Harvey Dale’s Warning About Contributions to Foreign Charity
Way back in 1995, Harvey warned us that the geographical limitations on charitable contributions would eventually spell trouble:
It is extremely difficult to justify the place-of-organization restriction. The rationale in the relevant legislative history is both inadequate and erroneous. No such restrictions apply for purposes of the gift or estate tax charitable deduction. In a world in which charity increasingly crosses — and ought to cross — national borders, U.S. donors should not be forced to resort to formalisms, such as “friends of” organizations, in order to provide needed support abroad. Although an intermediate U.S. organized donee may be administratively helpful, making it easier for the Internal Revenue Service to obtain and audit documents and records, there are other more suitable methods available to the Service to obtain foreign-located documents and information. The easiest would be to require more detailed substantiation of foreign-targeted charitable deductions under already-existing Code provisions.
He was speaking about the IRC 170(c)(2) rules that to get a tax deduction, individual donors must give to domestic organizations, and corporation donations to any non-corporate entity must be used in the United States. IRC 170(c)(2). And while there is legislative history for the proposition that all contributions (not just corporate contributions) are deductible only if used domestically, the Service nevertheless allows a deduction for contribution to domestic charities even if the entire donation is eventually used in a foreign country. I suppose that’s why deductions to the Red Cross are deductible even though intended for overseas humanitarian relief.
There is one catch, though. As a formal matter, the domestic charity must be completely free to use donations however it pleases, consistent with its charitable mission. Donations may not be earmarked for foreign use even if it turns out that way, nor may the charity be obligated to use donations overseas. Harvey notes in passing by the way, that the requirement is enforced by wink and nod. Everybody knows that a “Friends of [a foreign endeavor]” is going to spend all of its donations on the foreign endeavor. Still, donors will get their tax deduction and the “Friends of” organization will retain its tax exemption.
It’s the wink and nod part that caused problems for the Israeli Academy of Science and Humanities because deductibility is maintained by not including any provisions in a charity’s organizing documents mandating that donations be used for the foreign endeavor. That would be too specific. The [foreign] Academy set up the domestic charity, the Foundation for Basic Research in Israel, to attract deductible donations for use by the academy. And the Foundation, then controlled by the Academy, told all its donors that contributions would be used in Israel and that seemed not to bother anybody. But the Academy could not put that stipulation in the Foundation’s organizing documents so the law effectively conditions future support in foreign lands on the domestic corporation’s thoroughly romantic promise to love and adore its foreign parent forever.
Nothing stays the same. Alas, the romance faded and apparently whatever governing control the Academy had over what was essentially its supporting organization faded too over the 25 years since the Academy established its Foundation. The Academy established the Foundation, by the way, five years before Harvey’s article warning of trouble so it probably never saw trouble coming until it was too late.
So as it turns out Harvey was right. In the Southern District last week, a federal judge ruled that the famed Israel Academy of Sciences and Humanities lacked standing to challenge the American Foundation for Basic Research in Israel’s decision to cut the Academy off. There can be no doubt that the Foundation was birthed to attract tax deductible contributions from U.S. taxpayers for exclusive use by the Academy. In Israel. But that intention never made it into the Foundation’s organizing documents because to include them would have defeated the whole purpose of attracting tax deductible contributions from U.S. taxpayers.
To the Court, and despite an ocean of evidence to the contrary, the Academy was nothing more than a hopeful beneficiary, with no more standing than you or I would have if the Foundation rejected our grant application. And when you read the opinion, you almost want to pull your hair out asking why the Academy did not just clearly state that binding intention in the Foundation’s organizational documents. But the Academy couldn’t do that. The law would not allow it even though it allowed the same result via winks and nods. The law required what Harvey labeled mindless “formalism.”
So confident was the Academy in the Foundation’s forever loyalty that over the years it even directed its biggest donors to contribute to the Foundation instead of directly to the Academy. For safekeeping and tax deductions, I imagine. Well, people change, relationships change, and the romance fades. Eventually, the Foundation moved on, and decided it would no longer support the Academy that gave it life and drove all the Foundation’s donations. The Academy sued to enforce the implicit intention and lost. Because nothing in the Foundation’s article or bylaws made it beholding to its parent. In this case, formalism is the proverbial “trap for the unwary.”
darryll k. jones