Source: https://www.federalregister.gov/documents/2009/09/24/E9-22866/payout-requirements-for-type-iii-supporting-organizations-that-are-not-functionally-integrated
Timestamp: 2019-08-18 02:37:12
Document Index: 568610827

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A Proposed Rule by the Internal Revenue Service on 09/24/2009
Written or electronic comments and requests for a public hearing must be received by December 23, 2009.
74 FR 48672
48672-48687 (16 pages)
E9-22866
Integral Part Test—Functionally Integrated Type III Supporting Organizations
Integral Part Test—Non-Functionally Integrated Type III Supporting Organizations
https://www.federalregister.gov/d/E9-22866 https://www.federalregister.gov/d/E9-22866
This document contains proposed regulations regarding the requirements to qualify as a Type III supporting organization that is operated in connection with one or more supported organizations. The regulations reflect changes to the law made by the Pension Protection Act of 2006. The regulations will affect Type III supporting organizations and their supported organizations.
Send submissions to: CC:PA:LPD:PR (REG-155929-06), room 5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand-delivered Monday through Start Printed Page 48673Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-155929-06), Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue, NW., Washington, DC, or sent electronically via the Federal eRulemaking Portal at http://www.regulations.gov/​ (IRS REG-155929-06).
Concerning the proposed regulations, Philip T. Hackney or Don R. Spellmann at (202) 622-6070; concerning submissions of comments and requests for a public hearing, Richard A. Hurst at (202) 622-7180 (not toll-free numbers) or Richard.A.Hurst@irscounsel.treas.gov.
The collection of information contained in this notice of proposed rulemaking has been submitted to the Office of Management and Budget for review in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 3507(d)). Comments on the collection of information should be sent to the Office of Management and Budget, Attn: Desk Officer for the Department of the Treasury, Office of Information and Regulatory Affairs, Washington, DC 20503, with copies to the Internal Revenue Service, Attn: IRS Reports Clearance Officer, SE:W:CAR:MP:T:T:SP, Washington, DC 20224. Comments on the collection of information should be received by November 23, 2009. Comments are specifically requested concerning:
The collection of information in this proposed regulation is in Prop. Reg. § 1.509(a)-4(i)(2). The collection of information flows from section 509(f)(1)(A), which requires a Type III supporting organization to provide to each of its supported organizations such information as the Secretary may require to ensure that the Type III supporting organization is responsive to the needs or demands of its supported organization(s). The likely recordkeepers are Type III supporting organizations.
Treas. Reg. § 1.509(a)-4(f)(2) provides that a supporting organization must maintain one of three types of structural or operational relationships with its supported organization(s). A supporting organization that is operated, supervised or controlled by one or more supported organizations is commonly known as a Type I supporting organization. The relationship of a Type I supporting organization with its supported organization(s) is comparable to that of a corporate parent-subsidiary relationship. A supporting organization that is supervised or controlled in connection with one or more supported organizations is commonly known as a Type II supporting organization. The relationship of a Type II supporting organization with its supported organization(s) is comparable to a corporate brother-sister relationship. A supporting organization that is operated in connection with one or more supported organizations is commonly known as a Type III supporting organization. This NPRM focuses primarily on Type III supporting organizations.
Prior to the enactment of the PPA, the regulations under section 509(a)(3) generally provided that an organization is “operated in connection with” one or more supported organizations if it meets a “responsiveness test” and an “integral part test.”
Treas. Reg. § 1.509(a)-4(i)(2)(i) provides that an organization meets the responsiveness test if the organization is responsive to the needs or demands of its supported organizations. Treas. Reg. § 1.509(a)-4(i)(2)(ii) provides three ways that a supporting organization may demonstrate responsiveness to a supported organization: (1) The supported organization appoints or elects one or more of the officers, directors, or trustees of the supporting organization; (2) one or more members of the governing body of the supported organization serve as officers, directors, or trustees of, or hold other important offices in, the supporting organization; or (3) the officers, directors, or trustees of the supporting organization maintain Start Printed Page 48674a close continuous working relationship with the officers, directors, or trustees of the supported organization. In all three cases, the relationship must result in the supported organization having a significant voice in the investment policies of the supporting organization, the timing and the manner of making grants, the selection of the grant recipients of the supporting organization, and direction over the use of the income or assets of the supporting organization.
The existing regulations also provide an alternative means for charitable trusts to satisfy the responsiveness test. Under Treas. Reg. § 1.509(a)-4(i)(2)(iii), a supporting organization is responsive if: (1) it is a charitable trust under State law, (2) each specified supported organization is a named beneficiary under the charitable trust's governing instrument, and (3) each beneficiary organization has the power to enforce the trust and compel an accounting under State law.
In the case of an organization that was supporting one or more supported organizations before November 20, 1970, Treas. Reg. § 1.509(a)-4(i)(1)(ii) provides that additional facts and circumstances, such as a historic and continuing relationship between the supporting organization and its supported organization(s), also may be taken into account to establish compliance with the responsiveness test.
Treas. Reg. § 1.509(a)-4(i)(3)(i) provides that a supporting organization meets the integral part test by maintaining a significant involvement in the operations of one or more supported organizations that are dependent upon the supporting organization for the type of support which it provides. Under the existing regulations, there are two alternative ways to meet the integral part test: (1) The “but for” test under Treas. Reg. § 1.509(a)-4(i)(3)(ii); or (2) the “attentiveness” test under Treas. Reg. § 1.509(a)-4(i)(3)(iii).
Treas. Reg. § 1.509(a)-4(i)(3)(ii) states that the “but for” test is satisfied if “the activities engaged in [by the supporting organization] for or on behalf of the supported organizations are activities to perform the functions of, or to carry out the purposes of, such organizations, and, but for the involvement of the supporting organization, would normally be engaged in by the supported organizations themselves.”
