[Federal Register Volume 74, Number 184 (Thursday, September 24, 2009)]
[Proposed Rules]
[Pages 48672-48687]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E9-22866]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 53

[REG-155929-06]
RIN 1545-BG31


Payout Requirements for Type III Supporting Organizations That 
Are Not Functionally Integrated

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains proposed regulations regarding the 
requirements to qualify as a Type III supporting organization that is 
operated in connection with one or more supported organizations. The 
regulations reflect changes to the law made by the Pension Protection 
Act of 2006. The regulations will affect Type III supporting 
organizations and their supported organizations.

DATES: Written or electronic comments and requests for a public hearing 
must be received by December 23, 2009.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-155929-06), room 
5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand-delivered Monday through

[[Page 48673]]

Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-
155929-06), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue, NW., Washington, DC, or sent electronically via the Federal 
eRulemaking Portal at http://www.regulations.gov/ (IRS REG-155929-06).

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Philip T. Hackney or Don R. Spellmann at (202) 622-6070; concerning 
submissions of comments and requests for a public hearing, Richard A. 
Hurst at (202) 622-7180 (not toll-free numbers) or 
[email protected].

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collection of information contained in this notice of proposed 
rulemaking has been submitted to the Office of Management and Budget 
for review in accordance with the Paperwork Reduction Act of 1995 (44 
U.S.C. 3507(d)). Comments on the collection of information should be 
sent to the Office of Management and Budget, Attn: Desk Officer for the 
Department of the Treasury, Office of Information and Regulatory 
Affairs, Washington, DC 20503, with copies to the Internal Revenue 
Service, Attn: IRS Reports Clearance Officer, SE:W:CAR:MP:T:T:SP, 
Washington, DC 20224. Comments on the collection of information should 
be received by November 23, 2009. Comments are specifically requested 
concerning:
    Whether the proposed collection of information is necessary for the 
proper performance of the functions of the Internal Revenue Service, 
including whether the information will have practical utility;
    The accuracy of the estimated burden associated with the proposed 
collection of information;
    How the quality, utility, and clarity of the information to be 
collected may be enhanced;
    How the burden of complying with the proposed collection of 
information may be minimized, including through forms of information 
technology; and
    Estimates of capital or start-up costs and costs of operation, 
maintenance, and purchase of services to provide information.
    The collection of information in this proposed regulation is in 
Prop. Reg. Sec.  1.509(a)-4(i)(2). The collection of information flows 
from section 509(f)(1)(A), which requires a Type III supporting 
organization to provide to each of its supported organizations such 
information as the Secretary may require to ensure that the Type III 
supporting organization is responsive to the needs or demands of its 
supported organization(s). The likely recordkeepers are Type III 
supporting organizations.
    Estimated total annual reporting burden: 8,400 hours.
    Estimated average annual burden hours per recordkeeper: Two hours.
    Estimated number of recordkeepers: 4,200.
    Estimated frequency of collection of such information: Annual.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless it displays a valid 
control number assigned by the Office of Management and Budget. Books 
or records relating to a collection of information must be retained as 
long as their contents may become material in the administration of any 
internal revenue law. Generally, tax returns and return information are 
confidential, as required by 26 U.S.C. 6103.

Background

    An organization described in section 501(c)(3) of the Internal 
Revenue Code (Code) is classified as either a private foundation or a 
public charity. To be classified as a public charity, an organization 
must meet the requirements of section 509(a)(1), (2), (3), or (4). 
Organizations described in section 509(a)(3) are known as supporting 
organizations. Such organizations achieve their status by providing 
support to one or more organizations described in section 509(a)(1) or 
(2), which in this context are referred to as supported organizations.
    To meet the requirements of section 509(a)(3), an organization must 
satisfy an organizational test, an operational test, a relationship 
test, and a disqualified person control test. The organizational and 
operational tests require that the supporting organization be organized 
and at all times thereafter operated exclusively for the benefit of, to 
perform the functions of, or to conduct the purposes of one or more 
supported organizations. The relationship test requires the supporting 
organization to establish one of three types of relationships with one 
or more supported organizations. Finally, the disqualified person 
control test requires that the supporting organization not be 
controlled directly or indirectly by certain disqualified persons. 
Although each of these tests is a necessary requirement for an 
organization to establish that it qualifies as a supporting 
organization, this notice of proposed rulemaking (NPRM) focuses 
primarily on the relationship test.

Three Types of Supporting Organizations

    Treas. Reg. Sec.  1.509(a)-4(f)(2) provides that a supporting 
organization must maintain one of three types of structural or 
operational relationships with its supported organization(s). A 
supporting organization that is operated, supervised or controlled by 
one or more supported organizations is commonly known as a Type I 
supporting organization. The relationship of a Type I supporting 
organization with its supported organization(s) is comparable to that 
of a corporate parent-subsidiary relationship. A supporting 
organization that is supervised or controlled in connection with one or 
more supported organizations is commonly known as a Type II supporting 
organization. The relationship of a Type II supporting organization 
with its supported organization(s) is comparable to a corporate 
brother-sister relationship. A supporting organization that is operated 
in connection with one or more supported organizations is commonly 
known as a Type III supporting organization. This NPRM focuses 
primarily on Type III supporting organizations.

Qualification Requirements for Type III Supporting Organizations Prior 
to Enactment of the Pension Protection Act of 2006, Public Law 109-280 
(120 Stat. 780 (2006)) (PPA)

    Prior to the enactment of the PPA, the regulations under section 
509(a)(3) generally provided that an organization is ``operated in 
connection with'' one or more supported organizations if it meets a 
``responsiveness test'' and an ``integral part test.''

Responsiveness Test

    Treas. Reg. Sec.  1.509(a)-4(i)(2)(i) provides that an organization 
meets the responsiveness test if the organization is responsive to the 
needs or demands of its supported organizations. Treas. Reg. Sec.  
1.509(a)-4(i)(2)(ii) provides three ways that a supporting organization 
may demonstrate responsiveness to a supported organization: (1) The 
supported organization appoints or elects one or more of the officers, 
directors, or trustees of the supporting organization; (2) one or more 
members of the governing body of the supported organization serve as 
officers, directors, or trustees of, or hold other important offices 
in, the supporting organization; or (3) the officers, directors, or 
trustees of the supporting organization maintain

[[Page 48674]]

a close continuous working relationship with the officers, directors, 
or trustees of the supported organization. In all three cases, the 
relationship must result in the supported organization having a 
significant voice in the investment policies of the supporting 
organization, the timing and the manner of making grants, the selection 
of the grant recipients of the supporting organization, and direction 
over the use of the income or assets of the supporting organization.
    The existing regulations also provide an alternative means for 
charitable trusts to satisfy the responsiveness test. Under Treas. Reg. 
Sec.  1.509(a)-4(i)(2)(iii), a supporting organization is responsive 
if: (1) it is a charitable trust under State law, (2) each specified 
supported organization is a named beneficiary under the charitable 
trust's governing instrument, and (3) each beneficiary organization has 
the power to enforce the trust and compel an accounting under State 
law.
    In the case of an organization that was supporting one or more 
supported organizations before November 20, 1970, Treas. Reg. Sec.  
1.509(a)-4(i)(1)(ii) provides that additional facts and circumstances, 
such as a historic and continuing relationship between the supporting 
organization and its supported organization(s), also may be taken into 
account to establish compliance with the responsiveness test.

Integral Part Test

    Treas. Reg. Sec.  1.509(a)-4(i)(3)(i) provides that a supporting 
organization meets the integral part test by maintaining a significant 
involvement in the operations of one or more supported organizations 
that are dependent upon the supporting organization for the type of 
support which it provides. Under the existing regulations, there are 
two alternative ways to meet the integral part test: (1) The ``but 
for'' test under Treas. Reg. Sec.  1.509(a)-4(i)(3)(ii); or (2) the 
``attentiveness'' test under Treas. Reg. Sec.  1.509(a)-4(i)(3)(iii).
    Treas. Reg. Sec.  1.509(a)-4(i)(3)(ii) states that the ``but for'' 
test is satisfied if ``the activities engaged in [by the supporting 
organization] for or on behalf of the supported organizations are 
activities to perform the functions of, or to carry out the purposes 
of, such organizations, and, but for the involvement of the supporting 
organization, would normally be engaged in by the supported 
organizations themselves.''
    The ``attentiveness'' test under Treas. Reg. Sec.  1.509(a)-
4(i)(3)(iii) requires a supporting organization to: (1) Make payments 
of substantially all of its income to or for the use of one or more 
supported organizations, (2) provide enough support to one or more 
supported organizations to ensure the attentiveness of such 
organization(s) to the operations of the supporting organization; and 
(3) pay a substantial amount of the total support of the supporting 
organization to those supported organizations that meet the 
attentiveness requirement. Rev. Rul. 76-208, 1976-1 CB 161 (see Sec.  
601.601(d)(2)(ii)(b)), provides that the phrase ``substantially all of 
its income'' in Treas. Reg. Sec.  1.509(a)-4(i)(3)(iii) means at least 
85 percent of adjusted net income.

PPA Changes to Qualification Requirements for Type III Supporting 
Organizations

    The PPA made five changes to the requirements an organization must 
meet to qualify as a Type III supporting organization:
    (1) It removed the alternative test for charitable trusts as a 
means of meeting the responsiveness test;
    (2) It required the Secretary of the Treasury to set a new payout 
requirement for organizations that are not functionally integrated 
(generally, those organizations that met the integral part test by 
satisfying the attentiveness test under the existing regulations) to 
ensure that such organizations pay a ``significant amount'' to their 
supported organizations;
    (3) It provided that a Type III supporting organization must 
annually provide to each of its supported organizations such 
information as the Secretary may require to ensure that the supporting 
organization is responsive to the needs or demands of its supported 
organization(s);
    (4) It prohibited a Type III supporting organization from 
supporting any supported organization not organized in the United 
States; and
    (5) It prohibited a Type I or Type III supporting organization from 
accepting a gift or contribution from a person who, together with 
certain related persons, directly or indirectly controls the governing 
body of a supported organization of the Type I or Type III supporting 
organization.

Notice 2006-109

    On December 18, 2006, the Treasury Department and the IRS released 
Notice 2006-109 (2006-51 IRB 1121) (see Sec.  601.601(d)(2)(ii)(b)), 
which alerted taxpayers to the new supporting organization rules 
enacted by the PPA; provided interim guidance, including reliance 
standards for private foundations making grants to supporting 
organizations; and solicited comments regarding the new supporting 
organization requirements. Fifteen comments and numerous phone calls 
were received in response to the request for comments contained in 
Notice 2006-109.

