[Federal Register Volume 80, Number 246 (Wednesday, December 23, 2015)]
[Rules and Regulations]
[Pages 79684-79687]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2015-32146]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9746]
RIN 1545-BL44


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

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations and removal of temporary regulations.

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SUMMARY: This document contains final regulations regarding the 
distribution requirement for non-functionally integrated Type III 
supporting organizations. The regulations reflect changes to the law 
made by the Pension Protection Act of 2006. The regulations will affect 
non-functionally integrated Type III supporting organizations and their 
supported organizations.

DATES: Effective Date: These regulations are effective on December 21, 
2015.

FOR FURTHER INFORMATION CONTACT: Jonathan Carter at (202) 317-4394 or 
Mike Repass at (202) 317-6176 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

1. Overview

    This document contains amendments to the Income Tax Regulations (26 
CFR part 1) regarding organizations described in section 509(a)(3) of 
the Internal Revenue Code (Code). An organization described in section 
501(c)(3) is classified as either a private foundation or a public 
charity. To be classified as a public charity, an organization must be 
described in section 509(a)(1), (2), or (3). Organizations described in 
section 509(a)(3) are known as ``supporting organizations.'' Supporting 
organizations achieve their public charity status by supporting one or 
more organizations described in section 509(a)(1) or (2), which in this 
context are referred to as ``supported organizations.''
    To be described in section 509(a)(3), an organization must satisfy 
(1) an organizational test, (2) an operational test, (3) a relationship 
test, and (4) a disqualified person control test. The organizational 
and operational tests require that a supporting organization be 
organized and at all times thereafter operated exclusively for the 
benefit of, to perform the functions of, or to carry out the purposes 
of one or more supported organizations. The relationship test requires 
a supporting organization to establish one of three types of 
relationships with one or more supported organizations. Finally, the 
disqualified person control test requires that a supporting 
organization not be controlled directly or indirectly by certain 
disqualified persons.
    Each of the described tests is a necessary requirement for an 
organization to establish that it qualifies as a supporting 
organization. These final regulations, however, focus primarily on the 
relationship test for supporting organizations that are ``operated in 
connection with'' their supporting organization(s), otherwise known as 
``Type III'' supporting organizations. Specifically, the final 
regulations reflect statutory changes enacted by the Pension Protection 
Act of 2006, Public Law 109-280 (120 Stat. 780 (2006) (PPA)). Section 
1241(d)(1) of the PPA directed the Secretary of the Treasury to 
promulgate regulations under section 509 that establish a new 
distribution requirement for Type III supporting organizations that are 
not ``functionally integrated'' to ensure that a ``significant amount'' 
is paid to supported organizations. For this purpose, the term 
``functionally integrated'' means a Type III supporting organization 
that is not required under Treasury regulations to make payments to 
supported organizations because the supporting organization engages in 
activities that relate to performing the functions of, or carrying out 
the purposes of, its supported organization(s). These final regulations 
address the amount that a Type III supporting organization that is not 
functionally integrated (a non-functionally integrated (NFI) Type III 
supporting organization) must annually distribute to its supported 
organization(s).

2. Prior Rulemaking

    On August 2, 2007, the Treasury Department and the IRS published in 
the Federal Register (72 FR 42335) an advance notice of proposed 
rulemaking (ANPRM) (REG-155929-06) in response to the PPA. The ANPRM 
described proposed rules to implement the changes made by the PPA to 
the Type III supporting organization requirements and solicited 
comments regarding those proposed rules.
    On September 24, 2009, the Treasury Department and the IRS 
published in the Federal Register (74 FR 48672) a notice of proposed 
rulemaking (the 2009 NPRM) (REG-155929-06). The 2009 NPRM contained 
proposed regulations (the 2009 proposed regulations) setting forth the 
requirements to qualify as a Type III supporting organization under the 
PPA.
    On December 28, 2012, the Treasury Department and the IRS published 
in the Federal Register (77 FR 76382) a Treasury decision (TD 9605) 
containing final and temporary regulations (the 2012 TD) regarding the 
requirements to qualify as a Type III supporting organization. Based on 
the comments received, the 2012 TD made certain changes to the rules 
proposed in the 2009 NPRM, included in the temporary regulations 
significant changes to the distribution requirement, and reserved 
certain topics for further consideration. The 2012 TD was effective and 
applicable on December 28, 2012. The applicability of the temporary 
regulations expires on or before December 21, 2015. On December 28, 
2012, the Treasury Department and the IRS also published in the Federal

