Congratulations if your organization has achieved 501(c)(3) public charity status! Now what is your plan to keep it?

Public Charity or Private Foundation?

Organization founders are usually focused on obtaining 501(c)(3) status. Most likely they want to be a special type of 501(c)(3) – a public charity. The alternative is to be classified as a private foundation. The default status for a 501(c)(3) organization is private foundation unless it qualifies as a public charity.

A private foundation is funded by one or a few donors, such as an individual, family or corporation, rather than the general public. A private foundation is subject to more rules and restrictions than a public charity and to excise taxes on net investment income. Certainly people can and do establish private foundations. But if the intent is to attract support from the general public, then the goal is to be classified as a public charity.

Public Charity Status per Determination Letter

Look at your organization’s determination letter. See if you can find a line at the top of the letter that says “Public Charity Status” followed by a reference to an Internal Revenue Code section. This information tells you how your organization qualified as a public charity at the time the determination letter was issued.

Once your organization has public charity status, the objective turns to keeping public charity status in the coming years.

Some organizations receive public charity status because of their nature such as a church, a school or a hospital. Organizations that don’t fall into a “per se” category must apply one of two public support tests each year to determine if they continue to qualify as publicly supported. These tests are found on Schedule A which is attached to Form 990 or 990-EZ.

Public Support Tests

The first public support test, the 509(a)(1) test, is for organizations that are primarily supported by a governmental unit or the general public. The second public support test, the 509(a)(2) test, is for organizations that receive a significant amount of support from exempt function income (program service fees).

An organization can qualify as publicly supported if it passes either test. Both tests are based on an average that spans the past five years. The tests consider sources of income only and do not include expenses.

Under the first test, the objective is to show that public support “in the form of contributions from publicly supported organizations, governmental units, and/or the general public” is 33 1/3% or more of total support.

Under the second test, public support, defined as “contributions, membership fees, and gross receipts from activities related to its exempt functions,” must be more than 33 1/3 % of total support and investment income must be 33 1/3% or less of total support.

Part of the complexity of these tests is that public support and total support are defined differently for each test. Also public support is limited for large donors and customers.

Potential Pitfalls

The two areas where we have seen nonprofit organizations run into difficulty with meeting either of the public support tests are

1. Too much investment income, such as rental income not related to the mission of the organization, and
2. Too few donors; i.e., a few major donors are keeping the organization going.

If you think your organization falls into either scenario above, talk to your CPA about the Schedule A public support test. Organizations get a “free pass” the first five years of existence, but once your organization files Form 990 or 990-EZ for its sixth year of operations, it will be subject to the public support test. If it fails, you will have one more year to correct the outcome. Keep in mind the test is an average of the past five years. So trying to fix your sources of income in one year might not be enough to make up for the prior four years.

For More Detail…

From what we have seen, most organizations subject to the public support tests do not run into problems. If your organization enjoys a broad base of donors and/or earns revenue from programs that further the organization’s exempt purpose, you should be O.K. For more information, here are two articles by Neo Law Group that go into much greater detail:   Public Support Tests Part I: 509(a)(1)  and  Public Support Tests Part II: 509(a)(2). We thought you might be curious!