The Rule Most Foundation Stewards Get Wrong
Here's a scenario we see constantly: a private foundation wants to fund a promising project — maybe a fiscally sponsored initiative, a new organization still waiting on its IRS determination letter, an LLC doing social-impact work, or a foreign NGO. The board asks, "Can we make this grant?" and someone on the call says, "We can only grant to 501(c)(3) public charities."
That answer is wrong. Or more precisely, it's incomplete in a way that causes foundations to turn down grants they could legally make.
Private foundations can absolutely grant to organizations that aren't 501(c)(3) public charities. They just have to exercise something called expenditure responsibility — a specific procedure laid out in IRC §4945 and the Treasury regulations. It's not optional, it's not vague, and it's not as scary as it sounds once you've done it a few times.
This post walks through when you need expenditure responsibility, the five required steps, and the common places foundations trip up.
When Expenditure Responsibility Is Required
Under IRC §4945, any grant a private foundation makes to an organization that is not a public charity (and not a government unit, exempt operating foundation, or certain other qualifying recipients) is a "taxable expenditure" — unless the foundation exercises expenditure responsibility.
In practice, that means ER applies to grants to:
- LLCs, for-profit entities, and unincorporated associations working on charitable projects
- New nonprofits that have applied for but not yet received their 501(c)(3) determination letter (the 27-month retroactive window doesn't help the granting foundation in real time)
- Foreign organizations that haven't obtained a U.S. equivalency determination
- Private non-operating foundations (yes, foundation-to-foundation grants between two non-operating foundations require ER)
- 501(c)(4), (c)(5), (c)(6) organizations — they're tax-exempt, but they're not 501(c)(3) public charities
- Type III non-functionally integrated supporting organizations and certain other disqualified supporting organizations
ER does not apply when you're granting to a 501(c)(3) public charity, a private operating foundation, a governmental unit, or certain other safe recipients. For those, you just need the determination letter (or equivalent) on file and you're clear.
If you're not sure whether a recipient is a public charity, check the IRS Tax Exempt Organization Search at apps.irs.gov/app/eos before you grant. The IRS Business Master File confirms current status.
The Five Required Steps
The regulations (Treas. Reg. §53.4945-5) lay out five concrete things a foundation must do to satisfy expenditure responsibility. Miss any one of them and the grant becomes a taxable expenditure subject to a 20% excise tax on the foundation, plus a 5% tax on any foundation manager who knowingly approved it.
1. Pre-Grant Inquiry
Before the grant goes out, the foundation has to conduct a reasonable investigation of the grantee. The point is to establish that the grantee is capable of using the funds for the charitable purpose the foundation intends.
What counts as reasonable depends on the size of the grant and the nature of the recipient, but a standard pre-grant inquiry looks at: the organization's identity and prior history, experience and ability of its managers, any prior grant history, and whether the organization has the capacity to actually carry out the proposed work. For a small grant to a known grantee, this can be a one-page memo to file. For a large grant to a new LLC, it should be much more substantial.
Document this. The IRS can ask to see your pre-grant inquiry years later.
2. Written Grant Agreement
The grant must be made under a written agreement signed by an officer or director of the grantee. The agreement has to include specific things spelled out in the regulations:
- A commitment to use the grant only for the purposes described in the agreement
- A commitment to repay any portion not used for those purposes
- A commitment to maintain records of receipts and expenditures and make them available to the foundation
- A commitment to provide reports required by the foundation (see step 3)
- A prohibition on using the funds for lobbying, political activity, grants to individuals for travel or study (absent further procedures), or any non-charitable purpose
This isn't a generic grant letter. It's a binding commitment. We keep template ER grant agreements in our foundation kit because every deal needs one and they don't need to be reinvented.
3. Regular Reports from the Grantee
The grantee must provide the foundation with written reports on how the grant is being spent and the progress being made toward the stated purposes. Reports are required at least annually for multi-year grants, and a final report is required when the grant funds are fully expended.
