Private Foundations and Public CharitiesIt is important that you determine if your organization is a private foundation. Most organizations exempt from income tax (as organizations described in section 501(c)(3)) are presumed to be private foundations unless they notify the Internal Revenue Service within a specified period of time that they are not. This notice requirement applies to most section 501(c)(3) organizations regardless of when they were formed. Private FoundationsEvery organization that qualifies for tax exemption as an organization described in section 501(c)(3) is a private foundation unless it falls into one of the categories specifically excluded from the definition of that term (referred to in section 509(a)(1), 509(a)(2), 509(a)(3), or 509(a)(4)). In effect, the definition divides these organizations into two classes, namely private foundations and public charities. Public charities are discussed later. Organizations that fall into the excluded categories are generally those that either have broad public support or actively function in a supporting relationship to those organizations. Organizations that test for public safety also are excluded. Notice to IRS. Even if an organization falls within one of the categories excluded from the definition of private foundation, it will be presumed to be a private foundation, with some exceptions, unless it gives timely notice to the IRS that it is not a private foundation. This notice requirement applies to an organization regardless of when it was organized. The only exceptions to this requirement are those organizations that are excepted from the requirement of filing Form 1023 as discussed, earlier, under Organizations Not Required To File Form 1023. When to file notice. If an organization has to file the notice, it must do so within 15 months from the end of the month in which it was organized. If your organization is newly applying for recognition of exemption as an organization described in this chapter (a section 501(c)(3) organization) and you wish to establish that your organization is a public charity rather than a private foundation, you must complete the applicable lines of Part III of your exemption application (Form 1023). An extension of time for filing this application may be granted by the IRS if your request is timely and you demonstrate that additional time is needed. See Application for Recognition of Exemption, earlier in this chapter, for more information. In determining the date on which a corporation is organized for purposes of applying for recognition of section 501(c)(3) status, the IRS looks to the date the corporation came into existence under the law of the state in which it is incorporated. For example, where state law provides that existence of a corporation begins on the date its articles are filed by a certain state official in the appropriate state office, the corporation is considered organized on that date. Later nonsubstantive amendments to the enabling instrument will not change the date of organization, for purposes of the notice requirement. Notice filed late. An organization that states it is a private foundation when it files its application for recognition of exemption after the 15-month period will be treated as a section 501(c)(3) organization and as a private foundation only from the date it files its application. An organization that states it is a publicly supported charity when it files its application for recognition of exemption after the 15-month period cannot be treated as a section 501(c)(3) organization before the date it files the application. Financial support received before that date may not be used for purposes of determining whether the organization is publicly supported. However, an organization that can reasonably be expected to meet the support requirements (discussed later under Public Charities) can obtain an advance ruling from the IRS that it is a publicly supported organization. Excise taxes on private foundations. There is an excise tax on the net investment income of most domestic private foundations. This tax must be reported on Form 990-PF and must be paid annually at the time for filing that return or in quarterly estimated tax payments if the total tax for the year is $500 or more. In addition, there are several other rules that apply. These include:
Violations of these provisions give rise to taxes and penalties against the private foundation and, in some cases, its managers, its substantial contributors, and certain related persons. Governing instrument. A private foundation cannot be tax exempt nor will contributions to it be deductible as charitable contributions unless its governing instrument contains special provisions in addition to those that apply to all organizations described in section 501(c)(3). Sample governing instruments. The following samples of governing instrument provisions illustrate the special charter requirements that apply to private foundations. Draft A is a sample of provisions in articles of incorporation, Draft B, a trust indenture. Draft AGeneral
Draft B
Any other provisions of this instrument notwithstanding, the trustees shall distribute its income for each tax year at a time and in a manner as not to become subject to the tax on undistributed income imposed by section 4942 of the Internal Revenue Code, or the corresponding section of any future federal tax code. Any other provisions of this instrument notwithstanding, the trustees will not engage in any act of self-dealing as defined in section 4941(d) of the Internal Revenue Code, or the corresponding section of any future federal tax code; nor retain any excess business holdings as defined in section 4943(c) of the Internal Revenue Code, or the corresponding section of any future federal tax code; nor make any investments in a manner as to incur tax liability under section 4944 of the Internal Revenue Code, or the corresponding section of any future federal tax code; nor make any taxable expenditures as defined in section 4945 (d) of the Internal Revenue Code, or the corresponding section of any future federal tax code. Effect of state law. A private foundation's governing instrument will be considered to meet these charter requirements if valid provisions of state law have been enacted that:
The IRS has published a list of states with this type of law. The list is in Revenue Ruling 75-38, 1975-1 CB 161(or later update). Public CharitiesA private foundation is any organization described in section 501(c)(3), unless it falls into one of the categories specifically excluded from the definition of that term in section 509(a), which lists four basic categories of exclusions. These categories are discussed under the Section 509(a) headings that follow this introduction. If your organization falls into one of these categories, it is not a private foundation and you should state this in Part III of your application for recognition of exemption (Form 1023). If your organization does not fall into one of these categories, it is a private foundation and is subject to the applicable rules and restrictions until it terminates its private foundation status. Some private foundations also qualify as private operating foundations; these are discussed near the end of this chapter. Generally speaking, a large class of organizations excluded under section 509(a)(1) and all organizations excluded under section 509(a)(2) depend upon a support test. This test is used to assure a minimum percentage of broad-based public support in the organization's total support pattern. Thus, in the following discussions, when the one-third support test (see Qualifying As Publicly Supported, later) is referred to, it means the following fraction normally must equal at least one-third:
Excise tax on excess benefit transactions. A person who benefits from an excess benefit transaction such as compensation, fringe benefits, or contract payments from a section 501(c)(3) or 501(c)(4) organization may have to pay an excise tax under section 4958. A manager of the organization may also have to pay an excise tax under section 4958. These taxes are reported on Form 4720, Return of Certain Excise Taxes on Charities and Other Persons Under Chapters 41 and 42 of the Internal Revenue Code. The excise taxes are imposed if an applicable tax-exempt organization provides an excess benefit to a disqualified person and that benefit exceeds the value of the benefit an organization received in the exchange. There are three taxes under section 4958. Disqualified persons are liable for the first two taxes and certain organization managers are liable for the third tax. Taxes imposed on excess benefit transactions apply to transactions occurring on or after September 14, 1995. However, these taxes do not apply to a transaction pursuant to a written contract that was binding on September 13, 1995, and at all times thereafter before the transaction occurred. Tax on disqualified persons. An excise tax equal to 25% of the excess benefit is imposed on each excess benefit transaction between an applicable tax-exempt organization and a disqualified person. The disqualified person who benefitted from the transaction is liable for the tax. If the 25% tax is imposed and the excess benefit transaction is not corrected within the taxable period, an additional excise tax equal to 200% of the excess benefit is imposed. If a disqualified person makes a payment of less than the full correction amount, the 200% tax is imposed only on the unpaid portion of the correction amount. if more than one disqualified person received an excess benefit from an excess benefit transaction, all such disqualified persons are jointly and severally liable for the taxes. To avoid the 200% tax, a disqualified person must correct the excess benefit transaction during the taxable period. The taxable period begins on the date the transaction occurs and ends on the earlier of the date the statutory notice of deficiency is issued or the section 4958 taxes are assessed. The 200% tax is abated (refunded if collected) if the excess benefit transaction is corrected within a 90-day correction period beginning on the date a statutory notice of deficiency is issued. Tax on organization managers. An excise tax equal to 10% of the excess benefit is imposed on an organization manager who knowingly participated in an excess benefit transaction, unless such participation was not willful and was due to reasonable cause. This tax may not exceed $10,000 with respect to any single excess benefit transaction. There is also joint and several liability for this tax. A person may be liable for both the tax paid by the disqualified person and the organization manager tax. An organization manager is any officer, director, or trustee of an applicable tax-exempt organization, or any individual having powers or responsibilities similar to officers, directors, or trustees of the organization, regardless of title. An organization manager is not considered to have participated in an excess benefit transaction where the manager has opposed the transaction in a manner consistent with the fulfillment of the manager's responsibilities to the organization. For example, a director who votes against giving an excess benefit would ordinarily not be subject to the 10% tax. A person participates in a transaction knowingly if the person has actual knowledge of sufficient facts so that, based solely upon such facts, the transaction would be an excess benefit transaction. Knowing does not mean having reason to know. The organization manager ordinarily will not be considered knowing if, after full disclosure of the factual situation to an appropriate professional, the organization manager relied on the professional's reasoned written opinion on matters within the professional's expertise or if the manager relied on the fact that the requirements for the rebuttable presumption of reasonableness have been satisfied. Participation by an organization manager is willful if it is voluntary, conscious, and intentional. An organization manager's participation is due to reasonable cause if the manager has exercised responsibility on behalf of the organization with ordinary business care and prudence. Excess benefit transaction. An excess benefit transaction is a transaction in which an economic benefit is provided by an applicable tax-exempt organization, directly or indirectly, to or for the use of any disqualified person, and the value of the economic benefit provided by the organization exceeds the value of the consideration (including the performance of services) received for providing such benefit. To determine whether an excess benefit transaction has occurred, all consideration and benefits exchanged between a disqualified person and the applicable tax-exempt organization, and all entities it controls, are taken into account. For purposes of determining the value of economic benefits, the value of property, including the right to use property, is the fair market value. Fair market value is the price at which property, or the right to use property, would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy, sell or transfer property or the right to use property, and both having reasonable knowledge of relevant facts. Correcting the excess benefit. An excess benefit transaction is corrected by undoing the excess benefit to the extent possible, and by taking any additional measures necessary to place the organization in a financial position not worse than that in which it would be if the disqualified person were dealing under the highest fiduciary standards. A disqualified person corrects an excess benefit by making a payment in cash or cash equivalents, excluding payment by a promissory note, equal to the correction amount to the applicable tax-exempt organization. The correction amount equals the excess benefit plus the interest on the excess benefit. The interest rate may be no lower than the applicable federal rate. A disqualified person may, with the agreement of the applicable tax-exempt organization, make a payment by returning the specific property previously transferred in the excess transaction. In this case, the disqualified person is treated as making a payment equal to the lesser of:
If the payment resulting from the return of property is less than the correction amount, the disqualified person must make an additional cash payment to the organization equal to the difference. If the payment resulting from the return of the property exceeds the correction amount described above, the organization may make a cash payment to the disqualified person equal to the difference. Applicable tax-exempt organization. An applicable tax-exempt organization is a section 501(c)(3) or 501(c)(4) organization that is tax-exempt under section 501(a), or was such an organization at any time during a five-year period ending on the day of the excess benefit transaction. An applicable tax-exempt organization does not include:
An organization is not treated as a section 501(c)(3) or 501(c)(4) organization for any period covered by a final determination that the organization was not tax-exempt under section 501(a), but only if the determination was not based on private inurement or one or more excess benefit transactions. Disqualified person. A disqualified person is any person, with respect to any transaction, in a position to exercise substantial influence over the affairs of the applicable tax-exempt organization at any time during a five-year period ending on the date of the transaction. Persons who hold certain powers, responsibilities, or interests are among those who are in a position to exercise substantial influence over the affairs of the organization. This includes, for example, voting members of the governing body, and persons holding the power of:
A disqualified person also includes certain family members of a disqualified person, and 35% controlled entities of a disqualified person. Family members. Family members of a disqualified person include a disqualified person's spouse, brothers or sisters (whether by whole or half-blood), spouses of brothers or sisters (whether by whole or half-blood), ancestors, children (including a legally adopted child), grandchildren, great grandchildren, and spouses of children, grandchildren, and great grandchildren (whether by whole or half-blood). 35% controlled entity. The term 35% controlled entity means:
In determining the holdings of a business enterprise, any stock or other interest owned directly or indirectly shall apply. Persons not considered to have substantial influence. Persons who are not considered to be in a position to exercise substantial influence over the affairs of an organization include:
Facts and circumstances. The determination of whether a person has substantial influence over the affairs of an organization is based on all the facts and circumstances. Facts and circumstances that show a person has substantial influence over the affairs of an organization include, but are not limited to, the following.
