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Grantmaker Due Diligence

in the

Pension Protection Act Era:

How to identify supporting organizations and align your grants administration

process with the 21st century tax code

© 2011, GuideStar USA, Inc. All Rights Reserved. This information is copyrighted subject matter owned by GuideStar USA and is protected by United States and international copyright law.

15 February 2011

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Pamela Jowdy

Senior Product Manager, GuideStar

Suzanne Ross McDowell

Partner, Steptoe & Johnson, LLP

Today’s Facilitators

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Participant Poll

#grantmakerdd

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1. Internal Revenue Code: Impacts on

Grantmakers

Why Verify: Pension Protection Act of 2006

Supporting Organizations: Relationships and Control

Expenditure Responsibility: Defined

Due Diligence: Methods and Best Practices

2. GuideStar Charity Check: Anatomy of a

Solution

How it works

What it delivers

Why it works

3. “Automatic” Failure to File Revocations

4. Q & A

Today’s Objectives

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Internal Revenue CodeImpact of the Pension Protection Act of 2006 on Grantmakers

Suzanne Ross McDowell PartnerSteptoe & Johnson LLPsmcdowell@steptoe.com

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Summary of Pension Protection Act Provisions

Affecting Grants to Supporting Organizations

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Changes Made by the Pension Protection Act of 2006

Private Foundations (PFs) Grants to certain supporting organizations

(SOs) do not count towards minimum distribution• Penalty: 30% of shortfall; must make correction

Grants to certain SOs require expenditure responsibility• Penalty: 20% of grant on foundation; potentially

5% on directors and officers; must make correction

Donor Advised Funds (DAFs) Grants to certain SOs require expenditure

responsibility• Penalty: 20% of grant on sponsor of DAF

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What is a Supporting Organization?

Internal Revenue Code provides-- All 501(c)(3) organizations are either private

foundations or public charities Private foundations are subject to greater

regulation Public charities include:

Schools, hospitals, churches, government units Organizations that meet specific requirements

for broad public support SOs

All other 501(c)(3) organizations are private foundations

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What is a Supporting Organization? (cont’d)

SO is a 501(c)(3) organization which is-- Classified as a public charity (not a PF) Because it has a specified relationship with

another public charity (the supported organization)

Types of relationships Type I – Parent-subsidiary Type II – Brother-sister Type III – Operated in connection with

• Functionally Integrated • Not Functionally Integrated

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Which Supporting Organizations Require Expenditure Responsibility?

Type III Non-Functionally Integrated SOs All other SOs if--

A disqualified person of the foundation making a grant to the SO directly or indirectly controls the SO or a supported organization; or

A donor to a DAF, or a person designated by the donor to advise with respect to distributions, directly or indirectly controls a supported organization

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What is Expenditure Responsibility?

Procedures designed to ensure that PF funds are used for exclusively charitable purposes-- Pre-grant inquiry Written grant agreement with the

grantee Grantee must keep funds separate from

noncharitable funds Regular reports from the grantee to PF PF reports to IRS on Form 990-PF that

expenditure responsibility requirements were met

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Which Grants Do Not Count Toward a Private Foundation’s Minimum Distribution?

Grants to-- Type III Non-Functionally Integrated SOs All other SOs if--

A disqualified person of the foundation making a grant to the SO directly or indirectly controls the SO or a supported organization

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When Does a Person Have Control?

No IRS guidance provides clear method for determining whether control exists.

Control exists when one or more disqualified persons or donors may, by aggregating their votes or positions of authority, require the SO or supported organization to make an expenditure, or prevent the SO or supported organization from making an expenditure. See Notice 2006-109.

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When is a Type III Supporting Organization Functionally Integrated?

Proposed Regulations issued on September 24, 2009

Until temporary or final regulations are issued, can rely on Notice 2006-109 or Proposed Regulations Notice 2006-109: SO is functionally

integrated • When the activities engaged in for or on

behalf of a supported organization(s) are activities to perform the functions of, or to carry out the purposes of, such organization(s), and;

• But for the involvement of the SO, would normally be engaged in by the supported organization(s) themselves.