The “attentiveness” test under Treas. Reg. § 1.509(a)-4(i)(3)(iii) requires a supporting organization to: (1) Make payments of substantially all of its income to or for the use of one or more supported organizations, (2) provide enough support to one or more supported organizations to ensure the attentiveness of such organization(s) to the operations of the supporting organization; and (3) pay a substantial amount of the total support of the supporting organization to those supported organizations that meet the attentiveness requirement. Rev. Rul. 76-208, 1976-1 CB 161 (see § 601.601(d)(2)(ii)(b)), provides that the phrase “substantially all of its income” in Treas. Reg. § 1.509(a)-4(i)(3)(iii) means at least 85 percent of adjusted net income.
(2) It required the Secretary of the Treasury to set a new payout requirement for organizations that are not functionally integrated (generally, those organizations that met the integral part test by satisfying the attentiveness test under the existing regulations) to ensure that such organizations pay a “significant amount” to their supported organizations;
On December 18, 2006, the Treasury Department and the IRS released Notice 2006-109 (2006-51 IRB 1121) (see § 601.601(d)(2)(ii)(b)), which alerted taxpayers to the new supporting organization rules enacted by the PPA; provided interim guidance, including reliance standards for private foundations making grants to supporting organizations; and solicited comments regarding the new supporting organization requirements. Fifteen comments and numerous phone calls were received in response to the request for comments contained in Notice 2006-109.
On August 2, 2007, the Treasury Department and the IRS issued an ANPRM titled “Payout Requirements for Type III Supporting Organizations that Are Not Functionally Integrated” (Reg-155929-06, 72 FR 148). The ANPRM described proposed rules to implement the PPA changes to the Type III supporting organization requirements, and solicited comments regarding those proposed rules.
In the ANPRM, the Treasury Department and the IRS proposed that all Type III supporting organizations would be required to meet the responsiveness test under Treas. Reg. § 1.509(a)-4(i)(2)(ii). In addition, the Treasury Department and the IRS proposed that Type III supporting organizations that are functionally integrated would be required to meet: (A) The “but for” test in existing Treas. Reg. § 1.509(a)-4(i)(3)(ii); (B) an expenditure test resembling the section 4942(j)(3)(A) qualifying distributions test for private operating foundations; and (C) an assets test resembling the section 4942(j)(3)(B) alternative assets test for private operating foundations. However, the Treasury Department and the IRS indicated that an exception would be provided for certain Type III supporting organizations that oversee or facilitate the operation of an integrated system, such as certain hospital systems. The ANPRM stated that such organizations would be classified as functionally integrated as long as they satisfied the responsiveness and “but for” tests under the existing regulations.
The IRS received over 40 comments and numerous phone calls in response to the ANPRM. After consideration of all comments received, the Treasury Department and the IRS are issuing this Start Printed Page 48675NPRM regarding the new qualification requirements for Type III supporting organizations. The major areas of comment in response to the ANPRM are discussed in the preamble under Explanation of Provisions.
The proposed regulations provide that every Type III supporting organization must: (1) Satisfy the notification requirement set forth under Prop. Reg. § 1.509(a)-4(i)(2); (2) meet the responsiveness test set forth under Prop. Reg. § 1.509(a)-4(i)(3); and (3) demonstrate that it is an integral part of one or more supported organizations. A Type III supporting organization demonstrates that it is an integral part of a supported organization by satisfying either the requirements for functionally integrated Type III supporting organizations set forth in Prop. Reg. § 1.509(a)-4(i)(4), or the requirements for non-functionally integrated Type III supporting organizations set forth in Prop. Reg. § 1.509(a)-4(i)(5). Further, as set forth in Prop. Reg. § 1.509(a)-4(i)(10), a Type III supporting organization may not support a supported organization that is organized outside of the United States. Finally, as set forth in Prop. Reg. § 1.509(a)-4(f)(5), Type I and Type III supporting organizations are prohibited from accepting a gift or contribution from a person who, together with certain related persons, directly or indirectly controls the governing body of a supported organization of the Type I or Type III supporting organization.
Prop. Reg. § 1.509(a)-4(i)(2) implements section 509(f)(1)(A) of the Code, which provides that a Type III supporting organization must provide to each of its supported organizations such information as the Secretary may require to ensure that the supporting organization is responsive to the needs or demands of the supported organization.
The Treasury Department and the IRS requested comments in the ANPRM on the type of information a Type III supporting organization should be required to provide to its supported organizations. One commentator recommended that the proposed regulations adopt a recommendation of the Panel on the Nonprofit Sector, which suggested requiring Type III supporting organizations to provide annually to their supported organizations: (1) A copy of governing documents, including those filed with Form 1023, “Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code,” and any updates; (2) a copy of Form 990, “Return of Organization Exempt from Income Tax;” and (3) an annual report of activities, including a narrative, financial detail, and a description of the support provided (including how it was calculated or determined) and a projection of support to be provided in the subsequent year. Panel on the Nonprofit Sector, Strengthening Transparency, Governance, Accountability of Charitable Organizations (June 2005), at 45.
Another commentator recommended that the proposed regulations require only that the Form 990 be distributed to the “lead” supported organization. This commentator argued that any additional requirement would impose too much additional administrative burden and cost on the charitable sector. The comment also suggested allowing the notification to be provided electronically.
The proposed regulations provide that all Type III supporting organizations, including those organized as charitable trusts, must meet the responsiveness test under existing Treas. Reg. § 1.509(a)-4(i)(2)(ii).
One commentator recommended exempting trusts managed by institutional trustees from the responsiveness test. The commentator stated that institutional trustees employ strict rules to manage trusts, thereby making abuse of these trusts highly unlikely. Another commentator recommended transition relief for trusts in existence on the date the PPA was enacted similar to that provided in Treas. Reg. § 1.509(a)-4(i)(4) for trusts established before November 20, 1970, which would apply to a trust with a lengthy and continuous history of distributions, and no discretion to vary the beneficiaries or the amount of distributions.
