Final Regulations: Reliance Standards for Equivalency Determinations

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Last week, the IRS issued final regulations regarding the standards by which a private foundation may make a “good faith determination” of whether a potential foreign grantee is the equivalent to a U.S. public charity– a process known as an equivalency determination. An equivalency determination is required so that grants made to the foreign organization are considered qualifying distributions (as defined in Section 4948 of the Internal Revenue Code (the “Code”)) instead of taxable expenditures (as defined in Section 4945 of the Code).

In September of 2012, the IRS issued proposed regulations that allowed private foundations to rely on a broader class of practitioners, not just legal counsel, in making the good faith determination. The final regulations expand the class of advisors providing written advice on which foundations may ordinarily rely to qualified tax practitioners, including CPAs and enrolled agents (as well as attorneys) who are subject to the standards of practice before the IRS set out in Circular 230. The final regulations provide that a determination based on the written advice of such qualified tax practitioners ordinarily will be considered as made “in good faith.” This, however, does not include an opinion of foreign counsel of the grantor or grantee. In order to come within this particular special rule, the opinion of counsel must be made by a qualified tax practitioner, as described above.

Additionally, the IRS clarified that the written advice of the above practitioners must be “current,” or, as of the date of distribution, the relevant law on which the advice is based has not changed and the facts on which the advice is based is from the grantee’s current or prior taxable year (or annual accounting period if the grantee does not have a taxable year for United States federal tax purposes).

The most significant change under the final regulations is that private foundations cannot rely solely on a grantee affidavit as a basis upon which a determination ordinarily will be considered a good faith determination. Such affidavits are meant to extract the necessary information about the foreign grantee including financials for the current and previous years, governing documents (often a translated copy is required), details about the board of directors, and descriptions of program activities. While a grantee’s affidavit remains a good source of information on which qualified practitioners may rely when making the determination, the affidavit alone will not be enough. This does not preclude the use of such grantee affidavits—the final regulations state that a foundation manager with an understanding of U.S. charity tax law may under the general rule make a good faith determination that a foreign grantee is a qualifying public charity based on the information in an affidavit supplied by the grantee. This is especially true if the foundation managers and their in-house counsel are themselves qualified tax practitioners, whose written advice may be reasonably relied upon for determinations to come within the special rule.

Because this change may affect a number of foundations who previously relied on grantee affidavits as a basis for the determination, the regulations allow a 90-day transition period where foundations may continue to distribute grants in accordance with prior regulations. A foundation may make distributions to a foreign organization, in fulfillment of a prior written commitment and pursuant to a good faith determination made in accordance with prior regulations, for up to five years.

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