October 2009
Note: The following discussion is provided for informational purposes and is not intended to serve as legal or tax advice. For specific information about the proposed regulations for Type III supporting organizations, consult your legal or tax advisor.
Reprinted from Exempt Organizations Advisory
On September 23, the Internal Revenue Service released Proposed Regulations for Payout Requirements for Type III Supporting Organizations That Are Not Functionally Integrated. The IRS issued interim guidance in Notice 2006-109 and an advanced notice of proposed rulemaking on August 2, 2007. The Proposed Regulations reflect changes to the law made by the Pension Protection Act of 2006 (PPA).
The Proposed Regulations focus primarily on the relationship test for Type III supporting organizations. These organizations are described in section 509(a)(3) and operated in connection with one or more supported organizations. Notable provisions include:
Summary of Qualification as a Type III Supporting Organization
Every Type III supporting organization must: (1) satisfy the notification requirement in the Proposed Regulations, (2) meet the responsiveness test in the Proposed Regulations and 3) demonstrate that it is an integral part of one or more supported organizations, either as a functionally integrated or non-functionally integrated organization. In addition, Type I and Type III supporting organizations are prohibited from accepting a gift or contribution from a person who directly or indirectly controls the governing body of a supported organization of the Type I or Type III supporting organization.
Requirement to Notify Supported Organizations
The Proposed Regulations require that a Type III supporting organization must provide to each of its supported organizations: (1) a written notice addressed to a principal officer of the supported organization identifying the supporting organization and describing the amount and type of support it provided to the supported organization in the past year; (2) a copy of the supporting organization's most recently filed Form 990; and (3) a copy of the supporting organization's governing documents, including any amendments. Copies of governing documents need only be provided once.
Responsiveness Test
The Proposed Regulations require that all Type III supporting organizations, including those organized as charitable trusts, must meet the responsiveness test under existing Treas. Reg. § 1.509(a)-4(i)(2)(ii). This provision eliminates the special responsiveness test for trusts that is included in the existing regulations. Each Type III supporting organization must demonstrate the necessary relationship between its officers, directors or trustees and those of the supported organization, and show that this relationship results in the officers, directors or trustees of the supported organization(s) having a significant voice in the operations of the supporting organization.
Integral Part Test
The Proposed Regulations provide that a Type III supporting organization is functionally integrated if it either: (1) engages in activities substantially all of which directly further the exempt purposes of the supported organization(s) to which it is responsive by performing the functions of, or carrying out the purposes of, such supported organization(s) and that, but for the involvement of the supporting organization, would normally be engaged in by the supported organization(s); or (2) is the parent of each of its supported organizations. This is a modification of the "but for" test in the current regulations. The Proposed Regulations do not adopt the expenditure test or the assets test which were included in the advanced notice of proposed rulemaking.
Non-functionally integrated Type III supporting organizations must adhere to a distribution requirement equal to five percent of the fair market value of its non-exempt-use assets and meet an attentiveness requirement. The distribution requirements are similar to those in section 4942 for non-operating foundations. The attentiveness requirement modifies the current regulations under Treas. Reg. § 1.509(a)-4(i)(3)(iii) and provides that an organization must distribute one-third or more of its annual distributable amount to one or more supported organizations that are attentive to the supporting organization and to which the supporting organization meets the responsiveness test under the Proposed Regulations. The Proposed Regulations eliminate the limit to the number of organizations a supporting organization can support which was included in the advanced notice of proposed rulemaking.
An organization that fails to meet the requirements of the Proposed Regulations, once they are published as final or temporary regulations, will be classified as a private foundation.
The Proposed Regulations also include provisions under section 4943 that provide transition rules to address excess business holdings for private foundations that were previously classified as Type III supporting organizations. The transition rules effectively allow affected organizations additional time to dispose of certain business holdings.
Comments and requests for a public hearing are due by December 23, 2009.
Learn more about supporting organizations >
Suzanne Ross McDowell and Catherine W. Wilkinson, Steptoe & Johnson LLP
© 2009, Steptoe & Johnson LLP, 1330 Connecticut Ave., N.W., Washington, D.C. 20036. All rights reserved. Reprinted from Exempt Organizations Advisory, September 24, 2009.
Suzanne Ross McDowell is a partner in the Washington, D.C., office, of Steptoe & Johnson LLC, where she focuses on the law of tax-exempt organizations. Catherine W. Wilkinson is a certified public accountant practicing in the firm's Tax group. Exempt Organizations Advisory summarizes legal developments of interest to Steptoe & Johnson's exempt organization clients and friends of the firm. It is published on a periodic basis as developments warrant.