Final Regulations Retain Payout Rule for Type III Supporting Organizations
With the release of final regulations, the Internal Revenue Service (“IRS”) has retained payout requirements for certain supporting organizations that are required to give substantially all of their income to other public charities. These final rules, which adopted temporary regulations issued in 2012 with no changes, were effective December 23, 2015.
Public Charities
Organizations recognized as tax-exempt under Internal Revenue Code (“IRC”) §501(c)(3) can be further sub-classified as non-private foundations, or public charities, under IRC §509(a)(1), (2) or (3). Organizations that are classified as public charities under IRC §509(a)(3) are “supporting organizations” in that they exist and operate to support and distribute substantially all of their income to other public charities.
All supporting organizations must pass an organizational test, an operational test, a control test and a relationship test. Supporting organizations are classified as Type I, Type II or Type III supporting organizations based on how they satisfy the relationship test.
According to IRS rules and regulations and as outlined on the IRS’ website, a Type III supporting organization must be operated in connection with one or more publicly supported organizations. All supporting organizations must be responsive to the needs and demands of, and must constitute an integral part of or maintain significant involvement in, their supported organizations. Type I and Type II supporting organizations are deemed to accomplish the responsiveness and integral part requirements by virtue of their control relationships. However, a Type III supporting organization is not subject to the same level of control by its supported organization(s). Therefore, in addition to a notification requirement, Type III supporting organizations must pass separate responsiveness and integral part tests.
Under the integral part test a Type III supporting organization can either be functionally integrated or non-functionally integrated. All non-functionally integrated Type III supporting organizations must satisfy the “distribution requirement” as outlined below and in the final regulations and also an “Attentiveness Requirement”.
Final Regulations
The final regulations and associated payout requirements apply specifically to Type III non-functionally integrated supporting organizations that are recognized as tax-exempt under IRC §501(c)(3) and as non-private foundations, or public charities, under IRC §509(a)(3). Under the final regulations, these types of organizations are required to distribute the greater of 85% of their income or 3.5% of the fair market value of their non-exempt use assets to other public charities.
The IRS stated that these final rules will help to ensure that supported organizations receive the maximum possible distribution each year. Through two-tests, one for assets and another for income, the requirements ensure that these types of supporting organizations will be distributing a significant amount of their income. In addition, the IRS stated that “The same property valuation principles that apply to private foundations should continue to apply to non-functionally integrated Type III groups.”
The final regulations can be accessed below:
https://www.federalregister.gov/articles/2015/12/23/2015-32146/payout-requirements-for-type-iii-supporting-organizations-that-are-not-functionally-integrated
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