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DEPARTMENT OF THE TREASURY

U.S. Customs and Border Protection

CFR Citation: 26 CFR Parts 1 and 602

RIN ID: RIN 1545-BH85

TD ID: [TD 9423]

NOTICE: Part IV

DOCUMENT ACTION: Final and temporary regulations.

SUBJECT CATEGORY: Implementation of Form 990

DATES: Effective Date: These regulations are effective on September 9, 2008.

Applicability Date: These regulations apply to taxable years beginning on or after January 1, 2008.

DOCUMENT SUMMARY: This document contains final and temporary regulations necessary to implement the redesigned Form 990, ``Return of Organization Exempt From Income Tax.'' The final regulations contained in this document make only nonsubstantive revisions to comply with Federal Register requirements. The temporary regulations make revisions to the regulations under section 6033 and section 6043 to allow for new threshold amounts for reporting compensation, to require that compensation be reported on a calendar year basis, and to modify the scope of organizations subject to information reporting requirements upon a substantial contraction. The temporary regulations also eliminate the advance ruling process for new organizations, change the public support computation period for organizations described in sections 170(b)(1)(A)(vi) and 509(a)(1) and in section 509(a)(2) to five years, consistent with the revised Form 990, and clarify that support must be reported using the organization's overall method of accounting. All taxexempt organizations required under section 6033 of the Internal Revenue Code (Code) to file annual information returns are affected by these temporary regulations. The text of these temporary regulations also serves as the text of the proposed regulations (REG 14233307) published in the Proposed Rules section in this issue of the Federal Register.

SUMMARY: Treasury Department, Internal Revenue Service,

SUPPLEMENTAL INFORMATION

Paperwork Reduction Act

The collection of information contained in these temporary regulations has been reviewed and approved by the Office of Management and Budget in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 3507(d)) under control number 15452117. 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 tax return information are confidential, as required by 26 U.S.C. 6103.
Background

Form 990

Under section 6033 of the Code, organizations that are exempt from Federal income tax under section 501(a) are generally required to file an annual information return reporting gross income, receipts, disbursements and such other information as the IRS requires. Certain exceptions to this filing requirement apply. For example, churches are not required to file annual information returns. The Treasury regulations direct that the annual information return shall be filed on Form 990, ``Return of Organization Exempt From Income Tax'' or Form 990PF, ``Return of Private Foundation or Section 4947(a)(1) Nonexempt Charitable Trust Treated as a Private Foundation.'' The regulations further specify certain information to be reported on the return.

The IRS revises forms and instructions on an annual basis to reflect changes in the law and evolving tax administration needs. On December 20, 2007, the IRS released a redesigned Form 990. The Form 990 had not been significantly revised since 1979, and both the IRS and stakeholders regarded the form as needing major revision to keep pace with changes in the law and with the increasing size, diversity, and complexity of the exempt sector. The new form incorporates many recommendations made in public comments on the discussion draft released on June 14, 2007. With the exception of certain smaller organizations for which there is a graduated transition period, organizations must begin using the new form for the 2008 tax year (returns filed in 2009). The current Form 990 will be used for tax year 2007 (returns filed in 2008) but will be replaced with the redesigned Form 990 beginning with the 2008 tax year. Earlier this year, the IRS released draft instructions for the new form and schedules for public comment.

These regulations make the revisions that must be made to the regulations under sections 6033 and 6043 of the Code to implement the Form 990 redesign. For example, the regulation that currently gives organizations a choice of using either the calendar year or the organization's annual accounting period as the basis for reporting compensation of officers, directors, trustees and certain employees and contractors is revised to require calendar year reporting. Revisions are also made to allow for new threshold amounts for reporting compensation and to expand the scope of organizations subject to information reporting requirements upon a substantial contraction.

In addition, as discussed in further detail in this preamble, these regulations eliminate the advance ruling process and change the public support computation period for organizations described in sections 170(b)(1)(A)(vi) and 509(a)(1) and in section 509(a)(2) to five years, consistent with the revised Schedule A, ``Public Charity Status and Public Support'' to the redesigned Form 990. These regulations also clarify that support must be reported using the organization's overall method of accounting.
Private Foundation Status and Advance Rulings

Public Support Tests

Under present law, as established in the Tax Reform Act of 1969, an organization described in section 501(c)(3) of the Code is a private foundation unless it meets one of the exceptions described in sections 509(a)(1) through 509(a)(4). Organizations that are described in section 509(a)(1), (2), (3) or (4) are classified as public charities, and are not subject to various excise taxes in Chapter 42 that apply to private foundations. The Code defines two major categories of organizations that are considered public charities and not private foundations because they are broadly publicly supported: (1) Organizations described in section 170(b)(1)(A)(vi), which are not private foundations because they are referenced in section 509(a)(1); and (2) organizations described in section 509(a)(2).

Section 170(b)(1)(A)(vi) encompasses organizations that normally receive a substantial part of their support from a governmental unit or from direct or indirect contributions from the general public. The regulations under section 170 provide that an organization will be described in section 170(b)(1)(A)(vi) if it
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normally receives at least 33\1/3\ percent of its support from governmental units or from the general public. See Sec. 1.170A9(f). Alternatively, an organization can meet a ``facts and circumstances'' test, under which it may qualify as a section 170(b)(1)(A)(vi) organization if it normally receives at least 10 percent of its support from governmental units or the general public, and can establish that, under all the facts and circumstances, it normally receives a substantial part of its support from governmental units or the general public.

Section 509(a)(2) encompasses organizations that normally receive more than onethird of their support from a combination of gifts, grants, contributions, membership fees, and gross receipts from performing exempt function activities, and normally receive not more than onethird of their support from investment income and unrelated business taxable income. The major difference between the section 509(a)(2) and section 170(b)(1)(A)(vi) tests is that the former includes in support gross receipts from exempt function activities, for example, admission proceeds for a museum or ticket sales for a symphony, while the latter does not. As noted, section 509(a)(2) also includes an investment income limitation. For ease of reference, the tests in sections 170(b)(1)(A)(vi) and 509(a)(2) will be referred to collectively as the public support tests.

