What is a Section 509(a)(3) Supporting Organization? Can a Section 501(c)(3) organization avoid private foundation status by supporting other than a charity, such as a Section 501(c)(6) organization?
Under Title 26 of the Internal Revenue Code, all organizations described in section 501(c)(3) are considered private foundations, unless one of four exceptions applies. See 26 U.S.C. § 509(a)-(a)(4) (defining “private foundation”).
Those exceptions are, briefly: (1) organizations described in 26 U.S.C. § 170(b)(1)(A) and to whom charitable contributions may be given; (2) publicly supported organizations, as described in paragraph (2) of section 509(a); (3) organizations organized and operated exclusively for the benefit of, to perform the functions of, or to carry out the purposes of one or more specified organizations described in paragraph (1) or (2) of section 509(a); and (4) an organization which is organized and operated exclusively for testing for public safety. See 26 U.S.C. § 509(a)-(a)(4).
This Freeman Law blog focuses on supporting organizations, being those described in paragraph (3) of section 509(a).
Section 509(a)(3)—Supporting Organization
Section 509(a)(3) is an exception to private foundation status. Section 509(a)(3) describes an organization which:
(A) is organized, and at all times thereafter is operated, exclusively for the benefit of, to perform the functions of, or to carry out the purposes of one or more specified organizations described in paragraph (1) or (2) [of section 509(a)],
(B) is—
(i) operated, supervised, or controlled by one or more organizations described in paragraph (1) or (2) [of section 509(a)],
(ii) supervised or controlled in connection with one or more such organizations, or
(iii) operated in connection with one or more such organizations, and
(C) is not controlled directly or indirectly by one or more disqualified persons (as defined in section 4946) other than foundation managers and other than one or more organizations described in paragraph (1) or (2) [of section 509(a)][.] . . .
For purposes of paragraph (3), an organization described in paragraph (2) shall be deemed to include an organization described in section 501(c)(4), (5), or (6) which would be described in paragraph (2) if it were an organization described in section 501(c)(3).
26 U.S.C. § 509(a)(3)-(a)(3)(C) (emphasis added).
Thus, pursuant to the flush language of section 509(a)(3), supporting organization status is available where the supported organization is organized as described by section 501(c)(6) of the Code, provided (1) that the supporting organization meets the requirements of subsections (A), (B), and (C) of section 509(a)(3), and (2) the supported 501(c)(6) organization meets the requirements of section 509(a)(2).
Requirement of Qualified Supported Organization
To qualify as a supported organization for purposes of a supporting organization’s qualification under section 509(a)(3), the supported organization must be organized as described in paragraph (1) or (2) of section 509(a).
Paragraph (1) describes organizations that are referenced in subsections (i) through (ix) of section 170(b)(1)(A) of the Code, although organizations described in subsection (vii) and (viii) are excluded from the qualification under section 509(a)(3). See 26 U.S.C. § 509(a)(1); id. at § 170(b)(1)(A)-(b)(1)(A)(ix).
Paragraph (2) of section 509(a) describes an organization which
(A) normally receives more than one-third of its support in each taxable year from any combination of—
(i) gifts, grants, contributions, or membership fees, and
(ii) gross receipts from admissions, sales of merchandise, performance of services, or furnishing of facilities, in an activity which is not an unrelated trade or business (within the meaning of section 513–See Freeman Law 3-Part Series Blog on Tax-Exemption and Unrelated Business Income), not including such receipts from any person, or from any bureau or similar agency of a governmental unit (as described in section 170(c)(1)), in any taxable year to the extent such receipts exceed the greater of $5,000 or 1 percent of the organization’s support in such taxable year,
from persons other than disqualified persons (as defined in section 4946) with respect to the organization, from governmental units described in section 170(c)(1), or from organizations described in section 170(b)(1)(A) (other than in clauses (vii) and (viii)), and
(B) normally receives not more than one-third of its support in each taxable year from the sum of—
(i) gross investment income (as defined in subsection (e)) and
(ii) the excess (if any) of the amount of the unrelated business taxable income (as defined in section 512) over the amount of the tax imposed by section 511[.]
26 U.S.C. § 509(a)(2)-(a)(2)(B)(ii); see id. at § 509(a)(3) (flush language) (“For purposes of paragraph (3), an organization described in paragraph (2) shall be deemed to include an organization described in section 501(c) . . . (6) which would be described in paragraph (2) if it were an organization described in section 501(c)(3).”).
If an existing organization qualified as a public charity pursuant to section 509(a)(2) desires to reclassify itself as a supporting organization under section 509(a)(3), the applying organization, in its application for reclassification, must show that the supported organization—whether it be organized as described in 501(c)(3), (4), (5), or (6)—meets and is expected to continue to meet the public support test requirements of section 509(a)(2). Evidence of these requirements may form part of the applying organization’s proforma schedule D from the IRS Form 1023 Application for Recognition of Exemption in support of the Form 8940 Request for Miscellaneous Determination.
