Charitable Foundation Didn't Qualify As Public Charity Under Code Sec. 509(a)(3)

Polm Family Foundation v U.S. (CA DC 5/6/2011) 107 AFTR 2d ¶2011-804

The Court of Appeals for the District of Columbia has affirmed the district court's conclusion that a charitable foundation did not qualify as a public charity under Code Sec. 509(a)(3). The foundation lost because its beneficiary organizations couldn't readily be identified and thus it failed to satisfy the Code Sec. 509(a)(3)(A) organizational test.

Background. Under Code Sec. 501(c)(3), a corporation organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary or educational purposes is exempt from federal income taxes so long as no part of its net earnings inure to the benefit of a private individual and no substantial part of its activities involves lobbying or political activities. Contributions to Code Sec. 501(c)(3) organizations are deductible from the donor's income taxes. Code Sec. 501(c)(3) organizations are either public charities or private foundations. All Code Sec. 501(c)(3) organizations are considered private foundations unless they qualify for an exception under Code Sec. 509(a). Because of congressional concern about privately financed organizations abusing their tax-exempt status, private foundations are subject to more restrictions than public charities. Public charities include churches, schools and hospitals (Code Sec. 509(a)(1)), other publicly supported organizations (Code Sec. 509(a)(2)), and organizations supporting any of the above. (Code Sec. 509(a)(3))

Under Code Sec. 509(a)(3), an organization that is not a private foundation is one which meets all three of these tests:

It is organized and, at all times thereafter, operated exclusively for the benefit of, to perform the functions of, or to carry out the purposes of one or more of the specified organizations described in Code Sec. 509(a)(1) and Code Sec. 509(a)(2). (Code Sec. 509(a)(3)(A) —the organizational test)

It is:
* operated, supervised, or controlled by one or more organizations described in Code Sec. 509(a)(1) and Code Sec. 509(a)(2) (a Type I supporting organization),

* supervised or controlled in connection with one or more such organizations (a Type II supporting organization), or

* operated in connection with one or more such organizations (a Type III supporting organization). (Code Sec. 509(a)(3)(B) —the relationship test)

It is not controlled directly or indirectly by one or more disqualified persons as defined by Code Sec. 4946, other than foundation managers and other than one or more organizations listed in Code Sec. 509(a)(1) and Code Sec. 509(a)(2). (Code Sec. 509(a)(3)(C) —the control test).

Facts. The Polm Family Foundation (Foundation) is a Maryland non-stock corporation that exists to conduct and support activities for the benefit of, to perform the functions of, and/or to carry out the purposes of other organizations “which support, promote and/or perform public health and/or Christian objectives, including but not limited to Christian evangelism, edification and stewardship.”

In 2007, Foundation applied for tax-exempt status under Code Sec. 501(c)(3), and for recognition as a public charity under Code Sec. 509(a)(3). A year of correspondence with IRS resulted in Foundation amending its articles of incorporation and bylaws and altering the composition of its board of directors. Still, IRS did not reach a final determination on the Foundation's application. Foundation then sued in the district court for a declaratory judgment that it was exempt from federal income taxes under Code Sec. 501(c)(3), and that it qualified as a public charity under Code Sec. 509(a)(3).

IRS didn't dispute Foundation's status under Code Sec. 501(c)(3), but it moved for summary judgment on its claim for recognition as a public charity. The district court granted IRS's motion. It held that Foundation's argument that it qualified as a Type II supporting organization was belied by the fact that Richard Polm, its president who was a disqualified person under Code Sec. 4946, who wasn't himself required to be associated with any publicly supported beneficiary, had power to appoint directors from an infinitely large number of charities within a broadly defined class, so that there was lack of assurance that Foundation would remain responsive to the needs and requirements of its publicly supported organizations, and public scrutiny could be limited. Thus, the district court held that Foundation failed the Code Sec. 509(a)(3)(B) relationship test.

The district court ruled that Foundation also failed the Code Sec. 501(c)(3) control test, since it was indirectly controlled by a disqualified person (Polm), who in addition to holding extensive appointment power, was also in charge along with another disqualified person of Foundation's affairs and business.

Foundation fails organizational test. The Court of Appeals for the District of Columbia affirmed the district court's conclusion, but preferred to rest its decision on Foundation's failure to satisfy the Code Sec. 509(a)(3)(A) organizational test, which it characterized as the most straightforward of the three tests.

Under Reg. §1.509(a)-4(d)(2)(i), the organizational test generally requires the articles of incorporation of a supporting foundation to designate each of the specified organizations. However, under Reg. §1.509(a)-4(d)(2)(i)(b), a Type II supporting organization need not specify by name each publicly supported organization if its articles of incorporation “require that it be operated to support or benefit one or more beneficiary organizations which are designated by class or purpose....” Before the Appellate Court, IRS argued that the exception under Reg. §1.509(a)-4(d)(2)(i)(b), applies only if the class of beneficiary organizations is “readily identifiable.” IRS pointed to examples in the regs and in Rev Rul 81-43, 1981-1 CB 350, to support its position. In these examples, the description of the class allows easy identification of the beneficiary organizations (e.g., tax-exempt public charities in a State, or tax-exempt charities located within a specific city).

The Appellate Court concluded, as other courts have, that an agency's interpretation of its reg is controlling unless the interpretation is “plainly erroneous or inconsistent” with the reg. In the statute's terms, the organizations Foundation supports must be “specified.” This strongly suggests that either Foundation must identify those organizations by name or the organizations must be identifiable from Foundation's articles of incorporation. That essentially is what IRS's reg provides, and Foundation offered nothing to counter IRS's interpretation.

Unlike the examples contained in the regs and Rev Rul 81-43, Foundation's designation of supported organizations did not make its beneficiary organizations readily identifiable. There was no geographic limit, nor a limit by type of publicly supported organization (such as churches or seminaries). In light of the broad purposes mentioned in Foundation's articles of incorporation, the Appellate Court agreed with IRS that it would be difficult, if not impossible, to determine whether Foundation will receive oversight from a readily identifiable class of publicly supported organizations.

References: For supporting organizations performing functions of related charities, see FTC 2d/FIN ¶D-7211; United States Tax Reporter ¶5074; TaxDesk ¶683,503.