July 2007

U.S. Individuals and Foundations Funding Globally: Tax and Legal Concerns

By Robert P. Goldman, Esq. Goulston & Storrs, P.C., Boston

United States citizens and charitable foundations face some real barriers to advancing global philanthropy, but many of these barriers can be overcome with only a little effort. On the tax and legal side, funders must be aware of a few rules and resolve to deal with them rather than avoid them. This memorandum is intended to highlight some of the rules and illustrate some grant-making practices that will promote effective global philanthropy.

• Income Tax Deduction for Gifts to U.S.-based Charitable Organizations. Individuals receive an income tax charitable deduction only for contributions to charitable organizations that are incorporated or organized under the laws of a U.S. state. There is no income tax charitable deduction for gifts to foreign charities.
  
  Example: Donors receive an income tax deduction for contributions to U.S.-based Oxfam America, World Education, and International AIDS Trust, even though a charitable purpose of these organizations is to conduct charitable activities outside the U.S.
• "Friends of Foreign Charity" Organizations Assist in Achieving Income Tax Deduction. Global charitable causes that want to raise tax-deductible contributions must arrange for a U.S. organization to receive the contributions. Internal Revenue Service rulings hold that contributions to a U.S. organization that grants its funds for charitable purposes outside the U.S. will be deductible only if the U.S. organization has total control over the use of the contributions and the decision making of the U.S. organization is independent of both the donor and any foreign grantee. It is permissible for the U.S. organization to be affiliated with a foreign organization, so long as the U.S. organization can independently determine whether to make grants or deny grants to the foreign organization.
  
  Example: Friends of Yemin Orde is a U.S. organization sufficiently independent from the Israeli orphanage that it supports such that contributions to it are deductible. The board of directors of FYO is independent of the foreign charitable organization that it supports (only one of its directors is a representative of the foreign organization). FYO accepts requests from the foreign organization for both operating funds and specific projects, approves or rejects such requests, and then raises funds to meet the commitments that it has made. Donors who desire to restrict a gift to a project that has not yet been approved by the FYO board are told that the board must first consider the project and approve it.
  
