Grants to individuals
In general, a grant to an individual for travel, study, or other similar purposes by such individual is considered a taxable expenditure.
The exception would be if the individual grant is awarded on an objective and nondiscriminatory basis pursuant to a procedure approved in advance and one or more of the following:
- The grant constitutes a scholarship or fellowship grant excluded from gross income under IRC Section 117(a) for study at an educational institution described in IRC Section 170(b)(1)(A)(ii)
- The grant constitutes a prize or award subject to the provisions of IRC Section 74(b) if the recipient of such prize or award is selected from the general public
- 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
How does a private foundation receive advance approval from the IRS?
As noted above, if a private foundation is beginning an individual grant program that provides scholarships, fellowships, educational loans, or other educational grants that weren’t described in its exemption application, it must request advance approval of its grant-making procedures from the IRS.
Advance approval is a one-time approval of the private foundation’s system of standards and procedures for awarding grants. Approval will apply to succeeding grant programs if the standards and procedures under which they are conducted don’t differ materially from those described in the organization’s initial request for advance approval.
To request advance approval, the private foundation should send a letter providing the information requested on Form 1023.
Pass-through grants
A private foundation could be subject to taxable expenditure taxes for donating to an organization that subsequently awards grants to individuals for travel or study. The regulations provide a safe harbor that allows a private foundation to make a grant of this nature if:
- The private foundation doesn’t earmark the grant for any specific person.
- There isn’t an oral or written agreement allowing the private foundation to cause the selection of a specific person.
In a grant given to a public charity, the private foundation could participate in the selection of an individual grantee to a limited extent, as long as:
- The public charity remains in control of the selection process.
- The grant is made for a project under the public charity’s supervision.
A private foundation can make a grant to a government agency and earmark its use to an individual if the agency gets advance approval from the IRS that its grant-making program does the following:
- Furthers a charitable purpose
- Requires the individual to submit reports to the agency
- Requires the agency to investigate any grants in jeopardy
Disaster relief payments
Beyond grants for scholarships and travel, private foundations can provide direct assistance to individuals in need of assistance — including those hit by a natural disaster or the COVID-19 pandemic — without triggering a taxable expenditure. This typically, but not always, comes in the form of support for individuals who need emergency assistance and disaster relief.
Examples include grants to individuals in need of food or shelter because of a natural disaster, grants to individuals who need short-term emergency assistance, or grants to individuals experiencing hardship caused by job loss, family illness, violent crime, or physical abuse.
Grants to other organizations
A taxable expenditure includes any amount paid or incurred by a private foundation as a grant to an organization, unless the grant is made to certain types of public charity organizations or the foundation exercises expenditure responsibility.
A private foundation need not exercise expenditure responsibility for grants made to the organizations that are described in Section 501(c)(3) and or the categories below:
- IRC Section 509(a)(1): Churches described in Section 170(b)(1)(A)(i), educational institutions described in Section 170(b)(1)(A)(ii), hospitals described in Section 170(b)(1)(A)(iii) Organizations supporting state colleges and universities described in Section 170(b)(1)(A)(iv), governmental units described in Section 170(c)(1), organizations publicly supported by the general public and governmental units described in Section 170(b)(1)(A)(vi), state schools described in Section 511(a)(2)(B), foreign government agencies, and international organizations listed in Executive Order under 22 U.S.C. 288
- Section 509(a)(2) organizations receiving more than one-third of their support from any combination of gifts, grants, contributions, membership fees, and gross receipts from permitted sources
- Section 509(a)(3) supporting organizations unless the supporting organization is a Type III non-functionally integrated organization
- Section 4940(d)(2) organizations which describe certain private exempt operating foundations
Expenditure responsibility
IRC section 4945(h) states the private foundation, “is responsible to exert all reasonable efforts to establish procedures: (1) to see that the grant is spent solely for the purpose for which it is made, (2) to obtain full and complete reports from the grantee on how the funds are spent, and (3) to make full and detailed reports available to the IRS.”
Treasury Regulations Section 53.4945-5(b) provides additional guidance on the steps, including the following:
- The private foundation must conduct a pre-grant inquiry.
- The private foundation must receive a written agreement containing certain terms of the grant.
- The private foundation must obtain certain reports from the grantees.
- The private foundation must properly report the expenditure responsibility grants to the IRS.
- The private foundation must take-action in recovering the grant if the grantee fails to comply with any of the aforementioned items.
Additional guidelines related to expenditure responsibility can be found in our article, 3 Steps of Grantmaking Due Diligence for Private Foundations.
Expenditures for noncharitable purposes
According to Treasury Regulation 53.4945-6(b)(2), unreasonable administrative expenses — such as compensation, consultant fees, or payment for other services — will result in a taxable expenditures unless the private foundation can demonstrate the expenses were “paid or incurred in the good faith belief they were reasonable,” and payment of these expenses was done with “ordinary business care and prudence.” Facts and circumstances of each case will determine if an expense is unreasonable.
Expenses that aren’t treated as taxable expenditures
The regulations list several types of expenses that aren’t treated as taxable expenditures, including:
- Expenses for investments to earn income that is used to further the foundation’s charitable purpose
- Taxes
- Any expenses that qualify as deductions in the computation of unrelated business income
- Any payment that constitutes a qualifying distribution or an allowable deduction under IRC Section 4940
- Reasonable expenses to evaluate, acquire, modify, or dispose of program-related investments
- Business expenses by the recipient of a program-related investment
