Understanding Donor Restricted Donations

A Guide for Ministry Leaders & Church Administration

Overview

When a donor gives money to a church and designates it for a specific purpose, that gift is legally classified as a Donor Restricted donation. This is not merely a church policy or a bookkeeping preference—it is a legal obligation under federal tax law and nonprofit accounting standards. Once a donation is restricted by the donor, the church is legally bound to use those funds only for the purpose the donor specified.

This article explains what donor restricted donations are, why they matter, the legal framework that governs them, and what steps your church needs to take to handle them properly.

In summary, the church can only accept donor restricted funds if a fund for that reason is already setup. Otherwise the church would need to either (1) Set up a fund to accept the donation or (2) Explain to the donor it will only be accepted as general donation but they will keep their wishes in mind. More below.

What Is a Donor Restricted Donation?

A Donor Restricted donation (sometimes called a "restricted gift" or "donor-restricted contribution") is any donation where the donor specifies that the funds must be used for a particular purpose. Common examples include gifts designated for:

• A building fund or capital campaign
• Missions or a specific missionary
• Youth ministry programs
• Benevolence or community outreach
• A scholarship fund
• Music or worship ministry
• Disaster relief efforts

The Legal Framework

Donor restricted donations are governed by a combination of federal tax law, state charitable trust law, and nonprofit accounting standards. Churches and nonprofits that fail to honor donor restrictions can face serious legal, financial, and tax consequences.

Internal Revenue Code (IRC)

IRC Section 501(c)(3) — Tax-Exempt Status

Churches and religious organizations are recognized as tax-exempt under IRC §501(c)(3). A condition of this status is that the organization must operate exclusively for its exempt purposes and manage its resources in accordance with its stated mission and donor intent. Misuse of restricted funds can constitute private inurement or private benefit (prohibited under §501(c)(3)), potentially jeopardizing the organization’s tax-exempt status.

IRC Section 170 — Charitable Contributions

IRC §170 governs the tax deductibility of charitable contributions. For a donor’s contribution to be tax-deductible, the gift must be made to a qualifying organization for a qualifying purpose. When a donor restricts a gift to a specific purpose, the tax deduction is based on the understanding that the funds will be used as designated. If the church diverts those funds to another purpose, the deduction may become invalid, and the church could be required to issue corrected donation receipts.

IRC Section 6113 & 6710 — Disclosure Requirements

Under IRC §§6113 and 6710, tax-exempt organizations face penalties for failing to properly disclose how contributions are used. If a church solicits funds for a specific purpose but uses them otherwise, this can trigger disclosure violations and associated penalties.

State Law: Charitable Trust Doctrine

In most U.S. states, a donor restricted gift creates a charitable trust or is governed by the Uniform Prudent Management of Institutional Funds Act (UPMIFA), adopted in some form by 49 states and the District of Columbia. Under UPMIFA and the charitable trust doctrine:

• The church serves as the trustee of the restricted funds.
• The church has a fiduciary duty to use the funds only for the purpose designated by the donor.
• Diverting restricted funds to another purpose without donor consent or court approval may constitute a breach of fiduciary duty.
• State attorneys general have the authority to investigate and take legal action against nonprofits that misuse restricted funds.

Nonprofit Accounting Standards (ASC 958)

The Financial Accounting Standards Board (FASB) established Accounting Standards Codification (ASC) Topic 958 (formerly SFAS 116 and 117), which governs how nonprofit organizations—including churches—must account for and report contributions. Under ASC 958:

• Contributions must be classified as either with donor restrictions or without donor restrictions.
• Donor restricted contributions must be tracked separately in the organization’s financial records.
• The organization must report how restricted funds were received, held, and released in its financial statements.
• Restrictions are considered satisfied (and funds "released") only when the stated purpose has been fulfilled or the specified time period has elapsed.

Why This Matters for Your Church

Understanding and properly managing donor restricted donations is critical for several reasons:

1. Legal Compliance

Your church has a legal obligation to use restricted funds for their intended purpose. Failure to do so can result in lawsuits, state attorney general investigations, loss of tax-exempt status, and personal liability for board members.

