Treasury recently released proposed regulations concerning Type I and Type III supporting organizations. If adopted, these new regulations would implement the prohibitions on certain contributions to Type I and Type III supporting organizations, and clarify other requirements for Type III organizations, that were enacted as part of the Pension Protection Act of 2006.
An organization is classified as a Type I, II, or III supporting organization under IRC § 509(a)(3) if it satisfies the 1) organizational test, 2) operational test, 3) relationship test, and 4) disqualified person test. Among other things, the proposed regulations would modify the relationship test, specifically in regards to the notification requirement, the responsiveness test and the integral part test.
First, the proposed regulations modify the notification requirement of the relationship test. The notification requirement requires a Type III supporting organization to provide to each of its supported organizations written notice describing the types of support it provided for the previous year. The proposed regulations would mandate that these documents be delivered to each supported organization by the last day of the fifth month of the taxable year after the taxable year the support was provided.
Second, the responsiveness test is clarified based on previous rulemaking comments. The responsiveness portion of the relationship test requires a supporting organization to be responsive to the needs or demands of a supported organization. The officers, directors or trustees of the supporting organization must have a specified relationship with the supported organization. Likewise, the officers, directors or trustees of the supported organization must have a “significant voice” in the investment and grant activities of the supporting organization.
Prior comments to the responsiveness test raised concern that requiring a supporting organization to be responsive to each supported organization would create a heavy administrative burden for those with many supported organizations, and the test should therefore not apply to all supported organizations. However, the proposed regulations require a Type III supporting organization to be responsive to the needs and demands of each of its supported organizations. The regulations offer a new example—example 3—to address concerns about administrative burden. This new example describes a situation in which officers of a supporting organization hold joint meetings for all supported organizations and encourage post-meeting contact with the officers. The supporting organization would therefore meet the significant voice requirement.
Third, the proposed regulations make numerous changes to the integral part test. This test requires Type III supported organizations to maintain significant involvement in one or more supported organizations and provide support on which the supported organizations are dependent. The proposed regulations would clarify the requirements applicable to both categories of Type III supporting organizations (that is, both functionally integrated and non-functionally integrated Type III supporting organizations).
A Type III organization is functionally integrated if 1) substantially all of its activities directly further the exempt purposes of one or more supported organizations, 2) it is the parent of each supported organization, or 3) it supports a governmental supported organization. The regulations would make two major changes to the functionally integrated standard. First, the regulations clarify that for a supporting organization to qualify as a parent, the supporting and supported organizations must be part of an integrated system and the supporting organization must engage in activities typical of the parent of an integrated system. The regulations use the example of hospital systems when analyzing whether or not activities are typical of an integrated system. One key requirement is that the parent must have the power to appoint a majority of officers, directors or trustees of each supported organization. Second, the regulations clarify the definition of governmental supported organization is the definition of governmental unit as described in IRC § 170(c)(1)-(2).
A non-functionally integrated Type III supporting organization must satisfy the distribution and attentiveness requirements. Under the distribution requirement, supporting organizations must distribute the greater of 85 percent of its adjusted net income for the preceding year or its minimum asset amount for the preceding year. The proposed regulations clarify the distribution requirement portion of the test in two ways. First, the regulations clarify that taxes paid on unrelated business taxable income are not treated as a distribution to a supported organization because they do not further the supported organization’s exempt purposes. Second, the regulations provide that fundraising expenses of the supporting organization are generally not included as a distribution, but that reasonable and necessary expenses paid by the supporting organization that are related to the solicitation of contributions received by a supported organization directly from donors do count toward the distribution requirement.
Finally, the regulations offer guidance on one issue outside of the relationship test context—the meaning of control. Type I and III supporting organizations cannot accept gifts or contributions from certain related persons who directly or indirectly control the governing body of a supported organization. The regulations would clarify that a supported organization is controlled by a person if that person, alone or with the assistance of related persons, can require the governing body of the supported organization to perform any act that significantly affects its operations or prevents it from performing any such act. For this purpose, although all facts and circumstances must be taken into account, the governing body of a supported organization will generally be considered to be controlled directly or indirectly by one or more persons if the voting power of such persons is 50 percent or more of the total voting power of such governing body, or if one or more of such persons have the right to exercise veto power over the actions of the governing body of the supported organization.
Comments on the proposed regulations are due by May 19, 2016. For the full text of the proposed regulations, click here.