Social Impact Bonds: National Summit on Quality in Home-Visiting Programs

Risk and reward balance

I’ll be at the Fifth National Summit on Quality in Home Visiting Programs in Washington DC on May 7, 2015 participating on a panel discussing social impact bonds and pay-for-success financing. I’ll be joined on the panel, moderated by Lauren Schumer, The Pew Charitable Trusts, by:

David Juppe, Department of Legislative Services/Maryland General Assembly
Elizabeth Lower-Basch, Center for Law and Social Policy
Rhett Mabry, The Duke Endowment

Risk and Reward

Social impact bonds (SIBs) represent a form of pay-for-success financing.

In the Pay for Success model, governments partner with private sector investors who provide up-front funding to promising service providers. Investors only receive a repayment from the government if the service provider’s work is measurably successful. Because governments pay only if the programs work, the PFS model has the potential to more effectively allocate taxpayer dollars while increasing funding for programs that deliver improved social outcomes. – The Social Impact Bond Technical Assistance Lab (SIB Lab) at the Harvard Kennedy School

While SIBs provide for a mechanism in which governments can shift the risks of “unsuccessful” programs to the investors, they generally do so at the cost of paying more for “successful” programs. Typical profit-motivated investors will presumably develop strategies to mitigate the risks to maximize their opportunity for profits. Accordingly, SIBs must be seen as not merely a form of public-private partnership in which the interests of the government and investors are aligned to produce a favorable social outcome, but also one in which their respective interests are competing at selecting appropriate programs, metrics, parties, and payments.

For example, it would make little sense for governments to pay more for low-risk, high-social return programs that they should have simply funded directly. In contrast, it would make more sense for governments to pay more for high-risk, high-social return programs. Typical investors, on the other hand, will look for low-risk opportunities and/or mitigate the investment risks by negotiating metrics, terms, and conditions that favor their interests over the public interest. What will be required initially for the overall success of SIBs as a social financing strategy are true social investors who are willing to take on more risk for a less-than-market-rate return relative to such risk in exchange for advancing a social good.


What You Should Know About Social Impact Bonds, Gene Takagi

Social Impact Bonds: Overview and Considerations, Elizabeth Lower-Basch

Testimony of Dr. David B. Juppe, U.S. House Committee on Ways and Means, Subcommittee on Human Resources Hearing on Social Impact Bonds, September 9, 2014

Transcript for Pay for Success Social Impact Finance: South Carolina Home Visiting to Improve Health and Early Childhood Outcomes, March 11, 2013 (including comments from Rhett Mabry)

Quotes from Additional Resources

Social Impact Bonds: Lessons Learned So Far, Federal Reserve Bank of San Francisco

PFS contracts introduce several potentially valuable components: performance measurement, performance-based pay, an intermediary with management talent, financial resources for successful nonprofits to expand, and new program models. A subset of these components may be sufficient for, or may explain a large portion of, an intervention’s successful outcome. If the model is successful, we may not be able to tell the relative contributions of each.

Consider investments in prenatal health care. Such investments may produce short-term benefits such as improved infant and maternal health and lower health care costs, but they may also produce longer-term benefits such as reduced special education spending, reduced crime during teenage years, and increased adult earnings. While it would not make sense for a SIB contract to pay out over two decades as results become apparent—the feedback loop between management practices and results would be too long to be useful—it might be possible to design a SIB that paid out based upon short-term results that are predictive of longer-term benefits. It will be interesting to see whether any governments are willing to make payments based on these potential longer-term benefits.

How Will Governments Scale Pay for Success Contracts That Work?
In designing initial PFS contracts, it is important to have a vision for what will happen at the end of the contract if the project is successful. Clearly, it would be a bad idea to have the contract conclude, have services shut down, and then start the process of figuring out what comes next. But it is also not remotely possible to specify a plan for scaling up a successful intervention several years ahead of time since what is learned along the way will be critical to designing any follow-on plan. In practice, a sensible approach may be to write explicit deci- sion dates about contract extensions and scaling into the original contract with sufficient lead time to allow for effective expansion. For example, if the initial contract is for six years, then by the end of the fourth year a decision would be made about years seven and eight. Another question is whether follow-on contracts should assume the same PFS model or whether the government could simply contract directly for the now-proven program model. Ideally, the government will maintain capacity to measure impacts rigorously during successor contracts regardless of their setup.