The proposed regulations provide that a Type III supporting organization is functionally integrated if it either: (1) Start Printed Page 48676Engages 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 that, 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 ANPRM proposed requiring an organization to meet not only the “but for” test under existing Treas. Reg. § 1.509(a)-4(i)(3)(ii), but also two additional tests—an expenditure test and an assets test—in order to qualify as a functionally integrated Type III supporting organization. In general, commentators said that the additional tests were unduly restrictive and more burdensome than those proposed for non-functionally integrated Type III supporting organizations. These commentators argued that the ANPRM's expenditure test was arbitrary and that Congress did not authorize the Secretary to impose a payout requirement on functionally integrated organizations. Many commentators highlighted differences between a Type III supporting organization and a private operating foundation that warrant treating these types of organizations differently, including the fact that a supporting organization is dedicated to specific organizations and that those specified organizations rely on the supporting organization for consistent support.
Many commentators recommended exempting certain types of organizations from the proposed requirements for functionally integrated Type III supporting organizations, such as long-standing supporting organizations and supporting organizations that support governmental agencies, religious organizations, and grant-making organizations. Several commentators recommended that the proposed regulations take into account the historic and continuing relationship of “long-standing” organizations with their supported organizations. Additionally, many commentators requested an exemption for supporting organizations of governmental entities, contending that these organizations are not subject to abuse because of their connection to a governmental entity. These commentators argued that supporting organizations choose a Type III structure to ensure that funds are dedicated long-term to a specific purpose, and removed from the appropriation process of the government.
In formulating the criteria in the proposed regulations, the Treasury Department and the IRS also noted the suggestion in the Joint Committee on Taxation's Technical Explanation of the PPA that “substantially all of the activities of [a functionally integrated Type III supporting organization] should be activities in direct furtherance of the functions or purposes of supported organizations.” Staff of the Joint Committee on Taxation, Technical Explanation of H.R. 4, The “Pension Protection Act of 2006” (Aug. 3, 2006), at 360 n.571 (Technical Explanation). In the Technical Explanation, the Joint Committee on Taxation also expressed concern that “the current regulatory standards for satisfying the integral part test not by reason of a payout are not sufficiently stringent to ensure that there is a sufficient nexus between the supporting and supported organizations.” Technical Explanation at 360 n.571.
The Treasury Department and the IRS believe that a sufficient nexus exists between a supporting organization and its supported organization(s) where the supporting organization engages in activities that directly further the exempt purposes of the supported organization(s) and that would otherwise be conducted by the supported organization itself. Accordingly, the proposed regulations provide that a Type III supporting organization is functionally integrated if it either: (1) Engages in activities (a) 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 (b) that, 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 Treasury Department and the IRS request comments on how guidance might clarify the application of the “substantially all” test in this context. The proposed regulations do not adopt the expenditure test and the assets test described in the ANPRM.
The Treasury Department and the IRS recognize the unique circumstances of a governmental entity whose assets are subject to the appropriations process of a Federal, State, local or Indian Tribal government and that therefore organizes a Type III supporting organization to remove assets from the appropriations process of the government. The proposed regulations therefore provide an exception under which a supporting organization that supports a single governmental entity may treat investing and managing non-exempt-use assets as activities that directly further an exempt purpose, so long as a substantial part of the supporting organization's total activities directly furthers the exempt purposes of such governmental entity.
The proposed regulations specifically require that a functionally integrated Type III supporting organization's activities directly further the exempt purposes of those supported organizations with respect to which the supporting organization meets the responsiveness test under Prop. Reg. § 1.509(a)-4(i)(3). The Treasury Department and the IRS request comments on this requirement.
The proposed regulations provide examples that illustrate the Start Printed Page 48677requirements for functionally integrated Type III supporting organizations.
To satisfy the distribution requirement of Prop. Reg. § 1.509(a)-4(i)(5)(ii), a Type III supporting organization that is not functionally integrated must distribute, with respect to each taxable year, to or for the use of its supported organizations, amounts equaling or exceeding five percent of the aggregate fair market value of its non-exempt-use assets (the annual distributable amount), on or before the last day of such taxable year. The annual distributable amount is determined based on asset values measured over the preceding taxable year. Thus, for example, a Type III supporting organization that is not functionally integrated would determine its annual distributable amount for its 2012 taxable year, which must be distributed on or before the last day of the organization's 2012 taxable year, based on asset values measured over its 2011 taxable year. A Type III supporting organization that is not functionally integrated is not required to distribute any amount in its first year of existence.
The proposed regulations also provide a slightly different rule regarding the carryover of excess distributions than is applicable to private foundations. Under section 4942(i), a private foundation that distributes more than its distributable amount may carry forward that excess amount for five years. However, when calculating qualifying distributions in a future year under section 4942, amounts paid out in the future year count first towards the required distributable amount, and any amount carried forward is not “used” in the future year to the extent that the organization made qualifying distributions in that future year. These proposed regulations reverse the ordering rule and first count any excess amount carried forward toward the non-functionally integrated Type III supporting organization's annual distributable amount, followed by amounts paid out in the later year.Start Printed Page 48678
The proposed regulations provide a reasonable cause exception for failure to meet the distribution requirement applicable to non-functionally integrated Type III supporting organizations. Under the exception, an organization that fails to meet the distribution requirement will not be classified as a private foundation in the taxable year for which it fails to meet such distribution requirement, if the organization establishes to the satisfaction of the Secretary that: (1) The failure was due solely to an incorrect valuation of assets, a ministerial error, or unforeseen events or circumstances that are beyond the organization's control; (2) the failure was due to reasonable cause and not to willful neglect; and (3) the distribution requirement is met within 180 days after the date the incorrect valuation or ministerial error was or should have been discovered, or 180 days after the organization is first able to make its required payout notwithstanding the unforeseen event or circumstances. The reasonable cause exception applies only to the distribution requirement of Prop. Reg. § 1.509(a)-4(i)(5)(ii), and not to the attentiveness requirement of Prop. Reg. § 1.509(a)-4(i)(5)(iii). The Treasury Department and the IRS request comments regarding the reasonable cause exception for the distribution requirement.
