Publication 557 |
2001 Tax Year |
Private Foundations & Public Charities
It 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 Foundations
Every 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:
- Restrictions on self-dealing between private foundations and
their substantial contributors and other disqualified persons,
- Requirements that the foundation annually distribute income
for charitable purposes,
- Limits on their holdings in private businesses,
- Provisions that investments must not jeopardize the carrying
out of exempt purposes, and
- Provisions to assure that expenditures further exempt
purposes.
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 A
General
- The corporation will 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.
- The corporation 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.
- The corporation will not 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.
- The corporation will not make any investments in a manner as
to subject it to tax under section 4944 of the Internal Revenue Code,
or the corresponding section of any future federal tax code.
- The corporation will not 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.
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:
- Require it to act or refrain from acting so as not to
subject the foundation to the taxes imposed on prohibited
transactions, or
- Treat the required provisions as contained in the
foundation's governing instrument.
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 Charities
A 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:
| Qualifying support |
| Total support |
Including items of support in qualifying support (the
numerator of the fraction) or excluding items of support from total
support (the denominator of the fraction) may decide whether an
organization is excluded from the definition of a private foundation,
and thus from the liability for certain excise taxes. So it is very
important to classify items of support correctly.
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:
- The fair market value of the property on the date the
property is returned to the organization, or
- The fair market value of the property on the date the excess
benefit transaction occurred.
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:
- A private foundation as defined in section 509(a),
- A governmental entity that is exempt from (or not subject
to) taxation without regard to section 501(a), or
- A foreign organization, recognized by the IRS or by treaty,
that receives substantially all of its support (other than gross
investment income) from sources outside the United States.
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:
- Presidents, chief executives, or chief operating
officers.
- Treasurers and chief financial officers.
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:
- A corporation in which a disqualified person owns more than
35% of the total combined voting power,
- A partnership in which such persons own more than 35% of the
profits interest, or
- A trust or estate in which such persons own more than 35% of
the beneficial interest.
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:
- An employee who receives benefits that total less than the
highly compensated amount in section 414(q)(1)(B)(i) and
who does not hold the executive or voting powers mentioned earlier in
the discussion on Disqualified person, is not a family
member of a disqualified person, and is not a substantial
contributor,
- Tax-exempt organizations described in section 501(c)(3),
and
- Section 501(c)(4) organizations with respect to transactions
engaged in with other section 501(c)(4) organizations.
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.
- The person founded the organization.
- The person is a substantial contributor to the organization
under the section 507(d)(2)(A) definition, only taking into account
contributions to the organization for the past 5 years.
- The person's compensation is primarily based on revenues
derived from activities of the organization that the person
controls.
- The person has or shares authority to control or determine a
substantial portion of the organization's capital expenditures,
operating budget, or compensation for employees.
- The person manages a discrete segment or activity of the
organization that represents a substantial portion of the activities,
assets, income, or expenses of the organization, as compared to the
organization as a whole.
- The person owns a controlling interest (measured by either
vote or value) in a corporation, partnership, or trust that is a
disqualified person.
- The person is a non-stock organization controlled directly
or indirectly by one or more disqualified persons.
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.
- The person has taken a vow of poverty.
- The person is an independent contractor whose sole
relationship to the organization is providing professional advice
(without having decision-making authority) with respect to
transactions from which the independent contractor will not
economically benefit.
- Any preferential treatment the person receives based on the
size of the person's donation is also offered to others making
comparable widely solicited donations.
- The direct supervisor of the person is not a disqualified
person.
- The person does not participate in any management decisions
affecting the organization as a whole or a discrete segment of the
organization that represents a substantial portion of the activities,
assets, income, or expenses of the organization, as compared to the
organization as a whole.
