmare" for
her organization. The nonprofit has a line of credit it can draw on to
tide it over until it receives grant payments, but this increases
costs because it incurs interest and fees on the line of credit, which
are not reimbursed. Three of the nonprofits in our study said that
smaller nonprofits without cash reserves or lines of credit rely on
timely payments to sustain their operations. They said that even small
delays put these nonprofits at risk of failure. Some state and
nonprofit association officials we spoke with, however, said that
reimbursement delays also occur when nonprofit staff are so busy
operating programs that they do not keep up with filing invoices in a
timely manner; as a result, when nonprofits most need the money, it is
not available.
We and others have also cited challenges nonprofits face as a result
of delayed reimbursements from federal, state, or local governments.
In 2006 we reported that recipients of selected federal grants
reported that delayed awards create significant burden on them and
limit their ability to plan for and efficiently execute grant
programs.[Footnote 35] Grant recipients noted that they often received
award notifications significantly later than they had anticipated,
sometimes months after the expected award date provided in the
opportunity announcement. These uncertainties and delays caused
significant problems in planning for and executing grant projects.
Grant recipients in this study suggested that agencies should award
grants in a more timely way or provide more precise information on
when an award could be expected. A 2007 study on the financial health
of the human service providers in Massachusetts noted that when an
organization with limited cash experiences unexpected delays in the
receipt of income, a crisis situation can occur.[Footnote 36] A 2002
study that reviewed prior research on this topic noted that when
government agencies are delayed in approving contracts or grant
payments, recipient organizations often experience cash flow problems.
[Footnote 37] Consistent with comments from the nonprofits we
interviewed, this report suggested that payment delays are especially
difficult for smaller and new organizations because they do not have
established mechanisms to withstand delayed or unpredictable funding.
Costs of Administering Grants:
The high costs of grant administration sometimes discourage nonprofits
from applying for grant funds. Three nonprofits we interviewed
reported that they do not seek additional government grants or may not
reapply for grants they currently receive for this reason. For
example, a Maryland nonprofit official stated that her organization is
eligible for a Recovery Act grant program that provides services to
youth, but she is hesitant to take on the project because the grant's
administrative reimbursement rate is 3 percent, which would not cover
the cost of administering the grant.[Footnote 38] Over half of the
nonprofits in our study said that administrative reporting
requirements make it challenging to administer grants they receive.
Officials from a Louisiana nonprofit told us that complying with
reporting requirements for the more than 20 federal grants they manage
requires a significant amount of staff resources. A Maryland nonprofit
official explained that some of the nonprofits' federal grants are
"big, complex, and complicated" to acquire and manage because it does
not have a dedicated grants management team and establishing one would
redirect resources away from other areas. Likewise, officials from a
Wisconsin nonprofit said that complying with the county's challenging
bureaucratic process requires a significant amount of time that could
otherwise be spent on mission-related activities, and that the
organization regularly loses money as a result of these requirements.
We and others have previously reported on the challenges facing
nonprofits in administering grants. In July 2007, we testified that
practitioners and researchers alike acknowledged the difficulty that
nonprofit organizations, particularly smaller entities, have in
responding to the administrative and reporting requirements of their
diverse funders.[Footnote 39] We said that although funders need
accountability, the diverse requirements of different funders make
reporting a time-consuming and resource-intensive task. For example,
meeting the increasing expectations that nonprofits measure
performance, given the size of grants and the evaluation capabilities
of the staff, can be difficult. One researcher said that performance
evaluation is one of the biggest challenges they face. A 2002 study,
which included an analysis of Internal Revenue Service (IRS) Forms 990
from 1,172 nonprofit organizations from 1985 to 1995, found that for
some nonprofits, an increase in government funding is positively
correlated with an increase in the share of administrative expenses
the following year, which could be the result of the costs associated
with obtaining contracts and the challenges of meeting accountability
and reporting requirements.[Footnote 40] Similarly, a 2004 study on
nonprofit overhead costs of 9 nonprofit organizations reported that
the nonprofits with the weakest organizational infrastructures
received half or more of their revenue from public sector sources, and
that the public sector practice of providing little support for
overhead costs was directly associated with the organizational
weaknesses at these nonprofits.[Footnote 41]
Conclusions:
Federal, state, and local governments rely on nonprofit organizations
as key partners in implementing programs and providing services to the
public, such as health care, human services, and housing-related
services. Nonprofits' ability to determine and manage their indirect
costs is affected by inconsistencies in terminology and guidance
across federal programs on how to classify costs. Further, varying
reimbursement practices by state and local governments that award
federal funds affect the rate at which indirect costs are covered.
