Expenditure responsibilities

What Is Expenditure Responsibilities?

Expenditure responsibilities represent a crucial set of legal and procedural requirements within the realm of [Philanthropic Finance and Tax Compliance]. Specifically, they refer to the federally mandated oversight procedures that a private foundation (and, in some cases, other entities like donor-advised funds) must undertake when making a grant to an organization that is not a recognized public charity under U.S. tax law. This framework ensures that grant funds are used exclusively for charitable purposes, preventing potential misuse or diversion of funds. [Expenditure responsibilities] require the granting organization to exert all reasonable efforts to see that the grant is spent solely for its intended purpose, obtain comprehensive reports from the recipient (grantee) on how the funds are utilized, and report these expenditures in detail to the Internal Revenue Service (IRS).²⁶,²⁵

History and Origin

The concept of expenditure responsibilities originated from significant reforms to U.S. [tax laws] in the mid-22nd century. Prior to the Tax Reform Act of 1969, private charitable organizations were not clearly differentiated in the Internal Revenue Code, and concerns arose regarding potential abuses where wealthy individuals or families might use closely held foundations to shield assets from taxation or serve private interests rather than public good.²⁴,²³

To address these concerns and enhance accountability within the philanthropic sector, the Tax Reform Act of 1969 introduced a new framework that distinguished between public charities and private foundations, imposing stricter duties and obligations on the latter. One key reform was the introduction of rules against "taxable expenditures," which included certain grants made by private foundations without sufficient conditions or controls to ensure charitable use.²²,²¹ Congress mandated that private foundations must exercise "expenditure responsibility" for grants made to other private foundations or to organizations not classified as public charities. This required granting foundations to make reasonable efforts to monitor how funds were spent, obtain reports, and detail these expenditures to the IRS.²⁰ This landmark legislation aimed to ensure that tax-exempt funds truly served the public interest, a principle detailed further by resources like Learning to Give, which outlines the comprehensive changes brought by the act.¹⁹

Key Takeaways

• Mandatory Oversight: Expenditure responsibilities are a legally required set of procedures for private foundations making grants to organizations that are not U.S. public charities.
• Purpose-Driven Spending: The core objective is to ensure that grant funds are used solely for specific charitable purposes as outlined in the grant agreement.
• Documentation and Reporting: Strict due diligence, written agreements, grantee reporting, and grantor reporting to the IRS are essential components.
• Avoidance of Penalties: Proper exercise of expenditure responsibilities helps private foundations avoid excise tax penalties on "taxable expenditures."
• Broadened Grantmaking: These rules enable private foundations to engage in a wider scope of [grantmaking], including to international organizations or non-profit entities without 501(c)(3) status.

Interpreting Expenditure Responsibilities

Interpreting expenditure responsibilities involves understanding a multi-step process designed to ensure that charitable funds are properly used. The process generally begins with a thorough pre-grant inquiry by the granting foundation. This inquiry assesses the potential grantee's identity, history, experience, and capacity to use the funds for the specified charitable purposes.¹⁸,¹⁷ The goal is to establish a reasonable assurance that the grantee will utilize the grant as intended.

Following a satisfactory inquiry, a legally binding written grant agreement must be established between the foundation and the grantee. This agreement outlines the grant's charitable purpose, the terms of its use, requirements for financial record-keeping, and the grantee's commitment to submitting regular reports on fund utilization and progress toward the grant's objectives.¹⁶,¹⁵ Grantees are often required to segregate grant funds in a separate account to prevent commingling with non-charitable funds.¹⁴

Finally, the granting foundation must actively monitor the grantee's activities, review the submitted reports (which typically cover how funds were used, compliance, and progress), and make full and detailed reports on these expenditures to the IRS.¹³,¹² These reports are typically submitted on the foundation's annual IRS Form 990-PF until all grant funds are expended.¹¹

Hypothetical Example

Consider the "Altruistic Endeavors Foundation," a U.S. private foundation. They wish to provide a grant of $100,000 to "Global Green Initiatives," an emerging environmental advocacy group based in a foreign country that does not have a formal public charity designation from the IRS.

To meet its expenditure responsibilities, Altruistic Endeavors Foundation undertakes the following steps:

1. Pre-Grant Inquiry: They research Global Green Initiatives, reviewing their mission, governance structure, past projects, and available financial statements to assess their credibility and capacity to manage the grant. They confirm Global Green Initiatives has a history of successful environmental campaigns.
2. Written Grant Agreement: Altruistic Endeavors and Global Green Initiatives sign an agreement specifying that the $100,000 grant is solely for a tree-planting project in the Amazon rainforest. The agreement explicitly states that funds cannot be used for lobbying or political campaigns and that Global Green Initiatives must submit quarterly narrative and financial reports detailing expenditures and project progress until the grant is fully spent. The agreement also includes a clause for the repayment of any unspent or misused funds.
3. Grantee Reporting: Global Green Initiatives sends quarterly reports, detailing how funds were spent on saplings, labor, and transportation, along with photos and metrics of trees planted.
4. Grantor Reporting to IRS: Altruistic Endeavors Foundation includes a detailed report of this grant on its annual IRS Form 990-PF, summarizing the grant's purpose, amount, and status, along with the information received from Global Green Initiatives.

Through these steps, Altruistic Endeavors Foundation demonstrates its adherence to expenditure responsibilities, ensuring its charitable contributions are properly managed and reported.

