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Legal Responsibilities of US "Friends" Organizations

Legal Counsel for Philanthropy and the Nonprofit Sector

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Legal Responsibilities of US "Friends" Organizations

  1. Executive Summary
  2. Background
  3. Recommendations

  1. Summary

    Under US tax law, US "Friends" organizations must be operated independently of the foreign organizations they support. The governing boards of such Friends organizations are required to oversee all areas of Friends activities and to retain authority for grantmaking and financial decision-making. The formal legal relationship is essentially the same as that of any US charitable foundation and a foreign charitable grantee.

    In order to reconcile the required legal separation with the close working relationships between the foreign organization and the US Friends organization, there needs to be common understanding of the need for and role of the US Friends organization board of directors and the mechanics of approving the transfer of funds from donors to the US Friends organization to the foreign organization.

  2. Background

    In the US, charitable organizations are exempt from taxation and contributions to these organizations are tax-deductible to donors, a significant double benefit. Such organizations are known as 501(c)(3) organizations, which refers to the particular US Internal Revenue Code section under which they qualify for tax exemption. Generally, 501(c)(3) organizations are permitted to conduct activities abroad and provide funds to foreign organizations.

    In this instance, the key element in obtaining and maintaining 501(c)(3) status is not where the activities are carried out but with whom control of the organization lies. Control must lie in an independent US Friends organization board of directors that holds the authority and discretion to carry out its charitable purposes and maintains final oversight for the US Friends organization fundraising, management, and disbursements.

    Consider the following example: Suppose that a US Friends organization has a board of directors that has thus far been inactive and served merely in an advisory capacity. If the US Friends organization either does not have an operating board of directors or its actions are directed by an affiliated foreign organization's officials, then the US Friends organization may be considered to be a "controlled organization", i.e., an organization controlled by another organization that does not have tax-exempt status in the US. As a controlled organization, the US Friends organization would risk loss of tax exemption.

    Note that there is no requirement that the board of directors of a US Friends organization be comprised of a certain percentage of US citizens or that it excludes officials or directors from its affiliate foreign organization. However, the board may not be majority-controlled by this affiliate foreign organization.

  3. Recommendations

    In order to ensure that a US Friends organization maintains its US tax-exempt status, the following three-step approach is advised:

    1. Establish a true US Friends organization board of directors with actual legal responsibility for its own affairs and finances. This may be accomplished through the careful and strategic recruitment, screening, and nomination of a small number (initially) of well-qualified, dedicated, and trust-worthy individuals to serve as directors.
    2. If necessary, correct and amend the US Friends organization's organizational documents (including bylaws) in order to:
      • Eliminate any confusion over governing authority and the flow of responsibility and information within the US Friends organization.
      • Satisfy federal and state laws governing US tax-exempt organizations.
      • Clearly and simply describe the preferred organizational structure and lines of corporate authority.
    3. Educate directors and officials of both the US Friends organization and the affiliated charitable foreign organization in:
      • The role and responsibilities of US nonprofit boards of directors.
      • The extent of the legal relationship between the US Friends organization and the affiliated foreign charitable organization permitted under US tax law.
      • The types of informal operating understandings and best practices that develop under this framework between US Friends organizations and the foreign charitable organizations they support.
  4. In conclusion, it is not uncommon for problems to develop with relationships between US Friends organizations and their affiliated foreign charitable organizations seeking to establish a US base of support. Furthermore, these problems can be potentially serious if they are not properly identified and corrected. The problems typically do not result from true conflicts or actions taken in bad faith, but simply from a lack of understanding of the relationship mandated under US tax law between the domestic and foreign organizations.

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