Part IV. Items of General Interest

Announcement of Disciplinary Sanctions From the Office of Professional Responsibility

Announcement 2016–06

The Office of Professional Responsibility (OPR) announces recent disciplinary sanctions involving attorneys, certified public accountants, enrolled agents, enrolled actuaries, enrolled retirement plan agents, appraisers, and unenrolled/unlicensed return preparers (individuals who are not enrolled to practice and are not licensed as attorneys or certified public accountants). Licensed or enrolled practitioners are subject to the regulations governing practice before the Internal Revenue Service (IRS), which are set out in Title 31, Code of Federal Regulations, Subtitle A, Part 10, and which are released as Treasury Department Circular No. 230. The regulations prescribe the duties and restrictions relating to such practice and prescribe the disciplinary sanctions for violating the regulations. Unenrolled/unlicensed return preparers are subject to Revenue Procedure 81–38 and superseding guidance in Revenue Procedure 2014–42, which govern a preparer’s eligibility to represent taxpayers before the IRS in examinations of tax returns the preparer both prepared for the taxpayer and signed as the preparer. Additionally, unenrolled/unlicensed return preparers who voluntarily participate in the Annual Filing Season Program under Revenue Procedure 2014–42 agree to be subject to the duties and restrictions in Circular 230, including the restrictions on incompetent or disreputable conduct.

The disciplinary sanctions to be imposed for violation of the applicable standards are:

Disbarred from practice before the IRS —An individual who is disbarred is not eligible to practice before the IRS as defined at 31 C.F.R. § 10.2(a)(4) for a minimum period of five (5) years.

Suspended from practice before the IRS —An individual who is suspended is not eligible to practice before the IRS as defined at 31 C.F.R. § 10.2(a)(4) during the term of the suspension.

Censured in practice before the IRS —Censure is a public reprimand. Un

like disbarment or suspension, censure does not affect an individual’s eligibility to practice before the IRS, but OPR may subject the individual’s future practice rights to conditions designed to promote high standards of conduct.

Monetary penalty —A monetary penalty may be imposed on an individual who engages in conduct subject to sanction, or on an employer, firm, or entity if the individual was acting on its behalf and it knew, or reasonably should have known, of the individual’s conduct.

Disqualification of appraiser —An appraiser who is disqualified is barred from presenting evidence or testimony in any administrative proceeding before the Department of the Treasury or the IRS.

Ineligible for limited practice —An unenrolled/unlicensed return preparer who fails to comply with the requirements in Revenue Procedure 81–38 or to comply with Circular 230 as required by Revenue Procedure 2014–42 may be determined ineligible to engage in limited practice as a representative of any taxpayer. Under the regulations, individuals subject to Circular 230 may not assist, or accept assistance from, individuals who are suspended or disbarred with respect to matters constituting practice ( i.e ., representation) before the IRS, and they may not aid or abet suspended or disbarred individuals to practice before the IRS.

Disciplinary sanctions are described in these terms:

Disbarred by decision, Suspended by decision, Censured by decision, Mone- tary penalty imposed by decision, and Disqualified after hearing —An administrative law judge (ALJ) issued a decision imposing one of these sanctions after the ALJ either (1) granted the government’s summary judgment motion or (2) conducted an evidentiary hearing upon OPR’s complaint alleging violation of the regulations. After 30 days from the issuance of the decision, in the absence of an appeal, the ALJ’s decision becomes the final agency decision.

Disbarred by default decision, Sus- pended by default decision, Censured by default decision, Monetary penalty imposed by default decision, and Dis-

qualified by default decision —An ALJ, after finding that no answer to OPR’s complaint was filed, granted OPR’s motion for a default judgment and issued a decision imposing one of these sanctions.

Disbarment by decision on appeal, Suspended by decision on appeal, Cen- sured by decision on appeal, Monetary penalty imposed by decision on appeal, and Disqualified by decision on ap- peal —The decision of the ALJ was appealed to the agency appeal authority, acting as the delegate of the Secretary of the Treasury, and the appeal authority issued a decision imposing one of these sanctions.

Disbarred by consent, Suspended by consent, Censured by consent, Mone- tary penalty imposed by consent, and Disqualified by consent —In lieu of a disciplinary proceeding being instituted or continued, an individual offered a consent to one of these sanctions and OPR accepted the offer. Typically, an offer of consent will provide for: suspension for an indefinite term; conditions that the individual must observe during the suspension; and the individual’s opportunity, after a stated number of months, to file with OPR a petition for reinstatement affirming compliance with the terms of the consent and affirming current fitness and eligibility to practice ( i.e ., an active professional license or active enrollment status, with no intervening violations of the regulations).

Suspended indefinitely by decision in expedited proceeding, Suspended indef- initely by default decision in expedited proceeding, Suspended by consent in expedited proceeding —OPR instituted an expedited proceeding for suspension (based on certain limited grounds, including loss of a professional license for cause, and criminal convictions).

Determined ineligible for limited practice —There has been a final determination that an unenrolled/unlicensed return preparer is not eligible for limited representation of any taxpayer because the preparer violated standards of conduct or failed to comply with any of the requirements to act as a representative.

OPR has authority to disclose the grounds for disciplinary sanctions in these situations: (1) an ALJ or the Secretary’s delegate on appeal has issued a final deci

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sion; (2) the individual has settled a disciplinary case by signing OPR’s “consent to sanction” agreement admitting to one or more violations of the regulations and consenting to the disclosure of the admitted violations (for example, failure to file Federal income tax returns, lack of due dili

City & State Name

California

gence, conflict of interest, etc.); (3) OPR has issued a decision in an expedited proceeding for indefinite suspension; or (4) OPR has made a final determination (including any decision on appeal) that an unenrolled/unlicensed return preparer is ineligible to represent any taxpayer before the IRS.

Professional

Announcements of disciplinary sanctions appear in the Internal Revenue Bulletin at the earliest practicable date. The sanctions announced below are alphabetized first by state and second by the last names of the sanctioned individuals.

Designation Disciplinary Sanction Effective Date(s)

Inglewood Applewhite, Jeffery D. CPA Suspended by decision in expedited proceeding under 31 C.F.R. § 10.82(b)

Lake Elsinore Schultz, Richard E. Enrolled Agent

Schnur, Steven W., see Georgia

Florida

Suspended by default decision in expedited proceeding under 31 C.F.R. § 10.82(b)

Indefinite from November 5, 2015

Indefinite from October 21, 2015

Indefinite from November 3, 2015

Indefinite from October 6, 2015

Indefinite from November 3, 2015

Bradenton Penn, Joel CPA Suspended by default decision in expedited proceeding under 31 C.F.R. § 10.82(b)

Georgia

Peachtree Corners

Illinois

Schnur, Steven W. CPA Suspended by decision in expedited proceeding under 31 C.F.R. § 10.82(b)

Naperville McMahon, Brian CPA Suspended by default decision in expedited proceeding under 31 C.F.R. § 10.82(b)

Massachusetts

Scituate Rogers, Jr., John J. Attorney Reinstated to practice before the IRS December 14, 2015

New Jersey

Penn, Joel, see Florida

New York

Hicksville Napolitano, James CPA Reinstated to practice before the IRS December 14, 2015

North Carolina

Raleigh Howell, Robert Attorney Suspended by default decision in expedited proceeding under 31 C.F.R. § 10.82(b)

Oregon

Tualatin Phinney, William S. Attorney Suspended by decision in expedited proceeding under 31 C.F.R. § 10.82(b)

Indefinite from November 5, 2015

Indefinite from October 15, 2015

March 7, 2016 410 Bulletin No. 2016–10

City & State Name

Tennessee

Professional

Designation Disciplinary Sanction Effective Date(s)

Mount Juliet Haley, Robert W. CPA Suspended by default decision in expedited proceeding under 31 C.F.R. § 10.82(b)

Murfreesboro Riddle, Mark S. CPA Suspended by decision in expedited proceeding under 31 C.F.R. § 10.82(b)

Indefinite from November 5, 2015

Indefinite from December 15, 2015

Notice of Disposition of Declaratory Judgment Proceedings under Section 7428

Announcement 2016–11

This announcement serves notice to donors that on February 2, 2016, the United States Tax Court entered a stipulated decision that the organization listed below is recognized as an organization described in section 501(c)(3) and is exempt from taxation under section 501(a) for taxable years beginning July 1, 2001.

Academy of America, a Michigan Non-Profit Corporation

Oak Park, MI

Requirements for Type I and Type III Supporting Organizations

REG–118867–10

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

SUMMARY: This document contains proposed regulations regarding the prohibition on certain contributions to Type I and Type III supporting organizations and the requirements for Type III supporting organizations. The regulations reflect changes to the law made by the Pension Protection Act of 2006. The regulations will affect Type I and Type III supporting organizations and their supported organizations.

DATES: Written or electronic comments and requests for a public hearing must be received by May 19, 2016.

ADDRESSES: Send submissions to: CC: PA:LPD:PR (REG–118867–10), Room 5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be handdelivered Monday through Friday between the hours of 8:00 a.m. and 4 p.m. to CC:PA: LPD:PR (REG–118867–10), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue, NW, Washington, DC, 20224 or sent electronically via the Federal eRulemaking Portal at http://www.regulations. gov/ (IRS REG–118867–10).

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, Jonathan Carter at (202) 3175800 or Mike Repass at (202) 317-4086; concerning submissions of comments and requests for a public hearing, Regina Johnson at (202) 317-6901 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information contained in this notice of proposed rulemaking has been submitted to the Office of Management and Budget for review and approval in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 3507(d)). Comments on the collection of information should be sent to the Office of Management and Budget, Attn: Desk Officer for the Department of the Treasury, Office of Information and Regulatory Affairs, Washington, DC 20503, with copies to the Internal Revenue Service, Attn: IRS

Reports Clearance Officer, SE:W:CAR: MP:T:T:SP, Washington, DC 20224. Comments on the collection of information should be received by April 19, 2016.

