Public Charity versus Private Foundation Classification

Every 501(c)(3) organization is categorized as either a public charity or a private foundation. This is referred to as a “foundation classification” and the determination itself is called a 509(a) ruling. Don’t confuse this with 501(c)(3) status, which refers to tax exemption! The distinction between a public charity and a private foundation is primarily based on where financial support for the organization comes from.

Although “private foundation” is the default status, most nonprofits qualify as public charities as a result of falling within an exception. You will find your classification right at the top of your IRS Determination Letter.

The hallmark of public charities is that they have a broad base of donors and public support. The public support generally comes in one of two ways:

1. In the form of governmental grants or donations, individual donors, or even donations from other 501(c)(3) organizations; or

2. a substantial part of the organizations revenues come from individual contributions, membership fees, and gross receipts for activities that further their exempt purpose.

Organizations that do not qualify as public charities are categorized as private foundations. Private foundations are generally funded by a small group of mostly large donors.

Why does it matter?

Selecting the right foundation classification for your charity, private foundation or a public charity, will impact two things. The tax rules that will govern the organization and the limitations on donations.

Tax Rules

Private foundations are subject to stricter oversight. For example, they are subject to taxation on their net investment income and other excise taxes (this means taxes on certain goods, services, and activities). Private Foundations are also subject to annual income distribution requirements, limits on holdings in business and restrictions on certain investments, and strict restrictions on self-dealing, . Violations can result in taxes not only on the foundation itself but also on foundation directors and certain related parties.

Limitations on Donations

There is always a cap on the amount of a contribution that a donor can take as a charitable deduction.

For donations to a public charity, that limit is 50% of the giver’s adjusted gross income. For contributions to a private foundation, the limit is 30%. While the limit won’t impact the donations of most people, for donors that it does impact the difference in the cap is an important difference. In addition, contributors can deduct a higher percentage for contributions of capital gain property to public charities.

Is My Organization a Public Charity?

To be classified as a public charity – not a private foundation – an organization has to :

1. be one of the specific types of organizations named in the Code, like a hospital or church; OR

2. show that it has broad public support; OR

3. show a combination of broad public support and income from its exempt activities; OR

4. have a special relationship with another public charity.

Specific Types of Organizations Named in Code

There are some organizations that are specifically mentioned in the IRS Code as examples of public charities. This includes schools, hospitals, medical research organizations, churches (or synagogues, mosques, temples..) or other religious organizations.

Broad Public Support

There are two versions of the public support test. The first, the 509(a)(1) Public Support Test, is computed on Part II of Form 990, Schedule A.

It is the preferable option for nonprofits and is primarily meant for organizations that receive most of their revenue from donations and charitable contributions. 

For purposes of 509(a)(1), the most basic explanation of what constitutes public support is that 1/3 or 33.33% of donations must come from donors who give less than 2% of the organizations gross receipts. So, if your gross receipts are $100,000 for the year, and you have 300 donors, at least 100 of your donors must give less than $2,000 to your organization.

Donations may also come from certain other public charities or from state of federal grants.

While this seems straightforward, and it generally is, support is a little more complicated than just looking at the fraction. It is calculated differently depending on which subcategory of 501(c)(3) organization your nonprofit is and what type of public charity donates to your organization.

Know that if you have any concerns, you should speak with your attorney or accountant to make sure you are compliant with the public support test.

Although an organization reports its public support ratio each year, it is calculated over a five-year period. For a new organization, that period does not begin until your organization’s sixth year in existence.

Keep in mind that sometimes you may receive what is know as an unusual grant that can throw off your ratio. This can be excluded from the support test computation if it:

1. Was attracted by the publicly supported nature of the organization,

2. Was unusual or unexpected in amount, and

3. Would, because of its size, adversely affect the status of the organization as normally meeting the one-third support test. (The organization must otherwise meet the test in that year without benefit of the grant or contribution.)

Failing the Public Support Test

Failure to pass the public support test may result in your public charity reverting to private foundation status. With that comes the stricter reporting requirements and additional taxes touched upon above.

If you find that you have failed the public support test, but your public support is above 10%, you can request what is called a “facts and circumstances” test on your Form 990. The organization must assert to the IRS that it is operating as a charity, not a foundation, and that they are actively working to get their public support percentage back up to 33% or more. It is up to the discretion of the IRS whether or not to grant this.

The IRS looks at whether or not the organization 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). They take into account the following factors to determine whether or not the organization is a publicly supported organization despite failing to obtain the requisite public support:

• Percentage of Financial Support The most important factor is the percentage of public support. The higher above 10 percent it is, the lesser the burden of establishing the rest of the factors below.

  If the percentage is low due to a high percentage of its total support from investment income on its endowment funds, the IRS will also consider where the endowment came from (the general public, government sources, or from a limited group of donors).

• Sources of Support. Is the organization supported by government units, directly or indirectly from a representative number of persons, or a single family? This will be taken into consideration in determining if the organization is publicly supported. Also important is the age and type of organization, and whether it appeals to a limited number of persons or communities.

• Representative Governing Body. Does the organization have a governing body that represents the broad interests of the public or is does it cater to the personal or private interest of a limited number of donors?

  An organization’s governing body will generally be considered representative of the public interest if it is composed of: (a) public officials acting in their public capacity; (b) individuals selected by public officials acting in their public capacities; (c) persons having special knowledge or expertise in the particular field or discipline in which the organization is operating; and (d) community leaders, such as elected or appointed officials, members of the clergy, educators, civil leaders, or other such persons representing a broad cross-section of the views and interests of the community.

  For a membership organization, an organization will satisfy this factor if the governing body is comprised of individuals elected according to the organization’s governing instrument or bylaws by a broad based membership.

• Availability of Public Facilities or Service; Public Participation in Program or Policies. Does the organization:

  • Provide facilities or services directly for the benefit of the general public on a continuing basis? Examples include a museum or library that is open to the public, or a conservation organization that provides educational services to the public through the distribution of educational materials.

  • Publish scholarly studies that are widely available and used by colleges, universities, and members of the general public?

  • Participate in or sponsor programs by members of the public having special knowledge or expertise, public officials, or civil or community leaders?

  • Conduct and maintain programs that focus on charitable work in the community, such as workforce development or combating homelessness?

  • Receive a significant part of its funds from a public charity or governmental agency to which it is in some way held accountable as a condition of the grant, contract, or contribution?

• Additional Factors for Membership Organizations. To determine if a membership organization is publicly supported, examine:

  • Whether the solicitation for dues-paying members is designed to enroll a substantial number of persons in the community or area, or in a particular profession or field of special interest (taking into account the size of the area and the nature of the organization’s activities).

  • Whether membership dues for individual (rather than institutional) members have been fixed at rates designed to make membership available to a broad cross section of the interested public, rather than to restrict membership to a limited number of persons.

  • Whether the activities of the organization will be likely to appeal to persons having some broad common interest or purpose, such as educational activities in the case of alumni associations, musical activities in the case of symphony societies, or training in the case of business associations.

Combination of Public Support and Income from Exempt Activities

The second version of the public support test enables an organization to qualify as a public charity under Section 509(a)(2). This is applicable if your organization is one that collects a substantial part of its revenue (more than one-third) from sales of goods or services related to your exempt purposes (program revenue). This revenue is counted towards public support. (i.e., related earned income). It includes any combination of gifts, grants, contributions, membership fees, and gross receipts from certain permitted source.This public support test has a second requirement. Income that is unrelated business income, or investment income must also be calculated and must not total more than one-third of the income received less tax.Here’s a link to a video put together by the IRS on Foundation Classification. As always, it provides some good information straight from the source!