UnderstandingExpenditure ResponsibilityA Step by Step Guide

Annie Sherzer, Esq.,

Program Services Manager, W.K. Kellogg Foundation

Celeste Dado,

Senior Grants Manager, Arcus Foundation

Grants Managers Network, Sixth Annual ConferenceMarch 23, 2011

Arcus Foundation

Global foundation advancing

pressing social justice and conser-

vation issues by supporting LGBT

equality and protection of great apes

Founded in 2000 in Kalamazoo, MI,

with offices in NYC & Cambridge, U.K.

Annual giving of $26 million in

approximately 200 grants

Supporting work nationally and

internationally – all of Africa and

31 countries in the Middle East,

South and Southeast Asia

DIRECT grantmaking to non-U.S. based organizations in 2010

25 non-U.S.based grants in 22 countries

6 Equivalency Determination

19 Expenditure Responsibility grants

Expenditure Responsibility grants in 2010:

New awards: 38

U.S.-based: 19

Active (open) grants: 77

W.K. Kellogg Foundation

Established in 1930 and located

in Battle Creek, MI.

Grants are concentrated in the

United States, southern Africa,

Latin America and the Caribbean.

Annual giving is approximately $300M.

In 2010, Kellogg made 674 new grants

(14 are ER, totaling approx. $7M)

Total active grants 2,299 (30 are ER)

Total international grants 202 (15 are ER)

Mission:

Support children, families

and communities as they

strengthen and create

conditions that propel

vulnerable children to

achieve success as

individuals and as

contributors to the larger

community and society.

Expenditure Responsibility (ER) is:

A procedure mandated by the Internal Revenue Code that

requires a private foundation to comply with specific require-

ments when making a grant to an organization that is not

classified as a 501(c)(3) public institution or governmental unit.

Due diligence process designed to ensure grant is used for

charitable purpose and foundation maintains appropriate

oversight and documentation.

Covered in Reg.§53.4945-5(b) and§4945-6

Note to Community Foundations: ER must be used with certain grants made from donor-advised funds.

International Grantees – ED vs ER

Two regulatory ways of qualifying non-U.S. based organizations

to receive grants:

Equivalency Determination – process for determining if foreign

organization is equivalent to U.S. public charity.

Expenditure Responsibility – allows foundations to make

grants to foreign organizations that are not recognized as U.S.

public charities by IRS.

Organizations that Require ER

501(c) orgs other than 501(c)(3) charities, such as:

- 501(c)(4) social welfare orgs;

- 501(c)(5) labor unions;

- 501(c)(10) fraternal orders

Private foundations

For-profit companies

Organizations that have not received 501(c)(3) recognition

from IRS

Foreign orgs (in lieu of equivalency determination)

Five Basic Steps/Requirements

Pre-grant

Inquiry

1

Written

Agreement

2

Separate

Account for

Non-Charities

3

Annual

Reporting

by Grantee

4

Reporting

to IRS by

Private

Foundation

5

Step 1: Pre-Grant Inquiry

Pre-grant inquiry is a limited

inquiry that should be complete

enough to give a reasonable

person assurance that the

grantee will use grant for proper

charitable purpose. Inquiry

should concern itself with:

Documents that may

be helpful in completing

the inquiry:

Identity, prior history and experience of organization and its managers;

Any knowledge which the founda-tion has or other information which is readily available concerning the management, activities, and practices of the grantseeker

Evidence of legal status

Grantseeker’s annual report and audited financial statements

Business plan and organizational chart

List of directors and officers

Previous experience with grantee and/or staff

Arcus Pre-Grant Inquiry Process

Site visits by Program Officers in many cases

Grant proposal questions and requirements capture required

information

Grant recommendation write-up addresses regulatory

requirements

Grants Management unit reviews full proposal, project budget

and grant recommendation for legal compliance

Grants Management determines necessary clauses to include

in grant agreement

Step 2: Written Agreement

Agreement must be in writing & signed by officer, director,

or trustee of grantee. It must also include:

Specific charitable purpose(s)

Agreement by grantee to repay any portion of grant not used

for the purpose(s) of the grant

Requirement to submit annual report after the close of

the Grantee’s annual accounting period on how funds were

spent, progress on accomplishing purpose of grant, and

compliance with terms

Maintain record of receipts and expenditures

Provision to not use funds for lobbying, influencing elections,

regranting to individuals, or for any purpose other than

charitable

Grant Agreement Terms/Conditions

Step 3: Separate Account

Non-charitable grantees must maintain grants funds in a separate

fund dedicated for charitable purposes

Cannot comingle charitable

and non-charitable money

Grant to another

private foundation

does not require

a physically

separate account

Grant Agreement Clauses on Separate Account

Step 4: Annual Reporting by Grantee

Reports must be submitted by the Grantee within a “reasonable”

period of time after the close of the Grantee’s annual

accounting period.

