Private Foundation Foreign Giving

By R. Michael Sorrells, CPA

Grant making private foundations (PFs) are required to make a minimum amount of qualified distributions annually. This minimum is based upon a percentage of the PF’s investments, subject to a few modifications. Failure to make the amount of required minimum distributions annually can result in excise taxes and could even lead to loss of exempt status. Additionally, non-qualifying grants or contributions may be considered taxable expenditures and are subject to an excise tax of 20% (for the organization) and an additional 5% tax on PF officers or managers personally, if they knowingly approve such distributions.

During the process of preparing Form 990-PF returns at year-end, we have discovered many instances where PFs had made grants to foreign organizations which were not “qualified distributions.” These PFs had the very unpleasant experience of paying an unplanned and often significant excise tax on taxable expenditures and also finding out that their charitable distributions were less than required. It is essential for PF managers and officers who approve grants to know the basics of which foreign distributions are eligible for qualifying distribution treatment and when “expenditure responsibility” must be exercised (see discussion of expenditure responsibility below).

The General Rule
Grant making private foundations can make qualifying distributions to most 501(c)(3) public charities. Public charity status can be determined by consulting IRS Publication 78 (searchable on the IRS website at www.irs.gov/charities/article/0,,id=96136,00.html). Some foreign organizations have obtained a determination from the IRS that they are a 501(c)(3) charity and should be listed in Publication 78 or they can provide a copy of their determination letter. In that case, a distribution is a qualifying distribution and the PF should not have to exercise expenditure responsibility. However, the majority of foreign organizations will not be listed in Publication 78. For these organizations, distributions may still qualify under certain conditions as discussed below.

Equivalency Letter
One option for the PF that wishes to fund international activities directly is to make a determination that the foreign organization it wishes to support is essentially the equivalent of a U.S. 501(c)(3) public charity. This may be done by seeking an opinion of counsel or by having the potential foreign grantee fill out an affidavit. The affidavit is designed to elicit all the information about the foreign grantee that would enable the IRS to determine whether it would be granted tax-exempt, public charity status if it were to apply. The information required is fairly extensive and includes financials for the current and previous years, governing documents, details about the board of directors, descriptions of programs and activities, etc. The affidavit must be completed in English and supporting documentation, such as the potential grantee’s articles of organization and bylaws, must be translated into English. IRS Revenue Procedure 92-94 describes the affidavit requirements.

Expenditure Responsibility
A grant or contribution to a foreign charity can be allowed if there is a truly charitable purpose to the grant (e.g., an educational program) and expenditure responsibility is exercised. Expenditure responsibility entails a written commitment to utilize the grant only for the specified charitable purposes, provision of full periodic written reports on the use of grant funds and project progress, maintenance of records for funds received and expended, and agreement to return any funds not utilized for the charitable purpose once the project is completed. This is only a general description; see IRC Regulation 53-4945-5(b)(1) for full details. It is important that expenditure responsibility be carefully and fully implemented and monitored precisely as the regulations require.

In determining whether to exercise expenditure responsibility or do an equivalency determination, PFs should consider that the latter requires more investigation and work upfront, while the former requires more ongoing attention. If the potential grantee cannot provide the information necessary for the equivalency determination, the PF will have no choice but to exercise expenditure responsibility.

Tax Treaties
Lastly, a tax treaty with a foreign country may establish that a charity is the equivalent of a U.S. 501(c)(3) public charity. For example, it appears that if Mexican organizations are charities under Mexican law that they are presumed to be public charities under the U.S.-Mexican tax treaty. Therefore, grants to those organizations can be qualifying distributions and should not be considered taxable expenditures, despite the fact that there has been no expenditure responsibility exercised. Article 22 of the United States-Mexico Income Tax Convention states in part that “[i]f the Contracting States agree that a provision of Mexican law provides standards for organizations authorized to receive deductible contributions that are essentially equivalent to the standards of United States law for public charities ... an organization determined by Mexican authorities to meet such standards shall be treated, for purposes of grants by United States private foundations and public charities, as a public charity under United States law.”
On the other hand, for Canadian charities, the tax treaty is quite different. The U.S. presumes, in the absence of certain financial information, that all Canadian registered charities are private foundations. Grants from private foundations to other private foundations are typically not qualified expenditures. However, Canadian charities that have submitted the proper information will be listed on Publication 78 and are eligible for qualified distribution treatment. Therefore, the Canadian organization must have either a Publication 78 listing, an equivalency opinion or there must be expenditure responsibility exercised in order for distributions to be qualified.

There may be relief in other tax treaties for distributions from PFs. We recommend consulting with an expert in this area if a treaty is to be relied upon.

Conclusion
The laws and regulations concerning qualifying distributions from PFs are a complex area. PFs should be very careful and exercise due diligence prior to making distributions to foreign organizations, as the penalties are severe for doing otherwise. Policies should be implemented to assure that the rules are complied with and that documentation of the process for each grant is part of the organization’s records.