The statute does not define, for either provision, the meaning of ``normally.'' The current regulations for both public support tests generally use a rolling fouryear computation period, with two exceptions: New organizations and organizations that experience ``substantial and material changes'' in their sources of support for the current year are permitted to use a fiveyear computation period. For any particular taxable year, the fouryear computation period is the four years immediately preceding the current taxable year. For example, for taxable year 1998, the computation period would be taxable years 1994, 1995, 1996, and 1997. The regulations further provide that if the public support test is met for the fouryear computation period, the organization will be considered to meet the public support test for the taxable year being tested and the immediately succeeding taxable year. In the example above, a section 170(b)(1)(A)(vi) organization would meet the public support test for 1998 and 1999 if the support it received from the general public and from governmental units for the years 1994 through 1997 exceeded 33\1/3\ percent of the total support it received for those years.

The effect of the current rule regarding the subsequent taxable year is that an organization must fail to meet a public support test two years in a row to become a private foundation. In the example above, the organization met the public support test for 1998 and 1999, based on support received during the fouryear computation period 1994 through 1997. If the organization does not meet a public support test for the 1995 through 1998 computation period, it is still a public charity in 1999 because it met a support test for taxable year 1998. However, if the organization again does not meet a public support test for the 1996 through 1999 computation period, the organization becomes a private foundation effective at the beginning of its taxable year 2000.

Advance Rulings

In its application for recognition of taxexempt status (Form 1023, ``Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code''), a section 501(c)(3) organization also requests a determination of its private foundation status, that is, whether it is a private foundation and, if not, the Code provision excepting it from private foundation classification. Under the current statute and regulations, an organization can request either an advance ruling or a definitive ruling addressing the organization's exemption under section 501(c)(3) and its private foundation status under section 509(a).

Under the current regulations, a new organization applying for exemption can request a definitive ruling as to its foundation status only if it has completed its first tax year consisting of at least eight full months. In lieu of the general fouryear computation period for public support, a new organization requesting a definitive ruling tests its public support based on the years it has been in existence. If an organization qualifies as an organization described in section 509(a)(1) or (2) based on the support received in its initial year(s) of existence, the IRS issues a definitive ruling stating that the organization is recognized as exempt under section 501(c)(3) and classified as a public charity.

If a new organization has not yet completed its first tax year consisting of at least eight full months at the time it applies for recognition of tax exemption, or if the organization so elects, it requests an ``advance ruling'' regarding its private foundation status in its application for exemption. Current regulations provide for an advance ruling period of two or three years, depending on the length of the organization's first tax year, and an additional ``extended advance ruling period'' of three more years if the organization requests. These current regulations have been overridden. In the conference report to the Tax Reform Act of 1984, Congress directed that the advance ruling period in all cases be five years. See H.R. Rep. No. 98861, 98th Cong., 2d Sess. 1 (1984), 19843 CB (Vol. 2) 1090. The advance ruling period gives new organizations time to build up broad public support in the first few years of their existence. In lieu of the general four year computation period for public support, a new organization requesting an advance ruling tests its public support over the first five years of its existence as an organization described in section 501(c)(3). If an organization demonstrates to the IRS's satisfaction that it can reasonably be expected to meet a public support test during its first five years, the IRS issues an advance ruling stating that the organization is recognized as exempt under section 501(c)(3) and classified as a public charity during its first five years. With limited exceptions, donors can rely on this advance ruling as to public charity status.

At the end of the initial fiveyear advance ruling period, the organization is required to file Form 8734, ``Support Schedule for Advance Ruling Period'' to establish that it actually met a public support test. As noted above, for this purpose, public support is calculated over the fiveyear advance ruling period, rather than over a fouryear period. If the organization meets a public support test for its advance ruling period, the IRS issues a definitive ruling letter classifying the organization as a public charity. If the organization does not meet a public support test for its advance ruling period, or the organization fails to submit Form 8734, the IRS reclassifies the organization as a private foundation as of its first taxable year and publishes notice of the change in status in the Internal Revenue Bulletin and Publication 78, ``Cumulative List of Organizations described in Section 170(c) of the Internal Revenue Code of 1986,'' which can be searched at www.irs.gov. Once notice of a change in status is published, donors can no longer automatically rely on the advance ruling for charitable contribution deduction purposes and must assume that the organization is a private foundation. See Sec.

601.601(d)(2)(ii)(b).

An organization that is reclassified as a private foundation is subject to the
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section 4940 investment income tax and the section 507 termination tax for its fiveyear advance ruling period. The other Chapter 42 excise taxes applicable to private foundations do not apply during the five year advance ruling period. In year six, the reclassified organization is subject to all Chapter 42 excise taxes that apply to private foundations.

The advance ruling process is complex and burdensome for both taxpayers and the IRS and provides little tax administration or compliance benefit. While statistics vary from year to year, approximately 95 percent of the organizations that receive advance rulings later receive definitive rulings that the organizations are public charities at the end of the advance ruling period. The current regulations governing advance rulings are complex, and, as discussed above, were overridden in part by the Tax Reform Act of 1984. Moreover, the public support information that is reported on Form 8734 will be captured on Schedule A of the redesigned Form 990. For these reasons, in its 2003 report, the IRS Advisory Committee for Tax Exempt and Governmental Entities, a group that includes representatives of exempt organizations and practitioners, recommended that the advance ruling process be eliminated.

The IRS believes that it can more effectively deploy its compliance resources by eliminating the advance ruling process and Form 8734 and instead monitoring public charity status based on public support information reported on the revised Schedule A, to the redesigned Form 990. The revised Schedule A sets forth easiertofollow rules for calculating public support and captures all of the information necessary for the IRS to monitor and verify compliance with the public support tests.
Explanation of Provisions

Private Foundation Status and Advance Rulings

The temporary regulations eliminate the advance ruling process and provide instead that an organization will be a public charity in its first five years if it can show, in its application for exemption, that it can reasonably be expected to receive the requisite public support during such period. The temporary regulations also change the public support computation period for purposes of sections 170(b)(1)(A)(vi) and 509(a)(1) and section 509(a)(2) from a fouryear period prior to the tested year to a fiveyear period that includes the current year. The temporary regulations also eliminate the substantial and material changes exception, which is made obsolete by the establishment of a general fiveyear computation period. In addition, Sec. 1.170A9T(f), which corresponds to Sec. 1.170A9(e) of the prior regulations and governs section 170(b)(1)(A)(vi) organizations, has been revised throughout to simplify some of the language and to provide a better ``road map'' of what the provisions are designed to do.

