1. INTRODUCTION

   Section 501(c)(3) organizations are the most frequently encountered type of tax exempt organization. Section 509 divides Section 501(c)(3) organizations into two classifications: private foundations and public charities. There are four types of organizations that are excepted from private foundation status as public charities: (i) organizations conducting certain favored types of activities; (ii) organizations receiving a substantial amount of their support from the general public or from governmental entities; (iii) organizations whose exclusion is derivative because of their close association with one or more other organizations; and (iv) organizations organized and operated exclusively to test for public safety. The Internal Revenue Code imposes significant operating restrictions upon private foundations. Therefore, it is usually preferable for an organization to qualify as a public charity if it is able to do so.

2. TAXES AND REGULATORY REQUIREMENTS IMPOSED ON PRIVATE FOUNDATIONS.
   1. Tax on Net Investment Income - Section 4940.

      A tax of 2% (1% under certain circumstances) of the net investment income of a private foundation (other than an exempt operating foundation) for the taxable year is imposed under Section 4940(a).

   2. Excise Taxes for Self-Dealing - Section 4941.

      Section 4941 imposes an excise tax on various acts of self-dealing. The general effect of Section 4941 is to discourage private persons from engaging in certain financial transactions with private foundations by imposing excise taxes on the parties to such transactions. Due to these excise taxes, it is necessary to test any financial transaction between a private foundation and a private party to determine if excise tax liability will be imposed. There is a three-step method for testing such transactions:

      1. Ascertain whether the transaction is between a private foundation and one or more disqualified persons with respect to the foundation. "Disqualified persons" include, among others, "substantial contributors" and members of their family. A substantial contributor is anyone who has contributed more than $5,000 to the foundation if, in the taxable year in which the gift is made, or in the year of any subsequent gift, such person’s aggregate gifts exceed 2% of the total contributions received by the foundation as of the close of that taxable year.
      2. Determine if the transaction involves self-dealing. Examples:
         • Sale, exchange or leasing of property
         • Loans and extensions of credit
         • Furnishing goods, services or facilities
         • Compensating or reimbursing a disqualified person
         • Transfer or use of income or assets of the foundation
         • Payments of money or other property to a government official by the foundation
      3. Determine if any exceptions apply. Examples:
         • The furnishing of goods, services or facilities on the same basis offered to the general public
         • Compensation for personal services which are reasonable and necessary to carry out the exempt purposes of the foundation
         • Transactions between the foundation and a corporation pursuant to a corporate reorganization, provided all securities of the same class are subject to same terms and such terms provide that the foundation will receive no less than fair market value
         • Correction of a previous act of self-dealing
         • A transaction which initiates disqualified person status
         • Certain indirect transactions involving an organization, estate or a trust in which the foundation owns an interest
         • Certain transactions between the foundation and a corporate disqualified person involving securities that the foundation acquired before May 27, 1969.
   3. Minimum Income Distribution Requirements - Section 4942.

      Section 4942 imposes an excise tax if minimum requirements for distribution of a private foundation’s income are not met. A private foundation’s annual required distributable amount under § 4942(d) is an amount equal to: (i) its minimum investment return; (ii) repayments of amounts previously treated as qualifying distributions; (iii) amounts received or accrued from the sale or other distribution of property previously treated as a qualifying distribution; and (iv) amounts previously set aside for charitable purposes but not necessary to be so used, reduced by the taxes imposed on the foundation for such taxable year under Subtitle A of the Code (the unrelated business income tax) and Section 4940 (the 2% tax on investment income) and increased by the amounts received from certain charitable lead trusts.

      Section 4942 is designed to force a private foundation to distribute at least 5% of the fair market value of the foundation’s non-charitable assets. It is not necessary for a foundation to change its investment policies to secure the minimum return annually. However, foundations are, in effect, forced to adopt a total return philosophy in determining the "income" available from their investment assets for distribution for charitable purposes.

   4. Prohibition on Excess Business Holdings - Section 4943.

      A private foundation is subject to excise taxes if it retains excess business holdings under Section 4943. The general rule of Section 4943 is broadly summarized in the regulations as follows:

      The combined holdings of a private foundation and all disqualified persons in any corporation conducting a business which is not substantially related to the exempt purposes of a foundation are limited to 20% of the voting stock in such corporation [and, in the case of an unincorporated business (other than a sole proprietorship) which is not substantially so related,] to 20% of the beneficial or profits interest in such business. In the case of a sole proprietorship which is not substantially so related . . . Section 4943 provides that a private foundation shall have no permitted holdings.

