Publication 557 (3/2005), Tax-Exempt Status for Your Organization

3. Section 501(c)(3) Organizations

Table of Contents

Introduction

An organization may qualify for exemption from federal income tax if it is organized and operated exclusively for one or more of the following purposes.

Charitable.

Religious.

Educational.

Scientific.

Literary.

Testing for public safety.

Fostering national or international amateur sports competition (but only if none of its activities involve providing athletic facilities or equipment; however, see Amateur Athletic Organizations, later in this chapter).

The prevention of cruelty to children or animals.

To qualify, the organization must be a corporation, community chest, fund, or foundation. A trust is a fund or foundation and will qualify. However, an individual or a partnership will not qualify.

Examples. Qualifying organizations include:

Nonprofit old-age homes,

Parent-teacher associations,

Charitable hospitals or other charitable organizations,

Alumni associations,

Schools,

Chapters of the Red Cross or Salvation Army,

Boys' or Girls' clubs, and

Churches.

Child care organizations. The term educational purposes includes providing for care of children away from their homes if substantially all the care provided is to enable individuals (the parents) to be gainfully employed and the services are available to the general public.

Instrumentalities. A state or municipal instrumentality may qualify under section 501(c)(3) if it is organized as a separate entity from the governmental unit that created it and if it otherwise meets the organizational and operational tests of section 501(c)(3). Examples of a qualifying instrumentality might include state schools, universities, or hospitals. However, if an organization is an integral part of the local government or possesses governmental powers, it does not qualify for exemption. A state or municipality itself does not qualify for exemption.

Payments made as a result of September 11, 2001, Terroristic Attacks. Payments made on or after September 11, 2001 by a 501(c)(3) organization to individuals and their families because of death, injury, wounding, or illness of an individual as a result of the terrorist attacks against the United States on September 11, 2001, or for an attack involving anthrax, occurring on or after September 11, 2001, and before January 1, 2002, are treated as related to the charity's exempt purpose provided that the payments are consistently applied and are made using a reasonable and objective formula.

Topics - This chapter discusses:

Contributions to 501(c)(3) organizations
Applications for recognition of exemption
Educational organizations and certain other 501(c)(3) organizations
Private foundations and public charities
Lobbying expenditures

Useful Items - You may want to see:

Forms (and Instructions)

1023
Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code
8718
User Fee for Exempt Organization Determination Letter Request

See chapter 5 for information about getting publications and forms.

Contributions

Contributions to domestic organizations described in this chapter, except organizations testing for public safety, are deductible as charitable contributions on the donor's federal income tax return.

Fund-raising events. If the donor receives something of value in return for the contribution, a common occurrence with fund-raising efforts, part or all of the contribution may not be deductible. This may apply to fund-raising activities such as charity balls, bazaars, banquets, auctions, concerts, athletic events, and solicitations for membership or contributions when merchandise or benefits are given in return for payment of a specified minimum contribution.

If the donor receives or expects to receive goods or services in return for a contribution to your organization, the donor cannot deduct any part of the contribution unless the donor intends to, and does, make a payment greater than the fair market value of the goods or services. If a deduction is allowed, the donor can deduct only the part of the contribution, if any, that is more than the fair market value of the goods or services received. You should determine in advance the fair market value of any goods or services to be given to contributors and tell them, when you publicize the fund-raising event or solicit their contributions, how much is deductible and how much is for the goods or services. See Disclosure of Quid Pro Quo Contributions in chapter 2.

Exemption application not filed. Donors may not deduct any charitable contribution to an organization that is required to apply for recognition of exemption but has not done so.

Separate fund—contributions to which are deductible. An organization that is exempt from federal income tax other than as an organization described in section 501(c)(3) may, if it desires, establish a fund, separate and apart from its other funds, exclusively for religious, charitable, scientific, literary, or educational purposes, fostering national or international amateur sports competition, or for the prevention of cruelty to children or animals.

If the fund is organized and operated exclusively for these purposes, it may qualify for exemption as an organization described in section 501(c)(3), and contributions made to it will be deductible as provided by section 170. A fund with these characteristics must be organized in such a manner as to prohibit the use of its funds upon dissolution, or otherwise, for the general purposes of the organization creating it.

Personal benefit contracts. Generally, no charitable deduction will be allowed for a transfer to, or for the use of, a 501(c)(3) or (c)(4) organization if in connection with the transfer:

The organization directly or indirectly pays, or previously paid, a premium on a personal benefit contract for the transferor, or
There is an understanding or expectation that anyone will directly or indirectly pay a premium on a personal benefit contract for the transferor.

A personal benefit contract with respect to the transferor is any life insurance, annuity, or endowment contract, if any direct or indirect beneficiary under the contract is the transferor, any member of the transferor's family, or any other person designated by the transferor.

Certain annuity contracts. If an organization incurs an obligation to pay a charitable gift annuity, and the organization purchases an annuity contract to fund the obligation, individuals receiving payments under the charitable gift annuity will not be treated as indirect beneficiaries if the organization owns all of the incidents of ownership under the contract, is entitled to all payments under the contract, and the timing and amount of the payments are substantially the same as the timing and amount of payments to each person under the obligation ( as such obligation is in effect at the time of the transfer).

Certain contracts held by a charitable remainder trust. An individual will not be considered an indirect beneficiary under a life insurance, annuity, or endowment contract held by a charitable remainder annuity trust or a charitable remainder unitrust solely by reason of being entitled to the payment if the trust owns all of the incidents of ownership under the contract, and the trust is entitled to all payments under the contract.

Excise tax. If the premiums are paid in connection with a transfer for which a deduction is not allowable under the deduction denial rule, without regard to when the transfer to the charitable organization was made, an excise tax equal to the amount of the premiums paid by the organization on any life insurance, annuity, or endowment contract. The excise tax does not apply if all of the direct and indirect beneficiaries under the contract are organizations.

A charitable organization liable for excise taxes must file Form 4720, Return of Certain Excise Tax on Charities and Other Persons Under Chapters 41 and 42 of the Internal Revenue Code. Generally, the due date for filing Form 4720 occurs on the fifteenth day of the fifth month following the close of the organization's taxable year.

Application for Recognition of Exemption

This discussion describes certain information to be provided upon application for recognition of exemption by all organizations created for any of the purposes described earlier in this chapter. For example, the application must include a conformed copy of the organization's articles of incorporation, as discussed under Articles of Organization later in this chapter. See the organization headings that follow for specific information your organization may need to provide.

Form 1023. Your organization must file its application for recognition of exemption on Form 1023. See chapter 1 and the instructions accompanying Form 1023 for the procedures to follow in applying. Some organizations are not required to file Form 1023. These are discussed later in this section.

Form 1023 and accompanying statements must show that all of the following are true.

The organization is organized exclusively for, and will be operated exclusively for, one or more of the purposes (charitable, religious, etc.) specified in the introduction to this chapter.
No part of the organization's net earnings will inure to the benefit of private shareholders or individuals. You must establish that your organization will not be organized or operated for the benefit of private interests, such as the creator or the creator's family, shareholders of the organization, other designated individuals, or persons controlled directly or indirectly by such private interests.
The organization will not, as a substantial part of its activities, attempt to influence legislation (unless it elects to come under the provisions allowing certain lobbying expenditures) or participate to any extent in a political campaign for or against any candidate for public office. See Political activity, next, and Lobbying Expenditures, near the end of this chapter.

Political activity. If any of the activities (whether or not substantial) of your organization consist of participating in, or intervening in, any political campaign on behalf of (or in opposition to) any candidate for public office, your organization will not qualify for tax-exempt status under section 501(c)(3). Such participation or intervention includes the publishing or distributing of statements.

Whether your organization is participating or intervening, directly or indirectly, in any political campaign on behalf of (or in opposition to) any candidate for public office depends upon all of the facts and circumstances of each case. Certain voter education activities or public forums conducted in a non-partisan manner may not be prohibited political activity under section 501(c)(3), while other so-called voter education activities may be prohibited.

If your organization is uncertain as to the effect of its voter education activities, you should request a letter ruling from the Internal Revenue Service. Send the request to:

Internal Revenue Service
Attention: EO Letter Rulings
P.O. Box 27720, McPherson Station
Washington, DC 20038

Requests may also be hand delivered between the hours of 8:00 a.m. and 4:00 p.m. to:

Courier's Desk
Internal Revenue Service
Attention: T:EO
1111 Constitution Avenue, N.W.
Washington, DC 20224

A receipt will be given at the courier's desk. The package should be marked: RULING REQUEST SUBMISSION.

Effective date of exemption. Most organizations described in this chapter that were organized after October 9, 1969, will not be treated as tax exempt unless they apply for recognition of exemption by filing Form 1023. These organizations will not be treated as tax exempt for any period before they file Form 1023, unless they file the form within 15 months from the end of the month in which they were organized. If the organization files the application within this 15-month period, the organization's exemption will be recognized retroactively to the date it was organized. Otherwise, exemption will be recognized only for the period after the IRS receives the application. The date of receipt is the date of the U.S. postmark on the cover in which an exemption application is mailed or, if no postmark appears on the cover, the date the application is stamped as received by the IRS.

Private delivery service. If a private delivery service designated by the IRS, rather than the U.S. Postal Service, is used to deliver the application, the date of receipt is the date recorded or marked by the private delivery service. The following private delivery services have been designated by the IRS.

