A 501(c)(3) organization is presumed to be a private foundation unless it qualifies as a public charity. As discussed in a previous post and on our short YouTube clip, public charity classification is generally far more advantageous due to the burdensome rules and restrictions applicable to private foundations. Most 501(c)(3) organizations qualify as public charities under Section 509(a)(1) of the Internal Revenue Code (IRC). Generally, this group includes certain “per se” charities (churches, schools, hospitals, medical research institutions); governmental units; and organizations that pass either one of two public support tests.
The two public support tests referenced by IRC Sections 509(a)(1) and 170(b)(1)(A)(vi) are commonly referred to as the One-Third Support Test and the Facts and Circumstances Test. Both tests include a mathematical computation of an organization’s public support ratio (i.e., public support/total support) measured over a five-year period ending on the last day of the fiscal year for which the organization is filing its Form 990. An organization’s public support ratio is disclosed each year on its Form 990.
One-Third Support Test
————————— = 1/3 OR GREATER
An organization will be treated as a public charity under 509(a)(1)/170(b)(1)(A)(vi) 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 from governmental agencies and qualifying contributions or grants from the general public and other public charities. For example, if at the end of 2014, an organization has a public support ratio of at least 1/3 for the five years from 2010 through 2014, the organization will pass the test for 2014 and 2015 (even if it doesn’t pass the test for years 2011 through 2015).
Understanding what is and is not included in both “public support” and “total support” is critical to reporting and managing the public support ratio.
Total Support consists of:
- Gifts, grants, contributions and membership fees received*
- The value of services and facilities furnished by a governmental unit to the organization without charge (except services or facilities generally furnished to the public without charge)**
- Gross investment income
- Net income from unrelated business activities
- All other revenues EXCEPT:
- Gains from the sale of capital assets
- Gross receipts from admission, merchandise, or other business activities related to the charity’s exempt purposes
- Unusual grants
* Partly included in public support, subject to the 2% cap described below
** Fully included in public support
Public Support consists of:
- Grants from government agencies
- Contributions from other 509(a)(1)/170(b)(1)(A)(vi) public charities
- Gifts, grants, contributions, and membership fees from all other sources, subject to a 2% cap (i.e., any such contributions from a single source* count as public support only to the extent they do not cumulatively exceed 2% of total support). For example, if an organization has a total support figure (over the 5-year period) of $1 million, including $200,000 of cumulative contributions from Foundation X, the amount of Foundation X’s contributions that count as public support is limited to 2% of $1 million ($20,000).*
- The value of any services or facilities furnished by a governmental unit to the organization without charge (except services or facilities generally furnished to the public without charge)
- Benefits from tax revenues received by the charity
* Note that, when applying the 2% cap, amounts from certain related family members, and from business and their major owners, are combined and treated as coming from one source.
Facts and Circumstances Test
An organization that fails to meet the One-Third Support Test can alternatively qualify as a public charity under 509(a)(1)/170(b)(1)(A)(vi) if (a) it has a public support ratio of 10% or more; (b) the organization is organized and operated so as to attract new and additional public or governmental support; and (c) the facts and circumstances indicate it is a publicly supported organization (see the Five Factor Analysis below).
Attraction of public support. The organization must be organized and operated so as to attract new and additional public or governmental support. This may be shown if the organization maintains a “continuous and bona fide program” for solicitation of funds from the general public, community, or membership group involved, or if it carries on activities designed to attract support from governmental units or other charitable organizations described in Section 509(a)(1).
Five Factor Analysis. The organization must show that it is in the nature of a publicly supported organization, taking into account the following factors:
- Percentage of Financial Support. The greater the percentage of public support above 10 percent, the lesser the burden of establishing the rest of the factors below. If the percentage is low due to a high percentage of its total support from investment income on its endowment funds, the IRS will also consider whether the endowment came from general public, government sources, or from a limited group of donors.
- Sources of Support. Here, whether an organization is supported by government units, directly or indirectly from a representative number of persons, or a single family, will be taken into consideration in determining if the organization is publicly supported. Also important is the age and type of organization, and whether it appeals to a limited number of persons or communities.
- Representative Governing Body. The fact that an organization has a governing body that represents the broad interests of the public rather than the personal or private interest of a limited number of donors will be considered here. An organization’s governing body will generally be considered representative of the public interest if it is composed of: (a) public officials acting in their public capacity; (b) individuals selected by public officials acting in their public capacities; (c) persons having special knowledge or expertise in the particular field or discipline in which the organization is operating; and (d) community leaders, such as elected or appointed officials, members of the clergy, educators, civil leaders, or other such persons representing a broad cross-section of the views and interests of the community. Lastly, in the case of a membership organization, an organization will satisfy this factor if the governing body is comprised of individuals elected according to the organization’s governing instrument or bylaws by a broad based membership.
- Availability of Public Facilities or Service; Public Participation in Program or Policies. This factor looks for evidence that the organization:
- Provides facilities or services directly for the benefit of the general public on a continuing basis. Examples include a museum or library that is open to the public, or a conservation organization that provides educational services to the public through the distribution of educational materials.
- Publishes scholarly studies that are widely available and used by colleges, universities, and members of the general public.
- Participates in or sponsors programs by members of the public having special knowledge or expertise, public officials, or civil or community leaders.
- Conducts and maintains programs that focus on charitable work in the community, such as combating community deterioration or developing employment opportunities.
- Receives a significant part of its funds from a public charity or governmental agency to which it is in some way held accountable as a condition of the grant, contract, or contribution.
- Additional Factors for Membership Organizations. To determine if a membership organization is publicly supported, examine:
- Whether the solicitation for dues-paying members is designed to enroll a substantial number of persons in the community or area, or in a particular profession or field of special interest (taking into account the size of the area and the nature of the organization’s activities).
- Whether membership dues for individual (rather than institutional) members have been fixed at rates designed to make membership available to a broad cross section of the interested public, rather than to restrict membership to a limited number of persons.
- Whether the activities of the organization will be likely to appeal to persons having some broad common interest or purpose, such as educational activities in the case of alumni associations, musical activities in the case of symphony societies, or civil affairs in the case of parent-teacher associations.
If an organization is unable to satisfy both the One-Third Support Test and the Facts and Circumstances Test, there are alternative ways for an organization to become a public charity, including passing a public support test under IRC Section 509(a)(2) and meeting the requirements of a supporting organization under IRC Section 509(a)(3). Stay tuned for our next post, Public Support Tests Part II: 509(a)(2).