Requirement – Section 509(a)(3)(A)—Organizational / Operational Tests
To qualify as a supporting organization under section 509(a)(3), the supporting organization must be “organized, and at all times thereafter is operated, exclusively for the benefit of, to perform the functions of, or to carry out the purposes of one or more specified organizations described in paragraph (1) or (2) [of section 509(a)][.]” See 26 U.S.C. § 509(a)(3)(A).
Organizational Test
The Treasury Regulations provide as follows with respect to the organizational requirements of section 509(a)(3) of the Code:
An organization is organized exclusively for one or more of the purposes specified in section 509(a)(3)(A) only if its articles of organization . . . :
(i) Limit the purposes of such organization to one or more of the purposes set forth in section 509(a)(3)(A);
(ii) Do not expressly empower the organization to engage in activities which are not in furtherance of the purposes referred to in subdivision (i) of this subparagraph;
(iii) State the specified publicly supported organizations on whose behalf such organization is to be operated (within the meaning of paragraph (d) of this section); and
(iv) Do not expressly empower the organization to operate to support or benefit any organization other than the specified publicly supported organizations referred to in subdivision (iii) of this subparagraph.
26 C.F.R. § 1.509(a)-4(c)(1)-(c)(iv).
If the organization by which the supporting organization is operated, supervised, or controlled is a publicly supported section 501(c)(4), (5) or (6) organization, the supporting organization will be considered as meeting the organizational requirements of section 509(a)(3)(A) if the supporting organization’s articles require it to carry on charitable, educational, religious, etc. activities within the meaning of section 170(c)(2) of the Code. 26 C.F.R. § 1.509(a)-4(c)(2).
Operational Test
The supporting organization will be regarded as operated exclusively to support a specified publicly supported organizations only if the supporting organization engages “solely in activities which support or benefit the specified publicly supported organizations.” 26 C.F.R. § 1.509(a)-4(e)(1)-(2) (identifying permissible beneficiaries and permissible activities for the supporting organization).
An organization will not be regarded as operated exclusively if any part of its activities is in furtherance of a purpose other than supporting or benefiting the specified publicly supported organization.
The supporting organization may maintain tax-exemption pursuant to section 501(c)(3) if its assets are used primarily to support the qualified supported organization’s charitable, educational, religious, etc. activities within the meaning of section 170(c)(2) of the Code. See 26 C.F.R. § 1.509(a)-4(c)(2); id. at § 1.501(c)(3)-1(c)(1) (“An organization will be regarded as operated exclusively for one or more exempt purposes only if it engages primarily in activities which accomplish one or more of such exempt purposes specified in section 501(c)(3). An organization will not be so regarded if more than an insubstantial part of its activities is not in furtherance of an exempt purpose.”).
Requirement – Section 509(a)(3)(B)—Control or “In Connection With” Test
Another requirement to qualify as a supporting organization under section 509(a)(3) is that the supporting organization must be:
(i) operated, supervised, or controlled by one or more organizations described in paragraph (1) or (2) [of section 509(a)],
(ii) supervised or controlled in connection with one or more such organizations, or
(iii) operated in connection with one or more such organizations[.]
See 26 U.S.C. § 509(a)(3)(B); 26 C.F.R. § 1.509(a)-4(f)(1)-(2).
For any of these relationships, the arrangement must insure that: (i) the supporting organization will be responsive to the needs of demands of the publicly supported organization; and (ii) the supporting organization will constitute an integral part of, or maintain a significant involvement in, the operations of the publicly supported organizations. See 26 C.F.R. § 1.509(a)-4(f)(3).
Type I – Operated, supervised, or controlled by a Supported Organization
The distinguishing feature of this type of relationship is the presence of a substantial degree of direction by the publicly supported organizations over the conduct of the supporting organization. See 26 C.F.R. § 1.509(a)-4(g). A Type I relationship requires a substantial degree of direction over the policies, programs, and activities of the supporting organization by the publicly supported organizations. This relationship is established by the fact that a majority of the officers, directors, or trustees of the supporting organization are appointed or elected by the governing body or officers of the publicly supported organization.
An organization may qualify as a Type I organization even though its governing body is not comprised of representatives of the specified publicly supported organizations for whose benefit the supporting organization is operated.
Type II – Supervised or controlled in connection with a Supported Organization
The distinguishing feature of this type of relationship is the presence of common supervision or control among the governing bodies of all organizations involved, such as the presence of common directors. See 26 C.F.R. § 1.509(a)-4(h).
[T]here must be common supervision or control by the persons supervising or controlling both the supporting organization and the publicly supported organizations to insure that the supporting organization will be responsive to the needs and requirements of the publicly supported organizations. Therefore, in order to meet such requirement, the control or management of the supporting organization must be vested in the same persons that control or manage the publicly supported organizations.
