Private Foundation: New Rules Recognizing Mission-Related Investments

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On September 15, 2015, the IRS released Notice 2015-62, Investments Made for Charitable Purposes, which may provide comfort to private foundations about making mission-related investments with reasonable business care without violating the jeopardizing investments laws. It is hoped that this guidance will catalyze greater impact investing by foundations using their endowment assets.

Mission-Related Investments

While a mission-related investment or MRI is not currently defined by the Internal Revenue Code or Treasury Regulations, it is generally considered to be an investment for both a financial return and a social impact return (more specifically, one that advances the particular mission of the investor). In some cases, there may be no need to balance those potentially competing concerns. But in many cases, the investor will need to balance at least short-term financial return with the social impact return. Some simple examples of MRIs include a purchase of equity in a company creating jobs in economically disadvantaged communities, a loan to an organization distributing essential resources in developing countries, and an investment in an alternative energy company.

See Mission-Related Investing: Legal and Policy Issues to Consider Before Investing (MacArthur Foundation)

Jeopardizing Investments

According to the IRS: “Jeopardizing investments generally are investments that show a lack of reasonable business care and prudence in providing for the long- and short-term financial needs of the foundation for it to carry out its exempt function.”

Substantial penalty taxes may be imposed on private foundations that make jeopardizing investments pursuant to Section 4944 of the Internal Revenue Code. The foundation may be subject to a first-tier tax of 10% of the relevant amount so invested for each year in the taxable period. A 25% second-tier tax may be imposed if the violation is not corrected within the taxable period. Foundation managers (including directors) who knowingly participated in making that investment may also be subject to a first-tier tax of 10% and a second-tier tax of 5% of the relevant amount.

The general approach to avoiding the tax on jeopardizing investments is to invest in a reasonably diversified portfolio of assets rather than in a small number of speculative investments. The IRS provides: “In deciding whether the investment of an amount jeopardizes carrying out the exempt purposes, a determination must be made on an investment-by-investment basis taking into account the foundation’s portfolio as a whole.”

There is a specific exclusion from the jeopardizing investment prohibition for program-related investments (PRIs). Generally, a PRI is an investment in which (1) the primary purpose is to accomplish one or more charitable purposes; (2) the production of income or the appreciation of property is not a significant purpose; and (3) lobbying or electioneering is not a purpose. A PRI might take the form of a loan to a charity or a loan to, or equity investment in, a business entity for a charitable purpose, such as, to develop or distribute a lifesaving drug for use in developing countries that would not otherwise be commercially viable.

See Private Foundation – “Jeopardizing investments” defined (IRS)

The New Guidance

According to the IRS, Notice 2015-62 “confirms that under section 4944 of the Internal Revenue Code, private foundation managers may consider the relationship between a particular investment and the foundation’s charitable purpose when exercising ordinary business care and prudence in deciding whether to make the investment.”

In other words, it’s not a lack of reasonable business care and prudence (and therefore not a jeopardizing investment) merely because the private foundation managers consider the social impact return related to the foundation’s mission as well as the financial return the investment may produce in selecting an investment.

Prior to this guidance, it was uncertain whether private foundation manager could select an investment whose primary purpose was to accomplish one or more charitable purposes where the production of income or the appreciation of property was also a significant purpose, making the investment fall outside of the definition of a PRI. The Notice specifically states:

Foundation managers are not required to select only investments that offer the highest rates of return, the lowest risks, or the greatest liquidity so long as the foundation managers exercise the requisite ordinary business care and prudence under the facts and circumstances prevailing at the time of the investment in making investment decisions that support, and do not jeopardize, the furtherance of the private foundation’s charitable purposes.

Notably, this conforms the standard under federal tax laws with the state prudent investment laws under the Uniform Prudent Management of Institutional Funds Act (UPMIFA), “which generally provide for the consideration of the charitable purposes of an organization or certain factors, including an asset’s special relationship or special value, if any, to the charitable purposes of the organization, in properly managing and investing the organization’s investment assets.”


Michele Berger: On a webinar hosted by Mission Investors Exchange and the Council on Foundations titled “Impact Investing and Private Foundations: New Guidance from the IRS and Its Implications for the Field“, the following tips were discussed.

While foundations may now enjoy more comfort and less ambiguity when making impact investments, foundation managers must still exercise the same ordinary business care and prudence when making such investments. Some suggestions for implementing a process for MRIs include:

  • having a separate portfolio for impact investments;
  • creating a policy statement within the organization that addresses how to make MRIs;
  • looking at what the foundation sees as its purposes (examining Articles of Incorporation, the mission statement, programs) and measuring how the investment is tied to those purposes;
  • documenting the decision and rationale for the investment in meeting minutes or a summary of the investment;
  • making sure the board and senior management is apprised of such decisions and processes; and
  • consulting counsel.

See New IRS Rule Likely to Make Impact Investing Easier, The Chronicle of Philanthropy


International Grantmaking: Expenditure Responsibility


Private foundations in the United States are often interested in funding promising organizations and projects that are based outside of the country. When doing so, these foundations are required to follow certain rules and procedures promulgated by the IRS to help ensure that the foreign grantees are properly using those funds for charitable purposes. Currently, when a private foundation engages in international grantmaking, it has two options for complying with these rules: exercising expenditure responsibility or conducting an equivalency determination.

What is Expenditure Responsibility?

