Indiana Law Review Indiana Law Review Volume 39 2006 Number 2 ARTICLES Supporting the Supporting Organization: The Potential and Exploitation OF 509(A)(3) Charities Alyssa a. DiRusso* "One of the serious obstacles to the improvement of our race is indiscriminate charity. " Andrew Carnegie^ Summary Supporting organizations, a type ofcharity defined in section 509(a)(3) ofthe Internal Revenue Code, have vast potential for philanthropic impact but perhaps equally vast potential for abuse. Donors who establish supporting organizations may retain inappropriate levels of control over the assets they contribute, hoard funds within the organization rather than actually using them to accomplish a charitable benefit, or engage in abusive financial transactions with their supporting organization. This Article discusses the complex tax rules that apply to supporting organizations and explains their unique role in charitable giving. It then explores the allegations of abuse in the supporting organization realm and reviews current proposals for reforming the system. The Article concludes by recommending that the public disclosure rules be amended to require fuller transparency ofthe activities of supporting organizations and greater availability of this information. Table of Contents Introduction 209 I. History of Supporting Organizations 210 * Assistant Professor of Law, Samford University, Cumberland School of Law; J.D., University ofTexas School ofLaw; B.S., Carnegie Mellon University. The author wishes to thank the Cumberland School of Law for a sunmier research grant that supported work on this Article, participants in the faculty seminar at Cumberland, faculty who attended the presentation of this Article at Rorida State University, and the following individuals for their comments and assistance: research assistant Andrea Weed, Brannon Denning, Joshua Tate, Joseph Dodge, Kathleen M. Sablone, Jim Exum, Jedidiah McKeehan, and Ayanna Sterling-Jones. 1. See The Quotations Page, Quotations by Author, Andrew Carnegie, http://www. quotationspage.com/quotes/Andrew_Camegie/ (last visited Feb. 7, 2006). 208 INDIANA LAW REVffiW [Vol. 39:207 A. House and Senate Reports of the 1969 Tax Reform Act 211 B. Like Taxesfor Chocolate—The Hershey Trust Testimony 212 n. Tax Rules Applicable to Supporting Organizations 214 A. Overview 214 B. The Type ofRelationship Test 215 1. Type I Organizations 215 2. Type n Organizations 216 3. Type III Organizations 217 a. The Responsiveness Test 217 (i) The Significant Voice Test 217 | (ii) The Charitable Trust Test 218 ' b. The Integral Part Test 218 (i) The But For Test 218 (ii) The Substantially All Income Test 218 C The Organizational Test 221 1. The Purpose Limitations Test 221 2. The Charity Specification Test 221 D. The Operational Test 223 1. The Permissible Beneficiaries Test 223 2. The Permissible Activities Test 223 E. The Control Test 224 F. Grandfathered Supporting Organizations 225 1 . The Integral Part Test—Transitional Rules for Type HI Organizations 226 2. Consequences for Grandfathered Organizations 227 in. Benefits of Supporting Organizations 227 A. Benefits to Donors 227 B. Benefits to Charities 229 C. Promoting Supporting Organizations Too Hard 230 rv. Concerns with Supporting Organization Abuse 230 A. Abuse Makes Headlines 23 1 B. Simultaneous Scandals 233 C Loans to Donors: Abuse ofa Different Color 234 D. Legislative Response to Abuse Begins 236 E. Judicial Examination ofSupporting Organizations 239 V. Potential for Change 241 A. American Bar Association 241 B. Council on Foundations 242 C Panel on the Nonprofit Sector 243 D. Looking Beyond the Supporting Organization Regulations for Reform 245 VI. A New Suggestion for Reforming Supporting Organizations 245 Conclusion 250 Appendix A 252 2006] SUPPORTING THE SUPPORTING ORGANIZATION 209 Introduction Charity is perhaps the most regulated of the seven virtues. Although charity is often motivated by the best of intentions, modem charitable giving is riddled with scandals, complex regulations, and the overarching need for reform. One area ofcharitable giving struggling for legitimacy is the supporting organization,^ a type of charity that derives its freedom from income tax by reason of its relationship with other charities who enjoy broad public support.^ Supporting organizations are growing in popularity, net worth, and importance.'* According to the National Center for Charitable Statistics, there was a 26. 1 % increase in the numberofexisting supporting organizations between 1996 and 2004.^ In 2001, there were almost 400 large supporting organizations (organizations with assets over $50 million) with total assets of $76.7 billion.^ In 2004, a total of 45,453 supporting organizations were associated with public charities.^ While many wealthy Americans are doing well by doing good, a clever and devious few are using the complicated supporting organization structure for doing well by doing bad. The regulations that apply to supporting organizations are detailed and complex, but loopholes exist and the system is, to some degree, being exploited. Unlike private foundations,^ supporting organizations have no regime of excise taxes restricting their behavior, and these organizations can be manipulated through self-dealing transactions that are hard to detect.^ A tight legal framework is necessary to prevent supporting organizations 2. See I.R.C. § 509(a)(3) (2000). A "supporting organization" maintains certain relationships with other charities. Id. Examples of a supporting organization include a university printing press, Friends of the Swampscott Public Library, Friends of Harvard College, or similarly named groups. 