Type II supporting organizations: relationship issues in complex organizational structures.

• Author: Thomas, Randall

For a variety of complex tax, business, and operational purposes, tax-exempt entities may create complex organizational systems similar to their taxable counterparts that contain a variety of related entities: parents, subsidiaries, brothers, and sisters. These systems can contain both tax-exempt and taxable entities with a "parent" entity that coordinates the overall mission and activities of the whole system.

All Sec. 501(c)(3) organizations default to private foundation status unless described in Secs. 509(a)(1)-(4) (i,t., per se charities, publicly supported organizations, supporting organizations, and organizations that test for public safety). Therefore, complications may arise when the parent of a large, multientity system applies for recognition of tax-exempt status as a Sec. 501(c)(3) public charity. Through "derivative exemption" (i.e., carrying out the activities that a related organization could perform directly), the parent generally meets the requirements to be described in Sec. 501(c)(3); however, it must also rely on supporting organization status to qualify as a public charity.

The detailed rules applicable to supporting organizations have grown in complexity in recent years as a result of a stricter regulatory regime introduced by the Pension Protection Act of 2006, P.L. 109-280: statutory changes in 2006, final regulations in 2012 and 2015, and a revised Form 990, Return of Organization Exempt From Income Tax, Schedule A, Public Charity Status and Public Support. Failure to meet the detailed requirements could jeopardize the supporting organization's status as a public charity, cause it to default to private foundation status, and subject it to possible excise taxes under Chapter 42 and other penalties.

Introduction to Supporting Organizations

One type of tax-exempt entity often found in complex, related systems is the supporting organization. Supporting organizations come in a handful of varieties, defined by the relationship with their supported organizations: Type I (supervised or controlled by); Type II (supervised or controlled in connection with); and Type III (operated in connection with). Each supporting organization must meet an organizational test, operational test, relationship test, and control test. This item attempts to clarify the rules governing supporting organizations, with a particular focus on satisfying the Type II relationship test.

The Organizational Test

A Type II supporting organization must be...