Grantmaking Is Where the Mission Lives
Everything else a private foundation does — filing the 990-PF, managing investments, holding board meetings — exists to support one core activity: making grants. Grantmaking is how a foundation translates assets into charitable impact.
But if you've recently taken over a family foundation, you've probably discovered that making grants isn't as simple as picking a charity and writing a check. The IRS imposes specific rules on who you can fund, how you document it, and what happens if you get it wrong. These rules exist for good reason — they ensure foundation money actually reaches charitable purposes — but they're not intuitive, and most foundation inheritors weren't taught them.
This guide walks through the practical mechanics of foundation grantmaking: the legal requirements, the due diligence process, how to structure grants, and how to avoid the mistakes that trip up even experienced foundation boards.
The Basic Legal Framework
Private foundation grantmaking operates under IRC Chapter 42, the same set of excise tax rules that govern self-dealing, minimum distributions, and investment income taxes. Three rules directly affect how you make grants.
The 5% distribution requirement (IRC §4942). Your foundation must distribute at least 5% of its net investment assets annually for charitable purposes. Grants are the primary way most foundations meet this requirement. If you don't distribute enough, you face an initial excise tax of 30% on the undistributed amount — and a 100% tax if you still haven't corrected it.
Taxable expenditure rules (IRC §4945). This section restricts what your grants can fund. You cannot use foundation money for political campaigns, lobbying (with narrow exceptions), grants to individuals without IRS-approved procedures, or grants to non-charitable organizations without expenditure responsibility. Violations trigger a 20% excise tax on the foundation and a 5% tax on any foundation manager who approved the grant knowingly.
Self-dealing rules (IRC §4941). These prohibit virtually all financial transactions between the foundation and its insiders. In a grantmaking context, this means you can't make a grant to a charity where a disqualified person receives a direct financial benefit — like funding a nonprofit that pays your board member's spouse as a consultant.
None of these rules prevent you from making grants effectively. They just require you to be deliberate about who you fund and how you document it.
Who Can You Make Grants To?
The simplest path: grant to organizations that are recognized as 501(c)(3) public charities by the IRS.
When you grant to a public charity, the compliance burden is relatively light. You verify their tax-exempt status, execute a grant agreement, and report the grant on your 990-PF. The public charity handles how the money is spent, and the IRS holds them accountable through their own reporting requirements.
Verifying tax-exempt status is non-negotiable. Before approving any grant, confirm the organization's status through the IRS Tax Exempt Organization Search at apps.irs.gov/app/eos. Check that their EIN matches their determination letter, and verify they haven't been auto-revoked for failure to file. An organization that tells you they're tax-exempt but doesn't appear in the IRS database is a red flag — either they've lost their status, they're in the application process, or they're not what they claim to be.
You should also check the IRS Auto-Revocation List. Organizations that fail to file their annual return (Form 990, 990-EZ, or 990-N) for three consecutive years automatically lose their tax-exempt status. Granting to a revoked organization creates compliance problems for your foundation.
Grants to Non-501(c)(3) Organizations
You can make grants to organizations that aren't 501(c)(3) public charities — but doing so triggers expenditure responsibility under IRC §4945(h). This means your foundation takes on an active monitoring obligation to ensure the funds are used exclusively for charitable purposes.
Expenditure responsibility requires:
- A written grant agreement specifying the charitable purpose and how funds will be used
- Segregated funds — the grantee must maintain your grant money in a separate account (or adequately document its use)
- Annual reporting from the grantee on how the funds were spent
- IRS reporting on your Form 990-PF, Part VII-B, detailing each expenditure responsibility grant
If the grantee diverts funds to non-charitable purposes, your foundation must take reasonable steps to recover the money and report the diversion to the IRS. Failure to exercise expenditure responsibility triggers the taxable expenditure penalties — 20% on the foundation and 5% on the approving manager.
Most small and mid-sized foundations avoid expenditure responsibility grants entirely by sticking to 501(c)(3) public charities. That's a reasonable approach, especially when you're getting established. But if your mission requires funding organizations outside the 501(c)(3) universe — international NGOs, government agencies, or fiscal sponsorship arrangements — know that the path exists. It just requires more documentation and oversight.
