Exempt Organizations Advisory - IRS Releases Advance Notice of Proposed Rules Regarding Type III Supporting Organizations

By: Catherine W. Wilkinson (cwilkinson@steptoe.com)
Suzanne Ross McDowell (smcdowell@steptoe.com)

IRS RELEASES ADVANCE NOTICE OF PROPOSED RULES REGARDING TYPE III SUPPORTING ORGANIZATIONS:  
Today the IRS released an advance notice of proposed rulemaking concerning: (1) the payout requirement for Type III supporting organizations that are not functionally integrated; (2) the criteria for determining whether a Type III supporting organization is functionally integrated; (3) the modified requirements for Type III supporting organizations that are organized as trusts; and (4) the requirements regarding the type of information a Type III supporting organization must provide to its supported organization(s) to demonstrate that it is responsive to its supported organization(s).  

The Pension Protection Act of 2006 amended the law with respect to Type III supporting organizations, prompting a need to revise the rules regarding Type III supporting organizations.  The new requirements would apply to Type III supporting organizations as defined under code sections 509(a)(3)(B)(iii) and 4943(f)(5).

• In establishing a payout requirement for non-functionally integrated Type III supporting organizations, Treasury and IRS expect to follow the framework of the existing section 4942 qualifying distribution regulations applicable to private non-operating foundations.  Treasury and IRS expect that the proposed regulations will: (1)  require a non-functionally integrated Type III supporting organization to distribute annually to or for the use of its supported organizations an amount equal to at least five percent of the aggregate fair market value of all its assets (other than assets that are used, or held for use, directly in supporting the charitable programs of its supported organizations); and  (2) provide that non-functionally integrated Type III supporting organizations will be limited to supporting no more than five publicly supported organizations.
• Treasury and IRS anticipate that the proposed rules will define the term “functionally integrated Type III supporting organization” as a Type III supporting organization that meets: (1)  the “but for” test in existing Reg. §  1.509(a)-4(i)(3)(ii); (2) an expenditure test consistent with section 4942(j)(3)(A) that requires a functionally integrated Type III supporting organization to use substantially all of the lesser of (a) its adjusted net income or (b) five percent of the aggregate fair market value of all its assets (other than assets that are used, or held for use, directly in supporting the charitable programs of the supported organizations) directly for the active conduct of activities that directly further the exempt purpose of the organizations it supports; and (3) an assets test consistent with section 4942(j)(3)(B)(i) that requires the organization to devote at least 65 percent of the aggregate fair market value of all its assets directly for the active conduct of activities that directly further the exempt purposes of the organizations it supports.  
• Treasury and IRS expect that the proposed regulations will provide that charitable trusts must satisfy the responsiveness test under Reg. § 1.509(a)-4(i)(2)(ii).  
• Treasury and IRS do not expect to modify the responsiveness test.  Treasury and IRS anticipate that all Type III supporting organizations will be expected to meet the responsiveness test under Reg. § 1.509(a)-4(i)(2)(ii).  The proposed regulations will provide rules for the form, content, and timing of the information Type III supporting organizations are required to provide their supported organization(s) under section 509(f)(1)(A).  
• The proposed regulations will clarify that an organization that would otherwise be classified as a Type III supporting organization, but either does not establish that it is functionally integrated or does not satisfy the payout requirement for non-functionally integrated organizations in a taxable year, will be classified as a private foundation for such taxable year and all subsequent taxable years until it terminates its private foundation status under section 507.  
  

Treasury and IRS anticipate that the new rules for Type III supporting organizations would apply to taxable years with respect to each organization beginning after the date the rules are published in the Federal Register as final or temporary regulations.