Navigating Expenditure Responsibility for Private Foundations
While the majority of grants from private foundations are directed towards public charities—entities that are recognized under IRS Section 509(a)(1)-(3)—there exists a significant opportunity to broaden the scope of their philanthropic giving. This can be achieved by making grants to non-charities, such as foreign organizations, social welfare organizations (501(c)(4)), labor and trade associations (501(c)(5) and 501(c)(6)), advocacy groups, and start-up non-profit organizations that may not yet have an IRS designation. Additionally, grants can be directed to for-profit businesses that engage in charitable activities, provided the foundation ensures the funds are used for the intended charitable purpose.
However, this expanded scope of grantmaking comes with its own set of challenges and responsibilities. When providing grants to organizations other than public charities, to ensure that the funds are used for genuine charitable purposes and to comply with legal requirements, private foundations must exercise what is known as expenditure responsibility. This term refers to a series of due diligence steps that safeguard the foundation’s assets and ensure that the grants are utilized appropriately.
While the detailed nature of this process can be a hassle, it is entirely doable even for smaller foundations with limited administrative resources. By adhering to these guidelines, foundations can confidently extend their support beyond the confines of traditional public charities, addressing unmet needs within various sectors.
Understanding Expenditure Responsibility
Expenditure responsibility (ER) is a legal requirement imposed on private foundations to ensure that their funds are used for charitable purposes and not for private gain. This responsibility is especially relevant when a private foundation makes grants to entities that are not U.S.-based public charities.
ER involves a set of steps that allows private foundations to make grants to nearly any U.S. or international entity for charitable purposes, provided they adhere to legal guidelines such as avoiding self-dealing and lobbying. The primary goal of ER is to ensure these grants are genuinely used for charitable purposes. Failure to adhere to ER requirements can result in excise taxes and other penalties.
Steps of Expenditure Responsibility
1. Pre-grant Inquiry
The first step in exercising expenditure responsibility is conducting a thorough pre-grant inquiry. This involves taking reasonable steps to investigate a potential grantee's ability and commitment to carrying out the proposed charitable activity. This due diligence helps ensure that the grantee has the necessary infrastructure, experience, and motivation to achieve the intended charitable outcomes. The inquiry might include reviewing the grantee's mission, financial stability, past performance, and governance structure.
2. Written Grant Agreement
Once the pre-grant inquiry is complete, the next step is to draft a written grant agreement. This document must clearly specify the charitable purposes of the grant and outline the expectations for both the grantor and the grantee. The agreement should include requirements for annual grant reports, the maintenance of sufficient records, and restrictions on lobbying or other prohibited activities. The clarity and detail of the grant agreement are crucial in ensuring that both parties understand their obligations and the intended use of the grant funds.
3. Segregation of Funds / Financial Precautions
To prevent the commingling of charitable and non-charitable funds, grantees are generally required to set up a separate account for the grant funds. This financial precaution helps ensure that the funds are used solely for the intended charitable purposes and not for any other activities. It also simplifies the tracking and reporting of the grant's financial status, both for the grantee and the grantor.
4. Grantee Reports and Grantor Recordkeeping
Active monitoring and thorough recordkeeping are vital components of expenditure responsibility. The foundation must actively monitor the grantee’s activities, which may include reviewing financial statements, assessing project outcomes, and in some cases site visits. The grantee is required to provide regular reports detailing the financial status of the grant and the progress made toward achieving the charitable purposes outlined in the grant agreement. These reports help the grantor verify that the funds are being used appropriately and that the project is on track. The grantor must keep these reports on file and maintain comprehensive records of all correspondence and documentation related to the grant. This ongoing oversight ensures accountability and provides an opportunity for the foundation to offer support and guidance to the grantee, enhancing the likelihood of successful project outcomes.
5. Reporting the Grant to the IRS
Transparency with the IRS is essential when exercising expenditure responsibility. Grants made under this provision must be reported on Form 990-PF in the year they are made and in each subsequent year they remain outstanding. The report should include detailed information about the grant recipient, the grant amount, the purpose of the grant, a description of the grant activities, and the current status of the grant. This reporting ensures compliance with IRS regulations and provides a clear record of the foundation's charitable activities.
Conclusion
Making grants to non-charities can significantly expand the impact of a private foundation, enabling it to support a broader range of organizations and initiatives. By diligently following the steps of expenditure responsibility, foundation managers can ensure that their grants are used effectively and in compliance with legal requirements. This process, though detailed, is manageable and can open new avenues for charitable giving, allowing private foundations to make a meaningful difference in diverse and innovative ways.
For more detailed guidance and specific examples of how to implement expenditure responsibility, managers are encouraged to consult with legal and other advisors who specialize in nonprofit and foundation law.
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