Grants to Individuals
Foundations can make grants to individuals (scholarships, fellowships, emergency assistance), but only under procedures pre-approved by the IRS. You'll need to describe your selection criteria, the grant purpose, and your oversight process in a written request to the IRS, and receive their approval before making any individual grants. Without that approval, individual grants are taxable expenditures.
If you're considering individual grants, work with a qualified attorney to develop your procedures and submit the IRS application. This isn't a DIY exercise.
The Due Diligence Process
Due diligence isn't bureaucratic overhead — it's how you protect the foundation from compliance problems and ensure your grants actually achieve something. A consistent process also protects individual board members, since foundation managers face personal liability for approving grants that violate Chapter 42 rules.
Here's what a solid due diligence process looks like for grants to 501(c)(3) public charities:
Step 1: Verify Legal Status
Before anything else, confirm the basics:
- IRS tax-exempt status via the Tax Exempt Organization Search
- EIN matches the determination letter on file
- State charitable registration is current (check the state attorney general's database)
- OFAC screening — run the organization through the Treasury Department's Specially Designated Nationals list at sanctionsearch.ofac.treas.gov. This takes two minutes and protects your foundation from funding organizations connected to terrorism or sanctions violations.
Step 2: Review Financials
Pull the organization's most recent Form 990 (available free on Candid.org or ProPublica's Nonprofit Explorer). Look for:
- Revenue trends — is the organization growing, stable, or declining?
- Revenue diversity — is it dangerously dependent on one funder or one government contract?
- Overhead ratio — compare administrative and fundraising costs to program spending. There's no magic number, but extreme ratios (over 40% admin) warrant questions.
- Net assets — does the organization have reasonable reserves, or is it operating hand-to-mouth?
- Audit notes — if the organization has audited financials, check for going concern opinions or qualifications.
Step 3: Assess Organizational Capacity
A great mission means nothing without the capacity to execute. Evaluate:
- Leadership stability — has the executive director been there more than two years? Frequent turnover is a warning sign.
- Board engagement — does the board have relevant expertise? Do they actually meet?
- Track record — has the organization successfully managed grants of similar size before?
- Staff capacity — do they have the people and systems to manage your grant and report on outcomes?
Step 4: Evaluate Mission Alignment
This is where strategy meets process. Ask whether the proposed grant fits your foundation's grantmaking priorities:
- Does it fall within your defined focus areas?
- Does the organization's approach align with your theory of change?
- Is this the most effective use of this portion of your distribution budget?
If you don't have documented grantmaking priorities, this step becomes subjective — which is exactly why a written grantmaking policy matters. It turns "I think this is a good fit" into "this meets criteria 2 and 4 of our published guidelines."
Step 5: Document Everything
Create a grant file for every grant you make. Include:
- The grantee's IRS determination letter
- Most recent Form 990
- OFAC screening results
- Your due diligence notes
- The grant application (if applicable)
- The signed grant agreement
- Board approval documentation (meeting minutes showing the vote)
This isn't optional from a compliance perspective. Your 990-PF requires detailed grant reporting, and if the IRS ever audits the foundation, you'll need to demonstrate that you exercised appropriate oversight.
Structuring the Grant Agreement
Every grant should be documented with a written agreement, even grants to well-established 501(c)(3) organizations. A grant agreement protects both parties and creates a clear record for compliance purposes.
At minimum, the agreement should include:
- Grant amount and payment schedule (lump sum or installments)
- Grant purpose — a specific description of what the funds will support
- Grant period — start and end dates
- Reporting requirements — what the grantee will report and when
- Use restrictions — confirmation that funds will be used exclusively for the stated charitable purpose
- Unused funds provision — what happens to unspent money (typically returned to the foundation)
- Acknowledgment that the grantee is a 501(c)(3) public charity in good standing
For larger or multi-year grants, you might add performance milestones, site visit rights, and renewal conditions. Scale the complexity to the grant size — a $10,000 general operating grant doesn't need the same agreement as a $200,000 multi-year capacity building commitment.
Types of Grants to Consider
How you structure your grants affects both your impact and your administrative burden.
