Taxable Expenditures for Private Foundations: Excise Tax and Rules

Taxable expenditures for private foundations are the five categories of spending that Section 4945 of the Internal Revenue Code penalizes: lobbying, election activity, grants to individuals without an approved selection process, grants to non-public-charity organizations without expenditure responsibility, and any spending for a purpose that isn’t religious, charitable, scientific, literary, educational, related to amateur sports, or aimed at preventing cruelty to children or animals. The foundation owes an initial excise tax of 20% of the amount, which climbs to 100% if it doesn’t fix the problem in time. Managers who knowingly approve the spending owe a separate personal tax.¹

The Five Categories of Prohibited Spending

Section 4945 draws its lines by category rather than by intent. A payment can be well-meant and still taxable if it falls inside one of these boxes.

Lobbying. Money spent to influence legislation, whether by talking directly to lawmakers or by pushing the public to contact them.
Election activity. Money spent to influence a public election, plus voter registration drives that don’t meet every condition in Section 4945(f).
Grants to individuals. Scholarships, fellowships, prizes, awards, and travel or study grants made without prior IRS approval of the foundation’s selection procedures.
Grants to organizations that aren’t public charities. Grants to other private foundations, social welfare groups, or unrecognized entities, unless the foundation exercises formal expenditure responsibility over the funds.
Non-charitable spending. Anything paid out for a purpose outside those listed in Section 170(c)(2)(B).

That last category is the catch-all, and it reaches inside the foundation’s own budget. Unreasonable administrative expenses, including excessive compensation, inflated consultant fees, and overpriced service contracts, are ordinarily treated as taxable expenditures under this heading. A foundation avoids the penalty by showing the expense was incurred in good faith, appeared reasonable at the time, and was consistent with ordinary business judgment.² Paying a director wildly above market for comparable work is a live risk under this rule, not just a governance concern.¹

How the Excise Tax Works

The penalty structure is two-tier and it hits both the foundation and the people who authorized the spending.

The initial tax on the foundation is 20% of the taxable expenditure. A foundation manager who agreed to the expenditure knowing it was prohibited owes a separate personal tax of 5%, capped at $10,000 per expenditure. The manager escapes that personal tax if the agreement wasn’t willful and rested on reasonable cause, typically meaning reliance on professional advice.¹

If the expenditure isn’t corrected within the taxable period, the penalty on the foundation jumps to 100% of the original amount. Any manager who refused to agree to the correction owes an additional personal tax of 50% of the expenditure, capped at $20,000.

The math adds up quickly. A $50,000 taxable expenditure triggers an immediate $10,000 tax on the foundation. If a manager knowingly approved it, that manager personally owes $2,500. If nobody corrects the problem in time, the foundation owes another $50,000 and the manager owes another $20,000. Total exposure on a single $50,000 grant: $82,500.

The Correction Window

The taxable period runs from the date the expenditure occurs until either the IRS mails a notice of deficiency for the 20% tax or actually assesses that tax, whichever comes first. Fixing the problem inside that window is the only way to avoid the 100% second tier.¹

Correction primarily means recovering the funds. If full recovery isn’t possible, the IRS can require additional steps: withholding any unpaid future installments, halting further grants to the same grantee, mandating detailed reporting on future expenditures, or requiring improvements to grant-selection procedures. A foundation isn’t required to sue for recovery if the judgment would clearly be uncollectable.³

Two narrower correction paths exist for procedural slips. If the only violation was a failure to obtain or file a required grantee report, the foundation can correct by obtaining the report; if the report can’t be obtained despite reasonable efforts and no funds were diverted, documenting those efforts and reporting the failure to the IRS is enough. If the only problem was missing advance IRS approval for individual grant procedures, the foundation can correct by obtaining that approval retroactively and showing that no funds were misused and that the procedures would have been approved on time.

Lobbying: What’s Actually Off Limits

Section 4945 covers both direct lobbying, meaning communications with legislators about specific legislation, and grassroots lobbying, meaning attempts to move public opinion so the public in turn pressures lawmakers.¹ Three exceptions leave real room to work on policy.

Nonpartisan Analysis, Study, or Research

A foundation can fund and publish work on legislative topics if the work is an independent, objective treatment with enough factual depth for a reader to reach their own conclusion. The piece can even advocate a position, provided the underlying facts are presented fully and fairly. The disqualifier is a direct call to action: if the piece takes a view on specific legislation and tells the reader to contact a legislator, it becomes grassroots lobbying. Distribution can’t be limited to people who already agree.⁴

Technical Advice on Written Request

When a government body, committee, or subdivision sends a written request in its own name (not from a single member) asking for the foundation’s expertise, the response isn’t a taxable expenditure. The response has to be made available to every member of the requesting body. Because the government asked first, the response can include opinions and recommendations without meeting the nonpartisan-analysis standard.⁵

Self-Defense

A foundation can communicate with a legislative body about a decision that would affect its own existence, powers, tax-exempt status, or the deductibility of contributions to it. This exception is narrow and covers legislation aimed at the foundation itself.

