Today’s blog post about the Heckerling Institute is written by Withum’s Private Client Services Partner, Alfred La Rosa.
In the morning we heard from Victoria B. Bjorklund, of Simpson Thacher & Barlett LP NYC, on how to advise clients seeking U.S. tax deductions for charitable donations where those donations will be expended outside of the United States. The presentation also reviewed the “American Friends of” structure and the cross-border donor advised fund. Circumstances where the IRS may disallow the deductibility of cross-border charitable contributions and the loss of an entity’s exemption were addressed.
The rules governing charitable-contribution deductions for federal income-tax, gift-tax, and estate-tax contributions can be quite complex and confusing, especially when such donations are expended outside the U.S. Therefore, we must be careful when advising clients on cross border gifts or grants. Here are some of the issues, concerns and “quirks” that were discussed during the presentation.
- The Code does not allow U.S. persons any income tax deduction for direct contributions to foreign charities. Section 170(c) of the Code provides that an income tax deduction is permitted only if the donee organization was created or organized in the United States or any possession thereof, or under the law of the United States, any state, the District of Columbia or any U.S. possession. Unless there is a treaty exception, if a U.S. individual wants a charitable income tax deduction for funds designated for a foreign charity, the donation must be made to a U.S. tax exempt organization that operates abroad or can make grants abroad.
- The IRS may view a U.S. organization as a mere conduit and deny or revoke its tax-exempt status if it does not exercise control or discretion over donations and simply pays it over to a non-U.S. charity. The U.S. organization should be independent of and not dominated by its foreign affiliate in its decisions-making process. The U.S. charity must not be depicted as the agent of the foreign charity. “Conduit means no deduction” and has to be avoided at all costs!
- Foreign charities wishing to establish a base of support in the United States often seek to establish U.S. charities to solicit contributions from U.S. donors to support their causes. The U.S. affiliates of such foreign charities are often referred to as “Friends of” organizations, which must be operated independently of the foreign organizations they support and must meet various other requirements. “Friends of’’ organizations defeat the conduit problem.
- The U.S. income tax treaties with Canada, Israel and Mexico contain more generous provisions regarding deductions for gifts by U.S. persons to charities in the foreign jurisdiction. These treaties allow U.S. donors to deduct donations to charities in the contracting state against their foreign-source income from that jurisdiction
- In addition to “American Friends of” grant-making organizations, there are several sponsoring organizations of pre-approved projects, fiscal sponsorship or “donor advised funds” which make grants to foreign charitable organizations that have been determined in advance to make certain that they are suitable recipients.
- Where the donation is to be used abroad, the Treasury Department has determined that, to be deductible by a corporate donor, the gift must be paid to an organization created or organized under the laws of the United States or its territories, so long as the recipient organization is itself a corporation rather than a trust.
- In contrast, the estate and gift tax deduction provisions of the Code look exclusively to the purpose for which the contribution will be spent without regard to the geographic location of the expenditure or the jurisdiction in which the recipient organization was created. Therefore, estate and gift tax charitable deductions are not necessarily affected by geography.
- When dealing with contributions from a Private Foundation to a Foreign Charity it is imperative that the Foundation managers perform their necessary due diligence and make certain that such contributions are deemed qualified distributions. Federal tax law allows private foundations either to make an “equivalency determination” or to exercise “expenditure responsibility” in order to make a grant to a non-U.S. organization without incurring a taxable-expenditure excise tax.
During session two, Michelle B. Graham, from Withers Bergman LLP, provided a very informative presentation addressing the various U.S. income tax and estate & gift tax rules that apply to non-U.S. persons who invest in the United States. The session addressed tax treaty planning and other issues that should be considered when planning for non-U.S. persons who invest in the United States.
- Although a majority of the presentation focused on U.S. Tax concepts, Ms. Graham did address a number of non-tax considerations when advising and accepting an international client. Professionals should make sure they review their foreign clients’ intake procedures and exercise a higher threshold of due diligence before accepting an international client. “We need to understand the source of their income, where and how their money/wealth was generated, if they are compliant in their own country, do conflicts of law issues exist with the foreign country they are associated with? Etc.”