Advanced Notice of Proposed Rulemaking (ANPRM)

    On August 2, 2007, the Treasury Department and the IRS issued an 
ANPRM titled ``Payout Requirements for Type III Supporting 
Organizations that Are Not Functionally Integrated'' (Reg-155929-06, 72 
FR 148). The ANPRM described proposed rules to implement the PPA 
changes to the Type III supporting organization requirements, and 
solicited comments regarding those proposed rules.
    In the ANPRM, the Treasury Department and the IRS proposed that all 
Type III supporting organizations would be required to meet the 
responsiveness test under Treas. Reg. Sec.  1.509(a)-4(i)(2)(ii). In 
addition, the Treasury Department and the IRS proposed that Type III 
supporting organizations that are functionally integrated would be 
required to meet: (A) The ``but for'' test in existing Treas. Reg. 
Sec.  1.509(a)-4(i)(3)(ii); (B) an expenditure test resembling the 
section 4942(j)(3)(A) qualifying distributions test for private 
operating foundations; and (C) an assets test resembling the section 
4942(j)(3)(B) alternative assets test for private operating 
foundations. However, the Treasury Department and the IRS indicated 
that an exception would be provided for certain Type III supporting 
organizations that oversee or facilitate the operation of an integrated 
system, such as certain hospital systems. The ANPRM stated that such 
organizations would be classified as functionally integrated as long as 
they satisfied the responsiveness and ``but for'' tests under the 
existing regulations.
    The ANPRM proposal provided that a non-functionally integrated Type 
III supporting organization would be required to make an annual payout 
equal to the annual payout required from a private non-operating 
foundation (generally, five percent of the fair market value of non-
exempt-use assets). The Treasury Department and the IRS also proposed a 
limitation on the number of supported organizations a non-functionally 
integrated Type III supporting organization could support.
    The IRS received over 40 comments and numerous phone calls in 
response to the ANPRM. After consideration of all comments received, 
the Treasury Department and the IRS are issuing this

[[Page 48675]]

NPRM regarding the new qualification requirements for Type III 
supporting organizations. The major areas of comment in response to the 
ANPRM are discussed in the preamble under Explanation of Provisions.

Explanation of Provisions

Summary of Proposed Criteria To Qualify as a Type III Supporting 
Organization

    The proposed regulations provide that every Type III supporting 
organization must: (1) Satisfy the notification requirement set forth 
under Prop. Reg. Sec.  1.509(a)-4(i)(2); (2) meet the responsiveness 
test set forth under Prop. Reg. Sec.  1.509(a)-4(i)(3); and (3) 
demonstrate that it is an integral part of one or more supported 
organizations. A Type III supporting organization demonstrates that it 
is an integral part of a supported organization by satisfying either 
the requirements for functionally integrated Type III supporting 
organizations set forth in Prop. Reg. Sec.  1.509(a)-4(i)(4), or the 
requirements for non-functionally integrated Type III supporting 
organizations set forth in Prop. Reg. Sec.  1.509(a)-4(i)(5). Further, 
as set forth in Prop. Reg. Sec.  1.509(a)-4(i)(10), a Type III 
supporting organization may not support a supported organization that 
is organized outside of the United States. Finally, as set forth in 
Prop. Reg. Sec.  1.509(a)-4(f)(5), Type I and Type III supporting 
organizations are prohibited from accepting a gift or contribution from 
a person who, together with certain related persons, directly or 
indirectly controls the governing body of a supported organization of 
the Type I or Type III supporting organization.

Requirement To Notify Supported Organizations

    Prop. Reg. Sec.  1.509(a)-4(i)(2) implements section 509(f)(1)(A) 
of the Code, which provides that a Type III supporting organization 
must provide to each of its supported organizations such information as 
the Secretary may require to ensure that the supporting organization is 
responsive to the needs or demands of the supported organization.
    The Treasury Department and the IRS requested comments in the ANPRM 
on the type of information a Type III supporting organization should be 
required to provide to its supported organizations. One commentator 
recommended that the proposed regulations adopt a recommendation of the 
Panel on the Nonprofit Sector, which suggested requiring Type III 
supporting organizations to provide annually to their supported 
organizations: (1) A copy of governing documents, including those filed 
with Form 1023, ``Application for Recognition of Exemption Under 
Section 501(c)(3) of the Internal Revenue Code,'' and any updates; (2) 
a copy of Form 990, ``Return of Organization Exempt from Income Tax;'' 
and (3) an annual report of activities, including a narrative, 
financial detail, and a description of the support provided (including 
how it was calculated or determined) and a projection of support to be 
provided in the subsequent year. Panel on the Nonprofit Sector, 
Strengthening Transparency, Governance, Accountability of Charitable 
Organizations (June 2005), at 45.
    Another commentator recommended that the proposed regulations 
require only that the Form 990 be distributed to the ``lead'' supported 
organization. This commentator argued that any additional requirement 
would impose too much additional administrative burden and cost on the 
charitable sector. The comment also suggested allowing the notification 
to be provided electronically.
    The proposed regulations require that each taxable year, a Type III 
supporting organization must provide to each of its supported 
organizations: (A) A written notice addressed to a principal officer of 
the supported organization identifying the supporting organization and 
describing the amount and type of support it provided to the supported 
organization in the past year; (B) a copy of the supporting 
organization's most recently filed Form 990; and (C) a copy of the 
supporting organization's governing documents, including any 
amendments. Copies of governing documents need only be provided once. 
The proposed regulations provide that the required notice and documents 
may be delivered by electronic media. Organizations must satisfy the 
notification requirement to qualify as a Type III supporting 
organization and should retain proof of delivery in their records.

Responsiveness Test

    The proposed regulations provide that all Type III supporting 
organizations, including those organized as charitable trusts, must 
meet the responsiveness test under existing Treas. Reg. Sec.  1.509(a)-
4(i)(2)(ii).
    The ANPRM proposed to apply the responsiveness test to all Type III 
supporting organizations and to remove the special rule for charitable 
trusts. In response to the ANPRM, commentators argued that the PPA did 
not require imposition of the general responsiveness test on charitable 
trusts, and that the test could be difficult to satisfy because of 
State-law fiduciary requirements on trusts. Thus, a commentator 
recommended the development of an alternate charitable trust test based 
on facts and circumstances.
    One commentator recommended exempting trusts managed by 
institutional trustees from the responsiveness test. The commentator 
stated that institutional trustees employ strict rules to manage 
trusts, thereby making abuse of these trusts highly unlikely. Another 
commentator recommended transition relief for trusts in existence on 
the date the PPA was enacted similar to that provided in Treas. Reg. 
Sec.  1.509(a)-4(i)(4) for trusts established before November 20, 1970, 
which would apply to a trust with a lengthy and continuous history of 
distributions, and no discretion to vary the beneficiaries or the 
amount of distributions.
    The proposed regulations require that all Type III supporting 
organizations demonstrate the necessary relationship between its 
officers, directors or trustees and those of the supported 
organization, and show that this relationship results in the officers, 
directors or trustees of the supported organization having a 
significant voice in the operations of the supporting organization. The 
proposed regulations do not adopt a special rule for trusts.
    The Treasury Department and the IRS believe that requiring 
charitable trusts to meet the responsiveness test set forth in these 
proposed regulations is consistent with Congress' intent in the PPA. 
The Treasury Department and the IRS expect that some charitable trusts 
will be able to demonstrate that they meet the requirements of the 
responsiveness test. The proposed regulations provide examples that 
illustrate factors that could lead to a conclusion that a supporting 
organization organized as a trust is responsive to the needs of a 
supported organization. Additionally, the Treasury Department and the 
IRS request comments regarding a specific responsiveness rule for 
trusts that would be consistent with the existing responsiveness test 
and the Congressional intent behind section 1241 of the PPA, which 
removed the alternative trust test in the regulations.

Integral Part Test--Functionally Integrated Type III Supporting 
Organizations

    The proposed regulations provide that a Type III supporting 
organization is functionally integrated if it either: (1)

[[Page 48676]]

Engages in activities substantially all of which directly further the 
exempt purposes of the supported organization(s) to which it is 
responsive by performing the functions of, or carrying out the purposes 
of, such supported organization(s) and that, but for the involvement of 
the supporting organization, would normally be engaged in by the 
supported organization(s); or (2) is the parent of each of its 
supported organizations.
    The ANPRM proposed requiring an organization to meet not only the 
``but for'' test under existing Treas. Reg. Sec.  1.509(a)-4(i)(3)(ii), 
but also two additional tests--an expenditure test and an assets test--
in order to qualify as a functionally integrated Type III supporting 
organization. In general, commentators said that the additional tests 
were unduly restrictive and more burdensome than those proposed for 
non-functionally integrated Type III supporting organizations. These 
commentators argued that the ANPRM's expenditure test was arbitrary and 
that Congress did not authorize the Secretary to impose a payout 
requirement on functionally integrated organizations. Many commentators 
highlighted differences between a Type III supporting organization and 
a private operating foundation that warrant treating these types of 
organizations differently, including the fact that a supporting 
organization is dedicated to specific organizations and that those 
specified organizations rely on the supporting organization for 
consistent support.
    Many commentators recommended exempting certain types of 
organizations from the proposed requirements for functionally 
integrated Type III supporting organizations, such as long-standing 
supporting organizations and supporting organizations that support 
governmental agencies, religious organizations, and grant-making 
organizations. Several commentators recommended that the proposed 
regulations take into account the historic and continuing relationship 
of ``long-standing'' organizations with their supported organizations. 
Additionally, many commentators requested an exemption for supporting 
organizations of governmental entities, contending that these 
organizations are not subject to abuse because of their connection to a 
governmental entity. These commentators argued that supporting 
organizations choose a Type III structure to ensure that funds are 
dedicated long-term to a specific purpose, and removed from the 
appropriation process of the government.
    In formulating the criteria in the proposed regulations, the 
Treasury Department and the IRS also noted the suggestion in the Joint 
Committee on Taxation's Technical Explanation of the PPA that 
``substantially all of the activities of [a functionally integrated 
Type III supporting organization] should be activities in direct 
furtherance of the functions or purposes of supported organizations.'' 
Staff of the Joint Committee on Taxation, Technical Explanation of H.R. 
4, The ``Pension Protection Act of 2006'' (Aug. 3, 2006), at 360 n.571 
(Technical Explanation). In the Technical Explanation, the Joint 
Committee on Taxation also expressed concern that ``the current 
regulatory standards for satisfying the integral part test not by 
reason of a payout are not sufficiently stringent to ensure that there 
is a sufficient nexus between the supporting and supported 
organizations.'' Technical Explanation at 360 n.571.
    The Treasury Department and the IRS believe that a sufficient nexus 
exists between a supporting organization and its supported 
organization(s) where the supporting organization engages in activities 
that directly further the exempt purposes of the supported 
organization(s) and that would otherwise be conducted by the supported 
organization itself. Accordingly, the proposed regulations provide that 
a Type III supporting organization is functionally integrated if it 
either: (1) Engages in activities (a) substantially all of which 
directly further the exempt purposes of the supported organization(s) 
to which it is responsive by performing the functions of, or carrying 
out the purposes of, such supported organization(s) and (b) that, but 
for the involvement of the supporting organization, would normally be 
engaged in by the supported organization(s); or (2) is the parent of 
each of its supported organizations. The Treasury Department and the 
IRS request comments on how guidance might clarify the application of 
the ``substantially all'' test in this context. The proposed 
regulations do not adopt the expenditure test and the assets test 
described in the ANPRM.
    The proposed regulations provide that a supporting organization 
directly furthers the exempt purposes of its supported organization by 
holding or managing exempt-use assets but does not directly further 
such exempt purposes by fundraising, grantmaking, or investing and 
managing non-exempt-use assets. The Treasury Department and the IRS 
believe that fundraising, grantmaking, and investing and managing non-
exempt-use assets do not alone establish a sufficient nexus between a 
supporting organization and its supported organization. Further, the 
Treasury Department and the IRS believe that an organization that does 
not engage in activities that directly further a exempt purpose will 
achieve a sufficient nexus with its supported organization(s) only if 
it distributes a significant amount to its supported organizations, as 
Congress directed in the PPA.
    The Treasury Department and the IRS recognize the unique 
circumstances of a governmental entity whose assets are subject to the 
appropriations process of a Federal, State, local or Indian Tribal 
government and that therefore organizes a Type III supporting 
organization to remove assets from the appropriations process of the 
government. The proposed regulations therefore provide an exception 
under which a supporting organization that supports a single 
governmental entity may treat investing and managing non-exempt-use 
assets as activities that directly further an exempt purpose, so long 
as a substantial part of the supporting organization's total activities 
directly furthers the exempt purposes of such governmental entity.
    The proposed regulations specifically require that a functionally 
integrated Type III supporting organization's activities directly 
further the exempt purposes of those supported organizations with 
respect to which the supporting organization meets the responsiveness 
test under Prop. Reg. Sec.  1.509(a)-4(i)(3). The Treasury Department 
and the IRS request comments on this requirement.
    The proposed regulations provide that a supporting organization 
will be treated as the parent of a supported organization if the 
supporting organization exercises a substantial degree of direction 
over the policies, programs, and activities of the supported 
organization, and the majority of the officers, directors, or trustees 
of the supported organization is appointed or elected, directly or 
indirectly, by the governing body, members of the governing body, or 
officers of the supporting organization acting in their official 
capacity. Thus, the supporting organization could qualify as a parent 
of a second-tier (or lower) subsidiary. The classification of a parent 
supporting organization as functionally integrated is intended to apply 
to supporting organizations that oversee or facilitate the operation of 
an integrated system, such as hospital systems.
    The proposed regulations provide examples that illustrate the

[[Page 48677]]

requirements for functionally integrated Type III supporting 
organizations.

