Increasingly, globalization is impacting the tax-exempt sector's activities including fundraising, grantmaking and investing. With globalization comes increased scrutiny by the Internal Revenue Service and added compliance and reporting requirements. IRS examinations of international activities of tax-exempt organizations have revealed inadequate recordkeeping, lapses in control over grant funds sent offshore and compliance failure triggered by foreign investments.
Earlier this year, the IRS published its annual workplan (including ongoing projects) for the Division of Tax Exempt and Government Entities (EO) for fiscal year 2013. The workplan highlights areas where the EO is focusing resources -- and international activities of tax-exempt organizations figures high on the list of the EO division's ongoing projects.
The EO's focus on international activities centers on concerns that assets and income of domestic charities could be diverted to non-charitable uses when the funds are sent abroad. As a result of this concern, charities must comply with recordkeeping and reporting requirements to document oversight for use of the funds.
Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (FBAR), is used to report a financial interest in, or signature authority over, a foreign financial account with an aggregate value that exceeds $10,000 at any time during the calendar year. (See Form 990, Part V, Statements regarding other IRS filings and tax compliance, 4a.)
EO examinations of organizations that reported a foreign bank account on Form 990 have revealed:
Failure to file Form TD F 90-22.1, inadequate recordkeeping, lack of discretion and control over funds sent offshore and failure to file appropriate employment tax returns. As a result of these findings, the workplan indicates that the EO division is selecting for examination organizations that:
- Have high amounts of foreign grant expenditures.
- Accept donations of non-cash items and send these items to other domestic or foreign organizations.
- Have limited charitable activity and excessive compensation.
EO examinations of organizations reporting non-cash donations have revealed similar deficiencies, including poor recordkeeping, inaccurate reporting and inadequate discretion and control over dispersal. (For more information about accounting for non-cash donations, see "Applying Fair Value to Non-Cash Contributions", Nonprofit Advisor Summer 2011.)
As a result of examining this Work Plan, here are a few areas that are critical to consider.
Grantmakers are organizations that provide funding for projects and are required to maintain records to substantiate amounts, eligibility and selection criteria used for making grants and providing other assistance.
Private foundations (non-public charities) are required to exercise expenditure responsibility when making grants to domestic non-tax-exempt organizations. Expenditure responsibility means that the organization exerts reasonable effort and establishes adequate procedures to ensure that grant funds are spent for the intended purpose. Best practices include policies and procedures which demonstrate expenditure responsibility including:
- Taking reasonable steps to investigate potential grantee's capability and commitment.
- Drafting a written grant agreement.
- Requiring regular reports of grant expenditures and progress.
Due diligence may also include determining that the grantee:
- would qualify for exemption in the U.S.
- has sufficient internal controls.
- has the ability to spend funds effectively.
The grantmaker should also determine that grantee officials are properly vetted.
Grantmaking organizations are encouraged to adopt best practices for monitoring grants and other assistance for projects conducted offshore. Grant agreements should include clauses that address reporting from the grantee to the grantmaker. In certain circumstances, grantmakers should consider the feasibility of making site visits to monitor progress.
Monitoring and reporting of offshore activities is triggered by a series of questions (14 - 16) on Form 990, Part IV, Checklist of Required Schedules, with "yes" answers triggering the need to file Schedule F.
Schedule F requires grantmakers to provide a narrative disclosure of policies and procedures for monitoring the use of grants for the intended purpose by offshore recipients (e.g., best practices implemented).
Increasingly, as a result of globalization and investment diversification through alternative investments, hedge funds and indirect investments through foreign partnerships, many tax-exempt organizations may have foreign accounts, triggering a variety of filing requirements beyond the annual Form 990. "Yes" answers to new questions on the 2012 Form 990, Schedule F, Part IV prompt filing of:
- Form 926 - transfer of property by organization to a foreign corporation.
- Form 3520 - interest in a foreign trust.
- Form 5471 - ownership interest in a foreign corporation.
- Form 8621 - direct or indirect shareholder of a passive foreign investment company or a qualified electing fund.
- Form 8865 - ownership interest in a foreign partnership.
- Form 5713 - operations in or related to any boycotting countries.
Failure to file these required forms can result in penalties ranging from a minimum of 10% to 35% of the property or investment value to a flat $10,000, or fines of up to $25,000 and imprisonment.
As a result of recent examinations, the EO revoked the section 501(c)(3) status of two organizations due to insufficient charitable activity. Implementation of best practices is fundamental for any tax-exempt organization funding projects offshore. Can your policies and procedures for monitoring grants stand up to an IRS examination?
If you have questions or need assistance with implementing best practices, the professionals at Friedman LLP are available to advise and assist you.