Comments are specifically requested concerning: x Whether the proposed collection of information is necessary for the proper performance of the functions of the IRS, including whether the information will have practical utility; x The accuracy of the estimated burden associated with the proposed collection of information; x How the quality, utility, and clarity of the information to be collected may be enhanced; x How the burden of complying with the proposed collection of information may be minimized, including through forms of information technology; and x Estimates of capital or start-up costs and costs of operation, maintenance, and purchase of services to provide information.

The collection of information in these proposed regulations is in § 1.509(a)– 4(i)(4)(iv)(D) (written record of close cooperation and coordination by the governmental supported organizations) and § 1.509(a)–4(i)(6)(iii)(B) (written record of contributions received by the supported organization). Requiring the supporting organization to collect written records of its governmental supported organizations’ close cooperation and coordination with each other and written records of the contributions its supported organizations directly received in response to solicitations by the supporting organization permits the IRS to determine whether the supporting organization satisfies the requirements to be a functionally integrated or non

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functionally integrated Type III supporting organization. The record keepers are Type III supporting organizations.

Estimated number of recordkeepers: 7,872. Estimated average annual burden hours per recordkeeper: 2 hours. Estimated total annual recordkeeping burden: 15,744. Estimated frequency of collection of such information: Annual. An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a valid control number assigned by the Office of Management and Budget.

Books or records relating to a collection of information must be retained as long as their contents may become material in the administration of any internal revenue law. Generally, tax returns and return information are confidential, as required by 26 U.S.C. 6103.

Background

1. Overview

This document contains proposed amendments to the Income Tax Regulations (26 CFR part 1) regarding organizations described in section 509(a)(3) of the Internal Revenue Code (Code). An organization described in section 501(c)(3) is classified as either a private foundation or a public charity. To be classified as a public charity, an organization must be described in section 509(a)(1), (2), or (3). Organizations described in section 509(a)(3) are known as “supporting organizations.” Supporting organizations achieve their public charity status by providing support to one or more organizations described in section 509(a)(1) or (2), which in this context are referred to as “supported organizations.”

To be described in section 509(a)(3), an organization must satisfy (1) an organizational test, (2) an operational test, (3) a relationship test, and (4) a disqualified person control test. The organizational and operational tests require that a supporting organization be 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 supported organizations. The rela

tionship test requires a supporting organization to establish one of three types of relationships with one or more supported organizations. A supporting organization that is operated, supervised or controlled by one or more supported organizations is known as a “Type I” supporting organization. The relationship of a Type I supporting organization with its supported organization(s) is comparable to that of a corporate parent-subsidiary relationship. A supporting organization that is supervised or controlled in connection with one or more supported organizations is known as a “Type II” supporting organization. The relationship of a Type II supporting organization with its supported organization(s) involves common supervision or control by the persons supervising or controlling both the supporting organization and the supported organization(s). A supporting organization that is operated in connection with one or more supported organizations is known as a “Type III” supporting organization and is discussed further in the remainder of this preamble. Finally, the disqualified person control test requires that a supporting organization not be controlled directly or indirectly by certain disqualified persons.

These proposed regulations focus primarily on the relationship test for Type III supporting organizations. Specifically, the proposed regulations reflect statutory changes enacted by sections 1241 through 1243 of the Pension Protection Act of 2006, Public Law 109–280 (120 Stat. 780) (2006) (PPA)), which made the following five changes to the requirements an organization must satisfy to qualify as a Type III supporting organization:

(1) Removed the ability of a charitable trust to rely on the special rule under § 1.509(a)–4(i)(2)(iii) of the regulations then in effect;

(2) Directed the Secretary of the Treasury to promulgate regulations under section 509 that establish a new distribution requirement for Type III supporting organizations that are not “functionally integrated” (a non-functionally integrated (NFI) Type III supporting organization) to ensure that a “significant amount” is paid to supported organizations (for this purpose the term “functionally integrated” means a Type III supporting organization that is not required under Treasury regu

lations to make payments to supported organizations, because the supporting organization engages in activities that relate to performing the functions of, or carrying out the purposes of, its supported organization(s));

(3) Required a Type III supporting organization to provide annually to each of its supported organizations the information required by the Treasury Department and the IRS to ensure that the supporting organization is responsive to the needs or demands of its supported organization(s);

(4) Prohibited a Type III supporting organization from supporting any supported organization not organized in the United States; and

(5) Prohibited a Type I or Type III supporting organization from accepting a gift or contribution from a person who, alone or together with certain related persons, directly or indirectly controls the governing body of a supported organization of the Type I or Type III supporting organization.

These proposed regulations set forth additional rules on the requirements for Type III supporting organizations, including additional requirements to meet the responsiveness test for all Type III supporting organizations; additional rules regarding the qualification of an organization as a functionally integrated Type III supporting organization under § 1.509(a)– 4(i)(4), including provisions for supporting organizations that support governmental entities; and additional rules regarding the required annual distributions under § 1.509(a)–4(i)(5) by a NFI Type III supporting organization. The proposed regulations also define the term “control” for purposes of section 509(f)(2), which prohibits a Type I supporting organization or a Type III supporting organization from accepting contributions from persons who control the governing body of its supported organization(s).

2. Prior Rulemaking

On August 2, 2007, the Treasury Department and the IRS published in the Federal Register (72 FR 42335) an advanced notice of proposed rulemaking (ANPRM) (REG–155929–06) in response to the PPA. The ANPRM described proposed rules to implement the

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changes made by the PPA to the Type III supporting organization requirements and solicited comments regarding those proposed rules.

On September 24, 2009, the Treasury Department and the IRS published in the Federal Register (74 FR 48672) a notice of proposed rulemaking (the 2009 NPRM) (REG–155929–06). The 2009 NPRM contained proposed regulations (the 2009 proposed regulations) setting forth the requirements to qualify as a Type III supporting organization under the PPA.

On December 28, 2012, the Treasury Department and the IRS published in the Federal Register (77 FR 76382) a Treasury decision (TD 9605) containing final and temporary regulations (the 2012 TD) regarding the requirements to qualify as a Type III supporting organization. Based on the comments received, the 2012 TD made certain changes to the rules proposed in the 2009 NPRM, included in the temporary regulations significant changes to the distribution requirement, and reserved certain topics for further consideration. Also on December 28, 2012, the Treasury Department and the IRS published in the Federal Register (77 FR 76426) a notice of proposed rulemaking (the 2012 NPRM) (REG–155929–06) that incorporated the text of the temporary regulations in the 2012 TD by crossreference. The 2012 TD provided transition relief for Type III supporting organizations in existence on December 28, 2012, that met and continued to meet the test under former § 1.509(a)–4(i)(3)(ii), as in effect prior to December 28, 2012, treating them as functionally integrated until the first day of their second taxable years beginning after December 28, 2012. The preamble to the 2012 TD also identified issues for possible future rulemaking and requested comments. The IRS received three comments on these issues. The comments were considered in developing these proposed regulations and are available for public inspection at www.regulations.gov or upon request. No public hearing was requested.

The Treasury Department and the IRS published Notice 2014–4, 2014–2 I.R.B. 274, to provide additional transition relief for any Type III supporting organization that (1) supports at least one governmental supported organization to which the sup

porting organization is responsive within the meaning of § 1.509(a)–4(i)(3) and (2) engages in activities for or on behalf of the governmental supported organization that perform the functions of, or carry out the purposes of, the governmental supported organization and that, but for the involvement of the supporting organization, would normally be engaged in by the governmental supported organization itself. Notice 2014–4 provides that such an organization will be treated as a functionally integrated Type III supporting organization until the earlier of the date final regulations are published under § 1.509(a)–4(i)(4)(iv) in the Federal Register or the first day of the organization’s third taxable year beginning after December 31, 2013.

On December 23, 2015, the Treasury Department and the IRS published in the Federal Register (80 FR 79684) a Treasury Decision (TD 9746) containing final regulations (the 2015 TD) regarding the distribution requirement for NFI Type III supporting organizations. The preamble of those regulations provided that supporting organizations supporting a governmental supported organization could continue to rely on Notice 2014–4 until the date of publication of the notice of proposed rulemaking prescribing the new proposed regulations under § 1.509(a)– 4(i)(4)(iv). The IRS received three comments in response to Notice 2014–4, which the Treasury Department and the IRS considered in developing these proposed regulations.

Explanation of Provisions and Summary of Comments

This section describes the proposed provisions and addresses comments that the Treasury Department and the IRS received in response to the 2012 TD and Notice 2014–4.

1. Gifts from Controlling Donor – Meaning of Control

Type I and Type III supporting organizations are prohibited from accepting a gift or contribution from a person who, alone or together with certain related persons, directly or indirectly controls the governing body of a supported organization of the Type I or Type III supporting

organization, or from persons related to a person possessing such control. Section 509(f)(2) and § 1.509(a)–4(f)(5). For this purpose, related persons include family members and 35-percent controlled entities within the meaning of section 4958(f). Although the 2012 TD reserved § 1.509(a)–4(f)(5)(ii), “Meaning of control,” the preamble to the 2012 TD indicated that the Treasury Department and the IRS intended to issue proposed regulations that would provide such a definition.

These proposed regulations define “control” for this purpose consistently with § 1.509(a)–4(j), which relates to control by disqualified persons for purposes of the disqualified person control test. In general, under the proposed regulations, the governing body of a supported organization is considered “controlled” by a person if that person, alone or by aggregating his or her votes or positions of authority with certain related persons, as described in section 509(f)(2)(B)(ii) and (iii), may require the governing body of the supported organization to perform any act that significantly affects its operations or may prevent the governing body of the supported organization from performing any such act.

2. Type III Supporting Organization Relationship Test

Section 1.509(a)–4(i)(1) provides that for each taxable year, a Type III supporting organization must satisfy (i) a notification requirement, (ii) a responsiveness test, and (iii) an integral part test provided in the regulations. These proposed regulations provide additional rules regarding each of these requirements.