3. See id. § 509(a)(l)-(2). A "publicly supported organization" is a type of charity that generally is required to obtain a substantial amount of its support from the general public or from gross receipts from its charitable activities. Id. Examples of publicly supported organizations include museums, orchestras, universities, and churches. 4. Recent testimony before the Senate Finance Conunittee given by Jane G. Gravelle, Senior Specialist in Economic Policy for the Congressional Research Service of the Library of Congress, examined the issues surrounding supporting organizations. See Charities and Charitable Giving: Proposalsfor Reform: Hearing Before the S. Comm. on Finance, 109th Cong. (2005) (statement of Jane G. Gravelle, Senior Specialist in Economic Policy Congressional Research Service), available at http://www.fmance.senate.gov/hearings/testimony/2005test/jgtest040505.pdf [hereinafter Gravelle Statement]. 5. See id.; see also National Center for Charitable Statistics, Number of Nonprofit Organizations in the United States 1966-2004 (Dec. 2004), available at http://nccsdataweb. urban.org/PubApps/profile 1 .php?state=US . 6. See Gravelle Statement, supra note 4, at 13. 7. See id. 8. See LR.C. §§ 4941- 4945 (2000). 9. See Gravelle Statement, supra note 4, at 14. 210 INDIANA LAW REVIEW [Vol. 39:207 from being abused. The regulations governing supporting organizations are already extremely complex. It is not exactly a compliment for a tax regulation to be called "fantastically intricate and detailed" by a federal district courtjudge, as supporting organizations have been.^° But are the supporting organization regulations themselves the problem, and are they the only source of a solution? Some reformers believe rewriting the supporting organization regulations is necessary—^perhaps even to the extent of eliminating a form of supporting organization that the regulations created. Would this approach be necessary or sufficient? Or might the problems with supporting organizations lie not in their structure, but in their oversight? This Article suggests the latter. The abuses plaguing the supporting organization culture may be related to the way in which supporting organizations are required to share their information with the public: the public disclosure rules. Supporting organizations offer a creative planned giving option and a unique charitable structure. This Article explores the role of these charities, the abuses related to them, and proposals for reforming them. First, Parts I and II discuss the history of supporting organizations and the tax rules that govern them. Next, Part in explores what makes supporting organizations such a unique and useful charitable tool. Part IV then examines modem concerns with supporting organization abuse, and Part V discusses proposals for reform. Finally, Part VI recommends a way to reform supporting organizations through a back-door—^by expanding the public disclosure requirements. I. History of Supporting Organizations Supporting organizations, in their current form, were established by the Tax Reform Act of 1969 ("Tax Reform Act").^^ This legislation, aimed at curbing abuse of tax-exempt charitable foundations, distinguished two categories of exempt organizations: those that were categorized as private foundations and those that were not.^^ Among those exempt organizations not categorized as private foundations were publicly supported charities,^^ gross receipts charities,'"^ organizations promoting public safety,*^ and supporting organizations.'^ The legislative history relating to supporting organizations in the Tax Reform Act is 10. Windsor Found, v. United States, No. 76-0441-R, 1977 U.S. Dist. LEXIS 13643, at *5 (E.D. Va. Oct. 4, 1977). District Judge Warriner explained that "the Internal Revenue Service has drafted fantastically intricate and detailed regulations in an attempt to thwart the fantastically intricate and detailed efforts oftaxpayers to obtain private benefits from foundations while avoiding the imposition of taxes." Id. 11. Tax Reform Act of 1969, Pub. L. No. 91-172, 83 Stat. 487 (codified as amended at I.R.C. § 509 (2000)). 12. 5^eI.R.C.§ 509(a)(1) (2000). 13. See id. § 509(a)(2)(A)(i). 14. See id § 509(a)(2)(A)(ii). 15. See id § 509(a)(4). 16. See id § 509(a)(3). 2006] SUPPORTING THE SUPPORTING ORGANIZATION 21 1 relatively sparse. The Senate Report (No. 91-552)'^ and House Report (No. 91- 413)^^ mention supporting organizations only briefly. Notwithstanding the brevity of the congressional record, a review of the legislative history demonstrates a consistency in the justification for tax-exempt status of supporting organizations. The oversight rules created in the Tax Reform Act, applicable to private foundations, were created to combat abusive transactions rampant in the world of charitable foundations. Public charities were not subject to these rules, based on the belief that dependence on public support and accompanying public scrutiny would prevent such abuse from occurring with charitable funds. *^ Supporting organizations were distinguished from organizations subject to the rules applicable to private foundations because, in theory, "[supporting organizations] are subject to the scrutiny of a public charity."^^ A. House and Senate Reports ofthe 1969 Tax Reform Act The House Report of 1969 explains the establishment of section 509, defines "private foundations," and explores why certain types of charities are excluded from this definition and the rules incumbent upon private foundations.