How should a Section 501(c)(3) organization handle donations received from donors outside the United States? With a thank-you note, of course! And then what? A U.S. public charity should issue a charitable contribution receipt, but refrain from stating that such a donation is tax deductible to the donor. Here’s why, and how the gift’s tax deductibility may vary depending on the donor’s own tax status and situation.
Overview and General Rule
A key benefit to tax-exempt status under Section 501(c)(3) is that donors to such organizations may take tax deductions for their donations. If donors itemize deductions on their IRS Form 1040 tax return, and receive proper written acknowledgements from their donees, then donors can generally offset their U.S. income tax liability.
Broadly speaking, such tax benefit only applies to donors paying U.S. taxes who donate to U.S. charities. This is because the U.S. can only offset taxes it would otherwise collect, and other countries would not typically reduce their own taxes for donations to a U.S. organization. So what are the options for donors who live outside the U.S., donate to U.S. charities, and seek a tax deduction?
The short-version answer is that if a foreign donor to a U.S. charity files an IRS Form 1040 (or variant like the 1040NR, for nonresident aliens), the donor can likely take a tax deduction against his or her U.S. income tax liabilities to the extent of income from a U.S. source, and subject to the other limits imposed by statute, treaty, and regulation.
But who must (or may) file an IRS Form 1040 (or 1040NR)? Can a foreign donor ever claim a deduction against taxes in his own country for donations to a U.S. charity? The answer is: it depends. And this is why charities should tread carefully when donors ask about whether their charitable contributions are deductible.
Any given donor’s requirement or ability to file a U.S. tax return depends on an assortment of factors. Perhaps unexpectedly, the determining factor is not necessarily the citizenship of the donor. Consideration must be given to the donor’s tax status, the donor’s residency or tax home, and the donor’s income source.
1. Donor Tax Status
First, the tax status of the donor must be determined. Since the question concerns contributions to U.S. charities, the tax status should be considered from the U.S. legal perspective. A donor may be a citizen, a national, a resident alien, or a nonresident alien of the United States. U.S. citizens, nationals, or resident aliens are typically taxed similarly as compared to a nonresident alien, but an ability to claim a charitable tax deduction depends on still other factors.
2. Donor Residency or Tax Home
In addition to tax status, the donor’s residency or tax home must be considered. Varying requirements apply with respect to tax filings for donors who are residents of a U.S. Possession, each of which have their separate tax systems with individual rules. These areas include American Samoa, Puerto Rico, the Commonwealth of the Northern Mariana Islands, Guam, the U.S. Virgin Islands, and the Midway Islands. Some residents of certain Possessions need to file with their own tax system, some must file with only the U.S., and some with both their own and with the U.S. If such a resident had U.S. source income, as described below, that would determine the ability and extent to which a donor might be able to claim a deduction for a charitable contribution.
Notably, the U.S. has income tax treaties with several foreign countries that may provide residents (not necessarily citizens) of those countries a reduced rate of income taxation, exemptions from certain U.S. income taxes, or even reciprocal treatment of tax-exempt status for particular types of organizations. Treaty provisions are generally reciprocal, but not necessarily. And not every provision applies (e.g., U.S. citizens who do not reside in the U.S.). Each treaty is unique and must be considered independently of all the others—including its provisions on offsetting tax liability with charitable deductions to U.S. charities. To further complicate matters, some states in the U.S. honor the provisions of the federal tax treaties but some states do not, for purposes of state tax reporting requirements.
As one example of a U.S./foreign tax treaty, the U.S.-Canada Income Tax Treaty provides that a Canadian who contributes to a U.S. charity may be able to claim a deduction against his Canadian income tax – if the taxpayer has U.S. source income (as defined below) claimed on his or her Canadian tax return, and subject to various limitations imposed by both countries.
However, this same treatment is not necessarily the case with other countries with which the U.S. has income tax treaties. Donors who reside in a country whose treaty does not cover a particular kind of income, or perhaps does not have a treaty with the U.S., must pay income taxes (and take any allowable deductions) in accordance with their own country’s tax code and the IRS requirements, if applicable.
3. Donor Income Source
A final consideration, especially for nonresident aliens, is to determine the source of income. Donors who are resident aliens are generally subject to tax in the same manner as a U.S. citizen. However, a nonresident alien usually is subject to U.S. income tax only on U.S. source income.
The determination of the income source depends on the income type. For example, salaries, wages, and other compensation are generally deemed to find their source where services were performed. The income amount is determined using a time basis rather than a geographical basis, which would apply to fringe benefits. On top of that determination, whatever income is subject to U.S. income tax must be determined to be effectively connected with a trade or business in the U.S. or income not effectively connected (but is fixed, determinable, annual, or periodical). Only the taxes against the first type of income may be offset with a deduction for charitable contributions to U.S. charities.
Putting it All Together
Given the significant number of permutations, it is practically beyond any given organization’s ability to determine a foreign donor’s ability to deduct a contribution. Ultimately, it is ultimately the donor’s responsibility to determine the deductibility of the donation – not that of the nonprofit. The final determination of deductibility is very contextual and fact-specific, and is significantly affected by the donor’s specific financial situation and the tax code of their particular country of residence.
Donations from foreign donors thus should be recognized with gratitude, but nonprofits should refrain from affirmatively stating that such donations are tax deductible to the donors. The nonprofit may also wish to indicate that donors should consult their own tax professionals for guidance regarding tax deductibility.