Community Foundation Legal Question of the Month
We have a DAF advisor who is interested in making a grant to a new nonprofit organization that is still waiting on their 501(c)(3) determination. The grant they are recommending is for a specific project of the organization. Can we still make the grant if we do expenditure responsibility? If so, what information should we require in order to process this request?
Yes, if you decide you want to move forward with this grant before the nonprofit receives its determination letter, you will need to exercise expenditure responsibility. Although a newly approved 501(c)(3)’s status is retroactive to the date it filed its application with the IRS, you can’t presume the IRS will approve the application and should continue to treat it as you would any non-charity grantee until its status is official.
There are no specific pieces of information you are required to ask for as part of the expenditure responsibility pre-grant inquiry, but the IRS has stated: “The inquiry should deal with matters such as the identity, past history and experience, management, activities, and practices of the grantee organization, and should be complete enough to give reasonable assurance that the grantee will use the grant for the purposes for which it is made.” As part of this inquiry, it’s common to request basic financial information, details about the organization’s leadership/staff, or any other documentation that will give you a clear picture of the organization’s ability to use the grant for the intended purposes.
You will then need to enter into a written grant agreement establishing the charitable purpose(s) for which the grant is being made and requiring that grant funds only be used to further the stated purpose(s). The grant agreement should also state that no part of the grant may be used for lobbying activity, and that grant funds must be held in a separate account or accounted for separately on the grantee’s books.
Finally, the grantee will be required to provide regular reports, at least annually, until the grant funds are fully expended. Any amounts not used for the intended charitable purposes should be returned to the foundation.
Is there a legal clarification between using the term “Sponsor” vs. “Agent” when a Community Foundation enters into a fiscal sponsor/agent agreement?
Although the terms “fiscal agent” or “fiscal agency” are sometimes used by community foundations when they mean to refer to a fiscal sponsorship, we always try to stress that this is inaccurate and should be avoided.
Using the words agent or agency creates the appearance that there is a principal/agent relationship between the sponsored project and the foundation, with the foundation serving as an agent of the project. This would imply that the sponsored project directs or controls the activities the foundation carries out on the project’s behalf. If there were a true principal/agent relationship created by such an arrangement, contributions received from donors would be deemed as contributions made to the principal (the project) paid to its agent (the foundation), which would mean donors’ contributions would not qualify for a tax deduction.
A proper fiscal sponsorship doesn’t create a principal/agent relationship, because the foundation needs to have full discretion and control over all charitable funds raised for the purposes fulfilled by the project. Rather than acting at the direction of the sponsored project, the foundation needs to direct the use of the contributed funds to ensure they are applied exclusively to the charitable purpose for which they were raised.
It would be very unusual to see a true principal/agent relationship established for this kind of arrangement, because it would negate most of the benefits of fiscal sponsorship in the first place.
How far can community foundations push the IRS envelope of granting to local for-profit newspapers and radio stations?
Given that they are for-profit, assisting media companies requires an analysis of how such endeavors interact with the private benefit doctrine. The activity you are funding must not only be charitable but providing support for a for-profit must be absolutely necessary in order to achieve your charitable purpose.
The tax regulations state that a 501(c)(3) organization is not organized or operated exclusively for charitable purposes “unless it serves a public rather than a private interest.” The doctrine is broad and can apply to anyone to whom the foundation engages with. The key is determining what is impermissible private benefit—does the benefit to the public outweigh the private benefit both quantitatively and qualitatively?
Quantitative analysis is a balancing test. Is the private benefit incidental and insubstantial measured in the context of the overall charitable benefit conferred by the activity?
Qualitatively, is the incidental private benefit a necessary consequence of the charitable activity? Can the charitable purpose be achieved without necessarily benefitting private interests?
Here, the radio and newspapers, even though local, are for-profit media companies, thereby triggering the private benefit analysis. However, what is unclear is what exactly is the charitable purpose for which the foundation will assist these outlets. Keeping companies operational, albeit local ones, is not charitable in and of itself. Keeping media staff employed is not charitable either.
Disseminating local news and personal interest pieces may be charitable, but the way the doctrine works, the benefits flowing to media companies must be incidental and necessary to achieve the purposes of bringing local news and information to the region.
As such, assisting these companies is more akin to economic development. The economic development analysis requires that your financial support further a charitable purpose more than simply jumpstarting an economy or supporting commerciality in the region. Treasury has enumerated a list of traditional charitable purposes that have been developed by judicial decisions over time, and they may include purposes like (1) relief of the poor and distressed or of the underprivileged; (2) advancement of education or science; (3) erection or maintenance of public buildings, monuments or works: (4) lessening the burdens of government; (5) combatting community deterioration; etc. This list is not exhaustive.
To summarize: in order to support for-profit newspaper and radio stations, you will need to demonstrate that some charitable purpose is being supported, and that any benefits flowing to the for-profit companies are not only insubstantial but also necessary to achieve your identified charitable purposes.