International Grantmaking Withholding Requirements

Effective Jan. 1, 2001, final regulations require foundations making grants or awarding prizes to foreign individuals or foreign organizations that perform all or part of their grant-funded activities in the U.S. to withhold U.S. taxes from payments. Exemptions are allowed if the grant recipient qualifies for an exemption under a U.S. tax treaty or if the recipient entity shows that it can qualify as a tax-exempt organization in the U.S. If activities funded by a grant are conducted entirely outside the U.S., withholding is not required. The IRS can penalize foundations that fail to withhold or take advantage of the exemptions without filing the required forms.

Regulations' Impact

The regulations may trigger a withholding requirement if even a small part of a grant to a foreign entity is to be used in the U.S. Also, sometimes a grant covers travel and lodging expenses but does not compensate a grantee for his time spent in the U.S. It would seem that the grant should be excludible from income (according to a recent Service directive for foreign scholars visiting U.S. universities), but the final regulations appear to conflict with this interpretation.

Three possible solutions may be available to avoid withholding:

• Make a grant with the stipulation that the money be used only for activities that take place exclusively outside the U.S.
• Write two grants: one for the portion not used for activities in the U.S., the other for the portion used for activities in the U.S., and withholding only on the latter portion.
• Obtain an exemption from the withholding requirement by qualifying for exempt status in the U.S.; this option would require a tax determination letter from the IRS or a written opinion from a U.S. attorney.

The regulations' withholding requirement could conflict with a general information letter the Service released last May, IRS Information Letter (4/18/01), affirming that a grant from a private foundation to a foreign grantee would qualify as a distribution for Sec. 4942 purposes, not as a taxable expenditure for Sec. 4945 purposes, under each of the following three circumstances:

1. After making a good-faith determination that the foreign grantee is described in Secs. 501(c)(3) and 509(a) (i.e., the foreign grantee is the equivalent of a "public charity"), the private foundation would make the grant without exercising expenditure responsibility.

2. After making a good-faith determination that the foreign grantee is described in Sec. 501(c)(3)—classifying it as a private foundation because it is not described in Sec. 509(a)—the private foundation would exercise expenditure responsibility for the grant as prescribed by Sec. 4945(h) and the regulations, and obtain records verifying that the grantee distributed the full amount of the grant out of corpus by the end of the year following the year in which the grant was made, in accordance with Sec. 4942(g)(3).

3. The private foundation would treat the grantee as not being described in Sec. 501(c)(3) and exercise expenditure responsibility for the grant as prescribed by Sec. 4945(h) and the regulations, including the requirement that the grantee maintain the grant funds in a separate fund dedicated for Sec. 170(c)(2)(B) purposes, in accordance with Regs. Sec. 53.4945-6(c).

From Randy Snowling, J.D., and Jennifer Deutsch, CPA, MS, Washington, DC