Effective December 28, 2012, the Internal Revenue Service (IRS)
issued final and temporary regulations regarding "Type III
supporting organizations" under Internal Revenue Code
§509(a)(3)(B)(iii). "Supporting organizations" are
entities that are not themselves publicly supported but rather have
public charity status by virtue of supporting a public charity.
Supporting organizations are further classified into
"Types" (I, II or III) depending on the relationship
between the supporting organization and its supported public
charity. The Pension Protection Act of 2006 added provisions to the
Internal Revenue Code intended to more tightly regulate supporting
organizations because of actual and perceived abuses in the
operation of Type III supporting organizations, those that have the
loosest connection with their publicly supported charities (are
operated "in connection with" a supported public
charity).
In order to qualify as a supporting organization, an entity must
meet an organizational test, an operational test, a disqualified
person control test and a relationship test. The newly issued
regulations focus mainly on the relationship test and clarify that
Type III supporting organizations must meet (i) a notification
requirement -- requiring it to annually provide particular
documents to its supported public charity; and (ii) a
responsiveness test -- requiring the supported public charity to
have a significant voice in its operations. Type III supporting
organizations are further classified into those that are
functionally integrated (FI) and those that are non-functionally
integrated (NFI) with their supported public charity.
To further determine whether a Type III supporting organization is
FI or NFI, the entity must meet an integral part test, which is
satisfied if substantially all of the entity's activities are
"direct furtherance activities" (i.e., those that
directly further the exempt purposes of the supported public
charity and would be undertaken by it if not for the entity).
Merely controlling the assets of a supported public charity, such
as managing its endowment fund or fundraising, is not a direct
furtherance activity (unless the entity is the parent of its
supported public charity). Rather, running specific charitable
programs on behalf of the supported public charity is a direct
furtherance activity.
A Type III supporting organization that does not meet the integral
part test is classified as NFI. NFI Type III supporting
organizations are subject to a mandatory payout requirement (not
unlike that required for private foundations), and they must
annually distribute the greater of 85 percent of adjusted net
income from the prior tax year or 3.5 percent of the fair market
value of nonexempt-use assets. At least one-third of this
distribution must be to one or more supported public charities that
are "attentive" to the supporting organization, defined
with respect to the amount of support received by them from the
supporting organization.
The new regulations are complex, and the above is only a broad
overview of some of the changes imposed. If you have any questions
about how these regulations affect your organization, you should
contact your tax advisor.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.