      A private foundation, which violates Section 4943 incurs an initial excise tax equal to 5% of the value of its "excess business holdings" followed by a tax equal to 200% of such excess if the violation is not cured within a stated period.

   5. Limitations on High-Risk Investment of Foundation Assets - Section 4944.

      An excise tax is imposed by Section 4944 on a private foundation’s investment of its assets in such a manner that jeopardizes the carrying out of its exempt purposes. An initial excise tax of 5% of the amount of the investment is imposed on the foundation, with an equal tax imposed on any foundation manager who knowingly makes such an investment. If the foundation fails to remove the investment from jeopardy within a specified time, it is liable for an additional tax of 25% of the amount of the investment. A foundation manager who refuses to remove the investment from jeopardy is liable for an additional 5% tax.

      The IRS has applied a "prudent trustee" standard to Section 4944. Guidance can be found from the case of Friedland Foundation v. U.S., 144 F. Supp. 74 (D.N.J. 1956), which involved a foundation’s investment in certain mortgages and securities of the type not usually carried in foundation portfolios. The court indicated that the test is not whether an investment is one ordinarily found in a foundation portfolio, nor whether the investment is likely to fail. Instead, the test is whether whatever loss was apt to occur would imperil the capability of the organization to carry out its charitable purposes.

   6. Limitations on Expenditure of Foundation Funds - Section 4945.

      Section 4945 imposes an excise tax upon any "taxable expenditure" defined by Section 4945(d). Taxable expenditures are amounts paid or incurred by private foundations:

      1. To carry on propaganda, or otherwise attempt to influence legislation;
      2. To influence the outcome of any specific public election or to carry on, directly or indirectly, any voter registration drive, unless certain conditions are met;
      3. As a grant to an individual for travel, study or other similar purposes, unless the grant meets certain requirements;
      4. As a grant to an organization other than a "public charity," unless the granting foundation exercises "expenditure responsibility"; or
      5. For any purpose other than one specified in Section 170(c)(2)(B), i.e., religious, charitable, scientific, literary, or educational purposes, to foster certain amateur sports competitions, or for the prevention of cruelty to children or animals.
3. ADVANTAGES OF BEING CLASSIFIED AS A PUBLIC CHARITY RATHER THAN A PRIVATE FOUNDATION.
   1. Public charities are not subject to the tax on investment income or the regulatory excise taxes described above.
   2. Public charities (other than Section 509(a)(4) organizations that test for public safety) are 50% charities for purposes of the Section 170 charitable contribution deduction. Most private foundations are 30% charities.
   3. Public charities, which file an annual Form 990, are not required to submit the same detailed information required of a private foundation on Form 990-PF.
   4. Certain small public charities need not file Form 990 or may file Form 990-EZ, whereas all private foundations must file a Form 990-PF regardless of size.
   5. Public charities are eligible to make a limited amount of lobbying expenditures, whereas private foundations may make none.
4. PUBLIC CHARITY STATUS BASED ON ACTIVITIES: SECTION 509(a)(1) ORGANIZATIONS.
   1. Churches or a convention/association of churches.
   2. Educational organizations that normally maintain a regular faculty, curriculum and body of students.
   3. Medical organizations with the principal purpose of providing medical care, education or research.
   4. University endowment funds for state colleges or universities.
   5. Governmental units.
5. PUBLICLY SUPPORTED ORGANIZATIONS - SECTION 170(b)(1)(A)(vi) ORGANIZATIONS AND SECTION 509(a)(2) ORGANIZATIONS.
   1. General Observations.

      Section 501(c)(3) organizations that receive a substantial amount of their support from the public or governmental bodies may qualify for public charity status under Section 170(b)(1)(A)(vi) or Section 509(a)(2). Section 170(b)(1)(A)(vi) is directed to organizations primarily supported by gifts, grants and contributions, while Section 509(a)(2) is directed to organizations primarily supported by revenues from the performance of exempt activities. Many publicly supported organizations find that they satisfy the requirements of both of these provisions. The regulations under Section 509 provide that, generally, an organization qualifying under both of these exemptions will be classified under Section 170(b)(1)(A)(vi).

