Private foundations in the United States donated about $1.38 billion in grants to individuals in the last five years.1 But extensive regulatory requirements governing grants to individuals mean that such largess should be accomplished cautiously. Counsel to private foundations need to know the portion of the taxable expenditure rules under Internal Revenue Code Section 4945 that governs grants to individuals. Doing so can help guard against the excise tax traps into which private foundations can fall. If mistakes are made, cumbersome statutory and regulatory requirements must be followed to correct a taxable expenditure or abate an excise tax.2 Thus, it makes lot of sense for private foundations and their counsel to establish correct procedures for grants made to individuals.3


A private foundation and certain managers of the private foundation can be subject to an excise tax for taxable expenditures,4 including lobbying expenditures; political campaign expenditures; most grants to individuals unless made pursuant to programs pre-approved by the Internal Revenue Service; grants to organizations other than public charities unless the foundation exercises “expenditure responsibility”; and expenditures for non-charitable purposes.5 The effect of IRC Section 4945 is essentially to restrict the purposes and activities on which private foundations may spend their funds.

If a private foundation makes a taxable expenditure, IRC Section 4945(a)(1) imposes an excise tax in the amount of 10 percent of the taxable expenditure payable by the private foundation. When a foundation is subject to this tax, its managers also may be individually subject to initial excise taxes under IRC Section 4945(a)(2) in an amount equal to 2.5 percent of the taxable expenditure, if they knew that an expenditure is a taxable expenditure and agreed to make such expenditure. However, this initial tax on the foundation's managers is not applicable if the agreement to make such taxable expenditure was not willful and was due to reasonable cause.6 The taxes described in IRC Section 4945(a)(1) and 4945(a)(2) are known as first-tier taxes.7

An additional excise tax of greater severity (100 percent of the taxable expenditure) is imposed under IRC Section 4945(b)(1) on the private foundation if it fails to correct the taxable expenditure within the “taxable period.”8 Under IRC Section 4945(b)(2), additional excise taxes in the amount of 50 percent of the taxable expenditure are imposed on the foundation managers if they refuse to agree to correct the situation.9 The taxes described in Sections 4945(b)(1) and (b)(2) are known as second-tier taxes.

There is also a possibility of termination of the private foundation status under IRC Section 507(a)(2) in the case of either willful repeated acts (or failures to act) or a single willful and flagrant act (or failure to act) to which the taxable expenditure rules apply.10


IRC Section 4945(d)(3) provides that a taxable expenditure includes any amount paid or incurred by a private foundation “as a grant to an individual for travel, study, or other similar purposes by such individual, unless such grant satisfies the requirements of subsection (g).” The legislative history of Section 4945(d)(3) indicates that this statutory provision reflects, in part, congressional concern over the use of private foundations' funds for grants made essentially for the personal benefit of individuals.11

Treasury Regulations Section 53.4945-4 defines a “grant” as including, but “not limited to, such expenditures as scholarships, fellowships, internships, prizes, and awards.” An example of a grant is the payment of funds by a private foundation to enable an individual to write a book under circumstances in which the grantee is not providing personal services to the foundation.12

Treas. Reg. Section 53.4945-4(a)(4)(i) provides that “[a] grant by a private foundation to another organization, which the grantee organization uses to make payments to an individual for purposes described in section 4945(d)(3), shall not be regarded as a grant by the private foundation to the individual grantee if the foundation does not earmark the use of the grant for any named individual and there does not exist an agreement, oral or written, whereby such grantor foundation may cause the selection of the individual grantee by the grantee organization.” A grant meeting these requirements will not be treated as a grant by the private foundation to an individual grantee even though the private foundation has reason to believe that certain individuals would derive benefits from such grant, as long as the grantee organization in fact exercises control over the selection process and actually makes the selection independently of the private foundation.

There are two exceptions to these restrictions: First, in the case of grantee organizations that are public charities under IRC Sections 509(a)(1)-(3), the grantor private foundation may participate to a limited extent in the selection of the individual grantee, such as by making the first proposal of the names of grant candidates. However, the grantee organization must retain control of the selection process, and there must be an objective manifestation of that control by the grantee organization. Also, the public charity must supervise the project for which the grant is made. The regulations provide examples illustrating these situations.13

