IRC Section 4945(a) imposes an excise tax on private foundations if they make a “taxable expenditure.” IRC Section 4945(d)(4) provides a taxable expenditure includes “a grant to an organization unless” the grant is made to a public charity (except for non-functionally integrated supporting organizations) or private operating foundation or the foundation exercises expenditure responsibility with respect to such grants in accordance with Section 4945(h).
IRC Section 4945(h) provides that expenditure responsibility means that the private foundation is responsible to exert all reasonable efforts and to establish adequate procedures
- to see that the grant is spent solely for the purpose for which made;
- to obtain full and complete reports from the grantee on how the funds are spent; and
- to make full and detailed reports regarding the grants to the IRS.
This issue snapshot focuses on these expenditure responsibility requirements which are only triggered in circumstances of grants to certain organizations. If a grant to an organization is not subject to statutory expenditure responsibility, the grant must still meet the standards of Rev. Rul. 68-489. Grants to individuals have separate requirements regarding their treatment as taxable expenditures under Section 4945(g) and Rev. Rul. 56-304.
IRC Section and Treasury Regulation:
- IRC Section 4945, Taxes on taxable expenditures
- Treas. Reg. Section 53.4945-5, Grants to organizations
Resources (Court Cases, Chief Counsel Advice, Revenue Rulings, Internal Resources):
Mannheimer Charitable Trust v. Commissioner, 93 T.C. 35 found that a private foundation’s contributions to two other foundations were taxable expenditures by reason of its failure to exercise expenditure responsibility with respect to such contributions within any one of the three requirements of Section 4945(h).
Revenue Ruling 77-213 found that a private foundation failed to exercise expenditure responsibility within the meaning of Section 4945(h)(3) when it omitted a grant to an organization from its original annual information return.
Revenue Ruling 81-125 found that a grant for exclusively charitable purposes made by a private foundation to a wholly owned instrumentality of a political subdivision of a state is not a taxable expenditure under Section 4945(d)(4) even if the foundation does not exercise expenditure responsibility over the grant.
IRM 22.214.171.124.2.6, IRC 4945: Taxable Expenditures
IRM 126.96.36.199.5, Expenditure Responsibility
Grants made by private foundations to organizations are taxable expenditures, subject to initial and additional taxes as described in Sections 4945(a) and (b), unless the grants meet certain requirements or are made to certain types of organizations.
Grants made by private foundations to organizations will be considered taxable expenditures unless:
A. Such organization:
- is described in paragraph (1) or (2) of Section 509(a),
- is an organization described in Section 509(a)(3) (other than an organization described in clause (i) or (ii) of Section 4942(g)(4)(A), or
- is an exempt operating foundation, or
B. The private foundation exercises expenditure responsibility with respect to such grant in accordance with subsection (h).
See Section 4945(d)(4)
Expenditure responsibility - the private foundation is responsible to exert all reasonable efforts and to establish adequate procedures:
- to see that the grant is spent solely for the purpose for which made,
- to obtain full and complete reports from the grantee on how the funds are spent, and
- to make full and detailed reports with respect to such expenditures to the Secretary.
See Section 4945(h)
Grants to organizations described in Section 509(a)(1), such as publicly supported organizations described in Section 170(b)(1)(A)(vi), are not subject to expenditure responsibility. Generally, expenditure responsibility is triggered when a private foundation makes a grant to another private foundation, an exempt organization not described in Section 501(c)(3) such as a social welfare organization described in Section 501(c)(4), or a non-exempt organization such as an unincorporated association which does not have recognition from the IRS as a charitable organization.
Revenue Ruling 81-125 highlights a situation where a foundation provided a grant for charitable purposes to a wholly owned instrumentality of a political subdivision of a state. Because a grant to an instrumentality of a foreign government is treated as a grant to a Section 509(a)(1) organization (See Section 53.4945-5(a)(4)(iii)), for purposes of Section 4945(d)(4), the grant in this instance (to an instrumentality of a domestic political subdivision) should also be treated as a grant made to a Section 509(a)(1) organization. Accordingly, it was determined that the foundation was not required to exercise expenditure responsibility for this grant.
Expenditure Responsibility Requirements:
1. To see that the grant is spent solely for the purpose for which made: Before making a grant, a private foundation should conduct a limited inquiry (pre-grant inquiry) concerning the potential grantee which is complete enough to give a reasonable person assurance that the grantee will use the grant for the proper purposes. The inquiry should concern itself with matters such as:
- the identity, prior history, and experience (if any) of the grantee organization and its managers; and
- any knowledge which the private foundation has (based on prior experience or otherwise) of, or other information which is readily available concerning, the management, activities, and practices of the grantee organization.