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:
- All forms of cash and noncash compensation, including
salary, fees, bonuses, severance payments, and deferred compensation
that is earned and vested, whether or not funded and whether or not
paid under a deferred compensation plan that is a qualified plan under
section 401(a),
- The payment of liability insurance premiums for, or the
payment or reimbursement by the organization of taxes or certain
expenses under section 4958, unless excludable from income as a
de minimis fringe benefit under section 132(a)(4),
- All other compensatory benefits, whether or not included in
gross income for income tax purposes,
- Taxable and nontaxable fringe benefits, except fringe
benefits described in section 132, and
- Foregone interest on loans.
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:
- The organization produces a signed written employment
contract,
- The organization reports the benefit as compensation on an
original Form W-2, Form 1099 or Form 990, or on an amended form filed
before starting an IRS examination, or
- The disqualified person reports the benefit as income on the
person's original Form 1040 or on an amended form filed before
starting an IRS examination.
Exception. If the economic benefit is excluded from the
disqualified person's gross income for income tax purposes, the
applicable tax-exempt organization is not required to indicate its
intent to provide an economic benefit as compensation for
services.
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.
- The transaction is approved by an authorized body of the
organization (or an entity it controls) which is composed of
individuals who do not have a conflict of interest concerning the
transaction.
- Before making its determination, the authorized body
obtained and relied upon appropriate data as to comparability. (There
is a special safe harbor for small organizations. If the organization
has gross receipts of less than $1 million, appropriate comparability
data includes data on compensation paid by three comparable
organizations in the same or similar communities for similar
services.)
- The authorized body adequately documents the basis for its
determination concurrently with making that determination. The
documentation should include:
- The terms of the approved transaction and the date
approved,
- The members of the authorized body who were present during
debate on the transaction that was approved and those who voted on
it,
- The comparability data obtained and relied upon by the
authorized body and how the data was obtained,
- Any actions by a member of the authorized body having
conflict of interest, and
- Documentation of the basis of the determination before the
later of the next meeting of the authorized body or 60 days after the
final actions of the authorized body are taken, and approval of
records as reasonable, accurate and complete within a reasonable time
thereafter.
Disregarded benefits.
The following economic beneifts are disregarded for section 4958
purposes.
- Nontaxable fringe benefits that are excluded from income
under section 132.
- Benefits provided to a volunteer for the organization if the
benefit is provided to the general public in exchange for a membership
fee or contribution of $75 or less.
- Benefits provided to a member of an organization due to the
payment of a membership fee or to a donor as a result of a deductible
contribution, if a significant number of disqualified persons make
similar payments or contributions and are offered a similar economic
benefit.
- Benefits provided to a person solely as a member of a
charitable class that the applicable tax-exempt organization intends
to benefit as part of the accomplishment of its exempt purpose.
- A transfer of an economic benefit to or for the use of a
governmental unit, as defined in section 170(c)(1), if exclusively for
public 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) Organizations
Section 509(a)(1) organizations include:
- A church or a convention or association of churches,
- An educational organization such as a school or
college,
- A hospital or medical research organization operated in
conjunction with a hospital,
- Endowment funds operated for the benefit of certain state
and municipal colleges and universities,
- A governmental unit, and
- A publicly supported organization.
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:
- Receive, hold, invest, and administer property for a college
or university, and
- Make expenditures to or for the benefit of a college or
university.
The college or university must be:
- An agency or instrumentality of a state or political
subdivision, or
- Owned or operated by:
- A state or political subdivision, or
- An agency or instrumentality of one or more states or
political subdivisions.
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:
- Acquiring and maintaining real property comprising part of
the campus area,
- Erecting (or participating in erecting) college or
university buildings,
- Acquiring and maintaining equipment and furnishings used
for, or in conjunction with, normal functions of colleges and
universities,
- Libraries,
- Scholarships, and
- Student loans.
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:
- Museums of history, art, or science,
- Libraries,
- Community centers to promote the arts,
- Organizations providing facilities for the support of an
opera, symphony orchestra, ballet, or repertory drama, or for some
other direct service to the general public, and
- Organizations such as the American Red Cross or the United
Way.