Expenditure responsibility (also referred to colloquially as “ER”) means that the foundation exerts all reasonable efforts and establishes adequate procedures:

  1. To take certain precautions to ensure that the grant funds will be spent for proper purposes (in connection with this requirement the foundation must conduct a pre-grant inquiry concerning potential grantees and make all its grants subject to a certain type of written grant agreement with the grantee);
  2. To obtain full and complete reports from the grantee on how the funds are spent; and
  3. To make full and detailed reports to the IRS on the expenditures.

When is an Expenditure Responsibility Required?

ER is generally required whenever a private foundation makes a grant to an organization other than (i) a public charity described by Internal Revenue Code (IRC) §509(a)(1) or (2); (ii) a pubic charity described by IRC §509(a)(3) – or supporting organization – other than a non-functionally integrated Type III supporting organization; and (iii) an exempt operating foundation described in IRC §4940(d)(2), which has been publicly supported for at least 10 years. Accordingly, ER is required when a private foundation makes a grant to:

  • a foreign nongovernmental organization (NGO), unless an equivalency determination is conducted;
  • a private foundation (other than an exempt operating foundation);
  • a 501(c)(4) social welfare organization, 501(c)(5) labor union, or 501(c)(6) business league; or
  • a non-tax exempt (for-profit) business (for exclusively charitable purposes).

Pre-Grant Inquiry

The pre-grant inquiry should concern itself with matters such as:

  • the identity, prior history, and experience of the grantee and its managers; and
  • whether the grantee has a history of compliance or noncompliance with the terms of previous grants, and any knowledge concerning the management, activities, and practices of the grantee.

The scope of the pre-grant inquiry will vary in each case depending on —

  • the size and purpose of the grant;
  • the period over which it will be paid; and
  • any prior experience the grantor has had with the grantee.

The Internal Revenue Service Manual provides that “[o]rdinarily, no further pre-grant inquiry is necessary where a grantee has properly used all prior grants and filed the required reports.”

The grant agreement for an ER grant must include the following:

  • the grant purposes, which can include contributing to capital endowment, purchase of capital equipment, specific program or series of programs, or general support of the grantee, provided that neither the grants nor the income thereof may be used for a non-501(c)(3) purpose or for testing for public safety;
  • a provision indicating that the grantee must repay any funds not used for grant purposes;
  • a covenant that the grantee must submit annual reports on the use of funds (unless the grant is to a private foundation for endowment or other capital purposes, in which case other rules apply – see Treas. Reg. 53.4945-5(c)(2));
  • a covenant requiring complete records of receipts and expenditures to be maintained, and made available to the grantor;
  • a covenant not to use any funds (1) to influence legislation, (2) to influence the outcome of elections or carry on voter registration drives, (3) to make grants to individuals for travel, study, or other similar purposes by such individual, unless such grant satisfies the requirements of IRC §4945(g), (4) to make grants to other organizations except as provided in IRC 4945(d)(4) (it’s generally okay for the grantee to regrant to any organizations the private foundation can grant to, subject to the same conditions), or (5) to undertake any activity for any purpose other than a 501(c)(3) purpose (but not for testing for public safety).

Reports from Grantee

Reports from the grantee must be required annually and after all the grant funds have been expended (though an annual report may suffice as a final report if the grant funds are fully expended in a single year). Such reports should address the following:

  • the use of the funds;
  • compliance with the terms of the grant; and
  • the progress made by the grantee toward achieving the purposes for which the grant was made.

Reports to the IRS

Reports to the IRS from the grantor (made in its Forms 990-PF) must include the following information:

  • The name and address of the grantee;
  • The date and amount of the grant;
  • The purpose of the grant;
  • The amounts expended by the grantee (based upon the most recent report received from the grantee);
  • Whether the grantee has diverted any portion of the funds (or the income therefrom in the case of an endowment grant) from the purpose of the grant (to the knowledge of the grantor);
  • The dates of any reports received from the grantee; and
  • The date and results of any verification of the grantee’s reports, but only if undertaken pursuant to and to the extent required because the grantor had reason to doubt the accuracy or reliability of such reports.

Additional Resources

Grants to Organizations from Private Foundations: Is Expenditure Responsibility Required? – Council on Foundations

Office of Chief Counsel IRS Memorandum No. 200504031 – IRS

Expenditure Responsibility – A Primer & Ten Puzzling Problems – Adler & Colvin

IRC §4945 – Taxes on Taxable Expenditures

Treasury Reg. §53.4945-5 – Grants to Organizations


Private Foundations & Self-Dealing  

InvestmentWe recently added a post to the blog about private foundations and the rules that they are subject to.  Of the private foundation rules, those regarding self-dealing are some of the most complex and have some of the most serious potential ramifications for a private foundation if violated.  In this post, we’ll take a closer look at the self-dealing rules and some of the exceptions to the rules.

Internal Revenue Code (“IRC”) § 4941 sets forth the self-dealing rules for private foundations and defines self-dealing as any direct or indirect:

  • “sale or exchange, or leasing, of property between a private foundation and a disqualified person;
  • lending of money or other extension of credit between a private foundation and a disqualified person;
  • furnishing of goods, services, or facilities between a private foundation and a disqualified person;
  • payment of compensation (or payment or reimbursement of expenses) by a private foundation to a disqualified person;
  • transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a private foundation; and
  • agreement by a private foundation to make any payment of money or other property to a government official…, other than an agreement to employ such individual for any period after the termination of his government service if such individual is terminating his government service within a 90-day period.”

