Ideally, grantmakers will work with an existing charity or other well-established organization to provide disaster relief. But in the months after a disaster, it is not uncommon to see new charities cropping up in efforts to meet the immense and diverse needs of the affected communities. The problem is that it may take many months before a new organization is officially eligible to receive charitable contributions. 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. Grants to such organizations can legally be made, if grantmakers use caution to ensure the funds will not be taxable expenditures and will be put toward legitimate charitable use. To do this, private foundations and those making grants through donor advised funds must exercise expenditure responsibility. Community foundations, public foundations and other public charities should also adhere to due diligence procedures patterned closely after the expenditure responsibility rules. Corporate giving programs must be aware that the charitable deduction for the grant will be disallowed if the grantee ultimately fails to receive retroactive recognition of charitable status from the IRS.
Exceptions to this general rule include churches and charities that are covered by a group exemption letter. Since such groups are eligible under their group exemption (a larger church or charity), failure to achieve their own status as a charity does not affect charitable contributions.
Once new organizations receive public charity status, it is generally retroactive back to the date the organization was formed. However, retroactive status is not applicable when 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.
A drawback for many grantmakers when funding new organizations is, until the final determination letter is issued by the IRS, there is no guarantee that public charity status is forthcoming. The IRS may ultimately decide the organization is more appropriately classified as a private foundation or even as a non-charity.
Another factor is the length of time it takes for the organization to hear back from the IRS. It can take more than a year from the time an organization is created to the time it receives a definitive response from the IRS.
Since it will be impossible for a foundation to go back and correct the problem if the grantee fails to get its public charity letter, the foundation must follow the rules for making grants to a non-charity. In many cases, this means exercising expenditure responsibility.
The good news is, while a foundation may have to start the expenditure responsibility process with a grantee whose charitable status is pending, it may not have to complete it. Remember, 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 direct grants (e.g. through a corporate giving program) can only 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 be claimed prior to the grantee’s receipt of an IRS 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 for corporations to wait until a grantee’s public charity status is official.