[[Page 79685]]

Register (77 FR 76426) a notice of proposed rulemaking (the 2012 NPRM) 
(REG-155929-06) that incorporated the text of the temporary regulations 
in the 2012 TD by cross-reference. The IRS received five comments on 
the 2012 NPRM. The comments were considered in developing these final 
regulations and are available for public inspection at 
www.regulations.gov or upon request. No public hearing was requested.
    Under the 2012 TD, an NFI Type III supporting organization must 
annually distribute to or for the use of one or more supported 
organizations an amount equaling or exceeding the supporting 
organization's ``distributable amount'' for the taxable year. See Sec.  
1.509(a)-4(i)(5)(ii). The temporary regulations contained in the 2012 
TD defined an NFI Type III supporting organization's ``distributable 
amount'' as equal to the greater of (1) 85 percent of the supporting 
organization's adjusted net income or (2) its ``minimum asset amount,'' 
in each case for the immediately preceding taxable year. The temporary 
regulations defined ``minimum asset amount'' as 3.5 percent of the 
excess of the aggregate fair market value of the supporting 
organization's non-exempt-use assets over the acquisition indebtedness 
with respect to such nonexempt use assets. Additionally, the temporary 
regulations provided that the determination of the aggregate fair 
market value of an NFI Type III supporting organization's non-exempt-
use assets would be made using the valuation methods generally 
applicable to private foundations under Sec.  53.4942(a)-2(c). The 
temporary regulations also provided that, consistent with the private 
foundation rules, the ``non-exempt use'' assets of a supporting 
organization do not include certain investment assets described in 
Sec.  53.4942(a)-2(c)(2) or assets used (or held for use) to carry out 
the exempt purposes of the supported organization(s) (as determined by 
applying the principles described in Sec.  53.4942(a)-2(c)(3)).
    After consideration of all the comments received in response to the 
2012 NPRM, this Treasury decision adopts the 2012 NPRM without change, 
except to (1) conform the provision regarding the valuation of non-
exempt-use assets to the section 4942 regulation provision that it 
cross-references (Sec.  53.4942(a)-2(c)(2)), and (2) replace references 
in Sec.  1.509(a)-4 to the temporary regulations with references to 
these final regulations. Thus, other than the change conforming the 
provision in the final regulations regarding the valuation of non-
exempt-use assets to the provision in the section 4942 regulations, 
these final regulations are the same as the temporary regulations that 
have been applicable to Type III supporting organizations since 
December 28, 2012. Additionally, this Treasury decision removes the 
temporary regulations.
    The Treasury Department and the IRS intend to publish a notice of 
proposed rulemaking for Type III supporting organizations in the near 
future. Among other proposals, the new proposed regulations would make 
one change to these final regulations. Specifically, the new proposed 
regulations will propose removal of the provision in these final 
regulations that reduces the distributable amount by the amount of 
taxes subtitle A of the Code imposes on a supporting organization 
during the immediately preceding taxable year. In addition, the new 
proposed regulations will propose specific rules regarding the 
requirements for Type III supporting organizations that support 
governmental supported organizations to be treated as functionally 
integrated Type III supporting organizations. In addition, the new 
proposed regulations would provide transition relief beyond the period 
provided in Notice 2014-4, 2014-2 IRB 274. Supporting organizations may 
continue to rely on the transitional rule described in Section 3.01 of 
Notice 2014-4 until the date that the notice of proposed rulemaking 
prescribing the new proposed regulations under Sec.  1.509(a)-
4(i)(4)(iv) is published in the Federal Register. In the notice of 
proposed rulemaking publishing the new proposed regulations, the 
Treasury Department and the IRS will request comments on all proposed 
changes.

Explanation of Provisions and Summary of Comments

    This section discusses the comments received in response to the 
2012 NPRM.

