On September 23, 2009, the Internal Revenue Service released the text of proposed regulations for Type III supporting organizations. This is only a proposal. The changes described below will not take effect until the IRS publishes final or temporary regulations. The IRS will take comment on the proposal for sixty days beginning from the date the proposed regulations are published in the Federal Register. 
 
At first read, the highlights appear to be:

Type III supporting organizations that are not functionally integrated will be required to meet a five percent payout test.  Payout will generally be calculated the same as payout for private foundations, except that set-asides will not be allowed, carryover of excess distributions are handled differently and new supporting organizations in this category will not be required to make a distribution in their first year of existence.  The notice also proposes a “reasonable cause” exception to the payout requirement.  Existing non-functionally integrated supporting organizations will be given a two-year transition rule to come into compliance with the distribution requirement. Non-functionally integrated Type IIIs will not be limited in the number of organizations they support.  The Advance Notice of Proposed Rulemaking had proposed limiting them to not more than five.  However, the Notice proposes that non-functionally integrated Type III supporting organizations must distribute at least one-third of their annual distributable amounts to those supported organizations with respect to which they meet the responsiveness test.  The proposal also provides that these supporting organizations must: (1) provide 10 percent or more of the supported organization's total support; (2) provide support that is necessary to avoid the interruption of the carrying on of a particular function or activity of the supported organization; or (3) provide an amount of support that based on all the facts and circumstances is a sufficient part of a supported organization's total support. The test for whether a Type III supporting organization is functionally integrated is a modified version of the current “but for” test.  Under the proposal, a Type III SO seeking a functional integration classification must demonstrate that substantially all its activities directly further the exempt purposes of those of its supported organizations for which it meets the responsiveness test and but for but for the involvement of the supporting organization, would normally be engaged in by the supported organizations.  The new parts of the test are the requirement that substantially all, not just some, of the organization’s activities must be in support of the supported organizations, that these activities must directly further, not just further, those purposes, and that the supported organizations must be those to which the supporting organization is responsive.  With an exception for Type III supporting organizations that support a single governmental entity, the notice makes clear that Type III supporting organizations that are primarily grantmakers cannot meet the requirements to be functionally integrated. All Type III supporting organizations must provide each of their supported organizations each year with: A written notice addressed to a principal officer of the supported organization identifying the supporting organization and describing the amount and type of support it provided to the supported organization in the past year;  A copy of the supporting organization's most recently filed Form 990; and  A copy of the supporting organization's governing documents, including any amendments.  Unless there are amendments, these documents need only be supplied once.

The notice requirement may be met through the use of electronic media; however, the supporting organization must be able to demonstrate on audit that the notice was actually delivered.
 
A more detailed analysis has been posted by the Council on Foundations here.