Fact Sheet: Social Impact Bonds in the United States, Center for American Progress

At this early stage, SIBs are most appropriate for areas in which:

* Outcomes can be clearly defined and historical data are available

* Preventive interventions exist that cost less to administer than remedial services

* Some interventions with high levels of evidence already exist

* Political will for traditional direct funding can be difficult to sustain

 Building Networks Is Essential to Investment in Social Impact Bonds, Center for American Progress

The foundation staff also pointed out that potential collaborators should not assume foundations are exclusively interested in using any one type of capital: They have the ability to make grants, which require no payback; program-related investments, or PRIs, which are investments that focus on a charitable mission and range from 0 percent to below-market rate returns; and mission-related investments, or MRIs, which intend to achieve a market-rate return while advancing the foundation’s mission. Internally, most foundations split investment and grant-making functions into separate departments, which might mean different decision-making processes and priorities.

As conversations about social impact bonds continue, it is helpful to understand what drives potential collaboration among investors. Since each institution has multiple ways in which it could participate, it is not useful to make assumptions about whether or how any one organization would want to collaborate. Taking time to get to know an organi- zation’s mission, staff talent, available capital, appetite for risk, relationship with gov- ernment, and sustainability goals can help bridge the perception gap among potential investors. Participants at our discussions highlighted the role of networks in identifying expertise and understanding the bigger picture beyond the individual SIB transaction. Beyond access to financial capital, investors have intellectual and often community capi- tal that can be helpful in assessing whether to enter a deal.

Social Impact Bonds: Inside a Social Impact Bond Agreement, Center for American Progress

These challenges mean that the agreement itself—the contract signed by the government agency and the external organization—is critically important to the success or failure of a Social Impact Bond. Among other things, the contract will define the relationships and responsibilities of all the parties in this unusual arrangement, will set out the circumstances under which the external organization can expect to earn their payment, and will determine when either the government or the external organization can terminate the agreement. Writing the agreement well will help guarantee transparency and cooperation between the government and the external organization, help protect the vulnerable populations that the agreement serves, and make better outcomes possible.

Defining Terms in a Social Impact Bond Agreement, Center for American Progress

The contract should also place some restrictions on the government. In most SIB agreements this will include clauses prohibiting the government from exerting control over the external organization’s strategy or day-to-day operations. The contract should also prevent the government from intervening in the external organization’s selection of subcontractors and investors, though subcontractors will be held to the same standards as the external organization itself.

The Bottom Line: Investing for Impact on Economic Mobility in the U.S., Ascend | The Aspen Institute

Pay-for-success contracts are not appropriate for bleeding-edge innovation; they typically work best to scale up proven, battle-tested interventions.

For social service providers, social impact bonds represent a sea change not only in the amount, but in the kind of available capital. Payment in advance eliminates the challenge of meeting expenses while waiting for government reimbursement. Since investors are repaid based on outcomes, not inputs, unrestricted funding is not tied to specific program components and can be spent on what works best. With costs covered in full, providers can focus on services, not fundraising. All of that is intended to help high-performing nonprofits with proven interventions thrive, not merely survive.

 The Finalization of Urban Policy in the Age of Obama, Journal of Urban Affairs

The record on SIBs reveals several implications of the financialization of urban policy, that is, of aligning urban policy with the requirements of the funding mechanism. First is the pitfall of program selectivity. The tendency to fund programs that correspond to the underlying logic of SIBs is evident in the emphasis to date on programs designed to stem juvenile and adult recidivism and reduce use of healthcare and homelessness services. The aim of these programs is to reduce “subprime” behaviors that increase costs to governments and to use the cost savings to repay private investors and program needs that do not correspond to this logic are unlikely to be funded. A second and related problem is the monetization of outcomes. Because the aim is to reduce the cost of government programs rather than to address social issues per se, program success is defined in terms of cost reduction rather than the substantive effect on the underlying problem. As a consequence, programs that address a pressing social need but can’t directly be linked to cost reduction won’t be funded through SIBs. Third is the measurement problem arising from the assumption that changes in outcomes (e.g., reduced recidivism, lower healthcare costs) can be directly and causally attributed to the program intervention—a confidence in social science methodology that may be seriously misplaced. Ironically, given the logic of program evaluation, a positive outcome in the target population must exceed outcomes in the comparison population, so an improvement in the comparison population that could reasonably be considered a success for society as a whole would be deemed undesirable for investors. Fourth, SIBs’ reliance on independent evaluators to certify program success is likely to engender the same market-based pressures that bedeviled the bond rating agencies that certified the credit-worthiness of mortgage-backed securities prior to the economic collapse of 2007.

