In the seventh article in our 990 blog series, our advisors examine expenditure responsibility, a key requirement for private foundations making grants to certain organizations that are not public charities. Learn when expenditure responsibility applies, the steps foundations must take to monitor grants, and the reporting required on Form 990-PF.
Read our sixth blog to learn about political activity and lobbying compliance considerations for tax-exempt organizations.
Private foundations must ensure that their grants are used solely for charitable purposes. When a grant is made to an Internal Revenue Service-recognized 501(c)(3) public charity, this requirement is generally straightforward. Public charities are subject to their own compliance and reporting requirements, report directly to the government, and are monitored by the IRS to ensure they continue to meet tax-exempt rules.
However, private foundations may also seek to fund organizations that are not public charities to advance a specific charitable purpose. For example, a private foundation might provide a grant to a for-profit property management company to construct an affordable childcare facility within a low-income housing complex. In circumstances such as these, the private foundation may need to exercise “expenditure responsibility” to ensure that grant funds are used for their intended charitable purpose.
What is Expenditure Responsibility
Expenditure responsibility requires a private foundation to make all reasonable efforts and establish adequate procedures to:
- Ensure the grant is spent only for the purpose for which it was made;
- Obtain complete reports from the grantee on how the funds are spent; and
- Report the grant and related expenditures to the IRS.
Failure to satisfy these requirements can result in a taxable expenditure under Internal Revenue Code Section 4945, potentially exposing the foundation and certain managers to excise taxes.
When Is Expenditure Responsibility Required?
Expenditure responsibility is required when organizations grant to:
- Private non-operating foundations
- For-profit businesses
- Social Welfare organizations (section 501(c)(4))
- Trade associations (section 501(c)(6))
- A 509(a)(3) Type III supporting organization that isn’t functionally integrated.
- A 509(a)(3) Type III supporting organization that is functionally integrated but is controlled by a disqualified person.
When is Expenditure Responsibility Not Required?
Expenditure responsibility is not required when organizations grant to:
- A public charity
- An exempt private operating foundation
- Foreign charity that is the structural equivalent to a US 501(c)(2) organization
- Government entities
- Some supporting organizations (all Type I and II, but also Type III if it is functionally integrated and not controlled by a disqualified person)
How Does Expenditure Responsibility Work?
Expenditure responsibility requires four steps.
1. Pre-grant inquiry
- Obtain background on the organization to ensure that they are trustworthy to spend the funds for their intended charitable purpose.
2. Execute written agreement
- Defines the charitable purpose of the funds
- What the funds cannot be used for: any political, lobbying, or other non-charitable use
- Requirement to repay any unused funds
- Requirement to submit annual reports to the foundation
3. Annual reporting
- Collect annual reports from the grantee on how the funds are spent and how much remains
4. Information validation
- Report on 990-PF the details of the report, including:
- Name and address of grantee organization
- Date of the grant
- Charitable purpose
- Amount spent to date
- Affirmative statement that the grantee has complied with the agreement and that no funds have been diverted for non-charitable purposes.
Key Takeaways
Expenditure responsibility allows private foundations to support charitable projects beyond traditional public-charity grantmaking. However, the flexibility comes with additional oversight, documentation, monitoring, and Form 990-PF reporting requirements.
Before funding a grant to a nonpublic charity recipient, foundations should determine whether expenditure responsibility applies and establish the procedures needed to administer the grant from start to finish.
If you are considering a grant that may require expenditure responsibility, contact a member of RKL’s Nonprofit Tax Team. We are here to help.
