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New ‘Guide Sheets’ on Supporting Organizations

Tax Management Estates, Gifts and Trusts Journal

Originally Published in Tax Management Estates, Gifts and Trusts Journal.


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The Pension Protection Act of 2006 (PPA) transformed the familiar landscape of Code Section 509(a)(3) supporting organizations (SOs), and in an unusual outpouring of notices, announcements, memoranda, and other forms of guidance, the Service has been struggling with the many questions raised, but left unanswered, by PPA 2006.

Earlier this year, the Service issued its “Guide Sheet and Explanation for IRC 509(a)(3) Type I and Type II Supporting Organizations,” as well as its “Guide Sheet and Explanation for IRS 509(a)(3) Type III Supporting Organizations,” primarily for internal use by agents in processing applications for exempt status of SOs. 1 In what SOs will hope is a typographical error, the cover Memorandum states that the guidelines are for “processing applications for private foundation status classification”. Most of the pages of the Guide Sheets and Explanations are devoted to a summary of the SO requirements which were in place years before the PPA, and which continue to apply after the PPA, but the main importance for most practitioners is in the discussion of the new PPA and post-PPA requirements in the Guide Sheets.

The Guide Sheets observe that “[m]ost supporting organizations further legitimate charitable purposes,” but go on to cite these examples of the kind of “private benefit abuses” which the PPA was designed to remedy: (i) “situations where a supporting organization makes loans, grants, or compensation payments to or for the benefit of donors or donors’ families and businesses”; and (ii) “situations where the supporting organization is a recipient of closely held stock, personal residences, partnership interests, sole proprietorships, or insurance policies, as these asset types may be manipulated for the benefit of donors or donors’ families and businesses.” If these circumstances are present, the Explanations provide, “one needs to consider possible denial of IRC 501(c)(3) exemption, or possible denial of IRC 509(a)(3) supporting organization status.”

An earlier IRS Memorandum dated February 22, 2007 had suspended the issuance of determination letters with regard to functionally integrated Type III SOs. Under the Explanations, the Service can now issue determination letters classifying a Type III SO as functionally integrated, so long as the SO meets the criteria set forth in the Advance Notice of Proposed Rulemaking (ANPRM) dated August 2, 2007. 2 In these instances, the Explanations indicate that the SO must comply with the regulations defining functionally integrated Type III SOs when these are finalized. Even If an SO does not wish to comply with the ANPRM, it can still qualify for a determination letter classifying it as a Type III SO, without determining whether or not it is functionally integrated.

Substantially more guidance is provided in the Explanations with regard to the “control test” applicable to Type I, II, and III SOs than the Service had issued previously. The “control test” requires that an SO cannot be controlled directly or indirectly by its founders and other disqualified persons. 3 New investigative tools are provided in the Explanations to detect less obvious means of violating the control test. The Explanations confirm the acceptability of persons serving on the SO board to also be directors, officers or trustees of a supported organization, as in the view taken by the Explanations, this may help “improve the supporting organization’s operations and exercise appropriate supervision and control.” 4 The presence of any disqualified persons on the SO’s board, other than foundation managers who are solely by that status deemed to be disqualified persons, “is cause for close examination of whether prohibited control is present.” The following are some examples of impermissible control cited in the Explanations:

  • A five-person SO board, consisting of two appointees of the supported charity, two disqualified persons, and a fifth “so-called ‘independent’ director” appointed by the disqualified persons;
  • A four-person SO board, consisting of two appointees of the supported charity, one disqualified person, and one director paid by the disqualified person for accounting, legal or investment advice, as the disqualified person would then be in a position, from the perspective taken by the Explanations, to influence the decisions of the fourth director; 5 and
  • A five-person SO board, consisting of two appointees of the supported charity, two disqualified persons, and a fifth “so-called ‘independent’” director chosen by a nominating committee consisting of the two disqualified persons.