Facts and circumstances tending to show that a person does not have substantial influence over the affairs of an organization include, but are not limited to, the following.
In the case of multiple affiliated organizations, the determination of whether a person does or does not have substantial influence is made separately for each applicable tax-exempt organization. A person may be a disqualified person with respect to transactions with more than one organization. Date excess benefit transaction occurs. An excess benefit transaction occurs on the date the disqualified person receives the economic benefit from the organization for federal income tax purposes. However, when a single contractual arrangement provides for a series of compensation payments or other payments to a disqualified person during the disqualified person's tax year (or part of a tax year), any excess benefit transaction with respect to these payments occurs on the last day of the tax year (or if the payments continue for part of the year, the date of the last payment in the series). In the case of benefits provided to a qualified pension, profit-sharing, or stock bonus plan, the transaction occurs on the date the benefit is vested. In the case of the transfer of property subject to a substantial risk of forfeiture, or in the case of rights to future compensation or property, the transaction occurs on the date of the property, or the rights to future compensation or property, is not subject to a substantial risk of forfeiture. Where the disqualified person elects to include an amount in gross income in the tax year of transfer under section 83(b), the excess benefit transaction occurs on the date the disqualified person receives the economic benefit for federal income tax purposes. Reasonable compensation. Reasonable compensation is the value that would ordinarily be paid for like services by like enterprises under like circumstances. The section 162 standard will apply in determining the reasonableness of compensation. The fact that a bonus or revenue-sharing arrangement is subject to a cap is a relevant factor in determining reasonableness of compensation. To determine the reasonableness of compensation, all items of compensation provided by an applicable tax-exempt organization in exchange for performance of services are taken into account in determining the value of compensation (except for economic benefits that are disregarded under the discussion, Disregarded benefits, later). Items of compensation include:
An economic benefit is not treated as consideration for the performance of services unless the organization providing the benefit clearly indicates its intent to treat the benefit as compensation when the benefit is paid. An applicable tax-exempt organization (or entity that it controls) is treated as clearly indicating its intent to provide an economic benefit as compensation for services only if the organization provides written substantiation that is contemporaneous with the transfer of the economic benefits under consideration. Ways to provide contemporaneous written substantiation of its intent to provide an economic benefit as compensation include:
Rebuttable presumption that a transaction is not an excess benefit transaction. Payments under a compensation arrangement are presumed to be reasonable and the transfer of property (or right to use property) is presumed to be at fair market value, if the following three conditions are met.
Disregarded benefits. The following economic beneifts are disregarded for section 4958 purposes.
Special exception for initial contracts. Section 4958 does not apply to any fixed payment made to a person under an initial contract. A fixed payment is an amount of cash or other property specified in the contract, or determined by a fixed formula that is specified in the contract, which is to be part of or transferred in exchange for the provision of specified services or property. A fixed formula may, generally, incorporate an amount that depends upon future specified events or contingencies, as long as no one has discretion when calculating the amount of a payment or deciding whether to make a payment (such as a bonus). An initial contract is a binding written contract between an applicable tax-exempt organization and a person who was not a disqualified person immediately before entering into the contract. A binding written contract providing it may be terminated or cancelled by the applicable tax-exempt organization without the other party's consent (except as a result of substantial nonperformance) and without substantial penalty, is treated as a new contract, as of the earliest date any termination or cancellation would be effective. Also, if the parties make a material change to a contract, which includes an extension or renewal of the contract (except for an extension or renewal resulting from the exercise of an option by the disqualified person), or a more than incidental change to the amount payable under the contract, it is treated as a new contract as of the effective date of the material change. More information. For more information, see the instructions to Forms 990 and 4720. Organizations that are not private foundations. The following kinds of organizations are excluded from the definition of a private foundation. Section 509(a)(1) OrganizationsSection 509(a)(1) organizations include:
Church. The characteristics of a church are discussed earlier in this chapter under Religious Organizations. Educational organizations. An educational organization is one whose primary function is to present formal instruction, that normally maintains a regular faculty and curriculum, and that normally has a regularly enrolled body of pupils or students in attendance at the place where it regularly carries on its educational activities. The term includes institutions such as primary, secondary, preparatory, or high schools, and colleges and universities. It includes federal, state, and other publicly supported schools that otherwise come within the definition. It does not include organizations engaged in both educational and noneducational activities, unless the latter are merely incidental to the educational activities. A recognized university that incidentally operates a museum or sponsors concerts is an educational organization. However, the operation of a school by a museum does not necessarily qualify the museum as an educational organization. An exempt organization that operates a tutoring service for students on a one-to-one basis in their homes, maintains a small center to test students to determine their need for tutoring, and employs tutors on a part-time basis is not an educational organization for these purposes. Nor is an exempt organization that conducts an internship program by placing college and university students with cooperating government agencies an educational organization. Hospitals and medical research organizations. A hospital is an organization whose principal purpose or function is to provide hospital or medical care or either medical education or medical research. A rehabilitation institution, outpatient clinic, or community mental health or drug treatment center may qualify as a hospital if its principal purpose or function is providing hospital or medical care. If the accommodations of an organization qualify as being part of a skilled nursing facility, that organization may qualify as a hospital if its principal purpose or function is providing hospital or medical care. A cooperative hospital service organization that meets the requirements of section 501(e) will qualify as a hospital. The term hospital does not include convalescent homes, homes for children or the aged, or institutions whose principal purpose or function is to train handicapped individuals to pursue a vocation. An organization that mainly provides medical education or medical research will not be considered a hospital, unless it is also actively engaged in providing medical or hospital care to patients on its premises or in its facilities, on an in-patient or out-patient basis, as an integral part of its medical education or medical research functions. Hospitals participating in provider-sponsored organizations. An organization can be treated as organized and operated exclusively for a charitable purpose even if it owns and operates a hospital that participates in a provider-sponsored organization, whether or not the provider-sponsored organization is tax exempt. For section 501(c)(3) purposes, any person with a material financial interest in the provider-sponsored organization is treated as a private shareholder or individual with respect to the hospital. Medical research organization. A medical research organization must be directly engaged in the continuous active conduct of medical research in conjunction with a hospital, and that activity must be the organization's principal purpose or function. Publicly supported. A hospital or medical research organization that wants the additional classification of a publicly-supported organization (described later in this chapter under Qualifying As Publicly Supported) may specifically request that classification. The organization must establish that it meets the public support requirements of section 170(b)(1)(A)(vi). Endowment funds. Organizations operated for the benefit of certain state and municipal colleges and universities are endowment funds. They are organized and operated exclusively to:
The phrase expenditures to or for the benefit of a college or university includes expenditures made for any one or more of the normal functions of a college or university. These expenditures include those for:
The organization must normally receive a substantial part of its support from the United States or any state or political subdivision, or from direct or indirect contributions from the general public, or from a combination of these sources. Support. Support does not include income received in the exercise or performance by the organization of its charitable, educational, or other purpose or function constituting the basis for exemption. In determining the amount of support received by an organization for a contribution of property when the value of the contribution by the donor is subject to reduction for certain ordinary income and capital gain property, the fair market value of the property is taken into account. For more information, see the discussion of Support on page 30. Indirect contribution. An example of an indirect contribution from the public is the receipt by the organization of its share of the proceeds of an annual collection campaign of a community chest, community fund, or united fund. Governmental units. A governmental unit includes a state, a possession of the United States, or a political subdivision of either of the foregoing, or the United States or the District of Columbia. Publicly-supported organizations. An organization is a publicly-supported organization if it is one that normally receives a substantial part of its support from a governmental unit or from the general public. Types of organizations that generally qualify are:
Qualifying As Publicly SupportedAn organization will qualify as publicly supported if it passes the one-third support test. If it fails that test, it may qualify under the facts and circumstances test. One-third support test. An organization will qualify as publicly supported if it normally receives at least one-third of its total support from governmental units, from contributions made directly or indirectly by the general public, or from a combination of these sources. For a definition of support, see Support, later. Definition of normally for one-third support test. An organization will be considered as normally meeting the one-third support test for its current tax year and the next tax year if, for the 4 tax years immediately before the current tax year, the organization meets the one-third support test on an aggregate basis. See also Special computation period for new organizations, later, in this discussion. Facts and circumstances test. The facts and circumstances test is for organizations failing to meet the one-third support test. If your organization fails to meet the one-third support test, it may still be treated as a publicly-supported organization if it normally receives a substantial part of its support from governmental units, from direct or indirect contributions from the general public, or from a combination of these sources. To qualify, an organization must meet the ten-percent-of-support requirement and the attraction of public support requirement. These requirements establish, under all the facts and circumstances, that an organization normally receives a substantial part of its support from governmental units or from direct or indirect contributions from the general public. The organization also must be in the nature of a publicly-supported organization, taking into account five different factors. See Additional requirements (the five public support factors), on pages 29-30. Ten-percent-of-support requirement. The percentage of support normally received by an organization from governmental units, from contributions made directly or indirectly by the general public, or from a combination of these sources must be substantial . An organization will not be treated as normally receiving a substantial amount of governmental or public support unless the total amount of governmental and public support normally received is at least 10% of the total support normally received by that organization. For a definition of support, see Support, later. Attraction of public support requirement. An organization must be organized and operated in a manner to attract new and additional public or governmental support on a continuous basis. An organization will meet this requirement if it maintains a continuous and bona fide program for solicitation of funds from the general public, community, or membership group involved, or if it carries on activities designed to attract support from governmental units or other charitable organizations described in section 509(a)(1). In determining whether an organization maintains a continuous and bona fide program for solicitation of funds from the general public or community, consideration will be given to whether the scope of its fundraising activities is reasonable in light of its charitable activities. Consideration also will be given to the fact that an organization may, in its early years of existence, limit the scope of its solicitation to persons who would be most likely to provide seed money sufficient to enable it to begin its charitable activities and expand its solicitation program. Definition of normally for facts and circumstances test. An organization will normally meet the requirements of the facts and circumstances test for its current tax year and the next tax year if, for the 4 tax years immediately before the current tax year, the organization meets the ten-percent-of-support and the attraction of public support requirements on an aggregate basis and satisfies a sufficient combination of the factors discussed later. The combination of factors that an organization normally must meet does not have to be the same for each 4-year period as long as a sufficient combination of factors exists to show compliance. See also Special computation period for new organizations, later, in this discussion. Special rule. The fact that an organization has normally met the one-third support test requirements for a current tax year, but is unable normally to meet the requirements for a later tax year, will not in itself prevent the organization from meeting the requirements of the facts and circumstances test for the later tax year. Example. X organization meets the one-third support test in its 1999 tax year on the basis of support received during 1995, 1996, 1997, and 1998. It therefore normally meets the requirements for both 1999 and 2000. For the 2000 tax year, X is unable to meet the one-third support test on the basis of support received during 1996, 1997, 1998, and 1999. If X can meet the facts and circumstances test on the basis of those years, X will normally meet the requirements for 2001 (the tax year immediately after 2000). However, if on the basis of both 4-year periods (1996 through 1999 and 1997 through 2000), X fails to meet both the one-third and the facts and circumstances tests, X will not be a publicly-supported organization for 2001. However, X will not be disqualified as a publicly-supported organization for the 2000 tax year because it normally met the one-third support test requirements on the basis of the tax years 1995 through 1998 unless the provisions governing the Exception for material changes in sources of support (discussed later) become applicable. Additional requirements (the five public support factors). In addition to the two requirements of the facts and circumstances test, the following five public support factors will be considered in determining whether an organization is publicly supported. However, an organization generally does not have to satisfy all of the factors. The factors relevant to each case and the weight accorded to any one of them may differ depending upon the nature and purpose of the organization and the length of time it has existed. The combination of factors that an organization normally must meet does not have to be the same for each 4-year period as long as a sufficient combination of factors exists to show that the organization is publicly supported. 