IRC § 4946 provides the definition of a disqualified person for purposes of the rules applicable to private foundations.  With respect to the self-dealing rules, a disqualified person includes anyone who is:

  • a substantial contributor to the foundation;
  • a foundation manager (which includes officers, directors, trustees, or other individuals who have similar powers or responsibilities);
  • an owner of more than 20% of the combined voting power of a corporation, the profits interest of a partnership, or the beneficial interest of a trust which is a substantial contributor to the foundation;
  • a family member of any such persons;
  • a corporation, partnership, or trust of which any such persons own more than 35% of the total combined voting power, profits interest, or beneficial interest, respectively; or
  • a government official.

As we discussed in our recent post, if a private foundation enters into a self-dealing transaction with a disqualified person, both the disqualified person and the foundation managers who knowingly participated in the self-dealing transaction will be subject to taxes.  (See this IRS page for additional information on the taxes on self-dealing)

However, there are exceptions and special rules that apply to the self-dealing restrictions that private foundations and potential disqualified persons should be aware of, including:

  • Gifts – Although the furnishing of goods, services, or facilities by a disqualified person to a private foundation is typically considered an act of self-dealing, that will not be the case if the goods, services, or facilities are to be used exclusively for IRC Section 501(c)(3) exempt purposes and are provided to the private foundation without charge.
  • Compensation – The payment of compensation or the reimbursement of expenses by a private foundation to a disqualified person (other than a government official) for personal services that are reasonable and necessary to carrying out the foundation’s exempt purposes will not be considered self-dealing, so long as the compensation amount is not excessive. Although we don’t have a clear definition of what constitutes reasonable and necessary personal services, the Regulations state that personal services include legal services, investment advice, commercial banking services, and the services of a broker serving as an agent for the private foundation.  This exception does not apply to the purchase or sale of goods, even if services are a part of the process of producing the goods.  A private foundation may also provide goods, services, or facilities (such as meals or lodging) to a foundation manager, employee, or volunteer without engaging in a self-dealing transaction if the value of the items provided is reasonable and necessary to the performance of the foundation’s activities in carrying out its exempt purposes.
  • Loans – A disqualified person may loan money to a private foundation without it constituting a self-dealing transaction if the loan is made without interest or other charge and if the proceeds of the loan are used by the private foundation exclusively for IRC Section 501(c)(3) exempt purposes. A loan by a disqualified person to a private foundation at below-market rates, however, will still be treated as an act of self-dealing to the same degree that a loan at market rates would be.  The provision of general banking services, including checking and savings accounts (subject to certain conditions), will generally not be considered self-dealing.
  • Leases – The lease of space by a disqualified person to a private foundation will not be considered an act of self-dealing if the lease is without charge. The lease will still be considered to be without charge even if the foundation pays for janitorial expenses, utilities, or other maintenance or administrative costs it incurs, so long as the private foundation does not make the payments directly or indirectly to a disqualified person (rather, the payments should be made directly to the utility provider, for example).  There is also an exception for the leasing of office space to a private foundation in a building with other tenants who are not disqualified persons if the lease is pursuant to a binding contract that was in effect on October 9, 1969, or renewals thereof, and the lease reflects an arm’s length transaction.
  • Publicly Available Services – A private foundation may provide goods, services, or facilities to a disqualified person on a basis no more favorable than that on which the goods, services, or facilities are provided to the general public without violating the self-dealing rules. However, this exception only applies if a substantial number of persons other than disqualified person actually use the goods, services, or facilities in question.
  • Incidental Benefits – The receipt by a disqualified person of an incidental or tenuous benefit from the private foundation’s use of its income or assets is not sufficient in-and-of-itself to make the use an act of self-dealing. For example, if a substantial contributor gets public recognition for the activities of the foundation, that alone generally will not be sufficient to constitute self-dealing.
  • Recapitalization – A transaction between a private foundation and a corporation that is a disqualified person is not self-dealing if it is pursuant to a liquidation, merger, redemption, recapitalization, or other corporate adjustment, organization, or reorganization so long as all of the securities of the same class as those held by the foundation are subject to the same terms and the private foundation will receive no less than fair market value. In order for the securities to be considered subject to the same terms, the corporation must make a bona fide offer on an equal basis to the foundation and every other holder of securities of the same class.
  • Government Officials – Certain payments to government officials, including certain prizes and awards, scholarships for educational study, incidental gifts or services, and reimbursement of domestic travel expenses, will not constitute self-dealing.

Unless an exception applies, the prohibition on acts of self-dealing for private foundations is absolute and, given the stiff penalty taxes that are imposed, private foundations are well-advised to understand these rules and to ensure that they refrain from violating them.


NEO Law Group’s Video on Tips for Nonprofits: Private Foundation or Public Charity?


Yesterday, NEO Law Group released a new short video in its series of videos on tips for nonprofits, available on YouTube. This video focuses on the differences between private foundations and public charities. We hope that you enjoy it and please stay tuned for additional videos from NEO Law Group on tips for nonprofits.


Private Foundation Rules


A Section 501(c)(3) exempt organization is presumed to be a private foundation unless it qualifies as a public charity. The distinction between the private foundation and public charity classification may be critical for organizational leaders to understand, as public charity status is generally far more advantageous when there is a choice.

