Thursday, September 24, 2009

IRS Issues Proposed Type III Supporting Organization Regulations

The IRS has issued long-awaited proposed regulations relating to "Type III" supporting organizations.  Earlier this decade Congress became concerned that certain charitable organizations were improperly avoiding private foundation status, and the relatively tight federal tax rules that come with that status, by taking undue advantage of the existing supporting organization rules.  Supporting organizations avoid private foundation status based on having a close relationship with a public charity such as a school, hospital, church, or a charity that receives a significant amount of support from the public.  In theory, this close relationship is supposed to eliminate the need for the tight rules that apply to private foundations.  Congress concluded, however, that in practice at least some supporting organizations were asserting they had this close relationship without that relationship providing sufficient oversight over the activities of the supporting organizations.  Congress was particularly concerned with so-called Type III supporting organizations, because while Type I and Type II supporting organizations demonstrate this close relationship by virtue of having substantial or complete governing body overlaps with the related public charity or by giving the public charity appointment authority with respect to that governing body, Type III supporting organizations faced a much more flexible, but also potentially subject to abuse, relationship test.  The IRS issued the new proposed regulations as its interpretation of Congress statutory reaction to this concern, embodied in sections of the Pension Protection Act of 2006.

Consistent with Congress' statutory mandate, in the proposed regulations the IRS divides Type III supporting organizations into less-regulated "functionally integrated" Type III SOs and more-regulated non-functionally integrated Type III SOs.  To be functionally integrated, the SO must either:

    *  engage in activities substantially all of which directly further the exempt purposes of the supported organization(s), by performing the functions of, or carrying out the purposes of, such supported organizations(s) and that, but for the involvement of the supporting organization, would normally be engaged in by the supported organization(s) OR

    *  be the parent of each of its supported organizations.

The latter category appears to be designed to accommodate the common structure for health care systems, where a parent supported organization provides management and coordination support to two or more hospitals or other care entities in the system.  What this requirement does not accommodate are charitable trusts that under their governing documents are dedicated to supporting particular charities but do not meet either this requirement nor the requirements for Type I or Type II status, and may be subject to legally binding terms that are not consistent with the tighter, private foundation rules that apply to non-functionally integrated Type III SO.  Before the Pension Protection Act, the SO regulations provided an accommodation for these types of trusts.

Comments regarding the proposed regs are due by December 23, 2009.


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