What Are Expenditure Responsibility Requirements?

Expenditure responsibility requirements are the procedures a private foundation must follow whenever it grants money to an organization that is not a recognized U.S. public charity. Under Internal Revenue Code Section 4945(d)(4), the foundation has to investigate the grantee before sending funds, lock in a written grant agreement with specific terms, monitor how the money is spent, and report the grant to the IRS each year until the funds are exhausted.¹ Skip any step and the grant becomes a taxable expenditure, exposing the foundation to a 20 percent excise tax and its managers to personal liability.

When the Rules Apply

Any grant from a private foundation to an organization that is not a public charity under Section 509(a)(1) or (2), an exempt operating foundation, or certain supporting organizations triggers the requirement. The foundation must either exercise expenditure responsibility or accept the grant as a taxable expenditure.² Typical grantees that fall in this category include other private foundations, Section 501(c)(4) social welfare organizations, unincorporated associations without IRS recognition, and most foreign organizations.

Type III non-functionally integrated supporting organizations require expenditure responsibility even though they technically hold public charity status.¹ Foreign organizations almost always trigger the requirement unless the foundation has obtained an equivalency determination or the foreign entity holds an IRS determination letter recognizing it as a Section 501(c)(3) public charity.³

Two situations sit outside the rules. Grants to government agencies at any level do not require expenditure responsibility.⁴ And grants to individuals for travel, study, or similar purposes follow a different regime under Section 4945(d)(3), which calls for advance IRS approval of the foundation’s grant-making procedures rather than expenditure responsibility.⁵

Step One: The Pre-Grant Inquiry

Before any money moves, the foundation must investigate the prospective grantee. The Treasury Regulations describe this as a “limited inquiry” thorough enough to give a reasonable person assurance that the grantee will use the funds properly.⁶ It should cover the identity, history, and experience of the grantee organization and its leaders, along with anything the foundation already knows about how the organization is managed.

Depth should scale with risk. A large multi-year grant to an unfamiliar organization warrants far more scrutiny than a small grant to a grantee that has already used and reported on prior funding correctly. The regulations say that when a grantee has properly used all prior grants and filed the required reports, no further pre-grant inquiry is ordinarily needed.⁶ Even so, most compliance officers routinely review the grantee’s governing documents, recent financial statements, and operational capacity to run the project.

Step Two: The Written Grant Agreement

The core document is a written commitment signed by an officer, director, or trustee of the grantee before any funds are disbursed. The Treasury Regulations require specific terms:⁶

The grantee agrees to repay any portion of the grant not spent on the specified charitable purpose.
The grantee agrees to submit full annual reports on how the funds were spent and on progress toward the grant’s objectives.
The grantee agrees to keep records of receipts and expenditures and make them available to the foundation at reasonable times.
The grantee agrees not to use any of the funds for lobbying, political campaign activity, voter registration drives, grants that would themselves violate Section 4945, or any purpose outside those described in Section 170(c)(2)(B).

If the grantee plans to re-grant any of the funds to another organization, the foundation must approve that arrangement and extend its expenditure responsibility procedures down the chain.

One point trips up many foundations. Grantees that are already tax-exempt under Section 501(a) do not have to physically segregate grant funds or maintain a separate account unless the foundation writes that requirement into the agreement.⁶ Non-exempt grantees face stricter accounting rules. Many foundations impose separate accounting on all grantees anyway because it simplifies monitoring.

Step Three: Monitoring the Grantee

After the grant goes out, the foundation must require and review reports from the grantee at least annually. Reports should cover how the money was spent, whether the grantee complied with the agreement, and what progress was made toward the charitable objectives.⁶ Quarterly reporting is common for large or multi-year grants, though only annual reporting is mandated.

Each financial report should reconcile funds received against itemized expenses. The narrative should describe progress and flag delays. A final report at the end of the grant must provide a complete accounting of all funds received and spent and confirm that the charitable purpose was fulfilled.

If a report reveals questionable spending, or if the foundation learns from another source that funds may have been diverted, it must investigate promptly. Ignoring a red flag is treated the same as failing to exercise expenditure responsibility. When misuse is confirmed, the foundation should demand repayment, withhold any remaining installments, and document every step.² The IRS does not expect foundations to prevent every possible misuse. It expects them to have procedures that catch problems and to act on what those procedures reveal.

