Functional expenses in nonprofit accounting are a way of sorting every dollar an organization spends according to the purpose it served, not just the type of cost it was. Instead of stopping at “salaries” or “rent,” functional reporting asks whether that spending advanced the mission, kept the organization running administratively, or helped bring in more money. Section 501(c)(3) and 501(c)(4) organizations must break their spending across all three functional columns when filing IRS Form 990. Other exempt organizations report totals and can choose whether to break them out further.1Internal Revenue Service. Instructions for Form 990 Return of Organization Exempt From Income Tax (2025)
The Three Functional Categories
Every nonprofit expense belongs in one of three buckets: program services, management and general, or fundraising. Together they form the backbone of Part IX on Form 990 and the expense presentation required under GAAP. How an organization splits its costs across these three categories shapes how donors, grant-makers, and regulators read its finances.
Program Services
Program service expenses cover the cost of doing what the organization exists to do. The IRS defines these as activities that further the organization’s exempt purposes.1Internal Revenue Service. Instructions for Form 990 Return of Organization Exempt From Income Tax (2025) For a homeless shelter, that means bedding, food, and staff who work directly with residents. For an environmental group, it might be field research supplies, travel to conservation sites, and salaries for scientists. The common thread is a direct connection between the expense and the charitable mission.
The ratio of program expenses to total expenses gets close attention from donors and watchdog groups. That attention makes the category tempting to overload, but auditors and the IRS look for documentation linking each expense to a specific program outcome.
Management and General
Management and general expenses are the overhead costs of keeping the organization running when they don’t directly deliver a program or bring in donations. The IRS describes these as expenses related to overall operations and management.1Internal Revenue Service. Instructions for Form 990 Return of Organization Exempt From Income Tax (2025) Accounting fees, general legal compliance, HR staff salaries, board meeting costs, and rent for executive office space typically land here.
One important nuance: the CEO’s salary doesn’t automatically belong under management and general. If the executive director spends part of their time directly overseeing programs or participating in fundraising, that portion of their compensation should be allocated to those categories instead. Only the share genuinely spent on general organizational oversight belongs here. This is where sloppy allocation shows up most often, and one of the first places an auditor will probe.
Fundraising
Fundraising expenses capture everything spent on bringing money in. Campaign mailers, donor database software, event logistics, and staff time spent writing grant proposals or calling prospective donors all count.1Internal Revenue Service. Instructions for Form 990 Return of Organization Exempt From Income Tax (2025) The line between this and management and general comes down to purpose: fundraising costs exist to generate revenue, not to run day-to-day operations.
Organizations that hire outside professional fundraising firms report those fees separately on Part IX, line 11e. If total payments to professional fundraisers exceed $15,000, the organization must answer “Yes” on Part IV, line 17 of Form 990, which triggers additional disclosure.2Internal Revenue Service. 2025 Instructions for Form 990 Return of Organization Exempt From Income Tax Outsized fundraising costs relative to dollars raised draw scrutiny from regulators and donors alike.
Natural Versus Functional Classification
Functional categories answer the question “what was this spending for?” Natural classification answers a different question: “what type of expense was this?” Natural categories are the familiar accounting line items like salaries, rent, utilities, insurance, and depreciation. FASB Accounting Standards Update 2016-14 requires nonprofits to report expenses by both functional and natural classification, either in a single combined statement or in two consecutive statements.3Financial Accounting Standards Board (FASB). Accounting Standards Update 2016-14 Presentation of Financial Statements of Not-for-Profit Entities
Form 990 Part IX mirrors this two-dimensional approach. Each row represents a natural expense type, and the columns split those amounts across program services, management and general, and fundraising. The form lists over twenty natural categories, including compensation for officers and key employees, other salaries, pension contributions, payroll taxes, legal fees, accounting fees, occupancy, travel, depreciation, and insurance.4Internal Revenue Service. Return of Organization Exempt From Income Tax If any single “other” line item exceeds 10% of total functional expenses, the organization must itemize it on Schedule O.5Internal Revenue Service. Instructions for Schedule O (Form 990)
Allocating Shared Costs
Most costs serve more than one function. Rent covers the building where programs run, where the finance team works, and where fundraising staff make calls. A single employee might spend Monday through Wednesday on program delivery and Thursday on donor outreach. FASB ASC 958 requires that these shared costs be divided among functional categories using a reasonable methodology, and the organization must disclose which methods it uses.6AICPA & CIMA. Functional Expense Schedule Best Practices for Not-for-Profits
The two most common allocation methods are square footage and time tracking. For facility costs like rent, utilities, and insurance, organizations measure how much floor space each function uses. If a program occupies 70% of the building, 70% of occupancy costs go to program services. For personnel costs, staff maintain timesheets recording hours spent on each functional area. An executive director who splits time among program oversight, board governance, and donor relations would have their salary distributed proportionally across all three categories.