Qualifying As Publicly Supported
An 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:
- Public officials acting in their public capacities,
- Individuals selected by public officials acting in their
public capacities,
- Persons having special knowledge or expertise in the
particular field or discipline in which the organization is operating,
and
- Community leaders, such as elected or appointed officials,
members of the clergy, educators, civic leaders, or other such persons
representing a broad cross-section of the views and interests of the
community.
In a membership organization, the governing body
also should include individuals elected by a broadly based membership
according to the organization's governing instrument or bylaws.
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:
- A museum or library that is open to the public,
- A symphony orchestra that gives public performances,
- A conservation organization that provides educational
services to the public through the distribution of educational
materials, or
- An old-age home that provides domiciliary or nursing
services for members of the general public.
The fact that an educational or research institution regularly
publishes scholarly studies widely used by colleges and universities
or by members of the general public is also evidence that the
organization is publicly supported.
Similarly, the following factors are also evidence that an
organization is publicly supported.
- Participating in, or sponsoring of, the programs of the
organization by members of the public having special knowledge or
expertise, public officials, or civic or community leaders.
- Maintaining a definitive program by the organization to
accomplish its charitable work in the community, such as slum
clearance or developing employment opportunities.
- Receiving 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.
5. Additional factors pertinent to membership organizations.
The following are additional factors in determining whether a
membership organization is publicly supported.
- 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 civic affairs in the
case of parent-teacher associations.
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):
- Gifts, grants, contributions, or membership fees,
- Net income from unrelated business activities, whether or
not those activities are carried on regularly as a trade or
business,
- Gross investment income,
- Tax revenues levied for the benefit of an organization and
either paid to or spent on behalf of the organization, and
- The value of services or facilities furnished by a
governmental unit to an organization without charge (except services
or facilities generally furnished to the public without
charge).
Amounts that are not support.
The term support does not include:
- Any amount received from the exercise or performance by an
organization of the purpose or function constituting the basis for its
exemption (in general, these amounts include amounts received from any
activity the conduct of which is substantially related to the
furtherance of the exempt purpose or function, other than through the
production of income), or
- Contributions of services for which a deduction is not
allowed.
These amounts are excluded from both the numerator and the
denominator of the fractions in determining compliance with the
one-third support test and ten-percent-of-support requirement. The
following discusses an exception to this general rule.
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:
- Almost all support from gross receipts from related
activities, and
- An insignificant amount of support from governmental units
(without regard to amounts referred to in (3) in the list of items
included in support) and contributions made directly or indirectly by
the general public.
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:
- Amounts paid to maintain library facilities that are open to
the public,
- Amounts paid under government programs to nursing homes or
homes for the aged to provide health care or domiciliary services to
residents of these facilities, and
- Amounts paid to child placement or child guidance
organizations under government programs for services rendered to
children in the community.
These payments are mainly to enable the recipient organization
to provide a service or maintain a facility for the direct benefit of
the public, rather than to serve the direct and immediate needs of the
payor. Furthermore, any amount received from a governmental unit under
circumstances in which the amount would be treated as a grant will
generally constitute support from a governmental unit. See the
discussion of Grants on page 37.
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:
- Are attracted by the publicly-supported nature of the
organization,
- Are unusual or unexpected in amount, and
- Would adversely affect, because of the size, the status of
the organization as normally being publicly supported. (The
organization must otherwise meet the support test in that year without
benefit of the grant or contribution.)
For a grant (see the description of Grants on page
37) that meets the requirements for exclusion, if the terms of the
granting instrument require that the funds be paid to the recipient
organization over a period of years, the amount received by the
organization each year under the terms of the grant may be excluded
for that year. However, no item of gross investment income (defined
under Section 509(a)(2) Organizations, later) may be
excluded under this rule. These provisions allow exclusion of unusual
grants made during any of the applicable periods previously discussed
under Special computation period for new organizations and
to periods described in Advance rulings to newly created
organizations--Initial determination of status, later.
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.
- The grant or contribution is not made by a person (or
related person) who created the organization or was a substantial
contributor to the organization before the grant or
contribution.