Airborne Express (Airborne): Overnight Air Express Service, Next Afternoon Service, and Second Day Service.
DHL Worldwide Express (DHL): DHL “Same Day” Service, and DHL USA Overnight.
Federal Express (FedEx): FedEx Priority Overnight, FedEx Standard Overnight, FedEx 2Day, FedEx International Priority, and FedEx International First.
United Parcel Service (UPS): UPS Next Day Air, UPS Next Day Air Saver, UPS 2nd Day Air, and UPS 2nd Day Air A.M.

Amendments to enabling instrument required. If an organization is required to alter its activities or to make substantive amendments to its enabling instrument, the ruling or determination letter recognizing its exempt status will be effective as of the date the changes are made. If only a nonsubstantive amendment is made, exempt status will be effective as of the date it was organized, if the application was filed within the 15-month period, or the date the application was filed.

Extensions of time for filing. There are two ways organizations seeking exemption can receive an extension of time for filing Form 1023.

Automatic 12-month extension. Organizations will receive an automatic 12-month extension if they file an application for recognition of exemption with the IRS within 12 months of the original deadline. To get this extension, an organization must add the following statement at the top of its application: “Filed Pursuant to Section 301.9100–2.”
Discretionary extensions. An organization that fails to file a Form 1023 within the extended 12-month period will be granted an extension to file if it submits evidence (including affidavits) to establish that:
1. It acted reasonably and in good faith, and
2. Granting a discretionary extension will not prejudice the interests of the government.

How to show reasonable action and good faith. An organization acted reasonably and showed good faith if at least one of the following is true.

The organization requests relief before its failure to file is discovered by the IRS.
The organization failed to file because of intervening events beyond its control.
The organization exercised reasonable diligence (taking into account the complexity of the return or issue and the organization's experience in these matters) but was not aware of the filing requirement.
The organization reasonably relied upon the written advice of the IRS.
The organization reasonably relied upon the advice of a qualified tax professional who failed to file or advise the organization to file Form 1023. An organization cannot rely on the advice of a tax professional if it knows or should know that he or she is not competent to render advice on filing exemption applications or is not aware of all the relevant facts.

Not acting reasonably and in good faith. An organization has not acted reasonably and in good faith under the following circumstances.

It seeks to change a return position for which an accuracy-related penalty has been or could be imposed at the time the relief is requested.
It was informed of the requirement to file and related tax consequences, but chose not to file.
It uses hindsight in requesting relief. The IRS will not ordinarily grant an extension if specific facts have changed since the due date that makes filing an application advantageous to an organization.

Prejudicing the interest of the government. Prejudice to the interest of the government results if granting an extension of time to file to an organization results in a lower total tax liability for the years to which the filing applies than would have been the case if the organization had filed on time. Before granting an extension, the IRS may require the organization requesting it to submit a statement from an independent auditor certifying that no prejudice will result if the extension is granted.

The interests of the Government are ordinarily prejudiced if the tax year in which the application should have been filed (or any tax year that would have been affected had the filing been timely) are closed by the statute of limitations before relief is granted. The IRS may condition a grant of relief on the organization providing the IRS with a statement from an independent auditor certifying that the interests of the Government are not prejudiced.

Procedure for requesting extension. To request a discretionary extension, an organization must submit (to the IRS address shown on Form 8718) the following.

A statement showing the date Form 1023 was required to have been filed and the date it was actually filed.
Any documents relevant to the application.
An affidavit describing in detail the events that led to the failure to apply and to the discovery of that failure. If the organization relied on a tax professional's advice, the affidavit must describe the engagement and responsibilities of the professional and the extent to which the organization relied on him or her.
This affidavit must be accompanied by a dated declaration, signed by an individual who has personal knowledge of the facts and circumstances, who is authorized to act for the organization, which states, “Under penalties of perjury, I declare that I have examined this request, including accompanying documents, and, to the best of my knowledge and belief, the request contains all the relevant facts relating to the request, and such facts are true, correct, and complete.”
Detailed affidavits from individuals having knowledge or information about the events that led to the failure to make the application and to the discovery of that failure. This includes the organization's return preparer, and any accountant or attorney, knowledgeable in tax matters, who advised the taxpayer on the application. The affidavits must describe the engagement and responsibilities of the individual and the advice that he or she provided.
These affidavits must include the name, current address, and taxpayer identification number of the individual, and be accompanied by a dated declaration, signed by the individual, which states: “Under penalties of perjury, I declare that I have examined this request, including accompanying documents, and, to the best of my knowledge and belief, the request contains all the relevant facts relating to the request, and such facts are true, correct, and complete.”
The organization must state whether the returns for the tax year in which the application should have been filed or any tax years that would have been affected by the application had it been timely made is being examined by the IRS, an appeals office, or a federal court. The organization must notify the IRS office considering the request for relief if the IRS starts an examination of any such return while the organization's request for relief is pending.
The organization, if requested, has to submit copies of its tax returns, and copies of the returns of other affected taxpayers.

A request for this relief is a request that must be submitted as a request for a letter ruling and be accompanied by the applicable user fee.

More information. For more information about these procedures, see sections 301.9100–1, 301.9100–2, and 301.9100–3 of the regulations.

Notification from IRS. Organizations filing Form 1023 and satisfying all requirements of section 501(c)(3) will be notified of their exempt status in writing.

Organizations Not Required To File Form 1023

Some organizations are not required to file Form 1023.

These include:

Churches, interchurch organizations of local units of a church, conventions or associations of churches, or integrated auxiliaries of a church, such as a men's or women's organization, religious school, mission society, or youth group.
Any organization (other than a private foundation) normally having annual gross receipts of not more than $5,000 (see Gross receipts test, later).

These organizations are exempt automatically if they meet the requirements of section 501(c)(3).

Filing Form 1023 to establish exemption. If the organization wants to establish its exemption with the IRS and receive a ruling or determination letter recognizing its exempt status, it should file Form 1023. By establishing its exemption, potential contributors are assured by the IRS that contributions will be deductible. A subordinate organization (other than a private foundation) covered by a group exemption letter does not have to submit a Form 1023 for itself.

Private foundations. See Private Foundations and Public Charities, later, in this chapter, for more information about the additional notice required from an organization in order for it not to be presumed to be a private foundation and for the additional information required from a private foundation claiming to be an operating foundation.

Gross receipts test. For purposes of the gross receipts test, an organization normally does not have more than $5,000 annually in gross receipts if:

During its first tax year the organization received gross receipts of $7,500 or less,
During its first 2 years the organization had a total of $12,000 or less in gross receipts, and
In the case of an organization that has been in existence for at least 3 years, the total gross receipts received by the organization during the immediately preceding 2 years, plus the current year, are $15,000 or less.

An organization with gross receipts more than the amounts in the gross receipts test, unless otherwise exempt from filing Form 1023, must file a Form 1023 within 90 days after the end of the period in which the amounts are exceeded. For example, an organization's gross receipts for its first tax year were less than $7,500, but at the end of its second tax year its gross receipts for the 2–year period were more than $12,000. The organization must file Form 1023 within 90 days after the end of its second tax year.

If the organization had existed for at least 3 tax years and had met the gross receipts test for all prior tax years but fails to meet the requirement for the current tax year, its tax-exempt status for the prior years will not be lost even if Form 1023 is not filed within 90 days after the close of the current tax year. However, the organization will not be treated as a section 501(c)(3) organization for the period beginning with the current tax year and ending with the filing of Form 1023.

Example. An organization is organized and operated exclusively for charitable purposes and is not a private foundation. It was incorporated on January 1, 1999, and files returns on a calendar-year basis. It did not file a Form 1023. The organization's gross receipts during the years 1999 through 2002 were as follows:

1999	$3,600
2000	2,900
2001	400
2002	12,600

The organization's total gross receipts for 1999, 2000, and 2001 were $6,900. Therefore, it did not have to file Form 1023 and is exempt for those years. However, for 2000, 2001, and 2002 the total gross receipts were $15,900. Therefore, the organization must file Form 1023 within 90 days after the end of its 2002 tax year. If it does not file within this time period, it will not be exempt under section 501(c)(3) for the period beginning with tax year 2002 ending when the Form 1023 is received by the IRS. The organization, however, will not lose its exempt status for the tax years ending before January 1, 2002.

The IRS will consider applying the Commissioner's discretionary authority to extend the time for filing Form 1023. See the procedures for this extension discussed earlier.

Articles of Organization

Your organization must include a conformed copy of its articles of organization with the application for recognition of exemption. This may be its trust instrument, corporate charter, articles of association, or any other written instrument by which it is created.

Organizational Test

The articles of organization must limit the organization's purposes to one or more of those described at the beginning of this chapter and must not expressly empower it to engage, other than as an insubstantial part of its activities, in activities that do not further one or more of those purposes. These conditions for exemption are referred to as the organizational test.

Section 501(c)(3) is the provision of law that grants exemption to the organizations described in this chapter. Therefore, the organizational test may be met if the purposes stated in the articles of organization are limited in some way by reference to section 501(c)(3).

The requirement that your organization's purposes and powers must be limited by the articles of organization is not satisfied if the limit is contained only in the bylaws or other rules or regulations. Moreover, the organizational test is not satisfied by statements of your organization's officers that you intend to operate only for exempt purposes. Also, the test is not satisfied by the fact that your actual operations are for exempt purposes.

