There are many sub-categories within the 501(c)(3) exempt entity designation. What do each of these categories mean? Here, we discussed the differences between 509(a)(1), 509(a)(2), and 509(a)(3) public charities. Today we will be digging deeper into the 509(a)(3) classification, also known as a supporting organization, and one of the sub-categories available under the general 501(c)(3) umbrella.
What is a 509(a)(3)?
509(a)(3)’s serve as a supporting organization to another charity or charities. To be classified as a 509(a)(3), the organization that is being supported by the 509(a)(3) must be in a supervisory role over the 509(a)(3). Effectively, the relationship between the two is as if the supporting entity is a branch or subsidiary of the other charity. Additionally, the supporting organization must serve only for the benefit of the organization(s) that it supports. In order to receive the classification, an organization seeking to be a 509(a)(3) must undergo an organizational test, an operational test, and a relationship test to determine if they meet the qualifications.
Organizational Test:
Under the organizational test, a supporting organization must be able to show that it is organized exclusively for the benefit of, to perform the functions of, or to carry out the purposes of one or more publicly supported organizations. To do this, a supporting organization’s articles and bylaws must be organized in a way that gives the supported organization(s) supervisory authority over the 509(a)(3). Additionally, it must be explicitly stated in the articles that the supporting organization cannot engage in any activities that would not be in support of the supported organization(s).
Operational Test:
This test looks at the activities of the supporting organization to determine if they are operating for the sole benefit of the organization(s) they support. Supporting organizations may make grants and provide services and facilities for the benefit of the organization(s) that it supports. None of the activities that the supporting organization conducts can be used for any purpose that does not benefit the supported organization(s), otherwise, this test would fail.
Relationship Test:
This is where the 509(a)(3) gets more complicated: there are three types of supporting organizations, Type I, Type II, and Type III. Conducting the relationship test determines what type of organization the 509(a)(3) is.
Type I: These organizations must be fully operated, controlled, or supervised by the supported organization(s). This can be done by giving authority to the supported organization(s) to elect a majority of directors to the board of the supporting organization, ensuring direct control of the supporting organization. As in a general corporate structure, a Type I organization is akin to a true parent-subsidiary relationship.
Type II: Type II has a similar requirement, in that the supporting organization must be controlled or supervised by the supported organization(s). This is achieved by having a majority of the directors of the supported organization(s) serve as a majority of the directors on the supporting organization’s board. Type II’s can be viewed as a sibling relationship because of the overlap in directorships.
Type III: This type of supporting organization has the smallest amount of oversight of the three types, and merely requires that the organization be operated in connection with the supported organization(s). Since the bar is so low with respect to control, there are additional tests that Type III organizations must meet.
Notification Requirement: Type III organizations must provide certain documents to the organization(s) it supports on an annual basis (see here for the specific documents required).
Responsiveness Test: Type III organizations must also be responsive to the needs of the organization(s) they are supporting. This can be done by placing a single member from the supported organization(s) on the board or appointing someone in a director position from the supported organization(s)’ board. This can also be met by maintaining a close and continuous relationship between the two organizations. The key to the responsiveness test is to show that the supported organization(s) has a strong influence on the supporting organization.
Integral Part Test: Type III organizations can be functionally integrated (FISO) or non-functionally integrated (non-FISO). Electing to be a non-FISO creates greater restrictions. The test is lengthy and complicated, and for the sake of brevity, the full test will be omitted, but can be found here. Essentially, choosing to be a FISO or non-FISO will have an impact on taxes as well as Section 4943 distributions.
Bottom Line: Determining if your organization qualifies as a 509(a)(3) can be a daunting task and getting the help of a professional to run through the different IRS procedures and tests is the best way to see if you qualify. The Colorado Nonprofit Legal Center can help you run through the analysis and ensure compliance with the complicated world of nonprofit classifications.
By Justin Vanderveer