Over 200 UK charities have had their US tax exemption revoked by the Internal Revenue Service (IRS), without the IRS contacting them to make them aware of that fact. Other charities had their exemption withdrawn, but were later reinstated.

Thomas Dick, of DLA Piper, has written a helpful article in the Tax Journal, explaining the consequences and how to deal with them, and we are grateful to him for giving us permission to reproduce it. While the full article can be downloaded here, the following paragraphs are likely to be of particular interest:

“The consequences of revocation are that tax-advantaged gifts by US donors cannot be made without difficulty; and reduced rates of US withholding tax on US-source investment income cannot be obtained. Once listed, a UK charity’s only alternative is to file a request for reinstatement on Form 1023 (the briefer Form 1023-EZ is not available), and seek to demonstrate a reasonable basis for its non-filing of information returns if it wishes to obtain retroactive reinstatement, under procedures set forth in Revenue Procedure 2014-11.

What are the costs and benefits of reinstatement?

For those UK charities interested in attracting donations from US citizens (including the many who are resident in this country) and donor-advised funds, or grants from US private foundations, the benefits of reinstatement are apparent. While US individuals interested in benefiting UK charities customarily donate to ‘American Friends of’ charities, those intermediaries will need to demand an accounting from any listed UK charities to which they make on-grants. Moreover, US private foundations will be dissuaded by the need to exercise ‘expenditure responsibility’ over grants to listed UK charities. Finally, a simple bequest to a listed UK charity in the UK will of a US citizen resident here will fail to be excluded in computing his or her taxable estate (for US purposes) – a defect which will probably be noticed only after death, when the executor prepares the US estate and gift  tax return.

For those UK charitable endowments which do not seek US support but wish to minimise US withholding tax on investment income (which is not creditable against UK tax), the cost of revocation can be calculated in terms of excess withholding tax on US dividends (15% versus 4% for private foundations and zero for public charities) and on gains on unleveraged US real property (up to 39.6% for UK charities in trust form and 35% for those in corporate form versus zero for both).

The costs of reinstatement comprise not only the professional fees for completing Form 1023 and the filing fee of $850, but also a penalty for the failure to file information returns in the intervening years and the prospective filing ad infinitum of the annual information return on Form 990, 990-EZ, 990-N, or 990-PF, as applicable. If retrospective reinstatement is sought, the charity must create and file information returns for the three missing years (the earliest would be 2007 to 2009) and for all subsequent intervening years (2010 to 2016), and prepare a statement establishing its ‘reasonable cause’ for failing to file the three information returns. If granted, the failure to file penalty (which is normally $10,000 per year but can rise to $50,000 per year for the largest charities) will be waived (IRC section 6652(c)(1)(A)).

There may be a silver lining in seeking retroactive reinstatement for those UK public charities which have been unaware of their entitlement to zero US withholding tax on dividends. These should be able to claim a refund of withholding tax on their dividend income for at least some of the intervening years, if they achieve retroactive reinstatement.

In weighing alternatives, the costs of reinstatement should be compared with the cost to a listed UK charity of doing nothing, which includes liability for the failure to file penalty (should the IRS seek to collect it across the Atlantic) and the filing of any required US tax returns as a taxable non-US entity to report under-withheld US-source investment income for the intervening years and in future.

Action plan

1. Most importantly, every UK charity interested in the US should check whether it is included on the list of revoked charities on the EO Select Check page of the IRS website: click on ‘Exempt organisations select check tool’, then ‘were automatically revoked’; then select ‘United Kingdom’ on the ‘Country’ drop-down list.

2. If they do not appear there, they should continue as is but ensure that they file any required annual US information return, if they are not already doing so. It would be very unlucky if an initial filing of an annual information return led to an IRS inquiry, given that the purpose of the 2006 legislation would have been served.

3. If the UK charity finds its name on this list, it must consider whether the costs of reinstatement outweigh the benefits. In our experience, reinstatement is usually favoured.

4. The UK charity must then consider whether it should seek prospective or retrospective reinstatement. Prospective is cheaper and simpler, but the interim period of revoked status will be problematic if the charity received material gifts or investment income from the US during it. Retroactive reinstatement will require additional professional fees, but once obtained leads to an uninterrupted history of US tax exemption, which is much simpler for US donors and withholding agents, and does not require the UK charity to pay failure to file penalties or US withholding tax on investment income earned in the interim.”