In interpreting an organization's articles, the law of the state where the organization was created is controlling. If an organization contends that the terms of its articles have a different meaning under state law than their generally accepted meaning, such meaning must be established by a clear and convincing reference to relevant court decisions, opinions of the state attorney general, or other appropriate state authorities.

The following are examples illustrating the organizational test.

Example 1.

Articles of organization state that an organization is formed exclusively for literary and scientific purposes within the meaning of section 501(c)(3) of the Code. These articles appropriately limit the organization's purposes. The organization meets the organizational test.

Example 2.

An organization, by the terms of its articles, is formed to engage in research without any further description or limitation. The organization will not be properly limited as to its purposes since all research is not scientific. The organization does not meet the organizational test.

Example 3.

An organization's articles state that its purpose is to receive contributions and pay them over to organizations that are described in section 501(c)(3) and exempt from taxation under section 501(a). The organization meets the organizational test.

Example 4.

If a stated purpose in the articles is the conduct of a school of adult education and its manner of operation is described in detail, such a purpose will be satisfactorily limited.

Example 5.

If the articles state the organization is formed for charitable purposes, without any further description, such language ordinarily will be sufficient since the term charitable has a generally accepted legal meaning. On the other hand, if the purposes are stated to be charitable, philanthropic, and benevolent, the organizational requirement will not be met since the terms philanthropic and benevolent have no generally accepted legal meaning and, therefore, the stated purposes may, under the laws of the state, permit activities that are broader than those intended by the exemption law.

Example 6.

If the articles state an organization is formed to promote American ideals, or to foster the best interests of the people, or to further the common welfare and well-being of the community, without any limitation or provision restricting such purposes to accomplishment only in a charitable manner, the purposes will not be sufficiently limited. Such purposes are vague and may be accomplished other than in an exempt manner.

Example 7.

A stated purpose to operate a hospital does not meet the organizational test since it is not necessarily charitable. A hospital may or may not be exempt depending on the manner in which it is operated.

Example 8.

An organization that is expressly empowered by its articles to carry on social activities will not be sufficiently limited as to its power, even if its articles state that it is organized and will be operated exclusively for charitable purposes.

Dedication and Distribution of Assets

Assets of an organization must be permanently dedicated to an exempt purpose. This means that should an organization dissolve, its assets must be distributed for an exempt purpose described in this chapter, or to the federal government or to a state or local government for a public purpose. If the assets could be distributed to members or private individuals or for any other purpose, the organizational test is not met.

Dedication. To establish that your organization's assets will be permanently dedicated to an exempt purpose, the articles of organization should contain a provision insuring their distribution for an exempt purpose in the event of dissolution. Although reliance may be placed upon state law to establish permanent dedication of assets for exempt purposes, your organization's application probably can be processed much more rapidly if its articles of organization include a provision insuring permanent dedication of assets for exempt purposes.

Distribution. Revenue Procedure 82–2, 1982–1 C.B. 367, identifies the states and circumstances in which the IRS will not require an express provision for the distribution of assets upon dissolution in the articles of organization. The procedure also provides a sample of an acceptable dissolution provision for organizations required to have one.

If a named beneficiary is to be the distributee, it must be one that would qualify and would be exempt within the meaning of section 501(c)(3) at the time the dissolution takes place. Since the named beneficiary at the time of dissolution may not be qualified, may not be in existence, or may be unwilling or unable to accept the assets of the dissolving organization, a provision should be made for distribution of the assets for one or more of the purposes specified in this chapter in the event of any such contingency.

Sample Articles of Organization

The following are examples of a charter (Draft A) and a declaration of trust (Draft B) that contain the required information as to purposes and powers of an organization and disposition of its assets upon dissolution. You should bear in mind that requirements for these instruments may vary under applicable state law.

See Private Foundations and Public Charities, later, for the special provisions required in a private foundation's governing instrument in order for it to qualify for exemption.

Draft A

Articles of Incorporation of the undersigned, a majority of whom are citizens of the United States, desiring to form a Non-Profit Corporation under the Non-Profit Corporation Law of , do hereby certify:

First: The name of the Corporation shall be .

Second: The place in this state where the principal office of the Corporation is to be located is the City of , County.

Third: Said corporation is organized exclusively for charitable, religious, educational, and scientific purposes, including, for such purposes, the making of distributions to organizations that qualify as exempt organizations under section 501(c)(3) of the Internal Revenue Code, or the corresponding section of any future federal tax code.

Fourth: The names and addresses of the persons who are the initial trustees of the corporation are as follows:

Name Address

Fifth: No part of the net earnings of the corporation shall inure to the benefit of, or be distributable to its members, trustees, officers, or other private persons, except that the corporation shall be authorized and empowered to pay reasonable compensation for services rendered and to make payments and distributions in furtherance of the purposes set forth in Article Third hereof. No substantial part of the activities of the corporation shall be the carrying on of propaganda, or otherwise attempting to influence legislation, and the corporation shall not participate in, or intervene in (including the publishing or distribution of statements) any political campaign on behalf of or in opposition to any candidate for public office. Notwithstanding any other provision of these articles, the corporation shall not carry on any other activities not permitted to be carried on (a) by a corporation exempt from federal income tax under section 501(c)(3) of the Internal Revenue Code, or the corresponding section of any future federal tax code, or (b) by a corporation, contributions to which are deductible under section 170(c)(2) of the Internal Revenue Code, or the corresponding section of any future federal tax code.

If reference to federal law in articles of incorporation imposes a limitation that is invalid in your state, you may wish to substitute the following for the last sentence of the preceding paragraph: “Notwithstanding any other provision of these articles, this corporation shall not, except to an insubstantial degree, engage in any activities or exercise any powers that are not in furtherance of the purposes of this corporation.”

Sixth: Upon the dissolution of the corporation, assets shall be distributed for one or more exempt purposes within the meaning of section 501(c)(3) of the Internal Revenue Code, or the corresponding section of any future federal tax code, or shall be distributed to the federal government, or to a state or local government, for a public purpose. Any such assets not so disposed of shall be disposed of by a Court of Competent Jurisdiction of the county in which the principal office of the corporation is then located, exclusively for such purposes or to such organization or organizations, as said Court shall determine, which are organized and operated exclusively for such purposes.

In witness whereof, we have hereunto subscribed our names this day of 20 .

Draft B

The Charitable Trust. Declaration of Trust made as of the day of , 20 , by , of , and , of , who hereby declare and agree that they have received this day from , as Donor, the sum of Ten Dollars ($10) and that they will hold and manage the same, and any additions to it, in trust, as follows:

First: This trust shall be called “The Charitable Trust.”

Second: The trustees may receive and accept property, whether real, personal, or mixed, by way of gift, bequest, or devise, from any person, firm, trust, or corporation, to be held, administered, and disposed of in accordance with and pursuant to the provisions of this Declaration of Trust; but no gift, bequest or devise of any such property shall be received and accepted if it is conditioned or limited in such manner as to require the disposition of the income or its principal to any person or organization other than a “charitable organization” or for other than “charitable purposes” within the meaning of such terms as defined in Article Third of this Declaration of Trust, or as shall in the opinion of the trustees, jeopardize the federal income tax exemption of this trust pursuant to section 501(c)(3) of the Internal Revenue Code, or the corresponding section of any future federal tax code.

Third: A. The principal and income of all property received and accepted by the trustees to be administered under this Declaration of Trust shall be held in trust by them, and the trustees may make payments or distributions from income or principal, or both, to or for the use of such charitable organizations, within the meaning of that term as defined in paragraph C, in such amounts and for such charitable purposes of the trust as the trustees shall from time to time select and determine; and the trustees may make payments or distributions from income or principal, or both, directly for such charitable purposes, within the meaning of that term as defined in paragraph D, in such amounts as the trustees shall from time to time select and determine without making use of any other charitable organization. The trustees may also make payments or distributions of all or any part of the income or principal to states, territories, or possessions of the United States, any political subdivision of any of the foregoing, or to the United States or the District of Columbia but only for charitable purposes within the meaning of that term as defined in paragraph D. Income or principal derived from contributions by corporations shall be distributed by the trustees for use solely within the United States or its possessions. No part of the net earnings of this trust shall inure or be payable to or for the benefit of any private shareholder or individual, and no substantial part of the activities of this trust shall be the carrying on of propaganda, or otherwise attempting, to influence legislation. No part of the activities of this trust shall be the participation in, or intervention in (including the publishing or distributing of statements), any political campaign on behalf of or in opposition to any candidate for public office.

B. The trust shall continue forever unless the trustees terminate it and distribute all of the principal and income, which action may be taken by the trustees in their discretion at any time. On such termination, assets shall be distributed for one or more exempt purposes within the meaning of section 501(c)(3) of the Internal Revenue Code, or the corresponding section of any future federal tax code, or shall be distributed to the federal government, or to a state or local government, for a public purpose. The donor authorizes and empowers the trustees to form and organize a nonprofit corporation limited to the uses and purposes provided for in this Declaration of Trust, such corporation to be organized under the laws of any state or under the laws of the United States as may be determined by the trustees; such corporation when organized to have power to administer and control the affairs and property and to carry out the uses, objects, and purposes of this trust. Upon the creation and organization of such corporation, the trustees are authorized and empowered to convey, transfer, and deliver to such corporation all the property and assets to which this trust may be or become entitled. The charter, bylaws, and other provisions for the organization and management of such corporation and its affairs and property shall be such as the trustees shall determine, consistent with the provisions of this paragraph.