Elimination of Advance Ruling Process

The temporary regulations eliminate advance rulings and the Form 8734 filing requirement for all new section 501(c)(3) organizations. Under the temporary regulations, if, at the time of the initial application for exemption, an organization can establish to the satisfaction of the IRS that the organization can reasonably be expected to meet a public support test during its first five years, the organization qualifies as publicly supported for its first five years as a section 501(c)(3) organization. The IRS will issue a determination letter stating that the organization is exempt under section 501(c)(3) and is classified as a public charity. The organization will be a public charity for its first five years, regardless of the level of public support it in fact receives during this period. In addition, unlike a new organization's public charity status under an advance ruling, which was conditioned on its ultimate satisfaction of a public support test on a Form 8734 filed with the IRS, under the temporary regulations a new organization that can show it can reasonably be expected to meet a public support test will be classified as a public charity for all purposes during its first five years. The organization will not owe any section 4940 tax or section 507 termination tax with respect to its first five years. Beginning with the organization's sixth year, if the organization cannot establish that it is not a private foundation, such as a public charity or a supporting organization under section 509(a)(3), it will be liable for the section 4940 excise tax and other Chapter 42 excise taxes applicable to private foundations for any year for which it cannot establish that it is not a private foundation.

The standards for whether an organization can reasonably be expected to be publicly supported are drawn from the existing regulations. A new organization required to file Form 990 or Form 990 EZ, ``Short Form Return of Organization Exempt From Income Tax,'' will be required to report its support on Schedule A every year, but it will not be required to file Form 8734 after its first five years. Organizations will be required to meet a public support test using the general fiveyear computation period beginning in their sixth taxable years. The fiveyear computation period is discussed in detail in this preamble.

Computation Period for Public Support

The temporary regulations change the computation period for public support from a fouryear period comprised of the four years prior to the tested year to a fiveyear period that includes the current year. Because all organizations will use a fiveyear computation period under the temporary regulations, the temporary regulations eliminate the substantial and material change exception, which allowed organizations to use a fiveyear computation period rather than the fouryear computation period under certain circumstances.

An organization that meets a public support test for the current taxable year is treated as publicly supported for the current taxable year and the immediately succeeding taxable year. Thus, for example, a calendar year organization that meets a public support test for taxable year 2011, based on the fiveyear computation period 2007 through 2011, is a public charity for taxable years 2011 and 2012. If the organization cannot meet a public support test for taxable year 2012 (based on the fiveyear computation period 2008 through 2012), it still will be a public charity for taxable year 2012, because it met the public support test for taxable year 2011 (based on the fiveyear computation period 2007 through 2011). If, however, the organization cannot meet a public support test for taxable year 2013 as well, based on the computation period 2009 through 2013, the organization will be classified as a private foundation as of the beginning of taxable year 2013. Because an organization that cannot meet a public support test for the current taxable year is at risk of private foundation classification as of the first day of the subsequent taxable year, organizations may wish to carefully monitor their public support calculations.

The IRS and the Treasury Department recognize that an organization may not be able to compute its public support for the current taxable year until some time in the subsequent taxable year. In the example above, taxable year 2013 may have already begun by the time the calendar year organization computes its public support for taxable year 2012 and realizes (perhaps for the first time) that it is at risk of being classified as a private foundation as of January 1, 2013. [[Page 52531]]
Moreover, the organization may not know definitively that it is a private foundation for taxable year 2013 until some time in 2014, when it is able to definitively calculate its public support. Accordingly, the IRS will not assert private foundation excise taxes and/or penalties for all or part of the first taxable year in which an organization is reclassified as a private foundation due to failure to satisfy a public support test in cases where the imposition of such taxes would lead to unfair or inequitable results, such as where the change in the organization's public support was unforeseeable or due to circumstances beyond the organization's control. Organizations that believe that the imposition of private foundation excise taxes and/or penalties against them for all or part of the first year in which they are reclassified as a private foundation would be unfair or inequitable should contact the IRS, Exempt Organizations, Rulings and Agreements, Washington, DC, at (202) 2834905. An organization will be required to provide to the IRS all of the relevant facts and circumstances establishing that the imposition of private foundation taxes would be unfair or inequitable. Comments are requested regarding the specific circumstances that may warrant relief.

The existing regulations contain numerous examples reflecting the fouryear computation period. The temporary regulations update the examples to reflect the new computation period. These examples are in Sec. 1.170A9T(f)(9), Sec. 1.509(a)3T(c)(6) and Sec. 1.509(a) 3T(e)(3).

Method of Accounting

Previously, when a section 501(c)(3) organization computed its public support, it was required to use the cash method of accounting to report the amount of public support it received on Schedule A, even if it used the accrual method of accounting in keeping its books under section 446, and in otherwise reporting on Form 990. Under these temporary regulations, when a section 501(c)(3) organization computes its public support and reports the information on Schedule A, it must use the same accounting method that it uses in keeping its books under section 446 and that it otherwise uses to report on its Form 990. An organization that uses the accrual method will not be able to use the support information reported on Form 990 for prior years (because that support was reported using the cash method) to compute its public support for the current year, and instead must report all support for the computation period on the accrual method.

Reliance

These temporary regulations provide that donors may rely on an organization's ruling that the organization is described in sections 170(b)(1)(A)(vi) and 509(a)(1) or in section 509(a)(2) until notice of a change in status is provided to the public (such as by publication in the Internal Revenue Bulletin), unless the donor was responsible for or aware of the act or failure to act that results in the organization's loss of public charity status. This rule is substantively the same as the rules contained in the current regulations. The regulations further provide that donors may rely on advance rulings that expire on or after June 9, 2008, until notice of a change in status is provided to the public (such as by publication in the Internal Revenue Bulletin). Effective/Applicability Date and Transition Rules

These temporary regulations are effective on September 9, 2008, and apply to taxable years beginning on or after January 1, 2008. All organizations, including organizations that received a definitive ruling prior to the effective date of these regulations, must use the new fiveyear computation period to calculate public support for their first taxable year beginning on or after January 1, 2008 and for all subsequent taxable years.