Since private foundations are generally governed by a smaller, more insular group of individuals and receive funds from only a few sources, they are subject to many more burdensome rules, regulations, and potential penalties to help assure proper operation. Private foundations must also complete the lengthy annual information return, Form 990-PF, and cannot make use of the short-form options (Form 990-EZ and Form 990-N). Further, as compared to public charities, private foundations face significant disadvantages in terms of fundraising opportunities from other private foundations (due to the expenditure responsibility rules of Section 4945 of the Internal Revenue Code (the “Code”)) and major donors (due to the smaller charitable deduction limits applicable to gifts made to a private foundation).

Private foundations are also subject to a set of federal tax laws that impose monetary penalties on the organization and its managers for various infractions and activities. These rules regulate areas such as self-dealing, minimum distributions, excess business holdings, jeopardizing investments, and taxable expenditures. Leaders of private foundations should know how to manage their compliance with these laws and understand the potential consequences of a violation.

Private Foundation Excise Taxes

Self-Dealing – (IRC § 4941)

In general, a private foundation is constrained from having any financial transactions with persons who create, control, or fund the organization. These individuals are known in the Code as disqualified persons. A disqualified person may be a director, officer, substantial contributor, family members, or a 35% controlled entity. The Code identifies six specific transactions that, if engaged in by the foundation and a disqualified person, constitutes an act of self-dealing:

  • Lending money or credit;
  • Payment of compensation;
  • Furnishing goods, services, or facilities;
  • Selling, exchanging, or leasing property; and
  • Agreeing to pay a government official.

If such a transaction occurs, the disqualified person benefiting from the transaction will be subject to a 10% first-tier tax and 200% second-tier tax if the violation is not corrected within the taxable period. Generally, the tax is measured by the “amount involved,” which is defined as the “greater of the amount of money and the fair market value of the other property given [to the disqualified person] or the amount of money and the fair market value of the other property received [by the disqualified person].” Treas. Reg. § 53.4941(e)-1. To avoid the second-tier tax, the self-dealing error must be corrected between the date of the transaction and the date on which the tax is assessed or a notice of deficiency with respect to the tax is mailed, whichever is earlier.

Foundation managers (including directors) who knowingly approve a self-dealing transaction may also be subject to a 5% first-tier tax and 50% second-tier tax.

Additionally, there are several exceptions to self-dealing, where certain transactions are permitted between private foundations and disqualified persons. These include:

  • Payment of reasonable compensation for personal services (professional services reasonable and necessary to carrying out the mission); and
  • Furnishing of goods, services, or facilities to a disqualified person on a basis no more favorable than that on which such goods, services, or facilities are made available to the general public.

For more information on exceptions to the self-dealing rules, see Exceptions – Self-Dealing by Private Foundations.

Minimum Distribution Requirement – (IRC §4942)

A private foundation must spend a minimum amount for grants, administration, and other charitable distributions annually. The minimum disbursement required in order to avoid excise taxes, also known as a qualifying distribution, is 5% of the organization’s assets, not including those which are used (or held for use) directly in carrying out the foundation’s exempt purpose. The purpose behind this mandatory payout is to ensure private foundations are actively funding charitable programs and not simply hoarding charitable funds in perpetuity. Note that, a private foundation in its first year of existence has no distribution requirement.

For some grantmaking private foundations whose sole charitable activity is related to grantmaking, the minimum distribution requirement is equal to 5% of its investment assets. Qualifying distributions include grants to charities and reasonable and necessary administrative expenses paid to accomplish the foundation’s charitable purposes.

Failure to make the required distribution may subject the foundation to a first-tier tax equal to 30% of the amount of undistributed income at the beginning of subsequent taxable year. If uncorrected by the close of the taxable period, a second-tier tax of 100% of the undistributed portion remaining may be imposed. 

Excess Business Holdings – (IRC §4943)

Generally, a private foundation and its disqualified persons together may own no more than 20% of the voting or ownership interest in a business enterprise. The term “business enterprise” includes partnerships, joint ventures, or other unincorporated enterprises. The penalty for a violation of the excess business holdings rule is a first-tier tax of 10% of the value of such excess business holdings and a second-tier tax of 200% if the foundation still has excess business holdings at the end of the taxable period. The amount of excess holdings is determined as of the day during the tax year when the foundation’s excess holdings were the greatest.

There are a few exceptions to this general rule, including:

  • Where the private foundation (together with certain related private foundations) owns less than 2% of the voting stock and 2% of the value of all outstanding shares of all classes of stock.
  • Where the private foundation and its disqualified persons own up to 35% of the business enterprise but a third party effectively controls the management and policies of the enterprise.

Also note that the initial tax may be abated if the private foundation can demonstrate that the excess holdings were due to reasonable cause and not willful neglect, and that the excess holdings were disposed of within the correction period.

Jeopardizing Investment – (IRC §4944)

A private foundation’s managers must exercise prudence and good business judgment in investing the foundation’s assets. If a private foundation invests in a manner that jeopardizes its ability to carry out its exempt purposes, the foundation may be subject to a first-tier tax of 10% of the relevant amount so invested for each year in the taxable period. A 25% second-tier tax may be imposed if the violation is not corrected within the taxable period. Foundation managers (including directors) who knowingly participated in making that investment may also be subject to a first-tier tax of 10% and a second-tier tax of 5% of the relevant amount.

