7.27.27  Application of Taxes and Denial of Exemption to Certain Foreign Organizations

Manual Transmittal

November 18, 2013

Purpose

(1) This transmits revised IRM 7.27.27, Exempt Organizations Tax Manual - Application of Taxes and Denial of Exemption to Certain Foreign Organizations.

Material Changes

(1) This transmits revised IRM 7.27.27, Exempt Organizations Tax Manual - Application of Taxes and Denial of Exemption to Certain Foreign Organizations.

(2) IRM 7.27.27.3 was modified to describe with greater specificity the scope and effects of IRC 4948(b).

(3) IRM 7.27.27.4.1 was modified to describe in greater detail the prohibited transaction rules under IRC 4948(c).

(4) Other minor editorial changes were made throughout.

Effect on Other Documents

IRM 7.27.27, dated August 23, 2001, is superseded.

Audience

TEGE (Exempt Organizations)

Effective Date

(11-18-2013)

Kenneth C. Corbin
Acting Director, Exempt Organizations
Tax Exempt and Government Entities

7.27.27.1  (11-18-2013)
Introduction and Background

  1. This IRM discusses IRC 4948 for Examinations agents, Determinations agents, tax law specialists, Counsel, and other IRS employees dealing with issues arising under that section.

  2. Some of the private foundations rules set out in IRC 507 and 508 and Chapter 42 of the Internal Revenue Code, could not easily be applied in practice to foreign organizations. To take account of this fact IRC 4948 provides a series of modifications of the private foundation rules for application to foreign organizations.

  3. For purposes of IRC 4948 a "foreign organization" is any organization not created or organized in the United States or any possession thereof, or under the laws of the United States, any State, the District of Columbia, or any possession of the United States.

7.27.27.2  (11-18-2013)
Tax on Investment Income of Private Foundations Under IRC 4948(a)

  1. In lieu of the tax imposed under IRC 4940, there is imposed on foreign private foundations exempt under IRC 501(a) a tax equal to 4 percent of their gross investment income derived from sources within the United States. Gross investment income and United States source income are respectively defined in IRC 4940(c)(2) and IRC 861 and the regulations thereunder.

  2. The tax imposed by IRC 4940, by contrast, is generally a 2 percent tax on the worldwide net investment income of a domestic private foundation.

  3. The tax under either IRC 4940 or IRC 4948 does not apply to a foreign taxable foundation or foreign non-exempt charitable trust. Instead, they are taxed on their income in the same manner as nonresident aliens.

7.27.27.2.1  (11-18-2013)
Withholding and Reporting IRC 4948(a) Tax

  1. IRC IRC 1443(b) and the regulations thereunder describe requirements for withholding of tax on gross investment income of foreign private foundations subject to the IRC 4948(a) tax. See also Treas. Reg. §1.1443-1(b) (for information about withholding agents obligation to withhold taxes subject to IRC 4948 tax).

  2. The tax (if any) is to be reported on the form required to be filed by the foundation under IRC 6033 for the taxable year, at the time prescribed for filing such annual return without regard to any extension of time for filing.

7.27.27.2.2  (11-18-2013)
Effect of Tax Treaty

  1. Whenever there exists a tax treaty between the United States and a foreign country, and a foreign private foundation subject to IRC 4948(a) is a resident of such country or is otherwise entitled to the benefits of such treaty, if the treaty provides that any item or items of gross investment income shall be exempt from income tax, such item or items are not to be taken into account by the foreign private foundation in computing the tax to be imposed under IRC 4948(a) for any taxable year for which the treaty is effective. See also Treas. Reg. §1.1443-1(b)(4) (claiming benefits under an income tax treaty).

  2. In order to be eligible for an exemption from the tax imposed under section 4948, the excise tax imposed with respect to private foundations must be indentified as a covered tax within an applicable U.S. income tax treaty. If the tax is not identified as a covered tax then the private foundation is not eligible for an exemption from the 4 percent excise tax imposed under IRC 4948(a). In addition, if the income tax treaty does include taxes imposed on private foundations as a covered tax, the treaty must be examined to determine whether the United States has retained any right to impose excise tax on the type of gross investment income that is received by the foundation.

7.27.27.3  (11-18-2013)
Foreign Private Foundations Which Receive Substantially All Support From Sources Outside the United States

  1. IRC 507 (regarding termination of private foundation status), IRC 508 (notification requirement and other special rules) and chapter 42 of the Code (other than IRC 4948) shall not apply to a foreign organization which has received "substantially all" of its support (other than investment income) from sources outside the United States. IRC 4948(b)..

  2. Note that IRC 4948(b) applies to foreign public charities and other foreign exempt organizations as well as foreign private foundations, and applies to all chapter 42 provisions, not just those relating to private foundations.

  3. IRC 4948 and the regulations thereunder do not provide any exceptions concerning the application of the private foundation Note that IRC 4948(b) applies to foreign public charities and other foreign exempt organizations as well as foreign private foundations, and applies to all chapter 42 provisions, not just those relating to private foundations. rules to private foreign foundations which have not received " substantially all" of their support from sources outside the United States

7.27.27.3.1  (11-18-2013)
Meaning of "Substantially All"

  1. "Substantially all" for purposes of the exception in IRC 4948(b) means that the organization, from the date of its creation, has received at least 85 percent of its support as defined in IRC 509(d), other than gross investment income, from sources outside the Unites States.