These regulations provide a transition rule under which an organization that cannot meet a public support test for its first taxable year beginning on or after January 1, 2008, using the fiveyear computation period will continue to qualify as a public charity for its 2008 taxable year if it satisfied a public support test for its 2007 taxable year, based on public support received over the fouryear period 2003 through 2006.

These regulations also provide a transition rule under which organizations that received advance rulings that expire on or after June 9, 2008, are treated as new public charities under the new regulations, that is, public charities for all purposes without regard to public support in fact received during the first five years of their existence as section 501(c)(3) organizations. This rule effectively applies the temporary regulations to all organizations that are in their advance ruling period as of the effective date of these temporary regulations. As such, these organizations will not have to file Form 8734 at the end of the advance ruling period. Grantors and contributors can rely upon these organizations' advance ruling letter as if it were a definitive ruling letter. The IRS plans to send followup letters to such organizations explaining the new rules. An organization that did not timely file Form 8734 at the expiration of its advance ruling period is not covered by the transition rule. Such an organization must file information with the IRS establishing that it met a public support test during its advance ruling period in order to qualify as a public charity during its first five years.

Forms 1023 filed prior to the effective date of these regulations that have not yet been processed by the IRS will be processed under the new regulations. The IRS will issue definitive rulings regarding private foundation status to such organizations.

Community Trust Rules

Sections 1.170A9(f)(10) through 1.170A9(f)(14), which establish rules for when multiple trusts can be treated as a single entity for purposes of the public support tests, provide old transition rules that are obsolete, and, therefore, the transition rules are being deleted in these temporary regulations.

Compensation Reporting

Current Sec. 1.60332(a)(2)(ii)(g) requires that exempt organizations report on Form 990 the names and addresses of all officers, directors, trustees, and persons having responsibilities or powers similar to those of officers, directors or trustees, of the organization. The reference to a person having responsibilities and powers similar to those of officers, directors or trustees is meant to capture those persons who function as officers, directors or trustees of the organization, regardless of title, as well as the key employees of the organization. The redesigned Form 990 expanded the definition of key employee to cover not only persons having responsibilities or powers similar to those of officers, directors or trustees, but also persons who manage a discrete segment or activity of the organization that represents a substantial portion of the activities, assets, income, or expenses of the organization. The redesigned Form 990 requires reporting for only those key employees whose compensation exceeds $150,000. These temporary regulations add key employees to the list of persons in Sec. 1.60332T(a)(2)(ii)(g) who may be required to be reported on Form 990, as prescribed by publication, form or instructions.

Current Sec. 1.60332(a)(2)(ii)(g) requires that exempt organizations that make payments of more than $30,000 annually to employees and independent contractors report these persons' names [[Page 52532]]
and addresses on Form 990. Current Sec. 1.60332(a)(2)(ii)(h) requires a schedule showing the compensation or other payments made to the persons listed in paragraph (a)(2)(ii)(g). The redesigned Form 990 requires an organization to report, for each person listed (other than a key employee or a former director or trustee of the organization), compensation and other payments totaling more than $100,000 annually paid by the organization and its related organizations to the person. For key employees, the redesigned Form 990 requires an organization to report compensation and other payments totaling more than $150,000 annually paid by the organization and its related organizations to the person. For former directors and trustees, the redesigned Form 990 requires an organization to report compensation and other payments totaling more than $10,000 annually paid by the organization and its related organizations to the person solely on account of the person's past services as a director or trustee of the organization. As amended in these temporary regulations, Sec. 1.60332T(a)(2)(ii)(g) gives the Commissioner discretion to revise the threshold amount for reporting by form and instruction.

Furthermore, the current rule in Sec. 1.60332(a)(2)(ii)(h), which requires generally the reporting of compensation paid by an organization during its annual accounting period (or during the calendar year ending within such period), imposes no requirement that the compensation reported on Form 990 be consistent with what is reported on Form W2, ``Wage and Tax Statement,'' or Form 1099MISC, ``Miscellaneous Income.'' The current rule permits, but does not require, a fiscal year organization to report paid compensation on a calendar year basis. The redesigned Form 990 (Part VII and Schedule J) requires that compensation reported as paid to officers and other employees be consistent with Form W2 (box 5) and that compensation reported as paid to directors, individual trustees, and independent contractors be consistent with Form 1099MISC (box 7). As amended by these temporary regulations, Sec. 1.60332T(a)(2)(ii)(h) requires an organization to report compensation it has paid during the calendar year ending with or within the organization's annual accounting period, or during such other period as specified by form or form instructions. The rule in these temporary regulations will ensure consistency in compensation reporting, provide greater certainty about what compensation is to be reported, and reduce the reporting burden for most filing organizations. A fiscal year organization will continue to be required to use fiscal year accounting when reporting aggregate compensation as an expense item (Form 990, Part IX). In addition, an organization will not be required to reconcile compensation for individuals reported in Part VII with compensation for such individuals included in its Part IX statement of expenses.

Asset Disposition Reporting

Schedule N, ``Liquidation, Termination, Dissolution, or Significant Disposition of Assets,'' of the redesigned Form 990 requires information about organizations that liquidate, terminate, or dissolve, or sell, exchange, dispose of or otherwise transfer more than 25 percent of the organization's assets. The collection of this information is authorized by section 6033, the general authorization for the collection of information on Form 990. The collection of information with respect to liquidations, dissolutions, terminations and substantial contractions is also authorized by section 6043(b). While section 6043(b) and its companion penalty provision section 6652(c) contemplate a separate return, since 1981 this information has been collected on Form 990.

