"Supporting organizations are public charities that carry out their exempt purpose by supporting one or more other exempt organizations, usually public charities. The category can cover many types of entities including university endowment funds and organizations that provide essential services for hospital systems. The classification is important because it is one means by which a charity can avoid classification as a private foundation, a status that is subject to a much more restrictive regulatory regime. The key feature of a supporting organization is a strong relationship with an organization it supports. The strong relationship enables the supported organization to oversee the operations of the supporting organization. Therefore, the supporting organization is classified as a public charity, even though it may be funded by a small number of person[s] in a manner that is similar to a private foundation." – IRS website, "Section 509(a)(3) Supporting Organizations"
Internal Revenue Code Section 509(a)(3) provides an exception to classification of a Section 501(c)(3) organization as a private foundation to an organization which -
(A) is organized, and at all time therefore is operated, exclusively for the benefit of, or to carry out the purposes of one or more specified organizations described in Section 509(a)(1) or (a)(2) (Organizational and Operational Tests);
(B) is operated, supervised, or controlled by or in connection with one or more organizations described in Section 509(a)(1) or (a)(2) (Nature of Relationship Test); and
(C) is not controlled directly or indirectly by one or more disqualified persons (as defined in Section 4946) other than foundation managers and other than one or more organizations described in Section 509(a)(1) or (a)(2) – (Lack of Outside Control Test).
Note that for purposes of Section 509(a)(3), an organization described in Section 509(a)(2) shall be deemed to include an organization described in Section 501(c)(4) (social welfare organizations), (c)(5) (labor, agricultural or horticultural organizations), or (c)(6) (business leagues, chambers of commerce) which would be described in Section 509(a)(2) if it were an organization described in Section 501(c)(3). In other words, the "supported organization" may be a Section 501(c)(4), (c)(5) or (c)(6) organization if it otherwise meets the public support test and restrictions imposed by Section 509(a)(2). See Treas. Reg. 1.509(a)-4(k).
Collectively, the excepted organizations under Section 509(a)(3) are referred to as "supporting organizations" or "SOs." The IRS has carved out the language of the statute to come up with three distinct types of supporting organizations:
Type I SOs are "operated, supervised, or controlled by" the supported organization ("SDs"). Sufficient control may exist if a majority of the SO’s board is appointed by the SD. The relationship is somewhat akin to a parent-subsidiary relationship.
Type II SOs are "supervised or controlled in connection with" the SD. Generally, in a type II relationship, the SO and the SD are under common control. The relationship is somewhat akin to sister corporations.
Type III SOs are "operated in connection with" the SD. Since Type III relationships are less formal than a Type I or Type II relationship, Type III organizations must meet a responsiveness test and an integral part test. Section 1.509(a)-4(i)(2) and (3) of the Income Tax Regulations. These tests are designed to ensure that the SO is responsive to needs of a public charity and that the public charity oversees the operations of the SO. Finally, the SO must not be controlled directly or indirectly by disqualified persons, who generally are substantial contributors and their family members.
Organizational Test. Pursuant to Treas. Reg. 1.509(a)-4(c) and (d), the SO’s articles must:
(a) Limit purposes to Section 509(a)(3)(A) purposes;
(b) Not expressly empower the SO to engage in activities not in furtherance of (a);
(c) State the specified SDs on whose behalf such SO is to be operated*; and
(d) Not expressly empower the SO to support or benefit any SD other than those referred to in (c).
* Note, however, that the Type I or Type II SO need not designate the SD by name so long as it designates the SD "by class or purpose." See Treas. Reg. 1.509(a)-4(d)(2)(i)(b). With respect to a Type III SO, the SO need not designate the SD by name only if there is a "historic and continuing relationship between the SO and SD, which may not be possible if the SO is a new entity.
Operational Test. Treas. Reg. 1.509(a)-4(e) provides that an SO will be regarded as "operated exclusively" to support one or more SDs only if it engages solely in activities which support or benefit the specified SDs. In its support of the SD, the SO may make grants to the SD, make expenditures directly for the benefit of the individuals and causes served by the SD, or provide services or facilities to the beneficiaries served by the SD.
Nature of Relationship Test. Treas. Reg. 1.509(a)-4(g) provides that each of the items "operated by," "supervised by," and "controlled by," as used in IRC Sec. 509(a)(3)(B), presupposes a substantial degree of direction over the policies, programs and activities of a SO by one or more SD, comparable to the relationship between a parent and its subsidiary, where the subsidiary is under the direction of, and accountable or responsible to, the parent. This relationship is established by the fact that a majority of the officers, directors or trustees of the SO are appointed or elected by the governing body, members of the governing body, officers acting in their official capacity, or the membership of one or more SDs.
Type I: Treas. Reg. 1.509(a)-4(g)(ii) provides that an SO may be "operated, supervised, or controlled by" an SD even though its governing board is not comprised of representatives of the specified SDs for whose benefit the SO is operated. However, it must be demonstrated that the purposes of the SO are carried out by benefiting the SD.
