LegalEASE: Note from the Legal Experts - Characterizing Income of 501(c)(3) Public Charities

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In prior posts we discussed the different categories of public charities. They include publicly supported charities that qualify as such because they are both organized and operated exclusively for charitable purposes and they meet a mathematical public support test.

The public support test can be confusing because it requires organizations to track their income to determine what percentage is from public sources, as defined under the applicable U.S. regulations. For non-U.S. organizations, public support does not need to be reported in U.S. dollars, but it does need to be computed on the same basis as the organization's regular accounting method.

In this post we'll outline common income categories and discuss their relevance to U.S. public charities and non-U.S. organizations that seek equivalency determinations (EDs). Organizations might not have income from every possible category listed here. The definitions provided for income categories are the same for both 509(a)(1) and 509(a)(2) public charities, although the application of the income may vary. For more information on the difference between 509(a)(1) and 509(a)(2) publicly supported charities, see our prior post on this topic.

Gifts, Grants, and Contributions

Gifts, grants, and contributions refer to voluntary financial donations with no direct return benefit. This income category includes all donative income, regardless of the size. For example, it might include a million-dollar grant from a private foundation, as well as a $1 contribution from an individual. According to the IRS (PDF) "[a]ny payment of money or transfer of property without adequate consideration is considered a gift or contribution. The amount includible in computing support with respect to gifts, grants, or contributions of property or use of property is the fair market or rental value of the property at the date of the gift or contribution."

The source of the gift has no bearing on its classification as donative. A contribution may be made from a government, a for-profit company, an individual, a group of individuals, a public charity, or a private foundation. The source of the gift is, however, important for purposes of determining public support, further discussed below under "Major Donors."

This category also includes payments made from a governmental unit if the payment helps the organization (1) further its exempt purpose and (2) provide a service or facility directly to the general public.

Membership Fees

Membership fees may qualify either as gross receipts paid in exchange for services (defined below) or as donative gifts, grants, and contributions (defined above).

As the IRS explains (PDF), "if an organization uses membership fees as a means of selling admissions, merchandise, services, or the use of facilities to members of the general public who have no common goal or interest (other than a desire to purchase such admissions, merchandise, services, or facilities), the payments do not constitute [donative] membership fees; instead, they are gross receipts. On the other hand, to the extent that the basic purpose for making the payment is to provide support for the organization … the income received from the payment constitutes [donative] membership fees."

Tax Levies

The term tax levies refers to tax revenues collected by a federal, state, or local government for the organization's benefit and either paid to the organization or expended on its behalf. For example, a local government might levy a tax to raise funds to support the organization's activities. Tax levies is not a category of income we often see.

Government Services and Facilities

This category refers to the fair market value of services provided or facilities furnished without charge by a governmental unit. It does not include services or facilities generally furnished to the public without charge. For example, if a local government donates the use of classroom space to an organization, then the fair market value of the space if it were leased would qualify as income under this category.

Gross Receipts from Mission-Related Activities

Gross receipts are commonly referred to as mission-related income. This type of income includes such things as admission fees to educational events, conference revenue, publishing revenue for publications directly related to the organization's charitable activities, and income earned from conducting research on behalf of educational or government institutions.

Sometimes it is not immediately evident whether income is properly classified as gross receipts or as donative contributions. This is especially so in the case of contracted research. Many funders make grants to organizations specifically to fund a research project. Generally speaking, if the results of the research are only available to the funder, then the payment is likely gross receipts. Alternatively, if the results of the research will be made available to the public, with no exclusive benefit provided to the funder, then the income is likely grant income.

Below are just a few examples of common types of mission-related income.

  • Admission fees to a zoo, museum, planetarium, symphony, theater, ballet, opera, or natural park
  • Fees to attend a conference, symposium, or other educational forum
  • Payments to a hospital for medical care and treatment
  • School tuition or other course fees
  • Payments for contracted research, surveys, polls, or other data collected for the purposes of the payor, but still in furtherance of the organization's charitable or educational mission
  • Subscriptions to scholarly journals, research reports, or other informative publications
  • Payments for consulting work conducted by the organization below cost for the benefit of other charities

Unrelated Business Income

According to IRS Publication 598 (PDF), "Unrelated business income is the income from a trade or business regularly conducted by an exempt organization and not substantially related [at least 85%] to the performance by the organization of its [charitable] purpose or function, except that the organization uses the profits derived from this activity." Below are just a few examples of unrelated business income.

  • Income from the sale of t-shirts, jewelry, mugs, food, or other merchandise that does not directly serve to further the organization's charitable purposes (other than as a source of revenue)
  • Lease payments for the use of event spaces, or more long-term property rentals
  • Parking fees collected for the use of a parking lot open to the general public
  • Income from the sale of commercial advertising, even if the advertising appears in an educational publication of the organization
  • Income from the sale of membership mailing lists

Gross Investment Income

Gross investment income includes income from interest, dividends, payments received on securities loans, rents, royalties, and income from similar passive investment sources. Gross investment income does not include payments that result from activities of the organization that further its exempt purposes. See "Gross Receipts."

Major Donors

Major donors are individuals or organizations that have contributed more than 2 percent of the organization's total support over 5 years. The major donor distinction is important because the amount of public support from certain major donors will be capped at 2 percent of its total support to an organization over the same 5-year reporting period.

However, the 2 percent limitation does not apply to contributions from organizations that qualify as public charities or their equivalents; governmental units or agencies and instrumentalities; or international organizations designated by U.S. executive order.

More information on income categories of publicly supported charities may be found in the instructions to Schedule A of the Form 990 (PDF) annual information return filed by U.S. public charities.

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