- Look at the individual from an income tax perspective. Are they a U.S. citizen or resident? If so, they are taxed on their worldwide income.
- If they are not a U.S. citizen or resident, what income would be subject to income tax? Non-resident aliens are generally taxed in the same manner as a U.S. citizen or resident on all income that is “effectively connected” with the conduct of a trade or business in the United States.
- Understand if any foreign income and estate & gift tax treaties are applicable.
- While the determination of U.S. citizenship is generally very straightforward, the concept of residence differs for Federal income tax and Federal estate and gift tax purposes
While U.S. citizens and residents are subject to U.S. estate, gift and generation-skipping transfer tax on their worldwide assets, nonresident aliens are subject to federal estate taxes only on assets situated in the U.S. at the time of death. Therefore, a nonresident’s gross taxable estate is limited to U.S. situs assets, which includes U.S. real property, tangible assets located in the U.S. (note: currency and cash are considered tangible personal property), stock in a U.S. corporation (location of shares have no relevance), etc.
- Nonresident aliens are subject to federal gift taxes only with respect to transfers by them of real or tangible property situated in U.S. One simple estate planning technique is to have the non-resident gift any stock in a U.S. corporation prior to his/her death.
- Further, nonresidents are only subject to the Federal generation-skipping transfer tax with respect to transfers that are subject to the Federal estate or gift tax. Whether the skip person is a U.S. citizen or resident is irrelevant.
Before lunch, Dennis I. Belcher and Ronald D. Alcott of McGuireWoods, LLP from Richmond, Virginia, Samuel A. Donaldson (professor of Law at Georgia State University in Atlanta), Amy E. Heller from McDermott Will & Emery LLP in New York and John w. Porter from the Houston office of the law firm of Baker Botts LP, served on the Questions and Answers Panel to answer and comment on numerous questions from the audience. The following are just some of the questions, concerns and comments that were addressed during this very informative session:
- A great deal of time was spent discussing the potential repeal of estate tax and addressing certain planning techniques that may allow for some flexibility until we have better guidance on what is going to happen with the estate taxes (including use of QTIPs, Clayton QTIPs, Credit Shelter Trusts, disclaimer trusts and portability).
- Practitioners may be interpreting the proposed regulations under Section 2704 too broadly in that the purpose of the regulations was not intended to totally eliminate all marketability and minority discounts. There will be modifications to these proposed regulations which will clarify the applicability of these restrictions.
- In order to get the statute of limitations running, the panel felt that it is critical to disclose on a gift tax return transfers with valuation discounts, and that the valuation of such transfers may be inconsistent with the proposed regulations under Section 2704. “Over disclose – do not under disclose”.
- In order for a trust to take a charitable deduction, it must be made pursuant to the governing instrument. The IRS has challenged the validity of state modifications/reformations to a trust instrument in allowing the charitable deduction (on the basis that the deduction was not made pursuant to the original instrument).
- Beware of the potential gift tax implications if a trust reformation impacts on a beneficial interest in the trust.
- The panel addressed various questions pertaining the basis consistency rules and the filing of the Form 8971. The filing requirements were reviewed and concerns were raised as to the potential liability to fiduciaries if they failed to report an asset on the Form 8971 or if the value assigned to an asset on the Form 8971 was too low..
- Several questions were raised about the potential capital gains tax at death (replacing the estate tax). The panel has no idea what will ultimately pass, but they did discuss how the Canadian system operates, and how it taxes appreciation at death. They also addressed the complexities that we may face here in the U.S. if such a regime is passed.
- The requirement to also report charitable gifts on gift tax returns were addressed (although many practitioners do not follow this requirement). The panel addressed concern that if charitable gifts are not reported on a gift tax return, they exceed the annual gift tax exclusion amount (currently $14,000) and represent more than 25% of the total taxable gifts on the gift tax return, the statute of limitations may be extended to six years (refer to Sec. 6501(e)(2)). Therefore, this practice is advisable especially in situations where there might be other gifts (discounts, GRATS, etc.) on that gift tax return that can be scrutinized by the IRS.
Stay tuned for more from the Heckerling Institute as the week continues!