A "friends of" charity usually has a simple mission: raise funds for and awareness of the foreign charity that shares its name. For example, American Friends of the British Museum works in the United States to raise money to support projects and programs of the British Museum and to increase the museum's profile among Americans. The activities conducted in the United States by these organizations-lectures, galas, travel programs, exhibition tours, and more-follow the same rules as any other U.S. charity and serve the same purpose of educating, informing, and engaging audiences.
Where the charities get more complex is in their international activities, especially related to grantmaking and board composition. As a general rule, U.S. "friends of" charities strive to provide financial support to a foreign charity, usually in the form of grants. This international grantmaking is governed by regulations that pertain to the donor's tax deduction and to the charity's ability to maintain its tax-exempt status.
Preserving the Donor's Tax Deduction
For a donor to claim a tax deduction on a gift to a U.S. "friends of" charity, the board of the U.S. charity must maintain discretion and control over how funds are used. If the donor has control, then it is as if he made the gift directly to a foreign entity, which is not tax deductible. For example, if the donor's contribution is accompanied by a statement that this gift is required to given to the foreign charity for a specific exhibition, it would be treated as if it were made directly to the foreign charity and would not be tax deductible. However, the donor can request that the gift be used for a specific project, without requiring it. Then, the board must show its discretion and control, in the form of a vote on the use of the funds, which helps preserve the tax deduction for the donor, as well as the charity's tax-exempt status. A charity that wishes to keep its donors happy would be wise to honor donors' requests in terms of how contributions are used, but it is not technically required to do so.
Preserving the Charity's Tax-Exempt Status
For a U.S. "friends of" charity to comply with regulations and keep its tax-exempt status, the board must ensure that the foreign charity is using the grants from the U.S. charity for charitable purposes and that the U.S. board has control over deciding how the funds are used. While not required of public charities, it is recommended that U.S. friends use expenditure responsibility grant agreements for international grants in order to better ensure compliance.
To satisfy expenditure responsibility requirements, the U.S. charity (the grantor) must make a pre-grant inquiry to determine the charitable purposes of the grantee. In addition, it should use a written grant agreement, an expenditure responsibility agreement that requires the grantee to do the following:
- Segregate grant funds from other funds (via bookkeeping is okay), maintain records of receipts and expenditures, and make its books and records available for review.
- Submit to the grantor annual financial and narrative reports about the use of grant funds, around the end of the grantee's fiscal year.
- Repay grant funds not used for the specified purpose.
The written agreement should also include the specific purpose of the grant and should prohibit the grantee from using funds for noncharitable purposes, including lobbying or regranting.
Regarding the decision about how the funds are used, the foreign charity can-and should-requestgrants for specific projects from the U.S. charity; however, it is the U.S. board that should review and approve these grant requests at its discretion, which demonstrates that the U.S. charity, and not a foreign entity, is controlling how the funds are used. The U.S. charity should maintain records documenting the board's discretion and control, typically in the form of meeting minutes, signed expenditure-responsibility grant agreements, and reports from the grantee. These records can also demonstrate the charitable use of the granted funds.
Along with careful management of the international grantmaking process, U.S. friends must pay attention to the composition of their boards of directors. A majority of the board should be U.S. citizens or residents. In addition, a majority must be independent of the "home" institution. This helps to ensure that a board of independent American directors has discretion and control over how the U.S. charity's funds are spent.
Proceed with Caution
In a recent case, the IRS revoked the tax-exempt status of a U.S. "friends of" charity because its board had no discretion and control over its grant funds and there was a lack of process and documentation to demonstrate that grants were used for charitable purposes. Remediation-indeed, prevention-would have focused on having a clear, documented process by which the foreign charity requests grants and the board reviews and approves these grants (with thorough minutes of board meetings where these are discussed). The IRS also cited lax financial controls. In this case, no one on the board received or reviewed bank statements or financial reports of the organization's activity and no one from the Board was signing checks or even approving an expense budget. All financial activity was delegated to an unrelated party with no board oversight. The IRS had previously warned the organization to improve its financialcontrols, but no changes were made. Together, the lack of grant and financial controls was sufficient for the IRS to revoke this charity'stax-exemptstatus.
With attention to documentation and process, U.S. "friends of" charities can play a significant role in helping charities worldwide provide better, more, and new services, programs, and activities for the public good. The steps needed to ensure compliance are not unduly burdensome, and appropriate diligence and care can ensure a long life for U.S. friends.
Emily Grand is president of GHS Philanthropy Management, a company that provides administrative, management, and advisory services to grantmakers, including U.S. "friends of" charities and private family foundations.
Reprinted from Tax Stringer, the NYSSCPA Tax Publication, By Tax Experts, For Tax Experts