Supporting organizations, or organizations described under Section 509(a)(3) of the Internal Revenue Code (IRC), provide a powerful tool for charitable endeavors, enabling tailored support to public charities while avoiding the restrictions and complexities of private foundations. This article delves into what supporting organizations are, their classifications, requirements for compliance, and the unique benefits they offer. Drawing from IRS regulations, private letter rulings, and case law, this guide provides a comprehensive understanding of these organizations for nonprofit stakeholders.
What Is a Supporting Organization?
At their core, supporting organizations are public charities that exist to benefit and support other public charities. Unlike charities relying on broad public support under IRC §509(a)(1) or §509(a)(2), supporting organizations derive their public charity status from their relationship with one or more supported organizations. These relationships ensure that supporting organizations operate in alignment with the missions of their supported entities, while also safeguarding against potential abuses like private benefit or self-dealing.
Classifications of Supporting Organizations
The IRC outlines three distinct types of supporting organizations, each defined by the nature of their relationship with their supported organizations.
Type I supporting organizations are ones that are “operated, supervised, or controlled by” the supported organization. Often compared to a parent-subsidiary relationship, this type of supporting organization must be under the direct control of its supported organization(s). For example, a majority of its governing board members may be appointed by the supported organization.
Type II supporting organizations are ones that are “supervised or controlled in connection with” the supported organization. This “brother-sister” model requires overlapping governance structures. The same individuals must exercise control over both the supporting and supported organizations, fostering a direct alignment of objectives.
Type III supporting organizations are ones that are “operated in connection with” the supported organization. This is the most flexible but also the most complex category, requiring the supporting organization to satisfy two sub-tests: the responsiveness test and the integral part test. These tests ensure that the supporting organization remains responsive to and integrally involved with the operations of its supported entities (Treas. Reg. §1.509(a)-4(i)).
Each of the supporting organization types share similar requirements under IRS laws and regulations, but each also has its own twist.
Requirements for Supporting Organizations
To qualify and maintain status as a supporting organization, entities must meet several stringent requirements. These include compliance with both the general requirements for tax-exempt status under IRC §501(c)(3) and the specific mandates under IRC §509(a)(3).
- Organizational Test
A supporting organization must be organized exclusively for the benefit of, to perform the functions of, or to carry out the purposes of one or more public charities under §509(a)(1) or §509(a)(2). This requirement must be clearly stated in the organization’s governing documents, such as articles of incorporation or bylaws (Treas. Reg. §1.509(a)-4(c)).
For example, in Private Letter Ruling (PLR) 200437038, the IRS examined an organization whose articles of incorporation explicitly limited its purpose to benefiting specific publicly supported charities, thereby satisfying the organizational test.
- Operational Test
Supporting organizations must operate exclusively for the benefit of their supported organizations. Any activities must directly further the supported organizations’ exempt purposes, and the supporting organization must refrain from engaging in unrelated business activities that could endanger its status (Rev. Rul. 75-437, 1975-2 C.B. 218).
- Relationship Test
The relationship test, under IRC §509(a)(3)(B), is central to determining whether an organization qualifies as a supporting organization. This test ensures that the supporting organization maintains a defined and accountable connection with its supported organization(s). The relationship can take one of three forms, each with specific requirements:
- (Type I) Operated, Supervised, or Controlled By
This type of relationship is most akin to a parent-subsidiary structure, where the supported organization has significant oversight over the supporting organization’s activities and governance.
- The supported organization(s) must appoint or elect a majority of the supporting organization’s governing body (Treas. Reg. §1.509(a)-4(g)).
- The supported organization(s) must have substantial direction over the supporting organization’s policies, programs, and activities.
- This structure ensures that the supported organization has direct control over the supporting organization’s operations, preventing deviation from its mission.
Example: A university creates a supporting organization to manage scholarships for its students. The university appoints all members of the supporting organization’s board of directors, ensuring alignment with its educational objectives.
- (Type II) Supervised or Controlled in Connection With
This model is often referred to as a “brother-sister” relationship, requiring overlapping governance to ensure a unified direction between the supporting and supported organizations.
- The same individuals must govern both the supporting organization and the supported organization(s).
- These individuals do not need to hold identical positions in both organizations but must exercise control over both entities (Treas. Reg. §1.509(a)-4(h)).
- The relationship is designed to create parallel oversight by a common body of individuals, ensuring shared priorities and objectives.
Example: A regional hospital system establishes a supporting organization to fund medical research. The same trustees sit on the boards of both the hospital system and the supporting organization, enabling coordinated efforts to advance healthcare outcomes.
- (Type III) Operated in Connection With
This is the most flexible and commonly used relationship but also the most scrutinized, as it does not require direct governance ties. Instead, it demands a demonstrable alignment between the supporting and supported organizations through two sub-tests: the responsiveness test and the integral part test.
Responsiveness Test Requirements:
- The officers, directors, or trustees of the supported organization must be directly involved in the governance or operations of the supporting organization. This can be shown through:
- Appointment of one or more officers, directors, or trustees of the supporting organization by the supported organization (Treas. Reg. §1.509(a)-4(i)(2)(ii)).
