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Non-Profit Organizations

Expenditure Responsibility

By June 22, 2015No Comments

When making the decision to award a grant, a foundation must be mindful of the type of organization that will be the recipient.  If the organization is not a Section 501(c)(3) public charity, then your grant may be subject to expenditure responsibility regulations.

Expenditure responsibility requires a private foundation to assure that grants are utilized only for their intended purpose.  To achieve this, the IRS mandates that the grantor take the following steps:

  1. Conduct a pre-grant inquiry of potential grant recipients,
  2. Enter into a written grant agreement with the grantee,
  3. Obtain annual reports from the grantee,
  4. Report the grants to the IRS on the foundations tax return,
  5. Follow up on all potential diversions of grant funds.

Pre-grant Inquiry

The foundation must conduct a limited inquiry of the potential grantee before any grant is awarded.  This pre-grant inquiry must provide the foundation with confidence that any grant funds awarded will be used only for their intended purpose and may be achieved through site visits, interviews, a review of governing documents, or evidence of previous grants made to the organization.

Written Grant Agreement

The grantor must also enter into a written agreement with every grantee that is subject to expenditure responsibility and the agreement must contain the following components:

  • The specific charitable purpose of the grant;
  • A statement specifying that grant funds will only be used for their intended purpose and if any funds are used outside of this purpose, those funds will be refunded;
  • Full and complete reports will be provided to the grantor at least once per year on the manner that the funds are being spent and their progress in accomplishing the purpose of the grant;
  • Foundation book and records will be made available to the grantor;
  • Funds will not be used for any political purpose.

Reporting Requirements

The IRS requires the foundation to report all grants awarded on its annual tax return until all funds are spent.  When reporting this information, the foundation must provide the following information to the IRS:

  • The grantee and any relationship the grantee has to the foundation,
  • The date of the grant;
  • The amount of the grant;
  • The purpose of the grant;
  • The amount spent to date;
  • Grant funds remaining;
  • Any funds that have been diverted.

Recordkeeping Requirements

In addition to the information provided to the IRS when filing its annual return, the foundation must also make records available at their main office.  These records should include information obtained when evaluating potential grantees, a copy of each written grant agreement, and a copy of each report concerning expenditure responsibility made by the grantor’s personnel or independent auditors.

In the event that grant funds are diverted, the grantor foundation must take all reasonable steps to either recover the funds or ensure the restoration of the diverted funds.  The grantor must also withhold any future payments to the grantee until it has received assurance that future diversions will not occur and extraordinary precautions to prevent further diversions have been established.

What happens when grant funds are spent inappropriately?

In the event that funds are diverted and restoration is not achieved, that portion of the grant may become a taxable expenditure.  In addition, if the grantor fails to accomplish any of the required steps, the impacted grant funds may also be declared a taxable expenditure.  The IRS issues strict tax penalties when there is a diversion of funds.  These penalties can be issued against the foundation, the manager(s) involved or both.  The foundation may be subject to a 20% tax on the expenditure and if the diversion is not corrected before the end of the taxable year, the tax becomes 100% of the expenditure.  In addition, if the manager of the foundation makes the agreement with knowledge that the funds will be diverted, each manger involved could be subject to a 5% tax on the expenditure and if the manager refuses to correct it, the tax increases to 50% on each manager.

Expenditure responsibility can be difficult and time consuming, however it is important to have proper procedures in place that follow these steps in order to avoid expensive penalties.  If you have additional questions or are considering issuing a grant and would like advice on whether expenditure responsibility applies, please feel free to contact us.

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