^^ After differentiating publicly supported organizations and gross receipts organizations, the House discussed supporting organizations: Another category oforganizations removed from the definition ofprivate foundations comprises those organizations which are organized and operated exclusively for the benefit of one or more of the 30-percent organizations or broadly based organizations described above, provided that they are operated, supervised, or controlled by one or more such organizations, or in connection with one such organization, and are not controlled directly or indirectly by disqualified persons (other than foundation managers, 30-percent organizations, and broadly based organizations described above). In general, religious organizations other than churches, the Hershey Trust (which is organized and operated for a specific school for orphaned boys and is controlled in connection with that school), university presses, and similar organizations are examples of organizations expected to qualify for this category.^^ The Senate Report is virtually identical but does not name the Hershey Trust explicitly. Instead, it generally describes "organizations organized and operated for the benefit of a specific school and also controlled by or operated in 17. See infra note 23. 18. See infra not&s 21-22. 19. Quarrie Charitable Fund v. Comm'r, 603 F.2d 1274, 1277-78 (7th Cir. 1979). 20. /J. at 1278. 21. H.R. Rep. No. 91-413, pt. 1 (1969), as reprinted in 1969 U.S.C.C.A.N. 1645, 1686. 22. Id. at 225-21. 212 INDIANA LAW REVIEW [Vol. 39:207 connection with that school."^^ Although the legislative history is sparse, the reasoning behind Congress's creation of supporting organizations is expressed consistently. Supporting organizations do not need the rigorous oversight of the private foundation tax rules because they are theoretically monitored by publicly supported charities and therefore are indirectly overseen by the public. The same justification for their tax exemption has been expressed in case law. In Cockerline Memorial Fund v. Commissioner^'^ the Tax Court discussed Congress's intent when it enacted section 509.^^ ^ Public charities are exempt from private foundation treatment and, consequently, the excise taxes, on the theory that public scrutiny arising from a foundation's dependence upon public funds will prevent abusive acts by the foundation. Supporting organizations are similarly excepted on the theory that scrutiny by the publicly supported organizations will prevent abuse by the supporting organization. The belief that scrutiny by a publicly supported organization, under the appropriate circumstances, is sufficient to guard against abuse by the supporting organization is embodied in section 509(a)(3). The provisions of that section are designed to insure that a supported organization has the ability and motivation to properly oversee the activities ofthe supporting organization.^^ In Cockerline, the court concluded that a "close and continuous relationship" existed between the supported charity and the petitioner involved in the case.^^ The relationship produced "the type of close scrutiny which renders unlikely the congressionally feared abuses," and, in fact, no such abuses occurred in the Cockerline organization.^^ It is clear that Congress acknowledged the special role supporting organizations play and intended to provide a structured context in which supporting organizations would operate scrupulously. This structure relies upon attention by the supported charity to insure that abuses are curtailed. B. Like Taxesfor Chocolate—The Hershey Trust Testimony The Hershey Trust and its proponents were critical in developing the treatment of the supporting organization as exempt from the private foundation taxes of the 1969 Tax Reform Act. Pennsylvania's senior senator, Hugh D. Scott, Jr., offered several pages of testimony explaining why the enactment of section 23. S. Rep. No. 91-552 at 460-62 (1969), as reprinted in 1969 U.S.C.C.A.N. 2027, 2085-86. 24. 86 T.C. 53(1986). 25. /rf. at 64-65. 26. Id. at 65 (internal citations omitted). 27. Id. 28. Id. 2006] SUPPORTING THE SUPPORTING ORGANIZATION 213 509(a)(3) was of particular importance to the Hershey Trust.^^ The Milton Hershey School is an institution that originally housed poor orphan boys in Hershey, Pennsylvania.^^ Milton Hershey, who founded the Hershey Chocolate Company, established the school in 1909, before federal income taxes. Rather than funding the school directly, he established two entities: the school itself and a trust to hold the school's assets. The school qualified as a publicly supported charity because it was an educational organization, having a regular faculty, curriculum, and student body. The IRS apparently considered the trust to be effectively the same entity as the school, since the governing body of the trust and the school were the same and had similar purposes.^^ However, the 1969 Tax Reform Act caused some concern that the trust would be treated as a private foundation under the new rules. Senator Scott defended the trust, stating that it would be "most unfortunate" if the private foundation rules applied to the trust, and explaining that the "hardship would have been suffered by the School and its students."^^ Senator Scott's pleas on behalf of the Hershey Trust were well received.^^ References to the Hershey Trust by name appear in the regulations, and it is clear that this organization was critical in securing the advantages of public charity status to supporting organizations. Were it not for the quirky structure of this chocolate charity, supporting organizations might not exist today. 