July/August 2017 Conversions From Nonprofit to For-Profit Supporting Organizations — Reporting Requirements New Market Tax Credit Deals SCHEDULE A REPORTING: SECTION 509( a)(3) SUPPORTI NG ORGANIZATIONS JOHN V. WOODHULL AND JANICE M. SMITH Supporting organizations historically have been charity status. In most instances, charitable organiza - Because of expanded viewed as operating within a very complex area of the tions simply checked the same box in Part I (“Reason reporting requirements, tax law. The complexity arguably rose to a new level, for Public Charity Status”) that they had checked in supporting organization managers and tax however, with the 2014 introduction of an expanded the previous year or years, and moved on to the next practitioners have been Schedule A of Form 990—the form required for re - (and seemingly more important) schedules in Form forced to possess a porting public charity status and public support. Be - 990. Public charity status seemingly had been rele - deeper understanding cause of the expanded reporting requirements, gated to one of the less important issues for tax exempt of supporting supporting organization managers and tax practi - organizations to consider. If any effort was expended, organization tax law than required in the past. tioners have been forced to possess a deeper under - it was focused primarily on Parts II and III of Sched - standing of supporting organization tax law than ule A (the support schedules) that numerically veri - required in the past. fied a charitable organization’s public charity status If there is one area of tax law in which compliance under Section 509(a)(1)/Section 170(b)(1)(A)(vi) and can be amorphous, escaping even the most meticu - Section 509(a)(2). lous organizational and tax accounting profession - Schedule A previously had been revised in 2008 als, it is the area of supporting organizations. 1 Not when the entire Form 990 was redesigned and ex - only are the tax rules complex, but, as discussed panded to 16 schedules. The primary changes that below, expanded tax reporting under the rules affects were introduced to Schedule A at that time related situations that were not even intended to be affected, to the public support schedules, which were ex - thus forcing strained interpretations of the regulatory panded from a four-year rolling average to a five- requirements. year rolling average. Prior to 2008, organizations applying for recognition of charitable exemption on Form 1023, “Application for Recognition of Exemp - The previous Schedule A tion Under Section 501(c)(3) of the Internal Rev - Until the 2014 Form 990 series was released, Sched - enue Code,” were permitted to elect an “advance ule A of Form 990 was not much more than a pro ruling” that required the organization to submit forma checklist for charitable organizations’ public public support information on a separate schedule at the end of the five-year advance ruling period to JOHN V. WOODHULL is a tax managing director in the Chicago of - fice of Crowe Horwath LLP. JANICE M. SMITH is a tax senior man - confirm their public charity status under Section ager in the firm’s Washington, DC, office. 509(a)(1)/Section 170(b)(1)(A)(vi). However, al - JULY/AUGUST 2017 taxation of exempts 17 though Question 6a in Part X (“Request for Advance threshold (as the case may be) in Part IV-A of Sched - Ruling”) remains in Form 1023, instructions on the ule A could continue to file as publicly supported or - form itself indicate that the advance ruling election ganizations, albeit incorrectly, unless either the IRS is no longer available. This is another example of the audited the organization and directed it to begin fil - difficulty the IRS has had in trying to update its pub - ing a Form 990-PF or the organization itself stopped lications and regulations to reflect the statutory filing the Form 990. There was no automatic default changes enacted by Congress. to private foundation status in Part IV-A of the pre- At present, once an initial determination has been 2008 Form 990. made by the IRS regarding a charitable organization’s public charity status based on the financial informa - tion submitted with Form 1023, Schedule A is the The winds of change hit the only schedule that charitable organizations may use regulations ... and Schedule A to demonstrate that they are maintaining their pub - Notwithstanding the changes to Parts II and III of lic charity status under Section 509(a)(1)/Section Schedule A, Schedule A reporting issues did not re - 170(b)(1)(A)(vi). If, at the end of five years, a chari - ally come into focus until the Section 509(a)(3) reg - table organization does not meet the one-third test ulations were finalized in 2012 and Parts IV, V, and or the 10% facts-and-circumstances test—the math - VI were added to Schedule A beginning with the ematical tests that demonstrate that an organization 2014 tax year. 2 Prior to 2006 and the changes en - acted to Section 509(a)(3), Section 509(a)(3) often was used as a default public charity status, available Expanded tax reporting affects situations for charitable organizations that were unable to ef - that were not even intended to be affected. fectively solicit charitable contributions or charge admissions for exempt activities and satisfy the pub - receives the requisite amount of public support to lic support tests of Sections 509(a)(1)/Section maintain its public charity classification—the Sched - 170(b)(1)(A)(vi) and Section 509(a)(2). Although ule automatically defaults the organization into pri - the relationship tests are the most difficult part of the vate foundation status. 