Demystifying Tax Deductions for a US Charity with Overseas Operations

In the realm of internationalization of domestic nonprofits, more and more US-based domestic charities are extending their operations beyond borders, reaching out to communities in need worldwide. 

Understanding tax deductions for a US charity with foreign operations can help:

• ensure compliance with IRS regulations
• maximize the benefits of charitable giving
• enhance the charitable organization’s ability to plan and execute international philanthropic activities effectively.

So, in this blog, we will discuss how domestic charitable organizations can enjoy tax benefits while supporting causes overseas.

Qualifying a Foreign Charitable Contribution for Tax Deductions

A domestic charity with foreign operations refers to a US-based non-profit organization that extends its charitable activities beyond the national borders. This means that while the charity is registered and primarily operates within the US, it also conducts significant activities in foreign countries.

According to IRS regulations, for a donation to a US charity to be tax-deductible, the charity must have control and discretion over the use of the donated funds.

This means that the charity can use the funds to support foreign organizations or causes. However, the donor could not earmark funds for a specific foreign entity. 

“Earmarking” in this context refers to the practice of designating funds for a specific purpose or entity. When funds are earmarked for a specific foreign entity, it means that the donor has specified that their donation must go to a particular organization or cause in a foreign country.

In the case of a foreign subsidiary, the domestic organization should have full control of every aspect of its operations.

The charitable organization may or may not have an administrative arm or subsidiary in the foreign country. Here, the term “administrative arm” or “foreign subsidiary” typically refers to a part of an organization that handles administrative tasks.

These tasks can include things like managing finances, handling paperwork, coordinating activities, and other behind-the-scenes work that helps the organization function smoothly.

Reporting Requirements for Foreign Operations

Transparency and accountability are cornerstones of effective philanthropy. For US-based charities with foreign operations, this means adhering to specific reporting requirements set forth by the Internal Revenue Service (IRS). These requirements ensure that the organization’s activities align with its charitable mission and comply with US tax laws.

Important Note: Additional reporting requirements may apply if the organization has financial accounts in foreign countries or makes certain payments to foreign persons or entities.

One of the primary reporting tools for these organizations is Form 990, the “Return of Organization Exempt From Income Tax.” 

 

What is the Form 990?

The Form 990 is used by tax-exempt organizations, non-exempt charitable trusts, and section 527 political organizations to provide the IRS with the information required by section 6033.

Form 990 includes a variety of schedules that organizations may need to complete, depending on the nature of their activities. For charities with foreign operations, one of the most relevant is Schedule F, “Statement of Activities Outside the United States.”

What is Schedule F?

Schedule F is designed to report the organization’s activities conducted outside the US during the tax year. This includes grants and other forms of assistance to organizations or individuals in foreign countries. It also covers other types of foreign activities, such as investments, fundraising activities, program services, and the maintenance of offices or employees in foreign countries.

For example, if a US-based charity provides a grant to a school in India, this would need to be reported on Schedule F. Similarly, if the charity has an office in France or employees in Kenya, these will also need to be reported.

In addition to these activities, Schedule F also requires information about the organization’s policies and procedures related to its foreign activities. This includes the charity’s procedures for monitoring the use of its grant funds in foreign countries, its practices for ensuring that its foreign activities comply with US tax laws, and its procedures for maintaining records of its foreign activities.

Completing Schedule F accurately is crucial for maintaining a charity’s tax-exempt status and ensuring the integrity of its foreign operations. It provides the IRS with a comprehensive picture of the organization’s foreign activities and ensures that these activities are in line with the organization’s tax-exempt status.

Common Mistakes when Navigating Foreign Operations and Tax Deductions

Understanding common mistakes that charities make when dealing with foreign operations and tax deductions can help organizations proactively avoid these pitfalls. Here are some common errors and tips to mitigate them:

Lack of Proper Documentation: Failure to maintain accurate and detailed records of foreign activities, including grant agreements, financial transactions, and compliance documents, can result in difficulties during audits or when substantiating deductions.

So, establish robust record-keeping procedures and document all foreign transactions, ensuring compliance with IRS guidelines.

Inadequate Due Diligence: Insufficient due diligence when partnering with foreign entities or allocating funds can lead to potential misuse of donations or improper activities.

Conduct thorough research and vetting processes for foreign organizations, ensuring they align with the charity’s mission and adhere to local regulations. Implement internal controls and monitoring mechanisms to maintain accountability and mitigate risks.

Earmarking Contributions: As mentioned earlier, earmarking funds for specific foreign entities or purposes can jeopardize the tax-deductibility of donations. So, ensure that the charity has full control and discretion over the use of the funds. 

Non-compliance with Reporting Requirements: Failing to meet reporting obligations for foreign activities can lead to penalties and potential loss of tax-exempt status. Understand the reporting requirements, including Form 990 and Schedule F, and ensure timely and accurate submissions. 

However, navigating Form 990 and Schedule F can be a complex process. However, it is a crucial part of maintaining a charity’s tax-exempt status and ensuring the integrity of its foreign operations. 

So, it is recommended that organizations consult with a tax professional or legal advisor to understand their specific reporting obligations.