A slight improvement has been made by the Internal Revenue Service (IRS) in the procedures required for grants to section 509(a)(3) supporting organizations by private foundations and donor advised funds. The basic rules remain the same, however.

The Pension Protection Act of 2006 (“PPA”) negatively affected private non-operating (grant-making) foundations and donor advised funds that wish to make grants to certain types of supporting organizations. Specifically, private foundations and donor-advised funds are required under the PPA to exercise expenditure responsibility when making grants to (1) a supporting organization that is a Type III non-functionally integrated supporting organization, or (2) any other type of supporting organization if a disqualified person of the grantor directly or indirectly controls such supporting organization or a supported organization of the supporting organization. Furthermore, private foundations cannot count grants to these supporting organizations as satisfying their minimum distribution requirement. Thus, a private foundation or donor-advised fund is required to determine a potential grantee’s public charity status and classification before making a grant, if it is to avoid penalties.

In December 2006, the IRS issued Notice 2006-109, which provided a ready method for determining whether a grantee is a public charity under section 509(a)(1),(2) or (3) of the Internal Revenue Code, but left a major problem in determining whether a section 509(a)(3) organization is a Type I, Type II or functionally integrated Type III supporting organization. In determining whether a grantee is a section 509(a)(1), (2) or (3) organization, the Notice provided that a grantor, acting in good faith, can rely on either the grantee’s current IRS letter stating the grantee’s public charity classification, or information from the IRS Business Master File (BMF) that confirms the grantee’s public charity classification.

However, under Notice 2006-109, if a potential grantee is a section 509(a)(3) organization, a grantor must still make a “good faith” determination of potential grantee’s status by obtaining and relying on a legal opinion from the grantor’s lawyer or the proposed grantee’s lawyer, or a certificate from an officer, director or trustee of the proposed grantee as to the type of supporting organization (i.e., Type I, II or III), and if a Type III, the grantor must determine whether the supporting organization is “functionally integrated” with its supported organization.

Unfortunately, the June 30, 2009, additional guidance issued by the IRS in Revenue Procedure 2009-32 helps only with the first task and not with the second. It provides that private foundations and donor-advised funds can, in addition, now rely on a third party for determining the classification of a public charity. The third-party source must present the BMF information in a report that shows: (i) the grantee’s name, Employer Identification Number, and public charity classification under section 509(a)(1), (2) or (3); (ii) a statement that the information is from the most-currently available IRS monthly update to the BMF, along with the IRS BMF revision date; and (iii) the date and time of the grantor’s search. Additionally, the IRS requires the third-party BMF data source to “be in a form which the grantor can store in hard copy or electronically.” It appears that GuideStar Charity Check would satisfy these requirements, although each user is responsible for its own confirmation that the GuideStar information is adequate.

If a proposed grantee is a section 509(a)(3) organization, in order to determine what type it is, the foundation or donor advised fund is still required to obtain the proposed grantee’s organizational documents (e.g., articles of incorporation, charter or a trust instrument) and an analysis of them from the proposed grantee, and review the organizational documents to determine whether the legal opinion or certificate it receives is consistent with the documents. Thus, the grantor still cannot fully rely on the legal opinion or certificate by itself.

Moreover, the grantor still has the burden of determining whether the prohibited “control” exists with respect to the proposed grantee. The grantor will be required to exercise expenditure responsibility if a disqualified person of the grantor directly or indirectly controls the supporting organization or a supported organization of the supporting organization. Until new regulations are issued, the control standard that is described in the existing private foundation qualifying distribution regulations still apply—whether the person, alone or by aggregating votes or positions of authority with others similarly situated, can cause the organization to make an expenditure or prevent it from doing so.

In summary, although Revenue Procedure 2009-32 is helpful in permitting a grantor to rely on certain third-party information to determine a proposed grantee’s public charity classification, the grantor is still faced with the daunting task of determining whether it is prohibited from making a grant to a supporting organization for other reasons.