Twelve Activities That Require Extra Oversight

Key Issues

Private foundation trustees and staff oversee countless activities. Several activities—some mandatory, others voluntary—call for additional care. In particular, according to your fellow foundation leaders and the advisors who serve them, missteps happen in conjunction with the following activities more often than elsewhere in foundation work.

Terms

Expenditure responsibility. Expenditure responsibility is a set of procedures allowing private foundations to make grants to nearly any entity, as long as the grants are for charitable purposes and follow all other legal guidelines. Learn more about expenditure responsibility

Action Items

Be sure to exercise sufficient oversight in the following areas:

  1. Reducing your excise tax—Foundations must pay a small excise tax on net investment income each year. The tax is usually 2% of net investment income minus certain expenses, although it is possible to qualify for a 1% rate if, generally speaking, your current year’s expenditures exceed by 1% of net investment income your average expenditures over the past 5 years. Be sure to calculate your qualifying distributions a month or two before the year’s end to see if a small increase in distributions would qualify your foundation for the 1% rate. Some foundations accelerate their distributions to qualify.

  2. Choosing alternative investments—Alternative assets, or alternatives, have become an increasingly popular way to address limitations in traditional equities and fixed income securities. It’s important to do your due diligence before investing, however. Be sure to:
    • Determine whether the investment is consistent with your investment policy.
    • Know if any limitations on withdrawals will create the potential for liquidity problems.
    • Determine whether the investment will generate unrelated business income, which may trigger a tax at corporate rates, a requirement to file Form 990-T, or filing obligations in multiple states.
    • Determine whether the investment will generate U.S. filings for transactions with a foreign investment vehicle or require other annual disclosures (e.g., Report of Foreign Bank and Financial Accounts [FBAR]).
    • Have legal counsel review all offering information.
    • Meet face-to-face with the investment firm’s management team and look for reputable third-party information on the fund and its managers.


  3. Engaging in transactions with foundation insiders—Self-dealing rules prevent private foundations from entering into a broad range of transactions with foundation insiders, called disqualified persons, unless specific exceptions apply. No topic within the private foundation rules raises as many questions and concerns as self-dealing, because the rules can be counterintuitive and the penalties steep.

    To avoid self-dealing in all cases, be sure to understand the rules and take care when leasing space from foundation insiders, inviting guests to fundraisers, paying personal pledges, compensating trustees and staff, and paying for family travel with foundation funds—activities that lend themselves easily to self-dealing. Consult knowledgeable legal counsel before engaging in any transactions with insiders and see ASF’s primer How to Avoid Self-Dealing.

  4. Filing your Form 990-PF—The Form 990-PF is a complex public document filed annually with the IRS that can stump even savvy accountants. Regulators conservatively estimate that at least 25% of 990-PFs have errors, yet foundation managers and their accountants can easily avoid mistakes if they know what to look for. For dozens of tips and a complete sample Form 990-PF, see ASF’s primer Filing the Form 990-PF.

  5. Making program related investments (PRIs)—PRIs are loans, loan guarantees, or other investments to charitable or for-profit entities that count toward a foundation’s distribution requirement if they serve a charitable purpose and meet a few basic requirements.

    Although foundations can make PRIs through reputable intermediaries without much more diligence than a typical grant, making PRIs directly requires additional care, including: 

    • Structuring the PRI so that profit is not its primary purpose
    • Confirming, with help of an attorney, that the PRI serves a charitable purpose
    • Exercising expenditure responsibility if the PRI is made to a non-501(c)(3) public charity
    • Monitoring the PRI’s progress, perhaps more intensely than for a typical grant, and intervening in the event of problems or changes
    • Reporting the PRI appropriately on your foundation’s Form 990-PF


    See ASF’s primer Leveraging Your Assets With Loans and Other Program Related Investments (PRIs).

