This is the third post in an ongoing series on private foundation issues. For the first post on self-dealing issues, click here, and for the post on mandatory payout requirements, click here.

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Making grants is often a main method for private, non-operating foundations to accomplish their charitable purpose. Our previous post, for example, highlighted how grants are one common way of meeting the annual distribution requirement. But there are some parameters around grant activity for foundations—grants for certain purposes are disallowed, and some grants may require a heightened due diligence called expenditure responsibility. This post will discuss grantmaking areas where heightened regulation is at play under section 4945, and how to steer your foundation clear of trouble.

What is a Taxable Expenditure? Prohibited expenditures and grants are called “taxable expenditures.” They include amounts paid for:

• A non-501(c)(3) purpose;
• Lobbying activity;
• Influencing the outcome of any public election or carry on any voter registration drive (subject to one narrow exception);
• Grants to an individual for travel, study or other similar purposes unless a specific process is followed (see below); and
• Grants to organizations other than most public charities (e.g., other private foundations, organizations exempt under a section other than 501(c)(3) and grants to for-profit entities), unless expenditure responsibility is used.

How Can Foundations Award Scholarships? Scholarships, certain prizes, and grants to achieve a specific result or enhance a skill are considered grants to individuals for travel, study or other similar purposes, and foundations must award them on an objective and nondiscriminatory basis, pursuant to a plan approved in advance by the IRS. That plan must include provisions on supervising the grants and monitoring performance; investigating  diverted funds; and retaining records.

Do All Grants to Individuals Require Advance IRS Approval? No, only the grants discussed above, for travel, study or other similar purposes, require advance approval. Other common types of grants to individuals, such as grants for disaster relief and grants to low-income individuals to alleviate suffering or distress, do not require IRS approval. In addition, prizes that are based purely on past achievement and that require no future activity on the part of the recipient do not require approval.

What About Grants to Public Charities that Lobby? A private foundation cannot earmark grant funds for lobbying. However, there are a couple of ways that a foundation can make grants to public charities that lobby without running afoul of the rules.

• General support grant: a grant won’t be considered earmarked for lobbying as long as there is not written or verbal understanding with the grantee that the grant funds will be used for lobbying. In other words, a grantee can use grant funds from a general support grant from a general for lobbying, unless the grant agreement expressly prohibits such use.
• Project grant: the grant will not be considered earmarked as long as (i) there is not written or verbal understanding with the grantee that the grant funds will be used for lobbying, and (ii) the foundation reasonably expects that the non-lobbying expenses will equal or exceed the grant amount. In other words, a grantee could technically use grant funds from a foundation’s project grant for lobbying, even if the entire project is funded from a combination of private foundation grants. But it first must make sure that the project’s non-lobbying expenditures exceed the amount of each foundation grant (considered separately, not in the aggregate).

What is Expenditure Responsibility? Essentially, it is an elevated grantmaking process. A foundation must exert reasonable efforts and establish adequate procedures to:

• See that grant funds are spent solely for grant purposes;
• Obtain full and detailed reports from the grantee on how grant funds are spent; and
• Make full and detailed reports to the IRS with respect to such grants.

In general, this means that private foundations must conduct a “pre-grant inquiry” for potential grantees; enter into a written grant agreement that meets certain requirements (e.g., requiring repayment of funds not properly used, maintaining financial records, submitting grant reports and not using funds for disallowed purposes); conduct oversight over the grant; report the grant on its Form 990-PF; and maintain certain records.

What About International Grants? Private foundations making grants to non-U.S. organizations must either follow expenditure responsibility, discussed above, or make an equivalency determination. The latter is a process by which the foundation determines that the grantee is the equivalent of a U.S. public charity, private operating foundation or exempt operating foundation. While many foundations historically have opted for expenditure responsibility over an equivalency determination, updated rules now make the determination process easier and could boost this type of activity. See our earlier post for more detail on this.

For questions on grantmaking activity or other private foundation issues, contact kschauble@leafferlaw.com or bseidel@leafferlaw.com.