The general approach to avoiding the tax on jeopardizing investments is to look at the entire investment portfolio of the foundation rather than at individual investments. A diverse portfolio of investments may be characterized as prudently invested without looking to whether individual investments are jeopardizing, but that may not be the case where one single highly speculative investment dominates the investment portfolio.

There is a specific exclusion from the jeopardizing investment prohibition for program-related investments (PRIs). Generally, a PRI is an investment in which (1) the primary purpose is to accomplish one or more charitable purposes; (2) the production of income or the appreciation of property is not a significant purpose; and (3) lobbying or electioneering is not a purpose. A PRI might take the form of a loan to a charity or a loan to, or equity investment in, a business entity for a charitable purpose, such as, to develop or distribute a lifesaving drug for use in developing countries that would not otherwise be commercially viable.

Taxable Expenditures – (IRC §4945)

A private foundation must devote its income and principal exclusively to the charitable purposes for which it was created. Any payment made by the foundation for a non-charitable purpose is therefore a taxable expenditure. Examples of taxable expenditures include payments used for:

  • Lobbying;
  • Political intervention;
  • Grants to individuals for travel, study, or similar purposes unless such grants are awarded on an objective and nondiscriminatory basis pursuant to a procedure approved in advance by the IRS and otherwise meet certain statutory requirements;
  • Grants to domestic organizations that are not public charities, unless the foundation exercises expenditure responsibility over the grant; and grants to foreign charities, unless the foundation exercises expenditure responsibility or the grantee meets determines that the grantee passes an equivalency determination (i.e., is determined to be the foreign equivalent of a U.S. public charity); and
  • Other than charitable purposes.

If a private foundation makes such an improper expenditure, the foundation is subject to a first-tier tax of 20% of the amount and a 100% second-tier tax if the violation is not corrected within the taxable period. Foundation managers (including directors) who knowingly participated in making that taxable expenditure may also be subject to a first-tier tax of 5% and a second-tier tax of 50% of the relevant amount.

Excise Tax on Investment Income – (IRC §4940)

Private foundations must pay an excise tax of 2% annually on the income earned on its investments, including dividends, interests, royalties, rents, and capital gain from properties producing such income. In certain cases, the tax amount may be reduced to 1% in a year during which the foundation’s percentage of charitable giving in relation to its total assets increases.

For more information about payment and calculation of this tax, see the Instructions for Form 990-PF.


Best of the Nonprofit Law Blog 2014

Best of 2014 - The year in reviewHere are some selected highlights from NEO Law Group over the past year that we hope you’ll find helpful. 2014 was also highlighted by an addition to Erin’s family and Michele’s graduation and passage of the bar exam! Amazing year for all of us.

Blog Posts


What Issues Should a Nonprofit Board Consider Annually?

Executive Succession: 10 Tips for Boards

Executive Committees: Why You Should Limit Their Authority


Nonprofit Advocacy is More Than Lobbying

Charities and Issue Advocacy: Doing it Right – Part One

5 Things Nonprofits Should Know About Ballot Measure Advocacy in California

Fiscal Sponsorship

Fiscal Sponsor Due Diligence

Fiscal Sponsorship: A Valuable Option for Grantmakers and Grantees

Arts Projects: Charitable or Not?

Proposed Laws

12 Things Nonprofits Should Know About Proposed Tax Reform

California Bill to Strengthen Enforcement of Charity Registration and Reporting

Proposed Rules Affecting California Charities – Comment Period Ends Today!

UBIT / Social Enterprises

UBIT: Advertisements vs. Qualified Sponsorship Payments

Nonprofit Limited Liability Company

Nonprofit Crowdfunding Risks


Nonprofit Laws for Human Resources Managers to Be Aware Of

Retroactive Reinstatement Procedures: Simplified

Dissolution and Transfer of Remaining Assets: An Alternative to Merger


Fair or Foul: A Review of Federal Tax Laws Governing Unfair Competition, The Nonprofit Quarterly (2014)

12 Reasons Why You Should Gracefully Resign from a Nonprofit Board, The Nonprofit Quarterly (2014)

10 Issues To Address In Your Nonprofit’s Social Media Policy, The Nonprofit Times (2014)


Tips on Starting a Nonprofit: Initial Board of Directors

Tips on Starting a Nonprofit: Fundraising Before Exemption

Tips on Starting a Nonprofit: Initial Bylaws

Nonprofit Radio

Advocacy, Net Neutrality, & The Bright Lines Project

Your Board’s Role in Executive Hiring


Speaking Engagements


Profit for Good: How Social Enterprise Policy Affects You, Independent Sector Public Policy Action Institute

Hot Topics in Nonprofit Law, CalNonprofits Policy Convention

Small Charities – Problems and Solutions, American Bar Association, Tax Section Mid-Year Meeting


Earned Income 101 for Nonprofits, Lawline

Understanding UBIT: What Does It Mean for Your Shared Space? Nonprofit Centers Network

Navigating Legal and Ethical Issues, New Grantmakers Institute, Northern California Grantmakers


Fiscal Sponsorship: A Valuable Option for Grantmakers and Grantees


Yesterday, I had the honor of participating on a panel discussing fiscal sponsorship at the 2014 Grantmakers in the Arts 2014 Conference in Houston. Frances Phillips (Walter and Elise Haas Fund), Melanie Beene (consultant, former CEO of Community Initiatives), and Ian David Moss (Fractured Atlas) were my co-panelists, and we were joined by a very vocal group of attendees who made the session one of my favorites. The following post is from a handout we distributed at the session.

