IRC Section 4945(g) Individual Grants

 

IRC Section 4945(g) states Subsection (d)(3) shouldn’t apply to an individual grant awarded on an objective and nondiscriminatory basis pursuant to a procedure approved in advance by the Secretary, if it is demonstrated to the satisfaction of the Secretary that the grant constitutes a scholarship or fellowship grant, the grant constitutes a prize or award or the purpose of the grant is to achieve a specific objective, produce a report or other similar product, or improve or enhance a literary, artistic, musical, scientific, teaching, or other similar capacity, skill, or talent of the grantee.

IRC Section and Treas. Regulation

  • IRC Section 4945(g) Individual grants
  • IRC Section 4945(g)(1) The grant constitutes a scholarship or fellowship grant.
  • IRC Section 4945(g)(2) The grant constitutes a prize or award
  • IRC Section 4945(g)(3) The purpose of the grant
  • Treas. Reg. Section 53.4945-4(a)(1) Grants to individuals
  • Treas. Reg. Section 53.4945-4(a)(2) Grants defined
  • Treas. Reg. Section 53.4945-4(a)(3) Requirements for individual grants
  • Treas. Reg. Section 53.4945-4(a)(4) Certain designated grants
  • Treas. Reg. Section 53.4945-4(a)(5) Earmarked grants to individuals
  • Treas. Reg. Section 53.4945-4(b)(1) Selection of grantees on “an objective and nondiscriminatory basis”

Resources (Court Cases, Chief Counsel Advice, Revenue Rulings, Internal Resources)

Rev. Rul. 76-60, 1976-2 CB 371 - An unconditional and unrestricted grant by a private foundation to the winner of a competition conducted among students attending schools specializing in teaching a special craft is not a taxable expenditure within the meaning of Section 4945(d); Rev. Rul. 75-393 modified.

Rev. Rul. 77-360, 1977-2 CB 418 - Grants made by a private foundation primarily in recognition of past achievement, with the funds being unrestricted, or earmarked for subsequent travel or study and meeting the requirements of Section 4945(g) aren’t taxable expenditures within the meaning of Section 4945.

Rev. Rul. 81-46, 1981-1 CB 514 - A private foundation submitted a request for approval of its grant-making procedures to the IRS, didn’t receive a reply within 45 days, and considered the procedures to be approved under Treas. Reg. Section 53.4945-4 (d) (3). Later, the IRS notified the foundation that its grant-making program didn’t conform to the requirements of Section 4945(g). After receipt of the disapproval notification, the remaining installments of fixed-sum grants awarded during the period the foundation's procedures were deemed approved aren’t taxable expenditures; however, the renewals of any grants awarded during such period are taxable expenditures.

Rev. Rul. 85-175, 1985-2 CB 276 - A private foundation trust that awards scholarships on a preferential basis to family members and relatives of the trust's grantor doesn’t award such scholarships on an objective and nondiscriminatory basis as required by Section 4945(g).

See Grants to Individuals.

Analysis

How does a private foundation establish exemption from the excise tax under Section 4945(g) for individual grants?

An excise tax is imposed on private foundations for failure to distribute income for charitable purposes. To avoid liability for this tax, a foundation must make qualifying distributions each year at least equal to the foundation's distributable amount. However, grants to individuals which are not taxable expenditures because made in accordance with the requirements of Section 4945(g) may result in the imposition of excise taxes under other provisions of Chapter 42.

Grants defined

Grants include, but aren’t limited to, such expenditures as scholarships, fellowships, internships, prizes and awards. See Treas. Reg. Section53.4945-4(a)(2). Grants also includes loans for Section170(c)(2) purposes and program related investments such as investments in small businesses in central cities or in businesses which assist in neighborhood renovation. Similarly, grants include such expenditures as payments to exempt organizations to be used in furtherance of such recipient organizations' exempt purposes whether or not such payments are solicited by such recipient organizations.

Grants don’t ordinarily include salaries or other compensation to employees. For example, grants don’t ordinarily include educational payments to employees which are includible in the employees' incomes. In addition, grants don’t ordinarily include payments (including consultants' fees and reimbursement for travel expenses such as transportation, board, and lodging) to persons for personal services in assisting a foundation in planning, evaluating or developing projects or areas of program activity by consulting, advising, or participating in conferences organized by the foundation.

Grants to individuals

Section 4945(d)(3) provides that the term “taxable expenditure” means any amount paid or incurred by a private foundation as a grant to an individual for travel, study, or other similar purposes by such individual, unless such grant satisfies certain requirements.  Those requirements include:

  • The grant is awarded on an objective and nondiscriminatory basis,
  • The grant is made pursuant to a procedure approved in advance by the Service, and
  • The grant constitutes a scholarship or fellowship grant which would be subject to the provisions of Section 117(a) and is to be used for study at an educational organization described in Section 170(b)(1)(A)(ii) (see Section 4945(g)(1)); or
  • The purpose of the grant is to achieve a specific objective, produce a report or other similar product, or improve or enhance a literary, artistic, musical, scientific, teaching, or other similar capacity, skill, or talent of the grantee. See Section 4945(g)(3).

First requirement - Objective and nondiscriminatory basis: The grant must be awarded in accordance with a program consistent with the foundation's exempt status and the allowance of deductions to individuals under Section170 for contributions to the granting foundation (Treas. Reg. Section 53.4945-4(b)(1). Also, Treas. Reg. Section 53.4945-4(b)(2) provides that selection of grantees on an objective and nondiscriminatory basis ordinarily requires that:

  • The group from which grantees are selected be chosen based on criteria reasonably related to the purposes of the grant;
  • The group must be sufficiently broad so that the giving of grants to members of such group would be considered to fulfill a purpose described in Section 170(c)(2)(B); and
  • The group must be sufficiently large to constitute a charitable class.