- The grant or contribution is not made by a person (or
related person) who is in a position of authority, such as a
foundation manager, or who otherwise has the ability to exercise
control over the organization. Similarly, the grant or contribution is
not made by a person (or related person) who, because of the grant or
contribution, obtains a position of authority or the ability to
otherwise exercise control over the organization.
- The grant or contribution is in the form of cash, readily
marketable securities, or assets that directly further the
organization's exempt purposes, such as a gift of a painting to a
museum.
- The donee-organization has received either an advance or
final ruling or determination letter classifying it as a
publicly-supported organization and, except for an organization
operating under an advance ruling or determination letter, the
organization is actively engaged in a program of activities in
furtherance of its exempt purpose.
- No material restrictions or conditions have been imposed by
the grantor or contributor upon the organization in connection with
the grant or contribution.
- If the grant or contribution is intended for operating
expenses, rather than capital items, the terms and amount of the grant
or contribution are expressly limited to one year's operating
expenses.
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.
- Whether the contribution was a bequest or a transfer while
living. A bequest will be given more favorable consideration than a
transfer while living.
- Whether, before the receipt of the contribution, the
organization has carried on an active program of public solicitation
and exempt activities and has been able to attract a significant
amount of public support.
- Whether, before the year of contribution, the organization
met the one-third support test without benefit of any exclusions of
unusual grants.
- Whether the organization may reasonably be expected to
attract a significant amount of public support after the contribution.
Continued reliance on unusual grants to fund an organization's current
operating expenses (as opposed to providing new endowment funds) may
be evidence that the organization cannot reasonably be expected to
attract future support from the general public.
- Whether the organization has a representative governing
body.
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 Examples
Example 1.
For the years 1995 through 1998, M organization received support of
$600,000 from the following sources.
Investment Income |
$300,000 |
City Y |
40,000 |
United Way |
40,000 |
Contributions |
220,000 |
Total support |
$600,000 |
For 1999, on the basis of the above support, M is considered
to have normally received more than one-third of its support from a
governmental unit and from direct and indirect contributions from the
general public computed as follows.
One-third of total support |
$200,000 |
Support from a governmental unit |
$40,000 |
Indirect contributions from the general public
(United Way) |
40,000 |
Contributions by various donors (no one having
made contributions that total more than $12,000--2% of total
support) |
50,000 |
Six contributions (each in excess of $12,000
--2% of total support) 6 × $12,000 |
72,000 |
|
$202,000 |
Since M's support from governmental units and from direct and
indirect contributions from the general public normally is more than
one-third of M's total support for the applicable period
(1995-1998), M meets the one-third support test and satisfies
the requirements for classification as a publicly-supported
organization for 1999 and 2000. (This remains in effect if no
substantial and material changes took place in the organization's
character, purposes, methods of operation, or sources of support in
these years.)
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.
Contributions |
$520,000 |
Receipts from performances |
100,000 |
| $620,000 |
Less: |
Receipts from performances (excluded, see
Support) |
100,000 |
Total support |
$520,000 |
Z Community Chest (indirect support from the
general public) |
$120,000 |
Two contributions (each over $10,400--2%
of total support) 2 × $10,400 |
20,800 |
Total support from general public |
$140,800 |
P's support from the general public, directly and indirectly,
does not meet the one-third support test ($140,800/$520,000 = 27% of
total support). However, it meets the ten-percent-of-support
requirement. P also meets the requirement of the attraction of public
support. As a result of satisfying these requirements and the public
support factors, P is considered to be a publicly-supported
organization.
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.
Investment income |
$60,000 |
Contributions |
40,000 |
Total support |
$100,000 |
Contributions from the general public |
$15,000 |
One contribution (over $2,000--2% of total
support) 1 × $2,000 |
2,000 |
Total support from general public |
$17,000 |
Q's support from the general public does not meet the
one-third support test ($17,000/$100,000 = 17% of total support). Even
though it does meet the ten-percent-of-support requirement, its method
of solicitation makes it questionable whether Q satisfies the
attraction of public support requirement. Because of its method of
operating, Q also has a greater burden of establishing its publicly
supported nature under the percentage of financial support factor.
