Private Nonoperating Foundations and Supporting Organizations

By Sonja Lepkowski

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JUNE 2005 - Many charitably inclined individuals form private nonoperating foundations (PNOF) funded with long-term qualified appreciated stock (QAS). QAS includes any stock that is capital gain property and for which market quotations are readily available on an established securities market. The donor receives a charitable deduction for the fair market value of the QAS contributed and does not have to pay a capital gains tax on the appreciation. The PNOF will pay a maximum excise tax of 2% on the appreciation upon the sale of the QAS, using the donor’s cost.

Donors can also form a supporting organization (SO) to satisfy other charitable intentions. While both PNOFs and SOs are exempt under IRC section 501(c)(3), SOs fall under the public charity guidelines of IRC section 509(a)(3) because of their relationship with other public charities under section 509(a)(1) or (2). As a result, cash contributions made to a PNOF are limited to 30% of the donor’s adjusted gross income (AGI), while cash contributions made to an SO are limited to 50% of the donor’s AGI. Contributions of QAS made to a PNOF are limited to 20% of the donor’s AGI, while contributions of long-term capital gain securities (not just QAS) made to an SO are limited to 30% of the donor’s AGI.

To receive the same percentage limitations as contributing to a public charity or an SO, a PNOF can elect pass-through status, which is the same as being treated as a public charity for that year. Private pass-through foundations are described in IRC section 170(b)(1)(E)(ii). They must distribute to public charities all of the contributions they receive during the year—including the current year’s distributable amount and the prior year’s undistributed amount, if any—no later than two-and-a-half months following their year-end. If the PNOF has excess distributions from prior years, it can use that amount toward the required distribution amount.


Why would a donor with an existing PNOF form an SO? Donors to an SO can make a charitable contribution using a higher percentage of AGI, are not subject to the excise tax on net investment income, and do not need to make minimum qualifying distributions of at least 5% of the average investment asset value annually. In addition, an SO is not restricted in holding more than 20% (35% in some circumstances) of a single business enterprise, which is a restriction for PNOFs. Finally, an SO is not subject to self-dealing rules applicable to PNOFs but is subject to intermediate sanctions.

If a donor owns securities other than QAS, the only way to secure a deduction for the fair market value of those securities is to: 1) give them to public charities; 2) give them to an SO; or 3) elect pass-through status for the PNOF. An appraisal is required if the security is not tradable on an established securities exchange (such as the donor’s personal holding company).

Finally, an SO may be a foreign organization as long as it qualifies as a publicly supported entity.


An SO must pass four tests:

  • It must be operated, supervised, or controlled by or in connection with one or more organizations described in IRC section 509(a)(1) or (2).
  • It must be organized and operated exclusively for the benefit of, to perform the functions of, or to carry out the purposes of one or more organizations described in IRC section 509(a)(1) or (2).
  • It must not be controlled directly or indirectly by one or more disqualified persons, other than foundation managers and one or more organizations described in IRC section 509(a)(1) or (2). Disqualified persons include substantial contributors and their families and related entities.
  • The relationship between the SO and the supported organizations will indicate the ease or difficulty of meeting the other tests of IRC section 509(a)(3). Any relationship, however, must ensure that the SO will be responsive to the needs or demands of, and will be an integral part of or maintain a significant involvement in, the operations of one or more publicly supported organizations.

There are three types of SOs based on the SO’s relationship to the public charity or charities it supports:

  • A Type I SO must be operated, supervised, or controlled by the supported organization. The supported organization must maintain a substantial degree of direction over the SO.
  • A Type II SO must be supervised or controlled in connection with the supported organization; that is, by the same persons.
  • A Type III SO must be operated in connection with the supported organization. The responsiveness and integral-part requirements become very important in demonstrating a Type III relationship.

Under Treasury Regulations section 1.509(a)-4(i)(3)(iii), the supported organization must be attentive to the activities of the SO. The SO must make payments of most of its income (at least 85%) to or for the use of the supported organization. In addition, the amount of support must be sufficient to ensure the attentiveness of the supported entity (it must approach 10% of annual support), or the funds must be earmarked for a substantial program or activity of the supported entity (contributions made to a donor-advised fund would not qualify).

While an SO has many advantages over a PNOF, it gives donors less control and less flexibility in grant making. Both entities can be used to satisfy different charitable goals.

SOs have come under scrutiny from regulators and lawmakers. It is believed that SOs are used more extensively for tax planning purposes than to benefit charities. Several SOs are being examined to see if they have violated the current tax laws. Only time will tell what regulators decide on the future of the SO.

Sonja Lepkowski, CPA, CFP, is a senior manager at Anchin, Block & Anchin LLP, New York, N.Y.




















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