June 28, 2024

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If you are starting a faith-based nonprofit, you may have questions about the legal steps necessary to organize your entity. Napa Legal’s Skills Course, Getting Started 101: Forming Your Organization, can help you begin this journey of forming your nonprofit.

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Public Charity or Private Foundation?

As you begin the formation process, chances are you will apply for federal 501(c)(3) tax-exempt status. If this applies to you, whether your organization’s exempt purpose will be primarily religious or charitable, you may intend to refer to your organization colloquially as a “charity” or “charitable organization.” However, according to the IRS, the term “public charity” has a very specific meaning and not all 501(c)(3) nonprofits are public charities. In fact, the default assumption by the IRS is that a 501(c)(3) organization is not a public charity but a “private foundation.” Organizations applying for 501(c)(3) status should be aware of this default position, since private foundations are subject to certain restrictions that do not apply to public charities.  

So, will your organization be a public charity or a private foundation? Read on. The following introduction to this topic should give you a good idea of where your organization will fit in.

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What is a public charity?

According to the Internal Revenue Code, there are three main ways an organization may qualify as a public charity.

1. An organization may qualify based on the type of 501(c)(3) organization that it is. The IRS specifies the general types of 501(c)(3) organizations that qualify as public charities: “churches, hospitals, qualified medical research organizations affiliated with hospitals, schools, colleges and universities” generally qualify as public charities.  

2. An organization can also qualify as a public charity if enough of its revenue comes from “public support.” Public support is satisfied when an organization receives a certain percentage of its funds “from many sources, including the general public, governmental agencies, corporations, private foundations or other public charities . . . [or] income from the conduct of activities in furtherance of the organization's exempt purposes.” This basically means that an organization receives a substantial amount of its funding from sources other than one large, single donor. There are two different public support tests, plus an alternative “facts and circumstances” test, which are discussed below.

3. Finally, an organization can qualify as a public charity if it is a “supporting organization” that functions in a supporting relationship to one or more public charities. Supporting organizations are a unique type of nonprofit, the details of which go beyond the scope of this post, but you can read more about them on the IRS website here.

Your organization may qualify as a public charity simply because it is one of the specific types of organization listed above. If your organization does not fit into the first classification, do not worry. Many faith-based nonprofits will probably qualify as public charities because they receive public support from many sources. The public support tests will help your organization to determine whether it receives sufficient public support to qualify as a public charity.  

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The Public Support Tests

The applicable statute¹ has two different types of public support test:  

1. the test articulated in § 509(a)(2) and

2. the test articulated in § 509(a)(1) and § 170(b)(1)(A)(vi).  

The two tests have different criteria and apply to different organizations, depending on what types of revenue an organization receives.  

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The 509(a)(2) Test

The 509(a)(2) test typically applies to organizations that receive much of their revenue from sales related to their exempt purpose, such as nonprofit museums and zoos that charge admission or organizations that receive much of their support from membership fees. The 509(a)(2) public support test has two basic criteria to qualify as a public charity:  

1. It must normally receive more than one-third of its support from gifts, grants, contributions, membership fees, and gross receipts (sales) related to its exempt purpose(s); and

2. It must not normally receive more than one-third of its support from gross investment income and unrelated business taxable income.

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The 509(a)(1)/170(b)(1)(A)(vi) Test

The 509(a)(1) public support test (more precisely the 170(b)(1)(A)(vi) test, which defines the criteria necessary to qualify under this test) typically applies to organizations that receive most of their revenue from donations. To qualify under this test, the organization must receive over one-third of its revenue from charitable contributions from individuals or other organizations, or from the government.  

Note that if, as explained below, a single donor gives over 2% of the organization’s total revenue, every dollar above the 2% threshold does not count toward the one-third requirement for purposes of the public support test.  

If an organization can pass the 509(a)(1) test, it does not need to satisfy the criteria in the 509(a)(2) test regarding gross investment income and unrelated business income. This can be helpful for heavily-endowed organizations that hold investments that generate substantial income.

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Applying the Public Support Tests

What do these public support tests mean practically for your organization? Schedule A of the IRS Form 990 can be a helpful tool to understand the practical application of the public support test. Part II of the form explains the calculation that determines whether the organization qualifies as a public charity.

• First, the organization adds up all the revenue sources that qualify as public support. The relevant revenue sources will depend on which public support test your organization is using.  

• Second, the organization looks at each revenue source to find “[t]he portion of total contributions by each person (other than a governmental unit or publicly supported organization) . . .  that exceeds 2%” of the organization’s total revenue. If an individual donor gives over 2% of total revenue, every dollar of those funds over the 2% threshold is excluded from “public support.” So if an organization receives $100,000 in revenue and a donor contributes $5,000, only $2,000 of that contribution counts as public support.

• Finally, take your organization’s total revenue and subtract all the revenue that is not public support. If the final number you are left with is over one-third of your organization’s total revenue, you should qualify as a public charity.

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The Facts and Circumstances Test

Note that, if an organization is a 509(a)(1)/170(b)(1)(A)(vi) organization and does not meet the one-third public support requirement in a given year, but does receive more than 10% of its revenue from public support, there is a “facts and circumstances” test that may still allow the organization to qualify for public charity status.²  

Briefly, the facts and circumstances test applies when an organization’s public support is more than 10% but less than the one-third required by the public support tests. If that is the case, the organization can qualify as a public charity by showing that it normally receives a substantial portion of its support from public sources and that it maintains a bona fide program or carries on activities designed to attract public support. The IRS will consider several factors under this test, including:  

• how close the organization comes to the one-third public support threshold;  

• whether the organization’s support comes from a representative number of different people rather than a small group/family of donors;

• whether the governing body (often the board of directors) represents the broad interests of the public rather than the personal/private interests of a limited number of donors; and

• whether the organization generally provides facilities or services for the benefit of the general public on a continuing basis.

To learn more about this option, start with the IRS resource here.

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What if my organization does not qualify as a public charity?

An organization will have five years before the IRS will monitor whether it passes the public support test. At that point, if an organization fails to qualify as a public charity, the organization is reclassified as a private foundation.

The IRS identifies several restrictions or additional requirements imposed on private foundations, such as:

• more stringent restrictions on self-dealing between private foundations and their donors and other disqualified parties;

• certain requirements that the foundation distribute a percentage of its income for charitable purposes each year;  

• limits on a private foundation’s holdings in private business and certain investments; and

• restrictions to assure that the expenditures of the organization further a tax-exempt purpose.

Additionally, a private foundation is required to file a different kind of Form 990 each year, called the Form 990-PF. The Schedule B of Form 990-PF lists the identities of the organization’s donors, but those donor identities are not confidential as they are with a public charity. This is a crucial reason to maintain public charity status; many donors do not want their identities to be public.

Note also that, once an organization has been designated as a private foundation, it is stuck with that private foundation designation for five years.

For more on private foundations, you can review the IRS resource on the subject here.

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Conclusion

This article provides an introductory overview of the concept of a public charity and the requirements to achieve and maintain that status. If you are unsure whether your organization meets the requirements of a public charity, start by reviewing your organization’s revenue and determining if you meet the public support test. If you do not think you qualify as a public charity based on type of organization or the one of the “public support” tests, it may be time to speak to an attorney or accountant to make sure you are filing the correct Form 990 and following all the requirements that apply to your organization.

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¹ 26 U.S. Code § 509.

² See 26 CFR § 1.170A-9(f)(3).