- Shared individuals holding significant positions in both organizations.
- A close and continuous working relationship between the two organizations.
- The supported organization must have a significant voice in directing how the supporting organization uses its resources, including investment decisions, grant timing, and recipient selection (Rev. Rul. 75-437, 1975-2 C.B. 218).
Integral Part Test Requirements:
The supporting organization must either:
- Engage in activities that directly perform the functions of the supported organization or are essential to its purposes. These activities must be ones the supported organization would otherwise perform itself (Treas. Reg. §1.509(a)-4(i)(3)(ii)).
- Provide substantial financial support to the supported organization, ensuring attentiveness to the supporting organization’s operations. At least 85% of the supporting organization’s income must go to the supported organization, per Rev. Rul. 76-208, 1976-1 C.B. 161.
Example: A community foundation operates as a supporting organization for local nonprofits. It provides financial grants (meeting the integral part test) while maintaining a close working relationship with the nonprofits’ leaders (satisfying the responsiveness test).
Why the Relationship Test Matters
The relationship test ensures that supporting organizations remain accountable and aligned with their supported organizations’ missions. It protects against potential abuses, such as impermissible private benefit or lack of oversight, while allowing flexibility in structuring support to meet charitable goals. Careful planning and documentation are essential to satisfy the specific requirements of the chosen relationship type.
- Control Test
To prevent abuse, the supporting organization must not be controlled by disqualified persons, as defined in IRC §4946. Disqualified persons include substantial contributors, family members, or entities owned or controlled by such individuals.
In Lapham Foundation v. Commissioner, T.C. Memo 2002-293, the Tax Court emphasized the importance of ensuring that no undue influence by disqualified persons exists, as this could compromise the organization’s compliance with the control test.
Benefits of Supporting Organizations
Supporting organizations under IRC §509(a)(3) offer a robust set of benefits that combine the favorable tax treatment of public charities with the flexibility and control often associated with private foundations. Below is an expanded overview of these key advantages:
- Favorable Tax Treatment for Donors
One of the most attractive features of supporting organizations is their classification as public charities, which enables donors to enjoy the most advantageous tax benefits under IRC §170(b)(1)(A). Donors can deduct up to 60% of their adjusted gross income (AGI) for cash contributions and the fair market value of appreciated assets like stocks, without the capital gains tax liability imposed on private foundation gifts. These benefits make supporting organizations an ideal vehicle for significant charitable contributions.
- Greater Flexibility and Control
Supporting organizations allow donors and the supported charities to retain meaningful involvement in how funds are managed and used:
Customized Support: Supporting organizations can be designed to fulfill specific purposes, such as funding scholarships, managing endowments, or providing operational support to a public charity.
Donor Involvement: Donors can serve on the supporting organization’s board or work closely with supported organizations to guide decisions, providing a sense of stewardship over their charitable legacy.
Tailored Grant-Making: Unlike donor-advised funds, supporting organizations allow for grants and programs that are directly aligned with the missions of the supported charities, with fewer restrictions.
- Regulatory Advantages
Supporting organizations enjoy significant regulatory benefits over private foundations:
No Excise Tax on Investment Income: Supporting organizations are exempt from the 1.39% excise tax on net investment income that applies to private foundations under IRC §4940.
No Mandatory Payouts: While private foundations must annually distribute 5% of their net investment assets, supporting organizations have no such requirement, offering greater flexibility in the timing and scale of grants.
Simpler Reporting Requirements: Supporting organizations file the more straightforward Form 990 or Form 990-EZ, instead of the complex Form 990-PF required of private foundations. This reduces administrative burdens and costs. For more information on this topic, read our articles detailing the exemption process and choosing between Forms 990 and 990-EZ.
- Enhanced Fundraising and Collaboration
As public charities, supporting organizations are better positioned to attract contributions from individual donors, corporations, and other foundations:
Increased Grant Eligibility: Many private foundations are more willing to award grants to public charities than other private foundations, ensuring a broader pool of potential funding.
Public Appeal: Supporting organizations can highlight their public charity status, enhancing credibility and appeal to donors who prioritize transparency and accountability.
Pitfalls and Common Issues
Despite their advantages, supporting organizations face heightened scrutiny due to potential for abuse. Common pitfalls include failure to properly define relationships in governing documents, insufficient involvement by supported organizations, and excessive control by disqualified persons. Recent IRS enforcement efforts have targeted supporting organizations that fail the responsiveness or integral part tests, particularly those structured to provide impermissible private benefits.
Final Thoughts
Supporting organizations are a valuable structure for furthering charitable missions while maintaining the favorable tax treatment of public charities. However, they require meticulous planning and strict adherence to statutory and regulatory requirements to avoid jeopardizing their status. By understanding the nuances of IRC §509(a)(3) and implementing robust governance practices, supporting organizations can maximize their impact while staying compliant.
If your nonprofit is considering forming or working with a supporting organization, Lighthouse Legal is here to guide you through the complexities of compliance and strategic planning. Contact us to learn how we can support your mission.
