October 30, 2023

Written by: Carolyn Fjelstad and Sarah Huang, CPA, MST

Picture this: A newly formed not-for-profit organization, whose application for exemption was submitted to the IRS, finally has a determination letter in hand. Per the letter, the organization is declared to be exempt from federal income tax under 501(a) as an organization described in Code Sec. 501(c)(3). This organization is now running full steam ahead with its formal acknowledgement of a public charity status from the IRS. However, let’s take a brief step back…

How Did Our Organization Get Here in the First Place?

Whether you are an established public charity or one that just formed, understanding the public support test and how to maintain strong public support on an ongoing basis is key to preserving an organization’s exempt status with the IRS.

As a 501(c)(3) organization, which is the most common tax-exempt organization, you can either be categorized as a private foundation or a public charity. All 501(c)(3) organizations are automatically deemed private foundations unless they can meet the annual public support test. Private foundations are typically funded by few donors and earn revenue from their investment holdings, often preventing the foundation from meeting the annual public support test.

On the other hand, public charities are supported by many individuals, organizations, government entities, etc. Some public charities even earn revenue for charitable services provided to the public. Because of this, federal law requires exempt organizations to show qualification as a public charity on an ongoing basis with the completion of Schedule A on Form 990 or Form 990-EZ.

Which Organizations Are Required to Complete the Public Support Test?

Public charity isn’t a term that you will find in the tax code. Instead, they are called non-private foundations. If an organization is a qualifying non-private foundation (i.e., public charity), its IRS determination letter also assigns it a subsection of Code 509(a) or 170(b)(1)(A). This subsection determines which portion of Schedule A is required. For example, the determination letter may say:

The organization is not a private foundation within the meaning of 509(a) of the Code, because you are an organization described in sections 509(a)(1) and 170(b)(1)(A)(vi).”

In general, all 501(c)(3) organizations are required to complete Schedule A, Part I, to declare the reason for non-private foundation status. Not all organizations, however, need to complete the actual public support test. From the assigned code subsection, certain organizations are known to inherently benefit the pubic. Such organizations include:

  • A church, convention of churches, or association of churches – section 170(b)(1)(A)(i)
  • A school – section 170(b)(1)(A)(ii)
  • A hospital or a cooperative hospital service organization – section 170(b)(1)(A)(iii)
  • A medical research organization – section 170(b)(1)(A)(iii)
  • A federal, state, or local government or governmental unit – section 170(b)(1)(A)(v)
  • Supporting organizations – section 509(a)(3)
  • Public safety organizations – section 509(a)(4)

For an organization required to continue through Schedule A and calculate the percentage of public support, its support test is dependent on the type of revenue it generates.

  • Primarily contributions – An organization that normally receives a substantial part of its support from a governmental unit or from the general public.
  • Primarily program – An organization that normally receives (1) more than 33 1/3% of its support from contributions, membership fees, and gross receipts from activities related to its exempt functions, subject to certain exceptions; and (2) no more than 33 1/3% of its support from gross investment income and unrelated business taxable income.

We commonly refer to these entities as a 509(a)(1), which would complete Part II of Schedule A, and 509(a)(2), which would complete Part III of Schedule A.

When Does the Public Support Test Start to Count?

The public support test comes into play once an organization is in its sixth year of existence. In other words, the IRS provides a five-year grace period for newly formed organizations to meet the test. Once the grace period is over, the test is done annually but is calculated using the cumulative totals of the reporting year and four preceding years.

Even though the percentage is not declared until an organization’s sixth year of existence, it’s imperative the organization calculates and closely monitors public support each year. After its sixth year of existence, the organization must meet the rolling five-year support test in either the current filing year or the immediately preceding tax year.

What Is a 509(a)(1) Test? 

509(a)(1) organizations primarily receive funding from contributions. Because of this, a 509(a)(1) test will have no programmatic revenue included in the calculation. Although it appears on Part II, line 12 of the support test calculation, it is not part of the calculation.

This test also considers and excludes excess contributors from the calculation, which is a very important–though often overlooked–element of the 509(a)(1) test. An excess contributor is a donor that contributes more than 2% of the total support during the five-year support test window. This “excess” amount reduces a charity’s public support amount in the numerator while the full contribution from the donor remains in the denominator of the support test calculation.

to this test is the facts and circumstances test. An organization will technically “fail” the public support test if they do not meet 33 1/3% support, but this does not mean their public charity status is jeopardized. Failing the public support test happens when an organization falls below 10% public support, making it a private foundation. Instead, the facts and circumstances test is completed when an organization falls between 10% and 33 1/3% of public support, and still desires public charity status.

What Is a 509(a)(2) Test?

The support schedule for 509(a)(2) organizations has two elements to show the organization is broadly supported.

  1. The organization receives more than one-third support from both contribution revenue and program revenue (the public support test); and
  2. The organization normally does not receive more than one-third of its support from investment income (the investment income test).

A 509(a)(2) organization does not have the option of a facts and circumstances test. However, there is a one-year grace period for organizations failing in the current reporting period.

Similar to the 509(a)(1) test, the 509(a)(2) test limits certain revenue amounts:

  1. Any contributions, membership fees, and program revenue received from a disqualified person are excluded entirely from public support but remain in the total support amount.
  2. There is a limitation on program revenue from any one person, bureau, agency of a government unit to the extent it is greater than $5,000 or 1% of total support.

If these limitations are overlooked, an organization’s public support percentage will appear much higher than it actually is.

Can My Organization Switch Public Support Tests?

An organization can choose to prepare the alternative public support test and calculation for determining public support. We see this most often when there is a potential failure of the original test. Activities of an organization can change over time, causing a need to switch tests. In other instances, the organization simply selected the wrong test on its original exemption application. In any case, an organization is recommended to complete the other support test prior to reverting to private foundation status. No advance approval from the IRS is required for changing from a 509(a)(1) test to a 509(a)(2) test, and vice versa.

Next Steps

If you are concerned about your organization’s public support test, or simply want a second set of eyes to confirm your calculations are correct, please reach out to us. Clark Nuber has helped numerous organizations navigate the public support test calculation, adjust for incorrect amounts, and plan their path forward if private foundation status is inevitable.

This article is the first in a series that dives into the details of the public support test. Be on the lookout for additional articles that include the Facts and Circumstances Test, Common Errors in the Support Test, and more. To join our newsletter and receive notifications for future articles in the Public Support series, subscribe here.

Co-author Carolyn Fjelstad is a tax manager in Clark Nuber’s Not-for-Profit Service Group.

© Clark Nuber PS, 2023. All Rights Reserved.

This article contains general information only and should not be construed as accounting, business, financial, investment, legal, tax, or other professional advice or services. Before making any decision or taking any action, you should engage a qualified professional advisor.