  6. Making international grants—Private foundations may give directly to non-U.S. organizations for charitable purposes by making an equivalency determination or exercising expenditure responsibility. Foundations that give internationally (as well as domestically) must also comply with antiterrorism rules (see www.usig.org).

    An alternative to giving directly overseas, grants to U.S.-based intermediaries that have networks in foreign locations may reduce a foundation’s due diligence. Although simpler, this option may limit a foundation’s opportunity for direct contact with the beneficiaries of its grants. See ASF’s primer International Grantmaking: Opportunities for Small Foundations.

  7. Making grants to supporting organizations—Supporting organizations are not publicly supported but, rather, are closely associated with publicly supported charities. Examples include some university or hospital foundations, foundations created to support libraries or elementary schools, or personal trusts created to benefit particular public charities.

    Private foundations may make grants to supporting organizations (also known as 509(a)(3) public charities), but grants to certain types of supporting organizations may require expenditure responsibility and/or may not count as qualifying distributions.

    The restrictions on grants to supporting organizations vary by type of supporting organization and whether disqualified persons control it or its supported organization. It is critical for private foundations to know every grantee’s 509(a) status so as to not inadvertently incur a large fine.

    For step-by-step instructions to determine any grantee’s tax status, see the tear sheet It’s Not Enough to Know Your Grantee Is a 501(c)(3). If you wish to fund a 509(a)(3) supporting organization, be sure to follow the steps outlined in ASF’s tear sheet Supporting Organizations.

  8. Making grants to individuals—Private foundation can make grants to individuals. The rules vary by the grant’s purpose, but, as a general rule, all grants to individuals must be awarded on an objective and nondiscriminatory basis. For details, see ASF’s primer Awarding Grants to Individuals.

  9. Making grants to non-501(c)(3) public charities—Private foundations may make grants for charitable purposes to organizations without 501(c)(3) public charity status, including the Rotary, labor unions, chambers of commerce, government entities, and even for-profit entities, but the foundation must exercise expenditure responsibility for the grants to count toward the foundation’s 5% payout. Grants to other private foundations are permitted as well, although grants to private non-operating foundations require more than just expenditure responsibility to count toward the foundation’s 5% payout. See ASF’s primer Legal Essentials for Small Foundations.

  10. Making large grants to small organizations—Most public charities must demonstrate that they have (or plan to have) sufficient amounts of public funding to retain their public charity status. One large grant by a single private foundation can cause a grantee to tip out of its favored public charity status into that of private foundation—a status most public charities want to avoid. It is critical to understand how to avoid tipping while still allowing your grantees to realize the benefits of a large grant. See ASF’s tear sheet How to Avoid Tipping a Public Charity.

  11. Making grants to a fiscal sponsor—Rather than exercise expenditure responsibility when funding organizations or projects that do not have public charity status, private foundations may choose to fund fiscal sponsors with public charity status.

    In theory, fiscal sponsorships are relatively simple: A fiscal sponsor retains legal control and discretion over the funds it receives on behalf of the sponsored organization or project. In practice, however, grants to fiscal sponsors require special care. Foundations cannot earmark grants to fiscal sponsors for particular organizations or projects. Be sure to seek knowledgeable legal counsel before entering into such arrangements.

  12. Making grants for or engaging in advocacy—Foundations can legally fund or engage in many types of advocacy, although partisan political activity, most lobbying, and grants earmarked for lobbying are prohibited. Whether your foundation is interested in funding nonpartisan voter registration, training grantees to be effective advocates, or engaging in self-defense lobbying, be sure to seek knowledgeable legal counsel and follow the specific rules. See ASF’s primer Funding and Engaging in Advocacy.

Additional Resources

Many thanks to Tom Blaney, CPA, CFE, of O’Connor Davies Munns & Dobbins, LLP; Andras Kosaras, Esq., of Arnold & Porter, LLP; and Alan Rothschild, Jr., Esq., of Hatcher, Stubbs, Land, Hollis & Rothschild, LLP.