Grants to Supporting Organizations.
The Pension Act limits distributions by private foundations and from donor advised funds to certain types of supporting organizations. (Generally, the Pension Act provides for three types of supporting organizations, each based on the relationship between a supporting organization and its supported public charities.) The Pension Act effectively prohibits distributions by a private foundation and from a donor advised fund to “Type III” supporting organizations that are not “functionally integrated” or to any supporting organization that is controlled, or whose supported public charities are controlled, by disqualified persons of the private foundation or donor advised fund. Grants to non-controlled Type I and Type II entities continue to be permitted distributions. The principal difficulty presented by these provisions: How to distinguish between a Type I, Type II, and Type III supporting organization?
Notice 2006-109 explains that private foundations and sponsoring organizations of donor advised funds may determine the Type I or Type II status of a supporting organization by:
- Obtaining a written representation, signed by an authorized representative of the supporting organization, that describes the relationship between the supporting organization and its supported public charities, and
- Reviewing and retaining copies of the supporting organization’s current governing documents establishing the Type I or Type II relationship.
For distributions to Type III supporting organizations, the Notice suggests that private foundations and sponsoring organizations of donor advised funds obtain more detailed information to substantiate the relationship required for a Type III supporting organization to be “functionally integrated.” In short, a Type III supporting organization will be treated as “functionally integrated” if it meets a special “but for” test under existing Treasury Regulations section 1.509(a)-4(i)(3)(ii).
Educational Grants from Donor Advised Funds.
Generally, the Pension Act prohibits distributions from donor advised funds to individuals. Many sponsoring organizations have committed to scholarship grants from a donor advised fund prior to the enactment of the Pension Act (August 17, 2006). Notice 2006-109 allows a sponsoring organization to make payments from a donor advised fund with respect to such a pre-existing commitment so long as:
- The educational grant was awarded on an objective and nondiscriminatory basis and is reasonable in amount;
- The educational grant was not awarded to (and payments are not made to) a donor, donor advisor, or person related to the donor or donor advisor;
- The sponsoring organization maintains records establishing that, prior to August 17, 2006, the organization followed specific record-keeping procedures in awarding the educational grant to the individual or notified the payee, in writing, of the pending educational grant;
- The sponsoring organization keeps these records for three years; and
- There is no material change in the amount or conditions of the previously-awarded grant, such as a required reapplication for the grant.
(Note: This special rule for past scholarship awards is in addition to the exception that permits scholarships after August 17, 2006, from funds following the specific selection procedures set forth in Internal Revenue Code section 4966(d)(2)(B)(ii).)
Employer-Sponsored Disaster Relief Funds.
The Pension Act defines a donor advised fund broadly as any fund or account owned or controlled by a public charity separately identified with reference to the contribution of a donor (or donors) for which the donor, or anyone appointed by the donor, reasonably expects to have advisory privileges. Provisions in the Pension Act authorize the Secretary of the Department of the Treasury to exempt a fund or account from the definition of a donor advised fund. Pursuant to this authority, IRS Notice 2006-109 exempts employer-sponsored disaster relief funds from the definition of donor advised fund provided that the fund satisfies all of the following requirements:
- Serves a single charitable purpose, which is to provide relief from one or more qualified disasters within the meaning of Internal Revenue Code section 139(c)(1), (2), or (3);
- Serves a large, charitable class;
- Recipients of grants are selected based on objective determinations of need and are selected using either an independent selection committee or adequate substitute procedures to ensure that any benefit to the employer is incidental and tenuous (an independent selection committee must comprise a majority of members who are not in a position to exercise substantial influence over the affairs of the employer);
- No payment is made from the fund to or for the benefit of any director, officer, or trustee of the public charity that sponsors the fund or members of the selection committee; and
- Adequate records are maintained demonstrating the recipient’s needs for the disaster relief assistance.
Pre-Existing Contracts and Payments from Supporting Organizations.
As amended by the Pension Act, any grant, loan, compensation, or similar payment by a supporting organization to a substantial contributor or to a person related to the substantial contributor, and any loan by a supporting organization to a disqualified person, is treated as an automatic excess benefit transaction subjecting the entire payment to the substantial contributor or disqualified person to excise taxes. The rule applies to transactions that occurred after July 25, 2006.
Acknowledging that supporting organizations may have committed to such transactions prior to the enactment of the Pension Act, IRS Notice 2006-109 clarifies the date that new excise taxes will apply to these excess benefit transactions. The Notice explains that the IRS will not consider any payment made based on a written contract that was binding on August 17, 2006, as an excess benefit transaction provided that:
- The contract was binding after August 17, 2006, and before payment is made;
- The contract was not modified during such period; and
- Payment under the contract is made on or before August 17, 2007.
With respect to any such arrangement that is not governed by a binding contract and that involves an employment relationship or other legal obligation in effect on August 17, 2006, the IRS will not consider any payment an excess benefit transaction provided that:
- The terms of the arrangement are not modified after August 17, 2006;
- Any services are performed or goods are delivered no later than December 31, 2006; and
- The payment is made no later than August 17, 2007.
A copy of the Notice may be obtained from the IRS Web site at www.irs.gov/pub/irs-drop/n-06-109.pdf.