Private Foundation Grant Agreements: Basics and Beyond Elaine Waterhouse Wilson Quarles & Brady, LLP April 17, 2008

Grant Agreements, Generally A legal contract between an organization granting money and the organization receiving funds governing the distribution and use of grants funds What needs to be in the agreement varies based on Federal tax law State law – contract law basics Individual circumstances

What Law Applies? What the law requires will depend upon the classification of the both the donor and the recipient. The requirements for a grant given by a "private foundation" are far more stringent than for those given by a "public charity" The requirements for a grant given to a public charity are less stringent than those given to a private foundation, another tax-exempt entity or a for profit organization.

So, What Are You? In every day language, a foundation is generally thought of as being the same as a "charity" or an "endowment" There is a technical tax term "private foundation" Versus public charity (including supporting organizations) Versus Section 501(c)(3) organization Versus other tax-exempt entity (e.g. Section 501(c)(6)) Versus non-profit entity

Why Do We Care? Separate Legal Entity with separate tax status Consequences of Private Foundation Status Section 501(c)(3) requirements plus Private Foundation Excise Taxes Charitable Contribution Income Tax Deduction limits

Chambers of Commerce Most Chambers of Commerce are "business leagues" exempt from income tax under Section 501(c)(6) Tax exempt and nonprofit, but not a charity, foundation or endowment Some Chambers of Commerce have an affiliated "foundation" to undertake charitable work Usually a Section 501(c)(3) organization so as to be able to accept charitable contributions and grants For tax purposes, can be a "private foundation" or a public charity Section 170(b)(1)(A)(vi) or A supporting organization under Section 509(a)(3)

Parties to the Contract As a first step in drafting any grant agreement, identify the proper parties Get formal legal names and document it – you may find surprises Search the IRS website (Publication 78) Watch for -- Name changes and "d/b/a"s Departments, institutes and programs Affiliated entities such as "foundations" and "endowments"

Bad Fiscal Agents What if a foundation or individual wants to make a donation to an organization that is not a Section 501(c)(3) or a public charity BUT wants to get an income tax deduction or avoid Section 4945? You can't have your cake and eat it too! You cannot "use" another organization's tax exempt status Another Section 501(c)(3) cannot take the money and hand it over to you

Good Fiscal Agents A Section 501(c)(3) organization can make grants to a non-Section 501(c)(3) organization, if the grant is for charitable purposes The Section 501(c)(3) fiscal agent isn't an "agent" at all – it accepts the money and is responsible for it It may be subject to restrictions on use but watch the problem of "earmarking" The agent has the authority and discretion to make grants to the non-Section 501(c)(3) organization and to exercise fiduciary responsibility over the money

Section 4945 Taxable Expenditures Once you have the proper parties, then you need to determine the rules of the grant As both public charities and private foundations are exempt under Section 501(c)(3), both are required to make sure that their assets are used for Section 501(c)(3) purposes In addition, private foundations must comply with Section 4945, which governs the manner in which foundations may make grants Private foundation must comply; failure to comply results in an excise tax and a requirement to correct Other grant making organizations can look to the Section 4945 rules for best practices and good governance procedures

What is a Taxable Expenditure? Any amount paid by a private foundation for one of the following purposes: Certain Lobbying All Political Activity Grants to individuals for travel, study or similar purposes unless it meets the requirements of Section 4945(g) Grants to organizations unless The organization is a "favored organization" OR The private foundation exercises expenditure responsibility Any grant make for a non-chartable purposes Appropriate charitable purposes are described in Section 170(c)(2)(B)

Non-Charitable Expenditures The purpose of a grant – whether from a public charity or a private foundation – must be for charitable purposes Religious, charitable, scientific, literary or educational purposes, or to foster national or international amateur sports competition (but only if no part of its activities involve the provision of athletic facilities or equipment) or for the prevention of cruelty to animals All Section 501(c)(3) organizations need to be organized and operated for these purposes Can cost an organization its tax exempt status under Section 501(c)(3) In addition, private foundations are subject to the Section 4945 taxable expenditures excise tax for violations

Gifts to the Chamber? Can a Section 501(c)(3) "foundation" give money to a Chamber of Commerce exempt under Section 501(c)(6) ? If it's is a grant and the foundation is a "public charity," then yes, but it always must be limited to be used for Section 501(c)(3) purposes – what steps do you take to make sure that happens? If it’s a grant and the foundation is a "private foundation," then yes, but it must be used for Section 501(c)(3) purposes and the Section 4945 rules for grants to organizations must be followed (i.e., expenditure responsibility – see later discussion). If it's an expense reimbursement (shared staff or overhead) and the foundation is a public charity, then it must be in furtherance of the Section 501(c)(3) purposes of the charity and it must comply with the "excess benefit transaction rules" of Section 4958 – which requires some extra steps! If it's an expense reimbursement (shared staff or overhead) and the foundation is a private foundation, then it must be in furtherance of the Section 501(c)(3) purposes of the charity and it must comply with the prohibition on self dealing of Section 4941 – which is very difficult to do!

Lobbying Lobbying generally is contacting legislative officials regarding legislation, either directly or through grass roots activity Section 501(c)(3) organizations are limited in the amount of lobbying that they may do By statute, an "insubstantial amount" Private foundations are subject to additional limits under Section 4945 A private foundation itself cannot lobby A private foundation can not make grants to others that will be used for lobbying (can't do indirectly what you can't do directly) Should be directly prohibited in the grant agreement Very narrow exceptions to the definition of lobbying Technical assistance at the written request of the legislature Nonpartisan analysis and discussions of broad social issues Self-defense Lobbying

Political Activites All Section 501(c)(3) organizations are absolutely prohibited in engaging in political activities by statute. Period. Intervening in a campaign for public office on behalf of or in opposition to a candidate In addition, private foundations are subject to a Section 4945 excise tax on political activities You can't do indirectly what you can't do directly – so you cannot fund political activites through grants Prohibit political activities in your grant agreement Segregate funds if necessary

Grants to Individuals Grants to individuals for travel, study or similar purposes must meet Section 4945(g) Section 4945(g) requires the IRS to approve scholarship procedures IN ADVANCE Covers scholarships, fellowships and like awards Generally does not include grants to individuals for poverty or disaster relief

Grants to Organizations Grants to Favored Organizations – Mostly, public charities Section 509(a)(1) organizations Section 509(a)(2) organizations Some supporting organizations under Section 509(a)(3) Exempt operating foundations under Section 4940 Grants to Disfavored Organizations Some supporting organizations Other private foundations Other types of tax exempt entities (Section 501(c)(6)) Taxable or for-profit entities

Expenditure Responsibility Grants to Disfavored Charities are taxable expenditures unless you exercise expenditure responsibility over the grant Expenditure responsibility requires A written agreement Due diligence so you know the finances and operations of the charity Restrictions to make sure the funds are used for charitable purposes, which may include a segregated account (especially non-charitable entities) and special accounting rules Prohibitions on use for political and lobbying purposes Regular grant follow up, at least annually Defined record retention for certain grant documents Appropriate reporting to the IRS

Special Issue: Scholarships Private foundations making scholarships MUST get advance IRS approval of procedures Procedures must be objective and non-discriminatory Sufficiently broad charitable class to prevent private benefit Special rules for employer related scholarships

Special Issues: Foreign Grants Public charity equivalency test Get a legal opinion that the foreign charity is the same as a U.S. public charity OR Exercise expenditure responsibility Anti-terrorism issues Cannot intentionally, knowingly – and maybe willfully – support terrorists What steps can you take to prevent that?