C. In this Declaration of Trust and in any amendments to it, references to “charitable organizations” or “charitable organization” mean corporations, trusts, funds, foundations, or community chests created or organized in the United States or in any of its possessions, whether under the laws of the United States, any state or territory, the District of Columbia, or any possession of the United States, organized and operated exclusively for charitable purposes, no part of the net earnings of which inures or is payable to or for the benefit of any private shareholder or individual, and no substantial part of the activities of which is carrying on propaganda, or otherwise attempting to influence legislation, and which do not participate in or intervene in (including the publishing or distributing of statements) any political campaign on behalf of or in opposition to any candidate for public office. It is intended that the organization described in this paragraph C shall be entitled to exemption from federal income tax under section 501(c)(3) of the Internal Revenue Code, or the corresponding section of any future federal tax code.

D. In this Declaration of Trust and in any amendments to it, the term “charitable purposes” shall be limited to and shall include only religious, charitable, scientific, literary, or educational purposes within the meaning of those terms as used in section 501(c)(3) of the Internal Revenue Code, or the corresponding section of any future federal tax code, but only such purposes as also constitute public charitable purposes under the law of trusts of the State of .

Fourth: This Declaration of Trust may be amended at any time or times by written instrument or instruments signed and sealed by the trustees, and acknowledged by any of the trustees, provided that no amendment shall authorize the trustees to conduct the affairs of this trust in any manner or for any purpose contrary to the provisions of section 501(c)(3) of the Internal Revenue Code, or the corresponding section of any future federal tax code. An amendment of the provisions of this Article Fourth (or any amendment to it) shall be valid only if and to the extent that such amendment further restricts the trustees' amending power. All instruments amending this Declaration of Trust shall be noted upon or kept attached to the executed original of this Declaration of Trust held by the trustees.

Fifth: Any trustee under this Declaration of Trust may, by written instrument, signed and acknowledged, resign his office. The number of trustees shall be at all times not less than two, and whenever for any reason the number is reduced to one, there shall be, and at any other time there may be, appointed one or more additional trustees. Appointments shall be made by the trustee or trustees for the time in office by written instruments signed and acknowledged. Any succeeding or additional trustee shall, upon his or her acceptance of the office by written instrument signed and acknowledged, have the same powers, rights and duties, and the same title to the trust estate jointly with the surviving or remaining trustee or trustees as if originally appointed.

None of the trustees shall be required to furnish any bond or surety. None of them shall be responsible or liable for the acts or omissions of any other of the trustees or of any predecessor or of a custodian, agent, depositary or counsel selected with reasonable care.

The one or more trustees, whether original or successor, for the time being in office, shall have full authority to act even though one or more vacancies may exist. A trustee may, by appropriate written instrument, delegate all or any part of his or her powers to another or others of the trustees for such periods and subject to such conditions as such delegating trustee may determine.

The trustees serving under this Declaration of Trust are authorized to pay to themselves amounts for reasonable expenses incurred and reasonable compensation for services rendered in the administration of this trust, but in no event shall any trustee who has made a contribution to this trust ever receive any compensation thereafter.

Sixth: In extension and not in limitation of the common law and statutory powers of trustees and other powers granted in this Declaration of Trust, the trustees shall have the following discretionary powers.

a) To invest and reinvest the principal and income of the trust in such property, real, personal, or mixed, and in such manner as they shall deem proper, and from time to time to change investments as they shall deem advisable; to invest in or retain any stocks, shares, bonds, notes, obligations, or personal or real property (including without limitation any interests in or obligations of any corporation, association, business trust, investment trust, common trust fund, or investment company) although some or all of the property so acquired or retained is of a kind or size which but for this express authority would not be considered proper and although all of the trust funds are invested in the securities of one company. No principal or income, however, shall be loaned, directly or indirectly, to any trustee or to anyone else, corporate or otherwise, who has at any time made a contribution to this trust, nor to anyone except on the basis of an adequate interest charge and with adequate security.

b) To sell, lease, or exchange any personal, mixed, or real property, at public auction or by private contract, for such consideration and on such terms as to credit or otherwise, and to make such contracts and enter into such undertakings relating to the trust property, as they consider advisable, whether or not such leases or contracts may extend beyond the duration of the trust.

c) To borrow money for such periods, at such rates of interest, and upon such terms as the trustees consider advisable, and as security for such loans to mortgage or pledge any real or personal property with or without power of sale; to acquire or hold any real or personal property, subject to any mortgage or pledge on or of property acquired or held by this trust.

d) To execute and deliver deeds, assignments, transfers, mortgages, pledges, leases, covenants, contracts, promissory notes, releases, and other instruments, sealed or unsealed, incident to any transaction in which they engage.

e) To vote, to give proxies, to participate in the reorganization, merger or consolidation of any concern, or in the sale, lease, disposition, or distribution of its assets; to join with other security holders in acting through a committee, depositary, voting trustees, or otherwise, and in this connection to delegate authority to such committee, depositary, or trustees and to deposit securities with them or transfer securities to them; to pay assessments levied on securities or to exercise subscription rights in respect of securities.

f) To employ a bank or trust company as custodian of any funds or securities and to delegate to it such powers as they deem appropriate; to hold trust property without indication of fiduciary capacity but only in the name of a registered nominee, provided the trust property is at all times identified as such on the books of the trust; to keep any or all of the trust property or funds in any place or places in the United States of America; to employ clerks, accountants, investment counsel, investment agents, and any special services, and to pay the reasonable compensation and expenses of all such services in addition to the compensation of the trustees.

Seventh: The trustees' powers are exercisable solely in the fiduciary capacity consistent with and in furtherance of the charitable purposes of this trust as specified in Article Third and not otherwise.

Eighth: In this Declaration of Trust and in any amendment to it, references to “trustees” mean the one or more trustees, whether original or successor, for the time being in office.

Ninth: Any person may rely on a copy, certified by a notary public, of the executed original of this Declaration of Trust held by the trustees, and of any of the notations on it and writings attached to it, as fully as he might rely on the original documents themselves. Any such person may rely fully on any statements of fact certified by anyone who appears from such original documents or from such certified copy to be a trustee under this Declaration of Trust. No one dealing with the trustees need inquire concerning the validity of anything the trustees purport to do. No one dealing with the trustees need see to the application of anything paid or transferred to or upon the order of the trustees of the trust.

Tenth: This Declaration of Trust is to be governed in all respects by the laws of the State of .

Trustee

Educational Organizations and Private Schools

If your organization wants to obtain recognition of exemption as an educational organization, you must submit complete information as to how your organization carries on or plans to carry on its educational activities, such as by conducting a school, by panels, discussions, lectures, forums, radio and television programs, or through various cultural media such as museums, symphony orchestras, or art exhibits. In each instance, you must explain by whom and where these activities are or will be conducted and the amount of admission fees, if any. You must submit a copy of the pertinent contracts, agreements, publications, programs, etc.

If you are organized to conduct a school, you must submit full information regarding your tuition charges, number of faculty members, number of full-time and part-time students enrolled, courses of study and degrees conferred, together with a copy of your school catalog. See also Private Schools, discussed later.

Educational Organizations

The term educational relates to:

The instruction or training of individuals for the purpose of improving or developing their capabilities, or
The instruction of the public on subjects useful to individuals and beneficial to the community.

Advocacy of a position. Advocacy of a particular position or viewpoint may be educational if there is a sufficiently full and fair exposition of pertinent facts to permit an individual or the public to form an independent opinion or conclusion. The mere presentation of unsupported opinion is not educational.

Method not educational. The method used by an organization to develop and present its views is a factor in determining if an organization qualifies as educational within the meaning of section 501(c)(3). The following factors may indicate that the method is not educational.

The presentation of viewpoints unsupported by facts is a significant part of the organization's communications.
The facts that purport to support the viewpoint are distorted.
The organization's presentations make substantial use of inflammatory and disparaging terms and express conclusions more on the basis of emotion than of objective evaluations.
The approach used is not aimed at developing an understanding on the part of the audience because it does not consider their background or training.

Exceptional circumstances, however, may exist where an organization's advocacy may be educational even if one or more of the factors listed above are present.

Qualifying organizations. The following types of organizations may qualify as educational:

An organization, such as a primary or secondary school, a college, or a professional or trade school, that has a regularly scheduled curriculum, a regular faculty, and a regularly enrolled student body in attendance at a place where the educational activities are regularly carried on,
An organization whose activities consist of conducting public discussion groups, forums, panels, lectures, or other similar programs,
An organization that presents a course of instruction by correspondence or through the use of television or radio,
A museum, zoo, planetarium, symphony orchestra, or other similar organization, and
A nonprofit children's day-care center.

College book stores, cafeterias, restaurants, etc. These and other on-campus organizations should submit information to show that they are controlled by and operated for the convenience of the faculty and student body or by whom they are controlled and whom they serve.

Alumni association. An alumni association should establish that it is organized to promote the welfare of the university with which it is affiliated, is subject to the control of the university as to its policies and destination of funds, and is operated as an integral part of the university or is otherwise organized to promote the welfare of the college or university. If your association does not have these characteristics, it may still be exempt as a social club if it meets the requirements described in chapter 4, under 501(c)(7) — Social and Recreation Clubs.