Fiscal sponsorship describes a number of varying contractual relationships that have through custom and practice developed between “sponsors” and “projects,” making it possible for charitable projects to receive grants and deductible contributions without having their own 501(c)(3) status. These relationships can help facilitate grantmakers’ support of worthy arts projects that are not suited for independent legal existence as public charities. But the health of the sponsor and the structure of the fiscal sponsorship agreement are critical to ensuring that your grants are made appropriately and in compliance with applicable laws.

Most common forms of fiscal sponsorship

The two most common models of fiscal sponsorship are referred to as comprehensive (Model A) and the pre-approved grant relationship (Model C). The National Network of Fiscal Sponsors (NNFS) provides the following definitions:


In a Comprehensive Fiscal Sponsorship relationship, the fiscally-sponsored project becomes a program of the fiscal sponsor, and is a fully integrated part of the fiscal sponsor that maintains all legal and fiduciary responsibility for the sponsored project, including its employees and activities. This model of fiscal sponsorship is particularly valuable when a project has employees.

Pre-approved Grant Relationship

In a Pre-Approved Grant Relationship Sponsorship, the fiscally-sponsored project does not become a program belonging to the sponsor, but is a separate entity responsible for managing its own tax reporting and liability issues. In addition, the sponsor does not necessarily maintain ownership of any part of the results of the project’s work—ownership rights may be addressed in the fiscal sponsor agreement and could potentially result in some form of joint ownership. The sponsor simply assures that the project will use the grant funds received to accomplish the ends described in the grant proposal. This is the model of fiscal sponsorship primarily utilized in the arts.

Model A
Pre-Approved Grant ...
Model C
Project is housed in sponsorYesNo
Project is housed in separate legal entityNoYes
Project employeesEmployees of the sponsorEmployees of the project (sub-grantee)
SolicitationsBy agents of the sponsorBy agents of the sponsor
GrantsTo sponsor for purposes of the project (housed in sponsor)To sponsor for purposes of the project; sponsor may, but is not required to, regrant to project (sub-grantee)

An alternative to forming an independent charity

Having a charitable project fiscally sponsored by a sound and reputable fiscal sponsor may be an attractive alternative to starting a nonprofit, especially when:

  • An idea is being tested or incubated.
  • The project involves the work(s) of a single artist or collaborative group.
  • The project leaders are inexperienced or otherwise not well prepared to manage the administrative needs of a charity.
  • The project and/or funding is time sensitive.

Tips and traps for grantmakers


  • Carefully vet the fiscal sponsor (your grantee), not just the project leaders.
  • Check the fiscal sponsor’s articles/bylaws (consistency with grant purposes).
  • Check the fiscal sponsor’s financials (e.g., negative unrestricted net assets).
  • Review the fiscal sponsorship agreement (variance powers in Model C).


  • Directing a grant to the project in a Model C fiscal sponsorship.
  • Sending grants to Model A project leaders instead of the fiscal sponsor.
  • Granting to a fiscal sponsor that acts as a mere conduit to another entity.
  • Placing too much weight on overhead (incl. fiscal sponsorship fees).

International Grantmaking: Equivalency Determinations

equal sign

Private foundations in the United States are often interested in funding promising organizations and projects that are based outside of the country. When doing so, these foundations are required to follow certain rules and procedures promulgated by the IRS to help ensure that the foreign grantees are properly using those funds for charitable purposes. Currently, when a private foundation engages in international grantmaking, it has two options for complying with these rules: exercising expenditure responsibility or conducting an equivalency determination.

What is an Equivalency Determination?

An equivalency determination refers to the review and evaluation by a private foundation of whether a potential grantee is the foreign equivalent to a U.S. public charity. This involves a review of its organization (governing documents) and operations to ensure it meets the following requirements described in Section 501(c)(3) of the Internal Revenue Code (IRC):

  • It is organized exclusively for a charitable, educational, or other 501(c)(3) exempt purpose;
  • It is operated primarily for a qualified exempt purpose;
  • It does not engage in any transactions that would result in private inurement or a prohibited private benefit;
  • Its assets, upon dissolution, would be distributed to another nonprofit for a qualified exempt purpose or a government instrumentality;
  • It does not engage in substantial lobbying; and
  • It does not engage in prohibited political campaign intervention.

In addition, the review must ensure that the foreign grantee would qualify as a public charity (and not a private foundation) if it were to apply for IRS recognition of exemption under 501(c)(3). Most public charities qualify as such because they are “publicly-supported” (i.e., they receive a significant portion of their financial support from public sources). For such organizations that do not receive a significant amount of earned income, this may be proven using one of two tests referenced in IRC Sections 509(a)(1) and 170(b)(1)(A)(vi).

First, an organization can demonstrate that it receives at least 1/3 of its total support from governmental units or the public. If the organization cannot meet this first test, it may pass an alternative facts and circumstances test, which requires the organization to establish that, under all of the facts and circumstances, it normally receives a substantial part of its support from government units or the general public.  (For more information about public support, see Adler and Colvin’s Qualifying For Public Charity Status).