Grants to Individuals Require Advance Approval

Scholarships, fellowships, internships, prizes, awards, and other grants to individuals for travel or study are taxable expenditures unless the foundation has received advance IRS approval of its selection procedures. The awards must be made on an objective, nondiscriminatory basis.⁶

Approval is requested by filing Form 8940, Schedule C, which describes the grant criteria, selection process, and qualifications of the selection committee. A foundation can also request approval as part of its initial exemption application on Form 1023, Schedule H.⁷ Without an approved program on file, every grant to an individual is treated as a taxable expenditure, even if the recipient was well qualified and the selection genuinely fair. The IRS is checking process, not outcome.

Grants to Non-Public Charities Require Expenditure Responsibility

Grants to organizations that aren’t public charities (other private foundations, social welfare groups, unincorporated associations without IRS recognition) are taxable expenditures unless the foundation exercises expenditure responsibility.⁸ That responsibility has two parts.

Before sending money, the foundation must conduct a pre-grant inquiry into the grantee: identity, management, past history and experience, current activities, and practices. The depth of the inquiry can scale with the grant’s size and the foundation’s prior experience with the grantee. The point is a reasonable basis to believe the funds will be used for the intended charitable purpose.⁹

Before or at the time funds are transferred, the foundation must obtain a signed written agreement. The agreement has to specify the charitable purpose and commit the grantee to:

Repay any portion not used for that purpose.
Submit full annual reports on how the funds were spent and what was accomplished.
Maintain financial records and make them available to the foundation at reasonable times.
Not use the funds for lobbying, election activity, unapproved individual grants, or any non-charitable purpose.

The agreement can authorize general operating support or capital purchases so long as it makes clear that no funds, and no income from those funds, may be used outside recognized charitable purposes.¹⁰

Elections and Voter Registration

Any spending to influence the outcome of a specific public election is a taxable expenditure. Foundations cannot endorse candidates or fund campaigns. Nonpartisan voter education is permitted, but voter registration drives are prohibited unless every condition in Section 4945(f) is satisfied, including operating across five or more states, meeting an 85% activity-spending threshold, and meeting an 85% support test with no single exempt-organization donor providing more than 25%.¹¹ Most foundations don’t run drives themselves; they grant to organizations that already qualify, and even then they need to verify compliance rather than assume it.¹²

Reporting on the 990-PF and 4720

Every private foundation discloses taxable expenditures on its annual Form 990-PF. Part VI-A, line 5 asks whether the foundation engaged in any of the five prohibited categories during the year. A “yes” answer generally means the foundation also has to file Form 4720, the excise tax return used to calculate and pay the taxes owed.¹³

Form 4720 is due on the same deadline as the annual return. Managers or other disqualified persons who owe personal excise taxes file their own separate Form 4720. If the manager’s tax year matches the foundation’s, the deadline aligns; otherwise, it’s the 15th day of the fifth month after the end of the filer’s tax year.¹⁴

Foundations that exercised expenditure responsibility must also attach a separate report for each such grant to Form 990-PF, describing how the grantee used the funds. A missing expenditure responsibility report can itself be treated as a taxable expenditure, which restarts the whole penalty cycle on top of whatever else the foundation is dealing with.

1
Office of the Law Revision Counsel. 26 USC 4945 – Taxes on Taxable Expenditures
2
eCFR. 26 CFR 53.4945-6 – Expenditures for Noncharitable Purposes
3
eCFR. 26 CFR 53.4945-1 – Taxes on Taxable Expenditures
4
eCFR. 26 CFR 53.4945-2 – Propaganda Influencing Legislation
5
eCFR. 26 CFR Part 53 Subpart F – Taxes on Taxable Expenditures
6
Internal Revenue Service. Grants to Individuals
7
Internal Revenue Service. Instructions for Form 8940
8
Internal Revenue Service. IRC Section 4945(h) – Expenditure Responsibility
9
Internal Revenue Service. Pre-Grant Inquiry
10
eCFR. 26 CFR 53.4945-5 – Grants to Organizations
11
Internal Revenue Service. Influencing Elections and Carrying on Voter Registration Drives
12
eCFR. 26 CFR 53.4945-3 – Influencing Elections and Carrying on Voter Registration Drives
13
Internal Revenue Service. Instructions for Form 990-PF
14
Internal Revenue Service. Form 4720 – When to File