1. Percentage of financial support factor. When an organization normally receives at least 10% but less than one-third of its total support from public or governmental sources, the percentage of support received from those sources will be considered in determining whether the organization is publicly supported. As the percentage of support from public or governmental sources increases, the burden of establishing the publicly supported nature of the organization through other factors decreases, while the lower the percentage, the greater the burden. If the percentage of the organization's support from the general public or governmental sources is low because it receives a high percentage of its total support from investment income on its endowment funds, the organization will be treated as complying with this factor if the endowment fund was originally contributed by a governmental unit or by the general public. However, if the endowment funds were originally contributed by a few individuals or members of their families, this fact will increase the burden on the organization of establishing compliance with other factors. Facts pertinent to years before the 4 tax years immediately before the current tax year also may be considered. 2. Sources of support factor. If an organization normally receives at least 10% but less than one-third of its total support from public or governmental sources, the fact that it receives the support from governmental units or directly or indirectly from a representative number of persons, rather than receiving almost all of its support from the members of a single family, will be considered in determining whether the organization is publicly supported. In determining what is a representative number of persons, consideration will be given to the type of organization involved, the length of time it has existed, and whether it limits its activities to a particular community or region or to a special field that can be expected to appeal to a limited number of persons. Facts pertinent to years before the 4 tax years immediately before the current tax year also may be considered. 3. Representative governing body factor. The fact that an organization has a governing body that represents the broad interests of the public rather than the personal or private interest of a limited number of donors will be considered in determining whether the organization is publicly supported. An organization will meet this requirement if it has a governing body composed of:
4. Availability of public facilities or services factor. The fact that an organization generally provides facilities or services directly for the benefit of the general public on a continuing basis, is evidence that the organization is publicly supported. Examples are:
Similarly, the following factors are also evidence that an organization is publicly supported.
5. Additional factors pertinent to membership organizations. The following are additional factors in determining whether a membership organization is publicly supported.
Exception for material changes in sources of support. If for the current tax year substantial and material changes occur in an organization's sources of support other than changes arising from unusual grants (discussed later, under Unusual grants), then in applying either the one-third or the facts and circumstances test, the 4-year computation period applicable to that year, either as an immediately following tax year or as a current tax year, will not apply. Instead of using these computation periods, a computation period of 5 years will apply. The 5-year period consists of the current tax year and the 4 tax years immediately before that year. For example, if substantial and material changes occur in an organization's sources of support for the 1999 tax year, then, even though the organization meets the one-third or the facts and circumstances test using a computation period of tax years 1994-1997 or 1995-1998, the organization will not meet either test unless it meets the test using a computation period of tax years 1995-1999 (substituted period). Substantial and material change. An example of a substantial and material change is the receipt of an unusually large contribution or bequest that does not qualify as an unusual grant. Effect on grantor or contributor. If as a result of this substituted period, an organization is not able to meet either the one-third support or the facts and circumstances test for its current tax year, its status with respect to a grantor or contributor will not be affected until notice of change of status is made to the public (such as by publication in the Internal Revenue Bulletin). This does not apply, however, if the grantor or contributor was responsible for or was aware of the substantial and material change or acquired knowledge that the IRS had given notice to the organization that it would be deleted from classification as a publicly-supported organization. A grantor or contributor (other than one of the organization's founders, creators, or foundation managers) will not be considered responsible for, or aware of, the substantial and material change, if the grantor or contributor made the grant or contribution relying upon a written statement by the grantee organization that the grant or contribution would not result in the loss of the organization's classification as a publicly-supported organization. The statement must be signed by a responsible officer of the grantee organization and must give enough information, including a summary of the pertinent financial data for the 4 preceding years, to assure a reasonably prudent person that the grant or contribution would not result in the loss of the grantee organization's classification as a publicly-supported organization. If a reasonable doubt exists as to the effect of the grant or contribution, or, if the grantor or contributor is one of the organization's founders, creators, or foundation managers, the grantee organization may request a ruling from the EO area manager before accepting the grant or contribution for the protection of the grantor or contributor. If there is no written statement, a grantor or contributor will not be considered responsible for a substantial and material change if the total gifts, grants, or contributions received from that grantor or contributor for a tax year are 25% or less of the total support received by the organization from all sources for the 4 tax years immediately before the tax year. (If the organization has not qualified as publicly supported for those 5 years, see Special computation period for new organizations, next.) For this purpose, total support does not include support received from that particular grantor or contributor. The grantor or contributor cannot be a person who is in a position of authority, such as a foundation manager, or who obtains a position of authority or the ability to exercise control over the organization because of the grant or contribution. Special computation period for new organizations. Organizations that have been in existence for at least 1 tax year consisting of at least 8 months, but for fewer than 5 tax years, can substitute the number of tax years they have been in existence before their current tax year to determine whether they meet the one-third support test or the facts and circumstances test, discussed earlier. First tax year at least 8 months. The initial status determination of a newly created organization whose first tax year is at least 8 months is based on a computation period of either the first tax year or the first and second tax years. First tax year shorter than 8 months. The initial status determination of a newly created organization whose first tax year is less than 8 months is based on a computation period of either the first and second tax years or the first, second, and third tax years. 5-year advance ruling period. If an organization has received an advance ruling, the computation is based on all the years in the 5-year advance ruling period. Advance rulings are described later, under Advance rulings to newly created organizations--Initial determination of status. However, if the advance ruling period is terminated by the IRS, the computation period will be based on the period described above under First tax year at least 8 months and First tax year shorter than 8 months, or if the period is greater, the number of years to which the advance ruling applies. Support. For purposes of publicly-supported organizations, the term support includes (but is not limited to):
Amounts that are not support. The term support does not include:
Organizations dependent primarily on gross receipts from related activities. Organizations will not satisfy the one-third support test or the ten-percent-of-support requirement if they receive:
Example. X, an organization described in section 501(c)(3), is controlled by Thomas Blue, its president. X received $500,000 during the 4 tax years immediately before its current tax year under a contract with the Department of Transportation, under which X engaged in research to improve a particular vehicle used primarily by the federal government. During the same period, the only other support received by X was $5,000 in small contributions primarily from X's employees and business associates. The $500,000 is support under (1) above. Under these circumstances, X meets the conditions of (1) and (2) above and so does not meet the one-third support test or the ten-percent-of-support requirement. For the rules that apply to organizations that fail to qualify as section 509(a)(1) publicly-supported organizations because of these provisions, see Section 509(a)(2) Organizations, later. See also Gross receipts from a related activity in the discussion on section 509(a)(2) organizations. Membership fees. Membership fees are included in the term support if they are paid to provide support for the organization rather than to buy admissions, merchandise, services, or the use of facilities. Support from a governmental unit. For purposes of the one-third support test and the ten-percent-of-support requirement, the term support from a governmental unit includes any amounts received from a governmental unit, including donations or contributions and amounts received on a contract entered into with a governmental unit for the performance of services, or from a government research grant. However, these amounts are not support from a governmental unit for these purposes if they constitute amounts received from the exercise or performance of the organization's exempt functions. Any amount paid by a governmental unit to an organization will not be treated as received from the exercise or performance of its exempt function if the purpose of the payment is primarily to enable the organization to provide a service to, or maintain a facility for, the direct benefit of the public (regardless of whether part of the expense of providing the service or facility is paid for by the public), rather than to serve the direct and immediate needs of the payor. This includes:
Medicare and Medicaid payments. Medicare and Medicaid payments are received from contracts entered into with state and federal governmental units. However, payments are made for services already provided to eligible individuals, rather than to encourage or enable an organization to provide services to the public. The individual patient, not a governmental unit, actually controls the ultimate recipient of these payments by selecting the health care organization. As a result, these payments are not considered support from a governmental unit. Medicare and Medicaid payments are gross receipts derived from the exercise or performance of exempt activities and, therefore, are not included in the term support. Support from the general public. In determining whether the one-third support test or the ten-percent-of-support requirement is met, include in your computation support from direct or indirect contributions from the general public. This includes contributions from an individual, trust, or corporation but only to the extent that the total contributions from the individual, trust, or corporation, during the 4-year period immediately before the current tax year (or substituted computation period) are not more than 2% of the organization's total support for the same period. Thus, a contribution by any one individual will be included in full in the denominator of the fraction used in the one-third support test or the ten-percent-of-support requirement. However, the contribution will be included in the numerator only to the extent that it is not more than 2% of the denominator. In applying the 2% limit, all contributions made by a donor and by any person in a special relationship to the donor (certain Disqualified persons discussed on page 39) are considered made by one person. The 2% limit does not apply to support received from governmental units or to contributions from other publicly supported charities, except as provided under Grants from public charities, later. Indirect contributions. The term indirect contributions from the general public includes contributions received by the organization from organizations (such as publicly-supported organizations) that normally receive a substantial part of their support from direct contributions from the general public, except as provided under Grants from public charities, next. Grants from public charities. Contributions received from a governmental unit or from a publicly-supported organization (including a church that meets the requirements for being publicly supported) are not subject to the 2% limit unless the contributions represent amounts either expressly or impliedly earmarked by a donor to the governmental unit or publicly-supported organization as being for, or for the benefit of, the particular organization claiming a publicly-supported status. Example 1. M, a national foundation for the encouragement of the musical arts, is a publicly-supported organization. George Spruce gives M a donation of $5,000 without imposing any restrictions or conditions upon the gift. M later makes a $5,000 grant to X, an organization devoted to giving public performances of chamber music. Since the grant to X is treated as being received from M, it is fully includible in the numerator of X's support fraction for the tax year of receipt. Example 2. Assume M is the same organization described in Example 1. Tom Grove gives M a donation of $10,000, but requires that M spend the money to support organizations devoted to the advancement of contemporary American music. M has complete discretion as to the organizations of the type described to which it will make a grant. M decides to make grants of $5,000 each to Y and Z, both being organizations described in section 501(c)(3) and devoted to furthering contemporary American music. Since the grants to Y and Z are treated as having been received from M, Y, and Z each may include one of the $5,000 grants in the numerator of its support fraction. Although the donation to M was conditioned upon the use of the funds for a particular purpose, M was free to select the ultimate recipient. Example 3. N is a national foundation for the encouragement of art and is a publicly-supported organization. Grants to N are permitted to be earmarked for particular purposes. O, which is an art workshop devoted to training young artists and which is claiming status as a publicly-supported organization, persuades C, a private foundation, to make a grant of $25,000 to N. C is a disqualified person with respect to O. C makes the grant to N with the understanding that N would be bound to make a grant to O in the sum of $25,000, in addition to a matching grant of N's funds to O in the sum of $25,000. Only the $25,000 received directly from N is considered a grant from N. The other $25,000 is an indirect contribution from C to O and is to be excluded from the numerator of O's support fraction to the extent it exceeds the 2% limit. Unusual grants. In applying the 2% limit to determine whether the one-third support test or the ten-percent-of-support requirement is met, exclude contributions that are considered unusual grants from both the numerator and denominator of the appropriate percent-of-support fraction. Generally, unusual grants are substantial contributions or bequests from disinterested parties if the contributions:
Characteristics of an unusual grant. A grant or contribution will be considered an unusual grant if the above three factors apply and if it has all of the following characteristics. If these factors and characteristics apply, then even without the benefit of an advance ruling, grantors or contributors have assurance that they will not be considered responsible for substantial and material changes in the organization's sources of support.