1. Distributable Amount

    The PPA directed the promulgation of Treasury regulations requiring 
NFI Type III supporting organizations to make distributions of a 
percentage of either income or assets to their supported organizations 
to ensure that a significant amount is paid to those supported 
organizations. Under the Treasury regulations in effect when PPA was 
enacted, certain Type III supporting organizations were required to 
distribute ``substantially all'' of their income to one or more 
publicly supported organizations. For this purpose, ``substantially 
all'' had the same meaning of 85 percent or more that it had in Sec.  
53.4942(b)-1(c) (defining ``substantially all'' for purposes of the 
income test for private operating foundations). See Rev. Rul. 76-208, 
1976-1 C.B. 161.
    The 2009 NPRM had proposed to replace the income-based distribution 
requirement with an asset-based distribution requirement of 5 percent 
of the fair market value of an organization's non-exempt-use assets. In 
response to comments, the 2012 NPRM instead proposed to keep the 
historic income-based distribution requirement, and proposed to combine 
it with a reduced percentage-of-assets distribution requirement. 
Therefore, the temporary and proposed distributable amount for NFI Type 
III supporting organizations was the greater of 85 percent of adjusted 
net income or 3.5 percent of the net fair market value of non-exempt-
use assets, in each case as determined for the immediately preceding 
taxable year.
    One commenter stated that a distribution requirement based on 3.5 
percent of assets is sufficient to achieve the goals of Congress and 
that the distribution requirement based on 85 percent of income should 
be removed. The commenter stated that a distribution requirement based 
on income would prevent a supporting organization from smoothing its 
returns in high-earning years with low-earning years, and could result 
in organizations shifting investments away from income-producing assets 
toward appreciating assets to avoid erosion of an endowment even if 
that investment strategy results in forgoing higher returns. The 
commenter also said that having two tests increases administrative 
costs for a supporting organization by requiring it to make two 
calculations rather than one to determine its distributable amount, 
thus reducing the amount distributed for true charitable purposes. 
Another commenter suggested that organizations that were not previously 
identified as avoiding the prior substantially-all-of-income 
distribution requirement should be exempted from the asset-based 
distribution requirement because it potentially harms entities that are 
invested primarily in non-liquid assets.
    The Treasury Department and the IRS believe that a distribution 
requirement equal to the greater of 85 percent of adjusted net income 
or 3.5 percent of the net fair market value of an organization's non-
exempt-use assets strikes an appropriate balance. It ensures that NFI 
Type III supporting organizations distribute significant amounts to 
their supported organizations, as Congress directed in the PPA. 
Further, the 85 percent of income test will make it more likely that

[[Page 79686]]

supported organizations will timely benefit from higher returns 
received by their supporting organizations. Conversely, in years with 
lower returns or for organizations that invest in assets that produce 
largely appreciation rather than income, a 3.5-percent of assets 
distribution requirement will apply, which is less than the 5-percent 
of assets distribution requirement that applies to private non-
operating foundations. With respect to the suggestion that certain 
organizations be permitted to comply only with the income-based 
distribution requirement, the Treasury Department and the IRS believe 
it would be inequitable and administratively difficult to apply one 
requirement to some NFI Type III supporting organizations but another 
requirement to others.
    Therefore, the final regulations adopt the annual distributable 
amount rule of the 2012 NPRM without changes.

2. Income From Distributions From Subsidiary

    The 2012 NPRM provided that, for purposes of the calculation of the 
annual distributable amount, a supporting organization's adjusted net 
income would be determined using the principles of section 4942(f) and 
Sec.  53.4942(a)-2(d). These provisions apply the principles of 
subtitle A of the Code.
    One commenter requested that the definition of adjusted net income 
exclude dividend income resulting from a distribution of long-term 
capital gain property to a supporting organization by a corporate 
subsidiary. The commenter noted that without this exclusion, the 
receipt of distributed property could result in a much higher 
distribution requirement for that one year, but without producing any 
liquid assets to satisfy the higher distribution requirement.
    The 2012 NPRM provided that adjusted net income be determined by 
applying the principles that apply in calculating the adjusted net 
income of private operating foundations under sections 4942(d) and 
4942(j)(3) and are generally based on long-standing principles under 
subtitle A of the Code. The Treasury Department and the IRS believe 
that the rules for calculating adjusted net income should be applied 
consistently for all taxpayers and do not believe that there is a 
justification for the rules to be altered solely for supporting 
organizations. Therefore, the final regulations do not adopt this 
comment.

3. Real Property Valuations

    The 2012 NPRM provided that for purposes of determining the 
distributable amount for a taxable year, non-exempt-use assets would be 
valued using the principles generally applicable to private foundations 
under Sec.  53.4942(a)-2(c). One commenter suggested allowing the use 
of state property tax valuations for purposes of valuing real property 
under Sec.  53.4942(a)-2(c).
    Section 53.4942(a)-2(c) applies the principles of regulations under 
section 2031, which generally apply for estate tax purposes, to the 
valuation of real property. Section 20.2031-1(b) provides that the 
value at which property is assessed for local tax purposes may be 
considered only if that value represents the fair market value as of 
the valuation date. Section 20.2031-3 further provides that if real 
property is leased or otherwise used in a business, special valuation 
rules may apply. The Treasury Department and the IRS continue to 
believe that the same valuation principles that apply to private 
foundations should apply to NFI Type III supporting organizations. 
Therefore, the final regulations do not adopt this comment.
Effective Date
    These regulations are effective on December 21, 2015.