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When is a Type III Supporting Organization Functionally Integrated? (cont’d)

Proposed Regulations: SO is functionally integrated If engages in activities substantially all of

which directly further the exempt purposes of the supported organization(s), by performing the functions of or carrying out the purposes of the supported organization(s); and

But for the involvement of the SO, would normally be engaged in by the supported organizations

Includes owning and managing exempt-use property

Does not include fundraising or managing non-exempt use property for a supported organization

Special rules for hospitals and governmental units

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Conducting Due Diligence to Avoid Excise Taxes

under the Pension Protection Act

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Step 1: Determine if Potential Grantee is a 501(c)(3) Organization

Approved Methods IRS Determination Letter; and Verification of listing in IRS Pub. No. 78

• Pub. No. 78 Weekly Updates in Internal Revenue Bulletin

If grantee is not a 501(c)(3), no new rules

If grantee is a 501(c)(3), must determine if it is an SO

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Step 2: Determine if Potential Grantee is a SO

Approved Methods IRS Determination Letter

• Section 509(a)(1) and 509(a)(2) organization – not a SO

• Section 509(a)(3) organization = SO• IRS letter may be silent

IRS Business Master File• Direct access (Notice 2006-109)• Access to IRS BMF data through third party such

as GuideStar (Rev. Proc. 2009-32) If grantee is not a SO, can make grant—no

new rules If grantee is a SO, must determine the type

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Step 3: If Grantee is a SO, Determine the Type of SO

Method 1: IRS Determination Letter Most Determination Letters don’t include Type

• Prior to 2006, no need for Type Prior to February 22, 2007, IRS issued

Determination Letters on FI status based on an Advance Notice of Proposed Rulemaking (ANPRM)

ANPRM superseded by Prop. Reg. but can continue to rely on Determination Letter issued under ANPRM until Prop. Reg. are issued as temporary or final as long as SO meets the requirements of ANPRM or Prop. Reg.

IRS now issuing Determination Letters that a Type III is Functionally Integrated under Prop. Reg. definition

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Step 3: If Grantee is a SO, Determine the Type of SO (cont’d)

Method 2: Reasoned written opinion of counsel of

PF or DAF

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Step 3: If Grantee is a SO, Determine the Type of SO (cont’d) Method 3:

Good Faith Reliance on Written Representation by Grantee • Representation by officer, director or

trustee• Describes how officers, directors and

trustees of grantee are selected• For Type I or II, references governing

document provisions establishing relationship with supported organization

• For Type III-- identifies supported organizations

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Step 3: If Grantee is a SO, Determine the Type of SO (cont’d)

Method 3 (cont’d) Review by PF or DAF

• Governing documents of SO and supported organization

• For Type III, representation from supported organizationso Re types of activitieso That, but for SO, supported organization would

conduct activities of SO

Note: cannot rely on Form 990 to determine Type

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Step 3: If Grantee is a SO, Determine the Type of SO (cont’d)

If grantee is a Non-Functionally Integrated Type III SO, then PF or DAF must exercise expenditure responsibility and grant does not count toward non-operating foundation’s minimum distribution

If grantee is a Type I, Type II or Functionally Integrated Type III SO, must determine if a disqualified person of a PF or donor or donor’s designee of a DAF has control

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Step 4: Determine if Disqualified Person or Donor has Control over SO or Supported Organization

No IRS approved procedure; use definition in Notice 2006-109

Obtain list of supported organization(s) Identify disqualified persons for a PF and

donors and their designees for a DAF Determine if disqualified persons exercise

control over SO or supported organization Determine if donors/designees control

supported organization Direct or indirect control

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Step 4: Determine Control (cont’d)

If disqualified person or donor (or donor’s designee) has control, then must exercise expenditure responsibility and grant does not count toward a non-operating foundation’s minimum distribution

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Summary

Type III which is Not Functionally Integrated Grant does not count toward non-operating

foundation’s minimum distribution PFs and DAFs must exercise expenditure

responsibility Type I, II or Functionally Integrated Type III

with disqualified person or donor control Grant does not count toward non-operating

foundation’s minimum distribution PFs and DAFs must exercise expenditure

responsibility

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GuideStar Charity CheckAnatomy of a Solution

Pamela Jowdy Senior Product Manager

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The Challenge: RecapWhy Verify?

