Private foundations in the United States are often interested in funding promising organizations and projects that are based outside of the country. When doing so, these foundations are required to follow certain rules and procedures promulgated by the IRS to help ensure that the foreign grantees are properly using those funds for charitable purposes. Currently, when a private foundation engages in international grantmaking, it has two options for complying with these rules: exercising expenditure responsibility or conducting an equivalency determination.
What is Expenditure Responsibility?
Expenditure responsibility (also referred to colloquially as “ER”) means that the foundation exerts all reasonable efforts and establishes adequate procedures:
- To take certain precautions to ensure that the grant funds will be spent for proper purposes (in connection with this requirement the foundation must conduct a pre-grant inquiry concerning potential grantees and make all its grants subject to a certain type of written grant agreement with the grantee);
- To obtain full and complete reports from the grantee on how the funds are spent; and
- To make full and detailed reports to the IRS on the expenditures.
When is an Expenditure Responsibility Required?
ER is generally required whenever a private foundation makes a grant to an organization other than (i) a public charity described by Internal Revenue Code (IRC) §509(a)(1) or (2); (ii) a public charity described by IRC §509(a)(3) – or supporting organization – other than a non-functionally integrated Type III supporting organization; and (iii) an exempt operating foundation described in IRC §4940(d)(2), which has been publicly supported for at least 10 years. Accordingly, ER is required when a private foundation makes a grant to:
- a foreign nongovernmental organization (NGO), unless an equivalency determination is conducted;
- a private foundation (other than an exempt operating foundation);
- a 501(c)(4) social welfare organization, 501(c)(5) labor union, or 501(c)(6) business league; or
- a non-tax exempt (for-profit) business (for exclusively charitable purposes).
The pre-grant inquiry should concern itself with matters such as:
- the identity, prior history, and experience of the grantee and its managers; and
- whether the grantee has a history of compliance or noncompliance with the terms of previous grants, and any knowledge concerning the management, activities, and practices of the grantee.
The scope of the pre-grant inquiry will vary in each case depending on —
- the size and purpose of the grant;
- the period over which it will be paid; and
- any prior experience the grantor has had with the grantee.
The Internal Revenue Service Manual provides that “[o]rdinarily, no further pre-grant inquiry is necessary where a grantee has properly used all prior grants and filed the required reports.”
The grant agreement for an ER grant must include the following:
- the grant purposes, which can include contributing to capital endowment, purchase of capital equipment, specific program or series of programs, or general support of the grantee, provided that neither the grants nor the income thereof may be used for a non-501(c)(3) purpose or for testing for public safety;
- a provision indicating that the grantee must repay any funds not used for grant purposes;
- a covenant that the grantee must submit annual reports on the use of funds (unless the grant is to a private foundation for endowment or other capital purposes, in which case other rules apply – see Treas. Reg. 53.4945-5(c)(2));
- a covenant requiring complete records of receipts and expenditures to be maintained, and made available to the grantor;
- a covenant not to use any funds (1) to influence legislation, (2) to influence the outcome of elections or carry on voter registration drives, (3) to make grants to individuals for travel, study, or other similar purposes by such individual, unless such grant satisfies the requirements of IRC §4945(g), (4) to make grants to other organizations except as provided in IRC 4945(d)(4) (it’s generally okay for the grantee to regrant to any organizations the private foundation can grant to, subject to the same conditions), or (5) to undertake any activity for any purpose other than a 501(c)(3) purpose (but not for testing for public safety).
Reports from Grantee
Reports from the grantee must be required annually and after all the grant funds have been expended (though an annual report may suffice as a final report if the grant funds are fully expended in a single year). Such reports should address the following:
- the use of the funds;
- compliance with the terms of the grant; and
- the progress made by the grantee toward achieving the purposes for which the grant was made.
Reports to the IRS
Reports to the IRS from the grantor (made in its Forms 990-PF) must include the following information:
- The name and address of the grantee;
- The date and amount of the grant;
- The purpose of the grant;
- The amounts expended by the grantee (based upon the most recent report received from the grantee);
- Whether the grantee has diverted any portion of the funds (or the income therefrom in the case of an endowment grant) from the purpose of the grant (to the knowledge of the grantor);
- The dates of any reports received from the grantee; and
- The date and results of any verification of the grantee’s reports, but only if undertaken pursuant to and to the extent required because the grantor had reason to doubt the accuracy or reliability of such reports.
Grants to Organizations from Private Foundations: Is Expenditure Responsibility Required? – Council on Foundations
Office of Chief Counsel IRS Memorandum No. 200504031 – IRS
Expenditure Responsibility – A Primer & Ten Puzzling Problems – Adler & Colvin
IRC §4945 – Taxes on Taxable Expenditures
Treasury Reg. §53.4945-5 – Grants to Organizations