Q&A #86 – Is a private foundation always required to obtain an equivalency determination opinion letter before making a grant to a foreign charity?
Question: I run a private foundation that makes grants mainly to organizations in the United States. We recently learned about a foreign charity that we would like to help, but I have heard that we would need to first obtain an opinion letter from an attorney or CPA that the organization is equivalent to a United States public charity. We are wary of spending the funds to obtain this letter, given the relatively small size of the grant and project. Is there any way to make a grant to a foreign organization without obtaining this opinion letter?
Answer: In general, a private foundation that wishes to make a grant to a foreign organization is required to either: (1) verify that the foreign organization has been approved by the IRS as a 501(c)(3) public charity; (2) exercise “expenditure responsibility” over the grant; or (3) make a good faith determination that the foreign organization is equivalent to a United States public charity (typically by relying on an opinion letter from a qualified tax practitioner). Thus, it is not always necessary to obtain an equivalency determination, but this is generally the safest option for a private foundation in the event the grantee organization has not received an approval letter by the IRS.
Generally, a grant made by a private foundation to an organization that is not a 501(c)(3) public charity is considered a “taxable expenditure,” unless certain steps are taken to avoid this treatment. Taxable expenditures lead to substantial penalty taxes assessed on the foundation itself, and potentially on the foundation managers who knowingly and willfully agree to the grant. Thus, private foundations seek to avoid taxable expenditures at all costs. Additionally, foreign grants that are not treated as taxable expenditures are generally deemed “qualifying distributions,” which helps private foundations satisfy requirements to distribute a certain amount of their net assets each year.
While it is possible for foreign organizations to be approved as 501(c)(3) public charities by the IRS, many foreign organizations do not seek this status. Thus, as a practical matter, private foundation grantors generally must choose between exercising “expenditure responsibility” over the grant, or alternatively, obtaining an opinion letter from a qualified tax practitioner (an attorney, CPA, or enrolled agent) that the foreign grantee is equivalent to a United States public charity based on its governance, operations, sources of funding, and other relevant factors. The IRS provides a good overview of these options on its website.
Obtaining an equivalency determination opinion letter is generally the safest option, provided all parties involved follow the guidelines set forth by the IRS in Rev. Proc. 2017-53. These opinion letters are labor intensive and can entail significant up-front cost, but the foundation and its leadership will generally be well protected once the equivalency determination has been made, and the written advice can generally be relied on for up to two consecutive tax years.
Expenditure responsibility is an alternative option that requires continued oversight to be exercised by the foundation. Expenditure responsibility generally requires a pre-grant inquiry into the potential grantee, written commitments in the form of a grant agreement with specific recommended terms, ongoing monitoring and recordkeeping to ensure there is no diversion of grant funds for improper purposes, and additional reporting to the IRS.
Planning Tip – Regardless of whether an equivalency determination is made or expenditure responsibility is exercised, organizations that make grants to foreign organizations must be aware that careful and thorough due diligence is necessary to ensure that grant funds are not provided to terrorist organizations or otherwise in violation of sanctions programs administered by the Office of Foreign Assets Control (OFAC). At a minimum this involves checking the organization (including its leaders and all individuals involved in running the activities that are funded by the grant) on OFAC’s SDN List. Engaging expert counsel as far in advance as possible is highly recommended to help ensure that all best practices are followed in this sensitive area.
The expenditure responsibility option avoids some of the upfront cost of an equivalency determination, but requires significant ongoing oversight efforts throughout the course of the grant and entails much more uncertainty for the foundation. Thus, an equivalency determination opinion letter is usually recommended, although not always required.
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