Question: May a private corporate foundation or corporate giving program make a grant to a newly-established charity that has not yet received its IRS tax exemption letter?
Answer: Yes, but when making a grant to a charity whose application for exempt status is pending before the IRS, a private corporate foundation must exercise expenditure responsibility. Corporate giving programs must be aware that the charitable deduction for the grant will be disallowed if the charity does not subsequently receive retroactive recognition of its tax exempt status from the IRS.
Whenever a private corporate foundation makes a grant to almost any organization other than a 501(c)(3) public charity, it must exercise expenditure responsibility. Grants to non-charities, even to other private foundations, are considered "taxable expenditures" and will result in significant penalties for the corporate foundation unless the expenditure responsibility steps are followed. Generally, an organization is not considered to be a public charity until it has a determination letter from the IRS stating that its public charity status has been recognized. Exceptions to this general rule include churches and charities that are covered by a group exemption letter.
Public charity status, once granted, is generally retroactive. That means it is considered to have been in place back to the date the organization was formed. But "generally" does not mean "always." Retroactive status is not available where the charity waits more than 27 months from the date on which it was created to apply for exemption. Retroactive status may also be denied when the IRS insists on significant changes to the organization before granting public charity status. Furthermore, until that letter is issued by the IRS, there is no guarantee that public charity status is forthcoming; an organization that applies expecting to be a public charity may instead be classified as a private foundation or as a non-charity. Finally, it can be more than a year from the time an organization is created to the time it receives its determination letter. Since it will be impossible for a private foundation to go back and correct the problem if the grantee fails to get its public charity letter, the foundation must exercise expenditure responsibility from the beginning to avoid significant penalties.
Expenditure responsibility is a 5-step procedure that is designed to ensure that foundation funds are used for exclusively charitable purposes. The five basic steps that are required for completing expenditure responsibility include:
- Conducting a pre-grant inquiry,
- Signing a written grant agreement with the grantee,
- Requiring that the grantee maintain the funds in an account that is not commingled with noncharitable funds,
- Requiring regular reports from the grantee, and
- Reporting to the IRS on Form 990-PF that expenditure responsibility requirements were met.
The good news is that while a foundation may have to start the expenditure responsibility process with a grantee whose exemption application is pending, it may not need to complete it. Remember that in most cases an organization's charitable tax status will be made retroactive to its formation. If the organization's public charity tax status is determined before the end of the foundation's tax year, a grant made during the application period can retroactively be deemed a grant to a public charity. A foundation in such a situation should be able to suspend the exercise of expenditure responsibility.
A corporation that makes grants through a corporate giving program can claim a charitable contribution deduction for grants made to a Section 501(c)(3) charity that has received a determination letter from the IRS. A charitable contribution deduction may also be claimed prior to the organization's receipt of a favorable determination letter if the organization has timely filed its application for recognition of tax-exempt status. If the grantee's application is denied by the IRS after the charitable contribution is claimed, the charitable contribution deduction will be disallowed. For this reason, it is often prudent to wait until a grantee receives its determination letter before making a grant from a corporate giving program.