By Rebekuh Eley, CPA MST
Supporting organizations have been the subject of scrutiny over the last few years, from the Pension Protection Act in 2006, to Treasury Regulations in 2012 and 2015, to additional disclosure requirements to Form 990 Schedule A in 2014.
Supporting organizations, particularly those of grant-making foundations, are left wondering if their current activities will fall within these published rules. The consequences for not falling within these rules includes an organization being treated as a private foundation instead of a public charity. These organizations would be subject to excise taxes on investment income and would need to abide by stricter operational requirements.
Supporting organizations achieve public charity status by passing four tests, including an organizational test, operational test, relationship test and a control test. For the organizational test, an organization must be organized and operated exclusively for the benefit of, to perform the function of, or to carry out the purposes of one or more specified organizations described in IRC section 509(a)(1) or (2). The organization must also be operated, supervised, or controlled by or in connection with one or more organizations described in IRC section 509(a)(1) or (2). The control must not be direct or indirect by disqualified persons (other than foundation managers or organizations described in IRC sections 509(a)(1) or (2)).
Additionally, a supporting organization must fall into one of three relationship categories: operated, supervised, or controlled by a supported organization (Type I parent-subsidiary); supervised or controlled in connection with a supported organization (Type II, brother-sister) or; operated in connection with, one or more publicly supported organizations (Type III). The relationship must ensure that the supporting organization is responsive to the needs or demands of the supported organization(s), and the supporting organization will constitute an integral part of, or maintain a significant involvement in, the operations of the supported organization(s). Control is determined through the facts around the organizing documents, operations, and relationship between the supporting organization and the supported organization(s).
Many Type I and II supporting organizations do not make grants to the controlling organization, but rather make grants to other organizations that address the charitable purpose of the controlling organization. This commonplace industry practice could risk failure of the operational test. A supporting organization can only support or grant funds to an organization that is specified within its organizing documents. The rules on how to determine what is a “specified organization” are very complex and can be found in Treasury Regulation 1.509(a)-4(d). Specified organizations may be identified by designating an organization by name or by a charitable class that aligns with the mission of the controlling organization. If the supporting organization provides grants to organizations other than the controlling organization, the organizing documents should designate a supported organization by class rather than by name. The strict requirements for designating a supported organization by class are also found in the Treasury Regulations. This type of designation requires additional disclosures on the supporting organization’s Form 990 Schedule A, which may be scrutinized by the IRS.
Now is a good time to look at a supporting organization’s operations and confirm they are aligned with the governing documents, and grants made properly. If the organizational documents and operations are not aligned, the supporting organization may have to act intentionally to prevent private foundation status.
This article originally appeared in BDO USA, LLP’s “Nonprofit Standard” newsletter (Spring 2017). Copyright © 2017 BDO USA, LLP. All rights reserved. www.bdo.com