29. Gerald B. Treacy, Jr., Supporting Organizations, at B-401 to -402 (BNA Tax Management Portfolio No. 871 -2d, 2002) (excerpting from Congressional Record of December 6, 1969 (page S 15982) (Senate Debate)). The Hershey Trust and the administration of its assets have been under public scrutiny in recent years. See Evelyn Brody, Whose Public? Parochialism and Paternalism in State Charity Law Enforcement, 79 IND. L.J. 937, 985-99 (2004); Mark Sidel, The Strugglefor Hershey: CommunityAccountability and the Law in Modem American Philanthropy, 65 U. Pitt. L. Rev. 1, 2 (2003). 30. The school was originally founded for orphan boys, but the Milton Hershey School now accepts students of both sexes, and they do not have to be orphans. See Milton Hershey School, Admissions Criteria forNew Students, http://www.mhs-pa.org/adniissions/criteria/ (last visited Feb. 7, 2006). 3 1 . See Treacy, supra note 29, at B-401 (referencing a 195 1 Revenue Ruling issued to the school and the trust). 32. Id. 33 . Id. Senator Wallace F. Bennett of Utah, a member of the Committee on Finance, stated in his testimony that he would like to assure the senior Senator from Pennsylvania that the committee . . . was very mindful of the problem that certain organizations would have had in the absence of proposed section 509(a)(3) . . . [and that] the sort of situation involving the Milton Hershey School described by the senior Senator from Pennsylvania is what the Committee on Finance had in mind when it approved this part of the bill. Id. 214 INDIANA LAW REVIEW [Vol. 39:207 n. Tax Rules Applicable to Supporting Organizations A. Overviewr'^ The Tax Reform Act of 1969 created a scheme of rules that apply to private foundations.^^ These regulations specifically did not apply to charities that were not categorized as private foundations.^^ Supporting organizations were not private foundations, and thus were exempt from the new rules.^^ Supporting organizations are instead subject to the requirements of section 509(a)(3) of the Internal Revenue Code and that section's treasury regulations. Section 509(a)(3) provides that an organization is not a private foundation and is therefore classified as a supporting organization if it: (A) is organized, and at all times thereafter is operated, exclusively for the benefit of, to perform the functions of, or to carry out the purposes of one or more specified organizations described in paragraph (l)or(2), (B) is operated, supervised, or controlled by or in connection with one or more organizations described in paragraph (1) or (2), and (C) is not controlled directly or indirectly by one or more disqualified persons . . . other than foundation managers and other than one or more organizations described in paragraph (1) or (2).^^ As developed more fully in the regulations, 509(a)(3) establishes an Organizational Test and an Operational Test (in part A), a Type of Relationship Test (in part B), and a Control Test (in part C).^^ The Organizational and Operational Tests vary depending upon how the organization is classified under the Type of Relationship Test. The best way to understand the regulations is to begin with a discussion of the three types of relationships supporting organizations have with their supported charities. 34. See Appendix A for a "map" of supporting organization structures resulting from the applicable tax regulations. 35. See Tax Reform Act of 1969, Pub. L. No. 91-172, 83 Stat. 487 (codified as amended at I.R.C. § 509 (2000)). 36. Quarrie Charitable Fund v. Comm'r, 603 F.2d 1274, 1277 (7th Cir. 1979). "The definition of a private foundation is intentionally inclusive: all organizations exempted from tax by Section 50 1 (c)(3) are private foundations except for those specified in Section 509(a)( 1 ) through (4). The exceptions are churches, schools, and hospitals, § 509(a)(1), other publicly supported organizations, § 509(a)(2), and supporting organizations of such excepted organizations." Id. (citations omitted). 37. Id. 38. I.R.C. § 509(a)(3) (2000). For simplicity, this Article uses the term "charity' to refer to "organizations described in paragraph (1) or (2)." 39. For a good practitioner-oriented overview of the supporting organization rules, see Gerald B. Treacy, Jr., Supporting Organizations (1996), and the more recent B.N.A. Tax Management Portfolio of the same title. 2006] SUPPORTING THE SUPPORTING ORGANIZATION 215 B. The Type ofRelationship Test Section 509(a)(3)(B) contemplates three types of relationships between charities and their supporting organizations."^^ The relationships are categorized as Type I, Type II, and Type EI, and each type bases its justification for exemption on slightly different language in the Code section."^^ Type I organizations must be "operated, supervised, or controlled by" a charity."^^ Type norganizations mustbe "supervised or controlled in connection with" a charity."^^ Type in organizations must be "operated in connection with" a charity."^ Once a supporting organization has established that it meets the description of one of these three types of relationships, it must meet the requirements that apply to that relationship type. 1. Type I Organizations.—^Type I relationships are perhaps the simplest. A Type I organization must be operated, supervised, or controlled by its supporting charity."^^ Type I relationships are "comparable to that of a parent and subsidiary, where the subsidiary is under the direction of, and accountable or responsible to, the parent organization.""^^ Type I relationships are established when the supported charity (through its officers, members, or all or part of its governing body) appoints or elects a majority of the officers, directors, or trustees of the supporting organization."