Athletic organization. This type of organization must submit evidence that it is engaged in activities such as directing and controlling interscholastic athletic competitions, conducting tournaments, and prescribing eligibility rules for contestants. If it is not so engaged, your organization may be exempt as a social club described in chapter 4. Raising funds to be used for travel and other activities to interview and persuade prospective students with outstanding athletic ability to attend a particular university does not show an exempt purpose. If your organization is not exempt as an educational organization, see Amateur Athletic Organizations, later in this chapter.

Private Schools

Every private school filing an application for recognition of tax-exempt status must supply the IRS (on Schedule B, Form 1023) with the following information.

The racial composition of the student body, and of the faculty and administrative staff, as of the current academic year. (This information also must be projected, so far as may be feasible, for the next academic year.)
The amount of scholarship and loan funds, if any, awarded to students enrolled and the racial composition of students who have received the awards.
A list of the school's incorporators, founders, board members, and donors of land or buildings, whether individuals or organizations.
A statement indicating whether any of the organizations described in item (3) above have an objective of maintaining segregated public or private school education at the time the application is filed and, if so, whether any of the individuals described in item (3) are officers or active members of those organizations at the time the application is filed.
The public school district and county in which the school is located.

How to determine racial composition. The racial composition of the student body, faculty, and administrative staff may be an estimate based on the best information readily available to the school, without requiring student applicants, students, faculty, or administrative staff to submit to the school information that the school otherwise does not require. Nevertheless, a statement of the method by which the racial composition was determined must be supplied. The identity of individual students or members of the faculty and administrative staff should not be included with this information.

A school that is a state or municipal instrumentality (see Instrumentalities, near the beginning of this chapter), whether or not it qualifies for exemption under section 501(c)(3), is not considered to be a private school for purposes of the following discussion.

Racially Nondiscriminatory Policy

To qualify as an organization exempt from federal income tax, a private school must include a statement in its charter, bylaws, or other governing instrument, or in a resolution of its governing body, that it has a racially nondiscriminatory policy as to students and that it does not discriminate against applicants and students on the basis of race, color, or national or ethnic origin. Also, the school must circulate information that clearly states the school's admission policies. A racially nondiscriminatory policy toward students means that the school admits the students of any race to all the rights, privileges, programs, and activities generally accorded or made available to students at that school and that the school does not discriminate on the basis of race in administering its educational policies, admission policies, scholarship and loan programs, and athletic and other school-administered programs.

The IRS considers discrimination on the basis of race to include discrimination on the basis of color or national or ethnic origin.

The existence of a racially discriminatory policy with respect to the employment of faculty and administrative staff is indicative of a racially discriminatory policy as to students. Conversely, the absence of racial discrimination in the employment of faculty and administrative staff is indicative of a racially nondiscriminatory policy as to students.

A policy of a school that favors racial minority groups with respect to admissions, facilities and programs, and financial assistance is not discrimination on the basis of race when the purpose and effect of this policy is to promote establishing and maintaining the school's nondiscriminatory policy.

A school that selects students on the basis of membership in a religious denomination or unit is not discriminating if membership in the denomination or unit is open to all on a racially nondiscriminatory basis.

Policy statement. The school must include a statement of its racially nondiscriminatory policy in all its brochures and catalogs dealing with student admissions, programs, and scholarships. Also, the school must include a reference to its racially nondiscriminatory policy in other written advertising that it uses to inform prospective students of its programs.

Publicity requirement. The school must make its racially nondiscriminatory policy known to all segments of the general community served by the school. Selective communication of a racially nondiscriminatory policy that a school provides solely to leaders of racial groups will not be considered an effective means of communication to make the policy known to all segments of the community. To satisfy this requirement, the school must use one of the following two methods.

Method one. The school may publish a notice of its racially nondiscriminatory policy in a newspaper of general circulation that serves all racial segments of the community. Such publication must be repeated at least once annually during the period of the school's solicitation for students or, in the absence of a solicitation program, during the school's registration period. When more than one community is served by a school, the school may publish the notice in those newspapers that are reasonably likely to be read by all racial segments in the communities that the school serves.

If this method is used, the notice must meet the following printing requirements.

It must appear in a section of the newspaper likely to be read by prospective students and their families.
It must occupy at least 3 column inches.
It must have its title printed in at least 12 point bold face type.
It must have the remaining text printed in at least 8 point type.

The following is an acceptable example of the notice:

	NOTICE OF NONDISCRIMINATORY POLICY AS TO STUDENTS
	The M School admits students of any race, color, national and ethnic origin to all the rights, privileges, programs, and activities generally accorded or made available to students at the school. It does not discriminate on the basis of race, color, national and ethnic origin in administration of its educational policies, admissions policies, scholarship and loan programs, and athletic and other school-administered programs.

Method two. The school may use the broadcast media to publicize its racially nondiscriminatory policy if this use makes the policy known to all segments of the general community the school serves. If the school uses this method, it must provide documentation showing that the means by which this policy was communicated to all segments of the general community was reasonably expected to be effective. In this case, appropriate documentation would include copies of the tapes or scripts used and records showing that there was an adequate number of announcements. The documentation also would include proof that these announcements were made during hours when they were likely to be communicated to all segments of the general community, that they were long enough to convey the message clearly, and that they were broadcast on radio or television stations likely to be listened to by substantial numbers of members of all racial segments of the general community. Announcements must be made during the period of the school's solicitation for students or, in the absence of a solicitation program, during the school's registration period.

Exceptions. The publicity requirements will not apply in the following situations.

First, if for the preceding 3 years the enrollment of a parochial or other church-related school consists of students at least 75% of whom are members of the sponsoring religious denomination or unit, the school may make known its racially nondiscriminatory policy in whatever newspapers or circulars the religious denomination or unit uses in the communities from which the students are drawn. These newspapers and circulars may be distributed by a particular religious denomination or unit or by an association that represents a number of religious organizations of the same denomination. If, however, the school advertises in newspapers of general circulation in the community or communities from which its students are drawn and the second exception (discussed next) does not apply to the school, then it must comply with either of the publicity requirements explained earlier.

Second, if a school customarily draws a substantial percentage of its students nationwide, worldwide, from a large geographic section or sections of the United States, or from local communities, and if the school follows a racially nondiscriminatory policy as to its students, the school may satisfy the publicity requirement by complying with the instructions explained, earlier, under Policy statement.

The school may demonstrate that it follows a racially nondiscriminatory policy either by showing that it currently enrolls students of racial minority groups in meaningful numbers or, except for local community schools, when minority students are not enrolled in meaningful numbers, that its promotional activities and recruiting efforts in each geographic area were reasonably designed to inform students of all racial segments in the general communities within the area of the availability of the school. The question as to whether a school demonstrates such a policy satisfactorily will be determined on the basis of the facts and circumstances of each case.

The IRS recognizes that the failure by a school drawing its students from local communities to enroll racial minority group students may not necessarily indicate the absence of a racially nondiscriminatory policy when there are relatively few or no such students in these communities. Actual enrollment is, however, a meaningful indication of a racially nondiscriminatory policy in a community in which a public school or schools became subject to a desegregation order of a federal court or are otherwise expressly obligated to implement a desegregation plan under the terms of any written contract or other commitment to which any federal agency was a party.

The IRS encourages schools to satisfy the publicity requirement by using either of the methods described earlier, even though a school considers itself to be within one of the Exceptions. The IRS believes that these publicity requirements are the most effective methods to make known a school's racially nondiscriminatory policy. In this regard, it is each school's responsibility to determine whether either of the exceptions apply. Such responsibility will prepare the school, if it is audited by the IRS, to demonstrate that the failure to publish its racially nondiscriminatory policy in accordance with either one of the publicity requirements was justified by one of the exceptions. Also, a school must be prepared to demonstrate that it has publicly disavowed or repudiated any statements purported to have been made on its behalf (after November 6, 1975) that are contrary to its publicity of a racially nondiscriminatory policy as to students, to the extent that the school or its principal official was aware of these statements.

Facilities and programs. A school must be able to show that all of its programs and facilities are operated in a racially nondiscriminatory manner.

Scholarship and loan programs. As a general rule, all scholarship or other comparable benefits obtainable at the school must be offered on a racially nondiscriminatory basis. This must be known throughout the general community being served by the school and should be referred to in its publicity. Financial assistance programs, as well as scholarships and loans made under financial assistance programs, that favor members of one or more racial minority groups and that do not significantly detract from or are designed to promote a school's racially nondiscriminatory policy will not adversely affect the school's exempt status.

Certification. An individual authorized to take official action on behalf of a school that claims to be racially nondiscriminatory as to students must certify annually, under penalties of perjury, on Schedule A (Form 990) or Form 5578, Annual Certification of Racial Nondiscrimination for a Private School Exempt From Federal Income Tax, whichever applies, that to the best of his or her knowledge and belief the school has satisfied all requirements that apply, as previously explained.

Failure to comply with the guidelines ordinarily will result in the proposed revocation of the exempt status of a school.

Recordkeeping requirements. With certain exceptions, given later, each exempt private school must maintain the following records for a minimum period of 3 years, beginning with the year after the year of compilation or acquisition.