The foundation has to actually receive and review these reports. Filing them unread in a drawer doesn't count. If a report is late or missing, the foundation needs to follow up — and document the follow-up.
4. Report to the IRS on Form 990-PF
On the foundation's annual Form 990-PF, ER grants have to be separately reported. You'll disclose the name and address of the grantee, the date and amount of the grant, the grant's purpose, the amount expended by the grantee (based on the most recent report), whether the grantee has diverted any funds from purpose, the dates of any grantee reports received, and the date and results of any verification conducted.
This sits in a statement attached to the 990-PF. Skipping it or getting it wrong is a common way foundations fail ER compliance even when the underlying grant was administered properly.
5. Separate Recordkeeping
Foundations exercising ER have to maintain a separate file for each ER grant containing the pre-grant inquiry, the grant agreement, all reports from the grantee, and documentation of any verification steps. These records need to be kept for as long as the statute of limitations on the 990-PF remains open — which effectively means indefinitely in practice.
Common Places Foundations Go Wrong
Treating ER as a one-time event. It's not a pre-grant checklist. It's an ongoing responsibility that runs from the pre-grant inquiry all the way through the final grantee report. Foundations that think they're "done" once the check is cut miss the reporting and recordkeeping requirements.
Using a generic grant letter. A standard thank-you letter doesn't satisfy the written-agreement requirement. The five specific commitments in the regulations need to be in writing, and the grantee's officer has to sign.
Missing the 990-PF disclosure. Your CPA will fill out the 990-PF, but they can only report what you give them. If you don't hand over the ER grant file, it won't show up on the return — and an ER grant that isn't properly disclosed is a taxable expenditure even if everything else was done right.
Funding the wrong kind of expense. ER grants can't be used for lobbying, political activity, or grants to individuals for travel or study without additional procedures. If the grantee uses the funds for those purposes, the foundation has a problem unless it can show it took reasonable steps to prevent the misuse.
Forgetting that foundation-to-foundation grants need ER too. A grant from one private non-operating foundation to another private non-operating foundation requires expenditure responsibility. This catches people by surprise because "foundation to foundation" sounds safe.
When ER Makes Sense — and When It Doesn't
Expenditure responsibility opens up a lot of grantmaking possibilities, but it also adds real administrative weight. For a small grant, the compliance overhead can exceed the value of the grant itself. We generally recommend foundations think about ER grants in a few clear categories:
- Bridge grants to new organizations that will become 501(c)(3)s once their determination letter arrives — often worth the ER lift because the relationship continues.
- Strategic grants to LLCs, B Corps, or fiscally sponsored projects doing work that fits the foundation's mission and can't easily be routed through a public charity.
- International grants where equivalency determination is impractical or the grantee is the clear best actor.
For one-off grants to unknown recipients, the administrative cost of ER often outweighs the benefit. In those cases, finding a fiscal sponsor who is a 501(c)(3) public charity can be a cleaner path.
How Wylie Advisory Helps
Expenditure responsibility is exactly the kind of operational work most foundation boards shouldn't be doing themselves — it's procedural, document-heavy, and easy to get wrong in ways that trigger excise taxes years later.
We help private foundations build ER into their grantmaking workflow from the start: template grant agreements, pre-grant inquiry checklists, reporting tracker, and 990-PF preparation support. For foundations with ongoing ER grants, this lives inside our foundation monthly retainer. For foundations doing a one-time review of their grantmaking process, it's part of our foundation governance review. And if you've inherited a foundation and you're not sure whether the prior grantmaking was compliant, our foundation transition navigator is built exactly for that situation.
Expenditure responsibility isn't something to be afraid of. It's a procedure. Once you have the templates and the workflow in place, it becomes one more thing the foundation does well — and it opens up a much wider range of grantmaking than boards often realize they have.
If you want help setting this up for your foundation, get in touch and we'll walk through your grantmaking pipeline together.