Integral Part Test--Non-Functionally Integrated Type III Supporting 
Organizations

    The proposed regulations provide that a Type III supporting 
organization is non-functionally integrated if it satisfies a 
distribution requirement equal to five percent of the fair market value 
of non-exempt-use assets and an attentiveness requirement.
    Section 1241(d)(1) of the PPA directed the Secretary of the 
Treasury to promulgate new regulations on a payout requirement for non-
functionally integrated Type III supporting organizations, based on 
income or assets, in order to ensure that these supporting 
organizations pay a significant amount to their supported 
organizations. The ANPRM proposal required an annual payout of five 
percent of the fair market value of non-exempt-use assets. Many 
commentators said that this payout rate was too high and would erode an 
organization's assets over time. The commentators said that a Type III 
supporting organization provides long-term consistent support to 
specific organizations, while private foundations may pay out to 
whomever they choose. Further, a supporting organization maintains a 
governance relationship with its supported organization(s) in a way 
that a private foundation does not. Commentators argued that because of 
these differences, the private foundation payout requirement should not 
be imposed on a supporting organization. Imposing a five percent 
payout, these commentators contend, would jeopardize the ability of 
supporting organizations to provide the kind of consistent, reliable, 
long-term support supported organizations have come to expect.
    Commentators suggested a number of alternative payout rates. Many 
of them also recommended allowing an averaging of assets over a period 
of years for purposes of calculating the payout amount.
    The ANPRM proposed to limit the number of organizations a non-
functionally integrated Type III supporting organization can support to 
no more than five. The ANPRM further provided that Type III supporting 
organizations in existence before the date regulations are proposed may 
support more than five organizations, as long as the supporting 
organization pays 85 percent of its support to organizations to which 
the supporting organization is responsive.
    Many commentators asked that the proposed regulations not include 
the limitation on the number of supported organizations a non-
functionally integrated Type III supporting organization can support, 
arguing that such a rule is arbitrary. In particular, commentators 
pointed out that the original Senate bill associated with supporting 
organizations, contained in the Tax Increase Prevention and 
Reconciliation Act of 2005, Public Law 109-222 (120 Stat. 345 (2005)), 
limited the number of organizations a supporting organization could 
support to five, but that Congress ultimately did not enact such a 
limitation.
    One commentator suggested that the proposed regulations adopt a 
rule that one-third of a non-functionally integrated Type III 
supporting organization's required distribution must go to a supported 
organization that is attentive to the supporting organization and to 
which the supporting organization is responsive.
    Commentators recommended providing a transition period for the 
payout requirement to allow organizations sufficient time either to 
modify governing instruments or to sell assets.
    A number of commentators suggested that the proposed regulations 
exempt Type III supporting organizations that (1) have no continuing 
involvement of donors or their family in the governance of the 
organization; and (2) before the date of enactment of PPA, had 
distributed to or for the benefit of its supported organizations an 
amount equal to or greater than the amounts transferred to the 
organization for which charitable deductions were allowed.
    Under the proposed regulations, to qualify as a non-functionally 
integrated Type III supporting organization, an organization must meet 
a distribution requirement and an attentiveness requirement. The 
proposed regulations set the distribution requirement for non-
functionally integrated Type III supporting organizations at five 
percent of non-exempt-use assets, and retain the concept of 
attentiveness that is in the current regulations. The proposed 
regulations do not adopt the five organization limit described in the 
ANPRM.
Distribution Requirement
    To satisfy the distribution requirement of Prop. Reg. Sec.  
1.509(a)-4(i)(5)(ii), a Type III supporting organization that is not 
functionally integrated must distribute, with respect to each taxable 
year, to or for the use of its supported organizations, amounts 
equaling or exceeding five percent of the aggregate fair market value 
of its non-exempt-use assets (the annual distributable amount), on or 
before the last day of such taxable year. The annual distributable 
amount is determined based on asset values measured over the preceding 
taxable year. Thus, for example, a Type III supporting organization 
that is not functionally integrated would determine its annual 
distributable amount for its 2012 taxable year, which must be 
distributed on or before the last day of the organization's 2012 
taxable year, based on asset values measured over its 2011 taxable 
year. A Type III supporting organization that is not functionally 
integrated is not required to distribute any amount in its first year 
of existence.
    The proposed regulations generally draw from the regulations under 
section 4942 for principles on valuation, timing, and carryovers. 
However, the proposed regulations do not permit set-asides, which count 
towards a private foundation's distribution requirement under section 
4942(g)(2). While Congress statutorily provided that set-asides 
constitute qualifying distributions for private foundations, Congress 
made no such statutory provision for supporting organizations. Rather, 
in the PPA, it directed that a payout requirement be implemented for 
non-functionally integrated Type III supporting organizations that 
would result in a prompt, robust flow of support to supported 
organizations. The Treasury Department and the IRS request comments on 
whether set-asides are necessary and consistent with Congressional 
intent in determining whether Type III supporting organizations that 
are not functionally integrated have distributed their annual 
distributable amount.
    The proposed regulations also provide a slightly different rule 
regarding the carryover of excess distributions than is applicable to 
private foundations. Under section 4942(i), a private foundation that 
distributes more than its distributable amount may carry forward that 
excess amount for five years. However, when calculating qualifying 
distributions in a future year under section 4942, amounts paid out in 
the future year count first towards the required distributable amount, 
and any amount carried forward is not ``used'' in the future year to 
the extent that the organization made qualifying distributions in that 
future year. These proposed regulations reverse the ordering rule and 
first count any excess amount carried forward toward the non-
functionally integrated Type III supporting organization's annual 
distributable amount, followed by amounts paid out in the later year.

[[Page 48678]]

    The proposed regulations provide a reasonable cause exception for 
failure to meet the distribution requirement applicable to non-
functionally integrated Type III supporting organizations. Under the 
exception, an organization that fails to meet the distribution 
requirement will not be classified as a private foundation in the 
taxable year for which it fails to meet such distribution requirement, 
if the organization establishes to the satisfaction of the Secretary 
that: (1) The failure was due solely to an incorrect valuation of 
assets, a ministerial error, or unforeseen events or circumstances that 
are beyond the organization's control; (2) the failure was due to 
reasonable cause and not to willful neglect; and (3) the distribution 
requirement is met within 180 days after the date the incorrect 
valuation or ministerial error was or should have been discovered, or 
180 days after the organization is first able to make its required 
payout notwithstanding the unforeseen event or circumstances. The 
reasonable cause exception applies only to the distribution requirement 
of Prop. Reg. Sec.  1.509(a)-4(i)(5)(ii), and not to the attentiveness 
requirement of Prop. Reg. Sec.  1.509(a)-4(i)(5)(iii). The Treasury 
Department and the IRS request comments regarding the reasonable cause 
exception for the distribution requirement.
    The proposed regulations also provide for an emergency temporary 
reduction in the annual distributable amount. Under Prop. Reg. Sec.  
1.509(a)-4(i)(5)(ii)(D), the Secretary may provide by publication in 
the Internal Revenue Bulletin for a temporary reduction in the annual 
distributable amount in the case of a disaster or emergency.
    The Treasury Department and the IRS are aware that some supporting 
organizations impacted by the distribution requirement contained in 
these proposed regulations may be heavily invested in assets that are 
not readily marketable. The Treasury Department and the IRS request 
comments regarding the need for a transition rule for non-functionally 
integrated Type III supporting organizations whose assets, as of the 
effective date of these regulations, consist predominantly (in any 
event more than one-half) of assets that are not readily marketable.
Attentiveness Requirement
    These proposed regulations modify the attentiveness requirement in 
existing Treas. Reg. Sec.  1.509(a)-4(i)(3)(iii) to provide that an 
organization must distribute one-third or more of its annual 
distributable amount to one or more supported organizations that are 
attentive to the supporting organization and with respect to which the 
supporting organization meets the responsiveness test under Prop. Reg. 
Sec.  1.509(a)-4(i)(3).
    The proposed regulations provide that to demonstrate that a 
supported organization is attentive, a supporting organization must 
either: (1) Provide 10 percent or more of the supported organization's 
total support; (2) provide support that is necessary to avoid the 
interruption of the carrying on of a particular function or activity of 
the supported organization; or (3) provide an amount of support that 
based on all the facts and circumstances is a sufficient part of a 
supported organization's total support.

Consequences of Failure to Meet Requirements

    A Type III supporting organization that fails to meet the 
requirements of these proposed regulations, once they are published as 
final or temporary regulations, will be classified as a private 
foundation. Once classified as a private foundation, the section 507 
rules regarding termination of private foundation status apply. The 
Treasury Department and the IRS request comments on whether exceptions 
or special rules under section 507 are needed for Type III supporting 
organizations that are reclassified as private foundations as a result 
of the changes in the PPA.

