Whether you are an established public charity or one in its infancy years, or you’re a private foundation making grants to public charities, understanding the public support test is key to ensuring that donors maintain a favorable tax deduction and that private foundations do not inadvertently make a taxable expenditure. This article will cover what the public support test is and how your organization can best understand and manage it.
The Public Support Test and Public Charities
There are many different types of public charities. But for this article, we will focus on the public support tests for IRC Sections 509(a)(1) and 509(a)(2) organizations, both which are exempt under IRC Section 501(c)(3).
The distinguishing factor between these two organizations is that 509(a)(1) organizations primarily receive their funding from contributions, whereas 509(a)(2) organizations primarily receive their support from programmatic activities such as tuition and admission fees. 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, and once the grace period is over, the test is done annually but looks back over five years.
Maintaining Public Charity Status
To maintain public charity status, an organization must receive 33.33% of its support from public sources. This includes contributions and grants from individuals, corporations, private foundations, and the government. For a 509(a)(2) organization, it also includes revenue from programmatic activities.
Regardless of the type of public charity, public support excludes income from investments, fundraising, and unrelated business activities. For a 509(a)(1) organization, public support also excludes contributions from private donors and their related parties who give more than 2% of the total support over five years. For a 509(a)(2) organization, public support excludes contributions and program revenue from disqualified persons of the organization (e.g., trustees, officers, family members, entities in which they control, etc.) as well as program revenue from a single source that exceeds 1% of total support.
These exclusions prevent donors from treating these charities as their own (private) organization, while at the same time taking advantage of the favorable contribution limits of a public charity.
Decline in Public Support Percentage – Causes and Solutions
When organizations receive large amounts of funding from very few sources, they see a decline in their public support percentage. Often this occurs in organizations during their infancy years (though it can happen at any time during an organization’s lifetime) when they need funding to establish themselves, when there is a large bequest, or when a family or foundation continuously supports a specific organization. Large bequests that were not anticipated may qualify as an unusual grant and thus may be excluded from the calculation completely.
A decline in the public support percentage should not cause an organization immediate concern that it will lose its status as a public charity. If a charity meets the public support test in one year, it is automatically treated as publicly supported the following year. However, if it continuously decreases, charities should take the opportunity to find alternative ways of raising contributed or program revenue. Furthermore, should the public support percentage fall below 33.33% but still be above 10%, an organization may still be publicly supported if it meets a facts and circumstances test. The criteria for qualifying as an unusual grant and requirements of the facts and circumstances test is beyond the scope of this article.
The Public Support Test and Foundations
While the public support test is important for public charities, it is equally important for private foundations.
Foundations that provide grants to certain types of public charities are free from exercising expenditure responsibility for those grants. IRC Sections 509(a)(1) and 509(a)(2) organizations are two types of public charities that fall under this exception. As long as these organizations are publicly supported, no expenditure responsibility is required.
Exercise Caution with Large Gifts
Foundations that support public charities in their infancy years, or that are considering giving a sizable amount to a public charity, should be cautious of “tipping” the public charities into private foundation status.
Why? When a foundation makes a large enough grant to a public charity, there is potential for the public support percentage to significantly decline, causing the public charity to fail its support test and converting it to a private foundation. If the grantee loses its classification as a public charity by way of a grant from a foundation, the foundation must exercise expenditure responsibility or be subject to an excise tax on taxable expenditures.
Note that expenditure responsibility must happen before making a grant. Therefore, if it inadvertently “tips” the public charity to private foundation status without exercising expenditure responsibility, the foundation will be subject to an excise tax on a taxable expenditure.
Foundations that are considering making grants to newly organized public charities or of a sizable amount, or if they or their grantees are concerned about tipping, should refer to Rev. Proc. 89-23 and 2018-32. It goes through a calculation similar to Schedule A and assesses how the grantor’s contribution will affect the support percentage but utilizing a different percentage. Rather than ensuring a 33.33% public support, the foundation is allowed to fund 25% or less over the course of five years, including the year the grant was made, to the public charity to avoid tipping them to private foundation status.
Planning Tips for the Public Support Test
Track Large Donors
Maintain a list of donors who have contributed sizable amounts over the years. This not only serves as a good reminder of who the organization’s benefactors are, but it will also help with calculating and monitoring the organization’s public support percentage.
Understand the Public Support Calculations
Understand what goes into calculating the public support percentage by familiarizing oneself with the public support test calculations in Schedule A, Parts II or III.
Monitor Your Public Support Percentage
Continuously monitor the organization’s public support percentage, including planning several years out for those in the early stages, and especially when the organization experiences any momentous changes in its activities.
Review Grantee’s Tax Forms
For private foundations, review a grantee’s Form 990, Schedule A, as this will provide a high-level overview of the organization’s support percentage and whether the foundation will need to consider doing its due diligence to ensure their funding does not “tip” the grantee to private foundation status.
How Does the Receipt of PPP Loan Proceeds Affect My Public Support Percentage?
Organizations who received funding from the Paycheck Protection Program (PPP) and have had those loans forgiven can treat the funding as contributions received from a governmental unit in the year when the amounts are forgiven. They are also considered public support funds and, therefore, included favorably in the public support calculation in the year the amounts are forgiven.
If you have any questions regarding the public support test and your organization, please send me an email.
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