Have We Properly Verified the Tax-Exempt Status of Our Grantees?

The next time your family meets to review its governance practices, make sure you take the time to ask an important, but often overlooked, question:

Have we properly verified the tax-exempt status of our grantees?

Every grant award offers a potential risk that should be understood and properly mitigated.  Providing grants to a charity that has had its tax-exempt status revoked — even unknowingly — can lead to the disbursement being considered a taxable expenditure, prevent foundations from meeting the annual 5 percent distribution requirement, and cause the IRS to levy excise taxes — stiff fines — on the foundations involved.

Standard “old-school” governance practice generally includes verifying the status of a tax-exempt organization by getting a copy of its IRS tax determination letter and/or its most recently filed Form 990. 

But this is not considered best practice today. 

Well-intentioned giving often fails to realize that a nonprofit’s tax-exempt status is a fluid determination that involves multiple conditions that can change day-to-day or year-to-year.  What happens when the potential grantee has lost its tax-exempt status in the time since its most recent filing?  This will not be evident through the Form 990 or the historical record of the original 501(c)(3) exemption document. 

The IRS has become much more vigilant in revoking the tax-exempt status of organizations that have not met minimum IRS standards or fall outside of current Office of Foreign Asset Control (OFAC) standards. 

While the popular narrative is that the number of nonprofits is exploding, government data shows that the number of registered public charities has actually been on the decline in recent years.

The number of such organizations has declined by more than 60,000 between 2008 and 2013 — a move that is largely the result of the IRS removing the tax-exempt status of once-active charities.

Missteps in verifying tax-exempt status can trigger increased scrutiny from the IRS and compromise the reputation of family foundations.

This is especially important at a time when foundations are facing increased public skepticism in the wake of a series of high-profile reports that spotlighted questionable — and potentially illegal — behavior by the foundations operated by the families of each of the presidential candidates.

While most family foundations are committed to operating with integrity and transparency, the recent media coverage has fueled misperceptions about philanthropy that threaten the reputation of the sector and the charitable good that it fuels.  Unknowingly providing grants to non-exempt organizations unnecessarily exacerbates this threat. 

Unfortunately, the burden falls on the foundation to catch these changes. And old-school methods of verification aren’t sufficient.  Best practice is not to ask the charity to validate its status but to use third-party tools that remove all doubt about charitable status at the time of the gift.

The good news is that the families can avoid these inadvertent missteps by taking advantage of a number of online tools that provide up-to-date information about the status of tax-exempt organizations.

My nonprofit organization has offered a product called GuideStar Charity Check to help meet this need for 15 years. GuideStar Charity Check is fully compliant with IRS rules and syncs with the IRS Publication 78, IRS Business Master File, Internal Revenue Bulletin, IRS Automatic Revocation of Exemption list, and OFAC status. It also gives subscribers the option to receive real-time e-mail alerts and updates on tax-exempt status changes for nonprofits that are of common or consistent interest to your foundation.

If a family foundation is making dozens or hundreds of grants, GuideStar also offers the option to check the charities’ status en masse. You can simply provide our team with a list of potential grantees and we return an up-to-date status on each organization.  This is a time saver – keeping you from having to hand-enter each organization you are seeking to fund. 

The government also offers a number of resources, including the IRS Exempt Organizations Select Check and its regularly updated Internal Revenue Bulletin.

If your family hasn’t reviewed and revised its process for verifying grantees’ tax-exempt status, now is the time.

Doing so will give your family the confidence that it is doing all it can to fulfill its duty to responsible grant making and let you focus your energies on the good you are supporting.