IRS Guidance on Type III Supporting Organizations

In our earlier posts, we discussed a specific charitable entity called the Type III Supporting Organization.  We also examined the unique Advantages of a Type III Supporting Organization over a Private Foundation.

One of the challenges in setting up a Type III Supporting Organization are the technical rules and requirements imposed by the Internal Revenue Service.

These rules are so technical and confusing, sometimes it’s difficult to see what the IRS is really looking for.

A 2011 Private Letter Ruling – in which the entity was denied Type III status – provides some guidance on what the IRS is looking for when they examine these types of entities.

A comprehensive examination of this PLR is beyond the scope of this blog, however, let’s look at some of the points the IRS repeatedly raised when rejecting the applicant’s status.

  • Loans between Organization and a Disqualified Person – this is nearly always a red flag to the IRS.  Loans between an exempt entity and a Donor (or family of a Donor) indicate that the Organization exists for the benefit of a private party (not allowed) or gives the Disqualified person impermissible control over the Organization (also not allowed).  Therefore, loans between the Organization and a Disqualified person should be avoided.
  • Giving Family Board Member Veto Right Over Other Board Members – In this Organization’s case, the Family Member Board Member could not be removed without his own consent, which the IRS deemed to be impermissible Control by the Family over the Organization.  Therefore, the Organization was deemed to have failed the Control Test.
  • Failure to Give Significant Voice to Outside Board Member – While this Organization did have an outside Board Member who was the leader of the Supported Organization, it failed to demonstrate that the outside Board Member had a significant voice in the operations and use of the Organization’s assets.  The IRS used this in part to determine the Organization had failed the Responsiveness Test.

Conclusion:

In this case, the IRS rejected the status of this Organization as a Type III Supporting Organization.

It did so, in large part, because the IRS doubted the purpose of the Organization was actually to benefit the supported Charity as opposed to the Founding Donor’s family.

This is a common theme in what the IRS is looking for – evidence that the Organization is or is not independent of the Donor family.

Keep in mind that the default category for all Exempt Entities is Private Foundation status.  You must prove to the IRS – by complying with their requirements – that you are independent enough to be categorized as a Public Charity.

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