Transition and Other Relief Provisions

Responsiveness Test
    The proposed regulations continue to provide that additional facts 
and circumstances, such as a historic and continuing relationship with 
a supported organization, may be taken into account in establishing 
compliance with the responsiveness test for organizations that were 
operating prior to November 20, 1970.
Integral Part Test
    The proposed regulations provide a transition rule for Type III 
supporting organizations in existence on the date these regulations are 
published in the Federal Register as final or temporary regulations. 
Under the transition rule, such organizations that met and continue to 
meet the requirements of existing Treas. Reg. Sec.  1.509(a)-
4(i)(3)(ii) (i.e., an organization that meets the integral part test by 
satisfying the ``but for'' test) will be treated as meeting the 
requirements of a functionally integrated Type III supporting 
organization set forth in Prop. Reg. Sec.  1.509(a)-4(i)(4) until the 
first day of the organization's first taxable year beginning after the 
date these proposed regulations are published as final or temporary 
regulations.
    The proposed regulations also provide that Type III supporting 
organizations in existence on the date these regulations are published 
in the Federal Register as final or temporary regulations that met and 
continue to meet the requirements of existing Treas. Reg. Sec.  
1.509(a)-4(i)(3)(iii) will be treated as meeting the requirements of a 
non-functionally integrated Type III supporting organization set forth 
in Prop. Reg. Sec.  1.509(a)-4(i)(5) until the first day of the 
organization's second taxable year beginning after the date these 
proposed regulations are published as final or temporary regulations. 
Such organizations will be required to value their assets in accordance 
with Prop. Reg. Sec.  1.509(a)-4(i)(8) in the first taxable year 
beginning after final or temporary regulations are published, and to 
meet all of the requirements of Prop. Reg. Sec.  1.509(a)-4(i)(5)(i) in 
the second taxable year beginning after the publication of these 
regulations as final or temporary regulations and for all succeeding 
taxable years.
    For example, if the Treasury Department and the IRS publish these 
regulations as final or temporary regulations any time in 2010, a 
calendar-year non-functionally integrated Type III supporting 
organization must: (1) in 2010, meet all of the requirements of 
existing Treas. Reg. Sec.  1.509(a)-4(i)(3)(iii) (i.e., distribute to 
its supported organizations substantially all of its income in accord 
with the existing regulations); (2) in 2011, meet all of the 
requirements of current Treas. Reg. Sec.  1.509(a)-4(i)(3)(iii) and 
value its assets according to Prop. Reg. Sec.  1.509(a)-4(i)(8); and 
(3) in 2012, meet all of the requirements of Prop. Reg. Sec.  1.509(a)-
4(i)(5)(i), including the distribution requirement.
    The proposed regulations also retain the exception from the 
integral part test for pre-November 20, 1970 trusts that meet certain 
other requirements found in current Treas. Reg. Sec.  1.509(a)-4(i)(4).
    The Treasury Department and the IRS request comments on whether 
additional transition relief is needed.
    The proposed regulations eliminate current Treas. Reg. Sec.  
1.509(a)-4(i)(1)(iii), which provides an exception from the integral 
part test if an organization can establish that: (1) It met the payout 
requirement under current Treas. Reg. Sec.  1.509(a)-4(i)(3)(iii)(a) 
for any five-year period; (2) it cannot meet such payout requirement 
for its current taxable year solely because the amount received by

[[Page 48679]]

one or more of the supported organizations is no longer sufficient to 
satisfy the attentiveness requirement; and (3) there has been a 
historic and continuing relationship of support between such 
organizations between the end of the five-year period and the taxable 
year in question. The Treasury Department and the IRS believe that the 
breadth of this exception is inconsistent with Congress' intent in 
mandating a payout requirement in the PPA.

Regulations Under Section 4943

    This NPRM also includes proposed regulations under section 4943 
that provide two transition rules to address excess business holdings 
for Type III supporting organizations affected by the PPA. The PPA 
applied the section 4943 excess business holdings excise tax to non-
functionally integrated Type III supporting organizations. However, it 
provided that in calculating the ``present holdings'' of Type III 
supporting organizations in existence on August 17, 2006 (the date of 
enactment of the PPA), the transition rules that applied to private 
foundations in 1969, when section 4943 was first enacted, would apply. 
These transition rules effectively allow affected organizations 
additional time to dispose of certain business holdings.
    The proposed regulations provide transition relief to a private 
foundation that qualified as a Type III supporting organization under 
section 509(a)(3) immediately before August 17, 2006, and that was 
reclassified as a private foundation under section 509(a) on or after 
August 17, 2006, solely as a result of the rules enacted by Section 
1241 of the PPA. Thus, under the proposed regulations, the present 
holdings of such private foundations will be determined using the same 
rules that apply to Type III supporting organizations under section 
4943(f)(7).
    In addition, the Treasury Department and the IRS believe that pre-
November 20, 1970 trusts that are exempted from the integral part test 
under current regulations and these proposed regulations should not be 
subject to the excess business holdings excise tax that applies to non-
functionally integrated Type III supporting organizations. Therefore, 
the proposed regulations under section 4943 provide that a Type III 
supporting organization created as a trust before November 20, 1970, 
that meets the requirements of current Treas. Reg. Sec.  1.509(a)-
4(i)(4) and Prop. Reg. Sec.  1.509(a)-4(i)(9), will be treated as a 
``functionally integrated Type III supporting organization'' for 
purposes of section 4943(f)(3)(A).

Reliance on Prior Guidance

    In Notice 2006-109, the Treasury Department and the IRS provided 
guidance to private foundations regarding determinations of the public 
charity status of a section 501(c)(3) organization when making grants. 
In particular, because a grant to a non-functionally integrated Type 
III supporting organization is not considered a qualifying distribution 
under section 4942, and is considered a taxable expenditure unless 
expenditure responsibility is exercised under section 4945, the notice 
provided criteria for determining whether a Type III supporting 
organization is functionally integrated and allowed private foundations 
to rely on those criteria for purposes of sections 4942 and 4945. 
Commentators to the ANPRM requested that the Treasury Department and 
the IRS permit private foundations to continue to rely on the guidance 
in Notice 2006-109 on private foundation grantmaking until the IRS 
issues determination letters addressing functionally integrated status.
    Private foundations can continue to rely on the grantor reliance 
standards of section 3.0 of Notice 2006-109 until these proposed 
regulations are published as final or temporary regulations.
    In addition, the IRS stated in a September 24, 2007 memorandum from 
the Director of Exempt Organizations Rulings and Agreements that it 
would issue functionally integrated Type III supporting organization 
determinations to organizations that meet the requirements for 
functionally integrated organizations set forth in the ANPRM. As of the 
date of the publication in the Federal Register of this notice of 
proposed rulemaking, the IRS will issue a functionally integrated Type 
III supporting organization determination only to organizations that 
meet the requirements of Prop. Reg. Sec.  1.509(a)-4(i)(4). An 
organization that received a determination that it qualified as a 
functionally integrated Type III supporting organization under the 
ANPRM can continue to rely on such determination letter until final or 
temporary regulations are published in the Federal Register, so long as 
the organization continues to meet the requirements of either the ANPRM 
or Prop. Reg. Sec.  1.509(a)-4(i)(4). An organization that receives a 
determination that it is a functionally integrated Type III supporting 
organization under either the ANPRM or these proposed regulations will 
be required to meet the requirements established in final or temporary 
regulations as of the first taxable year beginning after final or 
temporary regulations are published in the Federal Register.

Effective Date

    The proposed regulations will apply to taxable years beginning 
after the date these rules are published in the Federal Register as 
final or temporary regulations.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
12866. Therefore, a regulatory assessment is not required. It is hereby 
certified that this regulation will not have a significant economic 
impact on a substantial number of small entities. This certification is 
based on the fact that this regulation will not impact a substantial 
number of small entities. Based on IRS Statistics of Income data for 
2005, there are over 1.4 million organizations that qualify as exempt 
from Federal income tax under section 501(c)(3). Approximately 13,000 
of the 1.4 million exempt organizations reported as supporting 
organizations; approximately 4,200 supporting organizations reported as 
Type III supporting organizations; and it is expected that some 
fraction of the 4,200 Type III supporting organizations may be 
classified as non-functionally integrated Type III supporting 
organizations. Thus, the number of organizations affected by this 
regulation will not be substantial. The collection of information in 
this regulation that is subject to the Regulatory Flexibility Act will 
impose a minimal burden upon the affected organizations. All of the 
information required to be delivered is information that the 
organization is already required to maintain. Further, the distribution 
requirement in Prop. Reg. Sec.  1.509(a)-4(i)(5)(ii) for non-
functionally integrated Type III supporting organizations does not have 
a significant economic impact. A non-functionally integrated Type III 
supporting organization that fails to satisfy the distribution 
requirement of Prop. Reg. Sec.  1.509(a)-4(i)(5)(ii) would be 
reclassified as a private non-operating foundation and as such, would 
be required under section 4942 to distribute amounts equal to five 
percent of the aggregate fair market value of non-exempt-use assets. In 
addition, as a private non-operating foundation, the organization would 
be subject to additional regulatory requirements and excise taxes that 
do not apply to non-functionally integrated Type III supporting 
organizations. Accordingly,

[[Page 48680]]

a Regulatory Flexibility Analysis under the Regulatory Flexibility Act 
(5 U.S.C. chapter 6) is not required. Pursuant to section 7805(f) of 
the Code, this regulation has been submitted to the Chief Counsel for 
Advocacy of the Small Business Administration for comment on its impact 
on small business.

Request for Comments

    Before these proposed regulations are adopted as final or temporary 
regulations, consideration will be given to any written (a signed 
original and eight (8) copies) or electronic comments that are 
submitted timely to the IRS. The Treasury Department and the IRS 
request comments on the clarity of the proposed rules and how they can 
be made easier to understand. All comments will be available for public 
inspection and copying. A public hearing will be scheduled if requested 
in writing by any person that timely submits written comments. If a 
public hearing is scheduled, notice of the date, time, and place for 
the public hearing will be published in the Federal Register.

Drafting Information

    The principal authors of these proposed regulations are Philip T. 
Hackney and Don R. Spellmann, Office of the Chief Counsel (Tax-Exempt 
and Government Entities). However, other personnel from the Treasury 
Department and the IRS participated in their development.

List of Subjects

26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 53

    Excise taxes, Foundations, Investments, Lobbying, Reporting and 
recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR parts 1 and 53 are proposed to be amended as 
follows:

PART 1--INCOME TAXES

    Par. 1. The authority citation for part 1 continues to read in part 
as follows:

    Authority: 26 U.S.C. 7805 * * *

    Par. 2. Section 1.509(a)-4 is amended by:
    1. The term ``publicly supported organization'' is removed and the 
term ``supported organization'' is added in its place wherever it 
appears.
    2. Paragraphs (a)(5) and (i) are revised.
    3. New paragraphs (a)(6) and (f)(5) are added.
    The revisions and additions read as follows:


Sec.  1.509(a)-4  Supporting organizations.