509(a)(3) regulations to satisfy, many charitable or - Prior to the 2008 tax year (and the changes to the ganizations choose to be classified as supporting or - Form 990), Part IV-A of Schedule A required Section ganizations, with only a limited understanding of the 509(a)(1)/Section 170(b)(1)(A)(vi) and Section restrictions that Section 509(a)(3) impose on their 509(a)(2) organizations to demonstrate their ability abilities to act independently. to satisfy the respective public support tests in much the same manner as Parts II and III of today’s Sched - ule A. The big difference with the revised Schedule A The ‘new’ Schedule A— is at the bottom of the respective Parts (lines 18 and Expanded reporting for 20, respectively). The revised Schedule A automati - supporting organizations cally defaults organizations that fail the mathematical As most supporting organizations discovered upon public support tests to private foundation status. completing their 2014 Form 990, the number and Prior to 2008, organizations that failed the public complexity of the questions in the expanded Sched - support test and fell below the 10% or one-third ule A can be confusing and overwhelming. The ex - 1 Supporting organizations are described in Section 509(a)(3). It de - organizations into the statute.” Specifically, Type I supporting organ - fines them as an organization that is organized, and at all times op - izations are “operated, supervised, or controlled by” one or more Sec - erated, exclusively for the benefit of, to perform the functions of, or to tion 509(a)(1) or 509(a)(2) organizations; Type II supporting carry out the purposes of one or more publicly supported organiza - organizations are “supervised or controlled in connection with” one tions (specifically, organizations described in Section 509(a)(1) or Sec - or more Section 509(a)(1) or 509(a)(2) organizations; and Type III tion 509(a)(2)). A supporting organization is either “operated, supporting organizations are “operated in connection with” a Sec - supervised or controlled by,” “supervised or controlled in connection tion 509(a)(1) or (2) organization. 4 with,” or “operated in connection with” one or more publicly sup - In considering the supporting organization regulations, a district ported organizations. Supporting organizations must not be con - court judge commented that “the Internal Revenue Service has trolled directly or indirectly by disqualified persons. drafted fantastically intricate and detailed regulations to thwart the 2 Even though Form 990, Schedule A, has been updated to conform fantastically intricate and detailed efforts of taxpayers to obtain pri - to the new supporting organization requirements, Form 1023, Sched - vate benefits from foundations while avoiding the imposition of ule D, has not been similarly updated. Thus, Form 1023 supporting taxes.” Windsor Foundation, 40 AFTR2d 77-6004 at 77-6005 (ED organization filers should include documentation (such as a narrative Va., 1977). 5 explanation) to demonstrate that the applicable supporting organ - See, for example, Mitchell et al, “Supporting Organizations in the ization tests will be met. Spotlight,” 27 Exempts 3, page 3 (Nov/Dec, 2015). 3 6 P.L. 109-208, 120 Stat. 780, 3/23/06. According to IRS Notice 2006- Throughout this article, the term “publicly supported organizations” 109, 2006-51 IRB 1121: “The PPA incorporates the previously infor - refers to organizations that receive broad public support and are clas - mal nomenclature used to distinguish among types of supporting sified as Section 509(a)(1) or Section 509(a)(2) organizations. 18 taxation of exempts JULY/AUGUST 2017 SUPPORTING ORGANIZATIONS panded tax reporting requirements necessitate were not finalized until the end of 2012 and were fi - much closer analysis than before. Specifically, Sched - nally incorporated into the instructions and Sched - ule A of Form 990 was substantially revised in 2014 ule A in 2014. to address the new reporting requirements of the final regulations governing supporting organiza - tions under Section 509(a)(3). Prior to 2014, Section Overview of supporting 509(a)(3) supporting organizations had to provide organization classifications only a minimum amount of information on Sched - The supporting organization statutes and regulations ule A, none of which had to be verified or cross ref - are very complex.