IRS Releases Proposed Rules for a Type of Supporting Organization

The Internal Revenue Service has released proposed regulations that would require a special type of nonprofit group to distribute at least 5 percent of its assets each year for charitable purposes.

At issue: so-called supporting organizations — charities that carry out their mission by supporting specific other groups, including hospitals and colleges.

The rules, issued by the IRS and the Treasury Department, were required by provisions of the federal Pension Protection Act of 2006, which Congress passed in an effort to crack down on abuses.

The IRS proposal focuses on so-called Type III supporting organizations, which are groups that “are operated in connection with” their supported organizations.

Organizations are classified as Type III based on two standards, one of which is called an “integral part” test.

One way a supporting organization can meet the integral part standard is, in part, by establishing that it pays substantially all of its income to or for the use of the college, hospital, or other supported group and that the amount of its support is enough to insure the “attentiveness” of the supported group.

Organizations that meet the integral part test in this way are known as “non-functionally integrated” Type III groups.

The Pension Protection Act directed the Treasury Secretary to require those organizations to distribute a minimum amount of their income or assets to charity each year to ensure they were not hoarding money.

The proposed IRS regulations would set the annual distribution requirement at 5 percent of “non-exempt-use assets” and retain the concept of “attentiveness.”

The proposed rules also seek to fight abuses by making changes in an alternative way a supporting organization can meet the integral part test. An organization can establish that its activities perform the functions of, or carry out the purposes of the supported group. It also must show that those activities would be carried out by the supported group “but for” the involvement of the supporting organization.

Organizations that meet the integral part test in this way are referred to as “functionally integrated” Type III groups.

The proposed IRS regulations note that an explanation of the Pension Protection Act by the Joint Committee on Taxation expressed concern that the current regulatory standards for satisfying the integral part test for functionally integrated groups “are not sufficiently stringent to ensure that there is a sufficient nexus between the supporting and supported organizations.”

The IRS proposal would strengthen the language in the standard for those organizations by requiring that they engage in activities “substantially all of which directly further the exempt purposes of the supported organization(s).”

The proposed rules say that such a supporting organization “directly furthers” such purposes “by holding or managing exempt-use assets” but not by “by fund raising, grant making, or investing and managing non-exempt-use assets.”

The IRS proposal will appear tomorrow in the Federal Register.

Comments and requests for a public hearing must be received by the IRS by December 23.