In order to eliminate the potential for inconsistency and confusion by taxpayers, the regulations under section 6043(b) have been amended so that they are consistent with section 6033 and the redesigned Schedule N. Generally, current Sec. 1.60433(b)(8) excuses from the information reporting requirement of section 6043(b) organizations other than former section 501(c)(3) organizations. The IRS believes that this exception is too broad, because information reporting from other exempt organizations may facilitate sound tax administration. Therefore, these temporary regulations amend Sec. 1.60433(b)(8) to provide discretion to narrow the exception and require reporting from organizations exempt under other Code sections by form or form instructions. In addition, these temporary regulations remove the definition of ``substantial contraction'' in Sec. 1.60433(d)(1), leaving this term to be defined by form or form instructions. Private Foundation Termination

Section 1.5072, which addresses private foundation terminations under section 507(b), contains references to the fouryear computation period for public support and old transition rules related to 12month terminations that are obsolete. These temporary regulations revise Sec. 1.5072 to delete references to the fouryear computation period and the transition rules related to 12month terminations.

Revisions To Comply With Federal Register

The final regulations make various nonsubstantive revisions to comply with Federal Register requirements. For example, the undesignated flush language preceding prior Sec. 1.170A9(a) was designated as paragraph (a), and all following paragraphs were redesignated accordingly.

Special Analyses

It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory 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. It is hereby certified that the collection of information in this regulation will not have a significant economic impact on a substantial number of small entities. This certification is based on the fact that burden on taxexempt entities will be reduced by (1) eliminating the separate advance ruling process and the additional process for subsequently seeking a definitive ruling, (2) clarifying rules regarding the method of accounting and period for reporting certain items, and (3) providing discretion for the IRS to narrow or clarify circumstances under which reporting is required. Accordingly, a Regulatory Flexibility Analysis under the Regulatory Flexibility Act (5 U.S.C. chapter 6) is not required. Pursuant to section 7805(f) of the Code, these regulations have been submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business. Drafting Information

The principal author of this regulation is Terri Harris, Office of Associate Chief Counsel (Tax Exempt and Government Entities). However, other personnel from the IRS and the Treasury Department participated in their development.
List of Subjects

26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements. 26 CFR Part 602

Reporting and recordkeeping requirements.
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Amendments to the Regulations
Accordingly, 26 CFR parts 1 and 602 are amended as follows: PART 1INCOME 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 1.170A9 is amended as follows:
1. Paragraphs (a), (b), (c), (d), (e), (f), (g), (h) and (i) are redesignated as paragraphs (b), (c), (d), (e), (f), (g), (h), (i) and (j), respectively.
2. The undesignated text following the section heading is designated as paragraph (a).
3. The newlydesignated paragraphs (a) and (d) are revised.
4. New paragraph (k) is added.

