On Feb. 19, 2016, the IRS published proposed regulations (REG-118867-10) providing guidance on certain requirements to qualify as Type I and Type III supporting organizations, which are described in Sec. 509(a)(3) and hence are eligible for public charity status. Final regulations published in 2015 (T.D. 9746) that govern how to qualify as Type III supporting organizations focus primarily on the "relationship test."
The new proposed regulations, which also follow on proposed regulations issued in 2007, 2009, and 2012, are part of a continuing regulatory process reflecting statutory changes made by the Pension Protection Act of 2006 (PPA), P.L. 109-280. The new regulations are proposed to be effective on the date final or temporary regulations are published. However, the IRS states that taxpayers may rely on the proposed rules until final regulations are published. Organizations should review the new proposed regulations and the lengthy preamble, as well as the 2015 final regulations, as a continuing reminder of what is required to obtain or maintain public charity status.
New Proposed Regulations
The proposed regulations update or reinforce key concepts from the previous proposed regulations for supporting organizations, including:
- Clarification of the due date for delivery of the required supported organization notification;
- Confirmation that the responsiveness test must be met for all supported organizations;
- Updates to the definition of functionally integrated Type III supporting organizations as it relates to the parent and governmental tests; and
- Clarification of the list in Prop. Regs. Sec. 1.509(a)-4(i)(6) of what types of distributions count toward the distribution requirement.
2015 Final Regulations
The 2015 final regulations primarily relate to nonfunctionally integrated Type III supporting organizations, including:
- Confirmation that a distribution requirement equal to the greater of 85% of the organization's adjusted net income or 3.5% of the net fair market value of the organization's nonexempt use assets is appropriate;
- Confirmation that the calculation of adjusted net income applies to all organizations without carving out an exclusion for supporting organizations; and
- Confirmation in the regulation's preamble of the government's position that the same valuation principles that apply to private foundations should apply to nonfunctionally integrated Type III supporting organizations.
Role of "Control" Definition
Under the statute, Type III supporting organizations may not accept a contribution from a person who, alone or with certain related persons, directly or indirectly controls the governing body of the supported organization, or from persons related to a person possessing that control (Sec. 509(f)(2)). The 2016 proposed regulations would define "control" over the governing body of the supported organization (Prop. Regs. Sec. 1.509(a)-4(f)(5)(ii)). The regulations would provide that control exists when a person—alone or by aggregating the person's votes or positions of authority with other family members or 35% controlled entities—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 acts.
Some exempt organization structures have been established that have a supporting organization to receive a donor's contributions where the donor also has some involvement with a supported public charity. For example, assume significant donor X wanted to establish and fund a new museum, rather than contribute to an existing museum that qualifies as a public charity on the basis that it is publicly supported. If donor X provides most of the funding for a new museum organization, it might not qualify as a publicly supported organization and hence would be classified as a private foundation. However, if donor X could establish a qualified Sec. 509(a)(3) supporting organization (supporting the museum), then the donor's contributions to the new supporting organization would be treated as made to a public charity rather than to a private foundation.
Absent a regulatory definition of control, a position existed that the supporting organization could accept gifts from donor X and still qualify as a public charity under Sec. 509(a)(3) if it was not clear that donor X was a person who directly or indirectly controlled the governing body of the supported museum. If the new regulations are finalized as proposed, providing a more definite meaning of control, this structure no longer would be viable for a donor seeking to avoid private foundation status for the supporting organization if control over the supported organization's governing body were deemed to exist in the donor or related persons.
For many Sec. 501(c)(3) public charities, supporting organization structures were established before the PPA was enacted and before the proposed and final regulations were issued. Supporting organizations may need to review the current requirements for qualifying under Sec. 509(a)(3) to be sure they comply. Also, Form 990, Return of Organization Exempt From Income Tax, Schedule A, Public Charity Status and Public Support, was changed in 2014 and now includes questions regarding whether a supporting organization continues to qualify as a public charity by satisfying all the supporting organization tests.
The 2015 final regulations provide guidance on how Type III nonfunctionally integrated supporting organizations must meet the payout requirement, which is now reportable annually on Form 990, Schedule A, Part V, Type III Non-Functionally Integrated 509(a)(3) Supporting Organizations, Section C, Distributable Amount. The Form 990, Schedule A, instructions describe a potential reasonable-cause exception for failing to meet this requirement. Supporting organizations should maintain continued diligence around monitoring their payout process to make sure they carry it out in conformity with the regulations.
Annette Smith is a partner with PricewaterhouseCoopers LLP, Washington National Tax Services, in Washington.
For additional information about these items, contact Ms. Smith at 202-414-1048 or firstname.lastname@example.org.
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