Records indicating the racial composition of the student body, faculty, and administrative staff for each academic year.
Records sufficient to document that scholarship and other financial assistance is awarded on a racially nondiscriminatory basis.
Copies of all materials used by or on behalf of the school to solicit contributions.
Copies of all brochures, catalogs, and advertising dealing with student admissions, programs, and scholarships. (Schools advertising nationally or in a large geographic segment or segments of the United States need only maintain a record sufficient to indicate when and in what publications their advertisements were placed.)

The racial composition of the student body, faculty, and administrative staff may be determined in the same manner as that described at the beginning of this section. However, a school may not discontinue maintaining a system of records that reflects the racial composition of its students, faculty, and administrative staff used on November 6, 1975, unless it substitutes a different system that compiles substantially the same information, without advance approval of the IRS.

The IRS does not require that a school release any personally identifiable records or personal information except in accordance with the requirements of the Family Educational Rights and Privacy Act of 1974. Similarly, the IRS does not require a school to keep records prohibited under state or federal law.

Exceptions. The school does not have to independently maintain these records for IRS use if both of the following are true.

Substantially the same information has been included in a report or reports filed with an agency or agencies of federal, state, or local governments, and this information is current within 1 year.
The school maintains copies of these reports from which this information is readily obtainable.

If these reports do not include all of the information required, as discussed earlier, records providing such remaining information must be maintained by the school for IRS use.

Failure to maintain records. Failure to maintain or to produce the required records and information, upon proper request, will create a presumption that the organization has failed to comply with these guidelines.

Organizations Providing Insurance

An organization described in section 501(c)(3) or 501(c)(4) may be exempt from tax only if no substantial part of its activities consist of providing commercial-type insurance.

However, this rule does not apply to state-sponsored organizations described in sections 501(c)(26) or 501(c)(27), which are discussed in chapter 4, or to charitable risk pools, discussed next.

Charitable Risk Pools

A charitable risk pool is treated as organized and operated exclusively for charitable purposes if it:

Is organized and operated only to pool insurable risks of its members (not including risks related to medical malpractice) and to provide information to its members about loss control and risk management,
Consists only of members that are section 501(c)(3) organizations exempt from tax under section 501(a),
Is organized under state law authorizing this type of risk pooling,
Is exempt from state income tax (or will be after qualifying as a section 501(c)(3) organization),
Has obtained at least $1,000,000 in startup capital from nonmember charitable organizations,
Is controlled by a board of directors elected by its members, and
Is organized under documents requiring that:
1. Each member be a section 501(c)(3) organization exempt from tax under section 501(a),
2. Each member that receives a final determination that it no longer qualifies under section 501(c)(3) notify the pool immediately, and
3. Each insurance policy issued by the pool provide that it will not cover events occurring after a final determination described in (b).

Other Section 501(c)(3) Organizations

In addition to the information required for all organizations, as described earlier, you should include any other information described in this section.

Charitable Organizations

If your organization is applying for recognition of exemption as a charitable organization, it must show that it is organized and operated for purposes that are beneficial to the public interest. Some examples of this type of organization are those organized for:

Relief of the poor, the distressed, or the underprivileged,
Advancement of religion,
Advancement of education or science,
Erection or maintenance of public buildings, monuments, or works,
Lessening the burdens of government,
Lessening of neighborhood tensions,
Elimination of prejudice and discrimination,
Defense of human and civil rights secured by law, and
Combating community deterioration and juvenile delinquency.

The rest of this section contains a description of the information to be provided by certain specific organizations. This information is in addition to the required inclusions described in chapter 1, and other statements requested on Form 1023. Each of the following organizations must submit the information described.

Charitable organization supporting education. Submit information showing how your organization supports education — for example, contributes to an existing educational institution, endows a professorial chair, contributes toward paying teachers' salaries, or contributes to an educational institution to enable it to carry on research.

Scholarships. If the organization awards or plans to award scholarships, complete Schedule H of Form 1023. Submit the following also.

Criteria used for selecting recipients, including the rules of eligibility.
How and by whom the recipients are or will be selected.
If awards are or will be made directly to individuals, whether information is required assuring that the student remains in school.
If awards are or will be made to recipients of a particular class, for example, children of employees of a particular employer—
1. Whether any preference is or will be accorded an applicant by reason of the parent's position, length of employment, or salary,
2. Whether as a condition of the award the recipient must upon graduation accept employment with the company, and
3. Whether the award will be continued even if the parent's employment ends.
A copy of the scholarship application form and any brochures or literature describing the scholarship program.

Hospital. If you are organized to operate a charitable hospital, complete and attach Section I of Schedule C, Form 1023.

If your hospital was transferred to you from proprietary ownership, complete and attach Schedule I of Form 1023. You must attach a list showing:

The names of the active and courtesy staff members of the proprietary hospital, as well as the names of your medical staff members after the transfer to nonprofit ownership, and
The names of any doctors who continued to lease office space in the hospital after its transfer to nonprofit ownership and the amount of rent paid. Submit also an appraisal showing the fair rental value of the rented space.

Clinic. If you are organized to operate a clinic, attach a statement including:

A description of the facilities and services,
To whom the services are offered, such as the public at large or a specific group,
How charges are determined, such as on a profit basis, to recover costs, or at less than cost,
By whom administered and controlled,
Whether any of the professional staff (that is, those who perform or will perform the clinical services) also serve or will serve in an administrative capacity, and
How compensation paid the professional staff is or will be determined.

Home for the aged. If you are organized to operate a home for the aged, complete and attach Schedule F of Form 1023. Explain on Schedule F:

How charges are or will be determined, such as on a profit basis, to recover costs, or at less than cost, and whether the charges are based on providing service at the lowest feasible cost to the residents,
Whether all residents are or will be required to pay fees,
Whether any residents are or will be accepted at lower rates or entirely without pay and, if so, how many, and
Whether federal mortgage financing has been applied for and if so, the type.

Community nursing bureau. If you provide a nursing register or community nursing bureau, provide information showing that your organization will be operated as a community project and will receive its primary support from public contributions to maintain a nonprofit register of qualified nursing personnel, including graduate nurses, unregistered nursing school graduates, licensed attendants and practical nurses for the benefit of hospitals, health agencies, doctors, and individuals.

Organization providing loans. If you make, or will make loans for charitable and educational purposes, submit the following information.

An explanation of the circumstances under which such loans are, or will be, made.
Criteria for selection, including the rules of eligibility.
How and by whom the recipients are or will be selected.
Manner of repayment of the loan.
Security required, if any.
Interest charged, if any, and when payable.
Copies in duplicate of the loan application and any brochures or literature describing the loan program.

Public-interest law firms. If your organization was formed to litigate in the public interest (as opposed to providing legal services to the poor), such as in the area of protection of the environment, you should submit the following information.

How the litigation can reasonably be said to be representative of a broad public interest rather than a private one.
Whether the organization will accept fees for its services.
A description of the cases litigated or to be litigated and how they benefit the public generally.
Whether the policies and program of the organization are the responsibility of a board or committee representative of the public interest, which is neither controlled by employees or persons who litigate on behalf of the organization nor by any organization that is not itself an organization described in this chapter.
Whether the organization is operated, through sharing of office space or otherwise, in a way to create identification or confusion with a particular private law firm.
Whether there is an arrangement to provide, directly or indirectly, a deduction for the cost of litigation that is for the private benefit of the donor.

Acceptance of attorneys' fees. A nonprofit public-interest law firm can accept attorneys' fees in public interest cases if the fees are paid directly by its clients and the fees are not more than the actual costs incurred in the case. Once undertaking a representation, the organization cannot withdraw from the case because the litigant is unable to pay the fee.

Firms can accept fees awarded or approved by a court or an administrative agency and paid by an opposing party if the firms do not use the likelihood or probability of fee awards as a consideration in the selection of cases. All fee awards must be paid to the organization and not to its individual staff attorneys. Instead, a public-interest law firm can reasonably compensate its staff attorneys, but only on a straight salary basis. Private attorneys, whose services are retained by the firm to assist it in particular cases, can be compensated by the firm, but only on a fixed fee or salary basis.

The total amount of all attorneys' fees (court awarded and those received from clients) must not be more than 50% of the total cost of operations of the organization's legal functions, calculated over a 5-year period.

If, in order to carry out its program, an organization violates applicable canons of ethics, disrupts the judicial system, or engages in any illegal action, the organization will jeopardize its exemption.

Religious Organizations

To determine whether an organization meets the religious purposes test of section 501(c)(3), the IRS maintains two basic guidelines.

That the particular religious beliefs of the organization are truly and sincerely held.
That the practices and rituals associated with the organization's religious belief or creed are not illegal or contrary to clearly defined public policy.

Therefore, your group (or organization) may not qualify for treatment as an exempt religious organization for tax purposes if its actions, as contrasted with its beliefs, are contrary to well established and clearly defined public policy. If there is a clear showing that the beliefs (or doctrines) are sincerely held by those professing them, the IRS will not question the religious nature of those beliefs.

Churches. Although a church, its integrated auxiliaries, or a convention or association of churches is not required to file Form 1023 to be exempt from federal income tax or to receive tax deductible contributions, the organization may find it advantageous to obtain recognition of exemption. In this event, you should submit information showing that your organization is a church, synagogue, association or convention of churches, religious order, or religious organization that is an integral part of a church, and that it is engaged in carrying out the function of a church.