Based on these facts and on Q's failure to receive favorable
consideration under the remaining factors, Q does not qualify as a
publicly-supported organization.
Community Trusts
Community 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.
- The organization must be commonly known as a community
trust, fund, foundation, or other similar name conveying the concept
of a capital or endowment fund to support charitable activities in the
community or area it serves.
- All funds of the organization must be subject to a common
governing instrument (or a master trust or agency agreement) that may
be embodied in a single (or several) document(s) containing common
language.
- The organization must have a common governing body (or
distribution committee) that either directs or, in the case of a fund
designated for specified beneficiaries, monitors the distribution of
all funds exclusively for charitable purposes. The governing body must
have the power in the governing instrument, the instrument of
transfer, the resolutions or bylaws of the governing body, a written
agreement, or otherwise--
- To modify any restriction or condition on the distribution
of funds for any specified charitable purposes or to specified
organizations if in the sole judgment of the governing body (without
the necessity of the approval of any participating trustee, custodian,
or agent), the restriction or condition becomes, in effect,
unnecessary, incapable of fulfillment, or inconsistent with the
charitable needs of the community or area served,
- To replace any participating trustee, custodian, or agent
for breach of fiduciary duty under state law, and
- To replace any participating trustee, etc., for failure to
produce a reasonable return of net income over a reasonable period of
time. (The governing body will determine what is reasonable.)
- The organization must prepare periodic financial reports
treating all of the funds that are held by the community trust, either
directly or in component parts, as funds of the organization.
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:
- Must be created by gift, bequest, legacy, devise, or other
transfer to a community trust that is treated as a single entity
(described above), and
- May not be directly subjected by the transferor to any
material restriction or condition with respect to the transferred
assets.
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) Organizations
Section 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.
- For section 509(a)(2) organizations, the term support
includes items of support discussed earlier (under Support,
in the discussion of Section 509(a)(1) Organizations)
and income from activities directly related to their exempt
function. This income is not included in meeting the support test for
a publicly-supported organization under section 509(a)(1).
- Section 509(a)(2) places a limit on the total gross
investment income and unrelated business taxable income (in excess of
the unrelated business tax) an organization may have, while section
509(a)(1) does not.
To be excluded from private foundation treatment under section
509(a)(2), an organization must meet two support tests.
- The one-third support test.
- The not-more-than-one-third support test.
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:
- Gifts, grants, contributions, or membership fees, and
- Gross receipts from admissions, sales of merchandise,
performance of services, or furnishing facilities in an activity that
is not an unrelated trade or business, subject to certain limits,
discussed below under Limit on gross receipts.
For this purpose, the support must be from permitted sources, which
include:
- Section 509(a)(1) organizations, described earlier,
- Governmental units, described on page 28 under Section
509(a)(1) Organizations, and
- Persons other than Disqualified persons (defined
on page 39 under Section 509(a)(3) Organizations).
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, and
- The excess (if any) of unrelated business taxable income
from unrelated trades or businesses acquired after June 30, 1975 over
the tax imposed on that income.
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:
- Was responsible for the substantial or material
change,
- Was aware of it, or
- Has acquired knowledge that the IRS gave notice to the
organization that it would no longer be classified as a section
509(a)(2) organization.
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:
- Was attracted by the publicly supported nature of the
organization,
- Was unusual or unexpected in amount, and
- 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.)
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.
- The grant or contribution is not made by a person (or
related person) who created the organization or was a substantial
contributor to the organization before the grant or
contribution.
- The grant or contribution is not made by a person (or
related person) who is in a position of authority, such as a
foundation manager, or who otherwise has the ability to exercise
control over the organization. Similarly, the grant or contribution is
not made by a person (or related person) who, because of the grant or
contribution, obtains a position of authority or the ability to
otherwise exercise control over the organization.
- The grant or contribution is in the form of cash, readily
marketable securities, or assets that directly further the
organization's exempt purposes, such as a gift of a painting to a
museum.