Statement of Availability of IRS Documents

    The IRS Notice 2014-4 cited in this preamble is published in the 
Internal Revenue Bulletin and is available from the Superintendent of 
Documents, U.S. Government Printing Office, Washington, DC 20402, or by 
visiting the IRS Web site at http://www.irs.gov.

Special Analyses

    Certain IRS regulations, including this one, are exempt from the 
requirements of Executive Order 12866, as supplemented and reaffirmed 
by Executive Order 13563. Therefore, a regulatory impact assessment is 
not required. It has also been determined that section 553(b) of the 
Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to 
these regulations, and because these regulations do not impose a 
collection of information on small entities, 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, the temporary 
and proposed regulations preceding these final regulations were 
submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on their impact on small business, and no 
comments were received.

Drafting Information

    The principal authors of these regulations are Mike Repass and 
Jonathan Carter, Office of Associate Chief Counsel (Tax-Exempt and 
Government Entities). However, other personnel from the Treasury 
Department and the IRS participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

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


0
Par. 2. Section 1.509(a)-4 is amended by:
0
1. Amending the second sentence of paragraph (i)(4)(ii)(C) to remove 
the language ``Sec.  1.509(a)-4T(i)(8)(ii)'' and adding ``paragraph 
(i)(8)(ii) of this section'' in its place.
0
2. Amending paragraph (i)(5)(ii)(A) to remove the language ``Sec.  
1.509(a)-4T(i)(5)(ii)(B)'' and adding ``paragraph (i)(5)(ii)(B) of this 
section'' in its place.
0
3. Revising paragraph (i)(5)(ii)(B).
0
4. Revising paragraph (i)(5)(ii)(C).
0
5. Amending the last sentence of paragraph (i)(5)(ii)(D) to remove the 
language ``Sec.  1.509(a)-4T(i)(5)(ii)(B)'' and adding ``paragraph 
(i)(5)(ii)(B) of this section'' in its place.
0
6. Amending the first sentence of Example 1 of paragraph (i)(5)(iii)(D) 
to remove the language ``Sec.  1.509(a)-4T(i)(5)(ii)(B)'' and adding 
``paragraph (i)(5)(ii)(B) of this section'' in its place.
0
7. Amending the first sentence of Example 2 of paragraph (i)(5)(iii)(D) 
to remove the language ``Sec.  1.509(a)-4T(i)(5)(ii)(B)'' and adding 
``paragraph (i)(5)(ii)(B) of this section'' in its place.
0
8. Amending the third sentence of Example 3 of paragraph (i)(5)(iii)(D) 
to remove the language ``Sec.  1.509(a)-4T(i)(5)(ii)(B)'' and adding 
``paragraph (i)(5)(ii)(B) of this section'' in its place.
0
9. Amending the fourth sentence of Example 4 of paragraph 
(i)(5)(iii)(D) to remove the language ``Sec.  1.509(a)-
4T(i)(5)(ii)(B)'' and adding ``paragraph (i)(5)(ii)(B) of this 
section'' in its place.
0
10. Amending paragraph (i)(6)(iv) to remove the language ``Sec.  
1.509(a)-

[[Page 79687]]

4T(i)(8)(ii)'' and adding ``paragraph (i)(8)(ii) of this section'' in 
its place.
0
11. Amending paragraph (i)(7)(ii) to remove the language ``Sec.  
1.509(a)-4T(i)(5)(ii)(B)'' and adding ``paragraph (i)(5)(ii)(B) of this 
section'' in its place.
0
12. Revising paragraph (i)(8).
0
13. Revising paragraph (l).
    The revisions and additions read as follows:


Sec.  1.509(a)-4  Supporting organizations.