The proposed regulations also provide for an emergency temporary reduction in the annual distributable amount. Under Prop. Reg. § 1.509(a)-4(i)(5)(ii)(D), the Secretary may provide by publication in the Internal Revenue Bulletin for a temporary reduction in the annual distributable amount in the case of a disaster or emergency.
These proposed regulations modify the attentiveness requirement in existing Treas. Reg. § 1.509(a)-4(i)(3)(iii) to provide that an organization must distribute one-third or more of its annual distributable amount to one or more supported organizations that are attentive to the supporting organization and with respect to which the supporting organization meets the responsiveness test under Prop. Reg. § 1.509(a)-4(i)(3).
The proposed regulations provide a transition rule for Type III supporting organizations in existence on the date these regulations are published in the Federal Register as final or temporary regulations. Under the transition rule, such organizations that met and continue to meet the requirements of existing Treas. Reg. § 1.509(a)-4(i)(3)(ii) (i.e., an organization that meets the integral part test by satisfying the “but for” test) will be treated as meeting the requirements of a functionally integrated Type III supporting organization set forth in Prop. Reg. § 1.509(a)-4(i)(4) until the first day of the organization's first taxable year beginning after the date these proposed regulations are published as final or temporary regulations.
The proposed regulations also provide that Type III supporting organizations in existence on the date these regulations are published in the Federal Register as final or temporary regulations that met and continue to meet the requirements of existing Treas. Reg. § 1.509(a)-4(i)(3)(iii) will be treated as meeting the requirements of a non-functionally integrated Type III supporting organization set forth in Prop. Reg. § 1.509(a)-4(i)(5) until the first day of the organization's second taxable year beginning after the date these proposed regulations are published as final or temporary regulations. Such organizations will be required to value their assets in accordance with Prop. Reg. § 1.509(a)-4(i)(8) in the first taxable year beginning after final or temporary regulations are published, and to meet all of the requirements of Prop. Reg. § 1.509(a)-4(i)(5)(i) in the second taxable year beginning after the publication of these regulations as final or temporary regulations and for all succeeding taxable years.
For example, if the Treasury Department and the IRS publish these regulations as final or temporary regulations any time in 2010, a calendar-year non-functionally integrated Type III supporting organization must: (1) in 2010, meet all of the requirements of existing Treas. Reg. § 1.509(a)-4(i)(3)(iii) (i.e., distribute to its supported organizations substantially all of its income in accord with the existing regulations); (2) in 2011, meet all of the requirements of current Treas. Reg. § 1.509(a)-4(i)(3)(iii) and value its assets according to Prop. Reg. § 1.509(a)-4(i)(8); and (3) in 2012, meet all of the requirements of Prop. Reg. § 1.509(a)-4(i)(5)(i), including the distribution requirement.
The proposed regulations also retain the exception from the integral part test for pre-November 20, 1970 trusts that meet certain other requirements found in current Treas. Reg. § 1.509(a)-4(i)(4).
The proposed regulations eliminate current Treas. Reg. § 1.509(a)-4(i)(1)(iii), which provides an exception from the integral part test if an organization can establish that: (1) It met the payout requirement under current Treas. Reg. § 1.509(a)-4(i)(3)(iii)(a) for any five-year period; (2) it cannot meet such payout requirement for its current taxable year solely because the amount received by Start Printed Page 48679one or more of the supported organizations is no longer sufficient to satisfy the attentiveness requirement; and (3) there has been a historic and continuing relationship of support between such organizations between the end of the five-year period and the taxable year in question. The Treasury Department and the IRS believe that the breadth of this exception is inconsistent with Congress' intent in mandating a payout requirement in the PPA.
This NPRM also includes proposed regulations under section 4943 that provide two transition rules to address excess business holdings for Type III supporting organizations affected by the PPA. The PPA applied the section 4943 excess business holdings excise tax to non-functionally integrated Type III supporting organizations. However, it provided that in calculating the “present holdings” of Type III supporting organizations in existence on August 17, 2006 (the date of enactment of the PPA), the transition rules that applied to private foundations in 1969, when section 4943 was first enacted, would apply. These transition rules effectively allow affected organizations additional time to dispose of certain business holdings.
In addition, the Treasury Department and the IRS believe that pre-November 20, 1970 trusts that are exempted from the integral part test under current regulations and these proposed regulations should not be subject to the excess business holdings excise tax that applies to non-functionally integrated Type III supporting organizations. Therefore, the proposed regulations under section 4943 provide that a Type III supporting organization created as a trust before November 20, 1970, that meets the requirements of current Treas. Reg. § 1.509(a)-4(i)(4) and Prop. Reg. § 1.509(a)-4(i)(9), will be treated as a “functionally integrated Type III supporting organization” for purposes of section 4943(f)(3)(A).
In addition, the IRS stated in a September 24, 2007 memorandum from the Director of Exempt Organizations Rulings and Agreements that it would issue functionally integrated Type III supporting organization determinations to organizations that meet the requirements for functionally integrated organizations set forth in the ANPRM. As of the date of the publication in the Federal Register of this notice of proposed rulemaking, the IRS will issue a functionally integrated Type III supporting organization determination only to organizations that meet the requirements of Prop. Reg. § 1.509(a)-4(i)(4). An organization that received a determination that it qualified as a functionally integrated Type III supporting organization under the ANPRM can continue to rely on such determination letter until final or temporary regulations are published in the Federal Register, so long as the organization continues to meet the requirements of either the ANPRM or Prop. Reg. § 1.509(a)-4(i)(4). An organization that receives a determination that it is a functionally integrated Type III supporting organization under either the ANPRM or these proposed regulations will be required to meet the requirements established in final or temporary regulations as of the first taxable year beginning after final or temporary regulations are published in the Federal Register.