Practical Applications

[Expenditure responsibilities] are broadly applicable in situations where private foundations aim to extend their philanthropic reach beyond conventionally recognized public charities. This includes, but is not limited to, grants to:

• International Organizations: U.S. private foundations frequently make grants to non-U.S. entities that do not have a U.S. tax-exempt designation. Expenditure responsibilities provide a compliant pathway for such international grantmaking, ensuring funds are used for charitable purposes even across borders.¹⁰
• Other Private Foundations: When one private foundation grants to another private foundation, expenditure responsibilities are typically required, unless the recipient foundation is an "exempt operating foundation."⁹,⁸
• Non-501(c)(3) Entities: Grants to organizations such as social welfare organizations (501(c)(4)), labor unions (501(c)(5)), or even for-profit entities for a specific charitable purpose necessitate the exercise of expenditure responsibilities.⁷,⁶ For example, a grant to a for-profit company for research on a new medical device that will be made available globally at an affordable price could be subject to these rules.

These procedures provide the necessary framework for foundations to support a diverse array of initiatives while maintaining compliance with U.S. [tax laws]. Organizations like CAF America offer guidance on how foundations can navigate these requirements to support a wide range of global causes.⁵

Limitations and Criticisms

While expenditure responsibilities are designed to ensure accountability and prevent the misuse of charitable funds, the process is not without its limitations and criticisms. One primary concern is the administrative burden it places on both the granting private foundation and the grantee. The requirement for extensive [due diligence], detailed written agreements, ongoing monitoring, and comprehensive reporting can be resource-intensive, particularly for smaller foundations with limited staff or for grantees in developing countries that may lack sophisticated accounting systems.⁴

Failure to properly exercise expenditure responsibilities can lead to significant penalties for the granting foundation. If a grant is deemed a "taxable expenditure" due to non-compliance (e.g., inadequate pre-grant inquiry, missing reports, or diversion of funds), the foundation may face an initial [excise tax] on the expenditure, and foundation managers who knowingly approved the non-compliant grant may also be subject to penalties.³,² This potential for substantial financial repercussions can sometimes deter foundations from making grants to organizations that require expenditure responsibilities, thereby limiting the scope of their charitable impact. Critics argue that the detailed nature of these regulations, while well-intentioned, can create a chilling effect on innovative or riskier [grantmaking] that might otherwise serve significant public good. Adler & Colvin provides a comprehensive look at some of the complex issues and challenges foundations face when implementing expenditure responsibilities.¹

Expenditure Responsibilities vs. Equivalency Determination

Expenditure responsibilities and equivalency determination are two distinct but related methods private foundations use to ensure grants to non-U.S. public charities comply with U.S. tax regulations.

• Expenditure Responsibilities (ER): This method focuses on the oversight and monitoring of how grant funds are used. The granting foundation actively tracks the use of funds, obtains regular reports from the grantee, and reports to the IRS. It's a proactive, ongoing process that holds the grantor responsible for ensuring the charitable use of funds. ER is often chosen when a foreign organization cannot easily be classified as a U.S. public charity, or when the grant is for a specific project.
• Equivalency Determination (ED): This method involves the granting foundation obtaining an opinion from qualified counsel (or utilizing an equivalency determination service) that the foreign organization is "equivalent" to a U.S. public charity. This determination typically involves an in-depth review of the foreign organization's legal structure, financial operations, and activities to confirm it meets the criteria of a U.S. public charity. If an ED is successfully obtained, the grant is treated as if it were made to a U.S. public charity, and the ongoing monitoring and reporting requirements of expenditure responsibilities are generally not required. ED essentially establishes the grantee's charitable status upfront, alleviating the ongoing burden of ER.

While ED can simplify future grants to the same organization, ER offers flexibility, especially for one-time or project-specific grants to entities that may not easily fit the ED criteria or for organizations where the time and cost of an ED are prohibitive.

FAQs

Q: What is the main goal of expenditure responsibilities?
A: The main goal of expenditure responsibilities is to ensure that grants made by private foundations to organizations that are not U.S. [public charities] are used solely for charitable purposes, as required by U.S. [tax laws]. This helps prevent tax abuses and ensures accountability in the philanthropic sector.

Q: Which types of organizations require a private foundation to exercise expenditure responsibilities?
A: Generally, a private foundation must exercise expenditure responsibilities when making grants to other [private foundations] (unless they are exempt operating foundations), foreign organizations not deemed equivalent to U.S. public charities, or other non-profit entities that are not recognized U.S. public charities (e.g., certain social welfare organizations) or even for-profit entities for charitable projects.

Q: What are the key steps involved in meeting expenditure responsibilities?
A: The key steps include conducting a pre-grant inquiry into the grantee's capabilities, establishing a written grant agreement with specific terms, requiring regular reports from the grantee on the use of funds and progress, and making detailed reports on these expenditures to the IRS on the foundation's annual [IRS Form 990-PF].

Q: Can a private foundation be penalized for failing to meet expenditure responsibilities?
A: Yes, if a private foundation fails to properly exercise expenditure responsibilities, the grant can be classified as a "taxable expenditure," leading to [excise tax] penalties on the foundation. Additionally, foundation managers who knowingly approve such non-compliant grants may also face personal penalties.

Q: Are expenditure responsibilities the same as seeking an equivalency determination?
A: No, they are different. [Expenditure responsibilities] involve ongoing monitoring and reporting for a specific grant, while an [equivalency determination] is a one-time process to ascertain if a foreign organization is equivalent to a U.S. public charity, which then typically negates the need for expenditure responsibilities for subsequent grants to that organization.