The equivalency determination process, outlined in IRS Revenue Procedure 92-94, requires the grantmaker to collect comprehensive information about the foreign organization’s operations and finances to make a “good faith determination” of whether the grantee would be given tax-exempt, public charity status in the U.S., including whether it is publicly supported.

Often, these requirements can be difficult to satisfy because of differences in a foreign grantee’s accounting system, language, and sometimes governing legal system and reporting procedures in the grantee’s own country.

Basic Requirements

The equivalency determination may be done either by the grantor itself, based on information provided in an affidavit completed by the grantee, or by written opinion of legal counsel of the grantor or the grantee. The affidavit is meant to extract all the necessary information about the foreign grantee including financials for the current and previous years, governing documents (often a translated copy is required), details about the board of directors, and descriptions of program activities.

More specifically, in order for a grantee to be equivalent to a public charity based on its level of public support, it must provide the grantor with a financial support schedule for the current year as well as the four most recently completed years. The schedule must be detailed and include information such as grants and contributions received, net income from unrelated business activities, and gross receipts for services performed. Furthermore, the schedule must show contributions from donors that are in excess of 2% of the total support received (because such excess is not included as public support in the public support test).

Proposed Regulations

In September of 2012, the IRS issued proposed regulations that allow private foundations to rely on a broader class of practitioners, not just legal counsel, in making the good faith determination.  The person issuing the opinion may be a “qualified tax practitioner,” such as an attorney, a certified public accountant (CPA), or an enrolled agent.  Foreign counsel is no longer included in this class unless they meet the requirements of a qualified tax practitioner. Although these changes are technically “proposed,” the regulations indicate that a private foundation may rely upon these changes for grants made on or after September 24, 2012.


While the regulations aim to simplify and expand equivalency determinations, the process is quite burdensome and costly. For many years, there was no mechanism for sharing information about foreign grantees among grantmakers, and no uniform standard for collecting and processing the equivalency determination information. Thus, grantees were, and many continue to be, asked to provide affidavits and supplemental materials to multiple grantmakers in various forms. The regulations required each grantmaker to use its own reasonable judgment and good faith determination based on the materials collected. Therefore, foundations were not permitted to rely upon each other’s determinations.

To address these issues, several leading organizations such as The Council on Foundations, InterAction, the Foundation Center, and Independent Sector, worked to create a centralized repository of information to improve the efficiency of international grantmaking. The product of this effort, NGOsource, recently launched an online equivalency determination service and repository . NGOsource members can easily access which projects and organizations are approved for grantmaking purposes, thus eliminating redundant determinations and lowering costs for both the grantmaker and the foreign grantee.

For information about how NGOsource’s equivalency determination service works, click here.

Underlying Law

[Grants to] Certain foreign organizations. If a private foundation makes a grant to a foreign organization which does not have a ruling or determination letter that it is an organization described in section 509(a)(1), (2), or (3), such grant will not be treated as a grant made to an organization other than an organization described in section 509(a)(1), (2), or (3) if the grantor private foundation has made a good faith determination that the grantee organization is an organization described in section 509(a)(1), (2), or (3). Such a “good faith determination” ordinarily will be considered as made where the determination is based on an affidavit of the grantee organization or an opinion of counsel (of the grantor or the grantee) that the grantee is an organization described in section 509(a)(1), (2), or (3). Such an affidavit or opinion must set forth sufficient facts concerning the operations and support of the grantee for the Internal Revenue Service to determine that the grantee would be likely to qualify as an organization described in section 509(a) (1), (2), or (3). See paragraphs (b)(5) and (b)(6) of this section for other special rules relating to foreign organizations. – Treasury Regulation §53.4945-5(a)(5)


Council on Foundations 2014 Annual Conference

Leadership with education

The Council on Foundations 2014 Annual Conference (Philanthropy Exchange) was held in Washington DC on June 8-10 with pre-conference sessions taking place on June 6 and 7. The Full Session Calendar shows the breadth of topics covered and is a wealth of resources. Here are some my favorites resources coming out of, or relating to topics covered by, the Conference:

Energizing Private Partnerships at the Federal Level
See Philanthropy and Government Working Together: The Role of Offices of Strategic Partnerships in Public Problem Solving

Public Policy Seminar
Investing in Change: A Funder’s Guide to Supporting Advocacy
Tax Reform Act of 2014 Summary

The State of the Nation: American History, Identity and Politics
Gallup’s Jim Clifton on The Coming Jobs War

Inequality, A Polarized Society, and Young Men of Color
A Time For Action – Mobilizing Philanthropic Support for Boys and Young Men of Color

Making Rights Real: Civic Literacy, Media Access, and the Democratic Imperative
Dialogues On Election Reform: A Continuing Conversation with the States (May 1, 2014 – American Bar Association Standing Committee on Election Law)

Civil Legal Aid: A Natural Ally in Tackling Poverty
Natural Allies: Philanthropy and Civil Legal Aid

President Obama’s Social Innovation Fund at Five… Where it’s been, and where it’s going
Innovation to Impact: Obama’s Social Innovation Fund at Four (Stanford Social Innovation Review)

Re-Emerging Art of Funding Innovation
Re-Emerging Art of Funding Innovation (Stanford Social Innovation Review)

Fostering Philanthropy and Civil Society Globally
Discussion Questions
Council on Foundations conference 2014: foundations and the post-2015 development goals (Alliance Magazine)

Closing Plenary: Finding Common Ground to Advance the Common Good
Common Ground with Bob Beckel & Cal Thomas


Also check out Rick Cohen‘s Live Blog: Council on Foundations Annual Meeting on the Nonprofit Quarterly site.