Social Impact Bonds: Phantom of the Nonprofit Sector, The Nonprofit Quarterly

It’s a public policy bet that has legislators of both parties and at the national, state, and local levels hopeful that private capital will somehow discover and fund public policy solutions that wouldn’t come to the fore without SIBs. It is a bipartisan dream built on a belief in the efficacy of the free market system that hasn’t borne much social progress fruit in recent years and rooted in a disparaging view of public servants, who have accomplished more than most free market true believers might ever guess.

Social Impact Investment, Building the Evidence Base, OECD

Social impact investment can potentially provide new ways to more efficiently and effectively allocate public and private capital to address social and economic challenges at the global, national and local levels. While these innovative new approaches will not replace the core role of the public sector or the need for philanthropy, they can provide models for leveraging existing capital using market-based approaches with potential to have greater impact. However, given that social impact investment is a nascent field, concrete evidence is needed in terms of its impact to date. In particular, further work is needed to demonstrate the gains from the social impact investment approach compared to existing social service delivery models.

While the social impact investment market has been growing significantly and has drawn increasing interest and attention, it is still in the early stages of development (Kohler et al, 2011) and is only a small share of the global capital markets today (Saltuk et al, 2014). While difficult to measure for a variety of reasons including the lack of clear definitions and the diversity of sectors and approaches across geographies, the social impact investment market potential has been estimated to be significant. This is due to growing interest among foundations and mainstream investors as well as an intergenerational transfer of wealth, estimated at USD 41 trillion that is expected to take place over the next 50 years with nearly USD 6 trillion of that expected to be directed towards social issues (Rangan et al, 2011).

Social impact investors, as well as targeted policies, can play a role in improving the effectiveness of social ventures (Jackson and Associates, 2012). Social impact investors can help social delivery organisations by providing not only financing but perhaps more importantly, support on strategy, management and growth (Bannick and Goldman, 2012). [Ed. Query the problems this can pose as well.] Helping social entrepreneurs grow their ventures to scale is the key to maximizing impact (Koh et al., 2012). The success of social impact investment is reliant on the long term sustainability and performance, both social and financial, of the impact organizations, for-profit and not-for-profit, in which the investments are made (Bannik and Goldman, 2012).

Despite the increased interest among institutional investors, securing commitment from traditional investors continues to be a challenge. The approach to institutional investors needs to be structured in way that works for them and in a language they can understand. Initiatives, such as GIIN, ANDE and SOCAP, which build links between mainstream and social impact investors, can help to create awareness and increase interest. Institutional investors also have certain legal requirements which can create barriers to social investing (Wood et al, 2012).

The lack of efficient intermediation in the social impact investment market translates into higher transaction costs caused by fragmented demand and supply as well as complex deal structuring (Freireich and Fulton, 2009). The early stage of ecosystem infrastructure development impedes the dialogue between investors and social ventures, which makes it difficult to break down historical barriers between philanthropy and investment (Freireich and Fulton, 2009). Platforms are needed to provide accessible distribution systems and offer comparable product performance (Jackson and Associates, 2012). This will also allow better matching of investor and investee risk/return profiles.


