The IRS recently issued new proposed regulations regarding supporting organizations that provide additional clarity, particularly for Type IIIs. This has been an area in flux for some time, and the IRS has issued a series of proposed and final regulations over the last several years that have changed this landscape for these organizations.
As background, under Section 509(a)(3) of the Internal Revenue Code, supporting organizations are given public charity status (as opposed to more cumbersome private foundation status) under Section 501(c)(3) based on the fact that they support traditional public charities. Sometimes referred to as “piggy-backing” their public charity status, these supporting organizations must satisfy several tests in order to qualify as public charities themselves, including an organizational test, an operational test, a relationship test and a disqualified person control test.
The relationship test categorizes supporting organizations as either Type I, Type II or Type III (either functionally integrated or not functionally integrated) based on the relationship the supporting organization has with the charities it supports. The bulk of the proposed regulations address the application of the relationship test to Type III supporting organizations, though one change has a bit broader application.
The Responsiveness Requirement for Type III Supporting Organizations. Type III supporting organizations typically have the least formal connections to their supported organizations and thus are subject to meeting additional requirements in order to qualify as a public charity. One of these additional requirements under the relationship test for Type III supporting organizations is the requirement to be “responsive to the needs or demands of a supported organization.” The new proposed regulations clarify that the responsiveness requirement means a supporting organization must be responsive to the needs and demands of each of its supported organizations in order to meet the test.
The Integral Part Test for Functionally Integrated Type III Supporting Organizations that Act as a Parent. The integral part test is another additional requirement under relationship test for Type III supporting organizations to qualify as a public charity. The integral part test for a functionally integrated Type III supporting organization requires the organization to show that it constitutes an integral part of its supported organization either (1) by showing that substantially all of its activities directly further the exempt purposes of the supported organization and those activities would normally be undertaken by the supported organization absent the involvement of the supporting organization, (2) by showing that the supporting organization is the parent of each of its supported organizations, or (3) by showing that the supporting organization supports a governmental supported organization. Under the current regulations, in order to be considered the “parent” of the supported organization, the functionally integrated Type III organization must be able to exercise a substantial degree of direction over the policies, programs and activities of the organization and must be able to appoint or elect a majority of the officers, directors or trustees of the supported organization. The proposed regulations keep these requirements, but also clarify that in order to qualify as a parent, the supporting organization and its supported organizations must be part of an integrated system, such as a hospital system, and the supporting organization must engage in activities typical of the parent of an integrated system. Such activities include, but are not limited to, coordinating activities of the supported organizations and engaging in overall planning, policy development, budgeting and resource allocation for the supported organizations.
The Integral Part Test for Functionally Integrated Type III Supporting Organizations that Support Governmental Supported Organizations. The proposed regulations also clarify the definition of a “governmental supported organization,” for the purposes of the integral part test. A governmental supported organization is defined using the Section 170(c)(1) definition, which includes all of the agencies, departments and divisions of the governmental unit. All such agencies, departments and divisions will be treated as one governmental supported organization for the purposes of the integral part test. The proposed regulations state that in order to be functionally integrated, the Type III supporting organization must only support governmental supported organizations. Further, if the Type III supports more than one such organization, it will be functionally integrated only if all of its governmental supported organizations operate within the same geographic region (city, county or metropolitan area) or work in close coordination with one another to conduct a service, program or activity that the supporting organization supports. In order to meet this requirement of close cooperation, the functionally integrated Type III supporting organization must maintain on file a letter from each governmental supported organization describing their collaborative or cooperative efforts with respect to the particular service, program or activity.
Changes to Distributable Amount Regime for Non-Functionally Integrated Type III Supporting Organizations. The proposed regulations remove the regulatory language that reduces the distributable amount that non-functionally integrated Type III supporting organizations must pay by the amount of income taxes imposed on the supporting organization for the immediately preceding tax year. Further, the proposed regulations clarify what distributions count toward meeting the distributable amount requirement and also make the list exclusive, which it had not been before. Thus, the effect of these two changes is to increase the amount a non-functionally integrated Type III supporting organizations must distribute on a yearly basis.
The Definition of “Control” For the Purposes of the No-Gift Rule Clarified. Under Section 509(f)(2), an organization cannot be a Type I or Type III supporting organization if it accepts gifts or contributions from a person who either alone or in conjunction with certain related persons directly or indirectly controls the governing body of the supported public charity. The new proposed regulations clarify “control” for the these purposes, by stating that the governing body of the supported organization is considered controlled by a person if that person, alone or by aggregating his or her votes or positions of authority with certain related persons, may require the governing body of the supported organization to perform any act that significantly affects its operations or may prevent the governing body of the supported organization from performing any such act. This definition of control mirrors the one that applies under the disqualified person control test, which applies to all supporting organizations.
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