It has been determined that this notice of proposed rulemaking is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It is hereby certified that this regulation will not have a significant economic impact on a substantial number of small entities. This certification is based on the fact that this regulation will not impact a substantial number of small entities. Based on IRS Statistics of Income data for 2005, there are over 1.4 million organizations that qualify as exempt from Federal income tax under section 501(c)(3). Approximately 13,000 of the 1.4 million exempt organizations reported as supporting organizations; approximately 4,200 supporting organizations reported as Type III supporting organizations; and it is expected that some fraction of the 4,200 Type III supporting organizations may be classified as non-functionally integrated Type III supporting organizations. Thus, the number of organizations affected by this regulation will not be substantial. The collection of information in this regulation that is subject to the Regulatory Flexibility Act will impose a minimal burden upon the affected organizations. All of the information required to be delivered is information that the organization is already required to maintain. Further, the distribution requirement in Prop. Reg. § 1.509(a)-4(i)(5)(ii) for non-functionally integrated Type III supporting organizations does not have a significant economic impact. A non-functionally integrated Type III supporting organization that fails to satisfy the distribution requirement of Prop. Reg. § 1.509(a)-4(i)(5)(ii) would be reclassified as a private non-operating foundation and as such, would be required under section 4942 to distribute amounts equal to five percent of the aggregate fair market value of non-exempt-use assets. In addition, as a private non-operating foundation, the organization would be subject to additional regulatory requirements and excise taxes that do not apply to non-functionally integrated Type III supporting organizations. Accordingly, Start Printed Page 48680a Regulatory Flexibility Analysis under the Regulatory Flexibility Act (5 U.S.C. chapter 6) is not required. Pursuant to section 7805(f) of the Code, this regulation has been submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.
1. The term “publicly supported organization” is removed and the term “supported organization” is added in its place wherever it appears.
(5) For purposes of this section, the term “supporting organization” means either an organization described in section 509(a)(3) or an organization seeking section 509(a)(3) status, depending upon its context.
(6) For purposes of this section, the term “supported organization” means an organization described in section 509(a)(1) or (2)—
(5) Organizations controlled by donors. An organization shall not be considered to be operated, supervised, or controlled by, or operated in connection with, one or more supported organizations, if such organization accepts any gift or contribution from any person (other than an organization described in section 509(a)(1), (2) or (4)) who—
(iii) Is a 35-percent controlled entity (as defined in section 4958(f)(3) by substituting “persons described in paragraph (f)(5)(i) or (ii) of this section” for “persons described in subparagraph (A) or (B) of paragraph (1)” in paragraph (A)(i) thereof).
(i) Meaning of “operated in connection with”—(1) General Rule. Except as otherwise provided in paragraphs (f)(5) and (i)(10) of this section, a supporting organization is operated in connection with one or more supported organizations only if it satisfies—
(2) Notification requirement. Each taxable year, the supporting organization must provide to each of its supported organizations—
(ii) A copy of the supporting organization's most recently filed Form 990, “Return of Organization Exempt from Income Tax,” or other return required to be filed under section 6033; and
(B) One or more members of the governing bodies of the supported Start Printed Page 48681organization are also officers, directors, or trustees of, or hold other important offices in, the supporting organization; or
X, an organization described in section 501(c)(3), is a trust created under the last will and testament of Decedent. The trustee of X is a bank (Trustee). Under the trust instrument, X supports M, a private university described in section 509(a)(1). The trust instrument provides that Trustee has discretion regarding the timing and amount of distributions consistent with the Trustee's fiduciary duties. Representatives of Trustee and an officer of M have quarterly face to face meetings, at which they discuss M's projected needs for the university and ways in which M would like X to use its income and invest its assets. Additionally, Trustee communicates regularly with the officer of M regarding X's investments and plans for distributions from X. Trustee provides the officer of M with quarterly investment statements, the information required under paragraph (i)(2) of this section, and an annual accounting statement. Based on these facts, X meets the responsiveness test of this paragraph (i)(3).
Y is an organization described in section 501(c)(3) and is organized as a trust under State law. The trustee of Y is a bank, Trustee. Y supports charities P, Q and R, each an organization described in section 509(a)(1). Y makes annual cash payments to P, Q and R. Once a year, Trustee sends to P, Q, and R the cash payment, the information required under paragraph (i)(2) of this section, and an accounting statement. Trustee has no other communication with P, Q or R. Y does not meet the responsiveness test of this paragraph (i)(3).
(4) Integral part test—functionally integrated Type III supporting organization—(i) General rule. A supporting organization meets the integral part test as a functionally integrated Type III supporting organization if it satisfies either paragraph (i)(4)(i)(A) or paragraph (i)(4)(i)(B) of this section.
(ii) “Directly further.” Holding title to exempt-use property and managing exempt-use property are activities that directly further the exempt purposes of the supported organization within the meaning of paragraph (i)(4)(i)(A) of this section. Except as provided in paragraph (i)(4)(iii) of this section, fundraising, investing and managing non-exempt-use property, and making grants (whether to the supported organization or to third parties) are not activities that directly further the exempt purposes of the supported organization within the meaning of paragraph (i)(4)(i)(A) of this section.
(C) A substantial part of the supporting organization's total activities directly furthers the exempt purpose(s) of its supported organization and are activities other than fundraising, grantmaking, and investing and managing non-exempt-use assets.
N, an organization described in section 501(c)(3), is the parent organization of a healthcare system consisting of two hospitals (Q and R) and an outpatient clinic (S), each of which is described in section 509(a)(1), and a taxable subsidiary (T). N is the sole member of each of Q, R, and S. Under the charter and bylaws of each of Q, R, and S, N appoints all members of the board of directors of each corporation. N engages in the overall coordination and supervision of the healthcare system's exempt subsidiary corporations Q, R, and S in approval of their budgets, strategic planning, marketing, resource allocation, securing tax-exempt bond financing, and community education. N also manages and invests assets that serve as endowments of Q, R and S. Based on these facts, N qualifies as a functionally integrated Type III supporting organization under paragraph (4)(i)(B) of this section.
