Discretionary Grants
Family foundations use discretionary grantmaking to achieve a variety of purposes. Discretionary grantmaking allows some foundations to avoid strife by giving each branch of the extended family a sum of money that it can think of as its own to control. For others, a discretionary fund provides training for the next generation of family trustees. Still other foundations find that allowing discretionary grants can help keep family members who are geographically or ideologically distant from the rest of the group interested in the foundation's work. Finally, some foundations use discretionary grantmaking as an alternative to trustee compensation; trustees may be more willing to serve if they know that they can steer grants to their favorite charities.
There is no legal definition of discretionary grantmaking, but most people understand the term to mean a formal or informal system under which certain individuals or groups connected to the foundation have the privilege of making grants to charities of their choosing without extensive review by others. So long as the grants made do not stray outside the foundation's purposes as approved by the IRS and do not violate prohibitions such as the rule against self-dealing, they should not get the foundation or its managers into legal trouble. Nonetheless, foundations reviewing an existing or proposed discretionary grant program should keep some basic legal principles and operational guidelines in mind.
Legal Principle:
Discretionary grants cannot be made for purposes that are outside the foundation's purposes as approved by the IRS.
A foundation's organizing documents, its deed of trust or certificate of incorporation and bylaws, generally set out the purposes of the charity. These may be as broad as making grants for any purpose described in Section 501(c)(3) (the provision in the Tax Code that lists all of the activities that the Internal Revenue Service considers charitable) or as narrow as making grants to increase public awareness of a single issue. It is this purposes' language that the IRS reviews when it grants charities, such as foundations, their exemption from income taxes, and the IRS grant of exemption is conditioned on a charity's continuing to operate for these purposes. Thus, no foundation grants, including discretionary grants, can be made for purposes other than those listed in the foundation's organizing documents.
This limitation poses little problem for a foundation with a broad purpose clause (any purpose described in Section 501(c)(3)), but could be a challenge for a grantmaker with a narrow focus. Whether the limitation in the organizing document relates to a geographical region or a subject area, discretionary grants cannot violate it.
Practice Pointer:
Make policy decisions about how discretionary grantmaking will fit into the foundation's overall program.
Many foundations have adopted mission statements and grant guidelines that are
considerably narrower than the purpose provisions in their organizing documents. Making a grant outside the areas described in the mission statement or grant guidelines will generally not place the foundation in legal jeopardy, but foundation managers should consider how these grants will relate to the foundation's other grantmaking. If the foundation is focused on environmental issues, should discretionary grants be allowed to unrelated arts or education groups? If the foundation has chosen to limit its grantmaking to a specific geographic area, will those with discretionary funds be permitted to suggest grants beyond the region? If the foundation's major donors expressed personal or political goals for the foundation's work, may discretionary grants be made to organizations that do not further those ends? These are policy choices that are best made and documented before a discretionary grants program begins.
Legal Principle:
Like all private foundation grants, discretionary grants are subject to all the private foundation rules, including the prohibition on self-dealing, and all foundation managers are accountable for discretionary grants.
Labeling a grant ‘discretionary’ does not free it from the rules that govern private foundation expenditures. This means that a discretionary grant cannot be made for a prohibited purpose (to help elect a candidate for public office, for example) or to a non-charity, unless the foundation exercises expenditure responsibility. Grants also cannot be made if they will provide a financial benefit to someone the Tax Code deems a ‘disqualified person’ (a category that includes the foundation's major donors, managers and their family members). A grant that fulfills the pledge of a disqualified person or results in goods or services being provided to a disqualified person would be likely to violate this prohibition on self-dealing.
The discretionary label also does not change the Tax Code's position on who is responsible for any violations of the foundation rules. Regardless of whether other foundation managers review the suggestions of the individual or groups with discretionary grantmaking authority, all foundation managers are equally accountable for the actions of the foundation. If a discretionary grant is found to violate the self-dealing rules, for example, a foundation board member cannot avoid a penalty tax by saying that he or she did not review or approve the grant suggestion; indeed, a failure to review might lead to charges that the board violated its fiduciary duty to oversee the expenditures of the charity.
Practice Pointer:
Develop procedures ensuring that all discretionary grants will receive appropriate review and approval.
No discretionary grant should be made without the knowledge and approval of the foundation's board. This does not mean that the entire board must have an extended debate on the merits and drawbacks of each and every grantee that is proposed; the board could delegate review of discretionary grants to a subcommittee of members that includes individuals other than those making discretionary grant suggestions. The board could also resolve to approve grants that meet a set of discretionary grant guidelines with a minimum of process.
At a minimum, the board must take steps to assure itself that the proposed grants do not violate any of the private foundation rules. Asking those with discretionary grantmaking privileges to complete a simple form in connection with each suggested grant is probably the most efficient way to do so. The form might ask for the name and address of the organization, a confirmation that it is a 501(c)(3) public charity and a brief description of the purpose of the grant if it is for anything other than general support. The form might also include an affirmation by the grant's sponsor that the payment will not result in goods or services being provided to him or her or any other disqualified person, and that the grant does not fulfill an outstanding pledge by a disqualified person. Retaining this completed form in the foundation's grant files can help the foundation document its good stewardship of discretionary funds, should the IRS, a state attorney general or the local newspaper ever inquire.
Discretionary grants can strengthen family foundations in many ways. By ensuring that their foundation's discretionary grants program is strong and well-run, foundation managers can maximize the benefits of this form of grantmaking.