Ruling request. Before any grant or contribution is made, a potential grantee organization may request a ruling as to whether the grant or contribution may be excluded. This request may be filed by the grantee organization with the EO area manager for its area. The organization must submit all information necessary to make a determination, including information relating to the factors and characteristics listed in the preceding paragraphs. If a favorable ruling is issued, the ruling may be relied upon by the grantor or contributor of the particular contribution in question. The issuance of the ruling will be at the sole discretion of the IRS. The potential grantee organization should follow the procedures set out in Revenue Procedure 2001-4 (or later update) to request a ruling. Grants and contributions that result in substantial and material changes in the organization and that fail to qualify for exclusion will affect the way the support tests are applied. See Exception for material changes in sources of support, earlier. If a ruling is requested, in addition to the characteristics listed earlier under Characteristics of an unusual grant, the following factors may be considered by the IRS in determining if the grant or contribution is an unusual grant.
Advance rulings to newly created organizations -- Initial determination of status. Many newly created organizations cannot meet either the 4-year normally publicly supported provisions or the provisions for newly created organizations to qualify as normally publicly supported because they have not been in existence long enough. However, a newly created organization may qualify for an advance ruling that it will be treated as an organization described in section 170(b)(1)(A)(vi) during an advance ruling period long enough to enable it to develop an adequate support history on which to base an initial determination as to foundation status. Generally, the type of newly created organization that would qualify for an advance ruling is one that can show that its organizational structure, proposed programs and activities, and intended method of operation are likely to attract the type of broadly based support from the general public, public charities, and governmental units that is necessary to meet the public support requirements discussed earlier, under Qualifying As Publicly Supported. An advance ruling or determination will provide that an organization will be treated as an organization described in section 170(b)(1)(A)(vi) for an advance ruling period of 5 years. 5-year advance ruling period. A newly created organization may request a ruling or determination letter that it will be treated as a section 170(b)(1)(A)(vi) organization for its first 5 tax years. The request must be accompanied by a consent to extend the statute (on Form 872-C) that, in effect, states the organization will be subject to the taxes imposed under section 4940 if it fails to qualify as an organization excluded as a private foundation during the 5-year advance ruling period. The organization's first tax year, regardless of length, will count as the first year in the 5-year period. The advance ruling period will end on the last day of the organization's 5th tax year. Between 30 and 45 days before the end of the advance ruling period, the EO area manager will contact the organization and request the financial support information necessary to make a final determination of foundation status. In general, this is the information requested in Part IV, A of Form 1023. Failure to obtain advance ruling. If a newly created organization has not obtained an advance ruling or determination letter, it cannot rely upon the possibility that it will meet the public support requirements discussed earlier. Thus, in order to avoid the risk of being classified as a private foundation, the organization may comply with the rules governing private foundations by paying any applicable private foundation taxes. If the organization later meets the public support requirements for the applicable period, it will be treated as a section 170(b)(1)(A)(vi) organization from its inception and any private foundation tax that was imposed may be refunded. Reliance period. The newly created organization will be treated as a publicly-supported organization for all purposes other than sections 507(d) (relating to total tax benefit resulting from exempt status) and 4940 (relating to tax on net investment income) for the period beginning with its inception and ending 90 days after its advance ruling period expires. The period will be extended until a final determination is made of an organization's status only if the organization submits, within the 90-day period, information needed to determine whether it meets either of the support tests for its advance ruling period (even if the organization fails to meet either test). However, this reliance period does not apply to the excise tax imposed on net investment income. If it is later determined that the organization was a private foundation from its inception, that excise tax will be due without regard to the advance ruling or determination letter. Consequently, if any amount of the tax is not paid on or before the last date prescribed for payment, the organization is liable for interest on the tax due for years in the advance ruling period. However, since any failure to pay the tax during the period is due to reasonable cause, the penalty imposed for failure to pay the tax will not apply. If an advance ruling or determination letter is terminated by the IRS before the expiration of the reliance period, the status of grants or contributions with respect to grantors or contributors to the organization will not be affected until notice of change of status of the organization is made to the public (such as by publication in the Internal Revenue Bulletin). However, this will not apply if the grantor or contributor was responsible for, or aware of, the act or failure to act that resulted in the organization's loss of classification as a publicly-supported organization. Also, it will not apply if the grantor or contributor knew that the IRS had given notice to the organization that it would be deleted from this classification. Before any grant or contribution is made, a potential grantee organization may request a ruling on whether the grant or contribution may be made without loss of classification as a publicly-supported organization. The ruling request may be filed by the grantee organization with the EO area manager. The issuance of the ruling will be at the sole discretion of the IRS. The organization must submit all information necessary to make a determination on the support factors previously discussed. If a favorable ruling is issued, the ruling may be relied upon by the grantor or contributor of the particular contribution in question. The grantee organization also may rely on the ruling for excluding unusual grants. Comprehensive ExamplesExample 1. For the years 1995 through 1998, M organization received support of $600,000 from the following sources.
Example 2. N organization was created to maintain public gardens containing plant specimens and displaying works of art. The facilities, art, and a large endowment were all contributed by a single contributor. The members of the governing body of the organization are unrelated to its creator. The gardens are open to the public without charge and attract many visitors each year. For the 4 tax years immediately before the current tax year, 95% of the organization's total support was received from investment income from its original endowment. N also maintains a membership society that is supported by members of the general public who wish to contribute to the upkeep of the gardens by paying a small annual membership fee. Over the 4-year period in question, these fees from the general public constituted the remaining 5% of the organization's total support. Under these circumstances, N does not meet the one-third support test for its current tax year. Furthermore, since only 5% was received from the general public, N does not satisfy the ten-percent-of-support requirement of the facts and circumstances test. For its current tax year, N therefore is not a publicly-supported organization. Since N failed to satisfy the ten-percent-of-support requirement, none of the other requirements or factors can be considered in determining whether N qualifies as a publicly-supported organization. Example 3. In 1980, O organization was founded in Y City by the members of a single family to collect, preserve, interpret, and display to the public important works of art. O is governed by a Board of Trustees that originally consisted almost entirely of members of the founding family. However, since 1990, members of the founding family or persons related to members of the family have annually been less than 20% of the Board of Trustees. The remaining board members are citizens of Y City from a variety of professions and occupations who represent the interests and views of the people of Y City in the activities carried on by the organization rather than the personal or private interests of the founding family. O solicits contributions from the general public and for each of its 4 most recent tax years has received total contributions (in small sums of less than $100, none of which is more than 2% of O's total support for the period) of more than $10,000. These contributions from the general public are 25% of the organization's total support for the 4-year period. For this same period, investment income from several large endowment funds has been 75% of its total support. O spends substantially all of its annual income for its exempt purposes and thus depends upon the funds it annually solicits from the public as well as its investment income to carry out its activities on a normal and continuing basis and to acquire new works of art. For the entire period of its existence, O has been open to the public and more than 300,000 people (from Y City and elsewhere) have visited the museum in each of its 4 most recent tax years. Under these circumstances, O does not meet the one-third support test for its current year since it has received only 25% of its total support for the applicable 4-year period from the general public. However, O has met the ten-percent-of-support requirement as well as the attraction of public support requirement and the factors to be considered, under the facts and circumstances test, in determining whether an organization is publicly supported. Therefore, O is classified as a publicly-supported organization for its current tax year and the next tax year. Example 4. In 1990, the P Philharmonic Orchestra was organized in Z City by a local music society and a local women's club to present to the public a wide variety of musical programs intended to foster music appreciation in the community. The orchestra is composed of professional musicians who are paid by the association. Twelve performances, open to the public, are scheduled each year. A small admission charge is made for each of these performances. In addition, several performances are staged annually without charge. During its 4 most recent tax years, P received separate contributions of $200,000 each from Amanda Green and Jackie White (not members of a single family) and support of $120,000 from the Z Community Chest, a public federated fundraising organization operating in Z City. P depends on these funds to carry out its activities and will continue to depend on contributions of this type to be made in the future. P has also begun a fundraising campaign in an attempt to expand its activities for the coming years. P is governed by a Board of Directors composed of five individuals. A faculty member of a local college, the president of a local music society, the head of a local bank, a prominent doctor, and a member of the governing body of the local Chamber of Commerce currently serve on the Board and represent the interests and views of the community in the activities carried on by P. For P's current tax year, its sources of support are computed on the basis of the 4 immediately preceding years, as follows.
