The primary activity of most non-operating private foundations is to distribute funds to other organizations for the conduct of various charitable activities. Private foundations can distribute funds to foreign organizations to conduct activities outside of the United States, but must follow special rules when dealing with foreign organizations to avoid the excise taxes under Section 4942 and Section 4945. IRC Section and Treas. Regulation IRC Section 4942(g)(1) In general IRC Section 4945(d) Taxable expenditure IRC Section 4945(h) Expenditure responsibility Treas. Reg. Section 53.4945-5(a)(1) In general Treas. Reg. Section 53.4945-5(a)(4) Certain "public" organizations Treas. Reg. Section 53.4945-5(a)(5) Certain foreign organizations Resources (court cases, Chief Counsel Advice, Revenue Rulings, internal resources) Rev. Proc. 2017-53, 2017-40 I.R.B. 263, provides guidelines that qualified tax practitioners may use for preparing written advice on which a domestic private foundation ordinarily may rely in making an equivalency determination that the foreign grantee of a grant made for Section 170 (c)(2)(B) purposes (other than a grant described in Section 507(b)(2) and Section 1.507-3(c)) is a qualifying public charity. IRC Section 4945(h) - Expenditure Responsibility Issue Snapshot Grants by Private Foundations: Expenditure Responsibility Audit Technique Guides Analysis Private foundations may wish to treat grants to foreign grantees as qualifying distributions that satisfy the distribution requirements imposed by Section 4942 and not as expenditures requiring expenditure responsibility to avoid the excise tax on taxable expenditures imposed by Section 4945. When private foundations make grants to foreign organizations, there are four common scenarios: The foreign organization has been recognized by the IRS as a Section 501(c)(3) public charity; The private foundation receives an equivalency determination for the foreign organization as a Section 501(c)(3) public charity; The private foundation limits the use of the grant to section 170(c)(2)(B) purposes and maintains expenditure responsibility for the foreign grant payments; or The foreign grant constitutes a taxable expenditure and is not a qualifying distribution. Let's look at the details for the first two situations. Foreign organization has an IRS determination letter Foreign organizations can apply to the IRS and receive a determination letter as a recognized exempt organization. If the IRS determines that the foreign organization is a Section 501(c)(3) public charity, then any grants from the private foundation to the foreign organization for charitable purposes will generally be a qualifying distribution. The private foundation would have to simply substantiate the foreign organization's exempt status (copy of the determination letter or listing in EO Select Check) and document proof of payment. For Section 4945 purposes, a public charity is a 501(c)(3) organization described in Section 509(a)(1), (2) or (3) [other than a supporting organization described in Section 4942(g)(4)(A)(i) or (ii)] or an exempt operating foundation [as defined in Section 4940(d)(2)]. Section 170(c)(2)(B) lists the following charitable purposes: religious, charitable, scientific, literary, or educational purposes (but only if no part of its activities involve the provision of athletic facilities or equipment), or to foster national or international amateur sports competition, or for the prevention of cruelty to children or animals. Equivalency determination If the foreign organization has not received an IRS determination letter, grantmaking by a private foundation becomes more complicated. However, if a private foundation makes a "good faith determination" that a foreign organization qualifies as a qualifying public charity, then the grant will generally be a qualifying distribution. This good-faith determination is known as an equivalency determination, which is described in Rev. Proc. 2017-53. The equivalency determination must be made by a qualified tax practitioner (attorney, CPA or enrolled agent) and written advice can generally be relied on for two consecutive tax periods. Expenditure responsibility If the foreign organization is not recognized as exempt under Section 501(c)(3) as a public charity and the private foundation doesn't have an equivalency determination, then the private foundation must exercise expenditure responsibility to avoid the grant being treated as a taxable expenditure. Expenditure responsibility means that the foundation exerts all reasonable efforts and establishes adequate procedures to: ensure that the grant is spent only for the purpose for which it is made, obtain full and complete reports from the grantee organization on how the funds are spent, and make full and detailed reports on the expenditure to the IRS. See Section 4945(h) and the Expenditure Responsibility Issue Snapshot for a detailed explanation. Taxable expenditure If the foreign organization is not recognized as exempt under Section 501(c)(3) as a public charity, the private foundation does not obtain an equivalency determination, and the private foundation fails to exercise expenditure responsibility, then the grant to the foreign organization is a taxable expenditure under Section 4945(d)(4). The taxes are imposed on both the foundation and on any foundation manager who knowingly and willfully agrees to the expenditure knowing it was a taxable expenditure. Both an initial tax and an additional tax under Section 4945(a) and (b) may be imposed. Correction of a taxable expenditure. In cases other than inadequate reporting, a correction is accomplished by recovering part or all of the expenditure to the extent possible, as stated in Section 4945(i)(1). When full recovery is not possible, any additional corrective action will be prescribed by the IRS. The type of additional action depends on the circumstances, and the Service may require any of the following: Withholding any unpaid funds due to a particular grantee; Stopping further grants to the grantee; Periodic reports to the IRS from the foundation for all its expenditures; Improving methods of exercising expenditure responsibility; Improving methods of selecting recipients of individual grants; and Any other action that the Service may prescribe in a particular case. See Treas. Reg. Section 53.4945-1(d)(1). Correction for inadequate reporting. If an expenditure is taxable only because of a failure to make or obtain a full and complete report as required, correction may be made by obtaining or making the report in question. In addition, if the expenditure is taxable only because of a failure to obtain a full and complete report as required and an investigation indicates that no grant funds have been diverted to any use not for a purpose specified in the grant, correction will be accomplished if all reasonable efforts are made to obtain the report and the Service is notified of the failure to obtain the report. See Treas. Reg. Section 53.4945-1(d)(2). Issue indicators or audit tips Part XV of Form 990-PF should list the name, address and foundation status of all grant recipients. Review the grantees for any that may have foreign addresses. The tax-exempt status of an organization can be verified by using EO Select Check (Publication 17). If the foreign organization does not have a determination letter, then ask the private foundation if it has an equivalency determination for the foreign organization. If provided, verify that the equivalency determination was prepared by a qualified tax practitioner, that it contains current information, and that it appears reasonable. If the private foundation was required to exercise expenditure responsibility, Treas. Reg. Section 53.4945-5(d) requires the private foundation to include certain reports with the Form 990-PF. Form(s) 990-PF for the tax period(s) under audit should be reviewed for compliance. If a private foundation fails to establish that grants are qualifying distributions, consider whether it has distributed sufficient amounts as qualifying distributions. If not, examine whether Section 4942 excise taxes should be imposed for failure to distribute income.
