A post to Exponent Philanthropy's blog

What’s Your “Type”? Complex New Regulations Highlight Importance of Supporting Organization Classification

For funders, especially private foundations, the federal tax rules governing supporting organizations can be important. Grants by private foundations to certain types of supporting organizations are subject to expenditure responsibility and may not be counted toward the private foundation’s annual 5% minimum distribution requirement.

The complexity of the rules governing supporting organizations, updated on February 19, 2016, can be daunting, and most foundations need only focus on the “type” of a potential supporting organization grantee to determine if they must modify their grantmaking process or reporting with respect to the grant, or to consider whether to make the grant at all.

Please see below for some general information about supporting organizations and the new regulations. If you find yourself with questions about a grant to a supporting organization, we encourage you to seek legal counsel.

First, some background.

A 501(c)(3) organization can be classified as a public charity in any of three ways: (1) by being an institution that is traditionally viewed as publicly supported, such as a church, school, or hospital; (2) by meeting one of two mathematical public support tests; or (3) by qualifying as a supporting organization to one or more other organizations that fall into one of the first two categories.

Within this last group are three categories of supporting organizations, distinguished by their different relationships with their publicly supported organizations (“PSOs”):

  • a Type I supporting organization is operated, supervised, or controlled by one or more PSOs;
  • a Type II supporting organization is supervised or controlled in connection with one or more PSOs (common supervision or control over both organizations by the same persons); and
  • a Type III supporting organization is operated in connection with one or more PSOs; Type III supporting organizations are further classified into functionally integrated supporting organizations (“FISOs”) or non-functionally integrated supporting organizations (“non-FISOs”).

Grants to non-FISOs do not count toward a private foundation’s minimum distribution requirement, and the foundation must use expenditure responsibility in making the grant.

Knowing your grantee’s “type.”

When making a grant to a supporting organization, the foundation needs to be aware of which of these types it is before making the grant. Unfortunately, the foundation cannot simply rely on the grantee’s own reporting on its Form 990. Also, the recent regulations provided additional complex rules regarding what it means to be a FISO and a non-FISO.

The IRS has indicated (both on its website and in other published guidance) that, in determining whether an organization is a public charity, and, if a supporting organization, its type, a private foundation “generally may rely on:

  • Information from the IRS Business Master File (“BMF”) downloaded from the IRS website or obtained from a third party, if certain requirements are met (see section 4 of Revenue Procedure 2011-33); or
  • The grantee’s current IRS letter recognizing the organization as tax-exempt and indicating its public charity classification.”

The IRS notes that a grantor cannot rely on these sources “to the extent that: [t]he IRS has provided public notice that the organization’s status has changed; or [t]he grantor had knowledge of the change of status prior to such publication, or was in part responsible for, or was aware of, the act or the failure to act that gave rise to such change of status.”

Since the grantee’s public charity classification may change from the time it is granted its determination letter, a funder should always check Select Check or the IRS BMF (or a service provided by a third party meeting the requirements of Revenue Procedure 2011-33, like GuideStar Charity Check) instead of relying solely on the determination letter.

If no information about a potential grantee’s supporting organization type may be found in any of the sources indicated above, the grantor may need to consult with legal counsel to obtain an opinion regarding the grantee’s classification.

Be careful about control by your insiders.

As part of your foundation’s analysis of what type the supporting organization is, be sure to consider your own foundation’s relationship with the organization. A private foundation grant to a Type I, II, or III (FISO) is not a qualifying distribution (and requires expenditures responsibility) if it is made to a supporting organization that is controlled, or any of whose supported organizations are controlled, directly or indirectly by foundation insiders and their related parties. This can be a difficult factual analysis, not least of all because a foundation may not always know the entire class of supported organizations of a given supporting organization grantee. But a foundation should be able to determine whether any of its own insiders control any public charities; if not, your foundation should not have a problem with avoiding this control issue.

With careful due diligence, private foundation funders should be able to assess whether to give the green light to a supporting organization grant, or whether additional steps are necessary.

nancy-mcglameryNancy McGlamery is a principal at the San Francisco-based law firm Adler & Colvin. Her clients include public charities, private foundations, grantmakers, nonprofit service providers, individual and corporate donors, nonprofit advocacy groups, and others. Her practice emphasizes corporate governance and federal and state tax law matters unique to nonprofit and tax-exempt organizations.

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