Warning: Illegal string offset 'status_txt' in /home/treacy/public_html/wp-content/plugins/share-and-follow/share-and-follow.php on line 1997

Warning: Illegal string offset 'status_txt' in /home/treacy/public_html/wp-content/plugins/share-and-follow/share-and-follow.php on line 1997

Warning: Illegal string offset 'status_txt' in /home/treacy/public_html/wp-content/plugins/share-and-follow/share-and-follow.php on line 2009

Warning: Illegal string offset 'status_txt' in /home/treacy/public_html/wp-content/plugins/share-and-follow/share-and-follow.php on line 1997

Warning: Illegal string offset 'status_txt' in /home/treacy/public_html/wp-content/plugins/share-and-follow/share-and-follow.php on line 2026

A Wake-Up Call for “Type III” Supporting Organizations

BNA/Tax Management

Originally Published in BNA/Tax Management.


Warning: Illegal string offset 'status_txt' in /home/treacy/public_html/wp-content/plugins/share-and-follow/share-and-follow.php on line 1997

Warning: Illegal string offset 'status_txt' in /home/treacy/public_html/wp-content/plugins/share-and-follow/share-and-follow.php on line 1997

Warning: Illegal string offset 'status_txt' in /home/treacy/public_html/wp-content/plugins/share-and-follow/share-and-follow.php on line 2009

Warning: Illegal string offset 'status_txt' in /home/treacy/public_html/wp-content/plugins/share-and-follow/share-and-follow.php on line 1997

Warning: Illegal string offset 'status_txt' in /home/treacy/public_html/wp-content/plugins/share-and-follow/share-and-follow.php on line 2026

After a silence of the better part of two decades, the U.S. Tax Court issued two important decisions late in 2002, Cuddeback v. Comr, T.C. Memo. 2002-300, and Lapham Foundation, Inc., v. Comr, T.C. Memo 2002-293. In both cases, the Tax Court ruled that foundations failed to meet the “integral part” tests relating to “Type III” supporting organizations (“operated in connection with” supported charities) under 509(a)(3).1 The decisions suggest a tightening of scrutiny to compliance with the various tests applicable to such supporting organizations and will send many supporting organizations back to the drawing board to craft appropriate grantmaking procedures.

Cuddeback Decision–Summary

In Cuddeback, the court noted that the trust and the Service had different interpretations of the meaning of the requirement in the “attentiveness prong” of the integral part test that applies to Type III supporting organizations: that prong requires that the supported charity will be attentive “in order to avoid the interruption” of a substantial program or activity.2 From the trust’s perspective, “interruption” should mean conducting the program in a different manner or degree rather than a complete cessation of the program. From the Service’s perspective, “interruption” means a discontinuance of the program. The court did not choose from between these alternative meanings and did not resolve this element of the dispute.

The court held: (1) it was not sufficiently shown that the supported charity would be sufficiently attentive to the trust’s operations in order to avoid an interruption of the supported program; (2) there was not sufficient evidence in the administrative record to permit the court to determine whether the supported grant program is “substantial”; (3) the information provided about the supported charity was “sketchy,” and this hindered the court’s ability to determine the issues presented; (4) the portion of the grants received from the trust–$27,236–was small in comparison to the value of grants made by the supported charity to needy participants on an annual basis; (5) the supported charity’s grant program was not funded entirely by the trust;3 (6) the court disagreed with the trust’s assertion that the supported charity’s letters to the trust demonstrated its attentiveness; (7) attentiveness is not established by the fact that the supporting organization is required to make available for inspection its annual tax return; and (8) no evidence was shown that the supported charity exercised actual attentiveness to the trust’s operations.

Grantmaking Activities in Light of Cuddeback

While “bad facts” and lack of sufficient evidence certainly contributed to the result in Cuddeback, the opinion suggests a number of new or underscored points of emphasis that apply to grantmaking procedures.

  • Consider Qualification as Type I Supporting Organization. Unlike a Type III, “operated in connection with” supporting organization, a Type I supporting organization does not need to comply with the integral part test. For supporting organizations that cannot meet the Type III tests, a switch to Type I status, in which the supported charities appoint a majority of the governing board, may be worth considering.
  • Establish that an Earmarked Program Would Cease if the Supporting Organization Did Not Provide Its Support. If the supporting organization is relying on grants to an earmarked fund or program within a supported charity to meet the integral part test, it would help to show that the fund or program would be terminated were it not for the support provided by the supporting organization.
  • Work With the Supported Charity to Develop Clear and Complete Financial Information. The supporting organization should work closely with the supported charity to develop clear and complete financial information, demonstrating that the supported fund or program is well-defined and is a substantial one for the supported charity.
  • Create a Record of Actual and Continuing Attentiveness by the Supported Charity. It is also essential to establish that the supported charity is motivated to be attentive to the supporting organization and, ideally, that it is actually attentive. Among the factors that may be helpful in establishing such attentiveness are the following: regular attendance by high-ranking representatives of the supported charity at the supporting organization’s annual meetings reflected clearly in the minutes; formal grant requests from the supported charity setting forth clearly the definition, scope and nature of the earmarked fund, its substantiality, the dependence of the supported charity on the support from the supporting organization for the continuance of the supported fund or program; formal follow-up reports from the supported charity detailing how the funds received from the supporting organization were applied and how any overages will in turn be applied; strong written expressions of gratitude for the support received and of its essential nature in continuing the supported program or fund; provision of copies of the supporting organization’s annual information return and other accounting information freely to the supported charity.