A. Notification Requirement

Section 509(f)(1)(A) provides that an organization shall not be considered a Type III supporting organization unless the organization provides to each supported organization, for each taxable year, such information as the Secretary may require to ensure that the organization is responsive to the needs or demands of the supported organizations.

To satisfy this notification requirement, § 1.509(a)–4(i)(2) requires a Type III sup

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porting organization to provide to each of its supported organizations for each taxable year: (1) A written notice addressed to a principal officer of the supported organization describing the type and amount of all of the support it provided to the supported organization during the supporting organization’s preceding taxable year; (2) a copy of the supporting organization’s most recently filed Form 990, “Return of Organization Exempt from Income Tax,” or other annual information return required to be filed under section 6033; and (3) a copy of the supporting organization’s governing documents, including any amendments (unless previously provided and not subsequently amended). For NFI Type III supporting organizations, the description of support in the written notice includes all of the distributions described in § 1.509(a)– 4(i)(6) to the supported organization. The proposed regulations amend § 1.509(a)–4(i)(2) to clarify that a supporting organization must deliver the required documents to each of its supported organizations by the last day of the fifth month of the taxable year after the taxable year in which the supporting organization provided the support it is reporting. This proposed change is intended to reduce confusion, but does not substantively change the due date or the content of the required notification. Date of delivery is determined applying the general principles of section 7502.

B. Responsiveness Test

Section 1.509(a)–4(i)(3)(i) provides that a supporting organization meets the responsiveness test if it is “responsive to the needs or demands of a supported organization.” To meet this responsiveness test, an organization must satisfy: (1) A relationship test described in § 1.509(a)– 4(i)(3)(ii) under which the officers, directors, or trustees of the organization have a specified relationship with the officers, directors, or trustees (and in some cases the members) of the supported organization; and (2) a significant voice test described in § 1.509(a)–4(i)(3)(iii) under which the officers, directors, or trustees of the supported organization, by reason of this relationship, have a significant voice in the investment policies of the supporting or

ganization, the timing of grants, the manner of making grants, and the selection of grant recipients by the supporting organization, and in otherwise directing the use of the income or assets of the supporting organization. The preamble to the 2012 TD stated that, in determining the appropriate distribution amount for NFI Type III supporting organizations, the Treasury Department and the IRS considered the required relationship between a supporting organization and its supported organizations, and that the Treasury Department and the IRS intended to issue proposed regulations in the future that would amend the responsiveness test by requiring a Type III supporting organization to be responsive to all of its supported organizations.

In response to this proposal in the preamble to the 2012 TD, one commenter stated that a supporting organization should not be required to be responsive to all of its supported organizations because the resulting administrative burden would effectively limit the total number of organizations a supporting organization could support. The commenter suggested alternatives under which a supporting organization would be responsive to only a subset of its supported organizations that would vary from year to year.

The Treasury Department and the IRS note that the distinguishing characteristic of Type III supporting organizations, and the basis for their public charity classification, is that they are responsive to and significantly involved in the operations of their publicly supported organizations. See § 1.509(a)–4(f)(4). The Treasury Department and the IRS believe that, unless a Type III supporting organization is responsive to each of its supported organizations, the supported organizations cannot exercise the requisite level of oversight of and engagement with the supporting organization. Limiting the responsiveness requirement to fewer than all of the supported organizations may result in the necessary oversight and accountability being present for less than all of a supporting organization’s operations. Therefore, the proposed regulations revise § 1.509(a)–4(i)(3)(i) to require a supporting organization to be responsive to the needs and demands of each of its sup

ported organizations in order to meet the responsiveness test.

To illustrate how concerns about potential administrative burdens may be addressed consistent with the responsiveness test, the proposed regulations include a new example. The proposed example is intended to demonstrate one way in which a Type III supporting organization that supports multiple organizations may satisfy the responsiveness test in a manner that can be cost-effective. The example shows that a supporting organization can, with respect to each of its supported organizations, meet a different subset of the required relationships with the supporting organization’s officers, directors, or trustees listed in § 1.509(a)–4(i)(3)(ii). It also shows how a supporting organization can organize and hold regular meetings, provide information, and encourage communication to help ensure that the supported organizations have a significant voice in the operations of the supporting organization.

Another commenter requested additional guidance regarding the ability of trusts to satisfy the significant voice requirement of the responsiveness test. The new Example 3 provides further illustration of how Type III supporting organizations, including charitable trusts, might satisfy the significant voice requirement of the responsiveness test. The Treasury Department and the IRS note that although the examples in the regulations relating to the responsiveness test may involve a Type III supporting organization that is organized as either a corporation or a trust, the applicable law and relevant regulatory provisions, as modified by the proposed regulations, are applicable to all Type III supporting organizations in the same manner, whether organized as a corporation or a trust. The Treasury Department and the IRS anticipate that Type III supporting organizations may be able to demonstrate they satisfy the responsiveness test in a variety of ways, and that the determination will be based on all the facts and circumstances.

As a result of the proposed changes to the responsiveness test, the proposed regulations also include conforming changes to examples and other regulatory provisions.

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C. Integral Part Test – Functionally Integrated Type III Supporting Organizations

Section 1.509(a)–4(i)(1) provides that, for each taxable year, a Type III supporting organization must satisfy the integral part test. The integral part test is satisfied under § 1.509(a)–4(i)(1)(iii) by maintaining significant involvement in the operations of one or more supported organizations and providing support on which the supported organizations are dependent. To satisfy this test, a Type III supporting organization must meet the requirements either for a functionally integrated Type III supporting organization or for an NFI Type III supporting organization, as set forth in § 1.509(a)–4(i)(4) or (5), respectively.

A Type III organization is functionally integrated under § 1.509(a)–4(i)(4) if (1) it engages in activities substantially all of which directly further the exempt purposes of one or more supported organizations and otherwise meets the requirements described in paragraph (i)(4)(ii) of that section, (2) it is the parent of each of its supported organizations as described in paragraph (i)(4)(iii) of that section, or (3) it supports a governmental supported organization and otherwise meets the requirements of paragraph (i)(4)(iv) of that section. The direct furtherance test is not addressed by these regulations.

i. Parent of Each Supported Organization

Under the current regulations, a supporting organization is the parent of a supported organization if the supporting organization exercises a substantial degree of direction over the policies, programs, and activities of the supported organization and a majority of the officers, directors, or trustees of the supported organization is appointed or elected, directly or indirectly, by the governing body, members of the governing body, or officers (acting in their official capacities) of the supporting organization. See § 1.509(a)–4(i)(4)(iii). This definition was adopted by the 2012 TD; however, the preamble to the 2012 TD stated that the Treasury Department and the IRS had determined that the definition of parent was

insufficiently specific. It further stated that the Treasury Department and the IRS intended to issue proposed regulations that would provide a new definition of parent.

As noted in the preamble to the 2009 NPRM, the classification of a parent organization as functionally integrated was intended to “apply to supporting organizations that oversee or facilitate the operation of an integrated system, such as hospital systems.” To more fully accomplish this purpose, the proposed regulations amend § 1.509(a)–4(i)(4)(iii) to clarify that in order for a supporting organization to qualify as the parent of each of its supported organizations, the supporting organization and its supported organizations must be part of an integrated system (such as a hospital system), and the supporting organization must engage in activities typical of the parent of an integrated system. Examples of these activities include (but are not limited to) coordinating the activities of the supported organizations and engaging in overall planning, policy development, budgeting, and resource allocation for the supported organizations. The Treasury Department and the IRS request comments on what activities are typical of the parent of an integrated system, and whether additional activities should be explicitly listed as examples.

The proposed regulations retain the requirement that the governing body, members of the governing body, or officers of the supporting organization must appoint or elect a majority of the officers, directors, or trustees of the supported organization. The Treasury Department and the IRS intend, as stated in the 2009 NPRM, the use of the phrase “appointed or elected, directly or indirectly” to mean the supporting organization could qualify as a parent of a second-tier (or lower) subsidiary. Thus, for example, if the directors of supporting organization A appoint a majority of the directors of supported organization B, which in turn appoints a majority of the directors of supported organization C, the directors of supporting organization A will be treated as appointing the majority of the directors of both supported organization B and supported organization C.

The preamble to the 2012 TD stated that the Treasury Department and the IRS

intended that the new definition of parent would specifically address the power to remove and replace officers, directors, or trustees of the supported organization. The Treasury Department and the IRS interpret the existing requirement under § 1.509(a)–4(i)(4)(iii) that the parent organization have the power to appoint or elect a majority of the officers, directors, or trustees of each supported organization to include the requirement that the parent organization also have the power to remove and replace such officers, directors, or trustees, or otherwise have an ongoing power to appoint or elect with reasonable frequency. The Treasury Department and the IRS request comments on whether § 1.509(a)–4(i)(4)(iii) should be amended to provide further clarification on this issue.

ii. Supporting a Governmental Supported Organization

The 2009 NPRM proposed an exception to the general rules for qualifying as a functionally integrated Type III supporting organization if the supporting organization supported only one governmental entity, which was defined as an entity the assets of which are subject to the appropriations process of a federal, state, local, or Indian tribal government. The 2009 NPRM also provided that in order to be considered functionally integrated, a substantial part of the supporting organization’s total activities had to directly further the exempt purpose(s) of its supported organization, and that exempt purposes are not directly furthered by fundraising, grantmaking, or investing and managing non-exempt-use assets. The Treasury Department and IRS received multiple comments regarding this proposal. The 2012 TD stated the Treasury Department and the IRS were continuing to consider the public comments on the 2009 NPRM regarding this governmental entity exception and reserved § 1.509(a)– 4(i)(4)(iv) for future guidance on how a Type III supporting organization can qualify as functionally integrated by supporting a governmental entity.