Absent a clear understanding among federal, state, local, and
nonprofit officials about how to interpret OMB's indirect cost
guidance and consistently classify activities typically thought of as
indirect costs, nonprofits will likely continue to struggle with
accurately and consistently reporting on their indirect and
administrative costs of doing business, and a clear picture of the
true gap between actual and reimbursed indirect costs will remain
elusive.
As the federal government increasingly relies on the nonprofit sector
to provide services, it is important to better understand the
implications of reported funding gaps, such as compromised quality of
important administrative functions, including information technology,
human resources, legal, and accounting operations. Such gaps further
limit nonprofits' capacity to correctly determine how indirect costs
should be treated. Collectively, these challenges potentially limit
the sector's ability to effectively partner with the federal
government, can lead to nonprofits providing fewer or lower-quality
federal services, and, over the long term, could risk the viability of
the sector. Given OMB's role in federal grants management, OMB is in a
unique position to convene stakeholders to review these issues.
Recommendation for Executive Action:
GAO recommends that the Director of OMB bring together federal, state,
and local governments, and nonprofit representatives to propose ways
to clarify and improve understanding of how indirect costs should be
treated, particularly for grants passed through state and local
governments to nonprofits by:
* clarifying the definitions of indirect costs and administrative
costs and their relationship to each other and:
* considering ways to help nonprofits improve their understanding and
ability to better capture, categorize, report, and recover indirect
and administrative costs.
Agency Comments and Our Evaluation:
We provided a draft of this report to OMB and the Departments of
Health and Human Services (HHS) and Housing and Urban Development
(HUD). OMB generally agreed with our findings, conclusions, and
recommendations. OMB also provided technical comments, which we
incorporated, and suggested clarifying language for the
recommendation, which we agreed with and incorporated. HHS and HUD did
not provide formal comments, but made technical comments by e-mail,
which we incorporated.
We will send copies of this report to the Director of OMB and the
Secretaries of Health and Human Services and Housing and Urban
Development. In addition, the report will be available at no charge on
the GAO Web site at [hyperlink, http://www.gao.gov].
If you have any questions about this report, please contact me at
(202) 512-6806 or czerwinskis@gao.gov. Contact points for our Offices
of Congressional Relations and Public Affairs may be found on the last
page of this report. Key contributors to this report are listed in
appendix II.
Sincerely yours,
Signed by:
Stanley J. Czerwinski:
Director, Strategic Issues:
[End of section]
Appendix I: Objectives, Scope, and Methodology:
Our objectives were to provide information for selected federal grant
programs and nonprofits on (1) how indirect cost terminology and
classification vary, (2) how indirect costs are reimbursed, and (3) if
gaps occur between indirect costs incurred and reimbursed, steps
nonprofits take to bridge the gaps.
To address our objectives and obtain information on federal grants
initially awarded to state and local governments and passed through to
nonprofit service providers and the impact of indirect cost funding on
nonprofits, we used several approaches. These included selecting a
nonprobability sample[Footnote 42] of federal grants, states, and
nonprofits to serve as case studies and conducting a literature review
to analyze published work related to this topic. The scope of the
third objective was broader to include the perspectives of nonprofits
that receive any federal funding, direct or pass-through. We also
interviewed nonprofit association officials.
First, we selected six federal grant programs--four from the
Department of Health and Human Services (HHS) and two from the
Department of Housing and Urban Development (HUD)--of 26 grant-making
federal agencies that offer over 1,000 grant programs annually. We
selected HHS and HUD as our two primary agencies of focus because of
their familiarity and historical relationship with nonprofit
organizations. HHS and HUD grants address many of the National
Taxonomy of Exempt Entities (NTEE) classifications related to social
and housing services. The NTEE classification system for nonprofits
was devised by the Urban Institute's National Center for Charitable
Statistics (NCCS), which is a national clearinghouse of data on the
nonprofit sector in the United States. NTEE classifications are widely
referenced by the Internal Revenue Service and nonprofit researchers
and practitioners. HUD and HHS grants address NTEE categories such as:
* Human Services:
* Housing and Shelter:
* Agriculture, Food, Nutrition:
* Community Improvement, Capacity Building:
* Youth Development:
* Health Care:
* Mental Health/Crisis Intervention:
* Civil Rights, Social Action, Advocacy:
As shown in table 2, the six grants selected are designed to fulfill
missions consistent with most of the NTEE categories listed above.
