What Are Expenditure Responsibility Requirements?

Expenditure responsibility requirements are the procedures a private foundation must follow whenever it makes a grant 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 writing the check, sign a written agreement locking in how the money can be used, collect annual reports on what the grantee actually did with the funds, and disclose the grant to the IRS each year on Form 990-PF.¹ Skip any step and the grant becomes a taxable expenditure, triggering a 20 percent excise tax on the foundation and personal taxes on the managers who approved it.

When the Rules Apply

The trigger is the identity of the grantee. Any time a private foundation sends money to an organization that is not a public charity under Section 509(a)(1) or (2), an exempt operating foundation, or certain supporting organizations, the foundation must either exercise expenditure responsibility or treat the grant as a taxable expenditure.² In practice, that pulls in grants to 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 are also on the list, 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 entity already holds an IRS determination letter recognizing it as a Section 501(c)(3) public charity.³

Two categories fall outside these rules and are easy to confuse with them. Grants to government agencies, whether federal, state, local, or foreign, do not require expenditure responsibility.⁴ Grants to individuals for travel, study, or similar purposes are governed by a separate provision, Section 4945(d)(3), which requires advance IRS approval of the foundation’s grant-making procedures rather than the expenditure responsibility process.⁵

The Pre-Grant Inquiry

Before any money moves, the foundation has to look into the prospective grantee. The Treasury Regulations describe this as a “limited inquiry” that should be thorough enough to give a reasonable person assurance that the grantee will use the funds properly.⁶ The inquiry should cover the identity, history, and experience of the grantee organization and its leaders, along with anything the foundation already knows about the organization’s management and practices.

Depth should match the risk. A large, multi-year grant to an unfamiliar organization warrants far more scrutiny than a modest grant to a group that has properly used and reported on prior funding. In fact, the regulations note that if a grantee has properly used all prior grants and filed the required reports, no further pre-grant inquiry is ordinarily needed.⁶ Most foundation compliance officers still go beyond the minimum, reviewing the grantee’s governing documents, recent financial statements, and operational capacity as a matter of standard practice.

The Written Grant Agreement

The legal backbone of the process is a written commitment signed by an officer, director, or trustee of the grantee before any funds change hands. The Treasury Regulations spell out the terms that must appear in this agreement:⁶

A promise to repay any portion of the grant not spent on the specified charitable purpose.
A commitment to submit full and complete annual reports on how the funds were spent and the progress made toward the grant’s objectives.
An obligation to maintain records of receipts and expenditures and make them available to the foundation at reasonable times.
A prohibition on using the funds for lobbying, political campaign activity, voter registration drives, grants that would violate Section 4945’s individual-grant or expenditure-responsibility rules, or any purpose other than those described in Section 170(c)(2)(B).

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

Segregating the money is a separate question. Grantees that are already tax-exempt under Section 501(a) do not need to physically separate the funds or keep a distinct account unless the foundation requires it in the grant agreement.⁶ Non-exempt grantees face stricter accounting requirements. Many foundations require separate accounting across the board because it makes monitoring and reporting simpler.

Monitoring the Grantee

Once the grant is out the door, the foundation’s job shifts to oversight. It must require and review reports from the grantee at least annually, covering how the money was spent, whether the grantee complied with the agreement’s terms, and what progress was made toward the charitable objectives.⁶ Each financial report should reconcile funds received against itemized expenses so every dollar can be traced. A final report at the close of the grant period must give a complete accounting and confirm that the charitable purpose was fulfilled.

If a report reveals questionable spending, or if the foundation learns through other channels that funds may have been diverted, it must investigate promptly. Ignoring a red flag is treated the same as failing to exercise expenditure responsibility in the first place. When misuse is confirmed, the foundation should demand repayment, withhold any remaining installments, and document every step, because the IRS will want to see evidence that the foundation acted reasonably and quickly.²

The regulations do not expect foundations to prevent every possible misuse. They expect foundations to have procedures that catch problems and to act on what those procedures reveal. A foundation that monitors diligently, discovers a diversion, demands repayment, and reports the situation has met its obligations even if the money is never recovered.

Reporting to the IRS on Form 990-PF

Each year, the foundation must report all expenditure responsibility grants on Form 990-PF. A separate statement is required for each grant, and it must include: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 funds were diverted from the grant’s purpose.
The dates of reports received from the grantee and the date and results of any verification the foundation undertook.

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

What Happens If You Fail

A grant that fails expenditure responsibility is classified as a taxable expenditure, and the tax structure runs in two tiers.

First-Tier Taxes

The foundation owes an initial 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.¹ The manager’s tax applies only when the agreement was willful and not due to reasonable cause, but proving reasonable cause after the fact is difficult.

Second-Tier Taxes

If the foundation does not correct the problem within the taxable period, the foundation faces an additional 100 percent tax on the grant amount, and a manager who refused to agree to the correction owes 50 percent, capped at $20,000 per expenditure.¹

What Correction Means

Correction means recovering the grant funds to the extent possible. Where full recovery is not feasible, the foundation must take whatever additional corrective action the IRS prescribes. For failures involving missing or incomplete reports rather than actual fund diversion, correction simply means obtaining or filing the required report.¹ The taxable period runs from the date the taxable expenditure occurs until the earlier of the IRS mailing a notice of deficiency or assessing the first-tier tax, so the window is not unlimited.

Program-Related Investments

Expenditure responsibility does not stop at grants. It also applies to program-related investments, where the foundation makes a loan, equity investment, or similar financial commitment for charitable purposes. The written agreement requirements are similar but tailored to the investment context: the recipient must commit to using funds solely for the stated purpose, repaying amounts not used for that purpose (with appropriate limits for equity investors), and avoiding lobbying, political activity, and impermissible sub-grants.⁸ Annual financial reports are pegged to what a commercial investor would ordinarily require in a comparable situation, which gives foundations flexibility to request data that fits the deal.

Skipping the Process: Equivalency Determination

For foreign grantmaking, an equivalency determination can eliminate the need for expenditure responsibility altogether. The determination is a legal analysis concluding that a foreign organization is the functional equivalent of a U.S. public charity, allowing the foundation to treat the grant as if it were made to a domestic public charity.³

The determination must come from a qualified tax practitioner and apply U.S. public support tests to the foreign entity’s financial and governing documents. The foundation can rely on it in good faith as long as the underlying law has not changed and the factual information used is reasonably current. Written advice is generally considered current for up to two years after it is provided, depending on the timing relative to the grantee’s fiscal year, and where the practitioner reviewed a five-year public support test period, the determination remains current for the two taxable years immediately following that period.⁹

Grants to government units qualify as another shortcut, since they do not require expenditure responsibility and count as qualifying distributions under Section 4942.⁴ If the grant is earmarked for use by an individual, though, 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