In an earlier post about public support tests, we briefly discussed how an organization might qualify as a publicly supported charity under either Section 509(a)(1) or 509(a)(2) of the Internal Revenue Code. We subsequently explained the various income categories key to both of the public support tests. One common point of confusion when characterizing income categories is distinguishing between grants and gross receipts from mission-related activities. In this post, we will elaborate on when income should be classified as either grant income or gross receipts from mission-related activities for purposes of correctly calculating public support.
Gross Receipts from Mission-Related Activities
Gross receipts from mission-related activities are referred to in U.S. tax law as "gross receipts from exercising or performing an organization's tax-exempt purpose or function." Here, we refer to them simply as "gross receipts from mission-related activities." The U.S. Treasury Regulations provide that, "in distinguishing the term gross receipts from the term grants, the term gross receipts means amounts received from an activity which is not an unrelated trade or business, if a specific service, facility, or product is provided to serve the direct and immediate needs of the payor, rather than primarily to confer a direct benefit upon the general public." See Treas. Reg. § 1.509(a)-3(g)(2).
In other words, it is
- From goods, services, or facilities
- In furtherance of the organization's charitable purposes
- Where such charitable goods, services, or facilities directly serve the needs of the payor rather than the general public
Examples of mission-related activities that generate gross receipts include
- Sales of admission tickets for museums or zoos
- Sales of merchandise made by a charitable class (for a definition of "charitable class" see this post)
- Performance of services offered at a substantial discount
- Renting spaces at a nominal fee for charitable events
On the other hand, contributions that are made to an organization exclusively for the public benefit are categorized as grant income for purposes of the public support test. As the Internal Revenue Service (PDF) explains, "[a]ny payment of money or transfer of property without adequate consideration is considered a gift or contribution." Grant income is most commonly received through general fundraising, an organization's donation page on its website, or applications for grants.
Grants may be made for an organization's general support or for specific projects or programs. They may also have certain conditions tied to them, as long as such conditions do not confer more than an insubstantial benefit on the payor. The U.S. Treasury Regulations explain that
[a] grant is normally made to encourage the grantee organization to carry on certain programs or activities in furtherance of its exempt purposes. It may contain certain terms and conditions imposed by the grantor to insure that the grantee's programs or activities are conducted in a manner compatible with the grantor's own programs and policies and beneficial to the public. The grantee may also perform a service or produce a work product which incidentally benefits the grantor. Because of the imposition of terms and conditions, the frequent similarity of public purposes of grantor and grantee, and the possibility of benefit resulting to the grantor, amounts received as grants for the carrying on of exempt activities are sometimes difficult to distinguish from amounts received as gross receipts from the carrying on of exempt activities. Treas. Reg. § 1.509(a)-3(g)(2)
An example of the distinction between these two categories of income can be observed in the types of income generated by a museum. If the museum receives a grant to restore a painting, the funds are classified as grant income since there is no condition that the funder own or keep the painting. Instead, the painting is held in the museum's exhibition and is ultimately for the benefit of the public and its visitors. Conversely, the fee that the museum's visitors pay to enter the museum (and view its paintings) would be classified as gross receipts from mission-related activities since visitors receive a direct benefit through visiting the museum.
Research contracts are an area where the distinction between grants and gross receipts from mission-related activities is often blurred. "Research leading to the development of tangible products for the use or benefit of the payor will generally be treated as a service provided to serve the direct and immediate needs of the payor, while basic research or studies carried on in the physical or social sciences will generally be treated as primarily to confer a direct benefit upon the general public." Treas. Reg. § 1.509(a)-3(g)(2). Income from the former would thus be categorized as gross receipts from mission-related activities and income from the latter as grants.
The vast majority of government payments are considered grants for the public support test. However, it can be difficult to distinguish between grants and gross receipts from mission-related activities in the context of government contracts. As the IRS explains in the instructions to the annual information return required of U.S. charities (Form 990, Schedule A) (PDF):
[a]n amount received from a governmental unit is treated as gross receipts from exercising or performing the organization's tax-exempt purpose or function if the purpose of the payment is primarily to serve the direct and immediate needs of the payor governmental unit, and is treated as a contribution, if the purpose is primarily to provide a direct benefit to the public. For example, a payment to maintain library facilities that are open to the public should be treated as a contribution.
Just because a government agreement is called a "contract" or a "grant," that does not determine how its income should be classified. A payment from a governmental unit is treated as a grant
if its primary purpose is to enable the organization to provide a service to, or maintain a facility for, the direct benefit of the public rather than to serve the direct and immediate needs of the governmental unit. In other words, the payment is [a grant] if the general public receives the primary and direct benefit from the payment and any benefit to the governmental unit is indirect and insubstantial as compared to the public benefit.
See Form 990 Instructions, Part VIII (PDF).
Below are a few examples of governmental payments that are treated as grants.
- Payments by a governmental unit for the construction or maintenance of library or museum facilities open to the public
- Payments by a governmental unit to nursing homes to provide care to their residents (but not Medicare or Medicaid or similar payments made on behalf of the residents)
- Payments by a governmental unit to child placement or child guidance organizations under government programs to better serve children in the community
See Form 990 Instructions, Part VIII (PDF).
On the other hand, Medicare and Medicaid payments made on behalf of specific individuals are treated as gross receipts from mission-related activities rather than as grants from the government for the public support test. See Rev. Rul. 83-153, 1983-2 C.B. 48 (PDF).
Membership fees are paid purely to support the charity; they are considered grant income. However, if the membership fees are payments to purchase admissions, merchandise, services, or use of facilities offered by the charitable organization, in furtherance of its aims, then the receipt of such fees may be classified as gross receipts from mission-related income.
Notably, membership dues may consist of both grants and gross receipts. In such a situation, the excess of the fair market value of the service or product provided would be categorized as grant income. The portion of the payment that is equal to the fair market value of the product or service provided would typically be characterized as gross receipts.
Certain insubstantial membership benefits will not be counted as gross receipts, however. For example, low-cost articles, free or discounted admission to the organization's activities, discounts on purchases from the organization's gift shop, or free or discounted parking, may generally still be treated as contributory membership dues. See Form 990 Instructions, Part VIII (PDF).
At NGOsource, we often see instances when organizations will inadvertently misclassify their income due to a misunderstanding of the income categories. While we understand that commonplace errors occur in income reporting, we make every effort to ensure that all financial information is correctly characterized.
- IRS Publication 4220 (R. 3-2018) (PDF)
- IRS Form 990 instructions (PDF)
- IRS Form 990 Schedule A instructions (PDF)
- Basic Determination Rules for Publicly Supported Organizations and Supporting Organizations (1993 IRS EO CPE Text) (PDF)
This article is for general informational purposes only and does not represent legal advice as to any particular set of facts. Please seek legal counsel as you deem necessary.