What can a private foundation spend money on?

Private foundations generally spend the majority of their money making philanthropic grants to public charities such as religious organizations, educational institutions, poverty relief agencies, and other 501(c)(3) organizations. Private foundations can also provide grants to individuals as well as international charities, and can set up award and prize programs.‍

Aside from grants, it is normal and expected that private foundations incur various kinds of operating expenses as they carry out their charitable mission. Think of the complex operations of the Bill and Melinda Gates Foundation with more than 1,500 paid staffers. The foundation provides hundreds of millions in grant funding each year to diverse causes such as basic worldwide sanitation, nutrition, education, and healthcare. An organization of this magnitude has operating expenses that are akin to a multinational business corporation.

On the opposite end of the endowment spectrum, there are many private foundations with endowments of less than $1 million. These small foundations also have legitimate operating expenses just on a different scale. Let’s take a very minor expense as an example: if a small foundation mails a grant check to a charity, the cost of the envelope and postage would count as a legitimate expense just the same as it would for the Bill and Melinda Gates Foundation. So, what are some regular expenses that private foundations customarily incur? It is normal for foundations to incur expenses such as office supplies, postage, bank fees, staff compensation, office rent, legal and accounting fees – really the list could go on and on and on. An expense is considered legitimate as long as it is incurred to carry out the foundation’s charitable mission and it fits within the statutory guidance of being a “reasonable and necessary” expense.

What exactly is a reasonable and necessary expense? Although there is no concise and definitive answer to this question, the meaning is discernable. If an expense furthers the foundation’s charitable mission and other foundations are incurring similar expenses in both nature and amount, then the expense is most likely legitimate. 

Legitimate expenses are categorized as either: (1) for charitable purposes, or (2) for investment purposes. Expenses incurred for charitable purposes qualify towards meeting the annual distribution requirement of approximately 5% of assets. Expenses incurred for investment purposes count as a deduction against net investment income and reduce the excise tax based on investment income. Federal excise taxes themselves do not count towards the annual 5% distribution requirement nor as a deduction against net investment income.

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