In determining whether an admittedly religious organization is also a church, the IRS does not accept any and every assertion that the organization is a church. Because beliefs and practices vary so widely, there is no single definition of the word church for tax purposes. The IRS considers the facts and circumstances of each organization applying for church status.

Integrated auxiliaries. An organization is an integrated auxiliary of a church if all the following are true.

The organization is described both in sections 501(c)(3) and 509(a)(1), 509(a)(2), or 509(a)(3).
It is affiliated with a church or a convention or association of churches.
It is internally supported. An organization is internally supported unless both of the following are true.
1. It offers admissions, goods, services or facilities for sale, other than on an incidental basis, to the general public (except goods, services, or facilities sold at a nominal charge or for a small part of the cost).
2. It normally gets more than 50% of its support from a combination of governmental sources, public solicitation of contributions, and receipts from the sale of admissions, goods, performance of services, or furnishing of facilities in activities that are not unrelated trades or businesses.

Special rule. Men's and women's organizations, seminaries, mission societies, and youth groups that satisfy (1) and (2) above are integrated auxiliaries of a church even if they are not internally supported.

Note: In order for an organization (including a church and religious organization) to qualify for tax exemption, no part of its net earnings may inure to any individual.

Although an individual is entitled to a charitable deduction for contributions to a church, the assignment or similar transfer of compensation for personal services to a church generally does not relieve a taxpayer of federal income tax liability on the compensation, regardless of the motivation behind the transfer.

Scientific Organizations

You must show that your organization's research will be carried on in the public interest. Scientific research will be considered to be in the public interest if the results of the research (including any patents, copyrights, processes, or formulas) are made available to the public on a nondiscriminatory basis; if the research is performed for the United States or a state, county, or municipal government; or if the research is carried on for one of the following purposes.

Aiding in the scientific education of college or university students.
Obtaining scientific information that is published in a treatise, thesis, trade publication, or in any other form that is available to the interested public.
Discovering a cure for a disease.
Aiding a community or geographical area by attracting new industry to the community or area, or by encouraging the development or retention of an industry in the community or area.

Scientific research, for exemption purposes, does not include activities of a type ordinarily incidental to commercial or industrial operations such as the ordinary inspection or testing of materials or products, or the designing or constructing of equipment, buildings, etc.

If you engage or plan to engage in research, submit all of the following.

An explanation of the nature of the research.
A brief description of research projects completed or presently being engaged in.
How and by whom research projects are determined and selected.
Whether you have, or contemplate, contracted or sponsored research and, if so, names of past sponsors or grantors, terms of grants or contracts, together with copies of any executed contracts or grants.
Disposition made or to be made of the results of your research, including whether preference has been or will be given to any organization or individual either as to results or time of release.
Who will retain ownership or control of any patents, copyrights, processes or formulas resulting from your research.
A copy of publications or other media showing reports of your research activities. Only reports of your research activities or those conducted in your behalf, as distinguished from those of your creators or members conducted in their individual capacities, should be submitted.

Literary Organizations

If your organization is established to operate a book store or engage in publishing activities of any nature (printing, publication, or distribution of your own material or that printed or published by others and distributed by you), explain fully the nature of the operations, including whether sales are or will be made to the general public, the type of literature involved, and how these activities are related to your stated purposes.

Amateur Athletic Organizations

There are two types of amateur athletic organizations that can qualify for tax-exempt status. The first type is an organization that fosters national or international amateur sports competition but only if none of its activities involve providing athletic facilities or equipment. The second type is a Qualified amateur sports organization (discussed below). The difference is that a qualified amateur sports organization may provide athletic facilities and equipment.

Donations to either amateur athletic organization are deductible as charitable contributions on the donor's federal income tax return. However, no deduction is allowed if there is a direct personal benefit to the donor or any other person other than the organization.

Qualified amateur sports organization. An organization will be a qualified amateur sports organization if it is organized and operated:

Exclusively to foster national or international amateur sports competition, and
Primarily to conduct national or international competition in sports or to support and develop amateur athletes for that competition.

The organization's membership may be local or regional in nature.

Prevention of Cruelty to Children or Animals

Examples of activities that may qualify this type of organization for exempt status are:

Preventing children from working in hazardous trades or occupations,
Promoting high standards of care for laboratory animals, and
Providing funds to pet owners to have their pets spayed or neutered to prevent overbreeding.

Private Foundations and 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 the organization's 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.

Payments made as a result of September 11, 2001 Terrorist Attacks. Payments made by a private foundation to individuals and their families because of death, injury, wounding, or illness of an individual paid as a result of the terrorist attacks against the United States on September 11, 2001, or for an attack involving anthrax, occurring on or after September 11, 2001, and before January 1, 2002, will not be treated as paid to a disqualified person for purposes of the excise tax on self-dealing. This rule applies to payments made on or after September 11, 2001.

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) heading 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 of the Code. 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 what it would have been 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, compounded annually, for the month the transaction occurred.

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:
1. Exempt from (or not subject to) taxation without regard to section 501(a), or
2. Not required to file an annual return
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 bona fide vow of poverty as an employee, agent, or on behalf of a religious organization.
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 either directly or indirectly aside from customary fees received for the professional advice rendered.
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 organizations affiliated by common control or governing documents, 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 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 noncash compensation.
The payment of liability insurance premiums for, or the payment or reimbursement by the organization of penalties, 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 of the Code, 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:
1. The terms of the approved transaction and the date approved,
2. The members of the authorized body who were present during debate on the transaction that was approved and those who voted on it,
3. The comparability data obtained and relied upon by the authorized body and how the data was obtained,
4. Any actions by a member of the authorized body having conflict of interest, and
5. 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 benefits 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.

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:
1. A state or political subdivision, or
2. 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.

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), later.

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 fund-raising 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 2002 tax year on the basis of support received during 1998, 1999, 2000, and 2001. It therefore normally meets the requirements for both 2002 and 2003. For the 2003 tax year, X is unable to meet the one-third support test on the basis of support received during 1999, 2000, 2001, and 2002. If X can meet the facts and circumstances test on the basis of those years, X will normally meet the requirements for 2004 (the tax year immediately after 2003). However, if on the basis of both 4-year periods (1999 through 2002 and 2000 through 2003), X fails to meet both the one-third and the facts and circumstances tests, X will not be a publicly-supported organization for 2004.

However, X will not be disqualified as a publicly-supported organization for the 2003 tax year because it normally met the one-third support test requirements on the basis of the tax years 1998 through 2001 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 2000 tax year, then, even though the organization meets the one-third or the facts and circumstances test using a computation period of tax years 1995–1998 or 1996–1999, the organization will not meet either test unless it meets the test using a computation period of tax years 1996–2000 (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 , later, under Section 509(a)(2) Organizations.

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 under Absence of control by disqualified persons) 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 Grants, later) 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 2003–4 (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 1998 through 2001, 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 2002, 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 (1998–2001), M meets the one-third support test and satisfies the requirements for classification as a publicly-supported organization for 2002 and 2003. (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 fund-raising 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 fund-raising 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, fund-raising 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—
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.)
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 under Section 509(a)(1) Organizations, and
Persons other than Disqualified persons (defined 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 2002, then even though the organization meets the requirements of the support tests based on the years 1997–2000 or 1998–2000, it does not meet these tests unless it meets the requirements based on the 5-year computation period of 1998–2002. 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.

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 2003–4 (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 1998, 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 1998 and 2001, Y was able to raise small amounts of contributions through fund-raising 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 2002, 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 2002. Marshall's contribution of M's common stock was 90% of Y's total support for 2002. Although Y could satisfy the one-third support test on the basis of the 4 tax years before 2002, a combination of the facts and circumstances preclude Marshall's contribution of M's common stock in 2002 from being excluded as an unusual grant. Marshall's contribution in 2002 was a substantial and material change in Y's sources of support and on the basis of the 5-year period (1998 to 2002), Y would not be considered as normally meeting the one-third support test for the tax years 2002 (the current tax year) and 2003 (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 fund-raising 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 fund-raising 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 under Qualifying As Publicly Supported.

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.

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:
1. The publicly-supported organizations referred to above (without designating the organizations by name), or
2. 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 fund-raising activities, such as solicitations, fund-raising 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:
1. The total combined voting power of a corporation that is (during such ownership) a substantial contributor to the foundation,
2. The profits interest of a partnership that is (during such ownership) a substantial contributor to the foundation, or
3. 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.), or
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.

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.

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.

Operational test. The requirements for meeting the operational test for organizations operated, supervised, or controlled by publicly-supported organizations (discussed earlier, 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 used 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).

Lobbying Expenditures

In general, if a substantial part of the activities of your organization consists of carrying on propaganda or otherwise attempting to influence legislation, your organization's exemption from federal income tax will be denied. However, a public charity (other than a church, an integrated auxiliary of a church or of a convention or association of churches, or a member of an affiliated group of organizations that includes a church, etc.) may avoid this result. Such a charity can elect to replace the substantial part of activities test with a limit defined in terms of expenditures for influencing legislation. Private foundations cannot make this election.

Making the election. Use Form 5768, Election/Revocation of Election By an Eligible Section 501(c)(3) Organization To Make Expenditures To Influence Legislation, to make the election. The form must be signed and postmarked within the first tax year to which it applies. If the form is used to revoke the election, it must be signed and postmarked before the first day of the tax year to which it applies.