^^ The regulations provide that "the distinguishing feature [of Type I organizations] is the presence of a substantial degree of direction by the publicly supported organizations over the conduct of the supporting organization."'^^ 40. I.R.C. § 509(a)(3)(B) (2000). 41. First, there is a distinction between charities that rely on the word "by" rather than the phrase "in connection with." Charities that rely on the word "by" are classified as Type I Organizations (operated, supervised, or controlled by a charity — "by" relationships). Type I organizations are ''operated, supervised, or controlled by or in connection with" qualifying charities. Second, there is a distinction, among charities that rely on the phrase "in connection with," between charities that rely on the phrase "supervised or controlled," and charities that rely on the word "operated." Charities that rely on the phrase "supervised or controlled" are classified as Type II Organizations (supervised or controlled in connection with a charity — "overseen with" relationships). Type II organizations are "operated, supervised, or controlled by or in connection with" qualifying charities. Charities that rely on the word "operated" are classified as Type III Organizations (operated in connection with a charity — "operated with" relationships). Type III organizations are ''operated, supervised, or controlled by or in connection with" qualifying charities. See id. § 509(a)(3)(B) (emphasis added). 42. See 26 C.F.R. § 1.509(a)-4(a)(3) (2005). 43. Id. 44. Id. 45. Id. 46. 5eeiW. § 1.509(a)-4(g)(l)(i). 47. Id. 48. Id. § 1.509(a)-4(f)(4). This direction should extend "over the policies, programs, and activities ofthe supporting organization." See id. § 1.509(a)-4(g)(l)(i). 216 INDIANA LAW REVIEW [Vol. 39:207 A Type I relationship may exist even though the supporting organization is not governed by representatives of the charity it supports."^^ It is possible for a supporting organization to be ''operated, supervised, or controlled by" one charity but to be operated "/or the benefit of" a different charity.^° These alternative relationship structures for Type I supporting organization are only allowed if it is clear that the purposes ofthe operating, controlling, or supervising charity are carried out by benefiting the other charity.^ ^ Although slight variations on the parent-subsidiary relationship are permitted, most Type I supporting organizations are clearly and directly supervised and controlled by their supported charity. 2. Type II Organizations.—^Type n relationships can be more complex than the parent-subsidiary style Type I relationships, but they are still easily categorized and defined. Type H organizations must be "supervised or controlled in connection with" their supporting charities.^^ These organizations are more akin to sibling entities with a common parent, as opposed to the parent-subsidiary relationship characterizing Type I relationships. For example, a supporting organization might function as a subsidiary fundraising entity for a hospital, with both the hospital and the supporting organization overseen by a parent management company. The regulations provide that "the distinguishing feature [of Type n organizations] is the presence of common supervision or control among the governing bodies of all organizations involved, such as the presence of common directors."^^ In Type n organizations, there must be "common supervision or control" by the leaders who oversee both the supporting organization and the supported charity.^'* Some people who have the power to manage or control the supported charity must also manage the supporting organization.^^ This common control requirement is "to insure that the supporting organization will be responsive to the needs and requirements" of the charity it supports.^^ A supporting organization will not qualify as a Type n organization if all it does is give money to a supported charity.^^ Payment of money by a supporting organization to a charity, even when the charity can enforce the payments under state law, does not establish a significant enough connection between the two organizations to satisfy the Type n Relationship Test.^^ Type n organizations, the least common of the three types, are most commonly used by publicly 49. Id. § 1.509(a)-4(g)(l)(ii) 50. Id. 51. Id. 52. Id. § 1.509(a)-4(a)(3). 53. Id. § 1.509(a)-4(f)(4). 54. Id. § 1.509(a)-4(h)(l). 55. Id. 56. Id. 57. Id. § 1.509(a)-4(h)(2). 58. Id. 2006] SUPPORTING THE SUPPORTING ORGANIZATION 217 supported charities who wish to establish a separate fund-raising arm.^^ 3. Type III Organizations.—Type HI organizations are complex. The Type in structure provides the loosest connection between the supporting organization and its supported public charity. These organizations need only be "operated in connection with" their supported charity.^^ The regulations provide that "the distinctive feature [of Type HI organizations] is that the supporting organization is responsive to, and significantly involved in the operations of, the publicly supported organization."^^ Type m organizations must, therefore, satisfy two tests: the "Responsiveness" Test and the "Integral Part" Test.^^ Complicating matters further, more liberal rules apply to grandfathered Type IQ supporting organizations—those operating before November 20, 1970.^^ a. The Responsiveness Test.—All Type IQ supporting organizations must meet the Responsiveness Test in one of two ways.^ Both ways are intended to ensure that the supporting organization will be "responsive to the needs or demands" of the charity it supports. ^^ (i) The Significant Voice Test.—The first way in which a supporting organization can meet the Responsiveness Test is by passing the "Significant Voice" Test.