These proposed regulations take the prior comments into consideration and provide rules to qualify as functionally integrated both for new and existing Type

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III supporting organizations that support governmental supported organizations. These proposed rules also define the term “governmental supported organization.”

One commenter stated that the definition of a governmental supported organization in the 2009 NPRM was too complicated and difficult to understand and administer. This commenter proposed using the existing definition of a governmental unit in section 170(b)(1)(A)(v) and (c)(1).

The Treasury Department and the IRS agree with the commenter that for simplicity and administrability the term “governmental supported organization” should be defined by using an existing Code definition of a governmental unit. The proposed regulations define a governmental supported organization as a governmental unit described in section 170(c)(1), or an organization described in section 170(c)(2) and (b)(1)(A) (other than in clauses (vii) and (viii)) that is an instrumentality of one or more governmental units described in section 170(c)(1). The Treasury Department and the IRS further note that a governmental unit described in section 170(c)(1) includes all of the agencies, departments, and divisions of the governmental unit, and all such agencies, departments, and divisions will be treated as one governmental supported organization for purposes of § 1.509(a)– 4(i)(4)(iv). The Treasury Department and the IRS specifically request comments on the proposed definition of governmental supported organization.

Two commenters said that the 2009 NPRM’s limit of only one governmental supported organization was too strict and instead recommended allowing a supporting organization to qualify for this exception if it supports at least one governmental supported organization, as Notice 2014–4 provides. One commenter noted that the 2009 NPRM’s limit of only one governmental supported organization would adversely affect existing supporting organizations that support an additional supported organization that is not itself a governmental entity, but that has a substantial operational connection with the governmental supported organization. Another commenter said that the test in Notice 2014–4 was not sufficient because it did not cover activities, such as fund

raising and grant making, that the governmental supported organization could not otherwise perform.

In response to these comments, the Treasury Department and the IRS propose a new test for Type III supporting organizations that support only governmental supported organizations to qualify as functionally integrated. The Treasury Department and the IRS agree it would be appropriate to treat a Type III supporting organization that supports two or more governmental supported organizations as functionally integrated, provided that the governmental supported organizations are themselves connected geographically or operationally, which will help ensure that the supported organizations provide sufficient input to and oversight of the supporting organization. Thus, the proposed regulations provide that a supporting organization that supports more than one governmental supported organization may be considered functionally integrated if all of its governmental supported organizations either: (1) Operate within the same geographic region (defined as a city, county, or metropolitan area); or (2) work in close coordination or collaboration with one another to conduct a service, program, or activity that the supporting organization supports. To satisfy the close cooperation or coordination requirement, the proposed regulations require a supporting organization to maintain on file a letter from each of the governmental supported organizations (or a joint letter from all of them) describing their collaborative or cooperative efforts with respect to the particular service, program, or activity. In addition, the proposed regulations incorporate the 2009 NPRM proposed requirement that a substantial part of the supporting organization’s total activities must directly further the exempt purposes of its governmental supported organization(s). The Treasury Department and the IRS believe that using a substantial part requirement, instead of the substantially all requirement in § 1.509(a)–4(i)(4)(iv)(A), is appropriate when supporting organizations support only governmental supported organizations operating in the same geographic region or working in close collaboration because the input from and oversight by the governmental supported

organizations minimize the potential for abuse.

Two commenters stated that activities such as fundraising, grant-making, and managing non-exempt-use assets should be considered activities that directly further the exempt purposes of a governmental supported organization. The Treasury Department and the IRS note that the integral part test’s definition of “directly further” in § 1.509(a)–4(i)(4)(ii)(C) generally excludes fundraising, making grants, and investing and managing nonexempt-use assets. The Treasury Department and the IRS excluded these items because they determined that a Type III supporting organization should qualify as functionally integrated only if the supporting organization itself conducts activities that perform the functions of or carry out the purposes of the supported organization (as distinguished from providing financial support for the activities carried out by the supported organization). The Treasury Department and the IRS do not believe a different definition of “directly further” should apply to supporting organizations that support governmental supported organizations. Accordingly, the proposed regulations do not adopt this comment. However, under the proposed rules, these types of organizations would be considered functionally integrated if a substantial part, but not substantially all, of their total activities directly further the exempt purposes of their governmental supported organization(s). Accordingly, these proposed regulations allow these organizations to conduct more fundraising and other financial activities, if certain requirements are met, than is permitted under the substantially all test of § 1.509(a)– 4(i)(4)(ii). In response to comments, the proposed regulations also provide a special rule for existing Type III supporting organizations, provided that they support no more than one additional supported organization that is not a governmental supported organization. A Type III supporting organization in existence on or before February 19, 2016 is treated as functionally integrated if: (1) It supports one or more governmental supported organizations and no more than one supported organization that is not a governmental supported organization; (2) it designated each

March 7, 2016 416 Bulletin No. 2016–10

of its supported organizations as provided in § 1.509(a)–4(d)(4) on or before February 19, 2016; and (3) a substantial part of its total activities directly furthers the exempt purposes of its governmental supported organization(s).

The proposed regulations also further extend the transition relief provided in Notice 2014–4 and extended by the 2015 TD. Under the proposed regulations, a Type III supporting organization in existence on or before February 19, 2016 that continues to meet the requirements of Notice 2014–4 is treated as functionally integrated until the earlier of the first day of the organization’s first taxable year beginning after the date final regulations under § 1.509(a)–4(i)(4)(iv) are published or the first day of the organization’s second taxable year beginning after February 19, 2016.

D. Integral Part Test – Non- Functionally Integrated Type III Support- ing Organizations

Section 1.509(a)–4(i)(5) generally provides that an NFI Type III supporting organization meets the integral part test if it satisfies the distribution requirement of paragraph (i)(5)(ii) of that section and the attentiveness requirement of paragraph (i)(5)(iii) of that section. Section 1.509(a)–4(i)(5)(ii) provides that, with respect to each taxable year, a supporting organization must distribute to or for the use of one or more supported organizations an amount equaling or exceeding its “distributable amount”. Section 1.509(a)– 4(i)(6) provides the amount of a distribution made to a supported organization is the amount of cash or the fair market value of the property distributed.

For clarity and consistency, the proposed regulations revise § 1.509(a)– 4(i)(5)(ii) to state that a supporting organization must make distributions as described in § 1.509(a)–4(i)(6) to satisfy the distribution requirement, and revise section 1.509(a)–4(i)(6) to describe in detail what distributions count towards the distribution requirement.

i. Reduction of Distributable Amount for Taxes Subtitle A Imposes

Section 1.509(a)–4(i)(5)(ii)(B) provides that the distributable amount is equal to the greater of 85 percent of an

organization’s adjusted net income for the immediately preceding taxable year (as determined by applying the principles of section 4942(f) and § 53.4942(a)–2(d)) or its minimum asset amount for the immediately preceding taxable year, reduced by the amount of taxes imposed on the supporting organization under subtitle A of the Code during the immediately preceding taxable year. See § 1.509(a)– 4(i)(5)(ii)(B). The Treasury Department and the IRS believe that, because the taxes under subtitle A of the Code are imposed on a supporting organization’s unrelated business taxable income (pursuant to section 511) and the activity that produces the unrelated business taxable income does not further the supported organization’s exempt purposes, these taxes should not be treated as an amount distributed to a supported organization. Therefore, the proposed regulations remove the provision in § 1.509(a)–4(i)(5)(ii)(B) that reduces the distributable amount by the amount of taxes subtitle A of the Code imposed on a supporting organization during the immediately preceding taxable year.

ii. Distributions that Count toward Distribution Requirement

As noted above, § 1.509(a)–4(i)(6) provides details on the distributions by a supporting organization that count toward satisfying the distribution requirement imposed in § 1.509(a)–4(i)(5)(ii). The current regulations provide that distributions include but are not limited to: (1) Any amount paid to a supported organization to accomplish the supported organization’s exempt purposes; (2) any amount paid by the supporting organization to perform an activity that directly furthers the exempt purposes of the supported organization within the meaning of § 1.509(a)–4(i)(4)(ii), but only to the extent such amount exceeds any income derived by the supporting organization from the activity; (3) any reasonable and necessary administrative expenses paid to accomplish the exempt purposes of the supported organization(s), which do not include expenses incurred in the production of investment income; (4) any amount paid to acquire an exempt-use as

set described in § 1.509(a)–4(i)(8)(ii); and (5) any amount set aside for a specific project that accomplishes the exempt purposes of a supported organization to which the supporting organization is responsive.

The preamble to the 2012 TD stated that the list in § 1.509(a)–4(i)(6) is not exhaustive and other distributions may count toward the distribution requirement. The preamble further stated the Treasury Department and the IRS intended to propose regulations that more fully describe the expenditures (including expenditures for administrative and additional charitable activities) that do and do not count toward the distribution requirement.

The Treasury Department and the IRS believe that the non-exclusive list in the current regulations creates uncertainty for supporting organizations and the IRS about what counts toward the distribution requirement. Therefore, the proposed regulations revise and clarify the list in § 1.509(a)–4(i)(6) of what counts toward the distribution requirement and make it an exclusive list.

The 2012 TD clarified that reasonable and necessary administrative expenses paid to accomplish the exempt purposes of supported organizations, and not expenses incurred in the production of investment income, count toward the distribution requirement. For example, if a supporting organization conducts exempt activities that are for the benefit of, perform the functions of, or carry out the purposes of its supported organization(s) and also conducts nonexempt activities (such as investment activities or unrelated business activities), then the supporting organization’s administrative expenses (such as salaries, rent, utilities and other overhead expenses) must be allocated between the exempt and nonexempt activities on a reasonable and consistently-applied basis. The administrative expenses attributable to the exempt activities are treated as distributions to its supported organization(s) if such expenses are reasonable and necessary. The administrative expenses and operating costs attributable to the nonexempt activities are not treated as distributions to the supported organization(s). The proposed regulations retain this provision, but also provide additional guidance on fundraising expenses.