If P were a newly created organization, it could obtain a ruling that it is a publicly-supported organization by reason of its purposes, organizational structure, and proposed method of operation. Even if P had initially been founded by the contributions of a few individuals, this would not, in and of itself, disqualify P from receiving the ruling. Example 5. Q is a philanthropic organization founded in 1985 by Anne Elm for the purpose of making annual contributions to worthy charities. Anne created Q as a charitable trust by transferring $500,000 worth of appreciated securities to Q. Under the trust agreement, Anne and two other family members are the sole trustees and are vested with the right to appoint successor trustees. In each of its 4 most recent tax years, Q received $15,000 in investment income from its original endowment. Each year Q solicits funds by operating a charity ball at Anne's home. Guests are invited and asked to make contributions of $100 per couple. During the 4-year period involved, $15,000 was received from the proceeds of these events. Anne and the family have also made contributions to Q of $25,000 over the course of the organization's 4 most recent tax years. Q makes disbursements each year of substantially all of its net income to the public charities chosen by the trustees. For Q's current tax year, Q's sources of support are computed on the basis of the 4 immediately preceding years as follows.
Community TrustsCommunity trusts are often established to attract large contributions of a capital or endowment nature for the benefit of a particular community or area. Often these contributions come initially from a small number of donors. While the community trust generally has a governing body composed of representatives of the particular community or area, its contributions are often received and maintained in the form of separate trusts or funds that are subject to varying degrees of control by the governing body. To qualify as a publicly-supported organization, a community trust must meet the one-third support test, explained, earlier, under Qualifying As Publicly Supported. If it cannot meet that test, it must be organized and operated so as to attract new and additional public or governmental support on a continuous basis sufficient to meet the facts and circumstances test, also explained earlier. Community trusts are generally able to satisfy the attraction of public support requirement (as contained in the facts and circumstances test) if they seek gifts and bequests from a wide range of potential donors in the community or area served, through banks or trust companies, through attorneys or other professional persons, or in other appropriate ways that call attention to the community trust as a potential recipient of gifts and bequests made for the benefit of the community or area served. A community trust, however, does not have to engage in periodic, community-wide, fundraising campaigns directed toward attracting a large number of small contributions in a manner similar to campaigns conducted by a community chest or a united fund. Separate trusts or funds. Any community trust may be treated as a single entity, rather than as an aggregation of separate funds, in which case all qualifying funds associated with that organization (whether a trust, not-for-profit corporation, unincorporated association, or a combination thereof) will be treated as component parts of the organization. Single entity. To be treated as a single entity, a community trust must meet all of the following requirements.
A community trust can meet the requirement in (3) above even if its exercise of the powers in (3)(a), (b), or (c) is reviewable by an appropriate state authority. Component part. To be treated as a component part of a community trust (rather than as a separate trust or a not-for-profit corporation), a trust or fund:
Grantors and contributors. Grantors, contributors, or distributors to a community trust may rely on the public charity status, which the organization has claimed in a timely filed notice, on or before the date the IRS informs the public (through such means as publication in the Internal Revenue Bulletin) that such reliance has expired. However, if the grantor, contributor, or distributor acquires knowledge that the IRS has notified the community trust that it has failed to establish that it is a public charity, then reliance on the claimed status expires at the time such knowledge is acquired. Section 509(a)(2) OrganizationsSection 509(a)(2) excludes certain types of broadly, publicly-supported organizations from private foundation status. Generally, an organization described in section 509(a)(2) may also fit the description of a publicly-supported organization under section 509(a)(1). There are, however, two basic differences.
To be excluded from private foundation treatment under section 509(a)(2), an organization must meet two support tests.
Both these tests are designed to insure that an organization excluded from private foundation treatment is responsive to the general public, rather than to the private interests of a limited number of donors or other persons. One-third support test. The one-third support test will be met if an organization normally receives more than one-third of its support in each tax year from any combination of:
For this purpose, the support must be from permitted sources, which include:
Limit on gross receipts. In computing the amount of support received from gross receipts under (2) above, gross receipts from related activities received from any person or from any bureau or similar agency of a governmental unit are includible in any tax year only to the extent the gross receipts are not more than the greater of $5,000 or 1% of the organization's total support in that year. Not-more-than-one-third support test. This test will be met if an organization normally receives no more than one-third of its support in each tax year from the total of:
Gross investment income. Gross investment income means the gross amount of income from interest, dividends, payments with respect to securities loans, rents, and royalties, but it does not include any income that would be included in computing tax on unrelated business income from trades or businesses. Definition of normally. Both support tests are computed on the basis of the nature of the organization's normal sources of support. An organization will be considered to have normally met both tests for its current tax year and the tax year immediately following, if it meets those tests on the basis of the total support received for the 4 tax years immediately before the current tax year. Exception for material changes in sources of support. If during the current tax year there are substantial and material changes in an organization's sources of support other than changes arising from unusual grants (discussed, later, under Unusual grants), neither the 4-year computation period for the current year as an immediately following tax year, nor the 4-year computation period for that year as a current tax year applies. Instead, the normal sources of support will be determined on the basis of a 5-year period consisting of the current tax year and the 4 preceding tax years. For example, if material changes occur in support for the year 1999, then even though the organization meets the requirements of the support tests based on the years 1994-1997 or 1995-1998, it does not meet these tests unless it meets the requirements based on the 5-year computation period of 1995-1999. An example of a substantial and material change is the receipt of an unusually large contribution that does not qualify as an unusual grant. Effect on grantor or contributor. If an organization is not able to meet either of the support tests because of a substantial or material change in the sources of support, its status with respect to a grantor or contributor will not be affected until notice of a change in status is made to the public (such as by publication in the Internal Revenue Bulletin). However, this rule does not apply to any grantor or contributor who:
A grantor or contributor (other than one of the organization's founders, creators, or foundation managers) is not considered responsible for, or aware of, the substantial and material change if the grantor or contributor made the grant or contribution relying upon a written statement by the grantee organization that the grant or contribution would not result in the loss of the organization's classification as an organization that is not a private foundation. The statement must be signed by a responsible officer of the grantee organization and must give enough information, including a summary of the pertinent financial data for the 4 preceding years, to assure a reasonably prudent person that the grant or contribution would not result in the loss of the grantee organization's classification as not a private foundation. If a reasonable doubt exists as to the effect of the grant or contribution, or if the grantor or contributor is one of the organization's founders, creators, or foundation managers, the grantee organization may request a ruling from its EO area manager for the protection of the grantor or contributor. If there is no written statement, a grantor or contributor will not be considered responsible for a substantial and material change if the total gifts, grants, or contributions received from that grantor or contributor for a tax year are 25% or less of the total support received by the organization from all sources for the 4 tax years immediately before the tax year. (If the organization has not qualified as publicly supported for those 5 years, see Special computation period for new organizations, next.) For this purpose, total support does not include support received from that particular grantor or contributor. The grantor or contributor cannot be a person who is in a position of authority, such as a foundation manager, or who obtains a position of authority or the ability to exercise control over the organization because of the grant or contribution. Special computation period for new organizations. A newly created organization may need several years to establish its normal sources of support. Organizations generally are allowed a 5-year period to establish that they meet the section 509(a)(2) support test. This is called the advance ruling period. If an organization can reasonably be expected to meet the support test by the end of its advance ruling period, the IRS may issue it an advance ruling or determination letter. See Advance rulings for newly created organizations, later. This will permit the organization to be treated as a section 509(a)(2) organization for its advance ruling period. An advance ruling or determination is not a ruling that the organization will meet the requirements of section 509(a)(2) during the advance ruling period. An organization that receives an advance ruling or determination letter must, at the expiration of the advance ruling period, establish that it satisfies the section 509(a)(2) support requirements for the years covered by the advance ruling, or the organization will be presumed to be a private foundation under section 508(b). Unusual grants. An unusual grant may be excluded from the support test computation if it:
Characteristics of an unusual grant. A grant or contribution will be considered an unusual grant if the above 3 factors apply and it has all of the following characteristics. If these factors and characteristics apply, then even without the benefit of an advance ruling, grantors or contributors have assurance that they will not be considered responsible for substantial and material changes in the organization's sources of support.
Ruling request. If there is any doubt that a grant or contribution may be excluded as an unusual grant, the grantee organization may request a ruling, submitting all of the necessary information for making a determination to its EO area manager. The IRS has the sole discretion of issuing a ruling, but if a favorable ruling is issued, it may be relied on by the grantor or contributor for purposes of a charitable contributions deduction and by the organization for purposes of the exclusion for unusual grants. The organization should follow the procedures set out in Revenue Procedure 2001-4 (or later update). In addition to the characteristics listed above, the following factors may be considered by the IRS in determining if the grant or contribution is an unusual grant.