^^ Under this test, the supported charity must influence the governing board of the supporting organization using one of three possible approaches: ( 1 ) the supported charity' s leaders or members ("officers, directors, trustees, or membership") must appoint or elect one or more of the supporting organization's leaders ("officers, directors, or trustees");^^ (2) one or more of the supported charity' s leaders must also be a leader of supporting organization;^^ or (3) the supporting organization's leaders must "maintain a close and continuous working relationship" with leaders of the supported charity.^^ Regardless of which approach is used, the result must be that the supported charity's leaders "have a significant voice in the investment policies of the supporting organization, the timing of grants, the manner of malcing them, and the selection of recipients by [the] supporting organization, and in otherwise directing the use 59 . June Klaassen &Constance J. Fontaine, Family Charitable Gifting: Private Foundations Versus Supporting Organizations, 53 J. FiN. SERVICE PROF. 64, 69 (1999) (citing Monica Langley, The SO Trend: How to Succeed in Charity Without Really Giving, WALL ST. J., May 29, 1998, at Al). 60. 26C.F.R. §1.509(a)-4(a)(3). 61. Id § 1.509(a)-4(f)(4). 62. Id § 1.509(a)-4(i)(l)(i). 63. Id. § 1.509(a)-4(i)(l)(ii). These grandfathered organizations are permitted additional means of meeting the Responsiveness Test; "additional facts and circumstances, such as a historic and continuing relationship between organizations, may be taken into account." Id. 64. Id § 1.509(a)-4(i)(2)(i). 65. Id. 66. Id § 1.509(a)-4(i)(2)(ii). 67. Id. § 1.509(a)-4(i)(2)(ii)(a). 68. Id. § 1.509(a)-4(i)(2)(ii)(b). 69. Id. § 1.509(a)-4(i)(2)(ii)(c). 218 INDIANA LAW REVIEW [Vol. 39:207 of the income or assets of [the] supporting organization."^^ All charities organized as corporations must meet this first alternative test.^^ (ii) The Charitable Trust Test.—Ifthe supporting organization is a charitable trust, it has a second way to meet the Responsiveness Test.^^ This test has three requirements: (1) the supporting organization must be a charitable trust under state law;^^ (2) the charitable trust's governing document must name the supported charity as a beneficiary;^"^ and (3) the supported charity must have the right to compel an accounting and to enforce the trust under state law.^^ b. The Integral Part Test,—In addition to meeting either prong of the Responsiveness Test, all Type HI supporting organizations must also meet the Integral Part Test.^^ The Integral Part Test is used to determine whether the supporting organization "maintains a significant involvement in the operations" of the supported charity, and that the supported charity is "in turn dependent upon the supporting organization for the type of support which it provides."^^ In order to meet this test, the supporting organization must satisfy one of two alternative prongs: the "But For" Test or the "Substantially All Income" Test.^^ (i) The But For Test.—A Type HI organization can satisfy the first alternative prong of the Integral Part Test by engaging in activities "for or on behalf of the supported charity.^^ The supporting organization must undertake these activities in order to "perform the functions of, or to carry out the purposes of [the supported charity]."^*^ The crux of this test is the requirement that ''butfor the involvement of the supporting organization," the supported charity would normally engage in the activities itself.^* (ii) The Substantially All Income Test.^^—Under the second alternative prong, the supporting organization must pay "substantially all of its income to or for the use of one or more publicly supported [charities]."^^ "Substantially all" means at least eighty-five percent of the supporting organization's net income.^"^ The amount of support received by one or more of these charities must be sufficient to insure that the charity is attentive to the supporting organization's 70. Id. § L509(a)-4(i)(2)(ii)(d). 7 1 . The second alternative test applies only to charitable trusts. Id. § 1 .509(a)-4(i)(2)(iii)(a). 72. Id. § 1.509(a)-4(i)(2)(i) and (iii). 73. Id. § 1.509(a)-4(i)(2)(iii)(a). 74. Id. § 1.509(a)-4(i)(2)(iii)(b). 75. Id. § 1.509(a)-4(i)(2)(iii)(c). 76. Id. § 1.509(a)-4(i)(l)(i). 77. Id. § 1.509(a)-4(i)(3)(i). 78. Id. 79. Id. § 1.509(a)-4(i)(3)(ii). 80. Id. 81. Id. 82. Some sources call this the Attentiveness Test. See Lapham Found, v. Comm'r, 84 T.C.M. (CCH) 586 (2002), aff'd, 389 F.3d 606 (6th Cir. 2004). 83. 26C.F.R. §1.509(a)-4(i)(3)(iii). 84. Rev. Rul. 76-208, 1976-1 C.B. \6Usee also Lapham Found., 84 T.C.M. (CCH) 586. 2006] SUPPORTING THE SUPPORTING ORGANIZATION 219 operations.^^ This "attentiveness" requirement contemplates that the charity will oversee the operations of the supporting organization to ensure continued financial contributions.^^ The regulations require that a "substantial amount" of the supporting organization's total support must be donated to those charities that meet this attentiveness requirement.^^ Further, the contribution that the supported charity receives from the supporting organization must be a significant enough portion of the charity's total support to insure that it will be attentive to the supporting organization' s operations.^^ To determine whether the supporting organization' s support represents a sufficient part of the supported charity's total support to ensure attentiveness, if the supporting organization "makes payments to ... a particular department or school of a university, hospital or church, the total support of the department or school [is] substituted for the total support of the beneficiary organization."