Bulletin No. 2016–10 417 March 7, 2016

The 2012 TD did not specifically address whether fundraising expenses count toward the distribution requirement. The proposed regulations specify that reasonable and necessary administrative expenses paid to accomplish the exempt purposes of a supported organization generally do not include fundraising expenses the supporting organization incurs. However, under the proposed regulations, reasonable and necessary expenses incurred by the supporting organization to solicit contributions that a supported organization receives directly from donors count toward the distribution requirement, but only to the extent that the amount of such expenses does not exceed the amount of contributions actually received by the supported organization as a result of the solicitation activities of the supporting organization. The Treasury Department and the IRS believe this rule would provide greater consistency with the treatment of contributions that supporting organizations receive directly and then distribute to their supported organizations (net of the supporting organizations’ solicitation expenses). To ensure that a supporting organization has the information it needs to calculate the allowable expenses, the proposed regulations require the supporting organization to obtain written substantiation from the supported organization of the amount of contributions the supported organization actually received as a result of the supporting organization’s solicitations.

One commenter requested that program related investments (PRIs) count toward the distribution requirement. The preamble to the 2012 TD stated the 2012 final and temporary regulations did not specifically address whether or not PRIs may count toward the distribution requirement or are excluded in calculating a supporting organization’s distributable amount for a taxable year. The Treasury Department and the IRS recognize that private foundations may use PRIs in a variety of ways to accomplish their exempt purposes and that PRIs thus are treated as qualifying distributions under section 4942. However, because supporting organizations must be operated exclusively for the benefit of, to perform the functions of, or to carry out the purposes of their supported organizations, they dif

fer from private foundations. For purposes of meeting the integral part test, the Treasury Department and the IRS do not believe that PRIs should be treated as distributions to supported organizations. The Treasury Department and the IRS believe that other provisions relating to the distribution requirement, such as the availability of set asides and the potential for carry-forwards of excess distributions, provide significant flexibility for supporting organizations to meet the current and future needs of their supported organizations. For these reasons, the proposed regulations do not adopt this comment.

Effective Date and Reliance

These regulations are proposed to be effective on the date the Treasury decision adopting these rules as final or temporary regulations is published in the Federal Register. However, taxpayers may rely on the provisions of the proposed regulations until final or temporary regulations are issued.

Statement of Availability of IRS Documents

The IRS Notice 2014–4 cited in this preamble is published in the Internal Revenue Bulletin and is available from the Superintendent of Documents, U.S. Government Printing Office, Washington, DC 20402, or by visiting the IRS Web site at http://www.irs.gov.

Special Analyses

Certain IRS regulations, including this one, are exempt from the requirements of Executive Order 12866, as supplemented and reaffirmed by Executive Order 13563. Therefore, a regulatory impact assessment is not required. It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations. In connection with the requirements of the Regulatory Flexibility Act (5 U.S.C. chapter 6), it is hereby certified that the collection of information contained in the proposed regulations will not have a significant economic impact on a substantial number of small entities. This certification is based on the fact that the proposed regulations will not impact a substantial number of small entities.

Based on IRS Statistics of Income data for 2013, there are 1,052,495 active nonprofit charitable organizations recognized by the IRS under section 501(c)(3), of which only 7,872 organizations selfidentified as Type III supporting organizations. The universe of organizations that would be affected by the collection of information under proposed § 1.509(a)– 4(i)(4)(iii) and § 1.509(a)–4(i)(6)(iii) is a subset of all Type III supporting organizations. Thus, the number of organizations that would be affected by the collection of information under proposed § 1.509(a)–4(i)(4)(iii) and (i)(6)(iii), which is expected to be significantly less than 7,872, would not be substantial. Moreover, the time to complete the recordkeeping requirements is expected to be no more than 2 hours for each organization, which would not have a significant economic impact. Therefore, the collection of information under proposed § 1.509(a)–4(i)(4)(iii) and (i)(6)(iii) would not have a significant economic impact.

Pursuant to section 7805(f) of the Code, this regulation has been submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

Comments and Requests for a Public Hearing

Before these proposed regulations are adopted as final regulations, consideration will be given to any electronic comments or written comments (a signed original and eight (8) copies) that are submitted timely to the IRS. The Treasury Department and the IRS request comments on all aspects of the proposed rules. All comments that are submitted by the public will be available for public inspection and copying at www.regulations.gov or upon request. A public hearing may be scheduled if requested in writing by any person that timely submits written comments. If a public hearing is scheduled, notice of the date, time, and place for the public hearing will be published in the Federal Register .

Drafting Information

The principal authors of these regulations are Jonathan Carter and Mike Re

March 7, 2016 418 Bulletin No. 2016–10

pass, Office of Associate Chief Counsel (Tax-Exempt and Government Entities). However, other personnel from the Treasury Department and the IRS participated in their development.

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Proposed Amendments to the Regulations

Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read in part as follows:

Authority: 26 U.S.C. 7805 - - Par. 2. Section 1.509(a)–4 is amended by:

1. Revising paragraphs (f)(5)(ii), (i)(2)(i) introductory text, (i)(2)(i)(A), (i)(2)(iii), and (i)(3)(i);

2. Adding Example 3 to paragraph (i)(3)(iv);

3. Revising paragraphs (i)(4)(ii)(A)( 1 ), (i)(4)(ii)(B), (i)(4)(iii) and (iv), (i)(5)(ii)(A) and (B), (i)(5)(iii)(A), Exam- ple 4 of paragraph (i)(5)(iii)(D), the third sentence of paragraph (i)(6) introductory text, and paragraphs (i)(6)(iii) and (v) introductory text and (l).

The revisions and additions read as follows:

§ 1.509(a)–4 Supporting organizations.

• • • • (f) - - (5) - - (ii) Meaning of control. For purposes of paragraph (f)(5)(i) of this section, the governing body of a supported organization will be considered controlled by a person described in paragraph (f)(5)(i)(A) of this section if that person, alone or by aggregating the person’s votes or positions of authority with persons described in paragraph (f)(5)(i)(B) or (C) of this section, may require the governing body of the supported organization to perform any act that significantly affects its operations or may prevent the governing body of the supported organization from performing any such act. The governing body of a supported organization will generally be considered to be controlled directly or

indirectly by one or more persons described in paragraph (f)(5)(i)(A), (B), or (C) of this section if the voting power of such persons is 50 percent or more of the total voting power of such governing body or if one or more of such persons have the right to exercise veto power over the actions of the governing body of the supported organization. However, all pertinent facts and circumstances will be taken into consideration in determining whether one or more persons do in fact directly or indirectly control the governing body of a supported organization.

• • • • (i) - - (2) - - *(i) Annual notification. For each taxable year (the Reporting Year), a Type III supporting organization must provide the following documents to each of its supported organizations:

(A) A written notice addressed to a principal officer of the supported organization describing the type and amount of all of the support (including all of the distributions described in paragraph (i)(6) of this section if applicable) the supporting organization provided to the supported organization during the supporting organization’s taxable year immediately preceding the Reporting Year (and during any other taxable year of the supporting organization ending after December 28, 2012, for which such support information has not previously been provided);

• • • • (iii) Due date. The notification documents required by this paragraph (i)(2) shall be delivered or electronically transmitted by the last day of the fifth calendar month of the Reporting Year.
• • • • (3) * * *(i) General rule. A supporting organization meets the responsiveness test only if it is responsive to the needs or demands of each of its supported organizations. Except as provided in paragraph (i)(3)(v) of this section, in order to meet this test, a supporting organization must satisfy the requirements of paragraphs (i)(3)(ii) and (iii) of this section with respect to each of its supported organizations.
• • • • (iv) - - Example 3. Z is described in section 501(c)(3). Z’s organizational documents provide that it sup

ports ten different organizations, each of which is described in section 509(a)(1). One of the directors of S (one of the supported organizations) is a voting member of Z’s board of directors and participates in Z’s regular board meetings. Officers of Z hold regular face-to-face or telephonic meetings during the year to which officers of all the supported organizations are invited. Z’s meetings with the supported organizations may be held jointly or separately. Prior to the meetings, Z makes available to the supported organizations (including by email) up-to-date information about its activities including its assets and liabilities, receipts and distributions, and investment policies and returns. In the meetings, officers of each of the supported organizations have an opportunity to ask questions and discuss with officers of Z the projected needs of their organizations, as well as Z’s investment and grant making policies and practices. In addition to holding these meetings with the supported organizations, Z provides the contact information of one of its officers to each of the supported organizations and encourages them to contact that officer if they have questions, or if they wish to schedule additional meetings to discuss the projected needs of their organization and how Z should distribute its income and invest its assets. Z provides the information required under paragraph (i)(2) of this section and a copy of its annual audited financial statements to the principal officers of the supported organizations. Z meets the relationship test of paragraph (i)(3)(ii)(B) or (C) of this section with respect to each of its supported organizations. Based on these facts, Z also satisfies the significant voice requirement of paragraph (i)(3)(iii) of this section, and therefore meets the responsiveness test of this paragraph (i)(3) with respect to each of its ten supported organizations.

• • • • (4) - - (ii) - - (A) - - ( 1 ) Directly further the exempt purposes of one or more supported organizations by performing the functions of, or carrying out the purposes of, such supported organization(s); and
• • • • (B) Meaning of substantially all. For purposes of paragraph (i)(4)(ii)(A) of this section, in determining whether substantially all of a supporting organization’s activities directly further the exempt purposes of one or more supported organization(s), all pertinent facts and circumstances will be taken into consideration.
• • • • (iii) Parent of supported organiza- tion(s). For purposes of paragraph (i)(4)(i)(B) of this section, in order for a supporting organization to qualify as the parent of each of its supported organizations, the supporting organization and its supported organizations must be part of an

Bulletin No. 2016–10 419 March 7, 2016

integrated system (such as a hospital system), the supporting organization must engage in activities typical of the parent of an integrated system, and a majority of the officers, directors, or trustees of each supported organization must be appointed or elected, directly or indirectly, by the governing body, members of the governing body, or officers (acting in their official capacities) of the supporting organization. For purposes of this paragraph (i)(4)(iii), examples of activities typical of the parent of an integrated system of supported organizations include (but are not limited to) coordinating the activities of the supported organizations and engaging in overall planning, policy development, budgeting, and resource allocation for the supported organizations.