    (a) * * *
    (5) For purposes of this section, the term ``supporting 
organization'' means either an organization described in section 
509(a)(3) or an organization seeking section 509(a)(3) status, 
depending upon its context.
    (6) For purposes of this section, the term ``supported 
organization'' means an organization described in section 509(a)(1) or 
(2)--
    (i) For whose benefit the supporting organization is organized and 
operated, or
    (ii) With respect to which the supporting organization performs the 
functions, or carries out the purposes.
* * * * *
    (f) * * *
    (5) Organizations controlled by donors. An organization shall not 
be considered to be operated, supervised, or controlled by, or operated 
in connection with, one or more supported organizations, if such 
organization accepts any gift or contribution from any person (other 
than an organization described in section 509(a)(1), (2) or (4)) who--
    (i) Directly or indirectly controls, either alone or together with 
persons described in paragraph (f)(5)(ii) or (iii) of this section, a 
supported organization supported by such supporting organization;
    (ii) Is a member of the family (determined under section 
4958(f)(4)) of an individual described in paragraph (f)(5)(i) of this 
section; or
    (iii) Is a 35-percent controlled entity (as defined in section 
4958(f)(3) by substituting ``persons described in paragraph (f)(5)(i) 
or (ii) of this section'' for ``persons described in subparagraph (A) 
or (B) of paragraph (1)'' in paragraph (A)(i) thereof).
* * * * *
    (i) Meaning of ``operated in connection with''--(1) General Rule. 
Except as otherwise provided in paragraphs (f)(5) and (i)(10) of this 
section, a supporting organization is operated in connection with one 
or more supported organizations only if it satisfies--
    (i) The notification requirement in paragraph (i)(2) of this 
section;
    (ii) The responsiveness test, which is set forth in paragraph 
(i)(3) of this section; and
    (iii) The integral part test, which is set forth in paragraphs 
(i)(4) and (i)(5) of this section. An organization is an integral part 
of a supported organization if it is significantly involved in the 
operations of the supported organization and the supported organization 
is dependent upon the supporting organization for the type of support 
the supporting organization provides. An organization can demonstrate 
that it is an integral part of a supported organization only if it 
satisfies either the requirements for functionally integrated Type III 
supporting organizations set forth in paragraph (i)(4) of this section 
or the requirements for non-functionally integrated Type III supporting 
organizations set forth in paragraph (i)(5) of this section.
    (2) Notification requirement. Each taxable year, the supporting 
organization must provide to each of its supported organizations--
    (i) A written notice addressed to a principal officer of the 
supported organization indicating the type and amount of support 
provided by the supporting organization to the supported organization 
in the past year;
    (ii) A copy of the supporting organization's most recently filed 
Form 990, ``Return of Organization Exempt from Income Tax,'' or other 
return required to be filed under section 6033; and
    (iii) A copy of the supporting organization's governing documents, 
including its charter or trust instrument and bylaws, and any 
amendments to such documents. Copies of governing documents need not be 
provided in a given year if such documents have previously been 
provided and have not subsequently been amended.
    (iv) Electronic media. Notification may be provided by electronic 
media.
    (v) Due date. The required notifications shall be postmarked or 
electronically transmitted by the last day of the 5th month after the 
close of the supporting organization's tax year.
    (3) Responsiveness test. (i) A supporting organization meets the 
responsiveness test if it is responsive to the needs or demands of a 
supported organization. Except as provided in paragraph (i)(3)(v) of 
this section, a supporting organization is responsive to the needs or 
demands of a supported organization if it satisfies the requirements of 
paragraphs (i)(3)(ii) and (i)(3)(iii) of this section.
    (ii) A supporting organization satisfies the requirements of this 
paragraph (i)(3)(ii) if:
    (A) One or more officers, directors, or trustees of the supporting 
organization are elected or appointed by the officers, directors, 
trustees, or membership of the supported organization;
    (B) One or more members of the governing bodies of the supported

[[Page 48681]]

organization are also officers, directors, or trustees of, or hold 
other important offices in, the supporting organization; or
    (C) The officers, directors, or trustees of the supporting 
organization maintain a close and continuous working relationship with 
the officers, directors, or trustees of the supported organization.
    (iii) By reason of paragraphs (i)(3)(ii)(A), (i)(3)(ii)(B), or 
(i)(3)(ii)(C) of this section, the officers, directors or trustees of 
the supported organization have a significant voice in the investment 
policies of the supporting organization, the timing of grants, the 
manner of making them, and the selection of recipients by such 
supporting organization, and in otherwise directing the use of the 
income or assets of such supporting organization.
    (iv) Examples. The provisions of this paragraph (i)(3) may be 
illustrated by the following examples:

    Example (1). X, an organization described in section 501(c)(3), 
is a trust created under the last will and testament of Decedent. 
The trustee of X is a bank (Trustee). Under the trust instrument, X 
supports M, a private university described in section 509(a)(1). The 
trust instrument provides that Trustee has discretion regarding the 
timing and amount of distributions consistent with the Trustee's 
fiduciary duties. Representatives of Trustee and an officer of M 
have quarterly face to face meetings, at which they discuss M's 
projected needs for the university and ways in which M would like X 
to use its income and invest its assets. Additionally, Trustee 
communicates regularly with the officer of M regarding X's 
investments and plans for distributions from X. Trustee provides the 
officer of M with quarterly investment statements, the information 
required under paragraph (i)(2) of this section, and an annual 
accounting statement. Based on these facts, X meets the 
responsiveness test of this paragraph (i)(3).
    Example (2). Y is an organization described in section 501(c)(3) 
and is organized as a trust under State law. The trustee of Y is a 
bank, Trustee. Y supports charities P, Q and R, each an organization 
described in section 509(a)(1). Y makes annual cash payments to P, Q 
and R. Once a year, Trustee sends to P, Q, and R the cash payment, 
the information required under paragraph (i)(2) of this section, and 
an accounting statement. Trustee has no other communication with P, 
Q or R. Y does not meet the responsiveness test of this paragraph 
(i)(3).

    (v) Exception for Pre-November 20, 1970 Organizations. In the case 
of a supporting organization that was supporting or benefiting a 
supported organization before November 20, 1970, additional facts and 
circumstances, such as a historic and continuing relationship between 
the organizations, may be taken into account, in addition to the 
factors described in paragraph (i)(3)(ii) of this section, to establish 
compliance with the responsiveness test.
    (4) Integral part test--functionally integrated Type III supporting 
organization--(i) General rule. A supporting organization meets the 
integral part test as a functionally integrated Type III supporting 
organization if it satisfies either paragraph (i)(4)(i)(A) or paragraph 
(i)(4)(i)(B) of this section.
    (A) The supporting organization engages in activities:
    (1) Substantially all of which directly further the exempt purposes 
of the supported organization(s) to which the supporting organization 
is responsive, by performing the functions of, or carrying out the 
purposes of, such supported organization(s); and
    (2) That, but for the involvement of the supporting organization, 
would normally be engaged in by the supported organization(s).
    (B) The supporting organization is the parent of each of its 
supported organizations. For purposes of the integral part test, a 
supporting organization is the parent of a supported organization if 
the supporting organization exercises a substantial degree of direction 
over the policies, programs, and activities of the supported 
organization and a majority of the officers, directors, or trustees of 
the supported organization is appointed or elected, directly or 
indirectly, by the governing body, members of the governing body, or 
officers (acting in their official capacity) of the supporting 
organization.
    (ii) ``Directly further.'' Holding title to exempt-use property and 
managing exempt-use property are activities that directly further the 
exempt purposes of the supported organization within the meaning of 
paragraph (i)(4)(i)(A) of this section. Except as provided in paragraph 
(i)(4)(iii) of this section, fundraising, investing and managing non-
exempt-use property, and making grants (whether to the supported 
organization or to third parties) are not activities that directly 
further the exempt purposes of the supported organization within the 
meaning of paragraph (i)(4)(i)(A) of this section.
    (iii) Governmental Entity Exception. A supporting organization may 
treat the investment and management of non-exempt-use assets and the 
making of grants directly to a supported organization as activities 
that directly further the exempt purposes of a supported organization 
if:
    (A) Such activities are conducted on behalf of a supported 
organization whose assets are subject to the appropriation process of a 
Federal, State, local or Indian Tribal government for purposes or 
programs unrelated to the exempt purposes of the supported 
organization;
    (B) The supporting organization supports only one supported 
organization; and
    (C) A substantial part of the supporting organization's total 
activities directly furthers the exempt purpose(s) of its supported 
organization and are activities other than fundraising, grantmaking, 
and investing and managing non-exempt-use assets.
    (iv) Examples. The provisions of this paragraph (i)(4) may be 
illustrated by the following examples. In each example, the supporting 
organization meets the requirements of paragraphs (i)(2) and (i)(3) of 
this section.

    Example 1. N, an organization described in section 501(c)(3), is 
the parent organization of a healthcare system consisting of two 
hospitals (Q and R) and an outpatient clinic (S), each of which is 
described in section 509(a)(1), and a taxable subsidiary (T). N is 
the sole member of each of Q, R, and S. Under the charter and bylaws 
of each of Q, R, and S, N appoints all members of the board of 
directors of each corporation. N engages in the overall coordination 
and supervision of the healthcare system's exempt subsidiary 
corporations Q, R, and S in approval of their budgets, strategic 
planning, marketing, resource allocation, securing tax-exempt bond 
financing, and community education. N also manages and invests 
assets that serve as endowments of Q, R and S. Based on these facts, 
N qualifies as a functionally integrated Type III supporting 
organization under paragraph (4)(i)(B) of this section.
    Example 2. V, an organization described in section 501(c)(3), is 
organized as a supporting organization to L, a church described in 
section 509(a)(1). L transferred to V title to the buildings in 
which L conducts religious services, Bible study and community 
enrichment programs. Substantially all of V's activities consist of 
holding and managing these buildings. But for the activities of V, L 
would normally engage in these same activities. Based on these 
facts, V satisfies the activities and but for requirements of 
paragraph (4)(i)(A) of this section and therefore qualifies as a 
functionally integrated Type III supporting organization.
    Example 3. O is a nonprofit publishing organization described in 
section 501(c)(3). It does all of the publishing and printing for 
the eight churches of a particular denomination located in a 
particular geographic region, each of which is described in section 
509(a)(1). Control of O is vested in a five-man Board of Directors, 
which includes an official from one of the churches and four lay 
members of the congregations of that denomination. The officers of O 
maintain a close and continuing working relationship with each of 
the eight churches for whom it publishes and prints materials and as 
a result of such relationship, each of the eight

[[Page 48682]]

churches has a significant voice in the operations of O. O does no 
other printing or publishing. O publishes all of the churches' 
religious as well as secular tracts and materials. All of O's 
activities directly further the exempt purposes of supported 
organizations to which it is responsive. Additionally, but for the 
activities of O, the churches would normally publish these materials 
themselves. Based on these facts, O qualifies as a functionally 
integrated Type III supporting organization under paragraph 
(4)(i)(A) of this section.
    Example 4. M, an organization described in section 501(c)(3), 
was created by B, an individual, to provide scholarships for 
students of a private secondary school, U, an organization described 
in section 509(a)(1). U establishes the scholarship criteria, 
publicizes the scholarship program, solicits and reviews 
applications, and selects the scholarship recipients. M invests its 
assets and disburses the funds for scholarships to the recipients 
selected by U. Based on these facts, M is not a functionally 
integrated Type III supporting organization.
    Example 5. J, an organization described in section 501(c)(3), is 
a supporting organization to community foundation G, an organization 
described in section 509(a)(1). In addition to maintaining field-of-
interest funds, sponsoring donor advised funds, and general grant-
making activities, G also engages in activities to beautify and 
maintain local parks. J's activities consist of maintaining all of 
the local parks in the area of community foundation G by activities 
such as establishing and maintaining trails, planting trees and 
removing trash. But for the activities of J, G would normally engage 
in these efforts to beautify and maintain the local parks. Based on 
these facts, J qualifies as a functionally integrated Type III 
supporting organization under paragraph (4)(i)(A) of this section.
    Example 6. W, an organization described in section 501(c)(3), is 
organized as a supporting organization to Z, a public university in 
State D described in section 509(a)(1). Z is the sole named 
supported organization in W's articles of incorporation. Under the 
laws of State D, assets under Z's control are subject to the 
appropriation process for any State D purpose by an action of the 
State D legislature. Z transfers the intellectual property developed 
by Z's science department to W for patenting and licensing, 
including making the property available to the public. The royalties 
generated by the licenses are shared among Z, the original 
researcher, and W. W invests and manages its share of the royalties 
and other income generated by the patenting and licensing of the 
intellectual property to build an endowment to support Z. W also 
conducts further research on scientific processes developed at Z and 
makes the results of this research available to the public. W's 
research activities make up a substantial part of W's total 
activities. But for the activities of W, Z would normally conduct 
the research engaged in by W and manage the royalties from the 
intellectual property generated at Z. W's activities of investing 
and managing its share of royalties and other income are not 
considered activities that directly further the exempt purposes of Z 
under paragraph (i)(4)(ii) of this section. However, because Z's 
assets are subject to the appropriation process of State D for 
purposes unrelated to Z's exempt purposes, Z is W's sole supported 
organization, and a substantial part of W's activities directly 
further Z's exempt purposes, W qualifies for the exception in 
paragraph (i)(4)(iii) of this section. Accordingly, based on these 
facts, W qualifies as a functionally integrated Type III supporting 
organization under paragraph (4)(i)(A) of this section.
    Example 7. P, an alumni association described in section 
501(c)(3), was formed to promote a spirit of loyalty among graduates 
of Y University, a public university in State E described in section 
509(a)(1), and to effect united action in promoting the general 
welfare of Y. Y is the sole named supported organization in P's 
articles of incorporation. Under the laws of State E, Y's assets are 
subject to the appropriation process for any State E purpose. P 
manages an endowment created by gifts from the alumni. A special 
committee of Y's governing board meets with P and makes 
recommendations as to the allocation of P's program of gifts and 
scholarships to the university and its students. More than a 
substantial part of P's activities, however, consist of maintaining 
records of alumni and publishing a bulletin to keep alumni aware of 
the activities of the university. But for the activities of P, Y 
would normally engage in these same activities. P's endowment 
management activities are not considered activities that directly 
further the exempt purposes of Y under paragraph (i)(4)(ii) of this 
section. However, because Y's assets are subject to the 
appropriation process of State E for purposes unrelated to Y's 
exempt purposes, Y is P's sole supported organization, and a 
substantial part of P's activities directly further Y's exempt 
purposes, P qualifies for the exception in paragraph (i)(4)(iii) of 
this section. Accordingly, based on these facts, P qualifies as a 
functionally integrated Type III supporting organization under 
paragraph (4)(i)(A) of this section.