Example 1. In 1995, Y, an organization described in section 501(c)(3), was created by Marshall Pine, the holder of all the common stock in M corporation, Lisa, Marshall's wife, and Edward Forest, Marshall's business associate. Each of the three creators made small cash contributions to Y to enable it to begin operations. The purpose of Y was to sponsor and equip athletic teams composed of underprivileged children of the community. Between 1995 and 1998, Y was able to raise small amounts of contributions through fundraising drives and selling admission to some of the sponsored sporting events. For its first year of operations, it was determined that Y was excluded from the definition of private foundation under the provisions of section 509(a)(2). Marshall made small contributions to Y from time to time. At all times, the operations of Y were carried out on a small scale, usually being restricted to the sponsorship of two to four baseball teams of underprivileged children. In 1999, M recapitalized and created a first and second class of 6% nonvoting preferred stock, most of which was held by Marshall and Lisa. Marshall then contributed 49% of his common stock in M to Y. Marshall, Lisa, and Edward continued to be active participants in the affairs of Y from its creation through 1999. Marshall's contribution of M's common stock was 90% of Y's total support for 1999. Although Y could satisfy the one-third support test on the basis of the 4 tax years before 1999, a combination of the facts and circumstances preclude Marshall's contribution of M's common stock in 1999 from being excluded as an unusual grant. Marshall's contribution in 1999 was a substantial and material change in Y's sources of support and on the basis of the 5-year period (1995 to 1999), Y would not be considered as normally meeting the one-third support test for the tax years 1999 (the current tax year) and 2000 (the immediately following tax year). Example 2. M, an organization described in section 501(c)(3), was organized to promote the appreciation of ballet in a particular region of the United States. Its principal activities will consist of erecting a theater for the performance of ballet and the organization and operation of a ballet company. The governing body of M consists of nine prominent unrelated citizens living in the region who have either an expertise in ballet or a strong interest in encouraging appreciation of ballet. To provide sufficient capital for M to begin its activities, X, a private foundation, makes a grant of $500,000 in cash to M. Although Albert Cedar, the creator of X, is one of the nine members of M's governing body, was one of M's original founders, and continues to lend his prestige to M's activities and fundraising efforts, Albert does not, directly or indirectly, exercise any control over M. By the close of its first tax year, M also has received a significant amount of support from a number of smaller contributions and pledges from members of the general public. Upon the opening of its first season of ballet performances, M expects to charge admission to the general public. Under these circumstances, the grant by X to M may be excluded as an unusual grant. Advance rulings for newly created organizations. Newly created organizations generally are allowed an advance ruling period of 5 years. An organization that is claiming on its Form 1023 (or other section 508(b) notice) to be described under section 509(a)(2) must have operated for at least 1 tax year consisting of at least 8 months before the IRS will make a final determination of its status. However, if an organization can show that it can reasonably be expected to qualify under section 509(a)(2), the IRS will issue an advance ruling or determination letter on the organization's private foundation status. Generally, an advance ruling or determination provides that an organization will be treated as an organization described in section 509(a)(2) for an advance ruling period of 5 years. A newly created organization may request a ruling or determination that it will be treated as a section 509(a)(2) organization for its first 5 tax years. This request must be filed with a consent to extend the statute (Form 872-C) that in effect states the organization will be subject to private foundation taxes (under section 4940) if it fails to qualify as not a private foundation during the 5-year advance ruling period. In determining whether an organization can meet the support tests, the basic consideration is whether its organizational structure, proposed programs or activities, and intended method of operation will attract the type of broadly based support from the general public, public charities, and governmental units that is necessary to meet the tests. The facts that are relevant to this determination and the weight accorded each fact may differ from case to case. A favorable determination will not be made when the facts indicate that an organization is likely to receive less than one-third of its support from permitted sources or to receive more than one-third of its support from gross investment income and unrelated business taxable income. All pertinent facts and circumstances are taken into account in determining whether the organizational structure, programs or activities, and method of operation of an organization will enable it to meet the tests for its advance ruling period (discussed earlier). Some pertinent factors considered are:
Reliance period. The reliance period for a ruling or determination letter begins with the inception of the organization and ends 90 days after the advance ruling period. The reliance period will be extended until a final determination is made of the organization's status only if the organization submits, within the 90-day period, the necessary information to determine whether it meets the requirements for a section 509(a)(2) organization. However, this reliance period does not apply to the section 4940 excise tax on net investment income. Therefore, if it is later determined that the organization was a private foundation from its inception, the tax on net investment income will be due without regard to the ruling or determination letter. Grantors or contributors. If a ruling or determination letter is terminated before the expiration of the reliance period, the status of a charitable contribution deduction of a grantor or contributor will not be affected until notice of change of status is made public (such as by publication in the Internal Revenue Bulletin). However, this rule will not apply if the grantor or contributor is responsible for, or aware of, the act or failure to act that resulted in the organization's loss of section 509(a)(2) status, or if a grantor or contributor acquires knowledge that the IRS had given notice of the loss of status to the organization. Failure to obtain advance ruling. See the corresponding discussion under Failure to obtain advance ruling on page 32. Gifts, contributions, and grants distinguished from gross receipts. In determining whether an organization normally receives more than one-third of its support from permitted sources, include all gifts, contributions, and grants received from permitted sources in the numerator of the support fraction in each tax year. However, gross receipts from admissions, sales of merchandise, performance of services, or furnishing facilities, in an activity that is not an unrelated trade or business, are includible in the numerator of the support fraction in any tax year only to the extent that the amounts received from any person or from any bureau or similar agency of a governmental unit are not more than the greater of $5,000 or 1% of support. Gifts and contributions. Any payment of money or transfer of property without adequate consideration is considered a gift or contribution. When payment is made or property is transferred as consideration for admissions, sales of merchandise, performance of services, or furnishing facilities to the donor, the status of the payment or transfer under section 170(c) determines whether and to what extent the payment or transfer is a gift or contribution as distinguished from gross receipts from related activities. The amount includible in computing support from gifts, grants, or contributions of property or use of property is the fair market or rental value of the property at the date of the gift or contribution. Example. P is a local agricultural club and is an organization described in section 501(c)(3). It makes awards at its annual fair for outstanding specimens of produce and livestock to encourage interest and proficiency by young people in farming and raising livestock. Most of these awards are cash or other property donated by local businessmen. When the awards are made, the donors are given recognition for their donations by being identified as the donor of the award. The recognition given to donors is merely incidental to the making of the award to worthy youngsters. For these reasons, the donations are contributions. The amount includible in computing support is equal to the cash contributed or the fair market value of other property on the dates contributed. Grants. Grants often contain certain terms and conditions imposed by the grantor. Because of the imposition of terms and conditions, the frequent similarity of public purposes of grantor and grantee, and the possibility of benefit to the grantor, amounts received as grants for carrying on exempt activities are sometimes difficult to distinguish from amounts received as gross receipts from carrying on exempt activities. In distinguishing the term gross receipts from the term grants, the term gross receipts means amounts received from an activity that is not an unrelated trade or business, if a specific service, facility, or product is provided to serve the direct and immediate needs of the payor rather than primarily to confer a direct benefit on the general public. In general, payments made primarily to enable the payor to realize or receive some economic or physical benefit as a result of the service, facility, or product obtained will be treated as gross receipts by the payee. For example, a profit-making organization, primarily for its own betterment, contracts with a nonprofit organization for a service from that organization. Any payments received by the nonprofit organization (whether from the profit-making organization or from another nonprofit) for similar services are primarily for the benefit of the payor and are therefore gross receipts, rather than grants. Research leading to the development of tangible products for the use or benefit of a payor generally will be treated as a service provided to serve the direct and immediate needs of the payor, while basic research or studies carried on in the physical or social sciences generally will be treated as primarily to confer a direct benefit upon the general public. Medicare and Medicaid payments are gross receipts from the exercise or performance of an exempt function. The individual patient, not a governmental unit, actually controls the ultimate recipient of these payments. Therefore, Medicare and Medicaid receipts for services provided each patient are included as gross receipts to the extent they are not more than the greater of $5,000 or 1% of the organization's total support for the tax year. Membership fees distinguished from gross receipts. The fact that a membership organization provides services, admissions, facilities, or merchandise to its members as part of its overall activities will not, in itself, result in the classification of fees received from members as gross receipts subject to the $5,000 or 1% limit rather than membership fees. However, if an organization uses membership fees as a means of selling admissions, merchandise, services, or the use of facilities to members of the general public who have no common goal or interest (other than the desire to buy the admissions, merchandise, services, or use of facilities), the fees are not membership fees but are gross receipts. On the other hand, to the extent the basic purpose of the payment is to provide support for the organization rather than to buy admissions, merchandise, services, or the use of facilities, the payment is a membership fee. Bureau defined. The term any bureau or similar agency of a governmental unit for determining amounts subject to the $5,000 or 1% limit means a specialized operating unit of the executive, judicial, or legislative branch of government in which business is conducted under certain rules and regulations. Since the term bureau refers to a unit functioning at the operating, as distinct from the policy-making, level of government, it normally means a subdivision of a department of government. The term would not usually include those levels of government that are basically policy-making or administrative, such as the office of the Secretary or Assistant Secretary of a department, but would consist of the highest operational level under the policy-making or administrative levels. Amounts received from a unit functioning at the policy-making or administrative level of government are treated as received from one bureau or similar agency of the unit. Units of a governmental agency above the operating level are combined and considered a separate bureau for this purpose. Thus, an organization that has gross receipts from both a policy-making or administrative unit and an operational unit of a department will be treated as having gross receipts from two bureaus. For this purpose, the Departments of Air Force, Army, and Navy are separate departments and each has its own policy-making, administrative, and operating units. Example 1. The Bureau for Africa and the Bureau for Latin America are considered separate bureaus. Each is an operating unit under the Administrator of the Agency for International Development, a policy-making official. If an organization had gross receipts from both of these bureaus, the amount of gross receipts from each would be subject to the greater of $5,000 or the 1% limit. Example 2. A bureau is an operating unit under the administrative office of the Executive Director. The subdivisions of the bureau are Geographic Areas and Project Development Staff. If an organization had gross receipts from these subdivisions, the total gross receipts from these subdivisions would be considered gross receipts from the same bureau and would be subject to the greater of $5,000 or the 1% limit. Grants from public charities. For purposes of the one-third support test, grants received from a section 509(a)(1) organization (public charity) are generally includible in full in computing the numerator of the support fraction for that tax year. However, if the amount received is considered an indirect contribution from one of the public charity's donors, it will retain its character as a contribution from the donor, and if, for example, the donor is a substantial contributor to the ultimate recipient, the amount is excluded from the numerator of the support fraction. If a public charity makes both an indirect contribution from its donor and an additional grant to the ultimate recipient, the indirect contribution is treated as made first. An indirect contribution is one that is expressly or impliedly earmarked by the donor as being for, or for the benefit of, a particular recipient rather than for a particular purpose. Method of accounting. An organization's support is determined solely on the cash receipts and disbursements method of accounting. For example, if a grantor makes a grant to an organization payable over a term of years, the grant will be includible in the support fraction of the grantee organization only when and to the extent amounts payable under the grant are received by the grantee. Gross receipts from a related activity. When the charitable purpose of an organization described in section 501(c)(3) is accomplished through furnishing facilities for a rental fee or loans to a particular class of persons, such as aged, sick, or needy persons, the support received from those persons will be considered gross receipts from a related exempt activity rather than gross investment income or unrelated business taxable income. However, if the organization also furnishes facilities or loans to persons who are not members of a particular class and furnishing the facilities or funds does not contribute importantly to accomplishing the organization's exempt purposes, the support received from furnishing the facilities or funds will be considered rents or interest and will be treated as gross investment income or unrelated business taxable income. Example. X, an organization described in section 501(c)(3), is organized and operated to provide living facilities for needy widows of deceased servicemen. X charges the widows a small rental fee for the use of the facilities. Since X is accomplishing its exempt purpose through the rental of the facilities, the support received from the widows is considered gross receipts from a related exempt activity. However, if X rents part of its facilities to persons having no relationship to X's exempt purpose, the support received from these rentals will be considered gross investment income or unrelated business taxable income. Section 509(a)(3) OrganizationsSection 509(a)(3) excludes from the definition of private foundation those organizations that meet all of the three following requirements.
