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THE PUBLIC
SUPPORT TEST for 501(c)(3) ORGANIZATIONS: Remember your Fractions* (click
to download printable version in PDF)
501(c)(3) Status. Organizations are recognized as exempt under Section "501(c)(3)" of the Internal Revenue Code because they are "organized" and "operated" for "exempt purposes" and are "not-for-profit." The 501(c)(3) exemption means that they pay no tax on revenues, and (in most cases) that donors get a deduction when making gifts to them. 501(c)(3) Universe: "Private Foundations" + "Public Charities." In the world of 501(c)(3) there are two categories: "private foundations" and "other than private foundations," often called "public charities." "Private foundations" are generally treated less favorably than "public charities." Why? The key to being a "public charity" is support from the general public. Congress thought that the need to keep raising money from the general public would keep "public charities" honest. By contrast, Congress though that "private foundations," living off the income from a large fund, controlled by a select few, with no need to demonstrate their good works to the public, would not "keep honest" without regulation. Disadvantages of being a "Private Foundation"? "Private foundations" pay 1%-2% tax on net investment income and are subject to various prohibitions on transactions between themselves and those who control them, including directors. They are prohibited from lobbying and pay tax on any lobbying expenses, which, along with other prohibited expenditures, are known as "taxable expenditures." Foundations are also subject to other regulations not applicable to public charities. The deductibility of gifts to private foundations is somewhat more limited than to "other than private foundations." Their donors' identities are subject to public disclosure and, in general, foundations have more extensive reporting obligations. ("Operating foundations" that carry on charitable activity other than grantmaking are slightly less heavily regulated.)
How Do You Get to be "Other Than" a "Private
Foundation"? The "other than private foundations"
(“public charities”) subcategory within the 501(3) category includes
things like schools, churches, hospitals and research affiliates, and also
"publicly supported" organizations (all of these are 509(a)(1) or (2)). Also included, and described in 509(a)(3), are "supporting organizations," of which
there are essentially three types. A supporting organization must
"support" one or more 509(a)(1) or (2)
organizations. The following figure illustrates the world of private
foundations and "other than private foundations" ("public
charities").
Section 509(a)(1)
How can the organization meet these 1/3 or 10% tests? There are two tricky aspects to this, one "bad" and three "good." "Unhelpful" and "helpful" might be another way to explain it.
The "bad" part is that when computing these fractions, the amount
by which an individual donation (by which we mean, from any individual person
or corporation, or from a non-publicly supported charity (e.g., a private
foundation) exceeds 2% of the total DOES NOT GO INTO THE NUMERATOR,
but it DOES GO INTO THE DENOMINATOR. This means that significant financial
support given by an individual, a corporation, or even another non-publicly
supported organization, could jeopardize the organization's status as other
than a private foundation.
The first "good" thing is
that gifts of services, or use of space, do not count in either numerator or
denominator. The second "good" thing is that "unusual
grants" (explained at length y regulation) also do not count. The
third "good" thing can really "save the day" for any
organization that has a small budget: contributions from government or
other publicly supported organizations count in BOTH numerator and
denominator. (Contributions from an organization's own supporting
organization wouldn't qualify because it is not, itself, publicly supported.)
A 509(a)(2) organization has a 1/3 public support
test similar to the one discussed above, but with some major
differences. It DOES include in its numerator not only gifts and
grants, but receipts from exempt activities (e.g. theater tickets for a
theater) -- let's call those "fees." This is why we sometimes think
of this section as appropriate for "service-providing"
organizations, those that "earn" their income. But it can NOT
include "fees" received from any individual, corporation or government
agency that exceed the greater of 1% of the total or $5,000. In other
words, when it comes to "fees," the numerator has instead of a
"2%" test, a "greater of 1% or $5,000" test. It
also can NOT include in its numerator ANY receipts from "disqualified
persons." These include board members and "major donors" and
those with certain family or business relationships. "Major
donor" has a very technical definition, but if anyone gives over $5,000,
look this up in Regulations section 1.507-6(b)(1). The organization must also pass another
test: it is prohibited from having more than 1/3 of its
income come from a combination of investment income and net
unrelated business income. (Investment income from its supporting organization
would pass through and be treated as its own.)
Although 509(a)(2) is
designed for what one could think of as "service-providing
organizations," it can also help out a very small organization that has
a few donors who give more than the 2% that would be a problem under
509(a)(1).
Observe that if this were a 509(a)(1) organization, the contributions of M, N, O and P would count as $2,000 each (2% x $100,000), but on the other hand, the contribution of each Major Donor would count for $2,000 rather than zero; accordingly, there would be $30,000 in the numerator. DISCLAIMER: Return to sharinglaw.net nonprofit page |
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