Table 2: Description of Selected Grants for Our Study:
Grant name: Promoting Safe and Stable Families;
Agency: HHS;
Division: Administration for Children and Families;
Purpose: To prevent the unnecessary separation of children from their
families; improve the quality of care and services to children and
their families; and ensure permanence for children by reuniting them
with their parents, by adoption or by another permanent living
arrangement.
Grant name: Family Violence Prevention and Services/Grants for
Battered Women's Shelters;
Agency: HHS;
Division: Administration for Children and Families;
Purpose: To support intervention and prevention of domestic violence.
Grant name: Block Grants for Community Mental Health Services;
Agency: HHS;
Division: Substance Abuse and Mental Health Services Administration;
Purpose: To enable states to provide comprehensive community mental
health services.
Grant name: Block Grants for Prevention and Treatment of Substance
Abuse;
Agency: HHS;
Division: Substance Abuse and Mental Health Services Administration;
Purpose: To support the development and implementation of prevention,
treatment, and rehabilitation activities related to alcohol and drug
abuse.
Grant name: Emergency Shelter Grants;
Agency: HUD;
Division: Office of Community Planning and Development;
Purpose: To provide homeless persons with basic shelter and essential
supportive services.
Grant name: Housing Opportunities for Persons with AIDS;
Agency: HUD;
Division: Office of Community Planning and Development;
Purpose: To provide housing assistance and supportive services to
persons with AIDS.
Source: GAO analysis of HHS and HUD information.
[End of table]
Second, we selected three states for our case study--Louisiana,
Maryland, and Wisconsin--as well as local governments within those
three states, as appropriate. As part of our criteria for selecting
states, we considered the following:
* Levels of HHS and HUD funding: We included states that receive
varying levels of HHS and HUD funding to observe how indirect cost
funding needs may be related to the amount of grant funding received
by a state.
* Population: We included states with different population sizes to
allow us to examine potential implications for states that need to
provide services to larger numbers of persons.
* Geographic dispersion: We included states that were geographically
dispersed to allow for regional representation across the country and
diversity with respect to the population receiving services; the
economic climate of the area; and other regional, cultural, and
demographic characteristics.
Third, we selected 17 501(c)(3) nonprofit organizations from
Louisiana, Maryland, and Wisconsin that receive at least one of the
six grants we selected. 501(c)(3) organizations are public charities
that are eligible to receive federal funding to support their missions
of providing for the public benefit. The nonprofits we selected had
varying missions and represented a wide range of operating budgets,
from less than $1 million to more than $25 million.
Once we selected our case study grants, states, and nonprofits, we
reviewed Office of Management and Budget (OMB), HHS, and HUD
documents, guidance, and policies governing the treatment of indirect
costs, and interviewed budget and program officials at the three
agencies. Further, we reviewed documents, guidance, and policies
governing the treatment of indirect costs from the selected states,
local governments, and nonprofits. We also interviewed budget and
program officials from state and local government entities as well as
from nonprofit organizations.
To further corroborate the information obtained from our case studies,
we reviewed existing research related to nonprofits' indirect costs
and overall financial health. We used several search strategies to
identify existing studies. Through snowball sampling techniques, we
identified research and received study referrals from numerous
nonprofit researchers and other nonprofit groups. We conducted
searches of several automated databases, including Checkpoint, the
Government Printing Office's Catalog, ProQuest, Lexis Nexis, Academic
OneFile, and FirstSearch. We also searched the OMB website,
Congressional Research Service website, and the Federal Audit
Clearinghouse. We searched on various combinations of the following
terms: nonprofit, indirect cost, administrative cost, cost, overhead
funding, nonprofit funding, overhead, administrative, pass through,
grant, grantee, federal, fund, gap, and trade-offs. Finally, search
results were limited to studies published after 1995. Through our
referrals and literature searches, we identified eight studies and
reports that were relevant to our work. We reviewed the studies we
included in our work to ensure that they were methodologically sound.
[End of section]
Appendix II: GAO Contact and Staff Acknowledgments:
GAO Contact:
Stanley J. Czerwinski, (202) 512-6806 or czerwinskis@gao.gov:
Acknowledgments:
Jacqueline M. Nowicki (Assistant Director) and Sonya Phillips (Senior
Analyst-in-Charge) managed this assignment. Carol Patey, Christine
Hanson, Mary Koenen, and Barbara Lancaster made key contributions to
various aspects of the work. Cindy Gilbert provided methodological
assistance; Donna Miller developed the report's graphics; Sabrina
Streagle provided legal support; and Jessica Thomsen provided key
assistance with message development and writing.
