Focus on Foundations: Supporting Charitable Causes in Foreign Countries
Many people would like to support charitable causes in foreign countries, but they are reluctant to do so because those donations do not qualify for a U.S. income tax deduction.1 Furthermore, a donation to a U.S. charity that is specifically earmarked for a foreign organization will not qualify for a U.S. income tax deduction.
However, donations to a U.S. charity that makes non-earmarked grants to a foreign organization will qualify for a charitable deduction for U.S. income tax purposes. For example, a donor may contribute to a U.S. private foundation he or she has established, and then the foundation can ultimately make contributions to foreign organizations for specified charitable purposes.2 This mechanism allows the donor to maintain control over the selection of the foreign charities, the timing and the amounts of the gifts to those charities.
If a U.S. private foundation wishes to make contributions to or on behalf of a foreign organization, there are certain requirements that must be met. If the foreign organization has obtained a ruling from the IRS that it satisfies criteria for a U.S. organization to be tax-exempt, then grants can be made to it relatively freely. Most foreign organizations will not have obtained such a ruling. So we will focus on the administrative requirements that apply in the more likely scenario where no ruling has been issued. It is important that these administrative requirements be specifically observed. Otherwise, a 10% excise tax will be imposed on the grant as a "taxable expenditure" by the U.S. foundation. A taxable expenditure is generally a distribution by a private foundation to an organization other than one classified as exempt from U.S. income tax (by way of a ruling from the IRS) as a public charity.3 But the U.S. foundation can avoid this tax by exercising what's known as "expenditure responsibility" with respect to the grant.
"Expenditure responsibility" means that the U.S. foundation must:
- Make a pre-grant inquiry to see if the foreign organization can accomplish the grant purpose;
- Obtain a written commitment from the foreign organization stating that it will (a) repay any portion of the grant not used for the grant's purpose, (b) submit periodic reports on how the grant is used, (c) maintain adequate records, and (d) not use the grant for legislative, political, or non-charitable purposes; and
- Report to the IRS on its annual information return (Form 990 PF) (a) the name and address of the foreign organization, (b) the date, amount, and purpose of the grant, (c) the amounts expended by the foreign organization, (d) if the U.S. foundation is aware of a diversion of funds by the foreign organization, (e) dates of any reports received from the foreign organization, and (f) results of any verification of the foreign organization's reports by the U.S. foundation.
In the alternative, the U.S. foundation can avoid exercising expenditure responsibility if it determines that the foreign organization is equivalent to a public charity under U.S. income tax law. That determination can be based upon an affidavit from the foreign organization or the opinion of counsel.4
A U.S. foundation can also count the foreign grants toward its 5% annual minimum distribution requirement if:
- The foreign organization spends all of the grant (i.e., not just income on the grant) by the close of the first taxable year after it is received;
- The foreign organization spends the grant in a manner that would be deemed "charitable"; and
- Adequate records are maintained by the foreign organization showing that the preceding requirements have been met.
Similarly, the U.S. foundation can avoid these requirements by making a good faith determination (as discussed above) that the foreign organization is equivalent to a U.S. public charity or private operating foundation.
Complying with the above administrative requirements can be a time-consuming and detail-oriented task. But with proper guidance, there is certainly no reason why a U.S. donor's tax-deductible dollars cannot be used to support worthy causes in other countries.
1. However, a tax treaty between the U.S. and a foreign country may specifically allow a charitable deduction, for U.S. income tax purposes, for a contribution by an individual to a charitable organization formed under the laws of that foreign country (but usually subject to some specific limitations). See, for example, the U.S. tax treaties with Mexico, Canada, and Israel.
2. In the alternative, a donor may contribute to a public charity or an unrelated private foundation which supports a foreign charitable organization. The public charity or unrelated private foundation would have its own guidelines to follow to support its tax-exempt status.
3. Treasury Regulation Section 53.4945-5(a)(4) has expanded the definition of a "public charity" to include, among other things, foreign governments, the United Nations, and the I.M.F.
4. These requirements are more specifically set forth in Treasury Regulation Section 53.4945-5(a)(5).