Aligning private foundation grantmaking procedures with PPA requirements
The Pension Protection Act of 2006 (PPA) brought many changes to the charitable sector. The most significant changes for private foundations are the rules for making grants to certain kinds of supporting organizations. While the number of grants actually affected by these rules is small, private foundations should review and update their grantmaking policies and procedures to meet the requirements and avoid potential IRS penalty taxes. Such a review and update of policies is necessary even for private foundations that only make grants to section 501(c)(3) organizations. Simply checking a potential grantee’s section 501(c)(3) status alone is not sufficient to comply with the law.
- What is a supporting organization?
- What is a supported organization?
- Can a private nonoperating foundation make a grant to a supporting organization?
- Which grants count toward “payout” and do not require a private foundation to use expenditure responsibility?
- Which grants will not count toward a private foundation’s payout?
- Determining Supporting Organization Status and Type
- What procedures can we implement to determine if control by disqualified persons is present?
- Who are disqualified persons?
- Practical Considerations
What is a supporting organization?
Put simply, a supporting organization is a section 501(c)(3) organization that qualifies as a public charity because it has a close relationship with another publicly supported organizations, typically another section 501(c)(3) organization. Absent this close relationship, the supporting organization would likely qualify as a private foundation. See “What is a Supporting Organization? ” for more information.
A supported organization is the Section 509(a)(1) or 509(a)(2) organization that the supporting organization is designed to support. In some cases, a supported organization may also be a section 501(c)(4), 501(c)(5) or 501(c)(6) organization. A supporting organization may have one or many supported organizations. In some cases, a supporting organization may have a class of supported organizations, such as all public universities in a particular state.
Can a private foundation make a grant to a supporting organization?
Yes. It’s clear that a private foundation can make grants to supporting organizations of all types. However, the technical type of the supporting organization will determine whether the foundation needs to follow specific grant procedures and whether the grant is includible in a foundation’s payout.
Which grants count toward “payout” and do not require a private foundation to use expenditure responsibility?
Private foundations may count toward their minimum distribution requirement (or “5 percent payout”) any grants made to Type I and Type II supporting organizations, and grants to those Type III supporting organizations that qualify as functionally integrated, provided no control by disqualified persons exists. In awarding such grants, private foundations are not required to follow expenditure responsibility.
Which grants will not count toward a private foundation’s payout?
Grants to Type III supporting organizations that are not functionally integrated may legally be made, but will not count toward the private foundation’s payout requirement and must be made using expenditure responsibility procedures. The same is true for grants to those Type I and Type II,or Type III non-functionally integrated supporting organizations where there is a presence of control by disqualified persons.
The IRS issued guidance (Notice 2006-109 ) to help private foundations determine whether an organization is a supporting organization and if so, how to determine what type. We broke this guidance into three steps, which should help private foundations develop procedures to determine whether they must exercise expenditure responsibility when making a grant to a public charity . Learn more about determining supporting organization status .
What procedures can we implement to determine if control by disqualified persons is present?
The available IRS guidance suggests one method for determining whether control is present. Specifically, if the private foundation is considering making a grant to a Type I, Type II, or functionally integrated Type III supporting organization, the foundation should request a list of organizations that the potential grantee supports. Then the foundation may work with its disqualified persons to determine whether the grantee or any of the supported organizations on the list are controlled by disqualified persons. For example, the private foundation might ask the foundation’s disqualified persons to certify whether they control the grantee or one of the grantee’s supported organizations, either directly or indirectly. Other foundations may choose to seek certifications directly from the grantee and its supported organizations which indicate that disqualified persons of the private foundation (as identified by the private foundation) do not control the organization. At some point, the IRS may issue guidance to clarify the steps. However, until that time, a private foundation should work with its local counsel to determine policies and procedures that adhere to the law.
- foundation managers (officers, directors, trustees, or individuals with similar responsibilities)
- substantial contributors (defined as any person who has contributed an aggregate amount of more than $5,000 to a private foundation, if such amount is more than 2 percent of the total cumulative contributions received by the foundation prior to the end of the taxable year in which the person makes a contribution)
- individuals who own more than 20 percent of a business enterprise that is a substantial contributor
- family members of any person described above (spouse, ancestors, lineal descendants, and spouses of lineal descendants)
- corporations, partnerships, trusts, or estates in which a person described above owns more than 35 percent the voting power, profits interest, or beneficial interest
A private foundation likely will find that the PPA rules affect only a few grants. However, the key is having a process in place to identify those few. What happens next is up to the foundation.
- Some foundations may determine that the foundation or giving program makes so few grants to supporting organizations that it is easier to exercise expenditure responsibility for all such grants, rather than undertake an inquiry about supporting organization type or control relationships.
- Others will develop processes that go through all the steps necessary to determine whether expenditure responsibility is required and then only exercise expenditure responsibility in cases absolutely required by law.
- Still others may choose to make a grant directly to a supported organization rather than exercise expenditure responsibility over a grant to an affected supporting organization.
Regardless of the foundation’s policy, each foundation should review its policies on an ongoing basis to ensure it addresses all of the necessary questions about a grantee’s charitable status.
- Expenditure Responsibility Chart for Private Foundations 
Explains which grants to section 501(c)(3) organizations from private foundations require expenditure responsibility
- Private Foundation Grants: Is Expenditure Responsibility Required? 
Flow chart summarizing one method for determining whether expenditure responsibility is required for a particular grant