Under the Internal Revenue Code, only U.S. charities are eligible to receive tax-deductible charitable contributions from individual U.S. taxpayers. Thus, U.S. taxpayers cannot take charitable deductions for contributions made to foreign charities. Nonetheless, U.S. taxpayers have various options for supporting international philanthropy and receiving tax benefits, as discussed below.
U.S. Charity with Overseas Operations
IRS rulings permit a U.S. charity to conduct all or part of its charitable activities in a foreign country. Thus, even though an individual taxpayer would not receive a tax deduction for making a donation to a foreign charity, such taxpayer could make a tax-deductible donation to a U.S. charity that conducts charitable activities in a foreign country. For example, a common method for U.S. persons to support international charitable activities is to make a donation to a U.S. "friends of" organization, typically a U.S. charity that supports a well-known foreign charitable or cultural institution (e.g., American Friends of the Louvre). So long as the "friends of" organization complies with IRS guidelines designed to ensure that the "friends of" organization retains ultimate control and discretion over the donations it receives and is not a mere conduit for donations to the foreign charity, U.S. donors can make tax-deductible contributions to the "friends of" organization.
Private Foundation or Donor-Advised Fund
U.S. taxpayers can also utilize a private foundation or donor-advised fund to make grants to foreign charities. However, unless the foreign charity has received a determination letter from the IRS recognizing that it meets the standards to qualify as a U.S. public charity, the private foundation or donor-advised fund will need to comply with certain regulatory guidelines to ensure that grants to the foreign charity are not subject to tax penalties. Namely, the private foundation or donor advised fund will need to (1) exercise "expenditure responsibility" with respect to the grant, or (2) make a good faith determination that the foreign charity is the equivalent of a U.S. public charity (an "equivalency determination").[1]
1. Expenditure Responsibility
To exercise expenditure responsibility over a grant to a foreign charity, a private foundation or donor-advised fund grantor must first conduct a pre-grant inquiry regarding the prospective foreign charity, so that the grantor has reasonable assurance that the grant will be used for its intended charitable purposes. After the pre-grant inquiry, expenditure responsibility requires the grantor to take the following measures: (1) enter into a written grant agreement with the foreign charity that requires the foreign charity to return the grant funds to the extent such funds are not used for the stated purposes; (2) exert all reasonable efforts, and establish adequate procedures to ensure, that the grant is spent solely for the purposes for which it is being made; (3) obtain full and complete reports from the foreign charity on how the funds are spent; and (4) make full and detailed reports with respect to those expenditures to the IRS. A number of donor-advised funds specialize in international grant-making, and can assist in complying with the expenditure responsibility rules.
2. Equivalency Determination
Alternatively, making an "equivalency determination" of a foreign charity typically requires collecting detailed information about the finances and activities of the foreign charity, reviewing English-language versions of its governing documents, and obtaining an opinion of counsel that the foreign organization is the equivalent of a U.S. public charity. Certain organizations (such as NGO Source and CAF America) have built databases of equivalency determinations, and can provide "equivalency determination certificates" to the grantor organization at a modest cost. Thus, if an equivalency determination for the foreign organization is on file in one of these databases, this process can be relatively simple. However, if the foreign organization does not have an existing equivalency determination, obtaining an opinion of counsel can be time and resource intensive, particularly if the foreign charity's governing documents must be translated into English.
Forming a Foreign Subsidiary Charity
In certain foreign jurisdictions, a U.S. charity can form a subsidiary charity that is qualified to receive charitable contributions that are deductible for both U.S. and foreign income tax purposes. The U.S. charity forms a foreign subsidiary corporation that subsequently applies to the relevant foreign government authority for recognition as a charitable organization under the laws of the foreign country. Provided that the foreign subsidiary is eligible to do so, it then files an election to be "disregarded" for U.S. tax purposes (i.e., treated as a branch or division of the U.S. parent charity instead of as a separate legal entity).[2] Thus, for U.S. tax purposes, a donation to the foreign subsidiary charity should be treated as a donation to the U.S. parent charity, whereas for foreign income tax purposes, the donation should be treated as a donation to a foreign charitable organization.
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Although foreign charitable organizations are not eligible to receive tax-deductible contributions from U.S. individuals, various options may be available for a U.S. individual to make a tax-deductible contribution that supports charitable activity in a foreign jurisdiction. Given the variety of options for international philanthropic planning, it is generally in the donor's best interest to consult with legal counsel to assist in planning.
- Although public charities (other than donor-advised funds) are not required to exercise expenditure responsibility or make an equivalency determination when making a grant to a foreign charity, IRS guidelines nevertheless require that the grantor charity establish safeguards to ensure that grant funds are used for the intended charitable purposes.
- Depending on the jurisdiction in which the foreign subsidiary is formed, it might not be eligible to both (1) qualify as a charitable organization in its jurisdiction of formation, and (2) make an election to be disregarded for U.S. tax purposes. Research needs to be done on the laws of the desired country in advance.