    (5) Integral part test--non-functionally integrated Type III 
supporting organization--(i) A supporting organization meets the 
integral part test as a non-functionally integrated Type III supporting 
organization if it satisfies either:
    (A) The distribution requirement of paragraph (i)(5)(ii) of this 
section and the attentiveness requirement of paragraph (i)(5)(iii) of 
this section; or
    (B) The pre-1970 trust requirements of paragraph (i)(9) of this 
section.
    (ii) Distribution requirement. (A) The supporting organization must 
distribute, with respect to each taxable year, to or for the use of one 
or more supported organizations, amounts equaling or exceeding the 
supporting organization's annual distributable amount for such year, as 
defined in paragraph (i)(5)(ii)(B) of this section, on or before the 
last day of such taxable year.
    (B) Annual distributable amount. Except as provided in paragraphs 
(i)(5)(ii)(C) and (i)(5)(ii)(D) of this section, the annual 
distributable amount for a taxable year is:
    (1) Five percent of the excess of the aggregate fair market value 
of all non-exempt-use assets (determined under paragraph (i)(8) of this 
section) over the acquisition indebtedness with respect to such non-
exempt-use assets, determined under section 514(c)(1) without regard to 
the taxable year in which the indebtedness was incurred; increased by
    (2) Amounts received or accrued as repayments of amounts which were 
taken into account by the organization to meet the distribution 
requirement imposed in paragraph (i)(5)(ii)(A) of this section for any 
taxable year; increased by
    (3) Amounts received or accrued from the sale or other disposition 
of property to the extent that the acquisition of such property was 
taken into account by the organization to meet the distribution 
requirement imposed in paragraph (i)(5)(ii)(A) of this section for any 
taxable year; and reduced by
    (4) The amount of taxes imposed on the supporting organization for 
such taxable year under subtitle A of the Code.
    (C) First taxable year of existence. The annual distributable 
amount for the first taxable year an organization is treated as a non-
functionally integrated Type III supporting organization is zero.
    (D) Emergency temporary reduction. The Secretary may provide by 
publication in the Internal Revenue Bulletin (see Sec.  
601.601(d)(2)(ii)(b) of this chapter) for a temporary reduction in the 
annual distributable amount in the case of a disaster or emergency.
    (E) Reasonable cause exception. An organization that fails to meet 
the distribution requirement of paragraph (i)(5)(ii) of this section 
will not be classified as a private foundation in the taxable year for 
which it fails to meet such distribution requirement, if the 
organization establishes to the satisfaction of the Secretary that:
    (1) The failure was due solely to an incorrect valuation of assets, 
a ministerial error, or unforeseen events or circumstances that are 
beyond the organization's control,
    (2) The failure was due to reasonable cause and not to willful 
neglect,
    and
    (3) The distribution requirement is met within 180 days after the 
date the incorrect valuation or ministerial error was or should have 
been discovered, or 180 days after the organization is first able to 
make its required payout

[[Page 48683]]

notwithstanding the unforeseen event or circumstances.
    (iii) Attentiveness requirement. (A) General rule. A non-
functionally integrated Type III supporting organization must 
distribute one-third or more of its annual distributable amount to one 
or more supported organizations that are attentive to the operations of 
the supporting organization and to which the supporting organization is 
responsive under paragraph (i)(3) of this section.
    (B) Except as provided in paragraph (i)(5)(iii)(C) of this section, 
a supported organization is attentive to the operations of the 
supporting organization if the supporting organization distributes 
annually to such supported organization an amount of support that 
represents a sufficient part of the supported organization's total 
support. A supporting organization must meet the requirements of 
paragraphs (i)(5)(iii)(B)(1), (i)(5)(iii)(B)(2), or (i)(5)(iii)(B)(3) 
of this section to demonstrate that it is attentive. If a supporting 
organization makes payments to, or for the use of, a particular 
department or school of a university, hospital or church, the total 
support of the department or school shall be substituted for the total 
support of the beneficiary organization.
    (1) The supporting organization distributes annually to the 
supported organization an amount that is 10 percent or more of the 
supported organization's total support.
    (2) The amount of support received from the supporting organization 
is necessary to avoid the interruption of the carrying on of a 
particular function or activity. The support is necessary if the 
supporting organization or the supported organization earmarks the 
support for a particular program or activity, even if such program or 
activity is not the supported organization's primary program or 
activity so long as such program or activity is a substantial one.
    (3) Based on the consideration of all pertinent factors, including 
the number of supported organizations, the length and nature of the 
relationship between the supported organization and supporting 
organization and the purpose to which the funds are put, the amount of 
support is a sufficient part of a supported organization's total 
support. Normally the attentiveness of a supported organization is 
motivated by reason of the amounts received from the supporting 
organization. Thus, the more substantial the amount involved, in terms 
of a percentage of the supported organization's total support, the 
greater the likelihood that the required degree of attentiveness will 
be present. However, in determining whether the amount received from 
the supporting organization is sufficient to ensure the attentiveness 
of the supported organization to the operations of the supporting 
organization (including attentiveness to the nature and yield of such 
supporting organization's investments), evidence of actual 
attentiveness by the supported organization is of almost equal 
importance. A supported organization is not considered to be attentive 
solely because it has enforceable rights against the supporting 
organization under State law.
    (C) Distribution to donor-advised fund does not establish 
attentiveness. Notwithstanding paragraphs (i)(5)(iii)(A) and 
(i)(5)(iii)(B) of this section, a supported organization will not be 
considered attentive to the operations of a supporting organization 
with respect to any amount received from the supporting organization 
that is held by the supported organization in a donor advised fund 
described in section 4966(d)(2).
    (iv) Paragraph (5)(iii)(B)(2) of this section is illustrated by 
examples 1 and 2 and paragraph(5)(iii)(B) of this section is 
illustrated by examples 3 and 4:

    Example 1. K, an organization described in section 501(c)(3), 
annually pays over an amount equal to five percent of its assets to 
L, a museum described in section 509(a)(2). K meets the 
responsiveness test described in paragraph (i)(3) of this section 
with respect to L. In recent years, L has earmarked the income 
received from K to underwrite the cost of carrying on a chamber 
music series consisting of 12 performances a year that are performed 
for the general public free of charge at its premises. The chamber 
music series is not L's primary activity. L could not continue the 
performances without K's support. Based on these facts, K meets the 
requirements of paragraph (i)(5)(iii)(B)(2) of this section.
    Example 2. M, an organization described in section 501(c)(3), 
pays annually an amount equal to five percent of its assets to the 
Law School of N University, an organization described in section 
509(a)(1). M meets the responsiveness test described in paragraph 
(i)(3) of this section with respect to N. M has earmarked the income 
paid over to N's Law School to endow a chair in International Law. 
Without M's continued support, N could not continue to maintain this 
chair. Based on these facts, M meets the requirements of paragraph 
(i)(5)(iii)(B)(2) of this section.
    Example 3. R is a charitable trust created under the will of B, 
who died in 1969. R's purpose is to hold assets as an endowment for 
S, a hospital, T, a university, and U, a national medical research 
organization (all organizations described in section 509(a)(1) and 
specifically named in the trust instrument), and to distribute all 
of the income each year in equal shares among the three named 
beneficiaries. Each year, R pays an amount equal to five percent of 
its assets to each of S, T, and U. Such payments are less than one 
percent of each organization's total support. Based on these facts, 
R does not meet the attentiveness requirement of paragraph 
(i)(5)(iii)(B). However, because B died prior to November 20, 1970, 
R could, upon meeting all of the requirements of paragraph (i)(9) of 
this section, be considered as meeting the requirements of paragraph 
(i)(5)(i)(B) of this section.
    Example 4. O is an organization described in section 501(c)(3). 
O is organized to support five private universities, V, W, X, Y and 
Z, each of which is described in section 509(a)(1). O meets the 
responsiveness test under paragraph (i)(3) of this section only as 
to V. Each year, O distributes five percent of the fair market value 
of its non-exempt-use assets in equal amounts to the five 
universities. O distributes annually more than 10 percent of the 
total annual support of V and W. Based on these facts O does not 
meet the requirements of paragraph (i)(5)(iii) of this section. 
Although both V and W are attentive to the operations of O under 
paragraph (i)(5)(iii)(B)(1) of this section, O is only responsive to 
V. Accordingly, O distributes only one-fifth (i.e., less than the 
required one-third) of its annual distributable amount to supported 
organization(s) that are both attentive to O and to which O is also 
responsive under paragraph (i)(3) of this section.