- The donee organization has received either an advance or
final ruling or determination letter classifying it as a
publicly-supported organization and, except for an organization
operating under an advance ruling or determination letter, the
organization is actively engaged in a program of activities in
furtherance of its exempt purpose.
- No material restrictions or conditions have been imposed by
the grantor or contributor upon the organization in connection with
the grant or contribution.
- If the grant or contribution is intended for operating
expenses, rather than capital items, the terms and amount of the grant
or contribution are expressly limited to one year's operating
expenses.
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.
- Whether the contribution was a bequest or a transfer while
living. A bequest will ordinarily be given more favorable
consideration than a transfer while living.
- Whether, before the contribution, the organization carried
on an actual program of public solicitation and exempt activities and
was able to attract a significant amount of public support.
- Whether the organization may reasonably be expected to
attract a significant amount of public support after the contribution.
Continued reliance on unusual grants to fund an organization's current
operating expenses may be evidence that the organization cannot
attract future support from the general public.
- Whether the organization met the one-third support test in
the past without the benefit of any exclusions of unusual
grants.
- Whether the organization has a representative governing
body.
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:
- Whether the organization has or will have a governing body
that is composed of persons having special knowledge in the particular
field in which the organization is operating or of community leaders,
such as elected officials, members of the clergy, and educators, or,
in the case of a membership organization, of individuals elected under
the organization's governing instrument or bylaws by a broadly based
membership,
- Whether a substantial part of the organization's initial
funding is to be provided by the general public, by public charities,
or by government grants rather than by a limited number of grantors or
contributors who are disqualified persons with respect to the
organization,
- Whether a substantial proportion of the organization's
initial funds are placed, or will remain, in an endowment and whether
the investment of those funds is unlikely to result in more than
one-third of its total support being received from gross investment
income and from unrelated business taxable income in excess of the tax
imposed on that income,
- Whether an organization that carries on fundraising
activities has developed a concrete plan for solicitation of funds on
a community or area-wide basis,
- Whether an organization that carries on community service
activities has a concrete program to carry out its work in the
community,
- Whether membership dues for individual (rather than
institutional) members of an organization that carries on education or
other exempt activities for or on behalf of members have been fixed at
rates designed to make membership available to a broad cross section
of the public rather than to restrict membership to a limited number
of persons, and
- Whether an organization that provides goods, services, or
facilities is or will be required to make its services, facilities,
performances, or products available (regardless of whether a fee is
charged) to the general public, public charities, or governmental
units rather than to a limited number of persons or
organizations.
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) Organizations
Section 509(a)(3) excludes from the definition of private
foundation those organizations that meet all of the three following
requirements.
- The organization must be organized and at all times
thereafter operated exclusively for the benefit of, to perform the
functions of, or to carry out the purposes of one or more specified
organizations (which can be either domestic or foreign) as described
in section 509(a)(1) or 509(a)(2). These section 509(a)(1) and
509(a)(2) organizations are commonly called publicly-supported
organizations.
- The organization must be operated, supervised, or controlled
by or in connection with one or more of the organizations described in
section 509(a)(1) or 509(a)(2).
- The organization must not be controlled directly or
indirectly by disqualified persons (defined later) other than
foundation managers and other than one or more organizations described
in section 509(a)(1) or 509(a)(2).
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:
- Operated, supervised, or controlled by a publicly-supported
organization,
- Supervised or controlled in connection with a
publicly-supported organization, or
- Operated in connection with one or more publicly-supported
organizations.
More than one type of relationship may exist between a
supporting organization and a publicly-supported organization. Any
relationship, however, must insure that the supporting organization
will be responsive to the needs or demands of, and will be an integral
part of or maintain a significant involvement in, the operations of
one or more publicly-supported organizations.
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:
- Limit the purposes of the organization to one or more of
those purposes,
- Do not expressly empower the organization to engage in
activities that are not in furtherance of those purposes,
- Specify (as explained, later, under
Specified organizations) the publicly-supported
organizations on whose behalf the organization is operated, and
- Do not expressly empower the organization to operate to
support or benefit any organization other than the ones specified in
item (3).