V, an organization described in section 501(c)(3), is organized as a supporting organization to L, a church described in section 509(a)(1). L transferred to V title to the buildings in which L conducts religious services, Bible study and community enrichment programs. Substantially all of V's activities consist of holding and managing these buildings. But for the activities of V, L would normally engage in these same activities. Based on these facts, V satisfies the activities and but for requirements of paragraph (4)(i)(A) of this section and therefore qualifies as a functionally integrated Type III supporting organization.
O is a nonprofit publishing organization described in section 501(c)(3). It does all of the publishing and printing for the eight churches of a particular denomination located in a particular geographic region, each of which is described in section 509(a)(1). Control of O is vested in a five-man Board of Directors, which includes an official from one of the churches and four lay members of the congregations of that denomination. The officers of O maintain a close and continuing working relationship with each of the eight churches for whom it publishes and prints materials and as a result of such relationship, each of the eight Start Printed Page 48682churches has a significant voice in the operations of O. O does no other printing or publishing. O publishes all of the churches' religious as well as secular tracts and materials. All of O's activities directly further the exempt purposes of supported organizations to which it is responsive. Additionally, but for the activities of O, the churches would normally publish these materials themselves. Based on these facts, O qualifies as a functionally integrated Type III supporting organization under paragraph (4)(i)(A) of this section.
M, an organization described in section 501(c)(3), was created by B, an individual, to provide scholarships for students of a private secondary school, U, an organization described in section 509(a)(1). U establishes the scholarship criteria, publicizes the scholarship program, solicits and reviews applications, and selects the scholarship recipients. M invests its assets and disburses the funds for scholarships to the recipients selected by U. Based on these facts, M is not a functionally integrated Type III supporting organization.
J, an organization described in section 501(c)(3), is a supporting organization to community foundation G, an organization described in section 509(a)(1). In addition to maintaining field-of-interest funds, sponsoring donor advised funds, and general grant-making activities, G also engages in activities to beautify and maintain local parks. J's activities consist of maintaining all of the local parks in the area of community foundation G by activities such as establishing and maintaining trails, planting trees and removing trash. But for the activities of J, G would normally engage in these efforts to beautify and maintain the local parks. Based on these facts, J qualifies as a functionally integrated Type III supporting organization under paragraph (4)(i)(A) of this section.
W, an organization described in section 501(c)(3), is organized as a supporting organization to Z, a public university in State D described in section 509(a)(1). Z is the sole named supported organization in W's articles of incorporation. Under the laws of State D, assets under Z's control are subject to the appropriation process for any State D purpose by an action of the State D legislature. Z transfers the intellectual property developed by Z's science department to W for patenting and licensing, including making the property available to the public. The royalties generated by the licenses are shared among Z, the original researcher, and W. W invests and manages its share of the royalties and other income generated by the patenting and licensing of the intellectual property to build an endowment to support Z. W also conducts further research on scientific processes developed at Z and makes the results of this research available to the public. W's research activities make up a substantial part of W's total activities. But for the activities of W, Z would normally conduct the research engaged in by W and manage the royalties from the intellectual property generated at Z. W's activities of investing and managing its share of royalties and other income are not considered activities that directly further the exempt purposes of Z under paragraph (i)(4)(ii) of this section. However, because Z's assets are subject to the appropriation process of State D for purposes unrelated to Z's exempt purposes, Z is W's sole supported organization, and a substantial part of W's activities directly further Z's exempt purposes, W qualifies for the exception in paragraph (i)(4)(iii) of this section. Accordingly, based on these facts, W qualifies as a functionally integrated Type III supporting organization under paragraph (4)(i)(A) of this section.
P, an alumni association described in section 501(c)(3), was formed to promote a spirit of loyalty among graduates of Y University, a public university in State E described in section 509(a)(1), and to effect united action in promoting the general welfare of Y. Y is the sole named supported organization in P's articles of incorporation. Under the laws of State E, Y's assets are subject to the appropriation process for any State E purpose. P manages an endowment created by gifts from the alumni. A special committee of Y's governing board meets with P and makes recommendations as to the allocation of P's program of gifts and scholarships to the university and its students. More than a substantial part of P's activities, however, consist of maintaining records of alumni and publishing a bulletin to keep alumni aware of the activities of the university. But for the activities of P, Y would normally engage in these same activities. P's endowment management activities are not considered activities that directly further the exempt purposes of Y under paragraph (i)(4)(ii) of this section. However, because Y's assets are subject to the appropriation process of State E for purposes unrelated to Y's exempt purposes, Y is P's sole supported organization, and a substantial part of P's activities directly further Y's exempt purposes, P qualifies for the exception in paragraph (i)(4)(iii) of this section. Accordingly, based on these facts, P qualifies as a functionally integrated Type III supporting organization under paragraph (4)(i)(A) of this section.
(5) Integral part test—non-functionally integrated Type III supporting organization—(i) A supporting organization meets the integral part test as a non-functionally integrated Type III supporting organization if it satisfies either:
(D) Emergency temporary reduction. The Secretary may provide by publication in the Internal Revenue Bulletin (see § 601.601(d)(2)(ii)(b) of this chapter) for a temporary reduction in the annual distributable amount in the case of a disaster or emergency.
(2) The failure was due to reasonable cause and not to willful neglect,
(3) The distribution requirement is met within 180 days after the date the incorrect valuation or ministerial error was or should have been discovered, or 180 days after the organization is first able to make its required payout Start Printed Page 48683notwithstanding the unforeseen event or circumstances.
