New Rules for Association Foundations from the IRS

Date: July 16, 2013

This article originally appeared in the May 2013 issue of Associations Now, the journal of ASAE: The Center for Association Leadership.

Associations with related foundations that are considered to be “supporting organizations” under Internal Revenue Code section 509(a)(3) should pay attention to a recent decision by the Internal Revenue Service.  The IRS published the final and proposed regulations for supporting organizations on December 28, 2012 in T.D. 9605 - Payout Requirements for Type III Supporting Organizations That Are Not Functionally Integrated.

The title of this Treasury Decision is a misnomer – it goes beyond addressing the payout requirements for non-functionally integrated supporting organizations.  T.D. 9605 makes changes to some of the other proposed regulations for supporting organizations that were published for comment in an Advance Notice of Proposed Rulemaking in 2009 (the “proposed regulations”).  It also identifies a few areas where the IRS will be publishing proposed rules in the future.  T.D. 9605 was effective on December 28, 2012, but it provides for up to a two-year phase in of some regulations. The following is an explanation of several areas covered by T.D. 9605.

Types of Supporting Organizations

There are three types of supporting organizations under Internal Revenue Code Section 509(a)(3):

Type I:  a supporting organization that is “operated, supervised or controlled by” one or more publicly supported organizations.1  A majority of the supporting organization's officers, directors or trustees are appointed or elected by the supported organization's officers, directors, trustees or members.  This is the most common type of supporting organization. It is usually described as a parent/subsidiary relationship.

Type II:  a supporting organization supervised or controlled in connection with one or more publicly supported organizations.  Control or management of the supporting organization is placed with the same persons that control or manage the supported organization(s). A Type II supporting organization usually involves overlapping board membership between the supported organization and the supporting organization with at least a majority of the board members of the supporting organization also on the board of the supported organization. This is described as a sibling relationship with two or more organizations working side by side for similar exempt purposes.

Type III:  a supporting organization that is operated in connection with one or more publicly supported organizations.  Type III supporting organizations operate with some degree of independence. They may have one or more board members appointed by the supported organization and governance provisions to ensure that they are responsive to the needs of the supported organization. They may provide financial support to their supported organization or may directly carry out programs or functions on behalf of the supported organization.  

Type III supporting organizations are further classified as either being functionally integrated or non-functionally integrated.

Type III Functionally Integrated:  a supporting organization which is not required to make payments to its supported organizations because the supporting organization performs some of  the functions of, or carries out the purposes of, its supported organization(s).2  Due to their close relationship with the organizations they support, Type III functionally integrated supporting organizations are exempt from some of the rules imposed on Type III non-functionally integrated supporting organizations.  If a supporting organization supports more than one supported organization, that alone can qualify it as a Type III functionally integrated supporting organization. 

Type III Non-Functionally Integrated:  a supporting organization which is required to make annual distributions to its supported organization(s) and follow other rules similar to those applicable to private foundations.  Because of their similarity to private foundations, they may not receive contributions from private foundations.

Prohibited Gifts

The final regulations prohibit a Type I or Type III supporting organization from accepting a contribution from “a person who, alone or 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, or from persons related to a person possessing such control.”  The IRS and Treasury intend to issue a proposed definition of “control” for this purpose in the near future.3

Required Notice to Supported Organizations

The final regulations require all Type III supporting organization to provide each of their supported organizations with: “(1) a written notice addressed to the principal officer of the supported organization describing the amount and type of support provided to the supported organization; (2) a copy of the supporting organization's most recently filed Form 990 . . . and (3) a copy of the supporting organization's governing documents, including any amendments.  The required notification documents must be postmarked or electronically transmitted by the last day of the fifth calendar month following the close of the supported organization's taxable year.”4

This required notice was in the proposed regulations.  Its purpose is to give the supported organization an opportunity to provide information to the supporting organization on the specific needs of the supported organization.  The theory is that when the supported organization receives this information, it can in turn provide guidance to the supporting organization of its needs for the year ahead. Once the supporting organization (the foundation) has this information, it can better meet the needs of the supported organization (typically an association) in providing funding or other assistance. 

The IRS has clarified that the notice must be sent to the principal officer of each supported organization, even if the same person holds that position in both organizations.  Rather than providing paper or electronic copies of the required documents, the notice may include a link to where the supported organization can find the most recently filed Form 990 and/or governing documents online.  The supporting organization may redact the name and address of any contributors before providing the Form 990 to the supported organization. 

