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International
Tax Issues for U.S. Donors and Charitable Organizations
By
James Cassidy, CPA
Many
times throughout my career providing U.S. tax services
to U.S. expatriates and foreign national executives, clients
have asked me if they can make tax deductible contributions
to foreign charities, located either in their countries
of residence or in their home countries. At the same
time,
administrators and executives working for foreign-based
charities have asked whether contributions made by U.S.
taxpayers could qualify as tax deductible charitable contributions
in order to attract more support from U.S. donors.
Below
are the key issues and rules regarding foreign-based
charities.
Individual
Donors
The
primary U.S. rule is that the organization must have
been created in the United States. A contribution
made by a U.S. taxpayer to a foreign entity that
has applied and qualified for tax-exempt status in the United States does
not result in a deductible contribution for the U.S.
taxpayer because the foreign
charity was not established in the United States.
There
are a few exceptions; the U.S. currently has treaties
with Canada, Mexico and
Israel that permit deductible contributions in some
circumstances, but
only to offset income earned from sources in the respective treaty country.
-
Canada: Article 21(5) – Contributions to Canadian college
or university not limited to Canadian income
- Mexico:
Article 22(2) – No
exception to limit for colleges or universities
- Israel:
Article 15A(1) – Contributions are limited
to 25 percent of income from Israeli sources
The
above treaty exceptions are generally available to U.S.
taxpayers
residing in or who derive income from these three countries. Nonresident
alien individuals
(including foreign trusts and foreign corporations) are permitted
to deduct charitable contributions only if conducting
trade or business
in the United
States and only
to U.S. charities and governmental units. There is no provision under
a tax treaty that permits a U.S. nonresident to deduct a charitable
contribution made to a
charity in the nonresident’s country of tax residence.
Under
U.S. estate and gift tax rules, however, full estate and gift tax
deductions are allowed for bequests and gifts to "any corporation" organized
and operated for charitable purposes. A bequest or gift to a foreign
corporation
is deductible if the corporation meets the following general standards:
- It
permits no private inurement to individuals (i.e.,
it is a nonprofit).
- It
prohibits lobbying activity.
- It
prohibits political activity.
- It
was organized and is operated solely for recognized
charitable purposes that are "religious, charitable
(eleemosynary), scientific, literary or educational."
Gifts
or bequests to trustees of charitable trusts for use
abroad or to foreign trusts
for charitable purposes abroad are also
generally deductible. The
regulations, however, prohibit a foreign charity from being
named as
the
remainderman of
a qualified charitable remainder trust.
Gifts
or bequests to foreign private foundations that receive
over 15 percent
of lifetime support from U.S. sources are not
deductible
unless
U.S. tax
exemption is obtained. Foreign private foundations with over
85 percent lifetime foreign
support are not required to apply and must generally comply
with private foundation distribution and other governing
rules in
order for a gift
to be deductible.
Generally, gifts to foreign governments are not permitted
unless limited to exclusively charitable purposes.
Decedents
who are not U.S. citizens or domiciliaries are only
permitted a charitable deduction for gifts and bequests
to
the U.S. federal
and local governments,
domestic charitable corporations and other gifts to be
used
in the United States. Exceptions
to this rule, however, are found in estate and gift tax
treaties. Generally under a treaty, transfers at death
to a charity
in the decedent’s home country
have the same treatment as if they were transferred to
a U.S. charity. Exceptions are found under the following
treaties:
Canada (income tax treaty), Denmark,
France, Germany, Greece and Sweden.
Foreign
Status by Entity
Under
Internal
Revenue Code (IRC) section 509, charitable entities
are classified as either “public
charities” or “private foundations.” How
and whether a U.S.-based charitable organization can
make foreign donations depends upon its tax classification.
- Public
charities generally receive support from a broad base
of contributors or payments for services related to
charitable goals and may make foreign expenditures
directly or through grants to individuals or
organizations. Any foreign activity must be within
the charitable objectives as a condition of exempt
status, and
a public charity must exercise sufficient control
of funds and ensure that funds are properly spent in
a foreign jurisdiction to avoid losing its tax exemption.
Public charities are not subject to excise taxes.
- Private
foundations do not receive broad support from the public
and are subject to statutory restrictions
and distribution
requirements. They are also subject
to excise taxes on investment income and, under
IRC
section 4942, “qualifying
distributions” equal to five percent of
annualized assets for the prior year must be
made or the tax
rate on investment income is not eligible for
a reduced rate of tax (one percent). Foreign
foundations
are subject to a four percent tax (or lower under
treaty for Canada, Germany, Mexico and the Netherlands).
Also,
under IRC
section 4945, penalty taxes may apply
if “taxable expenditures” are
made. Grants to individuals and to foreign nonpublic
charities may be considered taxable expenditures.
Private foundations must follow due diligence responsibilities
and exercise expenditure responsibility for foreign
grants.
Foreign
charitable organizations that have not qualified for
tax exemption and a tax classification
in the
United States
are considered
to be
private foundations
because they have not established that they are
entitled to another classification as a public
charity. To
avoid a “taxable expenditure,” U.S.
private foundations must determine that a foreign
entity qualifies as a public charity
(equivalent to a 501[3])
U.S.
Exempt Status of Foreign Charitable Organizations
Generally,
foreign charitable organizations should apply for U.S.
tax exempt status. Under
IRC
section 508(a),
any charitable
organization
(except certain
public charities) must apply or give notice
of intent to apply. U.S. tax exempt status
is important
not
only for
classification as a public
charity,
but also
for exemption from U.S. withholding tax on
taxable U.S. source non-effectively connected
income.