Opinion: Can Social-Impact Bonds Really Have Big Impact, The Chronicle of Philanthropy

I fear that even skilled nonprofits and intermediaries will have trouble translating great ideas into contracts that really provide the right incentives. When you look at how the parties do the accounting, how they measure “savings,” how they decide what the return should be and to whom at various break points, it gets inelegant, to say the least. – Clara Miller, President, F.B. Heron Foundation

Opinion: Social-Impact Bonds Need to Focus on Results, The Chronicle of Philanthropy

But financial savings are not our primary motivation, nor are they what brings our government, nonprofit, and investing partners to the table. Rather, progress toward social outcomes is the key motivator — supporting people in their efforts to get and keep jobs, build healthy families, improve educational opportunities; in short, finding ways to help our society’s most vulnerable reach their potential. Yes, the potential cost savings for government in the long term are compelling, but only because it offers a path to meaningfully solve or reduce problems that have stubbornly persisted even in the face of decades of effort. – Tracy Palandjian, CEO, Social Finance


Why Nonprofit Governance is Different from For-profit Governance


The basic legal duties of care and loyalty apply whether you’re a board member of a nonprofit or for-profit corporation, but what you’re responsible for overseeing may be very different.

Fiduciary Duties

The board of directors of a corporation, whether nonprofit or for-profit, is ultimately responsible for the management and direction of the corporation. Board members (or directors) are required to fulfill their duties of care and loyalty to the corporation in exercising their powers and meeting their responsibilities. The duty of care generally requires a director to act in a reasonable and informed manner under the given circumstances. The standard of care is typically expressed as that which “an ordinarily prudent person in a like position would use under similar circumstances.” The duty of loyalty generally requires a director to in good faith and in the best interests of the corporation. Accordingly, a director must place the interests of the corporation before her or his own interests or the interests of another person or entity and take appropriate steps wherever there is a conflict of interest or corporate opportunity.

For-Profit: Duties to Shareholders

Board members of a for-profit must consider the interests of the shareholders in exercising their powers and meeting their responsibilities. Attorney Douglas Park, in his article Board of Directors’ Fiduciary Duties to Shareholders, notes:

Just as board members owe a duty of care and duty of loyalty to the corporation, they owe the same duties to shareholders because they are considered to be fiduciaries of the shareholders.

It is important, however, to dispel the myth that shareholder wealth maximization is the only consideration for board members despite influential case law cited by respected academics (like my corporate law professor Stephen Bainbridge) stating:

“A business corporation is organized and carried on primarily for the profit of the stockholders. The powers of the directors are to be employed for that end.”

Nonprofit: Duty to Further the Exempt Purpose

Board members of a nonprofit do not have to consider shareholders (there are none), but for practical purposes, they should fulfill their duties to the corporation with consideration of its exempt purpose, the qualifying purpose for its tax-exempt status.

For charitable nonprofits exempt under Section 501(c)(3) of the Internal Revenue Code, board members must consider whether their actions are primarily intended to advance the corporation’s charitable purpose. The charitable purpose of the corporation (which may be determined by statements in its articles of incorporation, bylaws, exemption application, annual information returns, and other representations) impresses a charitable trust upon the assets of the corporation. Accordingly, the board members must act to protect such charitable assets from misuse and unlawful diversion. Although rarely enforced, board members may be held personally responsible by the state’s Attorney General or the Internal Revenue Service for misuse of charitable assets, particularly in egregious cases and cases in which the board members personally benefited from such misuse (e.g., self-dealing, excess benefit transactions).

Benefit Corporation

The board of a benefit corporation, which must pursue the general public benefit in its corporate activities, must consider the impact of its business decisions on the entity’s employees, its suppliers, the environment, and the community at large. But how such considerations balance against consideration of the shareholders’ interests is still to be determined.


Governance expert Lucy Marcus eloquently describes one of the most important roles of a board member (whether of a nonprofit or for-profit) – planning for the future and developing strategies using blue-sky thinking or stargazing:

This is where a board demonstrates its mettle in making sure their organization is ready and able to expand its horizons, strive to achieve more and stretch itself to become the robust and resilient business that is capable of responding effectively to the unknowns in its future.

For-profit governance has for practical purposes tended to focus on increasing short-term shareholder value, mitigating risks of lawsuits, and relying on an executive to stargaze under such constraints.