General operating support gives the grantee flexibility to allocate funds where they're needed most. Many experienced funders prefer this approach because it supports organizational health rather than fragmenting operations into isolated projects. The trade-off is less control over exactly how your dollars are spent.
Project-specific grants fund a defined program or initiative. They're easier to evaluate and report on, but they don't support the overhead and infrastructure that makes programs possible. If every funder gives project-restricted grants, the organization can't pay for accounting, HR, or IT — the systems that keep programs running.
Multi-year commitments provide stability and allow grantees to plan beyond a single year. They're particularly effective for capacity building. Structure them with annual renewal tied to reasonable progress benchmarks.
Capacity-building grants fund organizational infrastructure: leadership development, financial systems, strategic planning, board development. These grants often have the highest long-term impact but are harder to measure in the short term.
The best approach for most foundations is a mix — general operating support as the default, with project-specific grants when you want to fund something discrete, and occasional multi-year commitments to organizations you trust deeply.
Connecting Grants to Your Distribution Requirement
Your grantmaking doesn't happen in a vacuum — it's connected to your 5% distribution requirement. Every qualifying grant counts toward your minimum distribution for the year it's paid.
Here's the practical math: if your foundation's average net investment assets are $3 million, your minimum annual distribution is $150,000. That's your grantmaking budget floor. You can distribute more (and the excess creates carryover for future years), but you can't distribute less without facing excise taxes.
Track your distribution throughout the year. Many foundations make all their grants in Q4, scrambling to meet the deadline. Better practice: plan your grantmaking calendar at the start of each year, approve grants quarterly, and track cumulative distributions against your target. By September, you should know whether you're on pace or need to accelerate.
Qualifying distributions include grants, reasonable administrative expenses directly related to charitable activities, and certain program-related investments. Administrative expenses like investment management fees, office rent, and general overhead do not count. Your CPA can help you determine exactly what qualifies.
Common Grantmaking Mistakes
No written grantmaking policy. Without documented priorities, every grant decision is a debate. Board members push for their personal favorites. Staff can't evaluate proposals consistently. A one-page grantmaking policy that defines your focus areas, grant size range, and application process solves most of these problems.
Skipping due diligence for "known" organizations. Even if you've funded an organization for years, verify their tax-exempt status annually. Organizations lose their status more often than you'd think — and a grant to a revoked organization creates compliance problems regardless of your relationship.
Not tracking expenditure responsibility obligations. If you've made grants to non-501(c)(3) organizations and aren't maintaining the required documentation and IRS reporting, you have an open compliance exposure. Review your past grants and fix any gaps.
Spreading too thin. A foundation with $100,000 in annual distribution capacity that makes 25 grants of $4,000 each will have minimal impact and maximum administrative burden. Fewer, larger grants to organizations you know well typically produce better results.
Ignoring conflicts of interest. Board members should recuse themselves from voting on grants to organizations where they have a personal connection — whether as a board member, employee, donor, or family member of someone involved. Document every recusal in your meeting minutes. The self-dealing rules make this more than a governance best practice; it's a compliance necessity.
When to Get Professional Help
Most of the grantmaking process is operational work that doesn't require a law degree. Verifying tax-exempt status, conducting due diligence, drafting grant agreements, tracking distributions — these are administrative tasks that a competent foundation manager can handle.
But some situations warrant professional guidance:
- Expenditure responsibility grants to non-501(c)(3) organizations
- International grantmaking to foreign NGOs
- Individual grant programs requiring IRS-approved procedures
- Grants involving potential self-dealing conflicts
- Complex multi-year grant structures with performance-based disbursements
For legal questions, work with an attorney experienced in private foundation law. For tax reporting questions, work with a CPA who specializes in exempt organizations.
For the operational side — building your grantmaking process, developing policies, conducting due diligence, managing your distribution calendar, and running your board through the process — that's exactly what Wylie Advisory's foundation services are designed to handle. Whether you need a one-time governance review to assess your current grantmaking practices, advisory calls to talk through specific grant decisions, or an ongoing retainer for comprehensive operational support including grantmaking management, we work with you at whatever level of involvement makes sense.
The goal isn't to make grantmaking feel complicated. It's to give you a process you trust — so you can focus on the part that actually matters: funding organizations that advance your foundation's mission.