Guidance for Donor Advised Funds, Supporting Organizations, and Employer Disaster Funds

This resource is a Council Summary of IRS Interim Guidance found in IRS Notice 2006-109, issued December 6, 2006, and explains steps for determining supporting organization status, and important information on the employer disaster relief fund exemption.

Responding to requests from the Council on Foundations and Independent Sector, the Internal Revenue Service on December 4, 2006 issued interim guidance on several of the donor advised fund and supporting organization issues arising from the Pension Protection Act of 2006. The notice is available at http://www.irs.gov/pub/irs-drop/n-06-109.pdf .

Determining Supporting Organization Status of Grantees
IRS guidance for private foundations and sponsoring organizations of donor advised funds on how to:

• Determine whether a public charity is a supporting organization,
• Determine which type it is, and
• Determine whether a Type III supporting organization is "functionally integrated."

"Control Test" for Private Foundations
Provides guidance on the control test to be applied in determining whether a private foundation disqualified person or a donor/advisor controls an organization that the supporting organization supports.

Employer Disaster Relief Funds are not Donor-Advised
Certain employer-connected disaster relief (but not emergency hardship) funds are exempt from the definition of donor advised fund.

Supporting Organization Employment Contracts
Transition relief was provided for supporting organizations with preexisting contractual and employment relationships with the supporting organization’s substantial contributor or persons related to the contributor.

Scholarship Relief
Transition relief was provided for scholarships awarded prior to August 17, 2006.

Determining Supporting Organization Status of Grantees

Step 1: Obtain information from a reliable source to determine whether a public charity is a supporting organization.

According to IRS guidance, grantmakers may rely on any of the following sources:

• Select Check, an online IRS tool using data from the IRS public charity list, known as IRS Publication 78,
• IRS Business Master File (BMF)
• Reliable third party such as Guidestar's Charity Check Service

Important: Grantmakers may not rely on these sources for information once the IRS publishes notice that the organization’s status has changed. In addition, a grantmaker that was responsible for, or aware of, the circumstances that result in the supporting organization’s change in status will not be able to rely on Publication 78 or the IRS BMF for these purposes.

Relying on a Third Party: IRS guidance provides that a grantmaker may use a third party to obtain information from the IRS BMF to determine whether or not a charity is a supporting organization, provided that the grantmaker obtains a report from the third party that includes all of the following:

• the grantee’s name, Employer Identification Number, and public charity classification under Section 509(a)(1), (2), or (3)
• a statement that the information 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 grantmaker’s search

The grantmaker must retain the report in electronic or hard-copy form.

"Control Test" for Private Foundations

The IRS will use the definition of control found in the regulations under section 4942 in deciding whether a private foundation disqualified person or a donor advisor (and related parties) controls a supporting organization or an organization that a supporting organization supports. The notice suggests that grantmakers may need to obtain lists of the supported organizations from potential supporting organization grantees. The section 4942 regulations provide that an organization is controlled if disqualified persons can, by aggregating their votes or positions of authority, require the supported organization to make an expenditure or refrain from making one.

Employer Disaster Relief Funds are not Donor-Advised

The IRS provided only part of the relief that the Council requested under the PPA. The Council’s letter to Treasury asked whether employer-connected disaster relief and emergency hardship funds would be treated as donor-advised. The IRS did not provide guidance on this issue. However, the IRS did exercise its authority under the PPA to declare that if such funds are donor advised funds that provide assistance only in the case of "qualified disasters," they can qualify for exemption from the prohibition on payments to individuals.

To be eligible for exemption funds must:

• Have as their sole purpose providing relief in the case of a qualified disaster. A disaster is qualified if it: 1) results from terroristic or military action; 2) is the result of an accident involving a common carrier; or 3) has been declared by the President or the Secretary of the Treasury to be a disaster.
• Serve a charitable class
• Select recipients based on objective determinations of need
• Use either an independent selection committee or one that is independent (a majority of its members are not in a position to exercise substantial influence over the affairs of the employer)
• Make no payment to anyone who is a director, officer, or trustee of the sponsoring organization or to any member of the selection committee, and
• Maintain adequate records demonstrating the recipients’ need for the relief provided

The relief granted does not extend to payments for cases of individual hardship or disasters that are declared by state or local authorities. IRS officials told us that they need more information about how emergency hardship funds operate in order to make a decision about whether such funds should be exempted from the definition of donor-advised. Call one of the lawyers on COF's Legal Team if you have such a fund so that we can gather information about its operations. Foundation managers should keep in mind, though, that the IRS has not ruled that these funds are donor-advised. 

Supporting Organization Employment Contracts

Transition Relief for Supporting Organization Payments to Substantial Contributors and Related Parties

The Pension Protection Act prohibits most payments from a supporting organization to the organization’s substantial contributor and parties related to him or her. The PPA stated that this provision applied to transactions occurring after July 25, 2006, leaving open whether supporting organizations could continue to honor contracts entered into prior to that date and could continue to pay compensation to persons employed at will. The IRS addressed these problems by providing the following transition rules:

• Provided the contract is not modified in any way, payments could continue until August 17, 2007 under written contracts that were binding on August 17, 2006.
• Supporting organizations could continue other arrangements, including at will employment, through December 31, 2006. All goods and services were to be provided by that date and final payment had to be complete by August 17, 2007. As above, the arrangements could not be modified or they would lose the benefit of the transition rule.

The relief in the transition rule extended only to the automatic excess benefit penalties. Payments that exceed the fair market value of the goods and services received remain subject to penalties.

While these transition rules came too late for those foundations that have already acted to terminate contracts and employees, they allowed foundations that elected to ease transitions by making payments from other resources to obtain reimbursement from the supporting organization.

 Scholarship Relief

The IRS granted the relief the Council requested, exempting payments on educational grants awarded prior to August 17, 2006 from the PPA’s ban on distributions to individuals from donor advised funds. Scholarships are eligible for the special treatment if:

• The award was made on an objective and nondiscriminatory basis and is reasonable in amount in light of the purposes of the scholarship.
• The recipient is not the fund’s donor, donor advisor or someone related to them.
• On or before August 17, 2006 the sponsoring charity had records, or copies of correspondence with the recipient, showing:
  • The name of the recipient
  • The nature of the grant (e.g., scholarship)
  • The amount
  • The date on which the grant was awarded
  • The grant period

Records were to be kept for at least three years following the close of the taxable year in which the last payment was made. There could be no material change in the amount or conditions of the award or it would have become ineligible for the exemption. The notice states that a material change includes "a required reapplication for the grant." We do not believe that the process of checking that a student continues to meet the eligibility requirements for a scholarship would have been a "required reapplication." Provided the scholarship met the requirements outlined above, there was no deadline by which payments had to be complete.

The guidance in IRS Notice 2006-109 was released December 6, 2006.