The addition and revisions read as follows:
Sec. 1.170A9 Definition of section 170(b)(1)(A) organization. (a) The term section 170(b)(1)(A) organization as used in the regulations under section 170 means any organization described in paragraphs (b) through (j) of this section, effective with respect to taxable years beginning after December 31, 1969, except as otherwise provided. Section 1.1702(b) shall continue to be applicable with respect to taxable years beginning prior to January 1, 1970. The term one or more organizations described in section 170(b)(1)(A) (other than clauses (vii) and (viii)) as used in sections 507 and 509 of the Internal Revenue Code (Code) and the regulations means one or more organizations described in paragraphs (b) through (f) of this section, except as modified by the regulations under part II of subchapter F of chapter 1 or under chapter 42.
* * * * *
(d) Hospitals and medical research organizations(1) Hospitals. An organization (other than one described in paragraph (d)(2) of this section) is described in section 170(b)(1)(A)(iii) if
(i) It is a hospital; and
(ii) Its principal purpose or function is the providing of medical or hospital care or medical education or medical research.
(A) The term hospital includes
(1) Federal hospitals; and
(2) State, county, and municipal hospitals which are
instrumentalities of governmental units referred to in section 170(c)(1) and otherwise come within the definition. A rehabilitation institution, outpatient clinic, or community mental health or drug treatment center may qualify as a ``hospital'' within the meaning of paragraph (d)(1)(i) of this section if its principal purpose or function is the providing of hospital or medical care. For purposes of this paragraph (d)(1)(ii), the term medical care shall include the treatment of any physical or mental disability or condition, whether on an inpatient or outpatient basis, provided the cost of such treatment is deductible under section 213 by the person treated. An organization, all the accommodations of which qualify as being part of a ``skilled nursing facility'' within the meaning of 42 U.S.C. 1395x(j), may qualify as a ``hospital'' within the meaning of paragraph (d)(1)(i) of this section if its principal purpose or function is the providing of hospital or medical care. For taxable years ending after June 28, 1968, the term hospital also includes cooperative hospital service organizations which meet the requirements of section 501(e) and Sec. 1.501(e)1.
(B) The term hospital does not, however, include convalescent homes or homes for children or the aged, nor does the term include institutions whose principal purpose or function is to train handicapped individuals to pursue some vocation. An organization whose principal purpose or function is the providing of medical education or medical research will not be considered a ``hospital'' within the meaning of paragraph (d)(1)(i) of this section, unless it is also actively engaged in providing medical or hospital care to patients on its premises or in its facilities, on an inpatient or outpatient basis, as an integral part of its medical education or medical research functions. See, however, paragraph (d)(2) of this section with respect to certain medical research organizations.
(2) Certain medical research organizations(i) Introduction. A medical research organization is described in section 170(b)(1)(A)(iii) if the principal purpose or functions of such organization are medical research and if it is directly engaged in the continuous active conduct of medical research in conjunction with a hospital. In addition, for purposes of the 50 percent limitation of section 170(b)(1)(A) with respect to a contribution, during the calendar year in which the contribution is made such organization must be committed to spend such contribution for such research before January 1 of the fifth calendar year which begins after the date such contribution is made. An organization need not receive contributions deductible under section 170 to qualify as a medical research organization and such organization need not be committed to spend amounts to which the limitation of section 170(b)(1)(A) does not apply within the 5year period referred to in this paragraph (d)(2)(i). However, the requirement of continuous active conduct of medical research indicates that the type of organization contemplated in this paragraph (d)(2) is one which is primarily engaged directly in the continuous active conduct of medical research, as compared to an inactive medical research organization or an organization primarily engaged in funding the programs of other medical research organizations. As in the case of a hospital, since an organization is ordinarily not described in section 170(b)(1)(A)(iii) as a hospital unless it functions primarily as a hospital, similarly a medical research organization is not so described unless it is primarily engaged directly in the continuous active conduct of medical research in conjunction with a hospital. Accordingly, the rules of this paragraph (d)(2) shall only apply with respect to such medical research organizations.
(ii) General rule. An organization (other than a hospital described in paragraph (d)(1) of this section) is described in section 170(b)(1)(A)(iii) only if within the meaning of this paragraph (d)(2): (A) The principal purpose or functions of such organization are to engage primarily in the conduct of medical research; and
(B) It is primarily engaged directly in the continuous active conduct of medical research in conjunction with a hospital which is (1) Described in section 501(c)(3);
(2) A Federal hospital; or
(3) An instrumentality of a governmental unit referred to in section 170(c)(1).
(C) In order for a contribution to such organization to qualify for purposes of the 50 percent limitation of section 170(b)(1)(A), during the calendar year in which such contribution is made or treated as made, such organization must be committed (within the meaning of paragraph (d)(2)(viii) of this section) to spend such contribution for such active conduct of medical research before January 1 of the fifth calendar year beginning after the date such contribution is made. For the meaning of the term ``medical research'' see paragraph (d)(2)(iii) of this section. For the meaning of the term ``principal purpose or functions'' see paragraph (d)(2)(iv) of this section. For the meaning of the term ``primarily engaged directly in the continuous active conduct of medical research'' see
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paragraph (d)(2)(v) of this section. For the meaning of the term ``medical research in conjunction with a hospital'' see paragraph (d)(2)(vii) of this section.
(iii) Definition of medical research. Medical research means the conduct of investigations, experiments, and studies to discover, develop, or verify knowledge relating to the causes, diagnosis, treatment, prevention, or control of physical or mental diseases and impairments of man. To qualify as a medical research organization, the organization must have or must have continuously available for its regular use the appropriate equipment and professional personnel necessary to carry out its principal function. Medical research encompasses the associated disciplines spanning the biological, social and behavioral sciences. Such disciplines include chemistry (biochemistry, physical chemistry, bioorganic chemistry, etc.), behavioral sciences (psychiatry, physiological psychology, neurophysiology, neurology, neurobiology, and social psychology, etc.), biomedical engineering (applied biophysics, medical physics, and medical electronics, for example, developing pacemakers and other medically related electrical equipment), virology, immunology, biophysics, cell biology, molecular biology, pharmacology, toxicology, genetics, pathology, physiology, microbiology, parasitology, endocrinology, bacteriology, and epidemiology.
(iv) Principal purpose or functions. An organization must be organized for the principal purpose of engaging primarily in the conduct of medical research in order to be an organization meeting the requirements of this paragraph (d)(2). An organization will normally be considered to be so organized if it is expressly organized for the purpose of conducting medical research and is actually engaged primarily in the conduct of medical research. Other facts and circumstances, however, may indicate that an organization does not meet the principal purpose requirement of this paragraph (d)(2)(iv) even where its governing instrument so expressly provides. An organization that otherwise meets all of the requirements of this paragraph (d)(2) (including this paragraph (d)(2)(iv)) to qualify as a medical research organization will not fail to so qualify solely because its governing instrument does not specifically state that its principal purpose is to conduct medical research.
(v) Primarily engaged directly in the continuous active conduct of medical research(A) In order for an organization to be primarily engaged directly in the continuous active conduct of medical research, the organization must either devote a substantial part of its assets to, or expend a significant percentage of its endowment for, such purposes, or both. Whether an organization devotes a substantial part of its assets to, or makes significant expenditures for, such continuous active conduct depends upon the facts and circumstances existing in each specific case. An organization will be treated as devoting a substantial part of its assets to, or expending a significant percentage of its endowment for, such purposes if it meets the appropriate test contained in paragraph (d)(2)(v)(B) of this section. If an organization fails to satisfy both of such tests, in evaluating the facts and circumstances, the factor given most weight is the margin by which the organization failed to meet such tests. Some of the other facts and circumstances to be considered in making such a determination are
(1) If the organization fails to satisfy the tests because it failed to properly value its assets or endowment, then upon determination of the improper valuation it devotes additional assets to, or makes additional expenditures for, such purposes, so that it satisfies such tests on an aggregate basis for the prior year in addition to such tests for the current year;
(2) The organization acquires new assets or has a significant increase in the value of its securities after it had developed a budget in a prior year based on the assets then owned and the then current values;
(3) The organization fails to make expenditures in any given year because of the interrelated aspects of its budget and longterm planning requirements, for example, where an organization prematurely terminates an unsuccessful program and because of longterm planning requirements it will not be able to establish a fully operational replacement program immediately; and
(4) The organization has as its objective to spend less than a significant percentage in a particular year but make up the difference in the subsequent few years, or to budget a greater percentage in an earlier year and a lower percentage in a later year.
(B) For purposes of this section, an organization which devotes more than one half of its assets to the continuous active conduct of medical research will be considered to be devoting a substantial part of its assets to such conduct within the meaning of paragraph (d)(2)(v)(A) of this section. An organization which expends funds equaling 3.5 percent or more of the fair market value of its endowment for the continuous active conduct of medical research will be considered to have expended a significant percentage of its endowment for such purposes within the meaning of paragraph (d)(2)(v)(A) of this section.
(C) Engaging directly in the continuous active conduct of medical research does not include the disbursing of funds to other organizations for the conduct of research by them or the extending of grants or scholarships to others. Therefore, if an organization's primary purpose is to disburse funds to other organizations for the conduct of research by them or to extend grants or scholarships to others, it is not primarily engaged directly in the continuous active conduct of medical research.
(vi) Special rules. The following rules shall apply in determining whether a substantial part of an organization's assets are devoted to, or its endowment is expended for, the continuous active conduct of medical research activities:
(A) An organization may satisfy the tests of paragraph (d)(2)(v)(B) of this section by meeting such tests either for a computation period consisting of the immediately preceding taxable year, or for the computation period consisting of the immediately preceding four taxable years. In addition, for taxable years beginning in 1970, 1971, 1972, 1973, and 1974, if an organization meets such tests for the computation period consisting of the first four taxable years beginning after December 31, 1969, an organization will be treated as meeting such tests, not only for the taxable year beginning in 1974, but also for the preceding four taxable years. Thus, for example, if a calendar year organization failed to satisfy such tests for a computation period consisting of 1969, 1970, 1971, and 1972, but on the basis of a computation period consisting of the years 1970 through 1973, it expended funds equaling 3.5 percent or more of the fair market value of its endowment for the continuous active conduct of medical research, such organization will be considered to have expended a significant percentage of its endowment for such purposes for the taxable years 1970 through 1974. In applying such tests for a fouryear computation period, although the organization's expenditures for the entire four year period shall be aggregated, the fair market value of its endowment for each year shall be summed, even though, in the case of an asset held throughout the fouryear period, the fair market value of such an asset will be counted four times.
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Similarly, the fair market value of an organization's assets for each year of a fouryear computation period shall be summed.
(B) Any property substantially all the use of which is ``substantially related'' (within the meaning of section 514(b)(1)(A)) to the exercise or performance of the organization's medical research activities will not be treated as part of its endowment.
(C) The valuation of assets must be made with commonly accepted methods of valuation. A method of valuation made in accordance with the principles stated in the regulations under section 2031 constitutes an acceptable method of valuation. Assets may be valued as of any day in the organization's taxable year to which such valuation applies, provided the organization follows a consistent practice of valuing such asset as of such date in all taxable years. For purposes of paragraph (d)(2)(v) of this section, an asset held by the organization for part of a taxable year shall be taken into account by multiplying the fair market value of such asset by a fraction, the numerator of which is the number of days in such taxable year that the organization held such asset and the denominator of which is the number of days in such taxable year.
(vii) Medical research in conjunction with a hospital. The organization need not be formally affiliated with a hospital to be considered primarily engaged directly in the continuous active conduct of medical research in conjunction with a hospital, but in any event there must be a joint effort on the part of the research organization and the hospital pursuant to an understanding that the two organizations will maintain continuing close cooperation in the active conduct of medical research. For example, the necessary joint effort will normally be found to exist if the activities of the medical research organization are carried on in space located within or adjacent to a hospital, the organization is permitted to utilize the facilities (including equipment, case studies, etc.) of the hospital on a continuing basis directly in the active conduct of medical research, and there is substantial evidence of the close cooperation of the members of the staff of the research organization and members of the staff of the particular hospital or hospitals. The active participation in medical research by members of the staff of the particular hospital or hospitals will be considered to be evidence of such close cooperation. Because medical research may involve substantial investigation, experimentation and study not immediately connected with hospital or medical care, the requisite joint effort will also normally be found to exist if there is an established relationship between the research organization and the hospital which provides that the cooperation of appropriate personnel and the use of facilities of the particular hospital or hospitals will be required whenever it would aid such research.
(viii) Commitment to spend contributions. The organization's commitment that the contribution will be spent within the prescribed time only for the prescribed purposes must be legally enforceable. A promise in writing to the donor in consideration of his making a contribution that such contribution will be so spent within the prescribed time will constitute a commitment. The expenditure of contributions received for plant, facilities, or equipment, used solely for medical research purposes (within the meaning of paragraph (d)(2)(ii) of this section), shall ordinarily be considered to be an expenditure for medical research. If a contribution is made in other than money, it shall be considered spent for medical research if the funds from the proceeds of a disposition thereof are spent by the organization within the fiveyear period for medical research; or, if such property is of such a kind that it is used on a continuing basis directly in connection with such research, it shall be considered spent for medical research in the year in which it is first so used. A medical research organization will be presumed to have made the commitment required under this paragraph (d)(2)(viii) with respect to any contribution if its governing instrument or bylaws require that every contribution be spent for medical research before January 1 of the fifth year which begins after the date such contribution is made. (ix) Organizational period for new organizations. A newly created organization, for its ``organizational'' period, shall be considered to be primarily engaged directly in the continuous active conduct of medical research in conjunction with a hospital within the meaning of paragraphs (d)(2)(v) and (d)(2)(vii) of this section if during such period the organization establishes to the satisfaction of the Commissioner that it reasonably can be expected to be so engaged by the end of such period. The information to be submitted shall include detailed plans showing the proposed initial medical research program, architectural drawings for the erection of buildings and facilities to be used for medical research in accordance with such plans, plans to assemble a professional staff and detailed projections showing the timetable for the expected accomplishment of the foregoing. The ``organizational'' period shall be that period which is appropriate to implement the proposed plans, giving effect to the proposed amounts involved and the magnitude and complexity of the projected medical research program, but in no event in excess of three years following organization.
(x) Examples. The application of this paragraph (d)(2) may be illustrated by the following examples:

Example 1. N, an organization referred to in section 170(c)(2), was created to promote human knowledge within the field of medical research and medical education. All of N's assets were contributed to it by A and consist of a diversified portfolio of stocks and bonds. N's endowment earns 3.5 percent annually, which N expends in the conduct of various medical research programs in conjunction with Y hospital. N is located adjacent to Y hospital, makes substantial use of Y's facilities, and there is close cooperation between the staffs of N and Y. N is directly engaged in the continuous active conduct of medical research in conjunction with a hospital, meets the principal purpose test described in paragraph (d)(2)(iv) of this section, and is therefore an organization described in section 170(b)(1)(A)(iii).

Example 2. O, an organization referred to in section 170(c)(2), was created to promote human knowledge within the field of medical research and medical education. All of O's assets consist of a diversified portfolio of stocks and bonds. O's endowment earns 3.5 percent annually, which O expends in the conduct of various medical research programs in conjunction with certain hospitals. However, in 1974, O receives a substantial bequest of additional stocks and bonds. O's budget for 1974 does not take into account the bequest and as a result O expends only 3.1 percent of its endowment in 1974. However, O establishes that it will expend at least 3.5 percent of its endowment for the active conduct of medical research for taxable years 1975 through 1978. O is therefore directly engaged in the continuous active conduct of medical research in conjunction with a hospital for taxable year 1975. Since O also meets the principal purpose test described in paragraph (d)(2)(iv) of this section, it is therefore an organization described in section 170(b)(1)(A)(iii) for taxable year 1975.

