Goodwin Insights March 22, 2021

Introduction To “Friends Of” Organizations

Introduction to “Friends Of” Organizations

Under § 170(c) of the Internal Revenue Code of 1986 as amended (the “Code”), a U.S. taxpayer may only claim a deduction on his or her federal income tax return for contributions made to 501(c)(3) charitable organizations created or organized in the U.S. However, there are a variety of ways for U.S. taxpayers to support foreign charitable efforts.

In addition to supporting foreign charitable efforts by making gifts to a U.S. 501(c)(3) that has programs outside of the United States, a U.S. taxpayer can fund gifts to a U.S. 501(c)(3) which, in turn, makes grants to foreign entities, provided the 501(c)(3) is not a “mere conduit.” These types of U.S. 501(c)(3) organizations are typically referred to as “friends of” organizations (“FO”). U.S. taxpayers who wish to claim an income tax deduction should make contributions to a U.S. 501(c)(3) which makes an independent decision to make one or more grants to foreign charities.[1]

The FO will need to qualify for income tax exemption under § 501(c)(3) of the Code and meet the specific requirements for FOs described below.

Tax Exempt Status

As a general matter, FOs must qualify as tax-exempt charitable organizations under § 501(c)(3). These requirements are listed below. 

Exempt Purpose

A FO must have an exempt purpose, i.e., a purpose which is religious, charitable, scientific, literary or educational, or a purpose of testing for public safety, fostering national or international amateur sports competitions, or preventing cruelty to children or animals. 

Organizational and Operational Tests

A FO must be organized exclusively for one or more exempt purposes. Specifically, its governing documents must state that it is organized for one or more of the purposes described above and must state that if a FO goes out of existence, its assets will be distributed for exempt purposes (usually to another 501(c)(3) organization). Additionally, a FO must be operated in practice exclusively for one or more exempt purposes. 

No Private Inurement

No individual or private shareholder may receive unearned payments or other profits or benefits from a FO. 

Restrictions on Political Activities

No substantial part of a FO’s activities may constitute attempts to influence legislation (i.e., lobbying), and a FO must not participate or intervene in political campaigns in any way.

Public Charities or Private Foundations

Organizations that are tax-exempt under § 501(c)(3) of the Code are designated as either private foundations or public charities. Whether a FO will be categorized as a private foundation or a public charity will usually depend on the organization’s sources of funding and how much public support it receives. Due to the additional requirements that apply to foreign grant-making by private foundations, we typically recommend FOs qualify as public charities when possible.

Public Charities

Generally, it is preferable for a FO to qualify as a public charity because private foundations are subject to more burdensome requirements regarding international grants. In order to qualify as a public charity, in most cases, a FO must meet the “public support test” which requires an organization to “normally” receive at least one-third of its support from qualifying public and/or governmental sources. Alternatively, a FO could qualify as a public charity by being a supporting organization if it has a close relationship to another public charity.

Private Foundations

Private foundations generally receive their funding from a limited set of donors and are generally subject to stricter operating requirements than public charities.

U.S. private foundations may only make contributions to certain types of organizations, including organizations that qualify as U.S. public charities and to U.S. and foreign governmental entities for charitable purposes. A private foundation may also make grants to foreign entities but, among other obligations in connection with international grant-making, it must satisfy one of the following requirements: (i) it must determine that the foreign grantee is the “equivalent” of a U.S. public charity, or (ii) it must exercise “expenditure responsibility” with respect to each grant made to a foreign grantee.

Discretion and Control over Funds

In addition to satisfying the requirements of § 501(c)(3) of the Code, a FO must also demonstrate that it is not a “mere conduit” of the foreign grantees, but rather that it maintains the required degree of control over its funds. Although contributions from a U.S. taxpayer directly to a foreign charitable organization are not deductible, the IRS allows U.S. taxpayer deductions for contributions to a FO as long as the FO does not simply transmit donations directly or earmark the funds to a foreign charitable organization, but maintains independent control and discretion over where the funds are directed.

The IRS does not require any specific procedures for a FO to demonstrate it is not a “mere conduit” of a foreign organization, but the IRS has provided guidelines for a FO on how to avoid conduit status. Revenue Ruling 63-252 provides that the FO must have full control over contributions to it and full discretion over the use of these contributions. The ruling also provides that the donor’s income tax deduction will be disallowed if (i) the FO’s charter requires it to turn contributions over to a foreign organization, (ii) the domestic organization enters into an agreement with a foreign organization to conduct a fundraising campaign on the foreign organization’s behalf, or (iii) the donor earmarks his or her contribution to be turned over to a foreign organization.

The IRS provided further details as to how a domestic organization can exercise sufficient control over its contributions in Revenue Ruling 66-79, as described in the recommendations below. In particular, the IRS recognized the importance of having directors who are not acting on behalf of the foreign charity and noted that the directors in that case were U.S. directors.

  • A FO’s bylaws should contain the following provisions:
    • The making of grants shall be within the exclusive power of the Board of Directors;
    • The Board shall have the power to make grants to any charitable organization;
    • The Board shall review all requests for grants and require that all such requests specify how the funds will be used;
    • The Board shall require grantees to furnish periodic accountings;
    • The Board may refuse to make any grants;
    • The Board has the absolute power to withdraw its support of any grant; and
    • The Board may solicit contributions for specific projects only on the condition that the Board has full control over the use of the funds received.
  • A majority of a FO’s Board should have no affiliation with, and be independent from, any foreign grantee. 

Best Practices and Procedures

In order to ensure it is not considered a “mere conduit” of U.S. donor funds to foreign charitable organizations, a FO should broadly draft its charter to provide that the organization must be operated exclusively for 501(c)(3) purposes, including a general statement describing the organization’s primary purpose. The FO’s bylaws should give the Board of Directors complete discretion to conduct the affairs of the organization, and a majority of the FO’s Board of Directors should have no affiliation with and be independent from the foreign grantee organization.

In particular, a FO’s Board of Directors should observe the following procedures:

  • Review and approve each potential grant as being in furtherance of a FO’s own exempt purposes.
  • Decline contributions that a donor seeks to “earmark” to be turned over to a foreign grantee.
  • Enter into a written grant agreement with respect to each grant. The grant agreement should (i) clearly state that the FO has the power to discontinue the grant at any time, (ii) describe in detail how the grant funds will be used, and (iii) require the grantee to furnish periodic accountings to the FO.
  • If a FO embarks on a solicitation campaign to fund a particular project, the FO should make clear to donors in its fundraising materials that it retains the power to determine how the contributed funds will be used.
  • A FO must maintain proper and contemporaneous records that show it maintains control and discretion over use of its funds, and any grants have been reviewed and approved in advance to ensure that the FO’s exempt purposes are furthered.

Note that maintaining proper record-keeping is crucial for avoiding conduit status, as records will verify to the IRS that the organization did maintain sufficient control and discretion over its funds through the procedures outlined above.


[1] While not the subject of this overview, note that any organization with international programs and/or grants will need to comply with OFAC requirements, including checking payments to foreign payees against SDN and U.S. Treasury watchlists, and federal laws regarding terrorist financing, money laundering and bribery and foreign bank account reports.