How can U.S. foundations make a tax-advantaged gift to a foreign NGO that is not designated as exempt under Section 501(c)(3) of the Internal Revenue Code? And, how can donors be assured that their donation is used appropriately?
The IRS provides U.S. grantmakers with two different tools for ensuring grants to non-501(c)(3)s are exempt transactions:
1. Conducting an equivalency determination (ED)
2. Exercising expenditure responsibility (ER)
While both options provide grantmakers with the ability to fund non-exempt entities, there are situations where one may be more useful than the other.
Expenditure Responsibility
Expenditure Responsibility (ER) is a tool provided by the IRS for foundations that allows for targeted funding that supports a specific charitable project when giving, lending, or otherwise supporting an entity that is not designated as exempt under U.S. IRC Section 501(c)(3). ER is an alternative to equivalency determination, the other tool for funding non-exempt grantees.
Through ER, a private foundation may make a grant to a foreign NGO whether or not it is deemed the equivalent of a public charity. Expenditure responsibility requires that a foundation or grantor takes the following actions:
1. Conduct a pre-grant inquiry that ensures the intended grantee’s ability to fulfill the charitable purpose of the grant,
2. Execute a written grant agreement that restricts the grantee to using the funds for their specified charitable purpose,
3. Collect reports from the grantee organization on how the funds are spent
4. Report the grant on the foundation’s 990-PF.
Step 1: Pre-Grant Inquiry
The purpose of this inquiry is to provide assurance that the proposed grantee is capable of using grant funds for their intended purpose. While this may sound similar to ED, IRS regulations for ER do not technically require the review of any particular document. Therefore, it is the responsibility of the grantmaker to analyze the supplied documents and determine if there is enough information to provide assurance that funds will be disbursed properly.
Step 2: Written Agreement
Once the pre-grant inquiry has been reviewed and accepted, the grantor and grantee must enter into a grant agreement that includes the following commitments:
- Grantee must repay any funds that are not used for the charitable purposes defined in the agreement.
- Grantee commits to annual reporting on the use of the funds.
- Grantee agrees to account for the grant funding in a way that clearly shows receipts and expenditures – ideally, in a separate account or expense line in an annual budget.
- Grantee agrees not to use any funds to pursue political activities (lobbying, electioneering, etc)
See precise details of the requirements on the IRS website.
Step 3: Reporting
Grantee Reporting
Following distribution of funding, the IRS requires that a grantee submit annual reports, starting within a reasonable amount of time after the end of the grantee’s fiscal year. Generally speaking, these reports must state how grant funds were used and that use must comply with the executed grant agreement. These reports must be submitted annually until the grant’s funds are expended or the grant is terminated, with the final report covering full expenditures over the life of the grant.
Reporting to the IRS
While the grantmaker is not required to independently verify the accuracy of the reports, the grantmaker does need to verify receipt of the reports and confirm that the grant is still being used for its exempt purpose. This information must also be reported on the grantmaker’s annual 990-PF tax return for the duration of the grant.
Expenditure responsibility offers foundations the chance to support foreign NGOs of their choosing, even where those organizations would not be able to pass a more stringent ED review. It provides a flexibility that equivalency determination cannot, while still giving grantmakers many of the assurances offered by ED.
Learn more about expenditure responsibility’s counterpart tool, equivalency determination, here. Contact info@cafamerica.org today to learn how we can facilitate giving via ER for your foundation.