(iv) Supporting a governmental sup- ported organization —(A) In general. A supporting organization satisfies the requirements of this paragraph (i)(4)(iv) if—

( 1 ) The supporting organization supports only governmental supported organizations, and, if the supporting organization supports more than one governmental supported organization, all of the governmental supported organizations either—

( i ) Operate within the same geographic region; or

( ii ) Work in close coordination or collaboration with one another to conduct a service, program, or activity that the supporting organization supports; and

( 2 ) A substantial part of the supporting organization’s total activities are activities that directly further, as defined by paragraph (i)(4)(ii)(C) of this section, the exempt purposes of its governmental supported organization(s).

(B) Governmental supported organiza- tion defined. For purposes of paragraph (i)(4)(iv)(A) of this section, the term gov- ernmental supported organization means a supported organization that is–

( 1 ) A governmental unit described in section 170(c)(1); or

( 2 ) An organization described in section 170(c)(2) and (b)(1)(A) (other than in clauses (vii) and (viii)) that is an instrumentality of one or more governmental units described in section 170(c)(1).

(C) Geographic region defined. For purposes of paragraph (i)(4)(iv)(A)( 1 ) of this section, the term geographic region means a city, county, or metropolitan area.

(D) Close cooperation or coordination. To satisfy the close cooperation or coordination requirement of paragraph (i)(4)(iv)(A)( 1 ) of this section, the supporting organization shall maintain on file a letter from each of the governmental supported organizations (or a joint letter from all of them) describing their collaborative or cooperative efforts with respect to the particular service, program, or activity.

(E) Exception for organizations sup- porting a governmental supported organi- zation on or before February 19, 2016. A Type III supporting organization in existence on or before February 19, 2016 will be treated as meeting the requirements of this paragraph (i)(4)(iv) if it met and continues to meet the following requirements—

( 1 ) It supports one or more governmental supported organizations described in paragraph (i)(4)(iv)(B) of this section and does not support more than one supported organization that is not a governmental supported organization;

( 2 ) Each of the supported organizations is designated by the supporting organization as provided in paragraph (d)(4) of this section on or before February 19, 2016; and

( 3 ) A substantial part of the supporting organization’s total activities are activities that directly further, as defined by paragraph (i)(4)(ii)(C) of this section, the exempt purposes of its governmental supported organization(s).

(F) Transition rule for supporting or- ganizations in existence on or before Feb- ruary 19, 2016. Until the earlier of the first day of the organization’s first taxable year beginning after the date final regulations are published in the Federal Regis- ter under this paragraph (i)(4)(iv) or the first day of the organization’s second taxable year beginning after February 19, 2016, a Type III supporting organization in existence on or before February 19, 2016 will be treated as meeting the requirements of this paragraph (i)(4)(iv) if it met and continues to meet the following requirements—

( 1 ) It supports at least one supported organization that is a governmental entity to which the supporting organization is responsive within the meaning of paragraph (i)(3) of this section; and

( 2 ) It engages in activities for or on behalf of the governmental supported organization described in paragraph (i)(4)(iv)(F)( 1 ) of this section that perform the functions of, or carry out the purposes of, that governmental supported organization and that, but for the involvement of the supporting organization, would normally be engaged in by the governmental supported organization itself.

• • • • (5) - - (ii) * * *(A) Annual distribution. With respect to each taxable year, a supporting organization must make distributions described in paragraph (i)(6) of this section in a total amount equaling or exceeding the supporting organization’s distributable amount for the taxable year, as defined in paragraph (i)(5)(ii)(B) of this section, on or before the last day of the taxable year.

(B) Distributable amount. Except as provided in paragraphs (i)(5)(ii)(D) and (E) of this section, the distributable amount for a taxable year is an amount equal to the greater of 85 percent of the supporting organization’s adjusted net income (as determined by applying the principles of section 4942(f) and § 53.4942(a)–2(d) of this chapter) for the taxable year immediately preceding the taxable year of the required distribution (immediately preceding taxable year) or its minimum asset amount (as defined in paragraph (i)(5)(ii)(C) of this section) for the immediately preceding taxable year.

• • • • (iii) - - *(A) General rule. With respect to each taxable year, a nonfunctionally integrated Type III supporting organization must distribute one-third or more of its distributable amount to one or more supported organizations that are attentive to the operations of the supporting organization (within the meaning of paragraph (i)(5)(iii)(B) of this section).
• • • • (D) - - Example 4 . O is an organization described in section 501(c)(3). O is organized to support five private universities, V, W, X, Y, and Z, each of which is described in section 509(a)(1). O meets the responsiveness test described in paragraph (i)(3) of this section with respect to each of its supported organizations. Each year, O distributes an aggregate amount that equals its distributable amount described in paragraph (i)(5)(ii)(B) of this section and distributes an equal amount to each of the five universities. O distributes annually to each of V and W an amount that equals

March 7, 2016 420 Bulletin No. 2016–10

more than 10 percent of each university’s total annual support received in its most recently completed taxable year. Based on these facts, O meets the requirements of paragraph (i)(5)(iii) of this section because it distributes two-fifths (more than the required one-third) of its distributable amount to supported organizations that are attentive to O.

(6) Distributions that count toward dis- tribution requirement. - - - Distributions by the supporting organization that count toward the distribution requirement imposed in paragraph (i)(5)(ii) of this section are limited to the following—

• • • • (iii) Any reasonable and necessary— (A) Administrative expenses paid to accomplish the exempt purposes of the supported organization, which do not include expenses incurred in the production of investment income or the conduct of fundraising activities, except as provided in paragraph (i)(6)(iii)(B) of this section; and

(B) Expenses incurred to solicit contributions that are received directly by a supported organization, but only to the extent the amount of such expenses does not exceed the amount of contributions actually received by the supported organization as a result of the solicitation, as substantiated in writing by the supported organization;

• • • • (v) Any amount set aside for a specific project that accomplishes the exempt purposes of a supported organization, with such set-aside counting toward the distribution requirement for the taxable year in which the amount is set aside but not in the year in which it is actually paid, if at the time of the set-aside, the supporting organization—
• • • • (l) Effective/applicability dates. (1) Paragraphs (a)(6), (f)(5), and (i) of this section are effective on December 28, 2012, except— (i) Paragraphs (i)(4)(ii)(C), (i)(5)(ii)(C) and (D), (i)(6)(iv), (i)(7)(ii), and (i)(8) of this section are applicable on December 21, 2015; and (ii) Paragraphs (f)(5)(ii), (i)(2)(i) and (iii), (i)(3)(i), (i)(4)(ii)(A)(1), (i)(4)(ii)(B), (i)(4)(iii) and (iv), (i)(5)(ii)(A) and (B), (i)(5)(iii)(A), (i)(6)(i), (iii) and (v) of this section, Example 3 of paragraph (i)(3)(iv) of this section, and Example 4 of paragraph (i)(5)(iii)(D) of this section are effective on the date the Treasury decision

adopting these rules as final or temporary regulations is published in the Federal Register .

(2) See paragraphs (i)(5)(ii)(B) and (C) and (i)(8) of § 1.509(a)–4T contained in 26 CFR part 1, revised as of April 1, 2015, for certain rules regarding nonfunctionally integrated Type III supporting organizations effective before December 21, 2015. See paragraphs (i)(5)(ii)(A) and (B) and (i)(5)(iii)(D) of § 1.509(a)–4 (as effective December 21, 2015), for certain rules regarding non-functionally integrated Type III supporting organizations effective before the date the Treasury decision adopting these rules as final or temporary regulations is published in the Federal Register.

John Dalrymple, Deputy Commissioner for Services and Enforcement.

(Filed by the Office of the Federal Register on February 18, 2016, 8:45 a.m., and published in the issue of the Federal Register for February 19, 2016, 81 F.R. 8446)

Definition of Political Subdivision

REG–129067–15

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

SUMMARY: This document contains proposed regulations that provide guidance regarding the definition of political subdivision for purposes of tax-exempt bonds. The proposed regulations are necessary to specify the elements of a political subdivision. The proposed regulations will affect State and local governments that issue tax-exempt bonds and users of property financed with tax-exempt bonds. Under certain transition rules, however, the proposed definition of political subdivision will not apply for determining whether outstanding bonds are obligations of a political subdivision and will not apply to existing entities for a transition period. This document also provides a notice of a public hearing for these proposed regulations.

DATES: Written or electronic comments must be received by May 23, 2016. Re

quest to speak and outlines of topics to be discussed at the public hearing scheduled for June 6, 2016, at 10:00 a.m., must be received by May 23, 2016.

ADDRESSES: Send submissions to: CC: PA:LPD:PR (REG–129067–15), Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand delivered to: CC: PA:LPD:PR Monday through Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG–129067–15), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue, NW, Washington, DC, or sent electronically via the Federal eRulemaking Portal at www.regulations. gov (REG–129067–15). The public hearing will be held at the Internal Revenue Building, 1111 Constitution Avenue, NW, Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, Spence Hanemann at (202) 317-6980; concerning submissions of comments and the hearing, Oluwafunmilayo (Funmi) Taylor at (202) 317-6901 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

This document contains proposed amendments to 26 CFR part 1 under section 103 of the Internal Revenue Code (Code). Section 103 generally provides that, with certain exceptions, gross income does not include interest on any obligation of a State or political subdivision thereof. Section 1.103–1 of the Income Tax Regulations (the Existing Regulations) defines political subdivision as “any division of any State or local governmental unit which is a municipal corporation or which has been delegated the right to exercise part of the sovereign power of the unit.”