[End of section]
Footnotes:
[1] A. Abramson, L. Salamon, and C. E. Steurle, "Federal Spending and
Tax Policies: Their Implications for the Nonprofit Sector," Nonprofits
and Government, 2nd Edition, eds. E. Boris and C. E. Steurle
(Washington, D.C.: The Urban Institute Press, 2006), p. 118.
[2] Congressional Research Service, An Overview of the Nonprofit
Charitable Sector, R40919 (Washington, D.C.: Nov. 17, 2009).
[3] GAO, Nonprofit Sector: Increasing Numbers and Key Role in
Delivering Federal Services, [hyperlink,
http://www.gao.gov/products/GAO-07-1084T] (Washington, D.C.: July 24,
2007).
[4] Pub. L. No. 111-13 (2009).
[5] Pub. L. No. 111-5 (2009).
[6] S. 609, 111th Cong. (1st Sess. 2009).
[7] [hyperlink, http://www.gao.gov/products/GAO-07-1084T], and GAO,
Nonprofit Sector: Significant Federal Funds Reach the Sector through
Various Mechanisms, but More Complete and Reliable Funding Data Are
Needed, [hyperlink, http://www.gao.gov/products/GAO-09-193]
(Washington, D.C.: Feb. 26, 2009).
[8] The Homeless Emergency Assistance and Rapid Transition to Housing
Act of 2009 changed the name of this program from the Emergency
Shelter Grants to the Emergency Solution Grants effective November 20,
2010, or 3 months after the Secretary of Housing and Urban Development
issues final regulations implementing the act. Pub. L. No. 111-22
(2009).
[9] Federal grant funding may also be awarded to nonprofit subgrantees
through contracts.
[10] OMB Circular A-87, Cost Principles for State, Local, and Indian
Tribal Governments (2 CFR Part 225), and OMB Circular A-122, Cost
Principles for Non-Profit Organizations (2 CFR Part 230).
[11] OMB Circular A-133, Audits of States, Local Governments, and Non-
Profit Organizations.
[12] The other four eligible activities are renovation/rehabilitation
or conversion, social services, homeless prevention, and grant
administration.
[13] Nonprofit association officials also told us that some nonprofits
intentionally request no or low reimbursement for indirect costs to
show that they are operating efficiently and on a lean budget.
Further, they said that some nonprofits do not include their
accounting department, human resources department, or building
furnishings in their operating costs.
[14] GAO, Human Service Programs: Demonstration Projects Could
Identify Ways to Simplify Policies and Facilitate Technology
Enhancements to Reduce Administrative Costs, [hyperlink,
http://www.gao.gov/products/GAO-06-942] (Washington, D.C.: Sept. 19,
2006).
[15] GAO, Tax-Exempt Organizations: Improvement Possible in Public,
IRS, and State Oversight of Charities, [hyperlink,
http://www.gao.gov/products/GAO-02-526] (Washington, D.C.: Apr. 30,
2002).
[16] E. Keating, Reshaping the Overhead Debate: Getting to Mu (Hauser
Center on Nonprofit Organizations, Harvard University: 2007): p. 6.
Analysis for this report included synthesizing prior research,
convening nonprofit and foundation roundtables, and conducting
additional interviews with nonprofit executives.
[17] The report also noted that the confusion is not limited to
nonprofits' relationships with government entities. Some foundations
develop their own definitions of overhead for grant applications that
often mixes the concepts of indirect costs and administrative costs,
while others leave the definition unclear. A frustration voiced by
many was that fully funding efficient operations is made difficult by
the inconsistent definitions of overhead costs.
[18] Capacity-building grants are designed to supplement program
funding and support efforts to expand an organization's ability to
provide services.
[19] CRS, An Overview of the Nonprofit Charitable Sector.
[20] As previously discussed, nonprofits classify costs differently;
therefore, we lacked reliable data with which to confirm this gap.
[21] Management and general expenses as reported on the recipient
organizations' 2007 Internal Revenue Service (IRS) forms. IRS Form 990
is an annual reporting return that certain federally tax-exempt
organizations must file with IRS. It provides information on the
filing organization's mission, programs, and finances. IRS defines
management and general expenses as expenses that relate to the
organization's overall operations and management rather than to
fundraising activities or program services. Indirect costs are
generally equivalent to management and general expenses. Some
researchers have questioned the quality of IRS Form 990 data, as they
are self-reported.