^^ For example, a supporting organization's payment to a university's law school may be a large enough portion of the law school's budget to attract the attention of the university, which may have a dozen or more such schools. It is possible for a supporting organization to meet the Substantially All Income Test even where the amount of income the supporting organization gives to the supported charity fails to reflect a sizeable portion of its total support.^^ The Substantially All Income Test is not required if "in order to avoid the interruption of ... a particular function or activity" made possible by the supporting organization's donations, the supported charity is "sufficiently attentive to the operations of the supporting organization."^^ Earmarking the support for a particular program or activity may have the effect of insuring this attentiveness, "even if such program or activity is not the beneficiary organization's /7nmflry program or activity so long as [the] program or activity is a substantial one."^^ Imagine that a supporting organization funds a visiting speaker program at a medical school. This funding might be enough to secure the school's attention even if the cost of the program were small in relation to the school's total funding. However, a supporting organization will fail to meet the Substantially All Income Test if no supported charity relies upon the supporting organization for a "sufficient amount" of its total support, even if these charities 85. 26 C.F.R. § 1.509(a)-4(i)(3)(iii)(a). 86. Id.', see also Lapham Found., 389 F.3d at 61 1. The court agreed with the tax court's finding that future contributions from a revocable trust were not enough to satisfy this part of the Attentiveness Test. Id. at 612. "It is difficult to believe that [the supported charity] will give [the supporting organization] the sort of regular oversight contemplated by the test when it will not be receiving substantial support from the organization for another two decades." Id. 87. 26C.F.R. § 1.509(a)-4(i)(3)(iii)(a). 88. Id. 89. Id. 90. Id. § 1.509(a)-4(i)(3)(iii)(b). 91. Id. 92. Id. (emphasis added). 220 INDIANA LAW REVIEW [Vol. 39:207 can enforce their rights against the supporting organization under state law.^^ In determining whether the amount of support received by the charity is sufficient to insure that the charity is attentive to the supporting organization's operations, the IRS considers "[a]ll pertinent factors, including the number of [supported charities], the length and nature of the relationship between the [supported charity] and supporting organization and the purpose to which the funds are put."^"^ Because a supported charity's attention is often motivated by the amount of funds received from the supporting organization, the larger the contribution (in terms of a fraction of the supported charity's total support), the more likely it is that the supported charity will be sufficiently attentive to satisfy the Integral Part Test.^^ Evidence that the supported charity is actually attentive to the supporting organization is almost as important.^^ The regulations offer an example of sufficient evidence that a charity is actually attentive: terms requiring that the supporting organization provide the supported charity with annual reports.^^ These reports should furnish information to assist the supported charity to determine that the supporting organization's assets are invested productively, and that the supporting organization has not been indulging in activities that would trigger the private foundation excise taxes (if the supporting organization were a private foundation), like self-dealing and risky investing.^^ However, the annual report requirement is only one factor the IRS may consider in determining whether a supporting organization passes the Integral Part Test, and the lack of such a requirement is not fatal.^^ What if a supporting organization meets the Integral Part Test, but the endowment of the charity it supports grows, such that the supporting organization's contribution is no longer the substantial portion of the charity's income that it once was? The regulations provide an exception for supporting organizations in this situation. ^^^ Even though a supporting organization "cannot meet the requirements ... for its current taxable year solely because the amount received by [its supported charity] ... is no longer sufficient" to fulfill the test,^^^ the supporting organization will pass the Integral Part Test if it can show that it did meet the Integral Part Test for any five-year period, ^^^ and "[t]here has been a historic and continuing relationship of support between [the] organizations" since the end of the five-year period. ^^^ 93. Id. § 1.509(a)-4(i)(3)(iii)(e). 94. Id. § 1.509(a)-4(i)(3)(iii)(d). 95. Id. 96. Id. 97. Id. § 1.509(a)-4(i)(3)(iii)(d). 98. Id.; see also I.R.C. §§4941, 4944. 99. 26C.F.R. § 1.509(a)-4(l)(3)(iii)(d). 100. Id. § 1.509(a)-4(i)(l)(iii). 101. Id. § 1.509(a)-4(i)(l)(iii)(b) (emphasis added). 102. Id. § 1.509(a)-4(i)(l)(iii)(a). 103. Id. § 1.509(a)-4(i)(l)(iii)(c). 2006] SUPPORTING THE SUPPORTING ORGANIZATION 221 C. The Organizational Test After satisfying the Relationship Test, a supporting organization must also satisfy an Organizational Test. All types of supporting organizations must meet this requirement.'^"^ The regulations explain that a supporting organization will only meet the Organizational Test—the requirement that it be "organized . . . exclusively for the benefit of, to perform the functions of, or to carry out the purposes of one or more specified [public charities]"—if its governing documents meet certain requirements.'