Common Grant Compliance Mistakes LSC-Funded Legal Services Nonprofits Make

Legal Services Corporation compliance failures rarely come as a surprise to the auditors who find them. The same issues appear across grantee audits year after year: timekeeping gaps, fund balance oversights, cost allocation methods that don’t hold up under scrutiny and internal controls that exist on paper but not in practice. The organizations that avoid these findings aren’t operating under different rules. They’ve built systems that make compliance a function of how they operate, not something they reconstruct before each audit cycle.

Treating Timekeeping as an Administrative Task

Compliance findings don’t just create additional audit work. They can delay funding, increase oversight and consume staff time that should be spent serving clients. The most common finding across Legal Services Corporation (LSC) grantee audits is timekeeping. The August 2025 LSC OIG quality control review findings identified timekeeping deficiencies in 24% of the 34 grantee audits reviewed, covering inadequate timesheet samples and missing certifications for part-time employees.

The underlying problem is almost always the same. Organizations treat timekeeping as a payroll function rather than a compliance function. Timesheets get completed on approximate schedules, reviewed informally and filed without the reconciliation to labor cost distribution reports that 45 CFR Part 1635 and the LSC Financial Guide require. When the auditor tests the sample, the records don’t show what the regulation asks them to show.

The fix isn’t complicated. It requires a documented system, clear responsibility for review and completion, a quarterly certification process for part-time employees and an annual reconciliation before final fund allocation entries are made. What it requires most is treating it as a year-round obligation rather than a year-end cleanup.

Misclassifying Direct and Indirect Costs

Charging the wrong costs to the LSC grant is one of the most direct paths to questioned costs. LSC Program Letter 24-4, issued by LSC’s Office of Compliance and Enforcement in November 2024, identifies cost classification as among the most common issues observed during compliance oversight visits.

The Lone Star Legal Aid audit from March 2025 illustrates the problem in concrete terms. The OIG identified $438,032 in questioned costs due to improper documentation and noncompliance with disaster grant requirements, finding that costs charged to LSC disaster grants were either unsupported or didn’t meet allowability requirements under the LSC Financial Guide.

Leave and holiday costs are generally treated as indirect costs and should be allocated through the indirect cost pool rather than charged directly to a specific grant unless applicable guidance allows otherwise. Organizations that haven’t drawn a clear line between what qualifies as a direct cost and what doesn’t, and documented that line in their cost allocation policies, create conditions for exactly this kind of finding.

Using Undocumented or Inconsistent Allocation Methods

Cost allocation methodologies that aren’t written down can’t be consistently applied, and methodologies that change without explanation signal to auditors that costs are being managed rather than measured. The LSC Financial Guide requires that allocation bases be cost-driven, meaning they must measure the actual benefit provided to each funding source. Budgeted amounts and percentage of revenue are explicitly not allowable.

The practical failure usually looks like this: an organization allocates shared costs using one approach at the start of the year, adjusts mid-year for operational reasons and never documents the change. The annual reconciliation then doesn’t match the methodology in the policy. The auditor finds the inconsistency and it becomes a control deficiency.

Documenting the methodology, applying it consistently and updating the written policy when circumstances genuinely change is the standard. It’s also where discipline tends to slip first when staff capacity is stretched and the next audit cycle feels distant.

Overlooking Fund Balance Carryover Limits

LSC grantees may carry over up to 10% of their Basic Field Grant award to the following fiscal year without LSC approval. Amounts exceeding that threshold require a formal waiver request submitted within 30 days of the audit report submission. Missing the window requires repayment.

The QCR findings noted fund balance deficiencies in 18% of reviews. In most cases the issue wasn’t that organizations had excess carryovers. It was that neither the organization nor the auditor had calculated the prior-year fund balance or confirmed that controls were in place to identify when a waiver would be needed. The carryover limit is a straightforward calculation, but it only works as a control if someone is running it before the fiscal year closes, not after the audit begins.

Weak Internal Controls That Don’t Match the Policy

LSC Program Letter 24-4 specifically notes internal control weaknesses as a recurring theme in OCE oversight visits. The recurring version of this finding isn’t an absence of policy. It’s a gap between what the policy says and what actually happens.

An organization might have a written procurement policy that requires competitive bids above a certain threshold. In practice, the threshold gets applied inconsistently. Or a journal entry approval policy requires dual review, but the review step gets skipped when volume is high or staff is short. When the auditor tests transactions against policy, the deviations become findings.

Internal controls work when they’re designed to function under normal operational conditions, including staff turnover, compressed timelines and competing priorities. Policies that depend on ideal circumstances aren’t functioning controls.

Ignoring the Corrective Action Timeline

When an audit does identify findings, the response timeline is tight. Grantees must submit a corrective action plan to LSC within 30 days of the audit report submission. Organizations that treat the audit as the end of the process rather than the beginning of the remediation work frequently miss that window or submit plans that don’t address the root cause of the finding.

A corrective action plan that describes what happened without explaining what will prevent it from happening again doesn’t satisfy the requirement. LSC management reviews these plans and refers unresolved findings to enforcement. The 30-day deadline is real, and meeting it with a substantive response requires that the finance and program teams understand the finding and have a credible plan before the clock starts.

Build Compliance Into Operations, Not Onto Them

The organizations that accumulate findings aren’t making different mistakes than compliant ones. They’re missing the infrastructure that makes compliance routine: documented policies that reflect actual practice, timekeeping systems with clear ownership, cost allocation methods applied consistently and fund balance monitoring built into the monthly close. Successful compliance isn’t about preparing for an audit every few years. It’s about creating financial systems that produce audit-ready documentation every day.

James Moore’s nonprofit accounting team works with LSC-funded legal aid organizations on the compliance systems, cost allocation frameworks and audit preparation practices that keep findings from recurring. Contact us when you want an outside assessment of where your current systems stand.

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