Second, private foundation grants to grantee organizations that are governmental agencies, as described in IRC Section 170(c)(1), are not subject to Section 4945(d)(3), even though the grantor private foundation exercises considerable control over the selection of, or earmarks such grant for, an individual grantee. But the grantee organization must satisfy the IRS in advance that its grant making program furthers a purpose described in Section 170(c)(2)(B). This exception also requires that the individual grantee submit reports to the grantee organization and that the grantee organization investigate jeopardized grants (grants that are not being used in the furtherance of its purposes) of the purposes as prescribed under the regulations.14 The regulations also state that, even if a grant meets the requirements of Section 4945(d)(3) and (g), it still may be a taxable expenditure if the grant is earmarked for an activity that would constitute a taxable expenditure, there is an agreement to enter into such activity, and the parties actually engage in such activity, or the grant is not made for a charitable purpose.15

Section 4945(g) provides that “[s]ubsection (d)(3) shall not apply to an individual grant awarded on an objective and nondiscriminatory basis pursuant to a procedure approved in advance by the Secretary, if it is determined to the satisfaction of the Secretary that: (1) the grant constitutes a scholarship or fellowship grant which would be subject to the provisions of section 117(a) (as in effect on the day before the date of the enactment of the Tax Reform Act of 1986)16 and is to be used for study at an educational organization described in Section 170(b)(1)(A)(ii), (2) the grant constitutes a prize or award which is subject to the provisions of Section 74(b) (without regard to paragraph (3) thereof)17, if the recipient of such prize or award is selected from the general public, or (3) the purpose of the grant is to achieve a specific objective, produce a report or other similar product, or improve or enhance a literary, artistic, musical, scientific, teaching, or other similar capacity, skill, or talent of the grantee.”


Treas. Reg. Section 53.4945-4(b)(1) provides that, for a grant to an individual to be made on an “objective and non-discriminatory” basis, “the grants must be awarded in accordance with a program which, if it were a substantial part of the foundation's activities, would be consistent with: (i) the existence of the foundation's exempt status under section 501(c)(3); (ii) the allowance of deductions to individuals under section 170 for contributions to the granting foundation; and (iii) the requirements of” the subsequent three paragraphs of this section.18

The first requirement under Section 53.4945-4(b)(1)(iii) is that the candidates should be chosen on the basis of criteria “reasonably related to the purposes of the grant.” This provision also states that the group of candidates must be sufficiently broad, but adds that “selection from a group is not necessary where, taking into account the purposes of the grant, one or several persons are selected because they are exceptionally qualified to carry out these purposes or it is otherwise evident that the selection is particularly calculated to effectuate the charitable purpose of the grant rather than to benefit particular persons or a particular class of persons. Therefore, consistent with these requirements, the foundation may impose reasonable restrictions on the group of potential grantees.”

In addition, the selection of a grantee from within the group of potential grantees “should be related to the purpose of the grant”19 and the persons who choose the recipients of the grants should not be in a position to derive a private benefit if certain potential grantees are selected over others.20


To obtain advance approval of a grant-making procedure, the private foundation must demonstrate that:

  1. the grant-making procedure includes an objective and nondiscriminatory selection process;

  2. such procedure is reasonably calculated to result in the performance by the grantees of the activities that the grants are intended to finance; and

  3. the private foundation plans to obtain reports to determine whether the grantees have performed the activities that the grants are intended to finance.21

Treas. Reg. Section 53.4945-4(d) details the contents of a request for advance approval of the grant-making procedure and the IRS procedure for actions taken upon such a request. The regulations note that the procedure for advance approval of a particular grant program “does not contemplate specific approval of particular grant programs but instead one-time approval of a system of standards, procedures, and follow-up designed to result in grants which meet the requirements of Section 4945(g).” Unlike a private foundation that makes grants to an organization over which it must exercise expenditure responsibility, a private foundation that makes grants to individuals is not required to conduct a pre-grant inquiry or obtain a written commitment from the grantee.22

Failure to seek advance approval will result in the imposition of the excise tax, just as a violation of any other requirement under Section 4945 or its regulations. In John Q. Shunk Ass'n, Inc. v. United States,23 a foundation provided financial assistance to college students. The IRS determined that the grants were taxable expenditures, because the grant procedure had not received the IRS's advance approval. Although the IRS conceded that the grants would not have been taxable expenditures if the organization had applied for approval, the court held that advance approval was a substantive requirement of law and that the organization was liable for the excise tax.

