Legal Constraints of Private Foundation Funding: Key Takeaways for Both Grantors and Grantees
With more than 100,000 private foundations throughout the United States, it is vital for both—private foundations (grantors) and nonprofit organizations (grantees)—to understand the legal requirements encompassing their charitable relationship. Private foundations enjoy a unique tax-exempt status with their income often derived from a single source and continued donor involvement. This unique position generally results in closer scrutiny from the IRS as to the way private foundation funds are spent.
The two biggest areas for scrutiny: ensuring foundation funds are spent according to the stated organizational charitable purpose and officer or employee compensation is reasonable. Hence, both grantors and grantees need to be aware of best practices as to the administration and receipt of foundation funds to ensure proper legal compliance. Adhering to best practices will keep both grantors and grantees within appropriate guidelines and help avoid any trouble, including audits that could lead to both organizational and officer penalties.
Responsibilities of private foundations
Private foundations should be diligent in avoiding two things: conflicts of interest and grants awarded to disqualified persons. Tax-exempt funds cannot flow to those who have significant control over these foundation funds—like board members, donors, or any of their family members. Awarding grants to disqualified persons, or paying them unreasonable compensation, is considered self-dealing and should be avoided.
A conflict of interest occurs when the foundation hires or contracts with a board member or anyone closely connected to a board member, such as a spouse, child, or parent, to perform services for the foundation. The key takeaway in examining this conflictual relationship hinges on the unique qualifications of the person or entity to be hired, and if the proposed compensation or service fee is within the fair market value for such position or fee. If after a thorough market analysis, the foundation board determines that compensation or the service fees are unreasonable, then the individual or entity should not be hired. If, however, the foundation proceeds with the arrangement, then the board must adhere to the organization’s conflict of interest policy and ensure everything is clearly documented in board meeting minutes. Foundations should air on the side of caution and avoid these conflictual relationships as much as possible.
Private foundations also should ensure reasonable compensation for all staff members and board member expenses. Employees of the foundation should possess the requisite job qualifications, have written job duties, and compensation that aligns with fair market expectations for similar roles. While private foundations can hire family members as staff, they cannot unduly benefit from the foundation’s funds by getting a job for which they are not qualified.
“While private foundations can hire family members as staff, they cannot unduly benefit from the foundation’s funds by getting a job for which they are not qualified.”
Similarly, board expenses and any compensation of board members must be reasonable. For example, some reimbursement for travel expenses may be allowed for board members but travel costs for limo service and other luxury expenses should not be allowed. The key takeaway is reasonable expenses, hence, coach airfare, IRS mileage reimbursement rate, etc.
Finally, foundations as grantors need to have grant applications and agreements to provide clear guidelines for grantees as to how foundation funds can be spent. Grantors should also require documentation on how grantees spend funds (like accounting detail reports and receipts) and review that documentation regularly to ensure funds are being spent appropriately. A clearly delineated grant process inclusive of deadlines and reporting requirements is key for compliant foundation funding.
Considerations for grantees
Organizations applying for and receiving grants from private foundations also have critical responsibilities. Most available grants have clear spending guidelines and reporting requirements as to permitted usage of the awarded funds. Grantees thus need to be aware of these guidelines and ensure they can meet these expectations before applying for the grant.
Failure to adhere to foundation spending guidelines may result in the grantee paying back the misspent funds to the grantor and prohibit the grantee from all future funding.
Organizations who are applying for funds should also work to avoid any conflicts of interest. This might include family or business connections to the donor who funds the foundation or any members of the foundation’s board. If an organization realizes there is a conflict of interest with a specific foundation, they should not apply for funding.
Finally, if grant funds from a private foundation are used to pay employees of the grantee, reasonable compensation standards also apply. The grantee’s employee must be qualified for the position and paid according to fair market value standards for similar positions.
If your organization—either a grantor or grantee—needs help with legal compliance regarding private foundation funding, reach out to the Nonprofit Solutions team to schedule a consultation.
