International giving is picking up steam among U.S. taxpayers. As such, there is an increasing need for philanthropic advisors to help U.S. taxpayers understand how they can make tax deductible charitable contributions to overseas causes.
For some domestic donors, it’s the desire to help the people affected by international disasters. Others want to alleviate the problems of poverty and deadly but preventable diseases. The United States is also home to many individuals who were born in a different country or who have family still residing outside of the U.S. Because of this, there is often a strong desire to donate to causes in their home countries.
All these foreign charitable contributions have many restrictions not imposed on domestic charitable contributions. With proper tax planning, donors can maximize the tax deduction afforded to domestic giving, take advantage of the increased benefits charitable giving was afforded by the Tax Cuts and Jobs Act of 2017 (TCJA), and benefit the international causes they care about.
For U.S. taxpayers interested in funding philanthropic programs outside of the U.S., the following four options may prove effective in providing support to the charitable causes while supplying the individual donor with a favorable charitable tax deduction.
1. Contributions directly to a foreign charity may be deductible in some cases.
Direct contributions to a foreign charity only qualify for U.S. tax deductions in very limited circumstances. Federal tax law generally requires the charitable recipient to be a domestic organization. However, special rules apply when donating to certain foreign charities in Canada, Mexico, or Israel that are granted U.S. 501(c)(3) exempt status by the IRS. These three countries have tax-treaties with the U.S., and certain charitable donations made to them by a taxpayer are qualified for an income tax deduction – if the donor has some income sources from the corresponding countries. The deduction is limited to source income as well as other deduction limitations.
2. A donor may establish a donor advised fund with a sponsor specializing in foreign grantmaking.
A Donor Advised Fund (DAF) is a charitable investment account controlled by a section 501(c)(3) sponsoring organization, over which the donor has some advisory privileges on distributions from the fund. Some sponsoring organizations (such as United Way International, Charities Aid Foundation America, and the International Community Foundation) specialize in making grants to foreign charities based on the advice of their donors.
Generally, a strict vetting process is required by the sponsoring organization before making any advised grant to an unknown charity or an organization without a U.S. tax exemption letter issued by the IRS. The donor may rely on the oversight of the U.S. public charity which sponsors the DAF. When the donor makes the contribution to the sponsoring DAF, the charitable gift is complete, and a U.S. tax deduction is allowed immediately. The donor then advises grants to foreign charitable organizations or activities over time.
The sponsoring organization is required to ensure the operations of the recipient are for legitimate foreign charitable activities, and the grant is spent solely on the stated purpose. The sponsoring organization must also fully comply with anti-money laundering and terrorist-financing regulations. This is only an issue for the donor in that they need to make sure the DAF sponsor is sophisticated enough to understand the rules and not commit any violations with the donor’s assets. It is important for the sponsoring organization to perform its due diligence and properly screen the foreign charity and its activities. If the DAF does not do this, there is a risk the IRS would treat the donation as being earmarked for the foreign charity and consider the individual’s gift a direct contribution and not tax deductible.
3. The foreign charity may have a U.S. affiliated “friends of” organization to which the donor may contribute.
There are many U.S. “friends of” organizations, such as the American Friends of the Paris Opera, the American Friends of the London Business School, and the Friends of China Heritage Fund. All these organizations were founded to raise domestic (U.S.) funds to support their corresponding foreign charity organization described in the United States code section 501(c)(3).
Similar to the DAF sponsor, a common concern for U.S. “friends of” organizations is to avoid becoming merely a channel for funding a foreign organization. The donation must be a completed gift to the domestic “friends of” organization and under its dominion and control. For the gift to qualify as tax deductible, the domestic organization must control the timing and amount of transfers to the foreign organization, and they must maintain a two-way communication with the foreign organization on charitable activities, fundraising, etc. “Friends of” organizations often have close relationships with the foreign organizations they support and effectively fundraise substantial support and awareness for their programs within the United States.
4. If the donor has substantial resources, they may establish a private foundation.
For an individual of substantial means and the desire to do significant foreign activities and investments with more individual control, a private foundation may be the perfect option. A donor can establish a private foundation relatively quickly. However, they must still get the application for exemption approved by the IRS, which may take several months. A private foundation requires ongoing compliance and is therefore not a good option for a single charitable gift. However, for donors who want to set aside assets for ongoing foreign giving and have a high need for individual control, this could be the answer. The assets within the foundation are generally not subject to income tax; only a 1 or 2 percent excise tax on net investment income is assessed annually. As long as the foundation distributes 5% of the value of its assets annually and implements policies and procedures which comply with the foreign grant distribution rules for private foundations, it provides the highest level of control and autonomy to a donor wishing to engage in foreign philanthropy.
Private foundations make foreign grants in one of two ways. The first option is to determine if a foreign recipient is a charitable organization equivalent to a domestic 501(c)(3) organization. Rev. Proc. 2017-53 describes the requirements a private foundation must undertake to determine whether a foreign organization meets domestic exemption equivalence for qualifying distributions.
The second option is a private foundation may simply exercise expenditure responsibility oversight over foreign grants. This is a five-stop process including:
- Conducting a pre-grant inquiry ensuring the purpose of the grant can be met by the selected grantee;
- Obtaining a written grant agreement between the foundation and grantee specifying the terms of the grant;
- Requiring a grantee to maintain separate accounting for all grant funds;
- Obtaining an annual report of all funds expended or returned by the foreign grantee; and
- Submitting required reports of expenditures to the IRS on the foundation’s annual Form 990-PF for all years in which the grant or a grant report is outstanding.
In conclusion, tax deduction rules for international charitable donations may be more complicated and restrictive than domestic giving. However, there are several ways to make foreign charitable giving easier through intermediary organizations. An added benefit of foreign giving is, in many countries, a modest contribution can potentially make a larger impact.
If you are looking to donate overseas or have more questions, please contact your Clark Nuber tax advisor. We would be happy to assist you with your year-end charitable gift planning.
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