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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.

 
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The views expressed in articles published in Tax Stringer are those of the authors and not necessarily those of Tax Stringer, unless otherwise indicated. Articles contain information believed by the authors to be accurate as of original publication. The reader should not construe the content included in Tax Stringer as accounting, legal or other professional advice. If specific professional advice or assistance is required, the services of a competent professional should be sought.