Nonprofit governance has also tended to focus on addressing short-term issues, but for different reasons:

  • Limited resources and a desire to create immediate impact
  • Lack of training, facilitation, and investment in the board to engage in such thinking
  • Limited emphasis on recruitment of board members with the desire and capacity to engage in such thinking

When acting to best advance a nonprofit’s charitable purpose, board members should each consider intergenerational equity. How are charitable resources best deployed to benefit not only those in immediate need but also future intended beneficiaries of the nonprofit? There are difficult trade-offs when investing for the future, but if a board fails to do so, the corporation’s likelihood for survival and relevance are jeopardized. There are many examples of how such investments may take form:

  • Endowment fund
  • Technology improvements
  • Impact assessments
  • Employee, volunteer, and board training
  • Fair pay
  • Executive recruitment and succession planning
  • Collaborations

Nonprofit board members should recognize the unique considerations associated with nonprofit governance. And without owners to hold them accountable, nonprofit boards must demand and create strong systems of self-accountability.


Nonprofit Tweets of the Week – 5/1/15

Street protest

The past week was highlighted by protests in Baltimore, valid criticisms of the media characterization of the situation, and a devastating earthquake in Nepal. And the Council on Foundations Annual Meeting in our hometown of San Francisco (Erin was there). Have a listen to Baltimore native David Byrne‘s Life During Wartime while perusing our curated nonprofit tweets of the week:

  • Gene: Recent developments and trends for exempt organizations Lexology
  • Nell Eddington: The State of the Nonprofit Sector in 2015:  New survey results from @nff_news
  • BDO Nonprofit: Why might claims against nonprofits be on the rise? via @NonProfitTimes
  • Erin: Study finds nonprofit Boards fall short: PND How’s your Board doing?
  • CalNonprofits: Successful lawsuits vs #nonprofit #boards (non-employment) are rare as lightning strikes so good to read re one in PA Giving in LA
  • Vu Le: Our hiring practices are inequitable and need to change
  • Stanford Social Innovation Review: Read Laura Arrillaga Andreessen on the potential of technology to accelerate #SocialImpact #COFAnnual SSIR
  • Council on Foundations: “As a sector, we are caught flat footed about the issue of technology.” @darrenwalker #cofannual
  • Center for Effective Philanthropy: RT @PhilCEP Think nonprofits don’t care about assessment? Aren’t working on it? WRONG.
  • Ellis Carter: Nonprofits and Affiliated Entities:
  • Journal of Accountancy: New FASB proposal would create big changes for not-for-profit reporting — Details at
  • Philanthropy: Opinion: When charities act as a shill for corporate interests, the public good suffers @uiuNews
  • ACLU of Northern California: ACLU statement on the death of #FreddieGray in police custody. #Baltimore #PoliceReform
  • United Nations: Ban Ki-moon says every every donation & show of support matters. Here’s how you can help #NepalQuake response efforts
  • Newsweek: The #NFL will end its [501(c)(6)] tax-exempt status as of the 2015 fiscal year
  • AAPIP: We tip our hats to @PeggySaika for her years of building democratic philanthropy #COFAnnual #AAPIP25 [Ed. We share the widespread love for and admiration of Peggy and are privileged to have worked together with her for many years!]

Nonprofit Law: Hot Topics – CEB / CLE

CEB Hot TopicsOn February 26, 2015, Erin and I recorded a webinar for Continuing Education of the Bar – California on Nonprofit Law: Hot Topics. It’s an intermediate-level one-hour CLE program available here.

Providing counsel to nonprofits requires knowledge and understanding of corporate and tax laws that are often not intuitive or easy to research, and that often differ from the laws applicable to for-profits. In this program, we’ll explore considerations in the nonprofit formation process, potential alternatives to formation of a new nonprofit entity, the legal implications of nonprofits engaging in commercial activities and for-profit social enterprises pursuing charitable goals, common governance mistakes, and recent changes in the laws impacting nonprofits. We will use relevant examples to illustrate how these concepts might apply to your clients.

Program Highlights:

  • New Form 1023-EZ, the short-form federal exemption application
  • Fiscal sponsorship, an often appropriate alternative to a startup
  • Recent changes to the Nonprofit Corporations Law affecting governance and bylaws
  • Earned revenues and application of the unrelated business income tax
  • Prohibited private benefits and application to nonprofits affiliated with businesses
  • Introduction to alternative entities, including the benefit corporation and social purpose corporation

Recent News from IRS Exempt Organizations Division

SEO web development concept: Update on digital background

IRS Exempt Organizations (EO) Division Director Tamera Ripperda has been speaking at conferences and to a few select groups over the past several weeks, providing us with a glimpse with what is currently happening within the EO Division. Ripperda commented that:

the IRS will shift its approach in examinations to focus on data-driven analysis of specific compliance issues, rather than undertaking projects to examine a specific segment of the EO sector, such as group exemptions or supporting organizations. In explaining the new approach, Ms. Ripperda commented that the IRS’s new “issue-focused strategy” would be used to identify cases for examination, and noted that such issues included protecting charitable assets, the tax gap, the unrelated business income tax, excise taxes and international activities.

