A nonprofit organization that is organized and operated exclusively for charitable purposes may be deemed a public charity (and not a private foundation) under section 501(c)(3) of the Internal Revenue Code (IRC) in one of three principal ways.
- It meets certain requirements based on the nature of its activities;
- It qualifies as a "publicly supported charity" based on a mathematical public support test; or
- It is a "supporting organization" to another public charity.
In our previous post, we briefly addressed organizations of the first category. Here we will discuss a second category -- publicly supported charities -- and the tests that determine whether an organization qualifies as such. A future post will address supporting organizations.
A nonprofit organization may qualify as a publicly supported charity in one of two ways:
- By being primarily supported by gifts, grants, and contributions from the government and the public, as described under IRC section 509(a)(1); or
- By being primarily supported through income earned from conducting activities in furtherance of the organization's exempt purposes, as described under IRC section 509(a)(2)
These two types of publicly supported charities are subject to two different mathematical income tests, called public support tests. Under both tests, public support is measured over an aggregate 5-year computation period.
The 509(a)(1) Public Support Test
The majority of publicly supported charities qualify under this test. To qualify under IRC section 509(a)(1), an organization must normally receive a substantial part of its support in the form of contributions from government or the general public in one of these ways:
- It receives 33 1/3 percent or more of its total support from public support; or
- It receives 10 percent or more of its total support from public support, and it satisfies a set of facts and circumstances further defined below.
To calculate an organization's public support percentage, we divide its "public support" by its "total support."
What Is Public Support (the Numerator in the Calculation)?
Public support includes all funds received from gifts, grants, contributions, donative membership fees, and the value of taxes levied and other government facilities or services furnished to the organization without charge.
Generally, contributions from U.S. public charities and governments are counted in full. Contributions from individuals, private foundations, and other organizations (called private sources) are capped at 2 percent of an organization's total support.
What Is Total Support (the Denominator in the Calculation)?
Total support includes gifts, grants, contributions, membership fees, tax levies, government support, investment income, and unrelated business income. Essentially, total support includes all revenue except gains from the sale of capital assets, gross receipts from mission-related activities, and unusual grants.
What Is the 10 Percent Facts and Circumstances Test?
Even if an organization does not meet the 33 1/3 percent public support threshold, it may still qualify as a publicly supported charity if it receives 10 percent or more of its total support from public support and additionally satisfies a set of facts and circumstances. These facts and circumstances must demonstrate that it is "in the nature of an organization that is publicly supported." To be in the nature of a publicly supported organization means that the organization is organized and operated to "attract new and additional public or governmental support on a continuous basis" (meaning that it must have some type of fundraising plan). The organization must also demonstrate that it is accountable to the general public in other ways, such as by having a diverse board, and operating programs for the general public rather than simply making grants. See Treas. Reg. § 1.170A-9(f)(3).
Organizations in their first 5 years of existence must be able to demonstrate that they can be reasonably expeted to meet the public support test. When 5 complete years of financial information is not avilable, public support is calculated by reviewing a combination of actual and projected financials totaling 5 years. In addition, an organization might utilize the facts and circumstances test to demonstrate the organization's likelihood of meeting the public support test at the end of its first five years in existence.
The 509(a)(2) Public Support Test
To qualify as a publicly supported charity under IRC section 509(a)(2), an organization must receive most of its income from gross receipts earned in the conduct of its charitable activities. It is less common for an organization to qualify under this test.
Specifically, more than 33 1/3 percent of the organization's support normally must come from the following sources:
- Public support, as defined above; and
- Gross receipts from admissions, sales of merchandise, performance of services, or furnishing of facilities from an activity that is part of a related trade or business.
The test is much more complicated, so we will not describe it at length. Briefly, to qualify, an organization must receive "almost all of its support … from gross receipts from related activities." See Reg. 1.170A-9(f)(6).
Gross receipts from related activities are sometimes referred to as "mission-related income." The term refers to income from an activity related to the organization's charitable trade or business. The activity must provide a specific service, facility, or product to the paying entity.
Examples of organizations that meet this test are museums and zoos, for whom admission fees make up a significant part of their revenue.
The 509(a)(2) test does not allow for a 10 percent facts and circumstances test. It also subjects the organization to other support limitations that aren't discussed here: notably, there are certain public support limitations and restrictions on amounts received from Disqualified Persons and non-Disqualified Persons. In addition, no more than 33 1/3 percent of the organization's support can come from gross investment income and net unrelated business income.
What if an Organization Fails the Public Support Tests?
An organization that does not pass the 509(a)(1) or 509(a)(2) public support tests will not qualify as a public charity. However, if it is organized and operated for charitable purposes, it may still be classified as a private foundation.
This post is intended to serve as a general introduction and overview of the public support tests. For more detailed descriptions of the applicable rules, we recommend the following resources.