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CPAs Issue Client Memo on Type III Supporting Organizations

OCT. 9, 2006

CPAs Issue Client Memo on Type III Supporting Organizations

DATED OCT. 9, 2006
DOCUMENT ATTRIBUTES
  • Authors
    Blazek, Jody
    Nelson, David
  • Institutional Authors
    Blazek & Vetterling LLP
  • Code Sections
  • Subject Area/Tax Topics
  • Industry Groups
    Nonprofit sector
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 2006-21020
  • Tax Analysts Electronic Citation
    2006 TNT 197-38
Functionally Integrated -- Finding a Definition
Background: Grants by private foundations to § 509(a)(3) Type III Supporting Organizations (SO) that are not Functionally Integrated with their supported organization(s) (SDO) are no longer treated as qualifying distributions (as of August 18, 2006) for purposes of meeting the § 4942 payout requirement (5% of average assets' fair market value).1

Each Type III SO must, therefore, determine if it has this characteristic. The new tax code contains the following sentence that directs the Secretary (of the Treasury) to issue regulations:

 

"A functionally integrated type III supporting organization means a type III supporting organization which is not required to make payments to supported organizations due to the activities of the organization related to performing the functions of, or carrying out of the purposes of, such supported organizations."

 

Sources: Until regulations are issued, the existing regulations that define Type III SOs contain some clues to consider. The essence of the word functional is active conduct of direct programs by the SO and not simply holding investment assets to produce income to fund operations conducted by the supported organization. The existing regulations define an organization treated as an "integral part" of the supported organization as follows:

 

"It maintains a significant involvement in the operations of one or more supported organizations (SDO) and such publicly SDOs are in turn dependent upon the SO for the type of support it provides. The activities engaged in for or on behalf of the SDOs are activities to perform the functions of, or to carry out the purposes of, the SDOs, and but for the involvement of the SO, would normally be engaged in by the SDO themselves."

 

One must therefore focus on the question of how to evidence that the SO is "performing the functions of." The examples in the existing regulations2 address programs conducted by the supported organization -- a music series and law school chair -- deemed responsive partly because the institutions would not otherwise be able to conduct the programs. A university alumni association is deemed to be "performing the functions" when it supports its own program of educational activities for alumni, faculty and students.3

A concept similar in nature is found in the private operating foundation regulations4 that contain a good and bad example of a scholarship program where the PF has significant involvement, the same terms used in the existing SO regulations. The bad example says the PF does no more than "select, screen, and investigate applicants for grants or scholarships." In the good example, the PF instead conducts research in a particular discipline and provides scholarships to persons focused on the subject who work under the supervision and direction of foundation personnel in charge of the research program.

Many Type III Supporting Organizations have been created to hold property on behalf of their supported organizations. Unfortunately as stated above, those that simply hold investment assets to produce income on behalf of the SDO will very likely not be treated as "functionally integrated." But what if the SO holds the building in which the SDO operates its programs? It seems reasonable to claim in such a case that the supported organization is dependent upon the SO for the type of support it provides (use of the building). The answer might be different, however, if the SO charges the SDO rent or the use of the building is rent-free but the SDO must pay all of the maintenance, utilities, and other expenses associated with the building.

Answers: We hope others will join us in our quest to define the term functionally integrated. Undoubtedly significant funding rests on the ability to so classify a Type III organization. We welcome new examples and questions that will help all of us to refine the answer and potentially influence the definitions the IRS eventually provides. Send your comments by email please to jody.blazek@bvcpa.com and david.nelson@bvcpa.com.

 

FOOTNOTES

 

 

1 The Pension Protection Act of 2006 (H.R.4) Section 1244, "Treatment of Amounts Paid to Supporting Organizations by Private Foundations" that amends § 4943(f)(5)(B).

2 Reg. § 1.509-4(i)(3)

3 Reg. 1.509-4(e)(3), Example 1.

4 Reg. § 53.4942(b)(2)(i)

 

END OF FOOTNOTES
DOCUMENT ATTRIBUTES
  • Authors
    Blazek, Jody
    Nelson, David
  • Institutional Authors
    Blazek & Vetterling LLP
  • Code Sections
  • Subject Area/Tax Topics
  • Industry Groups
    Nonprofit sector
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 2006-21020
  • Tax Analysts Electronic Citation
    2006 TNT 197-38
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