The IRS, and specifically the EO Division, are also in the process of implementing a new knowledge management system, including content libraries that will initially be for internal use, but which Ripperda hopes will eventually allow for public access and contribution. This will help mitigate the loss of institutional knowledge resulting from the ongoing attrition of EO Division employees.

With respect to the backlog of exemption applications that reached as high as 74,000 applications with a median processing time of about 270 days, Ripperda claimed that the backlog has been reduced by 91 percent and the median processing time reduced to about 100 days. The approximate processing time of the controversial Form 1023-EZ is currently 3 weeks. Because about half of the applicants for exemption use the Form 1023-EZ, this seems to indicate that the processing time for the longer Form 1023 is about 120 days or 4 months.

2014-2015 Priority Guidance Plan

The Office of Tax Policy and IRS 2014-2015 Priority Guidance Plan (updated as of December 31, 2014) was released in January. Among the outstanding items related to the EO Division:

  • Proposed regulations under §501(c) relating to political campaign intervention. [Ed. Ripperda informed attendees at an Independent Sector event on April 24 that the Commissioner intended to get proposed regulations out this year. See also Recent Developments and Trends for Exempt Organizations – Ropes & Gray LLP]
  • Additional guidance on §509(a)(3) supporting organizations.
  • Guidance under §512 [Unrelated business taxable income] regarding methods of allocating expenses relating to dual use facilities.
  • Guidance under §4941 regarding a private foundation’s investment in a partnership in which disqualified persons are also partners.
  • Final regulations under §§4942 and 4945 on reliance standards for making good faith determinations. Proposed regulations were published on September 24, 2012.
  • Final regulations under §4944 on program-related investments and other related guidance. Proposed regulations were published on April 19, 2012.
  • Guidance regarding the excise taxes on donor advised funds and fund management.



Nonprofit Tweets of the Week – 4/24/15

Beautiful woman face close up with planet Earth texture

The past week was highlighted by Earth Day, a day for reflecting on the actions we are willing to take to protect our planet, our communities, our families. Conserving personal use of resources is great, but supporting, advocating, and effecting changes to policies, business ethics, and laws are critically necessary. Have a listen to Peter Gabriel’s Down to Earth (from the Pixar movie Wall-E) while perusing our curated nonprofit tweets of the week:

  • Stanford CorpGov: To improve governance and board-level performance, nonprofit organizations can incorporate nine recommendations: #corpgov
  • Stanford Business: 32% of nonprofit directors are not satisfied with the board’s ability to evaluate the performance of the organization #StanfordNBGI
  • Gene: Court of Appeals to Directors of Nonprofits: “Nonprofit” Does Not Mean “No Risk for You” NPQ … #governance
  • Phil Buchanan: This is 1 of most honestly self-critical & important pieces I have ever seen from a foundation exec. @ColoradoTrust [Ed. We hope you also look at the Center for Effective Philanthropy Report referenced in the article – Assessing to Achieve High Performance.]
  • Efram Bycer: “8 Ways to Better Board Meetings” via @CP_change #brdnxt
  • Tony Martignetti: 7 jaw dropping things I learned at AFP ICON | @GuideStarUSA #fundraising
  • Gene: Redefining capitalism (and prosperity)
  • Melissa Mikesell: This article: on @NRA fundraising highlights how corporations skirt federal PAC fundraising rules
  • Harvard Business Review: A must-read for any social entrepreneur: @RogerLMartin @SallyOsberg @SkollFoundation
  • McKinsey on Society: The first challenge for every #socent: “How do they get the initial financing?” @gennypi via @Entrepreneur
  • B Corporation: This piece in @guardian might be the best we’ve seen at breaking down #BCorp v benefit corporation! #BtheChange The Guardian
  • Gene: NY Times Opinion: Corporations Don’t Have to Maximize Profits [Ed. This is one of a series of opinions on this corporate governance issue.]