Section 509(a)(3) differs from the other provisions of section 509 that describe a publicly-supported organization. Instead of describing an organization that conducts a particular kind of activity or that receives financial support from the general public, section 509(a)(3) describes organizations that have established certain relationships in support of section 509(a)(1) or 509(a)(2) organizations. Thus, an organization may qualify as other than a private foundation even though it may be funded by a single donor, family, or corporation. This kind of funding ordinarily would indicate private foundation status, but a section 509(a)(3) organization has limited purposes and activities and gives up a significant degree of independence. The requirement in (2) above provides that a supporting (section 509(a)(3)) organization have one of three types of relationships with one or more publicly- supported (section 509(a)(1) or 509(a)(2)) organizations. It must be:
The first two relationships, operated, supervised, or controlled by and supervised or controlled in connection with, are based on an existence of majority control of the governing body of the supporting organization by the publicly-supported organization. They have the same rules for meeting the tests under requirement (1) and are discussed as Category one in the following discussion. The operated in connection with relationship requires that the supporting organization be responsive to and have operational relationships with publicly-supported organizations. This third relationship has different rules for meeting the requirement (1) tests and is discussed separately as Category two, later. Category one. This category includes organizations either operated, supervised, or controlled by or supervised or controlled in connection with organizations described in section 509(a)(1) or 509(a)(2). These kinds of organizations have a governing body that either includes a majority of members elected or appointed by one or more publicly-supported organizations or that consists of the same persons that control or manage the publicly-supported organizations. If an organization is to qualify under this category, it also must meet an organizational test, an operational test, and not be controlled by disqualified persons. These requirements are covered later in this discussion. Operated, supervised, or controlled by. Each of these terms, as used for supporting organizations, presupposes a substantial degree of direction over the policies, programs, and activities of a supporting organization by one or more publicly-supported organizations. The relationship required under any one of these terms is comparable to that of a parent and subsidiary, in which the subsidiary is under the direction of and is accountable or responsible to the parent organization. This relationship is established when a majority of the officers, directors, or trustees of the supporting organization are appointed or elected by the governing body, members of the governing body, officers acting in their official capacity, or the membership of one or more publicly-supported organizations. A supporting organization may be operated, supervised, or controlled by one or more publicly-supported organizations even though its governing body is not made up of representatives of the specified publicly-supported organizations for whose benefit it is operated. This occurs only if it can be demonstrated that the purposes of the publicly-supported organizations are carried out by benefiting the specified publicly-supported organizations (discussed, later, under Specified organizations). Supervised or controlled in connection with. The control or management of the supporting organization must be vested in the same persons that control or manage the publicly-supported organization. In order for an organization to be supervised or controlled in connection with a publicly-supported organization, common supervision or control by the persons supervising or controlling both organizations must exist to insure that the supporting organization will be responsive to the needs and requirements of the publicly-supported organization. An organization will not be considered supervised or controlled in connection with one or more publicly-supported organizations if it merely makes payments (mandatory or discretionary) to the publicly-supported organizations. This is true even if the obligation to make payments is legally enforceable and the organization's governing instrument contains provisions requiring the distribution. These arrangements do not provide a sufficient connection between the payor organization and the needs and requirements of the publicly-supported organizations to constitute supervision or control in connection with the organizations. Organizational and operational tests. To qualify as a section 509(a)(3) organization (supporting organization), the organization must be both organized and operated exclusively for the purposes set out in requirement (1) at the beginning of this section. If an organization fails to meet either the organizational or the operational test, it cannot qualify as a supporting organization. In the case of supporting organizations created before 1970, the organizational and operational tests apply as of January 1, 1970. Therefore, even though the original articles of organization did not limit its purposes to those in requirement (1), and even though it operated before 1970 for some purpose other than those in requirement (1), an organization will satisfy the organizational and operational tests if, on January 1, 1970, and at all times thereafter, it is so constituted as to comply with these tests. Organizational test. An organization is organized exclusively for one or more of the purposes specified in requirement (1) only if its articles of organization:
In meeting the organizational test, the organization's purposes as stated in its articles may be as broad as, or more specific than, the purposes set forth in requirement (1) at the beginning of the discussion of Section 509(a)(3) Organizations. Therefore, an organization that by the terms of its articles is formed for the benefit of one or more specified publicly-supported organizations will, if it otherwise meets the other requirements, be considered to have met the organizational test. For example, articles stating that an organization is formed to perform the publishing functions of a specified university are enough to comply with the organizational test. An organization operated, supervised, or controlled by, or supervised or controlled in connection with, one or more publicly-supported organizations to carry out the purposes of those organizations, will be considered to have met these requirements if the purposes set forth in its articles are similar to but no broader than the purposes set forth in the articles of its controlling organizations. If, however, the organization by which it is operated, supervised, or controlled is a publicly-supported section 501(c)(4), 501(c)(5), or 501(c)(6) organization, the supporting organization will be considered to have met these requirements if its articles require it to carry on charitable, etc., activities within the meaning of section 170(c)(2). Limits. An organization is not organized exclusively for the purposes specified in requirement (1) if its articles expressly permit it to operate, to support, or to benefit any organization other than the specified publicly-supported organizations. It will not meet the organizational test even though the actual operations of the organization have been exclusively for the benefit of the specified publicly-supported organizations. Specified organizations. In order to meet requirement (1), an organization must be organized and operated exclusively to support or benefit one or more specified publicly-supported organizations. The manner in which the publicly-supported organizations must be specified in the articles will depend on whether the supporting organization is operated, supervised, or controlled by or supervised or controlled in connection with the organizations or whether it is operated in connection with the organizations. Generally, the articles of the supporting organization must designate each of the specified organizations by name, unless:
If a supporting organization is operated, supervised, or controlled by, or is supervised or controlled in connection with, one or more publicly-supported organizations, it will not fail the test of being organized for the benefit of specified organizations solely because its articles:
Operational test -- permissible beneficiaries. A supporting organization will be regarded as operated exclusively to support one or more specified publicly-supported organizations only if it engages solely in activities that support or benefit the specified organizations. These activities may include making payments to or for the use of, or providing services or facilities for, individual members of the charitable class benefited by the specified publicly-supported organization. For example, a supporting organization may make a payment indirectly through another unrelated organization to a member of a charitable class benefited by a specified publicly-supported organization, but only if the payment is a grant to an individual rather than a grant to an organization. Similarly, an organization will be regarded as operated exclusively to support or benefit one or more specified publicly-supported organizations if it supports or benefits a section 501(c)(3) organization, other than a private foundation, that is operated, supervised, or controlled directly by or in connection with a publicly-supported organization, or an organization that is a publicly-owned college or university. However, an organization will not be regarded as one that is operated exclusively to support or benefit a publicly-supported organization if any part of its activities is in furtherance of a purpose other than supporting or benefiting one or more specified publicly-supported organizations. Operational test -- permissible activities. A supporting organization does not have to pay its income to the publicly-supported organizations to meet the operational test. It may satisfy the test by using its income to carry on an independent activity or program that supports or benefits the specified publicly-supported organizations. All such support, however, must be limited to permissible beneficiaries described earlier. The supporting organization also may engage in fundraising activities, such as solicitations, fundraising dinners, and unrelated trade or business, to raise funds for the publicly-supported organizations or for the permissible beneficiaries. Absence of control by disqualified persons. The third requirement an organization must meet to qualify as a supporting organization requires that the organization not be controlled directly or indirectly by one or more disqualified persons (other than foundation managers or one or more publicly-supported organizations). Disqualified persons. For the purposes of the rules discussed in this publication, the following persons are considered disqualified persons:
If a person who is a disqualified person with respect to a supporting organization, such as a substantial contributor, is appointed or designated as a foundation manager of the supporting organization by a publicly-supported beneficiary organization to serve as the representative of the publicly-supported organization, that person is still a disqualified person, rather than a representative of the publicly-supported organization. An organization is considered controlled for this purpose if the disqualified persons, by combining their votes or positions of authority, may require the organization to perform any act that significantly affects its operations or may prevent the organization from performing the act. This includes, but is not limited to, the right of any substantial contributor or spouse to designate annually the recipients from among the publicly-supported organizations of the income from his or her contribution. Except as explained under Proof of independent control, next, a supporting organization will be considered to be controlled directly or indirectly by one or more disqualified persons if the voting power of those persons is 50% or more of the total voting power of the organization's governing body, or if one or more of those persons have the right to exercise veto power over the actions of the organization. Thus, if the governing body of a foundation is composed of five trustees, none of whom has a veto power over the actions of the foundation, and no more than two trustees are at any time disqualified persons, the foundation is not considered controlled directly or indirectly by one or more disqualified persons by reason of this fact alone. However, all pertinent facts and circumstances (including the nature, diversity, and income yield of an organization's holdings, the length of time particular stocks, securities, or other assets are retained, and its manner of exercising its voting rights with respect to stocks in which members of its governing body also have some interest) are considered in determining whether a disqualified person does in fact indirectly control an organization. Proof of independent control. An organization is permitted to establish to the satisfaction of the IRS that disqualified persons do not directly or indirectly control it. For example, in the case of a religious organization operated in connection with a church, the fact that the majority of the organization's governing body is composed of lay persons who are substantial contributors to the organization will not disqualify the organization under section 509(a)(3) if a representative of the church, such as a bishop or other official, has control over the policies and decisions of the organization. Category two. This category includes organizations operated in connection with one or more organizations described in section 509(a)(1) or 509(a)(2). This kind of section 509(a)(3) organization is one that has certain types of operational relationships. If an organization is to qualify as a section 509(a)(3) organization because it is operated in connection with one or more publicly-supported organizations, it must not be controlled by disqualified persons (as described earlier) and it must meet an organizational test, a responsiveness test, an integral-part test, and an operational test. Organizational test. This test requires that the organization, in its governing instrument:
In the case of an organization that is operated in connection with one or more publicly-supported organizations, however, the designation requirement under the organizational test can be satisfied using either of the following two methods. Method one. If an organization is organized and operated to support one or more publicly-supported organizations and it is operated in connection with that type of organization or organizations, then, its articles of organization must designate the specified organizations by name to satisfy the test. But a supporting organization that has one or more specified organizations designated by name in its articles will not fail the organizational test solely because its articles:
If the beneficiary organization referred to in (2) is not a publicly-supported organization, the supporting organization will not meet the operational test. Therefore, if a supporting organization substituted a beneficiary other than a publicly-supported organization and operated in support of that beneficiary, the supporting organization would not be one described in section 509(a)(3). Method two. If a historic and continuing relationship exists between the supporting organization and the publicly-supported organizations, and because of this relationship, a substantial identity of interests has developed between the organizations, then the articles of organization will not have to designate the specified organization by name. Responsiveness test. An organization will meet this test if it is responsive to the needs or demands of the publicly-supported organizations. To meet this test, either of the following must be satisfied.
