Effective philanthropy requires more than generosity. Foundations and major donors operate under specific legal rules, private foundation excise taxes, self-dealing restrictions, and grantmaking compliance requirements, that shape how giving actually gets structured. This post covers what funders and grant-seekers alike should understand.
Table of contents
What’s the difference between a private foundation and a public charity?
Both are 501(c)(3) organizations, but they operate under different rules. Private foundations, typically funded by a single source such as a family or company, face additional excise taxes, minimum annual distribution requirements, and restrictions on self-dealing between the foundation and its founders or related parties. Public charities, which draw support from a broader base of donors, face fewer of these additional restrictions.
The distinction matters from the start of formation, since it shapes ongoing compliance obligations for the life of the organization. Founders sometimes assume a private foundation is simply the natural choice for family philanthropy without weighing whether a donor-advised fund or even a public charity might better fit their goals.
What is expenditure responsibility, and when is it required?
When a private foundation makes a grant to an organization that isn’t itself a public charity, an individual, a foreign organization without equivalent status, or certain other non-501(c)(3) entities, it generally must exercise expenditure responsibility: a defined process of pre-grant inquiry, a written grant agreement with specific terms, and ongoing reporting to confirm the funds were used for their charitable purpose.
Failing to follow expenditure responsibility procedures on a grant that requires them can expose the foundation to excise tax penalties. Foundations making grants to entities or causes other than a public charity should confirm whether expenditure responsibility applies before the grant agreement is signed, not after.
What questions should a funder ask before making a grant?
Ask how a prospective grantee measures program outcomes, what share of funding goes directly to programs versus overhead, and whether the organization has a documented conflict of interest policy. Request the most recent Form 990 and confirm the organization’s good standing in its state of incorporation. Reviewing governing documents for red flags around board independence or related-party transactions rounds out a solid due diligence process.
Organizations that are transparent about their finances and governance are generally easier to evaluate with confidence, and evasiveness about basic financial questions is a warning sign worth taking seriously before a significant gift.
What should grantmaking compliance cover on an ongoing basis?
Beyond individual grant due diligence, foundations need systems for tracking minimum distribution requirements, documenting self-dealing avoidance, and maintaining records that would satisfy an IRS inquiry into the foundation’s grantmaking practices. This is particularly important for family foundations where board members and grant recipients may have personal or professional connections that need to be properly disclosed and managed.
Jova Law advises foundations and individual philanthropists on entity selection, grantmaking compliance, and due diligence. Learn more about our Philanthropy, Grantmaking & Foundations practice.