Unless a 501(c)(3) organization proves they are a publicly supported charity, the IRS assumes they are a private foundation. The distinction is important because a publicly supported charity enjoys higher tax-deductible donation limits and generally is exempt from excise taxes and related penalties.
The tax code recognizes several types of publicly supported organizations, but most 501(c)(3) charities fall into one of two categories. The first, Sec. 509(a)(1) organizations, primarily rely on donations from the general public, governmental units, and other public charities. The second category, Sec. 509(a)(2) organizations, has significant program revenue. The IRS has established tests for each type of organization. If your nonprofit doesn’t pass the 509(a)(1) test, it may qualify under Sec. 509(a)(2).
The Sec. 509(a)(1) test requires that:
- You have at least one-third of your total support from the public, governmental agencies, or other public charities, or
- You have at least 10% of your total support from such sources and the “facts and circumstances” indicate you’re a publicly supported organization.
Several facts and circumstances help determine whether your organization is publicly supported — for example, whether you have actual sources of support above the 10% threshold, answer to a representative governing body and serve the general public on a continuing basis. Such tests measure public support over a five-year period, including the current and four prior tax years.
The public support percentage excludes certain types of contributions, program revenue fees from related activities, unrelated business income, investment income, and “unusual grants.” Net income from unrelated activities and gross investment returns are included in total support, though unusual grants aren’t.
Under the Sec. 509(a)(2) test, your 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 a five-year period.
This test is subject to limitations. When calculating public support, you can count only 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.
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.
It’s critical to maintain your nonprofit’s publicly supported charity status. Certain organizations, including universities and churches, automatically qualify as public charities. For other nonprofits, we can help determine whether you pass one of the two tests.