On a few occasions, Federal courts have ruled on whether an entity qualifies as a political subdivision. E.g., Philadel- phia Nat’l Bank v. United States, 666 F.2d 834 (3d Cir. 1981); Comm’r of Internal Revenue v. White’s Estate, 144 F.2d 1019 (2d Cir. 1944). The IRS has also addressed this issue in revenue rulings, most recently in 1983. E.g., Rev. Rul. 83–131 (1983–2 CB 184); Rev. Rul. 78–138

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(1978–1 CB 314). Because the results in these revenue rulings generally turn on the unique facts and circumstances of the individual cases, numerous entities have sought and received letter rulings on whether they are political subdivisions. Letter rulings, however, are limited to their particular facts, may not be relied upon by taxpayers other than the taxpayer that received the ruling, and are not a substitute for published guidance. See 26 U.S.C. 6110(k)(3) (2015) (providing generally that a ruling, determination letter, or technical advice memorandum may not be used or cited as precedent).

Commenters have requested additional published guidance, to be applied prospectively, on which facts and circumstances are germane to an entity’s status as a political subdivision. The Treasury Department and IRS recognize the need to clarify the definition of political subdivision to provide greater certainty to prospective issuers and to promote greater consistency in how the definition is applied across a wide range of factual situations. These proposed regulations (the Proposed Regulations) would provide a new definition of political subdivision for purposes of tax-exempt bonds and would update and streamline other portions of the Existing Regulations. The definition of political subdivision in the Proposed Regulations does not apply in determining whether an entity is treated as a political subdivision of a State for purposes of section 414(d) of the Code.

Explanation of Provisions

1. Definition of Political Subdivision

The Proposed Regulations clarify and further develop the eligibility requirements for a political subdivision. To qualify as a political subdivision under the Proposed Regulations, an entity must meet three requirements, taking into account all of the facts and circumstances: sovereign powers, governmental purpose, and governmental control. The Proposed Regulations also authorize the Commissioner to set forth in future guidance to be published in the Internal Revenue Bulletin additional circumstances in which an entity qualifies as a political subdivision.

A. Sovereign powers

The Proposed Regulations continue, without substantive change, the longstanding requirement that a political subdivision be empowered to exercise at least one of the generally recognized sovereign powers. The three sovereign powers recognized for this purpose are eminent domain, police power, and taxing power. See Comm’r of Internal Revenue v. Sham- berg’s Estate, 144 F.2d 998 (2d Cir. 1944). The entity must be able to exercise a substantial amount of at least one of these powers. See, e.g., Rev. Rul. 77–164 (1977–1 CB 20); Rev. Rul. 77–165 (1977–1 CB 21).

B. Governmental purpose

In determining whether an entity is a political subdivision, the case law and administrative guidance interpreting the definition of political subdivision in the Existing Regulations commonly consider whether the entity serves a public purpose. Historically, the determination of whether an entity serves a public purpose has focused on the purpose for which the entity was created, usually as set forth in the legislation authorizing creation of the entity, rather than on the entity’s conduct after its creation. See, e.g., Shamberg’s Estate, 144 F.2d at 1004. The Proposed Regulations require that a political subdivision serve a governmental purpose. A governmental purpose requires, among other things, that the purpose for which the entity was created, as set out in its enabling legislation, be a public purpose and that the entity actually serve that purpose. It also requires that the entity operate in a manner that provides a significant public benefit with no more than incidental benefit to private persons. Cf., Rev. Rul. 90–74 (1990–2 CB 34) (applying an “incidental private benefit” standard for purposes of determining whether income is included in gross income under section 115(1)).

C. Governmental control

The Proposed Regulations provide that a political subdivision must be governmentally controlled. The Proposed Regulations provide rules for determining both what constitutes control and which parties must possess that control.

i. Definition of Control

The Proposed Regulations define control to mean ongoing rights or powers to direct significant actions of the entity. Rights or powers to direct the entity’s actions only at a particular point in time are not ongoing and, therefore, do not constitute control. For example, the right to approve an entity’s plan of operation as a condition of the entity’s formation is not an ongoing right. To constitute control, a collection of rights and powers must enable its holder to direct the significant actions of the entity.

The Proposed Regulations provide three non-exclusive benchmarks of rights or powers that constitute control: (1) the right or power both to approve and to remove a majority of an entity’s governing body; (2) the right or power to elect a majority of the governing body of the entity in periodic elections of reasonable frequency; or (3) the right or power to approve or direct the significant uses of funds or assets of the entity in advance of that use. Aside from these three arrangements, the determination of whether a collection of rights and powers constitutes control will depend on the facts and circumstances. Neither the right to dissolve an entity nor procedures designed to ensure the integrity of the entity but not to direct significant actions of the entity are control. Cf., Rev. Rul. 69– 453 (1969–2 CB 182) (addressing procedures that do not constitute control in the context of instrumentalities).

ii. Control Vested in a State or Local Governmental Unit or an Electorate

Control by a small faction of private individuals, business corporations, trusts, partnerships, or other persons is fundamentally not governmental control. Therefore, the Proposed Regulations generally require that control be vested in either a general purpose State or local governmental unit or in an electorate established under an applicable State or local law of general application. If, however, a small faction of private persons controls an electorate, that electorate’s control of the entity does not constitute governmental control of the entity. Accordingly, the Proposed Regulations provide that an entity controlled by an electorate is not governmentally controlled when

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the outcome of the exercise of control is determined solely by the votes of an unreasonably small number of private persons.

The determination of whether the number of private persons controlling an electorate is unreasonably small generally depends on all of the facts and circumstances. To provide certainty, the Proposed Regulations limit application of this facts and circumstances test to situations that fall between two quantitative measures of concentration in voting power. The number of private persons controlling an electorate is always unreasonably small if the combined votes of the three voters with the largest shares of votes in the electorate will determine the outcome of the relevant election, regardless of how the other voters vote. The number of private persons controlling an electorate is never unreasonably small if determining the outcome of the relevant election requires the combined votes of more voters than the 10 voters with the largest shares of votes in the electorate. For example, control can always be vested in any electorate comprised of 20 or more voters that each have the right to cast one vote in the relevant election without giving rise to a private faction. For purposes of applying these measures of concentration in voting power, related parties are treated as a single voter and the votes of the related parties are aggregated.

iii. Possible Relief for Development Districts

Some observers have suggested that, despite private control, development districts should be political subdivisions during an initial development period in which one or two private developers elect the district’s governing body and no other governmental control exists. The Treasury Department and IRS recognize that the governmental control requirement may present challenges for such development districts. In these circumstances, the Treasury Department and IRS are concerned about the potential for excessive private control by individual developers, the attendant impact of excessive issuance of tax-exempt bonds, and inappropriate private benefits from this Federal subsidy. The Treasury Department and IRS seek public comment on whether it is necessary or appropriate to permit such districts to be political subdivisions during an initial

development period; how such relief might be structured; what specific safeguards might be included in the recommended relief to protect against potential abuse; and whether the proposed prospective effective dates and transition periods in § 1.103–1(d) of the Proposed Regulations provide sufficient relief.

2. Streamlining Amendments

In addition to amending the definition of political subdivision, paragraphs (a) and (b) of the Proposed Regulations update the references in the general provisions of the Existing Regulations to reflect changes to the Code made in the Tax Reform Act of 1986, Public Law 99–514, 100 Stat. 2085, and other laws and regulations since the promulgation of the longstanding Existing Regulations. The Proposed Regulations also streamline these provisions. In general, the Treasury Department and the IRS intend that these proposed amendments not change the meaning of the Existing Regulations. The last sentence of § 1.103–1(a) of the Proposed Regulations, however, clarifies that the continued tax-exemption of an issue of bonds depends on its issuer’s continued status as a qualifying issuer of tax-exempt bonds. The Treasury Department and IRS seek comments on the need for remedial action provisions in the event the entity ceases to qualify as a political subdivision and on the substance of any such provisions.

3. Applicability Dates and Reliance on Proposed Regulations

Subject to certain transition rules, the Proposed Regulations generally would apply to all entities for all purposes of the tax-exempt bond provisions of sections 103 and 141 to 150 beginning 90 days after the Proposed Regulations are finalized. In order to ease hardship that may arise from the new definition of political subdivision, under proposed transition rules, that definition would not apply for purposes of determining whether outstanding bonds and refunding bonds in which the weighted average maturity is not extended continue to be obligations of a political subdivision. While these transition rules for outstanding bonds and refunding bonds would apply for the purpose of determining whether these bonds

continue to be obligations of a political subdivision, the new proposed definition of political subdivision would apply for other purposes under sections 103 and 141 to 150, such as whether a new entity that subsequently became a user of a project financed with such bonds qualified as a State or local governmental unit for purposes of section 141. Furthermore, under another proposed transition rule that would apply to entities in existence prior to 30 days after the Proposed Regulations are published, the proposed definition of political subdivision would not apply for any purpose until three years and ninety days after the Proposed Regulations are finalized. This three-year transition period provides existing entities an opportunity to restructure as necessary to satisfy the new definition of political subdivision and allows existing entities to continue to issue new bonds during the transition period. To enhance certainty, an issuer also may choose to apply the definition of political subdivision in § 1.103–1(c) in the final regulations in circumstances in which that definition otherwise would not apply under the transition rules.

In addition, prior to the applicability date of the final regulations, issuers may elect to apply the definition of political subdivision in § 1.103–1(c) of the Proposed Regulations in whole, but not in part, for any purpose of sections 103 and 141 through 150, provided such use is applied consistently for all purposes of sections 103 and 141 through 150 to any given entity.

Special Analyses

Certain IRS regulations, including this one, are exempt from the requirements of Executive Order 12866, as supplemented and reaffirmed by Executive Order 13563. Therefore, a regulatory impact assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations, and because these regulations do not impose a collection of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Code, this notice of proposed rulemaking has been submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small entities.