Grantee must provide reports on:

1) the use of the funds,

2) compliance with the terms of the grant, and

3) progress made towards achieving the purpose

of the grant.

Reports must be submitted annually until all grant funds are

expended. The FINAL report must include reporting on all

expenditures, as well as progress made toward accomplishing

the goals of the grant.

Following the Grant $$$

Recording in grants management system

Coding of ER grants

Reporting requirements include notation of:

1) fiscal year end,

2) reporting period covered,

3) grant amount expended for reporting period

Dates when reports requested and subsequent follow-up,

as well as format of requests

Grants Management Database Record

Step 5: IRS Reporting by Foundation

ER grants must be separately reported on

Foundation’s IRS Form 990-PF:

- When grant is made

- Each year funds or a report are outstanding

Report must include:

- Grantee name and address

- Date and amount of grant

- Purpose of grant

- Amount expended by grantee based

on latest report

- Diversion of funds

- Dates of any reports received from Grantee

- Date and result of verification conducted,

if any

IRS Form 990-PF:Schedule of Expenditure Responsibility Grants

Failure to Report by Grantee

If Grantee has not submitted required reports, foundation must treat as taxable expenditure unless the foundation has:

Made grant in accordance with all ER requirements;

Complied with IRS reporting requirements;

Made reasonable effort to obtain reports; and

Withholds all future payments to this Grantee until such report is furnished.

When ER goes wrong…

Example 1: Michigan-based non

501(c)(3) organization

Funded as part of racial and economic

justice three-year initiative

Leadership changed after the

second year

Inadequate grant reports

Actions Taken

Engaged an independent accounting firm to conduct a grant “review”

Continued request for supporting documentation following grant “review”

Requested determination from outside legal counsel summarized in a memo

Legal Memo

Accountant report did not state any discovery of misuse or diversion of grant funds

Foundation made grant in accordance with expenditure responsibility requirements

Foundation complied with its requirements to report the grant to the IRS

Foundation made reasonable efforts to obtain the required reports

Foundation could no longer fund this non (c)(3) organization until reports are furnished

Not a taxable expenditure for the Foundation

Foundation no longer required to report on 990 PF return

Diversion of Funds

For a Private Foundation to avoid a penalty tax for diversion of

funds by Grantee, foundation must:

Take all reasonable and appropriate steps to recover the

grant funds or ensure restoration of diverted funds, and

Withhold future payments to Grantee after foundation becomes

aware that diversion may have taken place until it has:

- Received grantee’s assurance that future diversions will not occur

and

- Required grantee to take extraordinary precautions to prevent

future diversions from occurring.

When ER goes wrong…

Example 2: Kenyan-based chimpanzee sanctuary, not-publicly

supported, with a for-profit arm

Arcus supported since 2004 totaling $27.2 million in 14 grants and

1 program-related investment

Assessment report provided by a global accounting firm which also

performed an audit of a capital grant

Newly-appointed CFO discovers fraud in the Finance department

Actions Taken

Arcus demanded an audit of the organization by another independent firm

Arcus Board directed a forensic audit be conducted by yet another accounting firm

Forensic audit report reviewed by Foundation staff and project consultants

Requirements Imposed on Grantee

Prior to making a new grant – submission of written procedures for financial controls and administration of grant funds

Prior to making subsequent grant payments – submission of a copy of bank statement exclusively used for Arcus-funded activities

Submission of quarterly narrative and financial reports to ensure compliance

Special Circumstances

Earmarking – the foundation causes the selection of the

secondary grantee

- Cannot avoid ER by making grant to “fiscal agent”. Foundation must

exercise ER as if grant was made directly to secondary grantee.

Subgranting/Regranting – foundation awards a grant to a

Grantee and the Grantee gives all or a portion of the foundation

grant funds to another legal entity

- IRS will hold foundation responsible for the regranting undertaken

by the original grantee.

Capital Equipment and Endowment – regulations provide

clear guidance on reporting for private foundation grantees,

but not on non-501(c)(3) grantees. May want to explore

“useful life” approach.

General Operating Support – not allowed with ER

Resources

“Expenditure Responsibility:

Step by Step” by John A. Edie

www.cof.org

(search: expenditure responsibility)

Internal Revenue Code

Reg.§53.4945-5(b) and§4945-6

Pension Protection Act of 2006

Legal Counsel

Questions