K, an organization described in section 501(c)(3), annually pays over an amount equal to five percent of its assets to L, a museum described in section 509(a)(2). K meets the responsiveness test described in paragraph (i)(3) of this section with respect to L. In recent years, L has earmarked the income received from K to underwrite the cost of carrying on a chamber music series consisting of 12 performances a year that are performed for the general public free of charge at its premises. The chamber music series is not L's primary activity. L could not continue the performances without K's support. Based on these facts, K meets the requirements of paragraph (i)(5)(iii)(B)(2) of this section.
M, an organization described in section 501(c)(3), pays annually an amount equal to five percent of its assets to the Law School of N University, an organization described in section 509(a)(1). M meets the responsiveness test described in paragraph (i)(3) of this section with respect to N. M has earmarked the income paid over to N's Law School to endow a chair in International Law. Without M's continued support, N could not continue to maintain this chair. Based on these facts, M meets the requirements of paragraph (i)(5)(iii)(B)(2) of this section.
R is a charitable trust created under the will of B, who died in 1969. R's purpose is to hold assets as an endowment for S, a hospital, T, a university, and U, a national medical research organization (all organizations described in section 509(a)(1) and specifically named in the trust instrument), and to distribute all of the income each year in equal shares among the three named beneficiaries. Each year, R pays an amount equal to five percent of its assets to each of S, T, and U. Such payments are less than one percent of each organization's total support. Based on these facts, R does not meet the attentiveness requirement of paragraph (i)(5)(iii)(B). However, because B died prior to November 20, 1970, R could, upon meeting all of the requirements of paragraph (i)(9) of this section, be considered as meeting the requirements of paragraph (i)(5)(i)(B) of this section.
O is an organization described in section 501(c)(3). O is organized to support five private universities, V, W, X, Y and Z, each of which is described in section 509(a)(1). O meets the responsiveness test under paragraph (i)(3) of this section only as to V. Each year, O distributes five percent of the fair market value of its non-exempt-use assets in equal amounts to the five universities. O distributes annually more than 10 percent of the total annual support of V and W. Based on these facts O does not meet the requirements of paragraph (i)(5)(iii) of this section. Although both V and W are attentive to the operations of O under paragraph (i)(5)(iii)(B)(1) of this section, O is only responsive to V. Accordingly, O distributes only one-fifth (i.e., less than the required one-third) of its annual distributable amount to supported organization(s) that are both attentive to O and to which O is also responsive under paragraph (i)(3) of this section.
(7) Carryover of excess amounts—(i) In general. If with respect to any taxable year, an excess amount, as defined in paragraph (i)(7)(ii) of this section, is created, such excess amount may be used to reduce the annual distributable amount in any of the five taxable years immediately following the taxable year in which the excess amount is created (the “carryover period”). An excess amount created in a taxable year cannot be carried over beyond the succeeding five taxable years. With respect to any Start Printed Page 48684taxable year to which an excess amount is carried over, in determining whether an excess amount is created in that taxable year, the annual distributable amount is reduced first to the extent of any excess amounts carried over and then to the extent of distributions made in that taxable year.
(8) Valuation of assets—(i) General rules. (A) For purposes of determining the organization's annual distributable amount, as defined in paragraph (i)(5)(ii)(B) of this section, the determination of the fair market value of the non-exempt-use assets shall be made in the year preceding the year of the required distribution under paragraph (i)(5)(ii)(A) of this section. The aggregate fair market value of all non-exempt-use assets of a supporting organization is the sum of:
(2) The average of the supporting organization's cash balances on a monthly basis (less the same amount of cash balances excluded under paragraph (i)(8)(i)(C)(2)(i v) of this section) from the computation of the annual distributable amount); and
(B) Certain assets excluded. For purposes of this paragraph, the non-exempt-use assets taken into account in determining the annual distributable amount described in paragraph (i)(5)(ii)(B) of this section shall not include the following:
(2) The assets of an estate until such time as such assets are distributed to the supporting organization or, due to a prolonged period of administration, such estate is considered terminated for Federal income tax purposes by operation of Treas. Reg. § 1.641(b)-3(a);
(C) Assets used (or held for use) to carry out the exempt purposes of the supported organization(s)—(1) In general. For purposes of paragraph (i)(8)(i)(B)(5) of this section, an asset is “used (or held for use) to carry out the exempt purposes of the supported organization(s)” only if the asset is actually used by the supporting organization in activities that carry out the exempt purposes of its supported organization(s), or if the supporting organization owns the asset and establishes to the satisfaction of the Commissioner that its immediate use for such exempt purpose is not practical (based on the facts and circumstances of the particular case) and that definite plans exist to commence such use on behalf of its supported organization(s) within a reasonable period of time. Consequently, assets that are held for the production of income or for investment (for example, stocks, bonds, interest-bearing notes, endowment funds, or, generally, leased real estate) are not being used (or held for use) to carry out the exempt purposes of the supported organization(s), even though the income from such assets is used to carry out such exempt purposes. Whether an asset is held for the production of income or for investment rather than used (or held for use) by the supporting organization to carry out the exempt purposes of the supported organization(s) is a question of fact. For example, an office building used for the purpose of providing offices for employees engaged in the management of endowment funds is not being used (or held for use) by the supporting organization to carry out the exempt purposes of the supported organization(s). However, where property is used both to carry out the exempt purposes of the supported organization(s) and for other purposes, if the former use represents 95 percent or more of the total use, such property shall be considered to be used exclusively to carry out an exempt purpose of the supported organization(s). If the use of such property to carry out the exempt purposes of the supported organization(s) represents less than 95 percent of the total use, reasonable allocation between such use and other use must be made for purposes of this paragraph. Property acquired by the supporting organization to be used to carry out the exempt purposes of the supported organization(s) may be considered as used (or held for use) to carry out such exempt purposes even though the property, in whole or in part, is leased for a limited period of time during which arrangements are made for its conversion to the use for which it was acquired, provided such income-producing use of the property does not exceed a reasonable period of time. Generally, one year shall be deemed to be a reasonable period of time for purposes of the immediately preceding sentence. Where the income-producing use continues beyond a reasonable period of time, the property shall not be deemed to be used by the supporting organization to carry out the exempt purposes of the supported organization(s), but, instead, as of the time the income-producing use becomes unreasonable, such property shall be treated as disposed of within the meaning of paragraph (i)(5)(ii)(B)(3) of this section to the extent that the acquisition of the property was taken into account by the organization to meet the distribution requirement imposed in paragraph (i)(5)(ii)(A) of this section for any taxable year. If, subsequently, the property is used by the supporting organization to carry out the exempt purposes of the supported organization(s), a distribution to its supported organization(s) in the amount of its then fair market value, determined in accordance with the rules contained in this paragraph (i)(8), shall be deemed to have been made as of the time such exempt purpose use begins.
