The Pension Protection Act of 2006 made significant changes to the rules applicable to supporting organizations, and in particular Type III supporting
organizations. The latest regulatory guidance from the IRS continues the slow implementation of these changes. As background, the IRS previously published
an advance notice of proposed rulemaking on Aug. 2, 2007, proposed regulations on Sept. 24, 2009, final and temporary regulations on Dec. 28, 2012, and
Notice 2014-4, 2014-2 I.R.B. 274 to provide transitional relief. This past guidance, however, reserved certain areas for future guidance and left other
areas in need of further clarification.
On Dec. 23, 2015, the IRS issued the final regulations that confirmed the temporary regulations in 2012, without any changes. Those temporary regulations
had addressed the distribution requirement that a non-functionally integrated Type III supporting organization must meet. The preamble to the December 2015
final regulations promised additional guidance would be forthcoming and which arrived in the form of proposed regulations on Feb. 19, 2016.
The 2016 proposed regulations address four key areas:
- The integral part test as applied to a functionally integrated Type III supporting organization that supports a governmental entity or is a parent of its
- The prohibition that prevents a Type I or Type III supporting organization from accepting gifts from a controlling donor;
- Further guidance regarding the relationship test for Type III supporting organizations;
- The types of distributions that count toward a non-functionally integrated Type III supporting organization’s distribution requirement.
Integral Part Test
. A Type III supporting organization will ordinarily be considered functionally integrated if “substantially all” of its activities directly further the
exempt purposes of its supported organizations. The proposed regulations provide guidance on meeting the functional integration requirements for Type III
supporting organizations that support a governmental entity or are a “parent.”
For a Type III supporting organization that supports a governmental entity, the supporting organization will be functionally integrated if a substantial
part of its activities directly furthers the exempt purposes of its supported organizations. The proposed regulations give no explanation of why a
“substantial part” is required instead of “substantially all,” and no indication of what percentages might correspond to those levels of activities. The
regulations define a “governmental supported organization” by reference to the existing Code section 170(c). The proposed regulations clarify that a Type
III supporting organization may support more than one governmental entity if such governmental entities operate within the same geographic region or work
in close coordination or collaboration to conduct a service, program, or activity that the supporting organization supports.
For a Type III supporting organization that is a parent of the organization(s) that it supports, the proposed regulations indicate that the supporting
organization and its subsidiary(ies) must be part of any integrated system, and the supporting organization must engage in activities typical of the parent
of an integrated system. Examples provided include coordinating the activities of and engaging in overall planning, policy development, budgeting, and
resource allocation for the supported organizations. The IRS requested comments on what activities might be typical of a parent in an integrated system and
whether additional examples should be provided.
Contributions from Controlling Donors
. Type I and Type III supporting organizations are prohibited from accepting contributions from a person who, directly or indirectly, either alone or with
other related persons, can control the governing body of a supported organization. The proposed regulations indicate, not surprisingly, that a person
“controls” an organization if the person’s voting power is 50% or more of the total voting power of the governing body or if that person has veto power
over the governing body of the supported organization. The regulations also state that all facts and circumstances will be taken into consideration in
determining whether a person controls the governing body of the supported organization.
. The proposed regulations also provide clarification on the notification requirement and the responsiveness test for Type III supporting organizations.
The proposed guidance regarding the required notification to supported organizations is intended to reduce confusion, but does not substantively change the
notification requirement, which remains due by the last day of the fifth month of the taxable year, for reports on support provided in the prior taxable
year. The proposed regulations change the responsiveness test to require the supporting organization to be responsive to all (not just some) of its
supported organizations and add an example of how supporting organizations, including charitable trusts, can be responsive to multiple organizations in a
. Non-functionally integrated Type III supporting organizations must meet a distribution requirement each year, similar to private foundations. The
distributable amount is the greater of 85% of the supporting organization’s adjusted net income for the prior taxable year or 3.5% of the fair market value
of its assets. The proposed regulations clarify the types of expenditures that can be counted toward the distribution requirement. Taxes paid on unrelated
business taxable income do not count. Additional guidance is provided on the amounts previously described in the 2012 regulations, but the proposed
regulations change the guidance to being an exclusive list instead of a non-exhaustive list of examples. Expenditures that count toward the distribution
requirement are limited to:
- Amounts paid to the supported organization to accomplish the supported organization’s exempt purposes;
- Amounts paid to perform an activity substantially all of which directly furthers the exempt purposes of the supported organization, but only to the
extent such amounts exceed the income from the activity;
- Certain reasonable and necessary administrative expenses, but not those incurred in the production of investment income;
- Certain reasonable and necessary solicitation expenses, where contributions are received directly by the supported organization, but only to the extent
such expenses do not exceed the contributions actually received by the supported organization;
- Amounts paid to acquire exempt-use assets;
- Certain amounts set aside for a specific project to accomplish the exempt purposes of the supported organization.
While a few areas remain open for comments and future guidance, these proposed regulations fill in most of the holes from earlier regulatory guidance. Both
Type I and Type III supporting organizations are directly affected by these regulations, but community foundations and other public charities that are
supported organizations should also take note of the new requirements.
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