Two Unique Due Diligence To-Do’s:

Verify Current Charitable Status

Publication 78 and

Internal Revenue Bulletin

Identify Supporting Organizations with

509(a)(3) status

IRS Business Master File

To-Do: Data Source:

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Pub 78 and Internal Revenue BulletinWhy Verify: IRS Data Sources

Establish Tax Deductibility and Verify Current Charitable Status

IRS Publication 78: Also known as Cumulative List of Organizations Includes all organizations to which charitable contributions are tax deductible Current tax-exempt status, percentage of contributions that are tax deductible Deductibility limitations Published quarterly

IRS Internal Revenue Bulletin: Also known as the ‘IRB’ Lists organizations whose charitable status has been changed or revoked Updated weekly

Rev. Proc. 82-39, 1982-1 C.B. 759 Sec.3.01 and Sec.3.02 states that grantors “may rely on the classification of an organization listed in or covered by Publication No. 78.”

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IRS Business Master File

Determine 509(a) Status

IRS Business Master File: Lists all tax-exempt organizations registered with the IRS Published monthly Includes reason for non-private foundation status, aka “public charity classification” Reason for non-private foundation status = 509(a) status

Why Verify: IRS Data Sources

509(a)(1) and 509(a)(2): A public charity that receives a substantial amount of public support to fund its

operations

509(a)(3): Supporting Organization A public charity that provides support to one or more publicly supported organizations Must demonstrate that is has a particular type of relationship with the organization it

supports

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Supporting Organizations SnapshotIRS Business Master File

Why Verify: Pension Protection Act

32,191 509(a)(3) Supporting Organizations:

21,505 have filed a form 990 4% of all 509(a) orgs

12,305 of the 32,000 largest foundations, or 38%, made a grant to any supporting organization between 2000 and 2004

While the supporting organization universe is fairly discrete, failure to identify these organizations creates an exponentially greater fiscal and operational risk for private

foundations and sponsors of donor-advised funds.

509(a) Universe IRS Business Master File

509(a)(1)68%

509(a)(2)28%

509(a)(3)4%

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Internal Revenue Code Grants Administration Milestones

1969 August 2006

Pension Protection Act

New requirements on grants to certain

supporting organizations [509(a)

(3)]

Definition of Type III supporting

organizations

Definition of Type III functionally integrated

supporting organizations

IRS Revenue Procedure 2009-32

Formalizes March 2007 FAQ

Precedentialinstrument upon

which compliance and grantmaking teams can rely

Tax Reform Act

The legal framework for the regulation of private foundations and public charities

is established

December 2006

June 2009

Internal Revenue Code

Interim Guidance Regarding

Supporting Orgs and Donor-Advised

Funds

Grantor may rely on IRS BMF or Letter of

Determination for identifying supporting organization 509(a)

status

March 2007

IRS FAQ on Business Master File

Reliance

Allows grantors to use third party resources

to obtain required IRS BMF information about a potential grantee’s charity

classification under section 509(a)(1), (2)

or (3)

Charity Check v1.5

100% compliant with IRS FAQ and

Revenue Procedure 2009-32

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IRS Revenue Procedure 2009-32

June 2009

Why Verify: Pension Protection Act

Source: http://www.irs.gov/pub/irs-drop/rp-09-32.pdf

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How it Works

Incorporates Weekly Internal Revenue Bulletin Marries Publication 78 data with IRS Business Master File data

Married, but never modified OFAC verification included (organization level) 10 year track record of consuming and managing IRS data

An Integrated, One-Stop Verification Solution

GuideStar Charity Check

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What it Delivers

Date and time stamp

Latest Quarterly Pub 78

Weekly Bulletin Date

An Integrated, One-Stop Verification Solution

GuideStar Charity Check

Reason for Non-Private Foundation Status

EIN

IRS BMF Date

Verify Current Charitable Status

Identify Supporting

Organizations with 509(a)(3)

status

Electronic or hard copy documentation

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An Integrated, One-Stop Verification Solution

GuideStar Charity Check

Why it Works

The grantees’ name, EIN and public charity classification (aka “reason for non-private foundation status”) under section 509(a)(1), (2) or (3) is presented in the report

A statement that the information in the report is from the most currently available IRS monthly update to the BMF,

along with the IRS BMF revision date

The date and time of the grantor’s search is included on the report

The third party IRS BMF data and report must be in a form which the grantor can store in hard copy or

electronically.

