One of the main distinctions the IRS has established that distinguishes public charities from private foundations, is the broad base of support from the public that is required to establish a public charity.
To qualify as a public charity under Section 501(c)(3) of the Internal Revenue Code, an organization must meet specific requirements regarding the source and amount of its financial support.
There are two primary tests used to determine whether an organization qualifies as a public charity: the One-Third Support Test and the Facts and Circumstances Test.
Below is a detailed explanation of these tests and their associated rules, exceptions, and nuances.
1. One-Third Support Test (Section 509(a)(1))
The One-Third Support Test requires that at least one-third of an organization’s total support comes from the public or governmental sources. Specifically:
- The sources of support include contributions from the general public, governmental units, or other public charities.
- Qualifying public contributions must come from a broad base, including individual donors, governmental grants, or contributions from other public charities.
- No single donor or entity (excluding government units and other public charities) can contribute more than 2% of the organization’s total support. If a donor’s contributions exceed 2%, the excess amount will not count towards meeting the one-third public support threshold.
Exceptions and Nuances:
- Donations from public charities and government sources do not count toward the 2% limitation. This allows organizations to receive large sums from these sources without jeopardizing their public charity status.
- Contributions from gross receipts, such as fees for services, admissions, or memberships, can also count as public support, provided these amounts are received from the general public and are not concentrated among a few individuals or entities.
2. The 10% Facts and Circumstances Test (Section 509(a)(2))
If an organization cannot meet the One-Third Support Test, it may still qualify as a public charity under the Facts and Circumstances Test, also called the 10% Facts and Circumstances Test. This test provides more flexibility but requires that:
- The organization receives at least 10% of its total support from the public or governmental sources over a four-year period.
- In addition to meeting the 10% threshold, the organization must demonstrate that it meets a variety of other criteria, collectively referred to as “facts and circumstances,” that indicate it operates in the public interest. These criteria include:
- Having a diverse and representative board of directors, not dominated by a few private individuals.
- Conducting programs and fundraising efforts aimed at receiving broad public support.
- Engaging in activities that directly serve the general public or the community.
Special Rules for Determining Public Support
Several rules and exceptions apply when calculating whether an organization meets the public support test
1.Unusual Grants:
- The IRS allows organizations to exclude unusual grants from the public support calculation if these grants are unexpected, substantial, and not part of the regular solicitation activities of the organization. These are typically large, one-time contributions that could otherwise distort the support percentage.
- The exclusion of unusual grants helps ensure that a large, unexpected gift does not unfairly disqualify an organization from public charity status.
2. Gross Receipts Exception:
- Gross receipts from activities related to the organization’s exempt purpose can count as public support. However, these receipts are subject to certain rules:
- If the organization receives more than $5,000 or 1% of its total support from a single individual or entity through gross receipts, only that threshold amount counts toward public support. Anything above that threshold is not included.
- This rule helps prevent an organization from depending too heavily on income from a small group of individuals or organizations.
3. Related Organizations and Contributions from Substantial Contributors:
- Contributions from “substantial contributors” (defined as individuals or entities that contribute a significant portion of the organization’s funding) are generally not included in the public support calculation beyond the allowed thresholds.
- The purpose of this rule is to prevent an organization from claiming public charity status if it primarily relies on the support of one or a few large donors.
Exceptions and Exceptions to Exceptions
1.Exception for Membership Dues: Organizations that rely on membership dues as a form of support can include these amounts as public support, provided that the dues are structured so that they are accessible to a broad segment of the public (e.g., small annual fees).
If a significant portion of the dues comes from a few members, the excess may be excluded, similar to the 2% limitation applied to contributions.
2. Substantial Contributor Exception:
- While large contributions from substantial contributors are generally subject to the 2% limit, an exception exists for government entities and other public charities. Contributions from these sources are fully includable as public support regardless of their size.
3. Exception for Certain Types of Income:
- If an organization generates income from activities related to its exempt purposes (e.g., fees from educational programs or healthcare services), this income may count fully toward public support, even if received in large amounts from a few entities, as long as it is part of regular, exempt-function activities.
Final Considerations
The IRS reviews public charities’ adherence to these rules over a rolling four-year period. This time frame allows organizations flexibility in planning and managing their support sources. Organizations must maintain proper records and calculations to ensure compliance with these rules, and failure to meet either the One-Third Support Test or the Facts and Circumstances Test could result in reclassification as a private foundation, which carries stricter regulations and fewer tax advantages.
Navigating the nuances of public support can be complex, which is why it is advisable to work with professionals familiar with IRS regulations and charitable planning to ensure ongoing compliance and maximize benefits.