Withholding requirements for tax-exempt organizations making foreign grants.

• Author: Zarzar, Robert
• Position: Nonresident aliens

On Jan. 1,2001, new U.S. tax withholding rules went into effect in the form of amended final regulations under Secs. 1441, 1442 and 1443. The regulations are intended to clarify certain issues that arose under the prior regulations and to change the overall administrative requirements to ensure proper withholding. Although the new regulations do not address tax-exempt organizations specifically, they can affect withholding requirements for certain payments made by a U.S. tax-exempt entity to a foreign individual or entity.

The regulations also modify the rules for reporting to the IRS certain payments made to foreign individuals and entities. Generally, reporting is not required if there is no withholding requirement; however, this is not always true, especially when withholding is averted by invoking an applicable treaty.

Under the new regulations, withholding by a U.S. tax-exempt organization that makes a grant to a foreign individual or entity generally is required if either will use part or all of the grant funds to conduct activities within the U.S. The withholding rate for such grants made to nonresident aliens, foreign corporations or foreign trusts generally is 30%. However, certain exceptions apply to the withholding requirements for foreign grants made by U.S. tax-exempt organizations.

Exceptions to Withholding Requirements

Activities outside the U.S. Withholding is not required if the foreign individual or entity uses the grant funds to conduct activities entirely outside the U.S. Thus, a U.S. tax-exempt organization that wants to ensure that grant funds paid to a foreign individual or entity will not be subject to withholding should be able to do so by including a clause in the applicable grant agreement that requires the foreign recipient to use the grant funds to conduct activities solely outside the U.S.

Scholarships. Sec. 117 qualified scholarship payments to nonresident alien individuals are not subject to the withholding requirements. Additionally, Sec. 117 qualified scholarship payments made to nonresident alien individuals after 2000 no longer must be reported on Form 1042-S, Foreign Person's U.S. Source Income Subject to Withholding. Of course, a private foundation interested in making Sec. 117 qualified scholarship payments to nonresident aliens should ensure that it has received appropriate IRS approval before doing so, to avoid making taxable expenditures under Sec. 4945.

Treaty exemptions. A U.S. tax-exempt...