Fully compliant with recently issued guidance from IRS concerning reliance on third-party

resources for IRS BMF data:

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Recap

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Charity Check User Experience

Two Clicks to Compliance

Pamela Jowdy Senior Product ManagerGuideStar

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1. IRS Data Sources: Manual Verification Options

Publication 78

Internal Revenue Bulletin

Business Master File

2. The Letter of Determination: isn’t this good enough?

Common Participant Questions

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Grantmaker Verification Options

IRS website provides search functionality for Pub 78 Does not include IRB weekly updates; must search separately for changes and / or

revocations Cannot search by EIN No date or time stamp

IRS Publication 78

IRS Publication 78 Online

Source: http://apps.irs.gov/app/pub78

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Grantmaker Verification Options

Includes status changes and revocations Published weekly in pdf and html format Does not include EIN Not searchable

IRS Internal Revenue Bulletin

IRS IRB

Source: http://www.irs.gov/irb

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Draft of manual solution for 509(a)verification directly from

IRS BMF

Grantmaker Verification OptionsIRS Business Master File

IRS Downloadable Business Master File

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Isn’t this good enough?

What it is

The Letter of Determination

What it is NOT

Static, historic snapshot

Only accurate at time of issuance

Confirms 501c3 status

Does not account for changes in charitable status since date of original issuance

Some letters include SO Type (2006)

IRS suspended letters for Type III functionally integrated SOs 2.22.07

Does not reflect automatic revocations starting in 2011

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Failure to file annual return for 3 consecutive years Pension Protection Act of 2006 provision Forms 990-N, 990-EZ, 990 or 990-PF Religious organizations are still exempt from filing requirement GuideStar estimates 350,000 NPOs may be at risk Many NPOs with annual gross revenues < $25K previously not required to file; now must file 990-N First deadline: 5.17.10 for NPOs with FYE date of 12.31.09

IRS granted “temporary relief” extension until 10.15.10 “At Risk” Organizations: www.irs.gov/thelist

Automatic Revocations

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Failure to file annual return for 3 consecutive years IRS to publish list early 2011 Publication will be ongoing and updated monthly GuideStar working closely with IRS to understand timing, data structure and distribution model into BMF GuideStar Charity Check will include a flag for these “failure to file” organizations GuideStar Premium will include a flag for these “failure to file” organizations

Automatic Revocations

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1. International Grantmaking

2. Supporting Organization Type and Charity Check

3. Advance Ruling Process and Charity Check

4. OFAC: Definition and options

5. XML Delivery Options

Questions Already Submitted

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Considerations Does the foreign charity already have a Letter of Determination? Exercise expenditure responsibility Equivalency Determination International Repository Project:

www.USIG.org [COF-sponsored website] www.ngosource.org [international repository project website]

Become familiar with the USA Patriot Act

International Grantmaking

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Options and Approaches Supporting Organization Guidesheets published by IRS GuideStar Charity Check policy and long term product vision http://www.irs.gov/charities/article/0,,id=174956,00.html Consult your legal counsel!

Supporting Organization Types

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Temporary IRS Regulations Issued September 9, 2008 Eliminated the advance ruling process for 501(c)(3) organizations reasonably expected to be publically

supported IRS automatically classifies new 501(c)(3)s as public charities for first 5 years if can reasonably be expected to

be publically supported Includes public charities whose advance ruling period has not yet expired or expired after June 9, 2008 Charity Check still publishes the Advance Ruling date in the body of the report, where applicable Footer messaging and link to IRS resource persists

Advance Ruling Process

http://www.irs.gov/charities/charitable/article/0,,id=185568,00.html

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Definition and Options

http://www.ustreas.gov/offices/enforcement/ofac/

OFAC and SDN

Office of Foreign Assets Control / Specially Designated Nationals

Source: Technology Affinity Group and Council on Foundations’ 2007 Grantmakers Information Technology Report, September 2007

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XML* Data and PDF Report Delivery Charity Check Web Service

*Extensible Markup Language =

easy way to share structured

data via ether

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webinars@guidestar.

org

Contact Information

Suzanne Ross McDowell

Partner, Steptoe & Johnson, LLP

smcdowell@steptoe.com

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Appendix

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Access Points: ResultsGuideStar Charity Check

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Access Points: ReportGuideStar Charity Check

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509(a)(3) Supporting OrganizationGuideStar Charity Check

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Not Verified in Publication 78GuideStar Charity Check

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Not Listed in IRS Business Master File

GuideStar Charity Check

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OFAC Organization: Results GuideStar Charity Check

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OFAC Organization: ReportGuideStar Charity Check

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Grantmaker Due Diligence

in the

Pension Protection Act Era:

How to identify supporting organizations and align your grants administration process with the 21st

century tax code

© 2011, GuideStar USA, Inc. All Rights Reserved. This information is copyrighted subject matter owned by GuideStar USA and is protected by United States and international copyright law.