Public Charity: Public Support Tests Part II: 509(a)(2)

Glassy Pie Chart

A 501(c)(3) organization is presumed to be a private foundation unless it qualifies as a pubic charity. Part I of this post discussed how an organization can qualify as a public charity under one of two 509(a)(1) tests, either the one-third support test or the facts and circumstances test. Alternatively, an organization can qualify as a public charity under Section 509(a)(2) if it receives a substantial part of its income from activities related to the performance of the organization’s exempt purpose (i.e., related earned income) rather than from donations or investment income.

In order to qualify as a public charity under Section 509(a)(2), an organization (1) must normally receive more than one-third of its support from any combination of gifts, grants, contributions, membership fees, and gross receipts from certain permitted sources described below, and (2) must not receive more than one-third of its support from gross investment income and unrelated business income less tax. An organization must meet these tests – the One-Third Support Test and Not-More-Than-One-Third Support Test – in the aggregate over a five-year measuring period including the current taxable year and four prior taxable years.

To determine if an organization qualifies under 509(a)(2), three figures must be computed:

  1. Total support;
  2. Percentage of public support, which must exceed 33 1/3 percent of total support; and
  3. Percentage of investment income, which may not exceed 33 1/3 percent of the total.

Total Support

The sum of the following items, for the period in question, is the denominator of the fraction for computing both the percentage of public support and the percentage of investment income, further detailed below:

  •  Gifts, grants, contributions, and membership fees received
  • Gross receipts from admissions, merchandise sold or services performed, furnishing of facilities, or other business activities related to the charity’s exempt purposes
  • Gross investment income
  • Net income from unrelated business activities
  • Excluding: unusual grants

Percentage of Public Support


                        PUBLIC SUPPORT     

                       —————————              =    1/3 OR GREATER

                        TOTAL SUPPORT


An organization will be treated as a public charity under 509(a)(2) for its current year and the next taxable year if, over the five-year measuring period, one-third or more of its total support is public support, which generally includes donations, membership fees, gross receipts from admission, sales, performance of services, or furnishing of facilities related to an activity which is not an unrelated trade or business. There are, however, limitations with respect to what is included as public support. For example:

  • Gifts, grants, bequests, and gross receipts from the performance of exempt functions, if from a disqualified person, should not be included in the numerator. A disqualified person is generally defined to include a director, officer, substantial contributor (whose gifts to the charity exceed the greater of $5,000 or 2% of the total amount of donations received by the charity from its formation through the end of the taxable year in which the gift is made), owner of an entity that is a substantial contributor, and family members and 35% controlled entities of any of the foregoing.
  • Gross receipt amounts from the performance of exempt functions from government units, 509(a)(1) public charities, and individuals/entities that have not become disqualified persons as of the end of the taxable year may only be included in a taxable year up to the greater of $5,000 or 1% of the total support received by the charity in that taxable year.

Note that when computing the public support fraction, the entire amount of donations, membership fees, and exempt functions gross receipts for the period in question must be included in the denominator (total support), despite the limitations to such amounts in the numerator (public support). Unusual grants are excluded from this calculation.

It is important to note that the one-third public support test under 509(a)(2) is different from the one-third public support test under 509(a)(1). Both public support and total support are defined differently. In addition, there is no backup facts and circumstances test for organizations that have less than one-third public support under 509(a)(2).

If an organization is going to be making grants, it should understand the difference to its grantees between receiving a grant from a 509(a)(1) and a 509(a)(2) organization with respect to its characterization as public support. Contributions from organizations that qualify under 509(a)(1)/170(b)(1)(A)(vi) may be counted fully as public support, whereas contributions from other sources (including 501(a)(2) charities) are subject to a 2% cap as discussed in Part I.