The key word in the standard is “reasonable.” There is no single mandated formula, and the right approach depends on the organization’s structure. What matters is that the method is documented, applied consistently, and defensible under scrutiny. Auditors look for evidence that the organization thought carefully about the split rather than dumping everything into whichever column looked best.
Joint Costs for Combined Activities
A special allocation challenge arises when a single activity serves both fundraising and program purposes at once. A direct mail campaign that educates the public about a health issue while also soliciting donations is the classic example. Under ASC 958-720, organizations can allocate the costs of these combined activities across functional categories, but only if the activity passes three tests: purpose, audience, and content. All three must be met. If any one fails, the entire cost defaults to fundraising.
The purpose test asks whether the activity accomplishes a genuine program or management goal beyond raising money. A mailer that asks the reader to take a specific health action, like getting screened for a disease, meets this test. One that simply describes the cause to build sympathy before asking for a donation does not.
The audience test asks whether recipients were selected primarily for their likelihood to donate. If the mailing list consists of prior donors or people identified through wealth screening, the audience criterion fails, even when the content is educational.
The content test asks whether the material includes substantive program content that calls for specific action by the audience. Educational information that motivates someone to change behavior qualifies. A description of the problem that exists mainly to justify the fundraising ask does not.
Organizations that do allocate joint costs must disclose which activities involved joint costs, confirm the costs were allocated, and report both the total joint costs and the amounts assigned to each functional category. The financial incentive to shift fundraising costs into program services is obvious, which is why misapplied joint cost allocations are one of the fastest ways to draw auditor attention.
Donated Services
Volunteer labor keeps many nonprofits running, but most of it never shows up in the financial statements. Under GAAP, donated services get recorded as both revenue and expense only when they meet one of two conditions: the service creates or enhances a physical asset, such as a contractor building an addition to the office, or the service requires specialized skills that the organization would otherwise have to pay for. A lawyer providing free legal advice or a CPA donating audit services qualifies. General volunteers stuffing envelopes or serving meals do not.
When donated services do qualify for recognition, they get recorded at fair market value and then allocated across functional categories like any other expense. Pro bono legal work on a program-related matter goes to program services. Donated accounting services for the annual audit go to management and general. The allocation logic is the same whether the organization paid cash or received the service for free.
Where Functional Expenses Land on Form 990
Functional expense data gets reported in Part IX of IRS Form 990. The form uses a grid: rows for each natural expense type and four columns for total expenses, program services, management and general, and fundraising. Section 501(c)(3) and 501(c)(4) organizations must fill in all four columns. Other tax-exempt organizations filing Form 990 are required to complete only the total column, though they can voluntarily break out the functional columns as well.2Internal Revenue Service. 2025 Instructions for Form 990 Return of Organization Exempt From Income Tax
Smaller organizations may not need to deal with Part IX at all. Those with gross receipts under $200,000 and total assets under $500,000 can file the shorter Form 990-EZ, which does not require the same columnar functional expense breakdown.7Internal Revenue Service. 2025 Instructions for Form 990-EZ Organizations with gross receipts under $50,000 can file the even simpler Form 990-N (the e-Postcard), which asks for almost no financial detail. Some states require a full functional expense analysis regardless of federal filing thresholds, so smaller organizations should check state requirements before assuming the short form is enough.
Because Part IX is part of the public Form 990, functional allocation decisions are not just an internal accounting exercise. Donors, journalists, and grant-makers can see exactly how the organization divided its spending, and careless or aggressive allocations have a way of surfacing long after the return is filed.