      An organization must complete a tax year consisting of at least eight months to receive a definitive ruling under Section 170(b)(1)(A)(vi) or 509(a)(2). Organizations that do not meet the eight month requirement must request an advance ruling that covers their first five tax years. An organization that meets the eight month requirement has two options: (i) it may request a definitive ruling, in which case the organization’s public support computation will be based on the support the organization has received to date; or (ii) it may request an advance ruling, in which case the organization’s public support computation will be based on the support it receives during its first five tax years. A new organization should consider the advance ruling option if it has not received significant public support during its first tax year, but it reasonably expects to receive such support by the end of its fifth tax year.

      Within 90 days after the end of the organization’s advance ruling period, the organization must establish that it has become a publicly supported organization as classified under Section 170(b)(1)(A)(vi) or 509(a)(2) and that it continues to meet the requirements of the applicable support tests. If the organization does not meet the public support requirements during the advance ruling period, it will be classified as a private foundation for future periods. The advance ruling allows contributors to rely on the determination that the organization is not a private foundation until 90 days after the end of the advance ruling period.

   2. Section 170(b)(1)(A)(vi) Organizations.
      1. In order to qualify as a public charity under Section 170(b)(1)(A)(vi), the organization must satisfy one of the following two support tests:
         1. Pure Support Test - normally receives at least one-third of support from government, direct/indirect contributions from general public or a combination of these sources; or
         2. Facts and Circumstances Test
            1. Normally receives 10% or more of support from government, general public or combination thereof; and
            2. Maintains a continuous and bonafide program for soliciting funds or attracting support.
               • Three factors which are considered in determining whether this second requirement has been satisfied are: (i) whether the scope of the organization’s fundraising activities is reasonable; (ii) age of organization - new organizations may rely on limited sources of support until they can expand their solicitation programs; and (ii) the nature and purpose of the organization.
               • Example: Organization X is highly supported by an endowment fund established with contributions from a few individuals. Organization Y is highly supported by an endowment fund established with contributions from the government or general public. Both organizations receive 10% support from the government or general public. If X is a new organization, it may be found to be publicly supported, otherwise, probably not. Y has a favorable chance of being found to be publicly supported regardless of age.

                 Once an organization has satisfied both of the above requirements, it must demonstrate a "publicly supported nature" through the factors identified below. The higher an organization’s level of government or public support (in excess of 10%), the lower its burden to establish a publicly supported nature.

                 • Public support is derived from a representative number of persons rather than from a single family (less important if organization is new).
                 • The organization’s governing body represents the broad interests of the public, rather than the private interests of a limited number of donors.
                 • The organization provides a facility or service directly for the benefit of the general public on a continuing basis.
                 • Solicitations for dues-paying members are designed to enroll a substantial number of people in a particular area.
                 • Membership dues have been fixed at rates designed to make membership available to a broad class of people.
                 • Activities of the organization will appeal to people with broad common interests or purposes.
      2. Definition of Support. For purposes of the support tests identified above, the term "support" includes (but is not limited to): (i) gifts, grants, contributions or membership fees; (ii) net income from unrelated business activities, whether or not such activities are carried on regularly as a trade or business; (iii) gross investment income; (iv) tax revenues levied for the benefit of an organization and either paid to or expended on behalf of such organization; and (v) the value of services or facilities furnished by a governmental unit to an organization without charge, except for services or facilities generally furnished to the public without charge.

         Specifically excluded from the definition of "support" are the following: (i) any gain on the sale or disposition of a capital asset; (ii) the value of exemption from any federal, state or local tax or any similar benefit; (iii) any amount received from the exercise or performance by an organization of the purpose or function constituting the basis for its exemption; or (iv) contributions of services for which a deduction is not allowed. For purposes of the support tests of Section 170(b)(1)(A)(vi), all such amounts are to be excluded from both the numerator and denominator, with one exception. That exception applies to organizations dependent primarily on gross receipts from related activities. Such organizations will not satisfy the support tests of Section 170(b)(1)(A)(vi) if they receive: (i) almost all of their support from gross receipts from related activities; and (ii) an insignificant amount of support from governmental units and contributions made directly or indirectly by the general public. Section 509(a)(2), which is discussed below, is more properly suited for such organizations.

