Is a private foundation permitted to make a grant to another private foundation?
Yes, a private foundation can make a grant to another private foundation. However, the grant should not be treated the same way as a routine grant to a public charity. The correct compliance approach depends on the type of private foundation receiving the funds, whether the donor foundation needs the grant to count toward its own 5% minimum distribution requirement, and whether the donor foundation or related parties control the recipient foundation.
At a high level, the analysis involves two separate questions:
(1) Can the grant be made without being treated as a taxable expenditure?
(2) Will the grant count toward the donor foundation’s 5% minimum distribution requirement?
These two questions are related, but they are not the same.
A key concept in the first question is expenditure responsibility, often called ER. At a very high level, ER is a compliance process that requires the donor foundation to do basic due diligence before making the grant, use a written grant agreement, require reports from the recipient, and report the grant properly on Form 990-PF. ER is designed to show that the donor foundation took reasonable steps to ensure the funds were used only for charitable purposes.
However, ER does not answer every question. ER may make the grant permissible and defensible, but it does not automatically mean the grant counts toward the donor foundation’s annual 5% payout requirement. That separate payout question depends on the recipient’s status and, in some cases, whether the recipient redistributes the funds under special pass-through rules.
Private operating foundations vs. non-operating private foundations
Private foundations generally fall into two broad categories: private operating foundations and private non-operating foundations.
A private operating foundation primarily conducts its own charitable programs. In other words, it directly “does the work.” Examples might include a foundation that operates a museum, research program, camp, archive, clinic, or other direct charitable activity.
A private non-operating foundation primarily makes grants to other charitable organizations. It generally “funds the work” rather than directly operating its own programs.
This distinction matters because grants to private operating foundations are often more favorable from a qualifying-distribution standpoint. If the recipient is a legitimate private operating foundation and is not controlled by the donor foundation or related disqualified persons, the grant is more likely to count toward the donor foundation’s 5% minimum distribution requirement.
However, an ordinary private operating foundation is still a private foundation. It should not automatically be treated the same as a public charity. Unless the recipient is a specific type of operating foundation called an "exempt" operating foundation, or another exception applies, the donor foundation may still need to exercise expenditure responsibility. An "exempt" operating foundation is a special and very rare category of private operating foundation that meets additional requirements about receiving its operating funds from the public at large.
Grants to non-operating private foundations
A grant to a private non-operating foundation is usually more complicated.
Because a non-operating private foundation is itself typically a grantmaking vehicle, the IRS generally expects more structure and oversight when one private foundation routes funds to another private foundation. In most cases, the donor foundation should treat the grant as an expenditure responsibility grant.
Expenditure responsibility, often called ER, is a defined set of procedures designed to show that the donor foundation performed due diligence, restricted the grant to charitable purposes, required written reporting, and monitored whether the funds were used properly. ER is not just a best practice. In many cases, it is the mechanism that prevents the grant from being treated as a taxable expenditure.
What expenditure responsibility generally requires
A proper ER grant usually includes the following:
• Pre-grant inquiry: The donor foundation should perform reasonable due diligence on the recipient foundation, its charitable status, leadership, activities, and ability to carry out the grant purpose.
• Written grant agreement: The grant agreement should describe the charitable purpose of the grant, restrict the use of funds, prohibit improper uses, require repayment if funds are misused, and require the recipient to maintain appropriate records.
• Grantee reporting: The recipient foundation should provide reports showing how the funds were used and whether any funds remain unspent.
• Donor foundation reporting: The donor foundation must properly report the ER grant and related compliance information on Form 990-PF.
The level of due diligence should be reasonable based on the facts. A small grant to a well-established foundation may not require the same level of review as a large grant to a newly formed or related foundation. However, the donor foundation should still document its process.
ER does not automatically create 5% payout credit
The most common mistake is assuming that once ER is done, the grant automatically counts toward the donor foundation’s 5% minimum distribution requirement. That is not necessarily correct.
ER is primarily about avoiding taxable-expenditure treatment. The 5% payout question is a separate qualifying-distribution issue.
A grant to a private operating foundation may often count as a qualifying distribution, especially if the donor foundation does not control the recipient. But a grant to a private non-operating foundation generally does not count as a qualifying distribution unless special pass-through rules are satisfied.
In general terms, for a grant to a private non-operating foundation to count toward the donor foundation’s payout requirement, the recipient foundation must redistribute the funds within the required timeframe, properly treat the redistribution as being made out of corpus, and provide adequate records to the donor foundation.
This is why a grant can be perfectly charitable, properly documented, and handled under ER, but still fail to help the donor foundation satisfy its own annual payout requirement.
Common pitfalls
Some of the most common mistakes include:
• assuming a private operating foundation can always be treated like a public charity;
• making a grant to another private foundation without ER;
• using a handshake understanding instead of a written grant agreement;
• failing to obtain follow-up reports from the recipient foundation;
• assuming ER automatically makes the grant count toward the donor foundation’s 5% payout requirement;
What if the goal is simplicity?
If the donor foundation’s goal is simply to support charitable work with the least compliance burden, it may be simpler to make the grant directly to a public charity. If the decision is made to go forward with the grant to another private foundation, the donor foundation should slow down and analyze the compliance requirements before distributing the funds. When the recipient must be another private foundation, the grant can often still be made. It just needs to be structured properly.
Special note on large transfers or foundation splits
A normal grant from one private foundation to another is different from a larger transfer of corpus or endowment, such as when one foundation divides its assets between two successor foundations or transfers a substantial portion of its assets to another private foundation.
Those transactions may be governed by a separate set of rules under IRC Section 507 and should generally be treated as foundation reorganizations, liquidations, splits, or significant asset transfers rather than ordinary grants. They can be permissible, but they require more careful legal and tax analysis.
Bottom line
A private foundation is permitted to make a grant to another private foundation, but the grant should be handled carefully.
A grant to a private operating foundation may be more favorable, especially for qualifying-distribution purposes, but expenditure responsibility may still be required unless the recipient is a special (and rare) "exempt" operating foundation or another exception applies.
A grant to a private non-operating foundation usually requires expenditure responsibility and generally will not count toward the donor foundation’s 5% minimum distribution requirement unless the pass-through/out-of-corpus rules are satisfied.
The safest approach is to treat the analysis in two steps: first, determine what is required to avoid taxable-expenditure treatment; second, determine whether the grant will count toward the donor foundation’s annual payout requirement.
In short, the grant may be allowed, but it should not be treated casually. The donor foundation should confirm the recipient’s status, document the charitable purpose, use a written agreement when required, monitor the use of funds, and separately analyze whether the grant will count toward its 5% payout requirement.
Seeking expert guidance? We're here to help!
At CPA KPA, we're passionate about magnifying the positive impact of foundations. Feel free to reach out to us anytime at 888-402-1780 for a complimentary and obligation-free conversation. You can also conveniently submit your questions and inquiries through our contact page. Let's connect today and explore how we can help your foundation have a lasting and meaningful impact!
