Nonprofits that aren’t careful can stray over the line that distinguishes between public charities and private foundations. This can expose nonprofits to lower tax-deductible donation limits as well as potential excise taxes and penalties. Certain organizations, including universities and churches, automatically qualify as public charities, but others must pass a public support test.
Role of public support
The tax code recognizes two types of publicly supported organizations. The first, Section 509(a) (1) organizations, rely on donations from the general public, governmental units and other public charities as their primary means of support. The second category, Sec. 509(a)(2) organizations, have significant program revenue.
The IRS has established separate tests for each type. The Sec. 509(a)(1) test can be less stringent, and if your organization doesn’t pass it, you may qualify under Sec. 509(a)(2). The tests are included in the IRS Form 990 on Schedule A.
Sec. 509(a)(1) test
This test requires your organization to have 1) at least one third of your total support from the public, governmental agencies or other public charities, or 2) at least 10% of your total support from such sources and the “facts and circumstances” indicate you’re a publicly supported organization.
Relevant facts and circumstances include whether your organization:
- Can attract public support,
- Has a percentage of public support above the 10% threshold,
- Has sources of support,
- Answers to a representative governing body, and
- Serves the general public on a continuing basis.
The test measures public support over a five-year period, including the current and four prior tax years. If your organization wasn’t a Sec. 501(c)(3) organization for the entire period, it should report amounts for the years that it was.
Be careful about misclassifying gross receipts that are subject to the limit; IRS auditors will look for payments that should be deemed gross receipts.
When computing the percentage of public support, exclude from the numerator contributions from each individual, trust or corporation that exceed 2% of your total support. However, you should include these contributions in your “total support” figure, or denominator. The cap doesn’t apply to contributions from certain governmental units or some publicly supported organizations.
Note, too, that the Sec. 509(a)(1) test excludes, among other things, program revenue fees from related activities (for example, admission fees), unrelated business income, investment income and “unusual grants” from the public support figure. Net income from unrelated activities and gross investment returns are included in total support, though unusual grants aren’t.
The Sec. 509(a)(2) test
Under the second test, an organization must receive at least one-third of its support from contributions from the public and gross receipts from activities related to its tax-exempt purpose. No more than one-third of its support may be from investment income and unrelated business taxable income. Public support is measured over the same five-year period as above. No alternative facts-and-circumstances test is available.
The Sec. 509(a)(2) test is subject to limitations, though. When calculating public support, you can only count the greater of $5,000 or 1% of your total exempt-purpose-related revenue from a single individual, corporation or governmental unit in the numerator. Receipts of any type or amount from disqualified persons, such as board members, aren’t considered public support either. All such revenue is included in the total support part of the equation.
Be careful about misclassifying gross receipts that are subject to the limits. IRS auditors will look for payments that should be deemed gross receipts but instead are classified as, for example, contributions, gross investment income or unrelated business taxable activity.
Pass the test
Your organization must comply with the public support test on an ongoing basis — so stay on top of it. Contact us if you have any questions about whether you’re at risk of forfeiting your public charity status.