      3. Meaning of "Support from the General Public." In determining whether the one-third support test or the 10% of support requirement is met, contributions from any individual, trust or corporation are included only to the extent that the total contributions from any such individual, trust or corporation during the four-year period immediately preceding the current tax year does not exceed 2% of the organization’s total support for the same period. Thus, any such contribution by one individual will be included in full in the denominator of the fraction. However, the contribution will be included in the numerator only to the extent that it does not exceed 2% of the denominator. In applying the 2% limit, all contributions made by a donor and by any person in a special relationship to the donor are considered made by one person. The 2% limit does not apply to support received from governmental units or contributions from other publicly supported charities, unless the contributions represent amounts either expressly or impliedly earmarked by a donor to such governmental unit or publicly supported charity as being for, or for the benefit of, the particular organization claiming a publicly supported status under Section 170(b)(1)(A)(vi).
      4. Exclusion for Unusual Grants. In applying the 2% limit to determine whether the one-third support test or the 10% of support requirement is satisfied, the organization may exclude one or more contributions from both the numerator and denominator if the contributions are considered unusual grants. Generally, this exclusion applies to substantial contributions or bequests from disinterested parties if the contributions: (i) are attracted by the publicly supported nature of the organization; (ii) are unusual or unexpected with respect to the amount of the contribution; and (iii) would adversely affect, because of the size, the status of the organization as normally being publicly supported. In other words, the organization must otherwise meet the support test in that year without benefit of the grant or contribution. In addition to meeting the above three requirements, the grant or contribution must possess the following characteristics to be considered an unusual grant:
         1. The grant or contribution is not made by a person (or related person) who created the organization or was a substantial contributor to the organization before the grant or contribution.
         2. The grant or contribution is not made by a person (or related person) who is in a position of authority, such as a foundation manager, or who otherwise has the ability to exercise control over the organization. Similarly, the grant or contribution is not made by a person (or related person) who, because of the grant or contribution, obtains a position of authority or the ability to otherwise exercise control over the organization.
         3. The grant or contribution is in the form of cash, readily marketable securities, or assets that directly further the organization’s exempt purposes, such as a gift of a painting to an art museum.
         4. The organization has received either an advance or final ruling or determination letter classifying it as a publicly supported organization and is actively engaged in a program of activities in furtherance of its exempt purpose.
         5. No material restrictions or conditions have been imposed by the grantor or contributor upon the organization in connection with the grant or contribution.
         6. If the grant or contribution is intended for operating expenses, rather than capital items, the terms and amount of the grant or contribution are expressly limited to one year’s operating expenses.

         An organization may request a ruling as to whether the grant or contribution may be excluded. If a ruling is requested, the IRS may take into account the following factors (in addition to those previously identified):

         1. Whether the contribution was a bequest or a transfer while living. A bequest will be given more favorable consideration than a transfer while living.
         2. Whether before the receipt of the particular contribution, the organization has carried on an active program of public solicitation and exempt activities and has been able to attract a significant amount of public support.
         3. Whether, before the year of contribution, the organization met the one-third support test or the 10% of support requirement without benefit of any exclusions of unusual grants.
         4. Whether the organization may reasonably be expected to attract a significant amount of public support from the particular contribution. In this connection, continued reliance on unusual grants to fund an organization’s current operating expenses (as opposed to providing new endowment funds) may be evidence that the organization cannot reasonably be expected to attract future support from the general public.
         5. Whether the organization has a representative governing body.
   3. Section 509(a)(2) Organizations.

      An organization will qualify as a public charity under Section 509(a)(2) if it meets both the "one-third support test" and the "not more than one-third support test" described below.

      1. The One-Third Support Test. The organization must normally receive more than one third of its support from a combination of: (i) gifts, grants, contributions and membership fees; and (ii) gross receipts from admissions, sales of merchandise, performance of services or furnishing facilities in activities that do not constitute unrelated taxable businesses (UTBs). To determine whether this test has been satisfied, you must divide the total "public support" by the total "support."
         • The total "support," which is the denominator of the fraction, consists of:
         • Gifts, grants, contributions and membership fees;
         • Gross receipts from admissions, sales of merchandise, performance of service or furnishing of facilities in any activity which is not a UTB;
         • Net income from unrelated business activities, whether or not regularly carried on as a trade or business;
         • Gross investment income (as defined in Section 509(e));
         • Any tax revenues levied for the benefit of the organization and either paid to or expended on behalf of the organization; and
         • The value of services and facilities furnished without charge by governmental units, other than services and facilities generally furnished to the public without charge.

         Excluded from the definition of "support" are any capital gains from the sale or disposition of property, the value of exemption from taxation and amounts received in repayment of loans.

         • The total "public support," which is the numerator of the fraction, consists of:
           • Gifts, grants, contributions or membership fees; and
           • The gross receipts from admissions, sales of merchandise, performance of services or furnishing of facilities in an activity which is not a UTB to the extent the total receipts received from any person or government agency during the taxable year do not exceed the greater of $5,000 or 1% of the organization’s total support for the year.