The scope of the inquiry might be expected to vary from case to case depending upon the size and purpose of the grant, the period over which it is to be paid, and the prior experience which the grantor has had with respect to the capacity of the grantee to use the grant for the proper purposes. See Treas. Reg. Section 53.4945-5(b)(2)(i) for the complete statement of these rules and Section 53.4945-5(b)(2)(ii) for three examples of sufficient pre-grant inquiries.
Additionally, for each grant to an organization, the foundation must obtain a written commitment signed by an appropriate officer, director or trustee of the grantee organization. The written commitment must include agreement by the grantee:
- To repay any portion of the amount granted which is not used for the purposes of the grant;
- To submit full and complete annual reports on the manner in which the funds are spent and the progress made in accomplishing the purposes of the grant;
- To maintain records of receipts and expenditures and to make its books and records available to the grantor at reasonable times; and
- Not to use any of the funds:
- To carry on propaganda, or otherwise to attempt, to influence legislation (within the meaning of Section 4945(d)(1));
- To influence the outcome of any specific public election, or to carry on, directly or indirectly, any voter registration drive (within the meaning of Section 4945(d)(2));
- To make any grant which does not comply with the requirements of Section 4945(d)(3) or (4); or
- To undertake any activity for any purpose other than one specified in Section 170(c)(2)(B).
See Treas. Reg. Section 53.4945-5(b)(3).
In Mannheimer Charitable Trust v. Commissioner, 93 T.C. 35, the Tax Court held that the private foundation did not meet the written commitment requirement as the documents presented did not contain the commitments stated above as required by the regulations.
2. To obtain full and complete reports from the grantee on how the funds are spent: The granting private foundation shall require reports from the grantee on: (a) the use of the funds, (b) compliance with the terms of the grant, and (c) the progress made by the grantee toward achieving the purposes for which the grant was made.
Generally, the grantee must make such reports at the end of its annual accounting period within which the grant or any portion thereof is received.
See Treas. Reg. Section 53.4945-5(c). Special rules apply for capital endowment grants to exempt private foundations.
3. To make full and detailed reports with respect to such expenditures to the IRS: Treas. Reg. Section 53.4945(d)(2) requires that such reports include the following information:
- The name and address of grantee,
- The date and amount of grant,
- The purpose of the grant,
- The amounts expended by 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,
- The date and results of any verification of the grantee’s reports undertaken pursuant to and to the extent required under Section 53.4945-5(c)(1) by the grantor or by others at the direction of the grantor.
This information is reported on a private foundation’s Form 990-PF.
In addition to the above information, a granting foundation must maintain and make available to the IRS copies of each of the following items:
- Agreements covering each “expenditure responsibility” grant made during the taxable year.
- Reports received during the taxable year from each grantee on any “expenditure responsibility” grant, and
- Reports made by the grantor’s personnel or independent auditors of any audits or other investigations made during the taxable year with respect to any “expenditure responsibility” grant.
See Treas. Reg. Section 53.4945-5(d)(3)
In Revenue Ruling 77-123, a foundation failed to list on its original annual information return a grant to an organization not described in either Section 509(a)(1), (2) or (3) of the Code, but corrected the omission on an amended return filed after the due date. The ruling determined that the foundation failed to exercise the expenditure responsibility requirements of Section 4945(h)(3) with respect to the grant, and the grant is a taxable expenditure.
Failure to comply with any one of the three basic conditions of expenditure responsibility will cause the grant to be a taxable expenditure and subject to tax imposed by Section 4945(a)(1).
Grant funds diverted for improper purposes can meet expenditure responsibility requirements if reasonable and appropriate steps were taken by the granting foundation to recover lost funds and future payments were suspended.
See Treas. Reg. Section 53.4945-5(e)
Issue Indicators or Audit Tips
When examining the foundation, review all the expenditures and determine which expenditures constitute grants to organizations. If any of the grantee organizations are not organizations listed in Section 4945(d)(4)(A), then the grants are subject to expenditure responsibility in accordance with Section 4945(h). These grants must be reviewed in further detail to determine if all three conditions of expenditure responsibility are met.
See IRM 7.27.19, Taxable Expenditures of Private Foundations, which includes a discussion of grants to organizations and expenditure responsibility. Other helpful sections include those on pre-grant inquiries (188.8.131.52.6), grant agreements (184.108.40.206.7), the grantee reports (220.127.116.11.10), and the grantor reports (18.104.22.168.11).
If the grantor is unable to provide documentation to show they meet expenditure responsibility for applicable grants, propose the first-tier tax and request correction. See IRM 22.214.171.124.3, Correction, for a discussion of acceptable correction.