Key Takeaways

• Private Foundations that make grants to foreign organizations must either follow the rules for expenditure responsibility or acquire an equivalency letter from an attorney or accountant.
  
• Expenditure responsibility requires that the Private Foundation enter into a written contract with the foreign grantee, that the grantee submit reports to the Private Foundation, and that the Private Foundation report on its grants to the IRS.
  
• An equivalency letter will allow a Private Foundation to avoid expenditure responsibility, but it is only an option if the foreign grantee actually is equivalent to a Public Charity.

Introduction

It is quite common for 501(c)(3) organizations, whether a Public Charity and Private Foundation, to make grants to organizations outside the United States. In fact, it’s common enough that the term “friends-of” came about as a word to describe those US-based organizations that devote their activities to supporting a non-US organization.

However, there are two main differences between how Charities and Private Foundations operate when making those grants.  Primarily, the difference is “expenditure responsibility.” Private Foundations are legally obligated to take certain measures before and after making a grant, and failure to do so could mean that the grant becomes taxable to the Foundation and its managers. Charities don’t have a similar obligation.

What is expenditure responsibility?

Private Foundations get taxed on, well, “taxable expenditures.” What isn’t a taxable expenditure? Grants to Public Charities!  As you might have guessed, non-US organizations might not have applied for 501(c)(3) status in the United States. So, there needs to be another way to grant to the organization without having that grant be taxable to the Private Foundation.

Expenditure responsibility is the IRS’s way of making sure that Private Foundations are keeping a watchful eye on the money they make grants to organizations that don’t have 501(c)(3) status. It isn’t specifically related to grants to non-US organizations, but it does apply all the same.

The IRS will not consider the grant a taxable expenditure if the Private Foundation agrees to:

1. See that the grant is spent solely for the purpose for which made;
2. Obtain full and complete reports from the grantee on how the funds are spent; and
3. Make full and detailed reports regarding the grants to the IRS.

To ensure that the grant is spent for the purposes for which it was made, the IRS requires that the Private Foundation investigate, at lease enough to ensure that the grantee (the non-US organization) will use the money for the purposes of the grant, and have a written agreement with them to:

1. Repay any portion of the amount granted which is not used for the purposes of the grant;
2. 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;
3. Maintain records of receipts and expenditures and to make its books and records available to the grantor at reasonable times; and
4. Not to use any of the funds to do something that the Private foundation couldn’t do directly.

The “full and complete annual reports” must inform the Private Foundation about the grantee’s use of the funds, compliance with the terms of the grant, and progress made toward achieving the purposes for which the grant was made. Apart from the reports the non-US organization gives to the Private Foundation, the Private Foundation must also report to the IRS on all expenditures that require the exercising expenditure responsibility, including the name of the grantee, the grant amount, and the grant’s purpose.

Following these rules is easy enough for a diligent manager.  However, failure to follow these rules could result in the IRS requiring the Private Foundation, and potentially its managers, to pay a tax on the value of the grant.

The alternative to expenditure responsibility.

For various reasons, a Private Foundation may not want to be bound by expenditure responsibility rules. For example, perhaps avoiding the liability associated with inadvertently dropping the ball on the reporting rules gives the managers peace of mind. Or, a Private Foundation may simply not want to report the grant and grantee details on its 990-PF.

Whatever the case, an equivalency letter prepared by an attorney or accountant will be sufficient to avoid expenditure responsibility requirements.

An equivalency letter is a professional opinion written for the US-based organization that the non-US organization is equivalent to a 501(c)(3) Public Charity. Essentially, the letter states that the non-US organization is organized and operated for a charitable purpose, that it does not conduct the political activity prohibited for 501(c)(3) organizations, and that it is publicly supported. In other words, the letter states that if the non-US organization were to apply for exemption in the US, it would be eligible for exemption.

So, why don’t all Private Foundations do this?  Many do, but sometimes the non-US organization might not meet the test for public support, or it may have some political activity.  In those cases, an equivalency letter isn’t possible, and the Private Foundation must rely on expenditure responsibility.

How can a lawyer help?

Obviously,  if a Private Foundation wants an equivalency letter, it will need a lawyer or an accountant to draft it. This involves reviewing the potential grantee’s formation documentation and conducting a review of its activities. In most cases, an established grantee with a history of charitable activity will be eligible for equivalency.

Private Foundations that want to, or must, rely on expenditure responsibility can benefit from a properly drafted grant agreement. As mentioned above, expenditure responsibility has specific meaning and requires Private Foundations to monitor their grants in specific ways. An attorney can ensure that those specific requirements are met.

Even if you are a Public Charity and not a Private Foundation, most lawyers agree that it is good practice to follow expenditure responsibility rules when granting to organizations that are not exempt under 501(c)(3). Public Charities are not bound by the rules, but they are required to ensure their funds are used exclusively for charitable purposes.  So, Public Charities do have a duty to make sure their grants are not being used for purposes for which the Charity itself could not use the funds.