Supporting organizations, which are used to support specific charities, have had their tax exemptions revoked by the IRS in seventy-two instances in the last five years.
The IRS began investigating supporting organizations in 2004. In 2005, the IRS named these groups as one of the worst tax fraud schemes in the country. One of the ways the supporting organizations were abused was in financial planning schemes that allowed donors to a charity to take a tax deduction, but they got their donation back through offshore investments or interest-free loans.
When audited, another thirty supporting organizations simply agreed to close up. Fifty-nine more were reclassified as private foundations or as charities, which meant they would be subject to stricter reporting and granting requirements.
So far, most of the supporting organizations who have been examined by the exempt organizations division were those identified by other divisions of the IRS as likely to be part of a tax evasion scheme.
Most supporting organizations are "friends of" groups, which typically raise money of behalf of a university sports program or an arts institution.
The 2006 Pension Protection Act took a tough look at supporting organizations, and ended up applying similar rules to those that govern private foundations to prevent private benefit. In particular, the PPA zeroed in on Type III supporting organizations, which, unlike their Type I and Type II cousins, are not controlled by the charity they were created to support and are free to support any nonprofit organization.
Now the Treasury has proposed a payout rate of 5% of assets, for Type III supporting organizations, which is the rate required of private foundations. This is in an effort to make sure the Type IIIs are actually giving money to charity.
Some organizations are lobbying for a lower payout rate, but the revocation of the exemption for so many supporting organizations is making that lower payout rate unlikely.
Source: New York Times "I.R.S. Takes on Tax Abuse by Charity Support Groups" 2/15/2011