The Explanations discuss another form of impermissible control — the situation in which the disqualified person does not control the board itself, but continues to control the SO’s assets after these are contributed to the SO. Examples cited by the Explanations include these:

  • The disqualified person owns a general partnership interest in a limited partnership, in which the SO is a limited partner;
  • The disqualified person owns an interest of 51% or more of the voting stock of a corporation in which the SO holds stock;
  • The disqualified person holds 51% or more control of a corporation through a voting trust or other voting arrangement, and the SO is a stockholder in the corporation;
  • The disqualified person holds a controlling interest in an LLC, units of which are owned by the SO;
  • The disqualified person retains effective control of real estate, art work, or collectibles owned in part by the SO; for example, where a disqualified person donates an antique car collection to the SO and then houses the collection in a warehouse at his country residence, with the warehouse leased to the SO; and
  • The donor or the donor’s family members have the right to provide advice to the SO regarding investments or grantmaking.

The Explanations indicate that the agent should take into consideration all of the facts and circumstances in examining these varieties of potentially impermissible control situations.

What specific types of transactions call for an agent’s heightened scrutiny? The Explanations cite these as examples:

  • A cash contribution followed by a “loan” by the SO to the donor’s for-profit business, which is subject to an unsecured promissory note – the Explanations single these situations out, noting that “[m]uch of the abuse in the supported organization area relates to unreasonable compensation and loans to disqualified persons, their family members, and their businesses”;
  • A cash contribution which is not followed by any payments or scheduling of payments to any of the supported charities;
  • A cash contribution followed by a grant from the SO of a “scholarship” to the donor’s child;
  • A contribution of an historic façade easement, in circumstances in which local historic preservation laws already prohibit any alteration of the façade; and
  • A non-cash distribution of assets producing little or no income.

The agent encountering any of these situations is advised in the Guide Sheets to ask “[a]dditional questions” tailored to the specific situation.

The term “promoter” is defined in the Explanations as a person who organizes or assists in the organization of a partnership, trust, investment plan, or any other entity or arrangement which is sold to a third party. The concern motivating this portion of the Guide Sheets is that the entity might be used by the third party to obtain tax benefits which are not otherwise available under the Code. The questions which are raised by the Guide Sheets on this “promoter” issue include the following:

  • Are any promoters identified with the creation or operation of the SO?
  • Does the SO support more than five supported charities?
  • Is there any evidence of loan activity?
  • Does the SO own significant other investments (valued at $100,000 or more) which are not explained in detail in the application for exemption?
  • Does the SO own significant land or other non-income producing assets (valued at $100,000 or more)?
  • Does the SO own life insurance on the donor’s life or the lives of one or more family members?

With respect to grantmaking Type III SOs (as opposed to functionally integrated Type III SOs), the Explanations provide some elaboration on the requirements applicable when such an SO makes grants to an earmarked project or fund within the supported charity, as opposed to making an unrestricted grant to the charity. Recognizing the longstanding “administrative safe harbor” under which an SO can provide 50% or more of the funding for an earmarked activity or program, the Explanations provide that the funding should be for the same earmarked program year after year, as this is said to indicate a long term relationship. One might observe, however, that while many projects of supported charities do go on year after year, many others are shorter-term, perhaps lasting only a year or two, and these, too, may be quite important and substantial projects for the supported charity. It is hoped that the Explanations are not interpreted as meaning that such shorter-term programs will somehow no longer qualify for the 50% safe harbor, though this is indeed a conceivable interpretation. There would seem to be no good policy consideration supporting such a distinction.

  • 1 Memorandum of Robert Choi, Director, EO Rulings and Agreements.
    Emphasis added.
  • 2 See Announcement 2007-87, discussed above.
  • 3 I.R.C. Section 509(a)(3)(C).
  • 4 There seem to be missing words in the text of the Explanations, and what was probably intended was a phrase something like, “help the supported organization to” before existing phrase, “exercise appropriate supervision and control.”
  • 5 There is another apparent error in the text of the Explanations at this point, as they begin the example contemplating a four-person board, then abruptly switch mid-sentence to a five-person board.

IRS Circular 230 Disclosure: To the extent this message contains tax advice, the U.S. Treasury Department requires me to inform you that any such advice, whether in the body of the message or in any attachment, is not intended or written by my firm to be used, and cannot be used by any taxpayer, for the purpose of avoiding any penalties that may be imposed under the Internal Revenue Code. Advice from my firm relating to tax matters may not be used in promoting, marketing or recommending any entity, investment plan or arrangement to any taxpayer.

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