Id.
Type III – Operated in connection with a Supported Organization
The distinguishing feature of this type of relationship is that the supporting organization is responsive to, and significantly involved in the operations of, the publicly supported organization. See 26 C.F.R. § 1.509(a)-4(i). The Type III organization must satisfy a notification requirement, a responsive test, and an integral part test (either functionally integrated or non-functionally integrated) set forth in section 1.509(a)-4(i) of the Treasury Regulations. The details of that qualification are too great for this already-verbose blog.
Example of Type I Supporting Organization
With some exceptions, the publicly supported organization must be identified in the supporting organization’s articles of organization. See 26 C.F.R. § 1.509(a)-4(d)(1). And, there is a unique limitation on contributions that a supporting organization may receive. See id. at § 1.509(a)-4(f)(5)(A)(i) (prohibiting contributions from controlling donors).
To qualify as a supporting organization, an example of a purposes statement for inclusion in articles of organization is set forth below:
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SUPPORTING ORG is organized and operated as a nonprofit corporation pursuant to the laws of the State of _________ and a Type I supporting organization pursuant to section 509(a)(3) of the Internal Revenue Code. In this regard, SUPPORTING ORG is organized, and at all times shall be operated, exclusively for the benefit of, to perform the qualified charitable or educational functions (within the meaning of section 170(c)(2) of the Internal Revenue Code) of, or to carry out the qualified charitable or educational purposes of QUALIFIED SUPPORTED ORG, a ______________ corporation/organization and a publicly supported organization as described in paragraph (2) of section 509(a) of the Internal Revenue Code.
SUPPORTING ORG’s operations, activities and assets are dedicated exclusively to carry on qualified charitable and educational functions and activities (within the meaning of section 170(c)(2) of the Internal Revenue Code) for, or for the benefit of the SUPPORTED ORG.
Subject to any limitations prescribed by the Internal Revenue Code with regard to SUPPORTING ORG as a Type I supporting organization, SUPPORTING ORG is authorized to receive property by contributions, gifts, bequests or any other legal means, and to invest and reinvest the same, and to apply the income and principle thereof, as SUPPORTING ORG may from time to time determine, for the purposes outlined in these articles of organization.
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The statutory requirements also provide that the articles of organization shall not expressly empower the organization to engage in activities which are not in furtherance of the purposes referenced in subsection (3)(A) of section 509(a), that is, organized “exclusively for the benefit of, to perform the functions of, or to carry out the purposes” of the specified publicly supported organization.
The articles of organization should also dovetail with the governance control required by the Code and Treasury Regulations, which can be achieved by carefully crated articles or bylaws provisions. One example is as follows:
The affairs of SUPPORTING ORG shall be managed by a Board of Directors. The Board of Directors will be constituted by Directors. The specific number of Directors to serve on the Board of Directors, the qualifications, terms of office, manner of appointment, place, and notice of meetings, and the powers and duties of Directors shall be such as are prescribed by the Bylaws of SUPPORTING ORG; provided, however, at all times at least a majority of the Directors of SUPPORTING ORG’s Board of Directors shall consist of Directors who are the designated, ex officio officers of SUPPORTED ORG or are appointed by SUPPORTED ORG’s Board of Directors or officers.
The Supporting Organization’s Bylaws
The supporting organization’s bylaws should dovetail neatly with the articles of organization designed to qualify the organization pursuant to section 509(a)(3). The objectives of the organization, as stated in the bylaws, should correspond with the purposes stated in the articles of organization. The bylaws should accommodate the “supported-organization-control” required over the decision-makers of the supporting organization. As noted above, a Type I relationship requires a substantial degree of direction over the policies, programs, and activities of the supporting organization by the publicly supported organizations. According to the Treasury Regulations, this relationship is established by the fact that a majority of the officers or directors of SUPPORTING ORG are appointed or elected by the governing body or officers of SUPPORTED ORG. See 26 C.F.R. § 1.509(a)-4(g).
One way to capture this requirement is to confirm in the bylaws—and to put into practice—a requirement that at all times at least a majority of the directors of SUPPORTING ORG’s board of directors shall consist of directors who are the designated, ex officio officers of SUPPORTED ORG or are appointed by SUPPORTED ORG’s board of directors or officers.
Insights. Section 509(a)(3) offers opportunity for organizations desiring to exist without the burdens of private foundation status and exclusively to support one or more organizations described in section 509(a)(1) or (2) of the Code, including the charitable, etc. functions of organizations organized pursuant to sections 501(c)(4), (5), or (6). The “tax-devil” is in the details, and it is advisable to get the organizational structure right on the front end to avoid tax consequences to the supporting organization or its management in their support of another presumably qualified supported organization.
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