IRS Finalizes Regulations on Payout Requirements for Nonfunctionally Integrated Type III Supporting Organizations

The IRS in TD 9746 has issued final regulations on the payout requirements for nonfunctionally integrated Type III supporting organizations, generally adopting the rules that had been put in place by the 2012 temporary regulations that had governed such organizations.

As the preamble notes:

After consideration of all the comments received in response to the 2012 NPRM, this Treasury decision adopts the 2012 NPRM without change, except to (1) conform the provision regarding the valuation of non-exempt-use assets to the section 4942 regulation provision that it cross-references (§ 53.4942(a)-2(c)(2)), and (2) replace references in § 1.509(a)-4 to the temporary regulations with references to these final regulations. Thus, other than the change conforming the provision in the final regulations regarding the valuation of non-exempt-use assets to the provision in the section 4942 regulations, these final regulations are the same as the temporary regulations that have been applicable to Type III supporting organizations since December 28, 2012.

The regulations deal with changes made by the Pension Protection Act of 2006 (PPA).  The first change dealt with the computation of the distributable amount. The preamble describes both the required change imposed by the law and the method provided in the proposed and temporary regulations as follows:

The PPA directed the promulgation of Treasury regulations requiring NFI Type III supporting organizations to make distributions of a percentage of either income or assets to their supported organizations to ensure that a significant amount is paid to those supported organizations. Under the Treasury regulations in effect when PPA was enacted, certain Type III supporting organizations were required to distribute "substantially all" of their income to one or more publicly supported organizations. For this purpose, "substantially all" had the same meaning of 85 percent or more that it had in § 53.4942(b)-1(c) (defining "substantially all" for purposes of the income test for private operating foundations). See Rev. Rul. 76-208, 1976-1 C.B. 161.

The 2009 NPRM had proposed to replace the income-based distribution requirement with an asset-based distribution requirement of 5 percent of the fair market value of an organization's non-exempt-use assets. In response to comments, the 2012 NPRM instead proposed to keep the historic income-based distribution requirement, and proposed to combine it with a reduced percentage-of-assets distribution requirement. Therefore, the temporary and proposed distributable amount for NFI Type III supporting organizations was the greater of 85 percent of adjusted net income or 3.5 percent of the net fair market value of non-exempt-use assets, in each case as determined for the immediately preceding taxable year.

The final regulations adopted the rule noted above without making any changes to it.

The proposed and temporary regulations also provided that an organization’s adjusted income would be computed in accordance with the principles of IRC §4942(f) and Reg. §53.4942(a)-2(d), applying the principles of Subtitle A (Income Taxes) of the IRC. This also was adopted as part of the final regulations.

Finally the regulations provide that for purposes of determining the distributable amount for a taxable year, non-exempt use assets would be valued using the principles applicable to private foundations under Reg. §54.4942(a)-2(c).  The final regulations also adopt this treatment.

The final regulations were effective on December 21, 2015.

The IRS also announced, concurrently with the release of the final regulations, that the agency plans to release additional proposed regulations with a proposed change in these final regulations:

The Treasury Department and the IRS intend to publish a notice of proposed rulemaking for Type III supporting organizations in the near future. Among other proposals, the new proposed regulations would make one change to these final regulations. Specifically, the new proposed regulations will propose removal of the provision in these final regulations that reduces the distributable amount by the amount of taxes subtitle A of the Code imposes on a supporting organization during the immediately preceding taxable year.