Lapham Decision–Summary

The Tax Court in Lapham began its analysis by ruling that changes in the foundation’s governing instruments that may have been adopted after the “administrative process” (i.e., after the Service issued its notice of determination) would be disregarded.5

Turning to the integral part test, the court ruled that the foundation failed the “but-for” test applicable to supporting organizations that carry on their own charitable activities, stating that a supporting organization’s making of grants to a community foundation, which itself makes grants, “cannot properly be characterized as something in which [the supported charity] would be engaged but for [the foundation’s] support.”5

In its integral part test analysis, the court held that the supporting organization’s expected annual grants of $7,600, measured against the total annual contributions received by the supported charity of over $7 million, were not sufficient to meet the attentiveness part of the test. The court also held that the alternative “earmarked fund” prong of the integral part test was not met.

Impact on Supporting Organizations

Among the implications of the Lapham decision for Type III supporting organizations are the following:

  • Level of Support Outside “Earmarked” Fund. Except in the case of an earmarked grant, a grant of less than 10% of the supported charity’s overall contributions receipts for the year will not satisfy the attentiveness test.
  • Requirements for “Earmarked” Fund. A supporting organization relying on the earmarked fund provision of the attentiveness test should make certain that the fund is clearly defined by the supported charity in scope and purpose and that it is a substantial program or fund of the supported charity.
  • Type of Support Required. A small grant of funds for supplies, postage, telephone and travel expenditures of a large supported charity will not nearly suffice to establish satisfaction of the integral part test.
  • Grants to Community Foundations are not “Activities.” The Lapham decision makes it reasonably clear that a supporting organization cannot rely on grant making to a community foundation as constituting “activities” for purposes of the but-for prong of the integral part test.

Footnotes

  • 1 See Regs. 1.509-4(f)(2)(iii).
  • 2Regs. 1.509-4(i)(3)(iii).
  • 3Earlier rulings have determined that a supporting organization’s distributions to an earmarked fund should constitute more than 50% of the overall support for the fund or program, and the court’s ruling should probably not be seen as intended to overturn this fairly well-established benchmark.
  • 4The Foundation should have made the amendments and changes earlier, during the administrative process or, failing that, should have requested the court’s permission to introduce evidence as to later amendments.
  • 5Note that the court appears to be saying that a supporting organization cannot meet the “but-for” prong of the “integral part” test by making grants to a community foundation which in turn makes grants to other charities, regardless of whether the supporting organization makes recommendations as to ultimate recipients through a donor advised fund.

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.

Publications and Articles by Topic

Business Succession Planning
Savvy Business Owners Look For Creative Plans
Charitable Planning
The Very Versatile Disclaimer: A Guide to Its Use in Charitable Planning
Charitable Trusts
De-UBIT-izing CRTs: Recent Rulings
Community Property
BNA Tax Management Portfolio – Community Property
Planning for Community Property:
A Primer for the Other 40½ States
Planning to Preserve the Advantages of Community Property
Corporate Charitable Giving
Alternative Corporate Giving Formats
Another Way to Reach the Family Business Owner
Donor Advised Funds
Cold Snap for Donor Advised Funds: The New DAF Rules
Estate Planning
Savvy Business Owners Look For Creative Plans
Guardianships
Washington Guardianship Law: Administration and Litigation, Third Edition
Patents
Surviving and Thriving In the Tax Patent Era
Private Foundations
Rulings Go Beyond ‘Plain Vanilla’ Foundations
A Taxonomy of Tax-Exempt Organizations
Probate
Probate Primer for PGOs
Public Charities
Becoming “SO-Friendly”: The Advantages of Courting Supporting Organization Relationships
A Taxonomy of Tax-Exempt Organizations
Part of the Truth About Attorneys
Accelerate Your Charity’s CRT Interest
What’s Wrong With This Gift?
The Perilous Quest for Bequests
Three Hazards for PGOs
Probate Primer for PGOs
Supporting Organizations
Hangover for Type III SOs – Treasury Issues Final Regulations for Supporting Organizations
New Regulations for Type III SOs
BNA Tax Management Portfolio – Supporting Organizations
Not SO Bad – Proposed Regulations for Type III Supporting Organizations
New ‘Guide Sheets’ on Supporting Organizations
Aftershocks: Update on Supporting Organizations
Supporting Organizations After the Pension Protection Act
So What’s Left of SOs? – The Pension Protection Act of 2006 and Its Impact on Supporting Organizations
A Wake-Up Call for “Type III” Supporting Organizations
SO Much Better?: Supporting organizations may offer the perfect balance of tax benefits and donor control for some planned giving prospects

Sign up for our newsletter!