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:
- The supporting organization is operated, supervised, or
controlled by or supervised or controlled in connection
with one or more publicly-supported organizations and
the articles of organization of the supporting organization
require that it be operated to support or benefit one or more
beneficiary organizations that are designated by class or purpose and
include:
- The publicly-supported organizations referred to above
(without designating the organizations by name), or
- Publicly-supported organizations that are closely related in
purpose or function to those publicly-supported organizations,
or
- 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.
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:
- Permit the substitution of one publicly-supported
organization within a designated class for another publicly-supported
organization either in the same or a different class designated in the
articles,
- Permit the supporting organization to operate for the
benefit of new or additional publicly-supported organizations of the
same or a different class designated in the articles, or
- Permit the supporting organization to vary the amount of its
support among different publicly-supported organizations within the
class or classes of organizations designated by the articles.
See also the rules considered under the Organizational
test, in the later discussion for organizations in Category
two.
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:
- All substantial contributors to the foundation.
- All foundation managers of the foundation.
- An owner of more than 20% of:
- The total combined voting power of a corporation that is
(during such ownership) a substantial contributor to the
foundation,
- The profits interest of a partnership that is (during such
ownership) a substantial contributor to the foundation, or
- The beneficial interest of a trust or unincorporated
enterprise that is (during such ownership) a substantial contributor
to the foundation.
- A member of the family of any of the individuals just
listed.
- A corporation of which more than 35% of the total combined
voting power is owned by persons just listed.
- A partnership of which more than 35% of the profits interest
is owned by persons described in (1), (2), (3), or (4).
- A trust, or estate, of which more than 35% of the beneficial
interest is owned by persons described in (1), (2), (3), or
(4).
Remember, however, that foundation managers and
publicly-supported organizations are not disqualified persons for
purposes of the third requirement under section 509(a)(3).
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:
- Limit its purposes to supporting one or more
publicly-supported organizations,
- Designate the organizations operated, supervised, or
controlled by, and
- Not have express powers inconsistent with these
purposes.
These tests apply to all supporting organizations.
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:
- Permit a publicly-supported organization, that is designated
by class or purpose rather than by name, to be substituted for the
publicly-supported organization or organizations designated by name in
the articles, but only if the substitution is conditioned upon the
occurrence of an event that is beyond the control of the supporting
organization, such as loss of exemption, substantial failure or
abandonment of operations, or dissolution of the organization or
organizations designated in the articles,
- Permit the supporting organization to operate for the
benefit of an organization that is not a publicly-supported
organization, but only if the supporting organization is currently
operating for the benefit of a publicly-supported organization and the
possibility of its operating for the benefit of other than a
publicly-supported organization is remote, or
- Permit the supporting organization to vary the amount of its
support between different designated organizations, as long as it
meets the requirements of the integral-part test (discussed later)
with respect to at least one beneficiary organization.
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.
- The publicly-supported organizations must elect, appoint, or
maintain a close and continuous working relationship with the
officers, directors, or trustees of the supporting organization.
(Consequently, the officers, directors, or trustees of the
publicly-supported organizations have a significant voice in the
investment policies of the supporting organization, the timing of
grants and the manner of making them, the selection of recipients, and
generally the use of the income or assets of the supporting
organization.)
- The supporting organization is a charitable trust under
state law, each specified publicly-supported organization is a named
beneficiary under the trust's governing instrument, and the
beneficiary organization has the power to enforce the trust and compel
an accounting under state law.
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):
- The activities engaged in for, or on behalf of, the
publicly-supported organizations are activities to perform the
functions of or to carry out the purposes of the organizations, and,
but for the involvement of the supporting organization, would normally
be engaged in by the publicly-supported organizations themselves,
or
- The supporting organization makes payments of substantially
all of its income to, or for the use of, publicly-supported
organizations, and the amount of support received by one or more of
these publicly-supported organizations is enough to insure the
attentiveness of these organizations to the operations of the
supporting organization.