Step Four: Reporting to the IRS

The foundation must report all expenditure responsibility grants on its Form 990-PF each year, attaching a separate statement for each grant that includes:⁷

The name and address of the grantee organization.
The date and amount of the grant and the charitable purpose it was made for.
The amounts the grantee spent during the reporting period, based on the most recent grantee report.
Whether the foundation has any knowledge that the grantee diverted funds from the grant’s purpose.
The dates of reports received from the grantee and the date and results of any verification the foundation performed.

This obligation continues for as long as any grant funds remain unspent, even after the foundation’s own fiscal year has closed. An incomplete or missing attachment counts as a failure of expenditure responsibility and triggers the same excise taxes as any other violation.

What Noncompliance Costs

A grant that fails expenditure responsibility becomes a “taxable expenditure,” and the tax structure works in two tiers.

At the first tier, the foundation owes an excise tax of 20 percent of the grant amount. Any foundation manager who knowingly approved the expenditure owes a separate tax of 5 percent, capped at $10,000 per expenditure. The manager’s tax applies only when the approval was willful and not due to reasonable cause.¹

If the foundation does not correct the problem within the taxable period, the second tier kicks in: an additional tax of 100 percent of the grant amount on the foundation, and 50 percent on any manager who refused to agree to correction, capped at $20,000 per expenditure.¹

Correction means recovering the grant funds to the extent possible, or taking whatever additional action the IRS prescribes when full recovery is not feasible. For failures involving missing or incomplete reports rather than actual fund diversion, correction simply means obtaining or filing the report. The taxable period runs from the date of the taxable expenditure until the earlier of when the IRS mails a notice of deficiency or assesses the first-tier tax.¹

Program-Related Investments Follow the Same Rules

Expenditure responsibility applies not just to grants but also to program-related investments, where the foundation makes a loan, equity investment, or similar financial commitment for charitable purposes. The recipient must sign a written commitment specifying the investment’s purpose and containing the same core obligations: use the funds solely for the stated purpose, repay amounts not used for that purpose (with appropriate limits for equity investors), and refrain from lobbying, political activity, and impermissible sub-grants.⁸

Because the arrangement is a loan or equity stake rather than an outright gift, the reporting standard is pegged to what a commercial investor would ordinarily require in a comparable situation. That gives foundations flexibility to request the financial data that fits the deal instead of following a rigid template.

How to Avoid the Process

Expenditure responsibility is labor-intensive, and foundations with active international programs often look for lawful ways around it.

Equivalency Determination for Foreign Grantees

An equivalency determination is a legal analysis concluding that a foreign organization is the functional equivalent of a U.S. public charity. If the foundation obtains one, it can treat the grant as if it went to a domestic public charity and skip expenditure responsibility entirely.³ The determination must come from a qualified tax practitioner who applies U.S. public support tests to the foreign entity’s financial and governing documents.

Written advice is generally considered current for up to two years after it is provided, depending on timing relative to the grantee’s fiscal year. If the practitioner reviewed a five-year public support test period, the determination remains current for the two taxable years immediately following that period.⁹ The cost of obtaining an equivalency determination from outside counsel has historically ranged from $5,000 to $15,000 per organization, which foundations making repeated grants to the same foreign partners often find worthwhile compared to the ongoing compliance burden.

Grants to Government Agencies

Grants to domestic or foreign government units do not require expenditure responsibility and qualify as qualifying distributions under Section 4942.⁴ If the grant is earmarked for use by an individual, the government agency must satisfy the IRS that its program furthers exempt purposes, requires progress reports from individual grantees, and investigates any grants that appear to be in jeopardy. Foundations channeling funds through government partners should confirm those safeguards are in place before assuming the exemption applies.

1
Office of the Law Revision Counsel. 26 U.S. Code 4945 – Taxes on Taxable Expenditures
2
Internal Revenue Service. IRC Section 4945(h) Expenditure Responsibility
3
Internal Revenue Service. Grants to Foreign Organizations by Private Foundations
4
Internal Revenue Service. Grants to Governmental Agencies
5
Internal Revenue Service. Advance Approval of Grant-Making Procedures
6
eCFR. 26 CFR 53.4945-5 – Grants to Organizations
7
Internal Revenue Service. Reports to the Internal Revenue Service – Expenditure Responsibility
8
Internal Revenue Service. Terms of Program-Related Investments – Private Foundation Expenditure Responsibility
9
Internal Revenue Service. Revenue Procedure 2017-53