by Jamie Koglin, senior tax accountant, Alerding CPA Group
Whether your public charity is in the early years of formation or has operated for decades, there is one particular mathematical calculation that should always remain at the forefront of your decision making — the public support test. It is a small but mighty calculation that is vital to maintaining status as a public charity. On the Form 990, Schedule A is used to provide detail about sources of support, types of support and, ultimately, to calculate the public support percentage.
According to the IRS, there are two methods in which a non-profit may qualify as a publicly supported charity:
- Under IRC Section 509(a)(1): The organization is primarily supported by contributions from governmental units, publicly supported organizations, and/or the general public.
- Under IRC Section 509(a)(2): The organization receives no more than one-third of its support from gross investment income and more than one-third of its support from contributions, membership fees, and gross receipts from activities related to its exempt function.
An organization’s reason for public charity status determines which of the tests apply to calculate the public support percentage. For sake of simplicity, this article focuses on the testing under IRC Section 509(a)(1).
The 509(a)(1) Public Support Test
Organizations claiming public charity status under this section must receive at least 33.3% of its support from the public, or from governmental units over a 5-year period — the current year plus the prior four years. At a high level, public support/total support = public support %. Sounds simple right? Wrong. There are several factors used to determine this calculation, therefore, we will break it down further.
The public support portion, or the numerator, consists of four important line items. The first three lines include gifts, grants, contributions, membership fees, tax revenues levied and the value of services or facilities furnished by a governmental unit to the organization at no charge. Unusual grants are not to be included. All of these sources of revenue are considered “good money” and help the public support test. The fourth line item is the portion of support classified as excess contributions. Excess contributions are considered “bad money” in that they hurt the public support calculation.
Excess contributions are amounts from a single donor, during a 5-year period, that exceed 2% of the total support of the organization over that same 5-year period. The amounts in excess of 2% are subtracted from the public support total. Thus, large amounts from a single donor, are considered “bad money” and have a negative impact on the support test.
Unusual grants, which are excluded from the calculation entirely, are generally substantial and material contributions from disinterested persons. They are also unusual and unexpected in amount, and large enough to jeopardize the public support calculation. There are many factors that help determine whether a grant is considered unusual, the most common is whether the organization would typically meet the public support test without this grant occurring. The ability to classify a large contribution “unusual” would ultimately be favorable for the public support calculation.
The denominator of the calculation includes total contributions and grants, gross income from investments, income from unrelated business activities, other income, and gross receipts from related activities. If the numerator/denominator is greater than 33.3%, the organization passes the public support test. It is also important to note that in the first five years, the organization receives a grace period. The percentage is not calculated until year 6, therefore new organizations have some flexibility in their operations during the first few years.
Most organizations will pass the test consistently without issue. For those receiving a low percentage of support from the public, “tipping” becomes a concern. “Tipping” occurs when a substantial grant or contribution causes the percentage of public support to drop below 33.3%. If this occurs two years in a row, the organization will revert to private foundation status. “Tipping” into private foundation status not only has a negative impact on the organization but also on its donors. Private foundations are subject to more restrictions on its functions and their donors are subject to a lower deductibility of donations. In addition to that, the process to reclaim its public charity status will require a consecutive 60-month period of meeting the public charity test.
There are ways to prevent “tipping,” including seeking diverse sources of funding, ensuring that activities are classified correctly on Schedule A, and paying close attention to amounts that should be classified as unusual. Also, working with donors to ensure that contributions are received in appropriate installments or amounts is important as the impact it can have on the public support test can be unfavorable.
The public support test is critical. It is important to help these organizations understand this test and the impact it can have on maintaining their public status. These organizations are doing a great deal for our communities, and our country as a whole. We want them to do well and maintain their publicly supported status so that they can continue to carry on their mission and support the societies in which we live.
Oftentimes, the organization may not realize the impact on the public support calculation until the end of the year, which could result in an organization unexpectedly losing their public charity status or taxes being imposed. Because of this, it is important to monitor this calculation throughout the year to avoid any disruption when time to file the 990. The stakes are high, so it is important to keep good records and pay close attention. Need help? The trusted advisors at Alerding CPA Group can help navigate through the calculation.
As a senior tax accountant for Alerding CPA Group, Jamie Koglin prepares tax returns for individuals, corporations, partnerships, trusts, non-profits, property tax assessments and various states. Her responsibilities include managing client contact, research and recommendations, preparing extensions, strategic tax planning and quarterly payment consulting and interpreting tax laws and updates.