Best Supporting Actor: Refining the 509(a)(3) Type 3 Charitable Organization.(public Charity and Private Foundation Hybrid)

By Rambler, Mark | Duke Law Journal, February 2002 | Go to article overview

Best Supporting Actor: Refining the 509(a)(3) Type 3 Charitable Organization.(public Charity and Private Foundation Hybrid)


Rambler, Mark, Duke Law Journal


INTRODUCTION

Donors who contribute financially to certain charitable, educational, scientific, and religious organizations may receive tax deductions for their contributions. (1) Although the reasons the government foregoes these taxes are debated, the most widely accepted explanation is that the government is subsidizing the charitable organizations in return for the tangible and intangible societal benefits they provide. (2) Because it is imperative that society receive the benefits the government has subsidized, the analysis and improvement of Internal Revenue Service (IRS) regulations pertaining to charitable organizations is a significant endeavor.

According to the IRS, these organizations are divided into "public charities" and "private foundations." (3) The public charities defined in Internal Revenue Code [section] 509(a) include universities, churches, hospitals, museums, and ballet companies, and generally are engaged in "inherently public activities," meet one of several public support tests, or support one of the above-noted organizations. (4) These support requirements each allow for some form of supervision by the general public, thus making substantial governmental oversight unnecessary. (5) "Private foundations," defined by the Code as organizations not described in [section] 509(a), do not have to receive public support, and they receive less favored tax status than public charities. (6)

The [section] 509(a)(3) "supporting organization" is a hybrid of the public charity and the private foundation. Like private foundations and unlike public charities, supporting organizations do not need to satisfy any public support requirements. (7) For tax deduction purposes, however, supporting organizations are treated like public charities. (8) Theoretically, supporting organizations escape private foundation taxes and regulations because their close relationships with publicly supported organizations ensure public supervision. (9) Practically, this is not always the case.

A recent settlement involving Reader's Digest Association, Inc., illustrates how inadequate public supervision of supporting organizations can harm the public charities they are intended to support. Over the past two decades, seven supporting organizations endowed by the founders of Reader's Digest magazine, Lila and DeWitt Wallace, granted $900 million to public charities such as Lincoln Center, Colonial Williamsburg, and Memorial Sloan-Kettering Cancer Center. (10) On April 30, 2001, however, New York Attorney General Eliot Spitzer presided over a long-discussed settlement resulting in the dissolution of all seven supporting organizations and the transfer of the organizations' $1.7 billion endowment directly into the coffers of the public charities. (11) When Attorney General Spitzer finally announced the settlement, he said, "There was a sense that there wasn't as much independence as the beneficiary-entities wanted." (12) It appears that Attorney General Spitzer believed that Reader's Digest executives were exercising too much control over the supporting organizations' decisionmaking, and, therefore, that the supporting organizations were not properly "supporting" the public charities.

This Note discusses an element of supporting organizations that commentators and courts have not addressed at length: the inadequacy of the "significant voice" requirement for Type 3 supporting organizations. (13) As long as the Internal Revenue Code treats supporting organizations as public charities for tax deduction and tax exemption purposes, all supporting organizations--including Type 3 organizations--must be responsive (14) to the public charities they support. This Note argues that, as defined by the regulations, a "significant voice" does not guarantee enough responsiveness. The supported public charities need a more effective instrument to ensure that they receive the support that the government intends.

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