Under IRC
section 4948(b),
an 85 percent foreign
private foundation is exempt from application
requirements. But a foreign
charity
may be reluctant
to be subject to IRS reporting rules, scrutiny
and possible excise taxes.
Donations
for Charitable Purposes Abroad
The
use of funds by an exempt organization outside the United
States generally
determines
the income
tax deductibility
of a contributor's
donation. Other
considerations include obtaining and
retaining the tax exemption
and complying with other IRC
requirements.
Contributions
are not deductible if they are committed to go to a foreign
organization
and
rest momentarily
with a
U.S.
charity. A
U.S. donor
may make a deductible
gift to a U.S. charity to be used abroad;
however, the deductibility depends
upon the control
of the U.S. domestic
charity
In
Rev.
Rul. 63-252, the IRS addresses five arrangements
for gifts to be used
abroad,
and determined their
deductibility:
- As
part of a plan to solicit funds in the United States,
a foreign charity formed
a domestic organization to
conduct a fundraising campaign, pay the administrative
expenses and remit any balance to the foreign
organization. The IRS concluded
that the contributions were
not deductible.
- U.S.
residents formed a charitable organization within the
United States and drafted the
charter to
provide that it would receive contributions and send them,
at convenient intervals,
to the foreign organization. The contributions were
not deductible.
- A
foreign organization entered into an agreement with
a domestic charity to conduct a fundraising
campaign on behalf of the foreign organization. The domestic organization
represented to prospective
contributors that funds would go to the foreign organization. The contributions
were not deductible.
- A
domestic charity conducted charitable activities in
a foreign country. When its purposes could
be furthered by granting funds to a foreign charity, the domestic
organization made such
grants for purposes that it had reviewed and approved. The grants were paid
from its general funds,
although the organization solicited
from the public. No special
fund was raised by a solicitation on behalf of particular foreign organizations.
The contributions
were deductible.
- A
domestic charity conducted charitable activities in
a foreign country and formed a foreign
subsidiary to facilitate its operations there. The foreign organization
was formed for purposes
of administrative convenience and the domestic organization controlled every
facet of its operations.
In the
past, the domestic organization
solicited contributions
for the specific purpose of carrying out its charitable activities in the
foreign country,
and it planned
to continue to do so in the
future. Following the
formation of the foreign subsidiary, however, the domestic organization transmitted
funds
it received
for its foreign charitable activities
directly to that organization.
As above, the contributions are deductible.
Under
Rev. Rul. 63-252, contributions to the
first three organizations were
not deductible because
the U.S. organizations
were mere
conduits to foreign
recipients
and had no control over use of
the funds. Contributions to the last two organizations were deductible
because the domestic
organizations
were
fulfilling their
own charitable purposes by activities
they sponsored abroad.
Also
for contributions to be deductible, domestic organizations
that make
grants to foreign organizations
to further
their own programs
must establish
that
they control the use of the
funds to insure that the monies are used solely
for charitable
purposes. (See Rev. Rul. 75-65.)
The
IRS found that a domestic charity that gave funds to
foreign organizations
to
redistribute for humanitarian
purposes did
not sufficiently control
the contributions because
it did not choose the
ultimate projects or recipients.
In this case the contributions
were not
deductible.
(See
General Counsel
Memorandum 35319.)
“Friends
of” Organizations
Domestic
charities may be formed as "friends of" organizations
in order to support specific foreign
organizations. Under Rev.
Rul. 66-79, the IRS spelled
out in detail the requirements
for a qualified "friends of" organization
and concluded that contributions
to such an organization are considered to be made to
a domestic organization and are deductible. Rev. Rul.
66-79 generally
provides the blueprint
for creating and operating a qualifying domestic “friends
of” organization.
The
requirements are as
follows:
- Furtherance
of charitable mission;
- By-laws
must specify powers of board to choose, approve, authorize,
control, as well
as accountability
and absolute discretion;
- Right
to withdraw approval; and
- Proper
disclosure and refusal to accept “earmarked
funds.”
A domestic
organization may solicit deductible contributions
for
use by specific foreign
organizations so long as they
are not required to turn
over the funds,
they retain discretion
over the use of
the contributions and they
follow approved procedures
such as:
- Must
establish formal grant application and review procedures.
- Solicitation
materials should be monitored to ensure donors aware
that domestic
organization
retains discretion.
- Solicitation
materials should be monitored to ensure donors aware
that they are
not donating
to foreign organization.
- Cannot
accept earmarked contributions.
- Private
foundations can qualify; however, grant requirements
must be met.
 James
Cassidy, CPA, is a senior tax director at BDO
USA with the Expatriate Tax Services Group in its
New York office. He has spent over 22 years in public accounting and over
four years
on
assignment providing
expatriate tax
services in
Toronto and Mexico
City. Mr. Cassidy has
experience in
international
tax with an
emphasis on effective
planning strategies
for U.S.
expatriates and foreign national
assignees,
investors and entertainers in the United States. He
has also managed international
assignee engagements
for clients in diverse industries. Mr. Cassidy is a frequent speaker
and contributor of articles
for the NYSSCPA and the International Tax
Journal,
and is
the treasurer of the U.S.-Mexico Chamber of Commerce.
He can be reached at jcassidy@bdo.com or 212-885-7310. |
