Many practitioners have been anxious to leaf through regulations to confidently determine whether an organization is a “functionally integrated” or “non-functionally integrated” Type III supporting organization, and the implications of either classification.
On December 28, 2012, the Internal Revenue Service released the long-awaited final regulations for Type III supporting organizations, as well as temporary regulations addressing annual distribution requirements. The text of the temporary regulations also serves as the text of the proposed regulations. The final regulations describe all of the other requirements (outside of the annual distribution requirement explained below) of a Type III supporting organization’s relationship with its supported organization.
A supporting organization is an organization described in Section 509(a)(3) of the Code. These organizations achieve their public charity status by providing support to one or more public charities (supported organizations). Among other requirements, a supporting organization must satisfy a relationship test establishing one of three types of relationships with one or more supported organizations. As a result, there are three corresponding types of supporting organizations. A Type III supporting organization is “operated in connection with” one or more supported organizations.
Prior to the enactment of the Pension Protection Act of 2006 (“PPA”), the regulations for Type III supporting organizations provided for a responsiveness test requiring a supporting organization to be responsive to the needs or demands of its supported organization(s), and an integral part test requiring a supporting organization to maintain a significant involvement in the operations of one or more supported organizations that are dependent on the supporting organization for the type of support it provides.
The PPA, among other things, changed the requirements to qualify as a Type III supporting organization by requiring Type III supporting organizations that are “non-functionally integrated” to pay a certain amount to their supported organization(s). Type III “functionally integrated” supporting organizations, on the other hand, are not required to meet a payout requirement because of their activities related to performing the functions of their supported organizations.
In large part, the final regulations are very similar to the proposed regulations issued in 2009. Highlights of unchanged provisions include:
(i) Notification Requirement – Like the 2009 proposed regulations, the final regulations require that, for each taxable year, 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 describing the amount and type of support provided to the supported organization; (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. The PPA required such notification as required by the IRS, so this requirement is now in effect.
(ii) Responsiveness Test – The final regulations provide that all Type III supporting organizations must satisfy the ‘‘significant voice’’ responsiveness test by (1) demonstrating one of three necessary relationships between their officers, directors, or trustees and those of their supported organization(s), and (2) showing that this relationship results in the officers, directors, or trustees of the supported organization having a significant voice in directing the use of the income and assets of the supporting organization.
(iii) Like the 2009 proposed regulations, the final regulations provide that a Type III supporting organization is functionally integrated, and therefore not subject to a distribution requirement, 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 which, 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.
The regulations make a significant change in the requirements to qualify as a non-functionally integrated Type III supporting organization. The September 2009 proposed regulations provided that a non-functionally integrated Type III supporting organization would have to annually distribute a “distributable amount’’ equal to 5 percent of the fair market value of its non-exempt-use assets. The Treasury Department and the IRS decided to base this distribution requirement on non-exempt-use assets, rather than on income, due to concerns that the income-based payout test could result in little or nothing being paid to charity if the supporting organization’s assets produced little to no income. The provisions in the proposed 2009 regulations regarding the amount that nonfunctionally integrated Type III supporting organizations must annually distribute have thus been significantly revised in response to comments. Consequently, the temporary and proposed regulations change this requirement to the greater of 85 percent of adjusted net income or 3.5 percent of the fair market value of a supporting organization’s noncharitable use assets.
The final regulations also reserve a provision for a special rule for supporting organizations that support a governmental supported organization.
The regulations are effective as of December 28, 2012.
Interestingly, the preamble to the regulations states that there are certain topics regarding supporting organizations, based on the IRS’s and the Treasury Department’s review of all comments received on the supporting organization regulations, about which we can expect future proposed regulations. We will have to wait and see exactly what unfolds for supporting organizations.