Picture this—you have just been awarded a grant! You are able to spend an entire year doing your amazing work, realizing your awesome project, and making a community impact. Congratulations!
But wait—how do you account for this grant when tax time comes? How does a grant award impact nonprofit taxes?
This article will give you all the information and tools you need to build proper allowances for taxes, including what grants are, what their tax implications are, and what that means for you and your nonprofit.
What Is a Grant?
Before we go into the fine details of grant taxation, let’s start off with the basics of what a grant is. From there, we can then explain what nonprofit grants are, and how grants impact nonprofit taxes.
A grant is defined as money, goods, or services given from a grantmaking organization to another entity without an expectation of being repaid. Grants are usually sums of money. Although they can also be “in-kind” opportunities, which means grants in the form of goods or services as opposed to “cash”.
Common categories of grants include:
- Federal grant opportunities distributed by the various departments of the federal government
- State grants which are administered through state governments
- Private foundations (also known as “foundation grants”)
- Corporate social responsibility (CSR) grants support from private businesses
While grants are given without an expectation of being paid back, they require a return on investment—or ROI—in terms of measurable benefit to the target area you will use the grant in.
To receive grant funding for programs, a nonprofit will generally need to describe how the funds will be used, the types of services to be provided, the implementation plan, the demonstrated need and impact of the program, and the anticipated outcomes or goals to be met, and the evaluation measures.
To learn more about what types of grants exist for nonprofits, take a look at our article on The Most Common Types of Nonprofit Grants.
Are Grants Considered Taxable Income?
The answer is: it depends on what sort of organization you are representing, and what type of grant you are focused on.
Note: In this article, we will be focusing on grants and tax law in the United States. International grants will have additional tax implications to consider.
There are many types of grants that are awarded for many different reasons. There are for-profit opportunities, nonprofit opportunities, grants to tribal organizations, grants to research institutions—the list goes on.
The type of grant and the type of organization that is receiving the grant impact the guidance for the tax implications.
For example, COVID-19 grants have specific guidelines that look different from foundation grant guidance, which looks different from research grants to institutions.
As another example, if you are representing yourself as an individual/sole proprietor LLC (e.g. you are the organization) and the grant is not for educational purposes, the grant funds paid to you as a payment/stipend for your grant-related work should be accounted as taxable income.
A good general rule to keep in mind is that all income, regardless of its source, is considered taxable income unless the tax law specifically states an exception.
Since a grant is considered income, it is considered taxable unless the law has provisions that state otherwise. We will explore what that looks like for nonprofit taxes shortly.
Fun fact: if a grant is for expenditures that appear in your profit and loss account and you are deferring the grant income, you most likely would not have a tax liability on the income as it will be matched (canceled out) with its designated expenditure.
For the purposes of this article, we will do a brief overview of what the general grant taxation landscape looks like, and then hone in on nonprofit grants and their specific implications for nonprofit taxes.
What Types of Grants are Tax-Free?
Here’s a snapshot overview of what grants are considered tax-free, why they are considered tax-free, and what it means for you.
What do we mean when we say “nonprofit” grants? We’re looking at nonprofits defined as 501(c)(3) private foundations.
Every organization that qualifies for tax exemption as a 501(c)(3) organization is considered a private foundation unless it falls into one of the categories specifically excluded from the definition of that term (referred to in section 509(a) of the IRS tax code).
Nonprofits in the United States are exempt from federal corporate income taxes. Most are also exempt from state and local property and sales taxes.
However, nonprofits are required to pay taxes on income from activities that are unrelated to their mission.
An unrelated business activity (subject to Unrelated Business Income Tax, or “UBIT”) for a nonprofit includes the following characteristics:
- It is a trade or business
- It is regularly carried out and
- It is not substantially related to furthering the exempt purpose of the organization
If the grant is spent on equipment then the grant is not taxable but there is no capital allowance available on the equipment expenditure. A capital allowance is money directed towards long-term business growth and can be deducted each year from overall revenue by way of depreciation.
Qualified Educational Expense Grants
Grants for qualified educational expenses are treated the same as a tax-free scholarship, and the amounts you use to pay for qualified education expenses are tax-free. To be qualified for one of these grants, you must:
- Be a candidate for a degree at an eligible educational institution
- Use the grant to pay qualified educational expenses, and
- Not spend the majority of grant-funded time researching, testing, teaching, etc.
Qualified educational expense grants include Fulbright Grants, Pell Grants, and all Title IV need-based education grants.
COVID-19 Small Business Administration (SBA) Economic Injury Disaster Loan (EIDL) Grants and Grants for Shuttered Venue Operators
The 2020 COVID-19 responded Economic Injury Disaster Loan (EIDL) advance grants of $10,000 for small businesses were not considered taxable income. Additionally, grants for Shuttered Venue Operators (live venues, museums, arts organizations, etc.) were also considered to be tax-free. In some of these unique situations, Covid-19 grant opportunities are tax-deductible nonprofit grants.
Do Nonprofits Have to Issue 1099s for Grants?
The answer is NO.
When it comes to nonprofit taxes, because these funds are considered charitable grants and not designated as payment for services and/or compensation, organizations don’t need to issue 1099s for disbursed grant funds.
Some activities that nonprofits do have to issue 1099s for include:
- Payment issued for a non-employee for services performed in the course of the organization's business.
- Payment to an individual, partnership, vendor, or estate.
At this point, some of you might be asking: what if I happen to be a grantmaking organization that is also a nonprofit?
The answer to that is that a nonprofit's grants to organizations are taxable expenditures, unless:
- The recipients are public charities, and/or
- The foundation exercises expenditure responsibility with respect to the grant.
Expenditure responsibility means that the foundation exerts all reasonable efforts and establishes adequate procedures:
- To see that the grant is spent only for the purpose for which it is made,
- To obtain full and complete reports from the grantee organization on how the funds are spent, and
- To make full and detailed reports on the expenditures to the IRS.
General Rules for Nonprofit Grants and Taxes
Like we went over earlier, the general rule for nonprofit grants is that they are considered income in most situations, and therefore are exempt from federal corporate income taxes. Most are also exempt from state and local property and sales taxes, but you would want to check your specific state and municipality to make sure that you are also following local tax laws.
Each state has its own website dedicated to specific rules and regulations for nonprofit taxes, and you might also consider speaking with a certified tax professional in your area to ensure you have all the information that you need. Many firms will offer pro-bono consultation if you are representing a nonprofit organization.
For even more information about how the grants process works, for both tax structure and overall lifecycle, you can read our article How Do Government Grants Work? What You Need To Know, which provides a deep dive into common questions about government-supported grants.
Wrapping Up: Can Nonprofit Grants Be Taxed?
In this article, we explored the basics of rules and regulations for nonprofit taxes and grants. We went over general rules and delved into which categories of grants are considered to be tax-free. We also went over where you can take additional steps to learn more about grants.
Remember that you also want to check out your state and local tax regulations regarding nonprofits to make sure that you have a solid grasp of your specific situation.
Instrumentl is a great place to start as you think about how to account for your newest grant-funded endeavor. We have tons of resources, including articles and webinars, that can answer your questions and help you build your toolkit of resources for your overall grants experience. Check out our blog for more tips on how to thoroughly account for your next grant.