When a taxable expenditure results only because of a foundation's failure to obtain advance approval of its grant-making procedures, a correction may be made (and second-tier taxes avoided) by obtaining the IRS's approval of the procedures. The IRS also must be satisfied that:

  1. no grant funds have been diverted to any use not in furtherance of a purpose specified in the grant;

  2. the grant-making procedures under which any such grant was made would have been approved if advance approval of such procedures had been properly requested; and

  3. when advance approval of grant-making procedures is subsequently required, such approval will be properly requested.24

If the IRS fails to reply to a foundation's request for advance approval of its grant-making procedures within 45 days of submission of the request, the foundation may consider its procedure to be approved, unless the IRS subsequently notifies the foundation that its grant procedures do not meet the requirements of Section 4945(g).25 The IRS has ruled that inclusion of a detailed description of the procedures to be used in awarding scholarship grants by a newly created private foundation in its application for recognition of exemption constituted a properly submitted request for approval of grant procedures (and thus grants that were made in accordance with the submitted description would not be treated as taxable expenditures), even though the application made no specific request for grant procedure approval. Because the IRS did not notify the foundation that its procedures were not approved by the 45th day after submission of its exemption application, the IRS ruled that the organization's procedures were considered to have been approved from the date of the application.26


What is “objective and non-discriminatory” grant making that complies with Section 4945(g)(1)-(3)? A trio of revenue rulings show how the IRS defines this standard.

In Revenue Ruling 76-340,27 a private foundation provided college scholarship grants to students attending a high school in a certain locality within a city. An independent selection committee determined the scholarship recipients. The selection criteria for the private foundation's program included traditional factors such as scholastic ability and personal history, but also non-traditional factors such as the cost of the program of study to be pursued and the likelihood that the recipients would be able to finance the balance of the cost of their education. The IRS allowed the use of these non-traditional factors, because they helped assure that the foundation's grants would “see the recipients through to the completion of an educational program.” The program therefore met the requirements of IRC Section 4945(g)(1).

The private foundation in Rev. Rul. 77-380, Situation 2,28 made awards of its net income to individuals for excellence in investigative journalism. Journalists throughout the United States were eligible, and an independent selection committee chose the recipient. The foundation received advance approval from the IRS of its grant-making procedures. Recipients were to use the awarded money for domestic travel that might further the recipient's understanding of investigative journalism. The IRS held that the awards were made on an objective and non-discriminatory basis, meeting the requirements of Section 4945(g)(2).

In Rev. Rul. 77-44,29 a private foundation made educational grants to qualified individuals who expressed a willingness to teach in the state's public schools for two years immediately after graduating from college, although the private foundation did not require them to actually do so. The IRS determined that the grants were made for the “specific objective” of improving the quality of education in the state as well as the recipients' teaching skills. Therefore, the grants qualified under Section 4945(g)(3) as grants to achieve a specific objective. This ruling also provides an example of how a program may satisfy the requirements of Section 4945(g)(3), but may not provide scholarships as described in Section 4945(g)(1) and 117(a) because the grantor foundation expects to receive substantial services from the recipients in return for the grants.


Treas. Reg. Section 53.4945-4(c)(2)-(6) discusses additional procedural requirements regarding reports, the retention of records and a private foundation's duties when reports show evidence that the grants are not being used to further their purposes.

Correction generally involves recovering part or all of the expenditure to the extent that recovery is possible30 or, in instances when funds cannot be fully recovered, taking additional corrective action to prevent future violations of the taxable expenditure rules. Taking advantage of the correction provisions of IRC Chapter 42 or seeking abatement under Section 4962, can help the private foundation reduce or avoid the imposition of first- or second-tier taxes.31


Making grants to individuals is a viable and popular option for private foundations seeking alternative ways in which to accomplish their charitable purposes. However, the statutory and regulatory requirements are dense, and missteps can lead to serious consequences. If a private foundation believes that making grants to individuals is worthwhile, practitioners should ensure that the directors of the private foundation know that they must show at least the same commitment to meeting these requirements as they show when making grants to organizations.