Scholarships and Other Payments to Individuals

If a supporting organization provides grants, scholarships or other payments to individual beneficiaries, it must meet three additional requirements:

  1. The individual beneficiaries must be members of the charitable class benefitted by the supporting organization;
  2. The officers, directors or trustees of the supported organization must have a significant voice in the timing of the payments, the selection of recipients, and the manner in which payments are made; and
  3. The individual beneficiaries must be selected on an objective and nondiscriminatory basis.5

For association foundations with scholarship programs, this means that those selected for scholarships or other financial awards must be among those people intended to be benefited by the activities of the foundation.  The association's volunteer leaders must have a significant say in determining the timing of scholarship awards and the manner in which they are paid.  They must also have a role in the selection of scholarship award recipients.  This does not mean that every officer and director of the association must be involved in the scholarship selection and award process.  There are several ways for the association leadership to have a “significant voice” in the operation of the scholarship program.  The association board could work with the foundation to establish criteria for scholarship applicants, the budget for scholarship awards each year, and the number of applicants selected.  Or the association board could review and approve criteria for scholarships and the award budget.  Or the association board could form a committee to work with the foundation staff or board in selecting scholarship award winners. The point of this regulation is that the foundation and the association must collaborate on the scholarship program.

Parent Organization

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.”6

The IRS intends to issue proposed regulations in the near future to provide a new definition of “parent” that addresses the power to remove and replace officers, directors or trustees of the supported organization.

Nonfunctionally Integrated Payout Rule

A nonfunctionally integrated Type III supporting organization has payout (i.e., distribution) requirements that were initially designed under the Pension Protection Act of 2006 to be similar to the payout requirements of private foundations.  However, based on a number of negative comments the IRS received during the comment period, the final regulations change the payout rule for non-functionally integrated supporting organizations.  Rather than paying out 5% of the fair market value of its non-exempt-use assets, a non-functionally integrated Type III supporting organization is required to distribute a “distributable amount” that is “equal to the greater of 85 percent of adjusted net income or 3.5 percent of the fair market value of the supporting organization's non-exempt-use assets.” The distributable amount is based on the fair market value of the organization's non-exempt-use assets in the immediately preceding tax year.7  This pay out requirement is the primary reason why many Type III supporting organizations do not want to be found to be non-functionally integrated as it takes away some of the organization's control of its distributions.

Failure to Meet Requirements

If a Type III supporting organization fails to meet the requirements of the final and temporary regulations in T.D. 9605 and otherwise fails to qualify as a public charity under 509(a)(1), (2) or (4), it will be classified as a private foundation.  Note that failure to provide the required annual notice to the supported organization(s) is considered to be a failure to meet the requirements of the regulations. For this reason, it is critical for foundations to provide the annual report to the association, even if the same staff is involved in overseeing both entities.

Transition Relief

Organizations that were Type III supporting organizations as of December 28, 2012 were granted an extension of time to meet the notice requirements that matches the extension of time to file their Form 990.  This means that if an organization obtains an extension until November 15, 2013 to file its Form 990 for 2012, then its notice to its supported organizations is not due until November 15, 2013.  Thereafter, the notice to supported organizations is due at the end of the fifth month following the close of the taxable year (or by May 31 for those organizations with a calendar tax year).  If the Form 990 for the just completed tax year is not ready to accompany the notice by May 31, then the supporting organization should provide its most recently filed Form 990 to its supported organization.8

Non-functionally integrated supporting organizations have been given two years to comply with the distribution requirement so that those who have invested in non-liquid assets have time to convert those assets to cash.


Associations with related foundations that qualify as supporting organizations should become familiar with the regulations applicable to their relationship as failure to comply could cause the foundation to be reclassified as a private foundation with all of the compliance requirements that accompany private foundation status.

1. Section 509(a)(1) or 509(a)(2)) organizations.
2. IRC § 4943(f)(5)(B).
3. § 1.509(a)-4(f)(5).
4. § 1.509(a)-4(i)(2).
5. § 1.509(a)-4(i)(4)(ii)(D).
6. § 1.509(a)-4(i)(4)(iii).
7. § 1.509(a)-4(i)(5)(ii).
8. § 1.509(a)-4(i)(11).