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.
- All the unexpired interests in the trust are devoted to
charitable purposes.
- The trust did not receive any grant, contribution, bequest,
or other transfer on or after November 20, 1970.
- The trust is required by its governing instrument to
distribute all its net income currently to designated
publicly-supported beneficiary organizations.
- The trustee does not have discretion to vary either the
beneficiaries or the amounts payable to the beneficiaries.
- None of the trustees would be disqualified persons (other
than foundation managers) with respect to the trust if the trust were
treated as a private foundation.
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.
- The supporting organization must meet all the requirements
previously specified (the organizational tests, the operational test,
and the requirement that it be operated, supervised, or controlled by
or in connection with one or more specified organizations, and not be
controlled by disqualified persons).
- The section 501(c)(4), 501(c)(5), or 501(c)(6) organization
would be described in section 509(a)(2) if it was a charitable
organization described in section 501(c)(3). This provision allows
separate charitable funds of certain noncharitable organizations to be
described in section 509(a)(3) if the noncharitable organizations
receive their support and otherwise operate in the manner specified by
section 509(a)(2).
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.
- The supporting organization is operated to support or
benefit several specified beneficiary organizations.
- The beneficiary organization has a substantial number of
dues-paying members who have an effective voice in the management of
both the supporting and the beneficiary organizations.
- The beneficiary organization is composed of several
membership organizations, each of which has a substantial number of
members, and the membership organizations have an effective voice in
the management of the supporting and beneficiary organizations.
- The beneficiary organization receives a substantial amount
of support from the general public, public charities, or governmental
grants.
- The supporting organization uses its funds to carry on a
meaningful program of activities to support or benefit the beneficiary
organization and, if the supporting organization were a private
foundation, this use would be sufficient to avoid the imposition of
the tax on failure to distribute income.
- The operations of the beneficiary and supporting
organizations are managed by different persons, and each organization
performs a different function.
- The supporting organization is not able to exercise
substantial control or influence over the beneficiary organization
because the beneficiary organization receives support or holds assets
that are disproportionately large in comparison with the support
received or assets held by the supporting organization.
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:
- Had knowledge of the revocation of the ruling or
determination letter classifying the organization as an organization
described in section 509(a)(1), 509(a)(2), or 509(a)(3), or
- Was in part responsible for, or was aware of, the act, the
failure to act, or the substantial and material change on the part of
the organization that gave rise to the revocation.
Section 509(a)(4) Organizations
Section 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 Foundations
Some 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:
- Adjusted net income, or
- Minimum investment return.
Assets test.
A private foundation will meet the assets test if substantially
more than half (65% or more) of its assets are:
- Devoted directly to the active conduct of its exempt
activity, to a functionally related business, or to a combination of
the two,
- Stock of a corporation that is controlled by the foundation
(by ownership of at least 80% of the total voting power of all classes
of stock entitled to vote and at least 80% of the total shares of all
other classes of stock) and substantially all (at least 85%) the
assets of which are devoted as provided above, or
- Any combination of (1) and (2).
This test is intended to apply to organizations such as museums
and libraries.
Support test.
A private foundation will meet the support test if:
- Substantially all (at least 85%) of its support (other than
gross investment income) is normally received from the general public
and five or more unrelated exempt organizations,
- Not more than 25% of its support (other than gross
investment income) is normally received from any one exempt
organization, and
- Not more than 50% of its support is normally received from
gross investment income.
This test is intended to apply to special-purpose foundations,
such as learned societies and associations of libraries.
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:
- Is an operating foundation, as described previously,
- Has been publicly supported for at least 10 tax years or was
an operating foundation on January 1, 1983, or for its last taxable
year ending before January 1, 1983,
- Has a governing body that, at all times during the tax year,
is broadly representative of the general public and consists of
individuals no more than 25% of whom are disqualified individuals,
and
- Does not have any officer, at any time during the tax year,
who is a disqualified individual.
The foundation must obtain a ruling letter from the IRS
recognizing this special status.
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).
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