  1. According to The Foundation Center in New York City.
  2. Internal Revenue Code Sections 4945(i), 4961, 4963 and 6213(e); Treasury Regulations Section 53.4945-1(d), -1(e); German Society of Maryland, Inc. v. Comm'r, 80 T.C. 741 (1983); Thorne v. Comm'r, 99 T.C. 67 (1992).
  3. This article does not address employer-related scholarship grant and loan programs. See Revenue Procedure 76-47, 1976-2 C.B. 670, clarified by Rev. Proc. 85-51, 1985-2 C.B. 747; Rev. Proc. 81-65, 1981-2 C.B. 690.
  4. IRC Section 4945(a) and (b).
  5. IRC Section 4945(d).
  6. The regulations provide detailed definitions of the statutory terms “agreement,” “knowing,” “willful” and “due to reasonable cause,” (which means exercising “responsibility on behalf of the foundation with ordinary business care and prudence”). Treas. Reg. Section 53.4945-1(a)(2).
  7. If there are multiple foundation managers that are liable for the tax, they are jointly and severally liable. IRC Section 4945(c)(1); Treas. Reg. Section 53.4945-1(c)(1). The maximum first-tier tax that can be imposed on the foundation managers is $5,000. IRC Section 4945(c)(2).
  8. “Taxable period” is defined as the period beginning with the date on which the taxable expenditure occurs and ending on the earlier of (1) the date of the mailing of the notice of deficiency with respect to the tax imposed by subsection (a)(1) under IRC Section 6212 or (2) the date on which the tax imposed by subsection (a)(1) — which is the first-tier tax — is assessed. IRC Section 4945(i)(2).
  9. The maximum second-tier tax that can be imposed on foundation managers is $10,000. IRC Section 4945(c)(2).
  10. The excise tax also may be doubled by an additional penalty in certain situations in which the taxpayer is liable for multiple excise taxes. IRC Section 6684.
  11. Joint Comm. on Tax'n, General Explanation of Tax Reform Act of 1969, 91st Cong., 2d Sess. (1970), p. 48.
    Grants to individuals for purposes other than those proscribed by the statute are not taxable expenditures, regardless of whether or not the requirements of Section 4945(g) are met. Treas. Reg. Section 53.4945-4(a)(3)(i); See also Revenue Ruling 75-393, 1975-2 C.B. 451, modified, Rev. Rul. 76-460, 1976-2 C.B. 371 (annual awards made by a private foundation to the person who had written the best piece of literary criticism during the preceding year, and thus granted in recognition of such person's past achievements rather than intended to finance any particular future activities, were not taxable expenditures).
  12. Internal Revenue Manual, 17.5. The term “grant” also includes loans for charitable purposes described in Section 170(c)(2)(B), program-related investments and payments to exempt organizations to be used in furtherance of their exempt purposes. Treas. Reg. Section 53.4945-4(a)(2); Rev. Rul. 77-434, 1977-2 C.B. 420.
  13. Treas. Reg. Section 53.4945- 4(a)(4)(ii)&(iv).
  14. Treas. Reg. Section 53.4945-4(a)(4)(iii).
  15. Treas. Reg. Section 53.4945-4(a)(5).
  16. The provision referring to Section 117(a) as in effect before the Tax Reform Act of 1986 essentially ensures that grants made by private foundations will not be treated as taxable expenditures merely because such grants exceed the amount currently excludible by degree candidates under current IRC Section 117(a) (for example, a grant that includes funds for room and board) or because such grants were made to non-degree candidates.
  17. The prizes and awards that fall into this category include those made to the recipient primarily in recognition of religious, charitable, scientific, educational, artistic, literary or civic achievement; and the recipient is chosen without any action on his part to enter the contest or proceeding and is not required to render “substantial future services” in order to receive the prize or award.
  18. See Rev. Rul. 85-175, 1985-43 I.R.B. 12 (a foundation that awarded scholarships on a preferential basis to family members and relatives of the trust's grantor did not award such scholarships on an objective and non-discriminatory basis).
  19. Examples of proper criteria for selecting scholarship recipients include prior academic performance, performance on college aptitude tests, financial need and determinations made by a selection committee. Treas. Reg. Section 53.4945-4(b)(3); Rev. Rul. 76-340, 1976-2 C.B. 370.
  20. Treas. Reg. Section 53.4945-4(b)(2)-(4).
  21. Treas. Reg. Section 53.4945-4(c)(1).
  22. Treas. Reg. Section 53.4945-5(b).
  23. 626 F.Supp. 564 (S.D. Ohio 1985).
  24. Treas. Reg. Section 53.4945-1(d)(2).
  25. Treas. Reg. Section 53.4945-4(d)(3); See also Rev. Rul. 81-46, 1981-1 C.B. 514 (installments of fixed-sum grants approved by foundation during period in which procedures were deemed approved because foundation received no reply to approval request within 45 days of submission but subsequently paid out were not taxable expenditures because foundation was obligated to make such payments; however, any renewals of such grants after notification that program did not meet IRC Section 4945(g) requirements were discretionary by foundation and thus would constitute taxable expenditures).
  26. Rev. Rul. 86-77, 1986-21 I.R.B. 7.
  27. 1976-2 C.B. 370.
  28. 1977-2 C.B. 419.
  29. 1977-1 C.B. 355.
  30. Treas. Reg. Section 53.4945-1(d)(1)(vi).
  31. See also note 3 for additional sources regarding abatement and correction.

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German Treasures: Lucas Cranach the Elder painted the 1526-oil “Prince Moritz of Saxony,” a portrait of the son-in-law of Philipp the Magnanimous of Hesse, who grew up to rule Saxony in 1547. The portrait is on display at the Portland Art Museum in Portland, Ore. through March 19.

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