The criteria used in selecting grant recipients from the potential grantees should be related to the purpose of the grant. For example, proper criteria for selecting scholarship recipients might include:

  • Prior academic performance, performance on tests designed to measure ability and aptitude for college work, and
  • Recommendations from instructors, financial need, and the conclusions which the selection committee might draw from a personal interview as to the individual's motivation, character, ability, and potential. See Treas. Reg. Section 53.4945-4(b)(3).

Additionally, the selection committee should not be in a position to derive a private benefit, directly or indirectly, if certain potential grantees are selected over others. Treas. Reg. Section 53.4945-4(b)(4).

Example: Company employs 100,000 people of whom 1,000 are executives. The Company has organized the Company Foundation which, as its sole activity, provides annually 100 four-year college scholarships for children of Company's employees. Children of all employees (other than disqualified persons with respect to the foundation) who have worked for the Company for at least two years are eligible to apply for these scholarships. Average number of eligible applicants is 2,000 per year. The selection committee is made by three prominent educators, who have no connection with the Company, foundation or any of the employees of the Company. The selections are made based on prior academic performance, performance on certain tests designed to measure ability and aptitude for college work, and financial need. No disproportionate number of scholarships has been granted to relatives of executives of Company. Under these circumstances, the operation of the scholarship program by foundation: (1) Is consistent with the existence of the foundation's exempt status and with the allowance of deductions; (2) uses objective and nondiscriminatory criteria; and (3) uses an independent selection committee. See examples in Treas. Reg. Section 53.4945-4(b)(5).

Second requirement – Grant made pursuant to a procedure approved in advance:  Grants to individuals must be made pursuant to a procedure approved in advanced.  The foundation must demonstrate that:

  • Its grant procedure includes an objective and nondiscriminatory selection process;
  • Such procedure is reasonably calculated to result in performance by the grantees of the activities that the grants are intended to finance; and
  • The foundation plans to obtain reports to determine whether the grantees have performed the activities that the grants in are intended to finance.

No single procedure or set of procedures is required. Procedures may vary depending upon such factors as the size of the foundation, the amount and purpose of the grants and whether one or more recipients are involved. Treas. Reg. Section 53.4945-4(c)(1). Requests for approval of grant-making procedures should be sent to EO Determinations, using Form 8940. See the Instructions to Form 8940 for more information.

Third requirement – Grant constitutes a scholarship or fellowship grant which would be subject to the provisions of Section 117(a) and is to be used for study at an educational organization described in Section 170(b)(1)(A)(ii): Section 117(a) provides that gross income doesn’t include any amount received as a qualified scholarship by an individual who’s a candidate for a degree at an educational organization described in Section 170(b)(1)(A)(ii). Educational organizations described in Section 170(b)(1)(A)(ii) maintain a regular faculty and curriculum and normally have a regularly enrolled body of pupils or students in attendance at the place where their educational activities are regularly carried on.

Fourth requirement - Purpose of the grant: The grant’s purpose is to achieve a specific objective, produce a report or other similar product, or improve or enhance a literary, artistic, musical, scientific, teaching, or other similar capacity, skill, or talent of the grantee.

Certain designated grants

A grant by a private foundation to another organization, which the grantee organization uses to make payments to an individual for travel, study, or other similar purposes by such individual, shall not be regarded as a grant by the private foundation to the individual grantee if the foundation doesn’t earmark the use of the grant for any named individual and there doesn’t exist an agreement, oral or written, whereby such grantor foundation may cause the selection of the individual grantee by the grantee organization.

A grant described herein shall not be regarded as a grant by the foundation to an individual grantee even though such foundation has reason to believe that certain individuals would derive benefits from such grant so long as the grantee organization exercises control, in fact, over the selection process and actually makes the selection completely independently of the private foundation. See Treas. Reg. Section 53.4945-4(a)(4).

Earmarked grants to individuals

A grant by a private foundation to an individual for travel, study, or other similar purposes by such individual, is a taxable expenditure by such foundation only if:

  • The grant is earmarked to be used for any activity described in Section 4945(d) (1), (2), or (5) or is earmarked to be used in a manner which would violate Section 4945(d) (3) or (4),
  • There is an agreement, oral or written, whereby such grantor foundation may cause the grantee to engage in any such prohibited activity and such grant is in fact used in a manner which violates Section 4945(d), or
  • The grant is made for a purpose other than a purpose described in Section170(c)(2)(B).

A grant by a private foundation is earmarked if such grant is given pursuant to an agreement, oral or written, that the grant will be used for specific purposes.  See Treas. Reg. Section 53.4945-4(a)(5).

Issue Indicators or Audit Tips

Examine to see if the foundation, if it makes grants to individuals for travel, study, or other similar purposes, submitted the Form 8940 to request approval of its grant-making procedures. (Requests for advance approval may be made either as part of an exemption application or by separate ruling request).

Determine if the person or group of persons who select recipients of the grant can derive a private benefit, either directly or indirectly, if certain potential grantees are selected over others?

Determine if the four requirements of grants to individuals were followed.

Determine if the organizations approved grant-making procedures were followed.

Determine if the grant recipients are related to any foundation disqualified persons.

Review (sample) the files of grant recipients and those denied grants to ensure the grants were made in a non-discriminatory basis, and the grant process was adhered to.

Determine if the foundation has monitoring procedures to ensure the grant proceeds are being used in furtherance of the purposes for which it was originally granted.