^^ The supporting organization's governing documents must: (1) "limit the purposes" of the supporting organization to charitable purposes described in the Code'^^ and (2) "state the specified publicly supported [charities] on whose behalf [the] organization is to be operated."'^^ The Organizational Test, therefore, has a Purpose Limitations Test and a Charity Specification Test. 1. The Purpose Limitations Test.—Under the Purpose Limitations Test,'^^ the supporting organization's governing documents should state purposes consistent with the Code requirement that it be "organized . . . exclusively for the benefit of, to perform the functions of, or to carry out the purposes of one or more specified [public charities]."'^^ The supporting organization's purposes should be similar to the purposes set forth in the governing documents of the charity it supports; the purposes may be narrower than those of the charity it supports but cannot be broader. ' '° A supporting organization whose articles state that it "is formed for the benefit of [a] specified publicly supported [charity]" would meet this Purpose Limitation Test.''' 2. The Charity Specification Test.—Under the Charity Specification Test,"^ the supporting organization must specify in its governing documents which charities it will support,"^ and the documents cannot explicitly allow it to operate to support other entities.""^ The method of specifying a supported charity 104. Id. § 1.509(a)-4(b)(l). 105. Id. § 1.509(a)-4(a)(2) (quoting I.R.C. § 509(a)(3)(A) (2000)). 106. Id. § 1.509(a)-4(c)(l)(i). The documents must also not "expressly empower the organization to engage in activities which are not in furtherance of [those] purposes." Id. § 1 .509(a)-4(c)(l)(ii). The governing documents may include articles ofincorporation, a declaration of trust, or other materials. See id. § 1.50 1(c)(3)- 1(b)(2). 107. Id. § 1.509(a)-4(c)(l)(iii). The documents must also not "expressly empower the organization to operate to support or benefit" any other organization. Id. § 1.509(a)-4(c)(l)(iv). 108. Id. § 1.509(a)-4(c)(2). 109. Id. § 1.509(a)-4(a)(2) (quoting I.R.C. § 509(a)(3)(A)). 110. Id. § 1.509(a)-4(c)(2). 111. Id. 112. /^.§1.509(a)-4(c)(3), (d)(1). 113. Id. § 1.509(a)-4(d)(l). 114. Id. § 1.509(a)-4(c)(3). "The fact that the actual operations of [the supporting] organization have been exclusively for the benefit of the specified [charity] shall not be sufficient to . . . meet the organizational test" if the governing documents expressly permit the support of 222 INDIANA LAW REVIEW [Vol. 39:207 in the supporting organization's governing documents varies based on whether the supporting organization qualifies as a Type I, Type H, or Type HI under the Type of Relationship Test.^^^ Type ni organizations have a stringent standard for specifying their supported charity. The governing documents of Type HI organizations must either (1) specify the supported charities by name^^^ or (2) demonstrate a "historic and continuing relationship between the supporting organization" and the charity,' ^^ resulting in the development of a "substantial identity of interests" between the organization and the charity.''^ Type HI organizations are also limited in their ability to substitute their specified charities.*'^ Type I and Type n organizations have a more generous standard than Type in organizations for specifying their supported charity. In addition to the options afforded to Type m organizations (specifying expressly by name or by a historic and continuing relationship), Type I and Type n organizations may also designate their supported charities "by class or purpose."'^^ The governing documents may therefore provide that the supporting organization will "support or benefit one or more beneficiary organizations which are designated by class or purpose,"'^' including: (1) the charity that the supporting organization other organizations. Id. 115. Id.% 1.509(a)-4(d)(l). Thus, "[t]he manner in which the [supported charities] must be specified . . . will depend upon whether the supporting organization is operated, supervised, or controlled by[,] or supervised or controlled in connection with ...[, or] operated in connection with . . . such [charities]." Id. 116. Id.§ 1.509(a)-4(d)(2)(i). 117. /^. § 1.509(a)-4(d)(2)(iv)(a). 118. /t/. § 1.509(a)-4(d)(2)(iv)(b). 119. Id. § 1.509(a)-4(d)(4). Assuming that the supported charity is specified by name, the governing documents of the supporting organization may (a) [p]ermit a [supported charity] which is designated by class or purpose, rather than by name, to be substituted for the [supported charity or charities] designated by name in the articles, but only if such substitution is conditioned upon the occurrence of an event which is beyond the control of the supporting organization, such as loss of exemption, substantial failure or abandonment of operations, or dissolution of the publicly supported organization or organizations designated in the articles; (b) [p]ermit the supporting organization to operate for the benefit of a [supported charity] which is not a publicly supported organization, but only if such supporting organization is currently operating for the benefit of a publicly supported organization and the possibility ofits operating for the benefit ofother than a publicly supported organization is a remote contingency; or (c) [p]ermit the supporting organization to vary the amount of its support between different designated organizations, so long as it meets the requirements of the integral part test . . . with respect to at least one beneficiary organization. Id. 120. Id. § 1.509(a)-4(d)(2)(i)(b). 121. /