  2. In computing support for purposes of this test, gifts, grants, contributions or membership fees received directly or indirectly from a Unites States person (as defined in IRC 7701(a)(30)) are from sources within the United States.

7.27.27.4  (11-18-2013)
Denial of Exemption for Prohibited Transactions

  1. A foreign private foundation which receives substantially all of its support from sources outside the Unites States is generally excepted from the private foundation rules.

  2. However, tax exemption under IRC 501(a) is to be denied such as organization, pursuant to IRC 4948(c)(2), if it engages in a "prohibited transaction" after December 31, 1969.

7.27.27.4.1  (11-18-2013)
Meaning of Prohibited Transaction

  1. "Prohibited transaction" for purposes of denial of exemption under IRC 4948(c)(2) means any act or failure to act (other than with respect to IRC 4942(e) relating to minimum investment return) which would subject a foreign private foundation or a person with respect thereto to liability for a penalty under IRC 6684 or a termination tax under IRC 507 if the foreign private foundation were a domestic private foundation.

  2. Thus, foreign private foundations described in IRC 4948(b) and their disqualified persons are held to the same requirements as other private foundations except for IRC 4942 requirements and certain special variances concerning grants (see (3) below). However, for such foundations the sanction for failure to observe requirements is a potential denial of exemption under IRC 501(a) as opposed to a tax on nonconforming activity.

  3. In applying the "prohibited transaction " rule described in (1) above:

    1. Approval by an appropriate foreign government of grants by a foreign private foundation to individuals is sufficient to satisfy the requirements of IRC 4945(g);

    2. In the case of a grant to an organization by a foreign private foundation, the grantor’s determination as to the status of the grantee for purposes of IRC 4942(g)(1)(A)(ii) (relating to qualifying distributions to a private foundation which is not an operating foundation) or for purposes of IRC 4945(d)(4) and (h) (relating to grants for which expenditure control is required of the grantor) will be accepted if such determination is made in good faith after a reasonable effort to identify the status of its grantee.

  4. If a foreign private foundation (or disqualified person with respect to such foundation) commits a willful and flagrant act in violation of chapter 42 (except as discussed above), then such act is a prohibited transaction.

  5. Otherwise, the following events must occur for an act in violation of chapter 42 to constitute a prohibited transaction

    1. The foreign foundation or a disqualified person commits an act in violation of chapter 42.

    2. The commissioner warns the foundation that another act in violation of chapter 42 would result in a prohibited transaction

    3. The foundation or disqualified person commits another act in violation of chapter 42 (not necessarily the same type of act).

    4. The commissioner warns the foundation that the second act is a prohibited transaction unless corrected within 90 days after the warning.

    5. The foundation or disqualified person fails to timely correct. Treas. Reg. § 53.4948-1(c)(2) and (3).

7.27.27.5  (11-18-2013)
Taxable Years Affected With Respect to Denial of Exemption

  1. If a foreign private foundation described in IRC 4948(b) engages in a prohibited transaction, it will be denied exemption for all taxable years (except as provided in IRM 7.27.27.6 below) beginning with the taxable year during which it is notified by the commissioner that it has engaged in a prohibited transaction. IRC 4948(c)(3)(A). At a minimum, it will be denied exemption for the remainder of that tax year and the following tax year.

  2. The commissioner shall publish notice of such denial on the day on which the foreign private foundation is so notified. The Washington POD will coordinate issuance and publication of the notice of denial of exemption.

7.27.27.6  (11-18-2013)
Reestablishment of Exempt Status

  1. A foreign private foundation whose exempt status is denied because it engaged in a prohibited transaction may file a request for recognition of exemption under IRC 501(a) on Form 1023, Application for Recognition of Exemption, with respect to the second or any subsequent taxable year following the taxable year in which the notice of denial was issued. In addition to the information generally required in Form 1023, the foreign organization is also required to submit a written declaration made under the penalties of perjury by a principal officer of such foundation that it will not knowingly again engage in a prohibited transaction. Treas. Reg. § 53.4948-1(c)(3)(ii)(a).

  2. If the commissioner is satisfied that such foreign private foundation will not knowingly again engage in a prohibited transaction and that it otherwise satisfies the requirements for recognition of exemption, it will be notified in writing

    1. In such a case the foundation will not be denied exemption by reason of any prohibited transaction engaged in before notice of denial was issued.

    2. However, in no case may an organization denied exemption under IRC 4948(c), be again exempt under IRC 501(a) sooner than the conclusion of one full taxable year following the year in which notice of loss of exemption is given.

7.27.27.7  (11-18-2013)
Disallowance of Charitable Deductions

  1. IRC 4948(c)(4) provides that no charitable deduction is allowed under IRC 170, 545(b)(2), 642(c), 2055, 2106(a)(2) or 2522 for a gift, bequest, legacy, devise or transfer, if made:

    1. To a foreign private foundation after the date on which notice has been published in the Federal Register that the organization has been notified that it has engaged in a prohibited transaction; or

    2. In a taxable year of such organization for which it is not exempt by reason of the issuance of a notice of denial of exemption for engaging in a prohibited transaction.


More Internal Revenue Manual