           Support from both of these sources is includable in the numerator of the fraction only to the extent it comes from "permitted sources." "Disqualified persons" are not "permitted sources." A "substantial contributor" is a "disqualified person" and, thus, not a "permitted source." Section 507(d)(2) defines a "substantial contributor" as a person who contributes more than $5,000 to an organization if the amount contributed exceeds 2% of the organization’s total support during the year.

         • Example illustrating application of one-third support test.

           The following example derived from the regulations illustrates the application of the one-third support test. The gross receipts referred to in the example are receipts from activities not constituting UTB’s. Support from the general public in the example is support from other than disqualified persons and other than persons from whom the organization receives amounts in excess of the greater of $5,000 or 1% of its support in any taxable year. For the taxable year, Y, a 501(c)(3) organization, received support of $600,000 from the following sources:

           Bureau O (gross receipts for services rendered) 10,000
           Bureau P (gross receipts for services rendered) 10,000
           General public (gross receipts for services rendered) 150,000
           General public (contributions) 40,000
           Gross investment income 150,000
           Contributions from substantial contributors 240,000
           TOTAL $600,000.

           Since the $10,000 received from each bureau amounts to more than the greater of $5,000 or 1% of Y’s support for the taxable year (1% of $600,000 equals $6,000), each amount is includable in the numerator of the one-third support fraction only to the extent of $6,000. Thus, for the taxable year, Y received support from sources required to meet the one-third support test as follows:

           Bureau O 6,000
           Bureau P 6,000
           General Public (gross receipts) 150,000
           General Public (contributions) 40,000
           TOTAL $202,000

           Therefore, in computing the one-third support test, $202,000 is includable in the numerator and $600,000 is includable in the denominator. Thus, the organization passes the one-third support test.

      2. The Not More than One-Third Support Test. The organization must normally receive no more than one-third of its support from the sum of its gross investment income and the excess of the amount of UTB income over the amount of tax imposed on the UBT income by Section 511. To determine if an organization meets this test, you must divide the sum of the gross investment income and net UBT income by the total support. Gross investment income includes the income from interest, dividends, payment with respect to securities loans, rents and royalties, but not any income that is included in computing the tax on UBT imposed under Section 511.
   4. Advantages to Classification Under Section 170(b)(1)(A)(vi) Over Section 509(a)(2).
      1. A heavily endowed organization may encounter difficulty meeting the "not more than one-third support test" of Section 509(a)(2).
      2. Contributions from a single donor are disregarded in determining public support under Section 170(b)(1)(A)(vi) only to the extent they exceed 2% of the organization’s support for any taxable year. Whereas, under Section 509(a)(2), all contributions from a donor contributing the greater of $5,000 or 2% of all contributions are excluded from the calculation of the organization’s public support for all succeeding taxable periods.
      3. Since gross receipts from the performance of exempt functions are included in support for purposes of Section 509(a)(2), but are excluded from support for purposes of Section 170(b)(1)(A)(vi), there is a smaller denominator to satisfy for purposes of the support fraction under Section 170(b)(1)(a)(vi) than under Section 509(a)(2).
      4. Under Section 170(b)(1)(A)(vi), contributions from other Section 170(b)(1)(A)(vi) organizations are not subject to the 2% donor limitation in determining the percentage of public support or the $5,000 or 1% limitation on gross receipts from certain sources for purposes of determining the percentage of public support under Section 509(a)(2).
6. SUPPORTING ORGANIZATIONS - Section 509(a)(3).

   Organizations which meet the purpose requirement, the relationship requirement and the control requirement, outlined below, will be considered public charities because of their support relationships to one or more organizations described in Section 509(a)(1) or (2).

   1. Purpose Requirement.

      The organization 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 specified organizations described in Section 509(a)(1) or (2).

      1. Organizational Test
         • The purpose stated in the organization’s governing instrument may be as broad as or more specific than the language of the statute.

           Example: "to perform the publishing function" of a specified university in the charter of a university press controlled by the university.

         • Specified organizations
           • The beneficiary organization need not be designated by name if: (i) the Section 501(c)(3) organization is controlled or supervised by or in connection with one or more beneficiary organizations or is operated, supervised, or controlled by one or more beneficiary organizations; and (ii) the beneficiary organizations are designated by class or purpose in the articles of organization of the supporting organization and are either controlled or supervised by or in connection with or operated, supervised or controlled by or are closely related in purpose or function to the controlling organization.