For an organization that was supporting or benefiting one or more publicly-supported organizations before November 20, 1970, additional facts and circumstances, such as a historic and continuing relationship between organizations, may be taken into account in addition to the factors described earlier to establish compliance with the responsiveness test. Integral-part test. The organization will meet this test if it maintains a significant involvement in the operations of one or more publicly-supported organizations and these organizations are in turn dependent upon the supporting organization for the type of support that it provides. To meet this test, either of the following must be satisfied (unless transitional rules, discussed later, apply):
If item (2) is being relied on, a substantial amount of the total support of the supporting organization also must go to those publicly-supported organizations that meet the attentiveness requirement with respect to the supporting organization. Except as explained in the next paragraph, the amount of support received by a publicly-supported organization must represent a large enough part of the organization's total support to insure such attentiveness. In applying this, if the supporting organization makes payments to, or for the use of, a particular department or school of a university, hospital, or church, the total support of the department or school must be substituted for the total support of the beneficiary organization. Even when the amount of support received by a publicly-supported beneficiary organization does not represent a large enough part of the beneficiary organization's total support, the amount of support received from a supporting organization may be large enough to meet the requirements of item (2) of the integral-part test if it can be demonstrated that, in order to avoid the interruption of a particular function or activity, the beneficiary organization will be sufficiently attentive to the operations of the supporting organization. This may occur when either the supporting organization or the beneficiary organization earmarks the support received from the supporting organization for a particular program or activity, even if the program or activity is not the beneficiary organization's primary program or activity, as long as the program or activity is a substantial one. All factors, including the number of beneficiaries, the length and nature of the relationship between the beneficiary and supporting organization, and the purpose to which the funds are put, will be considered in determining whether the amount of support received by a publicly-supported beneficiary organization is large enough to insure the attentiveness of the organization to the operations of the supporting organization. Normally, the attentiveness of a beneficiary organization is motivated by the amounts received from the supporting organization. Thus, the more substantial the amount involved, in terms of a percentage of the publicly-supported organization's total support, the greater the likelihood that the required degree of attentiveness will be present. However, in determining whether the amount received from the supporting organization is large enough to insure the attentiveness of the beneficiary organization to the operations of the supporting organization (including attentiveness to the nature and yield of the supporting organization's investments), evidence of actual attentiveness by the beneficiary organization is of almost equal importance. Imposing this requirement is merely one of the factors in determining whether a supporting organization is complying with the attentiveness test. The absence of this requirement will not preclude an organization from classification as a supporting organization if it complies with the other factors. However, when none of the beneficiary organizations are dependent upon the supporting organization for a large enough amount of their support, the requirements of item (2) of the integral-part test will not be satisfied, even though the beneficiary organizations have enforceable rights against the supporting organization under state law. If an organization cannot meet the requirements of item (2) of the integral-part test for its current tax year solely because the amount received by one or more of the beneficiaries from the supporting organization is no longer large enough, it can still qualify under the integral-part test if it can establish that it has met the requirements of item (2) of the integral-part test for any 5-year period and that there has been an historic and continuing relationship of support between the organizations between the end of the 5-year period and the tax year in question. Transitional rule. A charitable trust created before November 20, 1970, will meet the integral-part test if for tax years beginning after October 16, 1972, the trustee makes annual written reports to all publicly-supported beneficiary organizations giving a description of the trust assets (including a detailed list of the assets and the income produced by them) and if the following five conditions have been met continuously since November 20, 1970.
Operational test. The requirements for meeting the operational test for organizations operated, supervised, or controlled by publicly-supported organizations (discussed earlier, beginning on page 29, under Qualifying As Publicly Supported) have limited applicability to organizations operated in connection with one or more publicly-supported organizations. This is because the operational requirements of the integral-part test, just discussed, generally are more specific than the general rules found for the operational test in the preceding category. However, a supporting organization can fail both the integral-part test and the operational test if it conducts activities of its own that do not constitute activities or programs that would, but for the supporting organization, have been conducted by any publicly-supported organization named in the supporting organization's governing instrument. A similar result occurs for such activities or programs that would not have been conducted by an organization with which the supporting organization has established an historic and continuing relationship. An organization operated in conjunction with a social welfare organization, labor or agricultural organization, business league, chamber of commerce, or other organization described in section 501(c)(4), 501(c)(5), or 501(c)(6), may qualify as a supporting organization under section 509(a)(3) and therefore not be classified as a private foundation if both the following conditions are met.
Special rules of attribution. To determine whether an organization meets the not-more-than-one-third support test in section 509(a)(2), amounts received by the organization from an organization that seeks to be a section 509(a)(3) organization because of its support of the organization are gross investment income (rather than gifts or contributions) to the extent they are gross investment income of the distributing organization. (This rule also applies to amounts received from a charitable trust, corporation, fund, association, or similar organization that is required by its governing instrument or otherwise to distribute, or that normally does distribute, at least 25% of its adjusted net income to the organization, and whose distribution normally comprises at least 5% of its adjusted net income.) All income that is gross investment income of the distributing organization will be considered distributed first by that organization. If the supporting organization makes distributions to more than one organization, the amount of gross investment income considered distributed will be prorated among the distributees. Also, treat amounts paid by an organization to provide goods, services, or facilities for the direct benefit of an organization seeking section 509(a)(2) status (rather than for the direct benefit of the general public) in the same manner as amounts received by the latter organization. These amounts will be treated as gross investment income to the extent they are gross investment income of the organization spending the amounts. An organization seeking section 509(a)(2) status must file a separate statement with its annual information return, Form 990 or 990-EZ, listing all amounts received from supporting organizations. Relationships created for avoidance purposes. If a relationship between an organization seeking section 509(a)(3) status and an organization seeking section 509(a)(2) status is established or availed of after October 9, 1969, and one of the purposes of establishing or using the relationship is to avoid classification as a private foundation with respect to either organization, then the character and amount of support received by the section 509(a)(3) organization will be attributed to the section 509(a)(2) organization for purposes of determining whether the latter meets the support tests under section 509(a)(2). If this type of relationship is established or used between an organization seeking 509(a)(3) status and two or more organizations seeking 509(a)(2) status, the amount and character of support received by the former organization will be prorated among the latter organizations. In determining whether a relationship exists between an organization seeking 509(a)(3) status (supporting organization) and one or more organizations seeking 509(a)(2) status (beneficiary organizations) for the purpose of avoiding private foundation status, all pertinent facts and circumstances will be taken into account. The following facts may be used as evidence that such a relationship was not established or availed of to avoid classification as a private foundation.
Effect on 509(a)(3) organizations. If a beneficiary organization fails to meet either of the support tests of section 509(a)(2) due to these provisions, and the beneficiary organization is one for whose support the organization seeking section 509(a)(3) status is operated, then the supporting organization will not be considered to be operated exclusively to support or benefit one or more section 509(a)(1) or 509(a)(2) organizations and therefore would not qualify for section 509(a)(3) status. Classification under section 509(a). If an organization is described in section 509(a)(1), and is also described in either section 509(a)(2) or 509(a)(3), it will be treated as a section 509(a)(1) organization. Reliance by grantors and contributors. Once an organization has received a final ruling or determination letter classifying it as an organization described in section 509(a)(1), 509(a)(2), or 509(a)(3), the treatment of grants and contributions and the status of grantors and contributors to the organization will generally not be affected by reason of a later revocation by the IRS of the organization's classification until the date on which notice of change of status is made to the public (generally by publication in the Internal Revenue Bulletin) or another applicable date, if any, specified in the public notice. In appropriate cases, however, the treatment of grants and contributions and the status of grantors and contributors to an organization described in section 509(a)(1), 509(a)(2), or 509(a)(3) may be affected pending verification of the continued classification of the organization. Notice to this effect will be made in a public announcement by the IRS. In these cases, the effect of grants and contributions made after the date of the announcement will depend on the statutory qualification of the organization as an organization described in section 509(a)(1), 509(a)(2), or 509(a)(3).
The preceding paragraph shall not apply if the grantor or contributor:
Section 509(a)(4) OrganizationsSection 509(a)(4) excludes from classification as private foundations those organizations that qualify under section 501(c)(3) as organized and operated for the purpose of testing products for public safety. Generally, these organizations test consumer products to determine their acceptability for use by the general public. Private Operating FoundationsSome private foundations qualify as private operating foundations. These are types of private foundations that, although lacking general public support, make qualifying distributions directly for the active conduct of their educational, charitable, and religious purposes, as distinct from merely making grants to other organizations for these purposes. Most of the restrictions and requirements that apply to private foundations also apply to private operating foundations. However, there are advantages to being classified as a private operating foundation. For example, a private operating foundation (as compared to a private foundation) can be the recipient of grants from a private foundation without having to distribute the funds received currently within 1 year, and the funds nevertheless may be treated as qualifying distributions by the donating private foundation; charitable contributions to a private operating foundation qualify for a higher charitable deduction limit on the donor's tax return; and the excise tax on net investment income does not apply to an exempt operating foundation. Private operating foundation means any private foundation that meets the assets test, the support test, or the endowment test, and makes qualifying distributions directly, for the active conduct of its activities for which it was organized, of substantially all (85% or more) of the lesser of its:
Assets test. A private foundation will meet the assets test if substantially more than half (65% or more) of its assets are:
Support test. A private foundation will meet the support test if:
Endowment test. A foundation will meet the endowment test if it normally makes qualifying distributions directly for the active conduct of its exempt function of at least two-thirds of its minimum investment return. The minimum investment return for any private foundation for any tax year is 5% of the excess of the total fair market value of all assets of the foundation (other than those used directly in the active conduct of its exempt purpose) over the amount of indebtedness incurred to acquire those assets. In determining whether the amount of qualifying distributions is at least two-thirds of the organization's minimum investment return, the organization is not required to trace the source of the expenditures to determine whether they were derived from investment income or from contributions. This test is intended to apply to organizations such as research organizations that actively conduct charitable activities but whose personal services are so great in relationship to charitable assets that the cost of those services cannot be met out of small endowments. Exempt operating foundations. The excise tax on net investment income does not apply to an exempt operating foundation. An exempt operating foundation for the tax year is any private foundation that:
New organization. If you are applying for recognition of exemption as an organization described in section 501(c)(3) and you wish to establish that your organization is a private operating foundation, you should complete Schedule E of your exemption application (Form 1023). |