  This issue suggests that a donor contributing to a private foundation controlled by himself or his family might be at risk for not achieving a charitable deduction if the foundation in turn grants the funds to a non-U.S. organization. A best practice would be that funds donated to a private foundation should not immediately be passed through to a foreign organization, and certainly there should not be a consistent pattern of such activity. If possible, consider funding from foundation income and gains. Where a foundation finds itself in a position of re-granting a recent contribution to a foreign organization, it might first choose to populate its decision-making board with non-family members who clearly are not benefiting from the income tax deduction.
• Private Foundation Governing Documents Should Permit Global Funding. Tax laws do not prohibit private foundations from supporting foreign charitable organizations. However, many foundation governing documents (including those drafted by major law firms) limit the class of permissible grantees to a boilerplate definition of "charitable organizations described in IRC Section 170(c)(2)" which precludes grants to non-U.S. organizations and is unnecessarily narrow. In some cases the governing document can be amended if the foundation would like the authority to consider global funding.
• Five Percent Minimum Distribution Test for Foundations. Foundations are able to count grants toward satisfying their five percent minimum distribution requirement in many cases where the funds will be used outside the U.S., including grants to a domestic public charity or private operating foundation that operates outside the U.S., to a foreign charity that has obtained a determination from the IRS that it is a public charity or private operating foundation (not very common because individual donors are unable to deduct gifts to a foreign charity), to a foreign charity that is equivalent to a public charity or private operating foundation pursuant to an equivalency determination (see below), to a foreign charity that is equivalent to a private non-operating foundation (similarly determined) so long as the foreign charity further makes a qualifying distribution of the same amount out of its corpus within one year, and to units of foreign governments (specifically limited for a charitable purpose). The IRS has privately ruled that a grant-making foundation can also satisfy its minimum distribution requirement with a grant to a foreign organization that does not meet any of the above requirements so long as the grant is restricted to be used solely for charitable purposes, the foreign organization holds the grant funds in a separate account dedicated to those purposes, and the grant-making foundation monitors the foreign organization's use of the grant funds in accordance with the rules known as expenditure responsibility (see below).
• Taxable Expenditure Penalty on Private Foundations that Grant to Foreign Charities. The tax code provides a penalty tax on a private foundation that grants to any organization which has not obtained a determination from the IRS that it is a public charity. However, such penalty will not apply if the grantee is a foreign charity that is equivalent to a public charity pursuant to an equivalency determination. As an alternative, a private foundation may without penalty make a grant to a foreign organization (whether or not the equivalent of a public charity) if it conducts expenditure responsibility
• Equivalency Determination. The determination that a foreign charity grantee is the equivalent of a public charity (or, for purposes of satisfying the grant-making foundation's minimum distribution requirement, an operating foundation) can be made by an affidavit of the foreign charity grantee or by an opinion of either the foreign charity grantee's counsel or the grant-making foundation's counsel. First, equivalency to a charity described in IRC Section 501(c)(3) must be established: the grantee's governing documents or governing law must require it to operate solely for charitable purposes and prohibit it from conducting any substantial lobbying, any political campaign activity, and any private benefit activity. Consider providing the foreign charity with an amendment to its governing instrument that sets forth all these elements. Next, equivalency to a public charity (or, for purposes of satisfying the grant-making foundation's minimum distribution requirement, an operating foundation) must be established. This is automatic for religious organizations, hospitals, and schools, but otherwise must be proven with historic financial data showing substantial public support for the grantee. Foreign schools further have to show that they have adopted and abide by a nondiscrimination policy. Not surprisingly, many grant-making foundations that grant to foreign charities opt for the alternative of expenditure responsibility.
• Expenditure Responsibility. Many inexperienced foundations fear the unknown of this monitoring exercise, but shouldn't. The expenditure responsibility requirements are generally no more onerous than the oversight that the foundation might prudently conduct with respect to any of its important grants, global or domestic. The requirements are:
• Conduct a pre-grant inquiry — is the proposed grantee capable of fulfilling the charitable purposes of the grant?
• Have a written gift agreement identifying a specific charitable purpose or project, and which includes: the grantee's promise to repay any funds not used for the agreed-upon charitable purpose; a requirement that the grantee submit annual reports; a requirement that the grantee's books and records be available to the foundation; and a prohibition on using funds for non-charitable purposes. Variations of these promises are acceptable if necessary under applicable non-U.S. law or custom.
• Actually receive the grantee's reports, which should set forth how the funds were used, how the grantee complied with the agreement, and what progress was made toward achieving the charitable purposes.
• If the grantee is not at least an equivalent to a charity, then it must maintain grant funds in a segregated fund and separately account for such funds.
• Report expenditure responsibility grants to the IRS on annual Form 990PF.
• Non-Tax Legal Limitations on Global Funding. The Office of Foreign Assets Control ("OFAC") of the U.S. Department of the Treasury administers and enforces economic and trade sanctions based on US foreign policy and national security goals. Through that office, the Department of the Treasury maintains lists of countries, groups, and individuals in which/to whom it is illegal to transfer funds or goods, including charitable grants. A master list of prohibited parties is at www.treas.gov/offices/enforcement/ofac/sdn. In some cases where policy permits an exception, OFAC may issue a license to engage in transactions otherwise prohibited.
• In addition, the Treasury Department has issued an advisory entitled "Anti-Terrorist Financing Guidelines: Voluntary Best Practices for U.S.-Based Charities," which contains suggestions meant to protect charitable organizations from terrorist abuse and to facilitate compliance with U.S. law. These guidelines are not limited to grant-making to foreign charities and presumably are meant to apply to all charitable grant-making. The guidelines have been much criticized for being overbearing and for effectively stifling global philanthropy by anyone but the largest of grant-making foundations. Here is a brief summary of the guidelines (as revised in September 2006):
• Before distributing funds to a grantee:
  
  (i) collect basic information about the grantee:
• organization's name in English and in language of origin, any acronyms used in jurisdictions in which it operates, with addresses and local phone numbers;
• copies of grantee's governing documents and information about its founders;
• a detailed report of organization's purposes, projects, and goals;
• names and addresses of organizations to which the grantee organization provides (or proposes to provide) funds, services, or material support, to the extent reasonably discoverable;
• names and addresses of any subcontracting organizations utilized by the grantee organization;
• copies of any of the grantee organization's public filings and annual reports;
• financial data of the grantee organization, including sources of income.
  
  
(ii) conduct basic vetting of the grantee:
• research public information about grantee to determine any connection to terrorism or terrorist financing;
• grantee must not be on any OFAC prohibited parties lists; consider similar lists of other nations created pursuant to United Nations Security Council Resolution 1373;
• obtain names, nationality, citizenship, and place and date of birth of grantee organization's board members and key staff in every field office; check to be sure names not on lists;
• get certification from grantee organization that it is in compliance with U.S. laws regarding OFAC prohibited parties lists; if grantee is a foreign organization, the certification should state that the grantee does not deal with any individuals, entities, or groups on OFAC prohibited parties lists or who support terrorism.