(2) Illustrations. Examples of assets that are “used (or held for use) to carry out the exempt purposes of the Start Printed Page 48685supported organization(s)” include, but are not limited to, the following:
(ii) Valuation of assets—timing. For purposes of determining the annual distributable amount for a taxable year, the supporting organization's assets are to be valued over the preceding taxable year.
(iii) Valuation of assets—(A) Certain securities. (1) For purposes of this paragraph, a supporting organization may use any reasonable method to determine the fair market value on a monthly basis of securities for which market quotations are readily available, as long as such method is consistently used.
(D) Other assets. (1) Except as otherwise provided in paragraph (i)(8)(iii)(D)(2) of this section, the fair market value of assets other than those described in paragraphs (i)(8)(iii)(A) through (i)(8)(iii)(C) of this section, shall be determined annually. Thus, the fair market value of securities other than those described in paragraph (i)(8)(iii)(A) of this section shall be determined in accordance with this paragraph (i)(8)(iii)(D)(1). If, however, a supporting organization owns voting stock of an issuer of unlisted securities and has, or together with disqualified persons or another supporting organization has, effective control of the issuer (within the meaning of § 53.4943-3(b)(3)(ii)), then to the extent that the issuer's assets consist of shares of listed securities issues, such assets shall be Start Printed Page 48686valued monthly on the basis of market quotations or in accordance with section 4942(e)(2)(B), if applicable. Thus, for example, if a supporting organization and a disqualified person together own all of the unlisted voting stock of a holding company that in turn holds a portfolio of securities of issues that are listed on the New York Stock Exchange, in determining the net worth of the holding company, the underlying portfolio securities are to be valued monthly by reference to market quotations for their issues unless a decrease in such value is authorized in accordance with section 4942(e)(2)(B). Such determination may be made by employees of the supporting organization or by any other person without regard to whether such person is a disqualified person with respect to the supporting organization. A valuation made pursuant to the provisions of this paragraph, if accepted by the Commissioner, shall be valid only for the taxable year for which it is made. A new valuation made in accordance with these provisions is required for the succeeding taxable year.
(3) For purposes of this paragraph (i)(8)(iii)(D)(3), commonly accepted methods of valuation must be used in making an appraisal. Valuations made in accordance with the principles stated in the regulations under section 2031 constitute acceptable methods of valuation. The term “appraisal,” as used in this paragraph (i)(8)(iii)(D)(3), means a determination of fair market value and is not to be construed in a technical sense peculiar to particular property or interests therein, such as, for example, mineral interests in real property.
(E) Definition of “securities”. For purposes of this paragraph (i)(8)(iii)(E), the term “securities” includes, but is not limited to, common and preferred stocks, bonds, and mutual fund shares.
(iii) The trust is required by its governing instrument to distribute all of its net income currently to a designated beneficiary supported organization. Where more than one beneficiary supported organization is designated in the governing instrument of a trust, all of the net income must be distributable and must be distributed currently to each of such beneficiary organizations in fixed shares pursuant to such governing instrument. For purposes of this paragraph (i)(9)(iii), the governing instrument of a charitable trust shall be treated as requiring distribution to a designated beneficiary organization where the trust instrument describes the charitable purpose of the trust so completely that such description can apply to only one existing beneficiary organization and is of sufficient particularity as to vest in such organization rights against the trust Start Printed Page 48687enforceable in a court possessing equitable powers;
(11) Transition rules—(i) A Type III supporting organization in existence on the effective date of these regulations that met and continues to meet the requirements of Treas. Reg. § 1.509(a)-4(i)(3)(ii), as in effect prior to the date these regulations are published as final or temporary regulations, will be treated as meeting the requirements of paragraph (i)(4)(i) of this section until the first day of the organization's first taxable year beginning after the date these regulations are published as final or temporary regulations.
(ii) A Type III supporting organization in existence on the effective date of these regulations that met and continues to meet the requirements of Treas. Reg. § 1.509(a)-4(i)(3)(iii), as in effect prior to the date these regulations are published as final or temporary regulations, will be treated as meeting the requirements of paragraph (i)(5)(i) of this section until the first day of its second taxable year beginning after the effective date of these regulations. Beginning in the first taxable year beginning after the effective date of these regulations, such organizations must value their assets according to paragraph (i)(8) of this section. Beginning in the second taxable year beginning after the effective date of these regulations (and in all succeeding taxable years), these organizations must meet all of the requirements of paragraph (i)(5)(i) of this section.
Par. 4. In § 53.4943-11, section heading is revised and paragraphs (f) and (g) are added to read as follows:
(g) Special transitional rule for Type III supporting organizations created as trusts before November 20, 1970. A trust that qualifies as a Type III supporting organization under section 509(a)(3) and meets the requirements of Treas. Reg. § 1.509(a)-4(i)(9) will be treated as a “functionally integrated Type III supporting organization” for purposes of section 4943(f)(3)(A).
[FR Doc. E9-22866 Filed 9-23-09; 8:45 am]