    (6) Distributions. For purposes of this paragraph (i)(6), the 
amount of a distribution made to a supported organization is the fair 
market value of such property as of the date such distribution is made. 
The amount of a distribution will be determined solely on the cash 
receipts and disbursements method of accounting described in section 
446(c)(1). Distributions that count toward the distribution requirement 
imposed in paragraph (i)(5)(ii)(A) of this section shall include:
    (i) Any amount paid to a supported organization to accomplish its 
exempt purposes,
    (ii) Any amount paid to acquire an asset used (or held for use) to 
carry out the exempt purposes of the supported organization(s), and
    (iii) Any amount expended by the supporting organization for 
reasonable and necessary administrative expenses.
    (7) Carryover of excess amounts--(i) In general. If with respect to 
any taxable year, an excess amount, as defined in paragraph (i)(7)(ii) 
of this section, is created, such excess amount may be used to reduce 
the annual distributable amount in any of the five taxable years 
immediately following the taxable year in which the excess amount is 
created (the ``carryover period''). An excess amount created in a 
taxable year cannot be carried over beyond the succeeding five taxable 
years. With respect to any

[[Page 48684]]

taxable year to which an excess amount is carried over, in determining 
whether an excess amount is created in that taxable year, the annual 
distributable amount is reduced first to the extent of any excess 
amounts carried over and then to the extent of distributions made in 
that taxable year.
    (ii) Excess amount. An excess amount is created for any taxable 
year beginning after the effective date of these regulations if the 
total distributions made by a supporting organization to its supported 
organization(s) for such taxable year exceeds the supporting 
organization's annual distributable amount for such taxable year, as 
defined in paragraph (i)(5)(ii)(B) of this section, determined without 
regard to this paragraph.
    (8) Valuation of assets--(i) General rules. (A) For purposes of 
determining the organization's annual distributable amount, as defined 
in paragraph (i)(5)(ii)(B) of this section, the determination of the 
fair market value of the non-exempt-use assets shall be made in the 
year preceding the year of the required distribution under paragraph 
(i)(5)(ii)(A) of this section. The aggregate fair market value of all 
non-exempt-use assets of a supporting organization is the sum of:
    (1) The average of the fair market values on a monthly basis of 
securities for which market quotations are readily available (within 
the meaning of paragraph (i)(8)(iii)(A)(1) of this section);
    (2) The average of the supporting organization's cash balances on a 
monthly basis (less the same amount of cash balances excluded under 
paragraph (i)(8)(i)(C)(2)(iv) of this section) from the computation of 
the annual distributable amount); and
    (3) The fair market value of all other assets (except those assets 
described in paragraph (i)(8)(i)(B) or paragraph (i)(8)(i)(C) of this 
section) for the period of time during the taxable year for which such 
assets are held by the supporting organization.
    (B) Certain assets excluded. For purposes of this paragraph, the 
non-exempt-use assets taken into account in determining the annual 
distributable amount described in paragraph (i)(5)(ii)(B) of this 
section shall not include the following:
    (1) Any future interest (such as a vested or contingent remainder, 
whether legal or equitable) of a supporting organization in the income 
or corpus of any real or personal property, other than a future 
interest created by the supporting organization after August 17, 2006, 
until all intervening interests in, and rights to the actual possession 
or enjoyment of, such property have expired, or, although not actually 
reduced to the supporting organization's possession, until such future 
interest has been constructively received by the supporting 
organization, as where it has been credited to the supporting 
organization's account, set apart for the supporting organization, or 
otherwise made available so that the supporting organization may 
acquire it at any time or could have acquired it if notice of intention 
to acquire had been given;
    (2) The assets of an estate until such time as such assets are 
distributed to the supporting organization or, due to a prolonged 
period of administration, such estate is considered terminated for 
Federal income tax purposes by operation of Treas. Reg. Sec.  1.641(b)-
3(a);
    (3) Any present interest of a supporting organization in any trust 
created and funded by another person;
    (4) Any pledge to the supporting organization of money or property 
(whether or not the pledge may be legally enforced); and
    (5) Any assets used (or held for use) to carry out the exempt 
purposes of the supported organization(s).
    (C) Assets used (or held for use) to carry out the exempt purposes 
of the supported organization(s)--(1) In general. For purposes of 
paragraph (i)(8)(i)(B)(5) of this section, an asset is ``used (or held 
for use) to carry out the exempt purposes of the supported 
organization(s)'' only if the asset is actually used by the supporting 
organization in activities that carry out the exempt purposes of its 
supported organization(s), or if the supporting organization owns the 
asset and establishes to the satisfaction of the Commissioner that its 
immediate use for such exempt purpose is not practical (based on the 
facts and circumstances of the particular case) and that definite plans 
exist to commence such use on behalf of its supported organization(s) 
within a reasonable period of time. Consequently, assets that are held 
for the production of income or for investment (for example, stocks, 
bonds, interest-bearing notes, endowment funds, or, generally, leased 
real estate) are not being used (or held for use) to carry out the 
exempt purposes of the supported organization(s), even though the 
income from such assets is used to carry out such exempt purposes. 
Whether an asset is held for the production of income or for investment 
rather than used (or held for use) by the supporting organization to 
carry out the exempt purposes of the supported organization(s) is a 
question of fact. For example, an office building used for the purpose 
of providing offices for employees engaged in the management of 
endowment funds is not being used (or held for use) by the supporting 
organization to carry out the exempt purposes of the supported 
organization(s). However, where property is used both to carry out the 
exempt purposes of the supported organization(s) and for other 
purposes, if the former use represents 95 percent or more of the total 
use, such property shall be considered to be used exclusively to carry 
out an exempt purpose of the supported organization(s). If the use of 
such property to carry out the exempt purposes of the supported 
organization(s) represents less than 95 percent of the total use, 
reasonable allocation between such use and other use must be made for 
purposes of this paragraph. Property acquired by the supporting 
organization to be used to carry out the exempt purposes of the 
supported organization(s) may be considered as used (or held for use) 
to carry out such exempt purposes even though the property, in whole or 
in part, is leased for a limited period of time during which 
arrangements are made for its conversion to the use for which it was 
acquired, provided such income-producing use of the property does not 
exceed a reasonable period of time. Generally, one year shall be deemed 
to be a reasonable period of time for purposes of the immediately 
preceding sentence. Where the income-producing use continues beyond a 
reasonable period of time, the property shall not be deemed to be used 
by the supporting organization to carry out the exempt purposes of the 
supported organization(s), but, instead, as of the time the income-
producing use becomes unreasonable, such property shall be treated as 
disposed of within the meaning of paragraph (i)(5)(ii)(B)(3) of this 
section to the extent that the acquisition of the property was taken 
into account by the organization to meet the distribution requirement 
imposed in paragraph (i)(5)(ii)(A) of this section for any taxable 
year. If, subsequently, the property is used by the supporting 
organization to carry out the exempt purposes of the supported 
organization(s), a distribution to its supported organization(s) in the 
amount of its then fair market value, determined in accordance with the 
rules contained in this paragraph (i)(8), shall be deemed to have been 
made as of the time such exempt purpose use begins.
    (2) Illustrations. Examples of assets that are ``used (or held for 
use) to carry out the exempt purposes of the

[[Page 48685]]

supported organization(s)'' include, but are not limited to, the 
following:
    (i) Administrative assets, such as office equipment and supplies 
that are used by employees or consultants of the supporting 
organization, to the extent such assets are devoted to and used 
directly in the administration of the supporting organization's 
activities that carry out the exempt purposes of the supported 
organization(s).
    (ii) Real estate or the portion of a building used by the 
supporting organization directly in its activities to carry out the 
exempt purposes of the supported organization(s).
    (iii) Physical facilities used in the supporting organization's 
activities to carry out the exempt purposes of the supported 
organization(s), such as paintings or other works of art owned by the 
supporting organization that are on public display, fixtures and 
equipment in classrooms, and research facilities and related equipment, 
which under the facts and circumstances serve a useful purpose in the 
conduct of such exempt purpose activities.
    (iv) The reasonable cash balances necessary to cover current 
administrative expenses and other normal and current disbursements 
directly connected to the supporting organization's activities to carry 
out the exempt purposes of the supported organization(s). The 
reasonable necessary cash balances will generally be deemed to be an 
amount, computed on an annual basis, equal to one and one-half percent 
of the fair market value of all of the supporting organization's 
assets, other than assets used or held for use to carry out the exempt 
purposes of the supported organization(s), without regard to this 
paragraph (i)(8)(i)(C)(2)(iv). However, if the Commissioner is 
satisfied that under the facts and circumstances an amount in addition 
to such one and one-half percent is necessary for payment of such 
expenses and disbursements, then such additional amount may also be 
excluded from the amount of assets described in paragraph (i)(5)(ii)(B) 
of this section. All remaining cash balances, including amounts 
necessary to pay any tax imposed by section 511 or section 4943, are to 
be included in the assets described in paragraph (i)(5)(ii)(B) of this 
section.
    (v) Any property leased by the supporting organization in carrying 
out the exempt purposes of its supported organization(s) at no cost (or 
at a nominal rent) to the lessee, such as the leasing of renovated 
apartments to low-income tenants at a low rental as part of the lessor-
supporting organization's program for rehabilitating a blighted portion 
of the community.
    (ii) Valuation of assets--timing. For purposes of determining the 
annual distributable amount for a taxable year, the supporting 
organization's assets are to be valued over the preceding taxable year.
    (iii) Valuation of assets--(A) Certain securities. (1) For purposes 
of this paragraph, a supporting organization may use any reasonable 
method to determine the fair market value on a monthly basis of 
securities for which market quotations are readily available, as long 
as such method is consistently used.
    (2) For purposes of this paragraph, market quotations are readily 
available if a security is:
    (i) Listed on the New York Stock Exchange, the American Stock 
Exchange, or any city or regional exchange in which quotations appear 
on a daily basis, including foreign securities listed on a recognized 
foreign national or regional exchange;
    (ii) Regularly traded in the national or regional over-the-counter 
market, for which published quotations are available; or
    (iii) Locally traded, for which quotations can readily be obtained 
from established brokerage firms.
    (3) For purposes of this paragraph, if the supporting organization 
can show that the value of securities determined on the basis of market 
quotations as provided by paragraph (i)(8)(iii)(A)(2) of this section, 
does not reflect the fair market value thereof because:
    (i) The securities constitute a block of securities so large in 
relation to the volume of actual sales on the existing market that it 
could not be liquidated in a reasonable time without depressing the 
market;
    (ii) The securities are securities in a closely held corporation 
and sales are few or of a sporadic nature; and/or
    (iii) The sale of the securities would result in a forced or 
distress sale because the securities could not be offered to the public 
for sale without first being registered under the Securities Act of 
1933 or because of other factors, then the price at which the 
securities could be sold as such outside the usual market, as through 
an underwriter, may be a more accurate indication of value than market 
quotations. On the other hand, if the securities to be valued represent 
a controlling interest, either actual or effective, in a going 
business, the price at which other lots change hands may have little 
relation to the true value of the securities. No decrease in the fair 
market value of any given class of securities determined on the basis 
of market quotations as provided by paragraph (i)(8)(iii)(A)(2) of this 
section shall be allowed except as authorized by this paragraph, and no 
such decrease shall in the aggregate exceed 10 percent of the fair 
market value of such class of securities so determined on the basis of 
market quotations and without regard to this paragraph.
    (4) In the case of securities described in paragraph 
(i)(8)(iii)(A)(2) of this section, that are held in trust for, or on 
behalf of, a supporting organization by a bank or other financial 
institution that values such securities periodically by use of a 
computer, a supporting organization may determine the correct value of 
such securities by use of such computer pricing system, provided the 
Commissioner has accepted such computer pricing system as a valid 
method for valuing securities for Federal estate tax purposes.
    (B) Cash. In order to determine the amount of a supporting 
organization's cash balances, the supporting organization shall value 
its cash on a monthly basis by averaging the amount of cash on hand as 
of the first day of each month and as of the last day of each month.
    (C) Common trust funds. If a supporting organization owns a 
participating interest in a common trust fund (as defined in section 
584) established and administered under a plan providing for the 
periodic valuation of participating interests during the fund's taxable 
year and the reporting of such valuations to participants, the value of 
the supporting organization's interest in the common trust fund based 
upon the average of the valuations reported to the supporting 
organization during its taxable year will ordinarily constitute an 
acceptable method of valuation.
    (D) Other assets. (1) Except as otherwise provided in paragraph 
(i)(8)(iii)(D)(2) of this section, the fair market value of assets 
other than those described in paragraphs (i)(8)(iii)(A) through 
(i)(8)(iii)(C) of this section, shall be determined annually. Thus, the 
fair market value of securities other than those described in paragraph 
(i)(8)(iii)(A) of this section shall be determined in accordance with 
this paragraph (i)(8)(iii)(D)(1). If, however, a supporting 
organization owns voting stock of an issuer of unlisted securities and 
has, or together with disqualified persons or another supporting 
organization has, effective control of the issuer (within the meaning 
of Sec.  53.4943-3(b)(3)(ii)), then to the extent that the issuer's 
assets consist of shares of listed securities issues, such assets shall 
be

