Background
Congress, in the Pension Protection Act of 2006 (the “PPA”), directed the Internal Revenue Service to issue regulations imposing payout requirements for certain Type III supporting organizations. These regulations are to apply to Type III supporting organizations that are not “functionally integrated” within the meaning of the PPA and were to ensure that a “significant amount” is paid to such organizations. On August 2, 2007, the IRS issued proposed regulations that impose a new minimum payout on Type III supporting organizations and address other provisions of the PPA applicable to supporting organizations. The text of the proposed regulations can be found on the IRS website.
Definition of “Functionally Integrated”
The proposed regulations define the term “functionally integrated,” which is key to determining whether a number of provisions of the PPA apply to a Type III supporting organization. A functionally integrated Type III organization is one that is not required to make payments to supported organizations because the activities of the organization are related to performing the functions, or carrying out the purposes of, such supported organizations.
These proposed criteria will replace the integral part test in the existing regulations. The functionally integrated category will encompass organizations that meet the “but for” test in existing Treas. Reg. §1.509(a)-4(i)(3)(ii), an expenditure test consistent with Code §4942(j)(3)(A), and an assets test consistent with Code §4941(j)(3)(B)(i).
New Five-Percent Payout Requirements for Non-Functionally Integrated Type IIIs
Type III supporting organizations that are not functionally integrated Type IIIs, under the proposed regulations, will be required to meet a new minimum payout requirement and may only support a limited number of organizations.
Similar to the private foundation minimum distribution rules, the payout requirement will require an annual distribution of at least 5 percent of the aggregate fair market value of all of an organization’s assets. In order to meet this requirement and maintain the same level of endowment, an organization may need an actual investment return of 8 or 9 percent in order to offset inflation and investment management expenses.
The number of publicly supported organizations that a non-functionally integrated Type III supporting organization may support will be limited to no more than 5 publicly supported organizations. One exception is made for organizations already in existence, which may support more than 5 organizations, but only if the supporting organization distributes at least 85 percent of its total required payout to organizations to which it is responsive.
Charitable Trusts
In accordance with the provisions of the PPA applicable to charitable trusts classified as Type III supporting organization, the proposed regulations no longer allow for a charitable trust to qualify as a Type III supporting organizations if it only satisfies the responsiveness test because it is a charitable trust under state law, the supported organization is a beneficiary of the trust, and the supported organization has the power to enforce the trust and compel an accounting under applicable state law.
These charitable trusts must now satisfy the responsiveness test under Treasury Regulation §1.509(a)-4(i)(2)(ii). Thus, a trust must show that the trustees have a close, continuous working relationship with the officers, directors, or trustees of its supported organization, and that this relationship results in the officers, directors, or trustees of such organization having a significant voice in the operations of the trust.
In Notice 2008-6 released on January 22, 2008, the IRS announced transitional relief for existing charitable trusts affected by this change. Under this relief, charitable trusts that became private foundations as of August 17, 2007 should continue to file Form 990 for tax years beginning before 2008 and will not be required to pay any excise taxes on net investment income un
Information Supplied to Supported Organization
The PPA requires Type III supporting organizations to provide their supported organization(s) with certain information to ensure that it is responsive to the needs of such organization. The proposed regulations provide new guidance as to the form, content, and timing of the required information.