EXECUTIVE SUMMARY:

On December 4, 2006, the IRS issued Notice 2006-109, interim guidance on several of the provisions under the Pension Protection Act of 2006 ("PPA") affecting donor advised funds and supporting organizations, as well as private foundations that make grants to supporting organizations. The notice addresses only a limited number of provisions requiring immediate guidance, although it indicates that the IRS expects to issue further guidance, including regulations, with respect to the PPA provisions impacting charitable organizations and their donors.

The rules provided in the notice apply until further guidance is issued.  The notice also invites comments from the public regarding the issues addressed in the notice and suggestions for future guidance implementing statutory changes under the PPA. 

FACTS:

 Specifically, Notice 2006-109:

�        Addresses grantor reliance issues for donor advised funds and private foundations making grants to supporting organizations, including determining whether the supporting organizations is "functionally integrated" or "controlled."  

�        Grandfathers certain arrangements in effect on August 17, 2006 (the date of the enactment of the PPA) from the new automatic excess benefit transactions rules involving supporting organizations.

�        Provides an exclusion for certain employer-sponsored disaster relief funds from the definition of donor advised fund. 

�        Grandfathers certain payments made through educational grants awarded on or before August 17, 2006 from the purview of the new excise tax rule prohibiting payments from donor advised funds to individuals. 

Grantor Reliance for Grants to Supporting Organizations by Private Foundations and Donor Advised Funds

Prior to the PPA, a distribution by a nonoperating foundation to all IRC � 509(a)(3) supporting organizations constituted a "qualifying distribution" under IRC � 4942(g) and was not considered a "taxable expenditure" under IRC � 4945(d).   This was the case because supporting organizations, whether classified as Type I, II or III supporting organizations, were treated the same as any other public charity for purposes of determining the tax treatment of distributions by private foundations. 

The PPA amended IRC � 4942(g) to provide that distributions by a private nonoperating foundation after August 17, 2006 to Type III supporting organizations that are not functionally integrated Type III supporting organizations are not considered "qualifying distributions." Thus, a distribution to such organizations is no longer counted towards the annual distribution requirement imposed on a private nonoperating foundation, i.e., that it make annual qualifying distributions generally equal to at least 5% of the fair market value of its assets. 

Moreover, IRC � 4945(d)(4) has been amended to provide that such a distribution constitutes a "taxable expenditure" (thereby exposing the private foundation to significant excises taxes) unless the private foundation exercises "expenditure responsibility" in accordance with IRC � 4945(h).

The same consequences result where a private non-operating foundation makes a distribution to a Type I or II supporting organization, as well as a functionally integrated Type III supporting organization, if a disqualified person with respect to the foundation directly or indirectly controls the supporting organization or a supported organization of such supporting organization. In such a case, therefore, no qualifying distribution results and, unless expenditure responsibility is exercised, a taxable expenditure will occur.

Similarly, the PPA provides that unless expenditure responsibility is exercised, a "taxable distribution" will result where a distribution is made from a donor advised fund to a Type III supporting organization that is not a "functionally integrated Type III supporting organization," as well as to (ii) a Type I, II or III supporting organization (even if functionally integrated) that is directly or indirectly controlled by the donor, a person designated by the donor as advisor to the fund, or any persons related to the donor or the advisor. 

These new rules make it imperative for a private foundation and donor advised fund to know whether a prospective grantee organization is a supporting organization and, if it is, the specific type of supporting organization (and, for a Type III supporting organizations, whether it is a functionally integrated Type III supporting organization or a non-functionally integrated type III supporting organization).

Determining whether a supporting organization is Type I, II or III supporting organization is not a simple task and can present a challenge for a grant maker, as such information is not available on any IRS data base, including Publication 78, and may not be readily apparent from the information provided on the grantee organization's Form 990. Quite often, even a director or an officer of a supporting organization will not know the organization's specific category of supporting organization for tax purposes.

Because of the potential negative tax implications introduced under the PPA for grants by private foundations and donor advised funds to supporting organizations, and, in particular, non-functionally integrated Type III supporting organizations and any "controlled" supporting organization, Notice 2006-109 provides standards on which private foundations and donor advised funds can rely in making grants to supporting organizations.  Although regulations may adopt different standards, those regulations will apply to grants made by private foundations and sponsoring organizations no sooner than the date that the regulations are proposed. The standards discussed below, as set forth in Notice 2006-019, apply with respect to any grants made prior to that date.