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Comments and Public Hearing

Before these Proposed Regulations are adopted as final regulations, consideration will be given to any comments that are submitted timely to the IRS as prescribed in this preamble under the “Addresses” heading. The Treasury Department and the IRS request comments on all aspects of the proposed rules. All comments will be available at www.regulations.gov or upon request.

A public hearing has been scheduled for June 6, 2016, at 10:00 a.m., in the Auditorium of the Internal Revenue Building, 1111 Constitution Avenue, NW, Washington, DC. Due to building security procedures, visitors must enter at the Constitution Avenue entrance. In addition, all visitors must present photo identification to enter the building. Because of access restrictions, visitors will not be admitted beyond the immediate entrance area more than 30 minutes before the hearing starts. For more information about having your name placed on the building access list to attend the hearing, see the “FOR FURTHER INFORMATION CONTACT” section of this preamble.

The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who wish to present oral comments at the hearing must submit an outline of the topics to be discussed and the time to be devoted to each topic by May 23, 2016. Submit a signed paper or electronic copy of the outline as prescribed in this preamble under the “Addresses” heading. A period of 10 minutes will be allotted to each person for making comments. An agenda showing the scheduling of the speakers will be prepared after the deadline for receiving outlines has passed. Copies of the agenda will be available free of charge at the hearing.

Drafting Information

The principal authors of these regulations are Spence Hanemann and Timothy Jones, Office of Associate Chief Counsel (Financial Institutions and Products), IRS. However, other personnel from the IRS and the Treasury Department participated in their development.

Availability of IRS Documents

IRS revenue rulings cited in this notice of proposed rulemaking are made available by the Superintendent of Documents, U.S. Government Printing Office, Washington, DC 20402.

- - - -

Proposed Amendments to the Regulations

Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read in part as follows:

Authority: 26 U.S.C. 7805 - - Par. 2. Section 1.103–1 is revised to read as follows:

§ 1.103–1 Interest on State or local bonds .

(a) Interest on State or local bonds . Under section 103(a), except as otherwise provided in section 103(b), gross income does not include interest on any State or local bond. Under section 103(c), the term State or local bond means any obligation (as defined in § 1.150–1(b)) of a State (including for this purpose the District of Columbia or any possession of the United States) or a political subdivision thereof (a State or local governmental unit). Obligations issued by or on behalf of any State or local governmental unit by a constituted authority empowered to issue such obligations are the obligations of such a unit. An obligation qualifies as a State or local bond so long as the issuer of that obligation remains a State or local governmental unit or a constituted authority.

(b) Certain limitations on interest ex- clusion . Under section 103(b), the interest exclusion in section 103(a) is inapplicable to a private activity bond under section 141(a) (unless the bond is a qualified bond under section 141(e)), an arbitrage bond under section 148, or a bond which does not meet the applicable requirements of section 149.

(c) Definition of political subdivision (1) In general . The term political subdivi- sion means an entity that meets each of the requirements of paragraphs (c)(2)

(sovereign powers), (c)(3) (governmental purpose), and (c)(4) (governmental control) of this section, taking into account all of the facts and circumstances, or that is described in published guidance issued pursuant to paragraph (c)(5) of this section. Entities that may qualify as political subdivisions include, among others, general purpose governmental entities, such as cities and counties (whether or not incorporated as municipal corporations), and special purpose governmental entities, such as special assessment districts that provide for roads, water, sewer, gas, light, reclamation, drainage, irrigation, levee, school, harbor, port improvements, and other governmental purposes for a State or local governmental unit.

(2) Sovereign powers . Pursuant to a State or local law of general application, the entity has a delegated right to exercise a substantial amount of at least one of the following recognized sovereign powers of a State or local governmental unit: the power of taxation, the power of eminent domain, and police power.

(3) Governmental purpose . The entity serves a governmental purpose. The determination of whether an entity serves a governmental purpose is based on, among other things, whether the entity carries out the public purposes that are set forth in the entity’s enabling legislation and whether the entity operates in a manner that provides a significant public benefit with no more than incidental private benefit.

(4) Governmental control . A State or local governmental unit exercises control over the entity. For this purpose, control is defined in paragraph (c)(4)(i) of this section and a State or local governmental unit exercises such control only if the control is vested in persons described in paragraph (c)(4)(ii) of this section.

(i) Definition of control . Control means an ongoing right or power to direct significant actions of the entity. Rights or powers may establish control either individually or in the aggregate. Among rights or powers that may establish control, an ongoing ability to exercise one or more of the following significant rights or powers, on a discretionary and non-ministerial basis, constitutes control: the right or power both to approve and to remove a majority of the governing body of the entity; the right or power to elect a majority of the governing body of the

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entity in periodic elections of reasonable frequency; or the right or power to approve or direct the significant uses of funds or assets of the entity in advance of that use. Procedures designed to ensure the integrity of the entity but not to direct significant actions of the entity are insufficient to constitute control of an entity. Examples of such procedures include requirements for submission of audited financial statements of the entity to a higher level State or local governmental unit, open meeting requirements, and conflicts of interest limitations.

(ii) Control vested in a State or local governmental unit or an electorate . Control is vested in persons described in paragraphs (c)(4)(ii)(A) or (c)(4)(ii)(B) of this section or a combination thereof:

(A) A State or local governmental unit possessing a substantial amount of each of the sovereign powers and acting through its governing body or through its duly authorized elected or appointed officials in their official capacities; or

(B) An electorate established under applicable State or local law of general application, provided the electorate is not a private faction (as defined in paragraph (c)(4)(iii) of this section).

(iii) Definition of private faction —(A) In general . A private faction is any electorate if the outcome of the exercise of control described in paragraph (c)(4)(i) of this section is determined solely by the votes of an unreasonably small number of private persons. The determination of whether a number of such private persons is unreasonably small depends on all of the facts and circumstances, including, without limitation, the entity’s governmental purpose, the number of members in the electorate, the relationships of the members of the electorate to one another, the manner of apportionment of votes within the electorate, and the extent to which the members of the electorate adequately represent the interests of persons reasonably affected by the entity’s actions. For purposes of this definition, the special rules in paragraphs (c)(4)(iii)(B) through (D) of this section apply.

(B) Treatment of certain limited elec- torates as private factions . An electorate is a private faction if any three private persons that are members of the electorate possess, in the aggregate, a majority of the

votes necessary to determine the outcome of the relevant exercise of control.

(C) Safe harbor—voting power dis- persed among more than 10 persons . An electorate is not a private faction if the smallest number of private persons who can combine votes to establish a majority of the votes necessary to determine the outcome of the relevant exercise of control is greater than 10 persons. For example, if an electorate consists of 20 private persons with equal, five-percent shares of the total votes, that electorate is not a private faction because a minimum of 11 members of that electorate is necessary to have a majority of the votes. By contrast, for example, if an electorate consists of 20 private persons with unequal voting shares in which some combination of 10 or fewer members has a majority of the votes, then that electorate does not qualify for the safe harbor from treatment as a private faction under this paragraph (c)(4)(iii)(C).

(D) Operating rules . The following rules apply for purposes of determining numbers of voters and voting control in paragraphs (c)(4)(iii)(B) and (C) of this section: ( 1 ) Related parties (as defined in § 1.150–1(b)) are treated as a single person; and

( 2 ) In computing the number of votes necessary to determine the outcome of the relevant exercise of control, all voters entitled to vote in an election are assumed to cast all votes to which they are entitled.

(5) Authority of the Commissioner . In guidance published in the Internal Revenue Bulletin, the Commissioner may set forth additional circumstances in which an entity qualifies as a political subdivision of a State or local governmental unit. See § 601.601(d)(2)(ii) of this chapter.

(d) Applicability dates —(1) In general . Except as otherwise provided in paragraphs (d)(2) through (4) of this section, this section applies to all entities for all purposes of sections 103 and 141 through 150 beginning on the date 90 days after the publication of the Treasury decision adopting these rules as final regulations in the Federal Register.

(2) Applicability date of the definition of political subdivision for outstanding bonds . For purposes of determining whether outstanding bonds of an entity are obligations of a political subdivision under

section 103, the definition of political subdivision in paragraph (c) of this section does not apply to that entity with respect to its outstanding bonds that are issued before the general applicability date under paragraph (d)(1) of this section.

(3) Applicability date of the definition of political subdivision for refunding bonds . For purposes of determining whether refunding bonds of an entity are obligations of a political subdivision under section 103, the definition of political subdivision in paragraph (c) of this section does not apply to that entity with respect to its refunding bonds that are issued on or after the general applicability date under paragraph (d)(1) of this section to refund bonds with respect to which paragraph (c) of this section otherwise does not apply, provided that the weighted average maturity of the refunding bonds is no longer than the remaining weighted average maturity of the refunded bonds.

(4) Applicability date of the definition of political subdivision for existing enti- ties . For existing entities that are created or organized before May 21, 2016, the definition of political subdivision in paragraph (c) of this section does not apply for any purpose of sections 103 and 141 to 150 during the three-year period beginning on the general applicability date under paragraph (d)(1) of this section.

(5) Elective application of definition of political subdivision . An issuer may choose to apply the definition of political subdivision in paragraph (c) of this section to an issue of bonds in circumstances in which that section otherwise would not apply to that issue under paragraph (d)(2) or (3) of this section, provided that choice is applied consistently to the issue. An entity may choose to apply the definition of political subdivision in paragraph (c) of this section to an entity in circumstances in which that section otherwise would not apply to that entity under paragraph (d)(4) of this section, provided that choice is applied consistently to the entity.

John Dalrymple Deputy Commissioner for Services and Enforcement.

(Filed by the Office of the Federal Register on February 22, 2016, 8:45 a.m., and published in the issue of the Federal Register for February 23, 2016, 81 F.R. 03790)

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