2002 Tax Help Archives  

Publication 557 2002 Tax Year

Tax-Exempt Status for Your Organization
(Revised 07/2001)

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This is archived information that pertains only to the 2002 Tax Year. If you
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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:

  1. Are attracted by the publicly-supported nature of the organization,
  2. Are unusual or unexpected in amount, and
  3. 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.

  1. 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.
  2. 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.
  3. 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.
  4. 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.
  5. No material restrictions or conditions have been imposed by the grantor or contributor upon the organization in connection with the grant or contribution.
  6. 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.

  1. Whether the contribution was a bequest or a transfer while living. A bequest will be given more favorable consideration than a transfer while living.
  2. 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.
  3. Whether, before the year of contribution, the organization met the one-third support test without benefit of any exclusions of unusual grants.
  4. 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.
  5. 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
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
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
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
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.

  1. 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.
  2. 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.
  3. 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 -
    1. 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,
    2. To replace any participating trustee, custodian, or agent for breach of fiduciary duty under state law, and
    3. 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.)
  4. 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:

  1. 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
  2. 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.

  1. 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).
  2. 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.

  1. The one-third support test.
  2. 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:

  1. Gifts, grants, contributions, or membership fees, and
  2. 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:

  1. Gross investment income, and
  2. 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:

  1. Was responsible for the substantial or material change,
  2. Was aware of it, or
  3. 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.

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