             Example: X is an organization controlled by an institution of higher learning in the State of Allen. X will satisfy the organizational test if its articles require it to operate for the benefit of all institutions of higher learning in the State of Allen, without naming them.

           • The beneficiary organization must be designated by name if the supporting organization is "operated in connection with" the beneficiary organization, unless there has been a historic and continuing relationship between the organizations, and a substantial identity of interest has developed between the organizations as a result of such relationship.
      2. Operational Test - The supporting organization may engage only in activities that support or benefit the specified public charities. However, the extent of permissible activities is not limited to paying money over to specified beneficiary organizations. For example, a supporting organization may engage in fund-raising activities for the benefit of the organizations it supports (even conducting unrelated trade or business) or it may conduct programs that carry out the charitable purposes and functions of the beneficiary organizations.
   2. Relationship Requirement.

      The organization must be operated, supervised or controlled by, or in connection with, one or more organizations described in Section 509(a)(1) or (2).

      1. "Operated, Supervised or Controlled By" - the relationship established by these terms is essentially that of a parent and subsidiary, where the subsidiary is under the control of the parent, giving the beneficiary organization control over the policies, programs and activities of the Section 509(a)(3) organization.
      2. "Supervised or Controlled in Connection With" - this relationship is the "brother-sister" type where the persons who control the supporting organization are the same persons who manage or control the beneficiary organizations. However, this relationship does not exist if the Section 509(a)(3) organization merely makes payments to the organizations it supports even if the beneficiaries are named in the governing instrument and the payment obligation is enforceable under state law.
      3. "Operated in Connection With"- to establish the existence of this relationship, both the "responsiveness" and the "integral part" tests set forth below must be met.
         1. Responsiveness Test - An organization can satisfy this test in two ways:
            1. One or more of the people in control of the supporting organization must be selected by the beneficiary organizations, or they must themselves be people in control of the supported organizations, or the people in control of the supported organizations must "maintain a close and continuous working relationship" with the people in control of the supporting organization. The people in control of the beneficiary organizations must have a significant voice (likely to have influence) in the investment policies of the supporting organization, the timing of grants, the manner of making them, and the selection of recipients, and in otherwise directing the use of the income or assets of such supporting organization; or
            2. The supporting organization must be a charitable trust under the state law, each beneficiary organization must be specifically named in the governing instrument of the trust, and each named beneficiary organization must have the power to enforce the trust and to compel an accounting under state law.
         2. Integral Part Test - An organization can satisfy this test in two ways:
            1. The supporting organization supports the beneficiary organizations by the conduct of activities that would normally be performed by the beneficiary organizations themselves; or
            2. The supporting organization must pay substantially all (85%) of its income to or for the use of one or more of its beneficiary organizations, and the amount of support received by one or more of such supported organizations is sufficient to insure the attentiveness of such organizations to the operations of the supporting organization.

               Example: X pays over all of its net income to the Y University Law School annually. X satisfies the responsiveness test. All of X’s income is earmarked to endow a chair in the Department of International Law of the Law School. Without X’s continued support, Y would have difficulty maintaining the chair. Under the circumstances, X provides Y University with a sufficient part of its support to insure Y’s attentiveness to X’s operations even though X does not furnish a substantial part of Y’s total support.

   3. Control Requirement.

      The organization may not be controlled, directly or indirectly, by one or more disqualified persons (as defined in Section 4946), other than a foundation manager and other than one or more organizations described in Section 509(a)(1) or (2).

      1. Generally. An organization is considered controlled by disqualified persons if, by aggregating their votes or positions of authority in the organization (50% or more of the votes, or veto power), they may require the organization to perform any acts which significantly affect its operation, or may prevent it from performing any significant acts.
      2. Disqualified Persons. Disqualified persons include, among others, "substantial contributors," which, as previously indicated, are persons who contribute more than $5,000 to the organization if the amount contributed exceeds 2% of the organization’s total support during the year. The members of the family of any such person are also considered disqualified persons.
      3. Proof of Independent Control. An organization may establish to the IRS, through all pertinent facts and circumstances, that disqualified persons do not control an organization even where they nominally constitute a majority of its governing body.

         Example: In the case of a religious organization operated in connection with a church, the fact that a majority of the governing body is composed of lay persons who are disqualified persons because they are substantial contributors to the organization does not disqualify the organization under Section 509(a)(3) if a church representative has control over the policies and decisions of the organization.

This paper was submitted to and published by the NCLE for it’s seminar on June 21, 2000.