2. Donor Trust

Donors give restricted gifts because they trust the church to honor their wishes. Mishandling restricted donations—even unintentionally—can erode trust, reduce future giving, and damage the church’s reputation in the community.

3. Financial Integrity

Proper tracking of restricted funds ensures that your church’s financial statements are accurate and that leadership can make informed decisions based on the true availability of funds. Commingling restricted and unrestricted funds is a common cause of financial misstatements in churches.

4. Board & Leadership Accountability

Board members (elders, deacons, trustees) have a fiduciary duty to ensure restricted funds are managed properly. Individual board members can be held personally liable for approving the misuse of restricted donations.

The Church’s Responsibility: Accepting Donor Restricted Donations

Because of the legal obligations attached to donor restricted gifts, your church can only accept a donor restricted donation if the church has a Donor Restricted Fund already established for that specific purpose. This ensures that:

• Proper bookkeeping is in place to track incoming and outgoing transactions for that fund.
• The Board has reviewed and approved the fund’s purpose.
• Financial reports can accurately reflect the restricted balance.
• The church can demonstrate compliance if ever questioned.

How to check if a Donor Restricted Fund exists: In most cases, you can identify which Donor Restricted Funds have been established by looking at the drop-down list in your church’s giving app or online giving platform. If a fund appears in the drop-down, it has been set up and is ready to receive designated gifts.

What to Do When a Donor Wants to Give a Restricted Gift

If a donor wants to make a donation designated for a specific purpose and there is no existing Donor Restricted Fund for that purpose, one of two things must happen:

Restricted vs. Designated: Understanding the Difference

It is important to understand the distinction between a donor restricted gift and a board designated (sometimes called "internally designated") fund:

Frequently Asked Questions

Q: What if a donor writes a purpose on the memo line of a check?

If a donor writes a specific purpose on the memo line (e.g., “For youth camp”), this constitutes a donor restriction. The church must either deposit it into the corresponding restricted fund or contact the donor to discuss alternatives if no such fund exists.

Q: Can the Board vote to redirect restricted funds to another purpose?

Generally, no. The Board cannot unilaterally redirect donor restricted funds. To change the purpose of restricted funds, the church would typically need to: (1) obtain the donor’s written consent, or (2) petition a court under the cy-près doctrine if the original purpose has become impossible or impractical. Some states allow modification under UPMIFA for older, smaller funds.

Q: What if the restricted fund’s purpose has been fulfilled?

When a restricted fund’s purpose is achieved (e.g., the building project is completed), remaining funds are still restricted. The church should consult with the donors or seek legal guidance on how to handle the surplus. Common approaches include returning funds to donors, asking donors for permission to redirect, or applying the cy-près doctrine through the courts.

Q: Does this apply to small donations or only large ones?

The legal obligation applies to all donor restricted donations regardless of amount. A $25 gift designated for missions carries the same legal restriction as a $25,000 gift.

Q: How do I know which restricted funds our church already has?

Check the drop-down list in your church’s giving app or online giving platform. Funds listed there have been established and are set up with proper bookkeeping. You can also ask your church administrator or bookkeeper for a list of active restricted funds.

Q: What happens if our church accidentally spends restricted funds on something else?

This is a serious matter. The church should immediately take steps to restore the restricted fund balance from unrestricted funds, disclose the error to leadership and potentially to donors, and implement stronger internal controls. Depending on the amount and circumstances, legal counsel may be advisable.

Legal & Regulatory References

The following sources provide the legal basis for the information in this article:

Summary

Donor restricted donations are a serious legal and fiduciary matter. Every ministry leader, board member, and church administrator should understand that:

• Any donation given for a specific purpose is a Donor Restricted donation and is legally restricted for that purpose only.
• The church can only accept donor restricted gifts when a Donor Restricted Fund has been properly established for that purpose.
• If no fund exists, the Board must vote to create one (with proper bookkeeping) or the donor should be guided toward making a general, unrestricted donation with an advisory note.
• Check the giving app drop-down list to see which restricted funds are currently active.
• When in doubt, consult your church administrator, bookkeeper, or legal counsel.

Churches should consult with a qualified attorney or