Example 3. M, an organization referred to in section 170(c)(2), was created to promote human knowledge within the field of medical research and medical education. M's activities consist of the conduct of medical research programs in conjunction with various hospitals. Under such programs, researchers employed by M engage in research at laboratories set aside for M within the various hospitals. Substantially all of M's assets consist of 100 percent of the stock of X corporation, which has a fair market value of approximately 100 million dollars. X pays M approximately 3.3 million dollars in dividends annually, which M expends in the [[Page 52536]]
conduct of its medical research programs. Since M expends only 3.3 percent of its endowment, which does not constitute a significant percentage, in the active conduct of medical research, M is not an organization described in section 170(b)(1)(A)(iii) because M is not engaged in the continuous active conduct of medical research. (xi) Special rule for organizations with existing ruling. This paragraph (d)(2)(xi) shall apply to an organization that prior to January 1, 1970, had received a ruling or determination letter which has not been expressly revoked holding the organization to be a medical research organization described in section 170(b)(1)(A)(iii) and with respect to which the facts and circumstances on which the ruling was based have not substantially changed. An organization to which this paragraph (d)(2)(xi) applies shall be treated as an organization described in section 170(b)(1)(A)(iii) for a period not ending prior to 90 days after February 13, 1976 (or where appropriate, for taxable years beginning before such 90th day). In addition, with respect to a grantor or contributor under sections 170, 507, 545(b)(2), 556(b)(2), 642(c), 4942, 4945, 2055, 2106(a)(2), and 2522, the status of an organization to which this paragraph (d)(2)(xi) applies will not be affected until notice of change of status under section
170(b)(1)(A)(iii) is made to the public (such as by publication in the Internal Revenue Bulletin). The preceding sentence shall not apply if the grantor or contributor had previously acquired knowledge that the Internal Revenue Service had given notice to such organization that it would be deleted from classification as a section 170(b)(1)(A)(iii) organization.
* * * * *
(k) Effective/applicability date. This section shall apply to taxable years beginning after December 31, 1969. The applicability of paragraph (f) of this section shall be limited to taxable years beginning before January 1, 2008.
Par. 3. Section 1.170A9T is added to read as follows:
Sec. 1.170A9T Definition of section 170(b)(1)(A) organization (temporary).
(a) through (e) [Reserved]. For further guidance, see Sec. 1.170A 9(a) through (e).
(f) Definition of section 170(b)(1)(A)(vi) organization(1) In general. An organization is described in section 170(b)(1)(A)(vi) if it
(i) Is referred to in section 170(c)(2) (other than an organization specifically described in paragraphs (b) through (e) of this section); and
(ii) Normally receives a substantial part of its support from a governmental unit referred to in section 170(c)(1) or from direct or indirect contributions from the general public (``publicly supported''). For purposes of this paragraph (f)(1)(ii), an organization is publicly supported if it meets the requirements of either paragraph (f)(2) of this section (33\1/3\ percent support test) or paragraph (f)(3) of this section (facts and circumstances test). Paragraph (f)(4) of this section defines normally for purposes of the 33\1/3\ percent support test, the facts and circumstances test and for new organizations in the first 5 years of the organization's existence as a section 501(c)(3) organization. Paragraph (f)(5) of this section provides for determinations of foundation classification and rules for reliance by donors and contributors. Paragraphs (f)(6), (7), and (8) of this section list the items that are included and excluded from the term support. Paragraph (f)(9) of this section provides examples of the application of this paragraph. Types of organizations that, subject to the provisions of this paragraph, generally qualify under section 170(b)(1)(A)(vi) as ``publicly supported'' are publicly or governmentally supported museums of history, art, or science, libraries, community centers to promote the arts, organizations providing facilities for the support of an opera, symphony orchestra, ballet, or repertory drama or for some other direct service to the general public.
(2) Determination whether an organization is ``publicly supported''; 33\1/3\ percent support test. An organization is publicly supported if the total amount of support (see paragraphs (f)(6), (7), and (8) of this section) that the organization normally (see paragraph (f)(4)(i) of this section) receives from governmental units referred to in section 170(c)(1), from contributions made directly or indirectly by the general public, or from a combination of these sources, equals at least 33\1/3\ percent of the total support normally received by the organization. See paragraph (f)(9) Example 1 of this section. (3) Determination whether an organization is ``publicly supported''; facts and circumstances test. Even if an organization fails to meet the 33\1/3\ percent support test, it is publicly supported if it normally receives a substantial part of its support from governmental units, from contributions made directly or indirectly by the general public, or from a combination of these sources, and meets the other requirements of this paragraph (f)(3). In order to satisfy the facts and circumstances test, an organization must meet the requirements of paragraphs (f)(3)(i) and (f)(3)(ii) of this section. In addition, the organization must be in the nature of an organization that is publicly supported, taking into account all relevant facts and circumstances, including the factors listed in paragraphs
(f)(3)(iii)(A) through (E) of this section.
(i) Ten percent support limitation. The percentage of support (see paragraphs (f)(6), (7) and (8) of this section) normally (see paragraph (f)(4) of this section) received by an organization from governmental units, from contributions made directly or indirectly by the general public, or from a combination of these sources, must be substantial. For purposes of this paragraph (f)(3), an organization will not be treated as normally receiving a substantial amount of governmental or public support unless the total amount of governmental and public support normally received equals at least 10 percent of the total support normally received by such organization.
(ii) Attraction of public support. An organization must be so organized and operated as to attract new and additional public or governmental support on a continuous basis. An organization will be considered to meet this requirement if it maintains a continuous and bona fide program for solicitation of funds from the general public, community, or membership group involved, or if it carries on activities designed to attract support from governmental units or other organizations described in section 170(b)(1)(A)(i) through (vi). In determining whether an organization maintains a continuous and bona fide program for solicitation of funds fr

FOR FURTHER INFORMATION CONTACT Terri Harris at (202) 622-6070 (not a tollfree number).