CalNonprofits Annual Convention


Photo-39 copy 2"The poor is not them, the poor is us." – Robert Reich

Our friends at the California Association of Nonprofits held their Annual Convention this Thursday in San Francisco. The Convention featured former Secretary of Labor Robert ReichJeanne Bell, CEO of CompassPoint; Emmett Carson, CEO of the Silicon Valley Community Foundation; Pete Manzo, CEO of United Ways of California; Pamela David, E.D. of the Walter & Elise Haas Fund; Melissa Breach, E.D. of the League of Women Voters of California; Nayantara Mehta, Senior Counsel, Alliance for Justice; exempt organizations attorney Rosemary Fei, Adler & Colvin; author and grassroots fundraising guru Kim Klein; and CalNonprofits CEO Jan Masaoka.

"The world needs more of what nonprofits do." – Jan Masaoka

The morning plenary moderated by Jan Masaoka focused on the theme of What Should Philanthropy be Doing Better? The panelist was comprised of foundation CEOs Fred Ali (Weingart Foundation), Emmett Carson, and Pam David. The first area explored was partnerships with government. David said this was essential and that government could not be treated as a grantee. Carson took the position that the power dynamic heavily favored government and that philanthropy has to use levers in knowing how to advance its goals. When asked about what new law should be created, David suggested a requirement that private foundations invest 5% of their endowments in mission-related investments. Carson cautioned that what was good for one nonprofit might be horrible for another, showing how difficult it can be for the sector to speak with one voice on many issues. Another area explored was collegiality among foundations. Carson shared his concern that collegiality was chilling debate; foundation leaders that criticized the practice of others could be treated as pariahs. When the discussion turned towards strategic philanthropy and its focus on measurable outcomes, David noted that some outcomes are unknown until the work is done. An audience member voiced some frustration about philanthropy funding innovation but not funding infrastructure to take proven ideas to scale. When asked what were the foundation leaders' beef with their charity grantees, Carson said they're not dreaming big enough, and Ali pointed to the need for more values-driven organizations.

Rosemary Fei led the session – I'm a Nonprofit Lawyer, Ask Me Anything? Rosemary, one of the most highly regarded exempt organizations practitioners in the country, was my grad school teacher in the 90s and continues to be an exceptional teacher. She responded to a wide variety of questions including those related to startup issues, fiscal sponsorship, governance and lobbying.

Jeanne Bell moderated the discussion on Emerging Nonprofit Funding Models featuring Gihani Fernando (Bridgespan Group) and Carla Javitz (President, REDF). Bell asked the provocative questions: (1) Do great organizations go out of business? and (2) Do organizations living hand-to-mouth as the accepted business model have the right leadership? Javitz pointed out that in operating a social enterprise, there are additional social costs involved, and, in her opinion, it's acceptable to look for subsidies for such costs as part of a prudent and sustainable business model. Fernando reminded us that organizations must properly match funding sources to the types of expenses (e.g., growth expenses vs. day-to-day fixed expenses).

Robert Reich provided the brilliant keynote address. Among the points he made:

  • Recovery? For 90% of Americans, this has been the slowest, most anemic economic recovery in the history of economic recoveries.
  • The problem: For more than 30 years, median household income has been stagnant (even though economic pie has doubled) – most growth has benefited the top 5%.
  • Coping mechanisms (more women in the workforce, longer hours, borrowing) have had impact but they have now been exhausted.
  • The value we add to the global economy relies on skills we bring to table; we need better affordable early and public education (community colleges are great unsung heroes of upward mobility).
  • History tells us there is a tipping point in our economy around the corner. Look at what the next generation values.
  • Immigration will be used to grow the economy as boomers age and the worker:retiree ratio moves to 2:1 in 20 years.
  • Washington is still hesitant about dealing with inequality. Outsiders need to push Washington and hold politicians accountable. Nonprofits are on the front line.
  • 1st step: Need to get big money out of politics so people's voices can be heard.
  • We have a powerful association for older and retired people that will be joined by 70 million boomers. We don't have an association of poor kids who need a voice in Washington.
  • We need to get the message out that the poor is not them, THE POOR IS US. We're in this together. As a country, we need to recapure the shared experience of interdependence that we had when confronted with earlier challenges.

Check out Reich's website and his film Inequality for All.

The final session I attended was a debate on the issue of whether nonprofits should be held to a higher ethical standards than for-profits moderated by Kim Klein. Melissa Breach and Dolores Garay (California Rural Legal Assistance) argued yes and Nayantara Mehta and Marco Montenegro (Mission Economic Development Agency) argued no. The debate was interesting but probably didnt change my mind. The public already holds nonprofits to a higher ethical standard and nonprofits that live up to such standards will have advantages over those that do not. The law holds charity leaders to a different standard than their for-profit counterparts because charities do not have shareholders that have legal rights and standing to hold directors accountable; charities hold charitable assets in trust and directors are charged in part with safeguarding those assets even though the charity's beneficiaries and donors generally have no right to hold the directors accountable. I am in agreement with Mehta's argument that the standard of care should not be higher for a director of a nonprofit than a for-profit.

Updated (11/14/13)