* * * * *
    (i) * * *
    (5) * * *
    (ii) * * *
    (B) Distributable amount. Except as provided in paragraphs 
(i)(5)(ii)(D) and (E) of this section, the distributable amount for a 
taxable year is an amount equal to the greater of 85 percent of the 
supporting organization's adjusted net income (as determined by 
applying the principles of section 4942(f) and Sec.  53.4942(a)-2(d) of 
this chapter) for the taxable year immediately preceding the taxable 
year of the required distribution (immediately preceding taxable year) 
or its minimum asset amount (as defined in paragraph (i)(5)(ii)(C) of 
this section) for the immediately preceding taxable year, reduced by 
the amount of taxes imposed on the supporting organization under 
subtitle A of the Internal Revenue Code during the immediately 
preceding taxable year.
    (C) Minimum asset amount. For purposes of this paragraph (i)(5), a 
supporting organization's minimum asset amount for the immediately 
preceding taxable year is 3.5 percent of the excess of the aggregate 
fair market value of all of the supporting organization's non-exempt-
use assets (determined under paragraph (i)(8) of this section) in that 
immediately preceding taxable year 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--
    (1) Amounts received or accrued during the immediately preceding 
taxable year as repayments of amounts which were taken into account by 
the organization to meet the distribution requirement imposed in this 
paragraph (i)(5)(ii) for any taxable year;
    (2) Amounts received or accrued during the immediately preceding 
taxable year 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 this 
paragraph (i)(5)(ii) for any taxable year; and
    (3) Any amount set aside under paragraph (i)(6)(v) of this section 
to the extent it is determined during the immediately preceding taxable 
year that such amount is not necessary for the purposes for which it 
was set aside and such amount was taken into account by the 
organization to meet the distribution requirement imposed in this 
paragraph (i)(5)(ii) for any taxable year.
* * * * *
    (8) Valuation of non-exempt-use assets. For purposes of determining 
its distributable amount for a taxable year, a supporting organization 
determines its minimum asset amount, as defined in paragraph 
(i)(5)(ii)(C) of this section, by determining the aggregate fair market 
value of all of its non-exempt-use assets in the immediately preceding 
taxable year. For these purposes, the determination of the aggregate 
fair market value of all non-exempt-use assets shall be made using the 
valuation methods described in Sec.  53.4942(a)-2(c) of this chapter. 
The aggregate fair market value of the supporting organization's non-
exempt-use assets shall not be reduced by any amount that is set aside 
under paragraph (i)(6)(v) of this section. For these purposes, the non-
exempt use assets of the supporting organization are all assets of the 
supporting organization other than--
    (i) Assets described in Sec.  53.4942(a)-2(c)(2)(i) through (iv) of 
this chapter (with the term ``supporting organization'' being 
substituted for ``foundation'' or ``private foundation'' and the date 
``August 17, 2006'' being substituted for ``December 31, 1969''); and
    (ii) Exempt-use assets, which are assets that are used (or held for 
use) directly in carrying out the exempt purposes of the supporting 
organization's supported organization(s) (determined by applying the 
principles described in Sec.  53.4942(a)-2(c)(3) of this chapter) by 
either--
    (A) The supporting organization; or
    (B) One or more supported organizations, but only if the supporting 
organization makes the asset available to the supported organization(s) 
at no cost (or nominal rent) to the supported organization(s).
* * * * *
    (l) Effective/applicability dates. Paragraphs (a)(6), (f)(5), 
(i)(1) through (i)(4)(ii)(B), (i)(4)(ii)(D) through (i)(5)(i), 
(i)(5)(ii)(E) through (i)(5)(iii)(C), (i)(6)(i) through (iii), 
(i)(6)(v) through (i)(7)(i), and (i)(9) through (11) of this section 
are applicable on December 28, 2012. Paragraphs (i)(4)(ii)(C), 
(i)(5)(ii)(A) through (i)(5)(ii)(D), (i)(5)(iii)(D), (i)(6)(iv), 
(i)(7)(ii) and (i)(8) of this section are applicable on December 21, 
2015. See paragraphs (i)(5)(ii)(B), (i)(5)(ii)(C), and (i)(8) of Sec.  
1.509(a)-4T contained in 26 CFR part 1, revised as of April 1, 2015, 
for certain rules regarding non-functionally integrated Type III 
supporting organizations effective before December 21, 2015.
* * * * *


Sec.  1.509(a)-4T  [Removed].

0
Par. 3. Section 1.509(a)-4T is removed.

John Dalrymple,
Deputy Commissioner for Services and Enforcement.
    Approved: December 14, 2015.
Mark J. Mazur,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2015-32146 Filed 12-21-15; 4:15 pm]
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