Eligible section 501(c)(3) organizations that have made the election to be subject to the limits on lobbying expenditures must use Part VI – A of Schedule A (Form 990) to figure these limits.

Attempting to influence legislation. Attempting to influence legislation, for this purpose, means:

Any attempt to influence any legislation through an effort to affect the opinions of the general public or any segment thereof (grass roots lobbying), and
Any attempt to influence any legislation through communication with any member or employee of a legislative body or with any government official or employee who may participate in the formulation of legislation (direct lobbying).

However, the term attempting to influence legislation does not include the following activities.

Making available the results of nonpartisan analysis, study, or research.
Examining and discussing broad social, economic, and similar problems.
Providing technical advice or assistance (where the advice would otherwise constitute the influencing of legislation) to a governmental body or to a committee or other subdivision thereof in response to a written request by that body or subdivision.
Appearing before, or communicating with, any legislative body about a possible decision of that body that might affect the existence of the organization, its powers and duties, its tax-exempt status, or the deduction of contributions to the organization.
Communicating with a government official or employee, other than:
1. A communication with a member or employee of a legislative body (when the communication would otherwise constitute the influencing of legislation), or
2. A communication with the principal purpose of influencing legislation.

Also excluded are communications between an organization and its bona fide members about legislation or proposed legislation of direct interest to the organization and the members, unless these communications directly encourage the members to attempt to influence legislation or directly encourage the members to urge nonmembers to attempt to influence legislation, as explained earlier.

Lobbying expenditures limits. If a public charitable organization makes the election to be subject to the lobbying expenditures limits rules (instead of the substantial part of activities test), it will not lose its tax-exempt status under section 501(c)(3), unless it normally makes:

Lobbying expenditures that are more than 150% of the lobbying nontaxable amount for the organization for each tax year, or
Normally makes grass roots expenditures that are more than 150% of the grass roots nontaxable amount for the organization for each tax year.

See Tax on excess expenditures to influence legislation, later, in this section.

Lobbying expenditures. These are any expenditures that are made for the purpose of attempting to influence legislation, as discussed earlier under Attempting to influence legislation.

Grass roots expenditures. This term refers only to those lobbying expenditures that are made to influence legislation by attempting to affect the opinions of the general public or any segment thereof.

Lobbying nontaxable amount. The lobbying nontaxable amount for any organization for any tax year is the lesser of $1,000,000 or:

20% of the exempt purpose expenditures if the exempt purpose expenditures are not over $500,000,
$100,000 plus 15% of the excess of the exempt purpose expenditures over $500,000 if the exempt purpose expenditures are over $500,000 but not over $1,000,000,
$175,000 plus 10% of the excess of the exempt purpose expenditures over $1,000,000 if the exempt purpose expenditures are over $1,000,000 but not over $1,500,000, or
$225,000 plus 5% of the excess of the exempt purpose expenditures over $1,500,000 if the exempt purpose expenditures are over $1,500,000.

The term exempt purpose expenditures means the total of the amounts paid or incurred (including depreciation and amortization, but not capital expenditures) by an organization for the tax year to accomplish its exempt purposes. In addition, it includes:

Administrative expenses paid or incurred for the organization's exempt purposes, and
Amounts paid or incurred for the purpose of influencing legislation, whether or not the legislation promotes the organization's exempt purposes.

Exempt purpose expenditures do not include amounts paid or incurred to or for:

A separate fund-raising unit of the organization, or
One or more other organizations, if the amounts are paid or incurred primarily for fund-raising.

Grass roots nontaxable amount. The grass roots nontaxable amount for any organization for any tax year is 25% of the lobbying nontaxable amount for the organization for that tax year.

Years for which election is effective. Once an organization elects to come under these provisions, the election will be in effect for all tax years that end after the date of the election and begin before the organization revokes this election.

Note: These elective provisions for lobbying activities by public charities do not apply to a church, an integrated auxiliary of a church or of a convention or association of churches, or a member of an affiliated group of organizations that includes a church, etc., or a private foundation. Moreover, these provisions will not apply to any organization for which an election is not in effect.

Expenditures of affiliated organizations. If two or more section 501(c)(3) organizations are members of an affiliated group of organizations and at least one of these organizations has made the election regarding the treatment of certain lobbying expenditures, then the determination as to whether excess lobbying expenditures have been made and the determination as to whether the expenditure limits, described earlier, have been exceeded by more than 150% will be made as though the affiliated group is one organization.

If the group has excess lobbying expenditures, each organization for which the election is effective for the year will be treated as an organization that has excess lobbying expenditures in an amount that equals the organization's proportionate share of the group's excess lobbying expenditures. Further, if the expenditure limits, described in this section, are exceeded by more than 150%, each organization for which the election is effective for that year will lose its tax-exempt status under section 501(c)(3).

Two organizations will be considered members of an affiliated group of organizations if:

The governing instrument of one of the organizations requires it to be bound by decisions of the other organization on legislative issues, or
The governing board of one of the organizations includes persons who:
1. Are specifically designated representatives of the other organization or are members of the governing board, officers, or paid executive staff members of the other organization, and
2. Have enough voting power to cause or prevent action on legislative issues by the controlled organization by combining their votes.

Tax on excess expenditures to influence legislation. If an election for a tax year is in effect for an organization and that organization exceeds the lobbying expenditures limits, an excise tax of 25% of the excess lobbying expenditures for the tax year will be imposed. Excess lobbying expenditures for a tax year, in this case, means the greater of:

The amount by which the lobbying expenditures made by the organization during the tax year are more than the lobbying nontaxable amount for the organization for that tax year, or
The amount by which the grass roots expenditures made by the organization during the tax year are more than the grass roots nontaxable amount for the organization for that tax year.

Eligible organizations that have made the election to be subject to the limits on lobbying expenditures and that owe the tax on excess lobbying expenditures (as computed in Part VI – A of Schedule A (Form 990)) must file Form 4720, Return of Certain Excise Taxes on Charities and Other Persons Under Chapters 41 and 42 of the Internal Revenue Code, to report and pay the tax.

Organization that no longer qualifies. An organization that no longer qualifies for exemption under section 501(c)(3) because of substantial lobbying activities will not at any time thereafter be treated as an organization described in section 501(c)(4). This provision, however, does not apply to certain organizations (churches, etc.) that cannot make the election discussed earlier.

Tax on disqualifying lobbying expenditures. The law imposes a tax on certain organizations if they no longer qualify under section 501(c)(3) by reason of having made disqualifying lobbying expenditures. An additional tax may be imposed on the managers of those organizations.

Tax on organization. Organizations that lose their exemption under section 501(c)(3) due to lobbying activities generally will be subject to an excise tax of 5% of the lobbying expenditures. The tax does not apply to private foundations. Also, the tax does not apply to organizations that have elected the lobbying limits of section 501(h) or to churches or church-related organizations that cannot elect these limits. This tax must be paid by the organization.

Tax on managers. Managers may also be liable for a 5% tax on the lobbying expenditures that result in the disqualification of the organization. For the tax to apply, a manager would have to agree to the expenditures knowing that the expenditures were likely to result in the organization's not being described in section 501(c)(3). No tax will be imposed if the manager's agreement is not willful and is due to reasonable cause.

Excise taxes on political expenditures. The law imposes an excise tax on the political expenditures of section 501(c)(3) organizations. A two-tier tax is imposed on both the organizations and the managers of those organizations.

Taxes on organizations. An initial tax of 10% of certain political expenditures is imposed on a charitable organization. A second tax of 100% of the expenditure is imposed if the political expenditure that resulted in the imposition of the initial (first-tier) tax is not corrected within a specified period. These taxes must be paid by the organization.

Taxes on managers. An initial tax of 2½% of the amount of certain political expenditures (up to $5,000 for each expenditure) is imposed on a manager of an organization who agrees to such expenditures knowing that they are political expenditures. No tax will be imposed if the manager's agreement was not willful and was due to reasonable cause. A second tax of 50% of the expenditures (up to $10,000 for each expenditure) is imposed on a manager if he or she refuses to agree to a correction of the expenditures that resulted in the imposition of the initial (first-tier) tax. For purposes of these taxes, an organization manager is generally an officer, director, trustee, or any employee having authority or responsibility concerning the organization's political expenditures. These taxes must be paid by the manager of the organization.

Political expenditures. Generally, political expenditures that will trigger these taxes are amounts paid or incurred by a section 501(c)(3) organization in any participation or intervention in any political campaign for or against any candidate for public office. Political expenditures include publication or distribution of statements for these purposes. Political expenditures also include certain expenditures by organizations that are formed primarily to promote the candidacy (or prospective candidacy) of an individual for public office and by organizations that are effectively controlled by a candidate and are used primarily to promote that candidate.

Correction of expenditure. A correction of a political expenditure is the recovery, if possible, of all or part of the expenditure and the establishment of safeguards to prevent future political expenditures.

Status after loss of exemption for lobbying or political activities. As explained earlier, an organization can lose its tax-exempt status under section 501(c)(3) of the Code because of lobbying activities or participation or intervention in a political campaign on behalf of or in opposition to a candidate for public office. If this happens to an organization, it cannot later qualify for exemption under section 501(c)(4) of the Code.