Percentage of Investment Income


                    INVESTMENT INCOME

                       —————————              =    LESS THAN 1/3

                        TOTAL SUPPORT


Under 509(a)(2), an organization may not receive more than one-third of its total support from gross investment income and unrelated business income activities. Very generally, gross investment income is defined in the Internal Revenue Code as gross amounts of income from interest, dividends, rents, and royalties, excluding capital gains. Unrelated business taxable income includes net income derived from any trade or business which is not substantially related to the organization’s exempt purpose, keeping in mind certain applicable exceptions (e.g., volunteer, convenience, and donated good exceptions).

Therefore, at the end of each measuring period, the charity must compute a fraction with its total support as the denominator, and a numerator of gross amounts of income from interest, dividends, rents, and royalties, excluding capital gains, and any excess amount of unrelated business taxable income over the amount of tax imposed on that income.


Nonprofit Radio: Legal Issues Related to Volunteers

Volunteer Charity and Relief Work Donation Help Concept

I’ll be on Nonprofit Radio speaking with host Tony Martignetti this Friday at 10:30 am PT / 1:30 pm ET discussing volunteers and the legal issues nonprofits must consider when working with volunteers. You can tune in to the live feed on Talking Alternative or catch up later on iTunes.

We’ll be talking about:

  • Liability for acts of your volunteers
  • Protecting your organization
  • Protecting your volunteers


Risky Business: There’s liability for the acts of your volunteers | The Nonprofit Times (6/4/14)

Volunteers | National Council of Nonprofits

Managing Volunteers: Balancing Risk and Reward | Nonprofits’ Insurance Alliance of California & Alliance of Nonprofits for Insurance

Volunteers: A Primer on Possible Perils | For Purpose Law Group

Nonprofit Volunteers – Minimizing the Risks | Charity Lawyer Blog

Volunteer Protection Act of 1997 – An Imperfect Solution | Lisa Runquist

Employee or Volunteer: What’s the Difference? | Nonprofit Risk Management Center


Nonprofit Tweets of the Week – 4/17/15

equal pay

This week was marked by Equal Pay Day and National Volunteer Week (not to mention Tax Day). Have a listen to Sarah Jones recite Your Revolution while perusing our curated nonprofit tweets of the week:

  • Exponent Philanthropy: We name our favorite resources for #philanthropists who operate with a volunteer board or just one or two staff:
  • The New York Times: Cooper Union investigation should be a ringing alarm for nonprofit boards across the U.S.
  • Nonprofit Quarterly: #Nonprofits should be monitoring several major pieces of legislation in the months ahead
  • Nonprofit Quarterly: TRENDING: Do the Fruits of Philanthropy Now Fall Closer Than Ever to the Tree?
  • Alex Daniels: “Redskins” foundation –“Not Philanthropy”  The Spectrum
  • Gene: A Moving Target: The regulation of online fundraising platforms The Nonprofit Times … #nonprofit #crowdfunding
  • Independent Sector: The latest Nat’l value of volunteer time is $23.07 per/hr, a 2.3% increase frm last yr! More info here  #NVW2015
  • CalNonprofits: Open letter to Charity Navigator @CharityNav from Calif Assn of Nonprofits — advice as they choose new CEO
  • Jermyn K.Y. Voon: Great read –> Four Factors for Effective #NonprofitGovernance via @alicekorngold #corpgov
  • Debra Beck: Getting to great #nonprofit board dialogue: 4 critical factors
  • Blackbaud: When Good Donors Do Bad Things Wall Street Journal
  • Philantopic: From Nonprofit to Social Profit: Exploring Assessment for #SocialGood  @triplepundit #nonprofits #socent
  • Camfed: @jeffskoll at #SkollWF: “If there’s a silver bullet to global development, it’s girls education.” Full recap: [Ed. Day 1 of the Skoll World Forum.]



Critical Nonprofit Legal Knowledge for Emerging (and Current) Executive Directors

learning never ends

I’ll be joined by attorney Michele Berger in presenting our first small group seminar of 2015: Critical Nonprofit Legal Knowledge for Emerging (and Current) Executive Directors. There are a few spaces still open. Please RSVP if you’re in our neighborhood.

We’ll be covering:

  • Executive’s role in governance
  • Prohibited activities and transactions
  • Collaborations
  • Social media risks

With attendance limited to 10 persons, we expect there to be lots of Q&A.

Thursday, April 30th
12:00pm – 1:00pm
201 Spear Street, Suite 1100
San Francisco, CA​