The Internal Revenue Service (IRS) and the US Department of the Treasury released final regulations on October 16 that address the changes enacted by the Pension Protection Act of 2006 (PPA).
The regulations provide guidance on the prohibition on certain gifts or contributions to Type I and Type III supporting organizations from persons who control the supported organization and on certain other requirements for Type III supporting organizations.
A supporting organization is a 501(c)(3) tax-exempt organization that is treated as a public charity despite lacking the broad public support typical of public charities because it is organized and operated to support or benefit one or more other publicly supported organizations. Supporting organizations are subject to numerous requirements to maintain their status. These requirements are intended to ensure the supporting organization is organized and operated exclusively for the benefit of, to perform the functions of, or to carry out the purposes of one or more of the publicly supported organizations it supports.
There are generally three types of supporting organizations: "Type I,” “Type II,” and “Type III,” with Type III supporting organizations further classified as either “functionally integrated” or “non-functionally integrated.” Each type of supporting organization is subject to different requirements. The Treasury Department and the IRS published multiple regulations regarding Type III supporting organizations between August 2007 and February 2016 in response to the PPA. The regulations focused on implementing changes made by the PPA to the Type III supporting organization requirements, as well as addressing issues identified in previous regulations.
In February 2016, the Treasury Department and the IRS published proposed regulations regarding the prohibition on certain contributions to Type I and Type III supporting organizations and requirements for Type III supporting organizations. They received six comments in response to the 2016 proposed regulations. After considering the comments, the Treasury Department and the IRS adopted the 2016 proposed regulations with certain revisions.
The final regulations address comments received by the Treasury Department and the IRS in response to the 2016 proposed regulations. These final regulations define the term “control” under section 509(f)(2), which prohibits Type I or Type III supporting organizations from accepting gifts or contributions from individuals controlling the governing body of the supported organization(s). In addition, the final regulations modify the requirements for an organization to qualify as a Type III supporting organization.
“Control” under Section 509(f)(2)
Under the 2016 proposed regulations, the governing body of a supported organization is considered “controlled” by a person if that person, alone or by aggregating his or her votes or positions of authority with certain related persons can 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 act. The final regulations clarify that control exists if such persons hold 50% or more of the total voting power of the governing body or have the right to exercise veto power over the actions of the governing body. These final regulations also clarify that even if this control test is not met, those persons may still be treated as controlling the governing body if the facts and circumstances show that they do in fact directly or indirectly control the governing body of the supported organization.
Modifications to Type III Supporting Organization Requirements
In addition to the requirements for supporting organizations generally, Type III supporting organizations are required to satisfy (1) a notification requirement, (2) a responsiveness test, and (3) an integral part test provided in the Treasury regulations. The final regulations adopt the additional rules provided in the 2016 proposed regulations for these requirements with the following key modifications.
1. Integrated Systems Not Limited to Hospital Systems
A Type III supporting organization may qualify as “functionally integrated” if it is the parent of an integrated system of supported organizations and exercises a substantial degree of direction over the
policies, programs, and activities of the supported organizations and a majority of the officers, directors, or trustees of the supported organizations are appointed or elected, directly or indirectly, by the governing body, members of the governing body, or officers (acting in their official capacities) of the supporting organization. The final regulations clarify that an “integrated system” is not limited to hospital systems but also includes other industries that have integrated systems. The preamble to the regulations provides examples of other industries with integrated systems, including private schools and universities, continuing care retirement communities, and residential rehabilitation facilities.
The final regulations also clarify that a parent of an integrated system of supported organizations must direct the overall policies, programs, and activities of the supported organizations (for example, coordinating the activities of the supported organizations and engaging in overall planning, policy development, budgeting, and resource allocation). Additionally, they clarify that a supporting organization can qualify as a parent of a second tier (or lower) subsidiary by indirectly controlling the second tier subsidiary. For example, if the directors of the supporting organization appoint a majority of the directors of the first tier subsidiary, which in turn appoints a majority of the directors of the second tier subsidiary. Finally, they also clarify that the power to appoint or elect a majority of the officers, directors, or trustees of each supported organization includes a requirement that the parent organization also has the power to remove and replace those individuals.
2. Governmental Supported Organizations
The final regulations clarify that a “governmental unit” includes all of its agencies, departments, and divisions, and that they will be treated as one governmental supported organization for these purposes. They also provide that, in determining whether a substantial part of a supporting organization’s total activities directly further the exempt purposes of its governmental supported organization(s), all pertinent facts and circumstances will be taken into consideration and add a new example to clarify that a supporting organization that supports more than one governmental organizations can satisfy this requirement of its activities directly further the exempt purpose of at least one of those organizations.
3. Distribution Requirements
Type III non-functionally integrated supporting organizations are required to distribute a certain amount to or for the use of one or more of its supported organizations. The final regulations allow for expenses the supporting organization incurs to solicit contributions count towards the distribution requirement when the resulting contributions are received directly by a supported organization in certain circumstances and subject to certain limitations. The final regulations also clarify timing requirements for purposes of applying these limitations for each year, and they clarify that the supporting organization may substantiate the contributions provided to the supported organization by a single annual written statement if the amount of contributions received, if any, by the supported organization as a result of each solicitation is separately identified.