[[Page 48686]]

valued monthly on the basis of market quotations or in accordance with 
section 4942(e)(2)(B), if applicable. Thus, for example, if a 
supporting organization and a disqualified person together own all of 
the unlisted voting stock of a holding company that in turn holds a 
portfolio of securities of issues that are listed on the New York Stock 
Exchange, in determining the net worth of the holding company, the 
underlying portfolio securities are to be valued monthly by reference 
to market quotations for their issues unless a decrease in such value 
is authorized in accordance with section 4942(e)(2)(B). Such 
determination may be made by employees of the supporting organization 
or by any other person without regard to whether such person is a 
disqualified person with respect to the supporting organization. A 
valuation made pursuant to the provisions of this paragraph, if 
accepted by the Commissioner, shall be valid only for the taxable year 
for which it is made. A new valuation made in accordance with these 
provisions is required for the succeeding taxable year.
    (2) If the requirements of this paragraph are met, the fair market 
value of any interest in real property, including any improvements 
thereon, may be determined on a five-year basis. Such value must be 
determined by means of a certified, independent appraisal made in 
writing by a qualified person who is neither a disqualified person with 
respect to, nor an employee of, the supporting organization. The 
appraisal is certified only if it contains a statement at the end 
thereof to the effect that, in the opinion of the appraiser, the values 
placed on the assets appraised were determined in accordance with 
valuation principles regularly employed in making appraisals of such 
property using all reasonable valuation methods. The supporting 
organization shall retain a copy of the independent appraisal for its 
records. If a valuation made pursuant to the provisions of this 
paragraph in fact falls within the range of reasonable values for the 
appraised property, such valuation may be used by the supporting 
organization for the taxable year for which the valuation is made and 
for each of the succeeding four taxable years. Any valuation made 
pursuant to the provisions of this paragraph may be replaced during the 
five-year period by a subsequent five-year valuation made in accordance 
with the rules set forth in this paragraph (i)(8)(iii)(D)(2), or with 
an annual valuation made in accordance with paragraph (i)(8)(iii)(D)(1) 
of this section, and the most recent such valuation of such assets 
shall be used in computing the supporting organization's annual 
distributable amount. A valuation made in accordance with this 
paragraph must be made no later than the last day of the first taxable 
year for which such valuation is applicable. A valuation, if properly 
made in accordance with the rules set forth in this paragraph, will not 
be disturbed by the Commissioner during the five-year period for which 
it applies even if the actual fair market value of such property 
changes during such period.
    (3) For purposes of this paragraph (i)(8)(iii)(D)(3), commonly 
accepted methods of valuation must be used in making an appraisal. 
Valuations made in accordance with the principles stated in the 
regulations under section 2031 constitute acceptable methods of 
valuation. The term ``appraisal,'' as used in this paragraph 
(i)(8)(iii)(D)(3), means a determination of fair market value and is 
not to be construed in a technical sense peculiar to particular 
property or interests therein, such as, for example, mineral interests 
in real property.
    (E) Definition of ``securities''. For purposes of this paragraph 
(i)(8)(iii)(E), the term ``securities'' includes, but is not limited 
to, common and preferred stocks, bonds, and mutual fund shares.
    (F) Valuation date. (1) In the case of an asset that is required to 
be valued on an annual basis as provided in paragraph (i)(8)(iii)(D)(1) 
of this section, such asset may be valued as of any day in the 
supporting organization's taxable year to which such valuation applies, 
provided the supporting organization follows a consistent practice of 
valuing such asset as of such date in all taxable years.
    (2) A valuation described in paragraph (i)(8)(iii)(D)(2) of this 
section may be made as of any day in the first taxable year of the 
supporting organization to which such valuation is to be applied.
    (G) Assets held for less than a taxable year. For purposes of this 
paragraph (i)(8)(iii)(G), any asset described in paragraph (i)(8)(i)(A) 
of this section that is held by a supporting organization for only part 
of a taxable year shall be taken into account for purposes of 
determining the supporting organization's annual distributable amount 
for such taxable year by multiplying the fair market value of such 
asset (as determined pursuant to paragraph (i)(8) of this section) by a 
fraction, the numerator of which is the number of days in such taxable 
year that the supporting organization held such asset and the 
denominator of which is the number of days in such taxable year.
    (9) Exception to integral part test for certain trusts. A trust 
(whether or not exempt from taxation under section 501(a)) that on 
November 20, 1970, met and continues to meet the requirements of 
paragraphs (i)(9)(i) through (i)(9)(v) of this section, shall be 
treated as meeting the requirements of the integral part test (whether 
or not it meets the requirements of paragraph (i)(4) or paragraph 
(i)(5) of this section) if for taxable years beginning after October 
16, 1972, the trustee of such trust makes annual written reports to all 
of the beneficiary supported organizations with respect to such trust 
setting forth a description of the assets of the trust, including a 
detailed list of the assets and the income produced by such assets. A 
trust organization that meets the requirements of this paragraph may 
request a ruling that it is described in section 509(a)(3) in such 
manner as the Commissioner may prescribe.
    (i) All the unexpired interests in the trust are devoted to one or 
more purposes described in section 170(c)(1) or (2)(B) and a deduction 
was allowed with respect to such interests under sections 170, 
545(b)(2), 556(b)(2), 642(c), 2055, 2106(a)(2), 2522, or corresponding 
provisions of prior law (or would have been allowed such a deduction if 
the trust had not been created before 1913);
    (ii) The trust was created prior to November 20, 1970, and did not 
receive any grant, contribution, bequest or other transfer on or after 
such date. For purpose of this paragraph (i)(9)(ii), a split-interest 
trust described in section 4947(a)(2) that was created prior to 
November 20, 1970, was irrevocable on such date, and that becomes a 
charitable trust described in section 4947(a)(1) after such date shall 
be treated as having been created prior to such date;
    (iii) The trust is required by its governing instrument to 
distribute all of its net income currently to a designated beneficiary 
supported organization. Where more than one beneficiary supported 
organization is designated in the governing instrument of a trust, all 
of the net income must be distributable and must be distributed 
currently to each of such beneficiary organizations in fixed shares 
pursuant to such governing instrument. For purposes of this paragraph 
(i)(9)(iii), the governing instrument of a charitable trust shall be 
treated as requiring distribution to a designated beneficiary 
organization where the trust instrument describes the charitable 
purpose of the trust so completely that such description can apply to 
only one existing beneficiary organization and is of sufficient 
particularity as to vest in such organization rights against the trust

[[Page 48687]]

enforceable in a court possessing equitable powers;
    (iv) The trustee of the trust does not have discretion to vary 
either the beneficiaries or the amounts payable to the beneficiaries. 
For purposes of this paragraph (i)(9)(iv), a trustee shall not be 
treated as having such discretion where the trustee has discretion to 
make payments of principal to the single section 509(a)(1) or (2) 
organization that is currently entitled to receive all of the trust's 
income or where the trust instrument provides that the trustee may 
cease making income payments to a particular charitable beneficiary in 
the event of certain specific occurrences, such as the loss of 
exemption under section 501(c)(3) or classification under section 
509(a)(1) or (2) by the beneficiary or the failure of the beneficiary 
to carry out its charitable purpose properly; and
    (v) None of the trustees would be disqualified persons within the 
meaning of section 4946(a) (other than foundation managers under 
section 4946(a)(1)(B)) with respect to the trust if such trust were 
treated as a private foundation.
    (10) Foreign supported organizations. A supporting organization is 
not operated in connection with one or more supported organizations if 
it supports any supported organization organized outside of the United 
States.
    (11) Transition rules--(i) A Type III supporting organization in 
existence on the effective date of these regulations that met and 
continues to meet the requirements of Treas. Reg. Sec.  1.509(a)-
4(i)(3)(ii), as in effect prior to the date these regulations are 
published as final or temporary regulations, will be treated as meeting 
the requirements of paragraph (i)(4)(i) of this section until the first 
day of the organization's first taxable year beginning after the date 
these regulations are published as final or temporary regulations.
    (ii) A Type III supporting organization in existence on the 
effective date of these regulations that met and continues to meet the 
requirements of Treas. Reg. Sec.  1.509(a)-4(i)(3)(iii), as in effect 
prior to the date these regulations are published as final or temporary 
regulations, will be treated as meeting the requirements of paragraph 
(i)(5)(i) of this section until the first day of its second taxable 
year beginning after the effective date of these regulations. Beginning 
in the first taxable year beginning after the effective date of these 
regulations, such organizations must value their assets according to 
paragraph (i)(8) of this section. Beginning in the second taxable year 
beginning after the effective date of these regulations (and in all 
succeeding taxable years), these organizations must meet all of the 
requirements of paragraph (i)(5)(i) of this section.
    (iii) For the first taxable year after the effective date of these 
regulations, the annual distributable amount for Type III supporting 
organizations that are not functionally integrated is zero.
    (12) Effective/applicability date. These regulations are effective 
on the date of publication of the Treasury decision adopting these 
rules as final or temporary regulations.
* * * * *

PART 53--FOUNDATION AND SIMILAR EXCISE TAXES

    Par. 3. The authority citation for part 53 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *

    Par. 4. In Sec.  53.4943-11, section heading is revised and 
paragraphs (f) and (g) are added to read as follows:


Sec.  53.4943-11  Effective/Applicability date.

* * * * *
    (f) Special transitional rule for private foundations that 
qualified as Type III supporting organizations before August 17, 2006. 
The present holdings of a private foundation that qualified as a Type 
III supporting organization under section 509(a)(3) immediately before 
August 17, 2006, and that was reclassified as a private foundation 
under section 509(a) on or after August 17, 2006, solely as a result of 
the rules enacted by section 1241 of the Pension Protection Act of 
2006, Public Law 109-280 (120 Stat. 780), will be determined using the 
same rules that apply to Type III supporting organizations under 
section 4943(f)(7).
    (g) Special transitional rule for Type III supporting organizations 
created as trusts before November 20, 1970. A trust that qualifies as a 
Type III supporting organization under section 509(a)(3) and meets the 
requirements of Treas. Reg. Sec.  1.509(a)-4(i)(9) will be treated as a 
``functionally integrated Type III supporting organization'' for 
purposes of section 4943(f)(3)(A).

Linda E. Stiff,
Deputy Commissioner for Services and Enforcement.
[FR Doc. E9-22866 Filed 9-23-09; 8:45 am]
BILLING CODE 4830-01-P