[22] T. Pollack, P. Rooney, and M. Hager, Understanding Management and
General Expenses in Nonprofits (Urban Institute Center on Nonprofits
and Philanthropy and Indiana University Center on Philanthropy: 2001):
pp. 24-29. Researchers reported in a working paper that of the 19,786
health-related organizations in their study, the average management
and general expenses level was approximately 17 percent. Of the 43,988
human services organizations whose IRS Forms 990 were reviewed in that
study, the average management and general expenses level was
approximately 16 percent.
[23] W. Bedsworth, A. G. Gregory, and D. Howard, Nonprofits Overhead
Costs: Breaking the Vicious Cycle of Misleading Reporting, Unrealistic
Expectations, and Pressure to Conform (The Bridgespan Group, April
2008), pp. 4-7.
[24] DMA Health Strategies, Financial Health of Providers in the
Massachusetts Human Service System (Massachusetts: Commonwealth of
Massachusetts Executive Office of Health and Human Services, October
2007), pp. 1-2. This study consisted of providers who were recipients
of federal funds.
[25] W. Bedsworth, A.G. Gregory, and D. Howard, pp. 4-7.
[26] Fiscal Management Associates, Administrative Management Capacity
in Out-of-School Time Organizations: An Exploratory Study (New York:
The Wallace Foundation, December 2008), pp. 51-55.
[27] Fiscal Management Associates, pp. 1-6.
[28] Urban Institute Center on Nonprofits and Philanthropy and Indiana
University Center on Philanthropy, "Getting What We Pay For: Low
Overhead Limits Nonprofit Effectiveness" Nonprofit Overhead Cost
Project Brief No. 3 (2004), pp. 1-4. The Nonprofit Overhead Cost
Project is a study that had three phases: analysis of over 250,000 IRS
Forms 990, in-depth case studies of nine organizations, and 1,500
responses to a survey of U.S. nonprofits. The project defines overhead
costs as an organization's infrastructure, including accounting,
fundraising, information technology, human resources, physical plant,
and other common organizational elements that stand behind and support
a nonprofit's mission and program. The definition of overhead costs is
consistent with our definition of indirect costs.
[29] DMA Health Strategies, p. 2.
[30] Urban Institute Center on Nonprofits and Philanthropy and Indiana
University Center on Philanthropy, pp. 1-4.
[31] A. Blackwood and T.H. Pollak, "Washington-Area Nonprofit
Operating Reserves," The Urban Institute: Charting Civil Society No.
20 (July 2009): pp. 1-12.
[32] Fiscal Management Associates, pp. 18-20.
[33] DMA Health Strategies, pp. 14-15. Although the conclusions from
these studies are nongeneralizable and often include a small number of
cases, these reports illustrate how organizations can have trouble
covering near-term operating expenses, as well as replacing aging
infrastructure.
[34] CRS, An Overview of the Nonprofit Charitable Sector.
[35] GAO, Grants Management: Grantees' Concerns with Efforts to
Streamline and Simplify Processes, [hyperlink,
http://www.gao.gov/products/GAO-06-566] (Washington, D.C.: July 28,
2006).
[36] DMA Health Strategies, p. 21.
[37] P. Frumkin and M.T. Kim, The Effect of Government Funding on
Nonprofit Administrative Efficiency: An Empirical Test (Harvard
University: 2002), p. 6; S.R. Bernstein, Managing Contracted Services
in the Nonprofit Agency, 1st ed. (Philadelphia, PA: Temple University
Press, 1991), pp. 30-31; and K. Grønbjerg, Understanding Nonprofit
Funding, 1st ed. (San Francisco, CA: Jossey-Bass Publishers, 1993),
pp. 219-240.
[38] For more information on Recovery Act funds and related
administration challenges, see GAO, Recovery Act: One Year Later,
States' and Localities' Uses of Funds and Opportunities to Strengthen
Accountability, [hyperlink, http://www.gao.gov/products/GAO-10-437]
(Washington, D.C.: Mar. 3, 2010).
[39] [hyperlink, http://www.gao.gov/products/GAO-07-1084T].
[40] P. Frumkin and M.T. Kim, pp. 11-15. This study presented the
analysis of IRS Forms 990 from 1,172 nonprofit organizations from 1985
to 1995.
[41] Urban Institute Center on Nonprofits and Philanthropy and Indiana
University Center on Philanthropy, pp. 1-4.
[42] Results from nonprobability samples cannot be used to make
inferences about a population because in a nonprobability sample, some
elements of the population being studied have no chance or an unknown
chance of being selected as part of the sample.
[End of section]
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