What Are Expenditure Responsibility Requirements?

Expenditure responsibility is a set of procedures from the Internal Revenue Service (IRS) for private foundations. These rules are triggered when a foundation makes a grant to an organization that is not a registered public charity. The purpose of these rules is to ensure the foundation’s funds are used for the intended charitable activities, placing the legal responsibility on the foundation to track the proper use of its grant money. By following these steps, a private foundation can make grants to a wider range of entities while maintaining its tax-exempt status and avoiding penalties.

Determining When Expenditure Responsibility is Necessary

The requirement for a private foundation to exercise expenditure responsibility is determined by the grantee’s tax status. These procedures are mandatory when a foundation awards a grant to an entity that is not a 501(c)(3) public charity. This includes grants made to other private foundations, for-profit companies for a distinct charitable project, and foreign organizations that are not recognized as equivalent to a U.S. public charity. If an organization has its public charity status revoked by the IRS, any subsequent grants to it would also fall under these rules.

Conversely, certain grants are exempt from these oversight procedures. The most common exemption is for grants made to 501(c)(3) public charities, which are organizations that receive broad public support as described in Internal Revenue Code Section 509. Grants to federal, state, or local governmental units are also not subject to expenditure responsibility. Another exempt category is grants to “exempt operating foundations,” a specific type of private foundation that actively conducts its own charitable programs.

The Pre-Grant Inquiry

Before any funds are committed, a private foundation must conduct and document a thorough pre-grant inquiry of the potential grantee. This initial due diligence is a formal review intended to provide the foundation with reasonable assurance that the grantee is capable of performing the charitable work and managing the funds appropriately. The foundation must actively gather and assess specific information about the recipient organization.

The investigation should cover the grantee’s history, its experience in the relevant field, and the identities and qualifications of its key management personnel. A review of the grantee’s financial systems and internal controls is also required, as the foundation needs to be confident that the grantee can segregate and track the grant funds. This process also involves assessing the grantee’s general reputation and past performance. Foundations review items like organizing documents, financial statements, and current budgets to inform their inquiry.

Required Grant Agreement Provisions

Following a satisfactory pre-grant inquiry, the foundation must execute a legally binding grant agreement with the grantee. This written contract must contain specific provisions as required by Treasury Regulation 53.4945-5. The agreement must begin with a clear statement defining the charitable purpose of the grant, as it cannot be for general support unless the grantee is also a private foundation.

The contract must also include a commitment from the grantee to repay any portion of the funds not used for the specified purposes. The agreement must obligate the grantee to several terms, including:

• A prohibition on using funds for activities considered taxable expenditures, such as lobbying or participating in political campaigns.
• A commitment to maintain the grant funds in a separate account on its books for clear tracking.
• An obligation to submit comprehensive annual reports to the foundation.
• An agreement to make its records available for inspection by the grantor foundation.

Post-Grant Supervision and Reporting

Once the grant is active, the foundation’s responsibilities shift to ongoing supervision. The grantee is required to submit detailed reports to the grantor foundation at least once a year. These reports must provide a substantive update on the progress made toward the charitable goals and include a detailed financial accounting showing how the grant funds were spent. This reporting continues annually until all funds have been expended.

The grantor foundation has its own reporting obligation to the IRS and must disclose each expenditure responsibility grant on its annual tax return, Form 990-PF. For each grant, the foundation must list the grantee’s name and address, the date and amount of the grant, its charitable purpose, the amounts expended by the grantee, and the dates it received the required reports. This public disclosure provides transparency and demonstrates the foundation’s compliance.

Corrective Actions for Grant Diversions

If a foundation discovers that a grantee has misused funds or diverted them from their stated charitable purpose, it must take prompt action. The IRS requires the foundation to make reasonable efforts to recover the diverted funds. Failure to do so can result in the grant being classified as a taxable expenditure, leading to significant penalties for the foundation and its managers.

The first step is to investigate to confirm the nature and extent of the diversion. Once confirmed, the foundation must make a formal demand for the return of the misused funds and withhold any further grant payments until the issue is resolved. The foundation is also obligated to report the diversion to the IRS on its next Form 990-PF. This disclosure must detail the grant, the amount diverted, and the steps taken to recover the funds. Pursuing these corrective measures is necessary to show the foundation has met its oversight responsibilities.