Type II: Treas. Reg. 1.509(a)-4(h) provides that an SO will be considered to be supervised or controlled in connection with an SD if there only if there is common supervision or control by the persons supervising or controlling both the SO and the SD to insure that the SO will be responsive to the needs and requirements of the SD. In order to meet this requirement, the control or management of the SO must be vested in the same persons that control or manage the SD. The requirement is not met if the SD merely makes payments (mandatory or discretionary) to the SO.
Type III: Treas. Reg. 1.509(a)-4(i) provides that an SO will be considered to be "operated in connection with" an SD only if it meets the Responsiveness Test and the Integral Part Test described below.
Responsiveness Test. Treas. Reg. 1.509(a)-4(i)(2) provides that a SO will be considered to meet the Responsiveness Test if it is responsive to the needs or demands of the SO, as evidenced by one of the following (assuming the SO is not a charitable trust):
(a) One or more officers, directors or trustees of the SO are elected or appointed by the officers, directors, trustees or membership of the SD; or
(b) One or more members of the governing body of the SD are also officers, directors or trustees of, or hold other important offices in, the SO; or
(c) The officers, directors or trustees of the SO maintain a close or continuous working relationship with the officers, directors or trustees of the SD; AND
(d) By reason of (a), (b) or (c), the officers, directors or trustees of the SD have a significant voice in the investment policies of the SD, the timing of grants, the manner of making them, and the selection of recipients by such SO, and in otherwise directing the use of the income or assets of such SO.
If the SO is a charitable trust, (i) each specified SD must be a named beneficiary under the trust’s governing instrument; and (ii) the beneficiary SD must have the power to enforce the trust and compel an accounting under State law.
Integral Part Test. Treas. Reg. 1.509(a)-4(i)(3) provides the general rule that a SO will be considered to meet the Integral Part Test if it maintains a significant involvement in the operations of one or more SDs and such SDs are in turn dependent upon the SO for the type of support which it provides. This requirement is met if either of the following are satisfied:
(1) The activities engaged in for or on behalf of the SDs are activities to perform the functions of, or to carry out the purposes of, the SDs, and but for the involvement of the SO, would normally be engaged in by the SDs themselves.
(2)(a) The SO makes payments of substantially all of its income to or for the use of one or more SDs and the amount of support received by one or more SDs is sufficient to insure the attentiveness of such SDs to the operations of the SO. In addition, a substantial amount of the total support of the SO must go to those SDs which meet the attentiveness requirement with respect to such SO. Except as provided in (b) below, the amount of support received by SD must represent a sufficient part of the SD’s total support so as to insure attentiveness.
(b) Even where the amount of support received by an SD does not represent a sufficient part of the SD’s total support, the amount of support received from a SO may be sufficient to meet the requirements above if it can be demonstrated that in order to avoid the interruption of the carrying on of a particular function or activity, the SD will be sufficiently attentive to the operations of the SO. This may be the case where either the SO or the SD earmarks the support received from the SO for a particular program or activity, even if such program or activity is not the SD’s primary program or activity so long as such program or activity is a substantial one.
All pertinent factors, including the number of beneficiaries, the length and nature of the relationship between the SD and SO, and the purpose to which the funds are put, will be considered in determining whether the amount of support received by the SD is sufficient to insure its attentiveness to the operations of the SO. As the attentiveness of a SD is normally motivated by reason of the amounts received from the SO, the more substantial the amount involved, in terms of a percentage of the SD’s total support, the greater the likelihood that the required degree of attentiveness will be present. Evidence of actual attentiveness by the SD "is of almost equal importance."
Lack of Outside Control Test. Treas. Reg. 1.509(a)-4(j) reiterates that a SO may not be controlled directly or indirectly by one or more disqualified persons other than foundation managers and other than one or more SDs. If a person who is a disqualified person with respect to a SO, such as a substantial contributor to the SO, is appointed or designated as a foundation manager of the SO by a SD to serve as the representative of such SD, then such person will be regarded as a disqualified person, rather than as a representative of the SD.
The SO will be considered "controlled" for the purposes of this test, if the disqualified persons, by aggregating their votes or positions of authority, may require the SO to perform any act which significantly affects its operations or may prevent the SO from performing such act. This includes, but is not limited to, the right of any substantial contributor or his or her spouse to designate annually the recipients, from among the SDs of the income attributable to the contributor’s contribution to the SO.
Except as provided below, a SO will be considered to be controlled directly or indirectly by one or more disqualified persons if the voting power of such persons is 50% or more of the total voting power of the SO’s governing body or if one or more of such persons have the right to exercise veto power over the actions of the SO. However, all pertinent facts and circumstances, including the nature, diversity and income yield of an organization’s holdings, the length of time particular stocks, securities or other assets are retained, and its manner of exercising its voting rights with respect to stocks in which members of its governing body also have some interest, will be taken into consideration in determining whether a disqualified person does in fact indirectly control an organization.
Notwithstanding the above provisions regarding the Lack of Outside Control Test, an organization shall be permitted to establish to the satisfaction of the Commissioner that disqualified persons do not directly or indirectly control it.
For more information about Supporting Organizations, see IRS Publication "Public Charity or Private Foundation Status – Issues under IRC 509(a)(1)-(4), 4942(j)(3), and 507" (2003 EO CPE Text), pp. 116-145.