Private Foundation Law Made Easy E-Book

Bruce R. Hopkins

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Sprache: Englisch
• Veröffentlichungsjahr: 2008

Seitenzahl: 606

Beschreibung

Now your foundation can be fully informed about the basic legal requirements affecting private foundations and avoid the perils lurking in nonprofit tax law traps. Private Foundation Law Made Easy clearly shows you how, with information on reaping the charitable and tax advantages of your private foundation. Filled with straightforward guidance, author Bruce Hopkins?a leading authority on the laws regulating private foundations?demystifies this topic for you and your board members with practical legal information in easy-to-understand English.

Leseprobe

Table of Contents

Title Page

Copyright Page

Preface

About the Author

Chapter 1 - PRIVATE FOUNDATIONS AND PUBLIC CHARITIES

PRIVATE FOUNDATION DEFINED

PRIVATE OPERATING FOUNDATIONS

EXEMPT OPERATING FOUNDATIONS

CONDUIT FOUNDATIONS

NONEXEMPT CHARITABLE TRUSTS

CONCEPT OF PUBLIC CHARITY

INSTITUTIONS

DONATIVE PUBLICLY SUPPORTED ORGANIZATIONS

SERVICE PROVIDER PUBLICLY SUPPORTED ORGANIZATIONS

COMPARATIVE ANALYSIS OF PUBLICLY SUPPORTED CHARITIES

SUPPORTING ORGANIZATIONS

PUBLIC SAFETY TESTING ORGANIZATIONS

IMPORT OF PUBLIC-PRIVATE DICHOTOMY

SOME STATISTICS

SUMMARY

Chapter 2 - DISQUALIFIED PERSONS

BASIC CONCEPTS

FOUNDATION MANAGERS

SUBSTANTIAL CONTRIBUTORS

20%-PLUS OWNERS

MEMBERS OF FAMILY

CORPORATIONS

PARTNERSHIPS

TRUSTS AND ESTATES

PRIVATE FOUNDATIONS

GOVERNMENT OFFICIALS

TERMINATION OF DISQUALIFIED PERSON STATUS

PRIVATE BENEFIT AND SELF-DEALING

SUMMARY

Chapter 3 - TAX LAW RULES IN GENERAL

FORM OF ORGANIZATION

ORGANIZATIONAL TEST IN GENERAL

ORGANIZATIONAL TEST FOR FOUNDATIONS

OPERATIONAL TEST

PRIMARY PURPOSE TEST

CHARITABLE PURPOSES AND ACTIVITIES

RECOGNITION OF TAX EXEMPTION

PRIVATE INUREMENT DOCTRINE

INTERMEDIATE SANCTIONS

LEGISLATIVE ACTIVITIES

POLITICAL CAMPAIGN ACTIVITIES

PROHIBITED TAX SHELTER TRANSACTIONS

PERSONAL BENEFIT CONTRACTS

TAX ON INVESTMENT INCOME

TERMINATION OF FOUNDATION STATUS

SUMMARY

Chapter 4 - MANDATORY PAYOUT RULES

SOME HISTORY

PAYOUT RULES IN GENERAL

DETERMINING PAYOUT PERCENTAGE AMOUNT

TYPES OF ASSETS USED IN CALCULATION

FUTURE INTERESTS OR EXPECTANCIES

EXEMPT FUNCTION ASSETS

DUAL-USE PROPERTY

ASSETS HELD FOR FUTURE USE

ACQUISITION INDEBTEDNESS

DETERMINING FAIR MARKET VALUE

DISTRIBUTABLE AMOUNT

QUALIFYING DISTRIBUTIONS

SET-ASIDES IN GENERAL

SET-ASIDE TYPE I: SUITABILITY TEST

SET-ASIDE TYPE II: CASH DISTRIBUTION TEST

DISTRIBUTIONS TO FOREIGN RECIPIENTS

DISTRIBUTIONS TO CERTAIN SUPPORTING ORGANIZATIONS

IMPOSITION OF EXCISE TAX PENALTIES

CORRECTION

TAX ABATEMENT

THIRD-TIER TAX REGIME

SUMMARY

Chapter 5 - PROHIBITED EXPENDITURES RULES

OVERVIEW OF RULES

LEGISLATIVE ACTIVITIES

POLITICAL CAMPAIGN ACTIVITIES

GRANTS TO INDIVIDUALS

GRANTS TO PUBLIC CHARITIES

GRANTS TO FOREIGN ORGANIZATIONS

EXPENDITURE RESPONSIBILITY

EXPENDITURES FOR NONCHARITABLE PURPOSES

DISTRIBUTIONS TO CERTAIN SUPPORTING ORGANIZATIONS

IMPOSITION OF EXCISE TAX PENALTIES

CORRECTION

TAX ABATEMENT

THIRD-TIER TAX REGIME

SUMMARY

Chapter 6 - SELF-DEALING RULES

BASIC DEFINITION OF SELF-DEALING

SALES OR EXCHANGES OF PROPERTY

LEASING OF PROPERTY

FURNISHING OF PROPERTY

CO-OWNED PROPERTY

LOANS AND OTHER EXTENSIONS OF CREDIT

PAYMENT OF COMPENSATION

ADVANCES AND EXPENSE REIMBURSEMENTS

BANK FEES

INDEMNIFICATION AND INSURANCE

USES OF INCOME OR ASSETS

SHARING SPACE, PEOPLE, EXPENSES

OFFICE SPACE, EQUIPMENT, AND PERSONNEL

PAYMENTS TO GOVERNMENT OFFICIALS

INDIRECT SELF-DEALING

PROPERTY HELD BY FIDUCIARIES

EARLY TERMINATIONS OF CHARITABLE REMAINDER TRUSTS

EXCEPTIONS TO RULES

IMPOSITION OF EXCISE TAX PENALITIES

CORRECTION

TAX ABATEMENT

THIRD-TIER TAX REGIME

SUMMARY

Chapter 7 - INVESTMENT RULES

PURPOSE OF RULES

GENERAL RULES

DEFINING JEOPARDY

DONATED ASSETS

PRUDENT INVESTMENT STANDARDS

PROGRAM-RELATED INVESTMENTS

IMPOSITION OF EXCISE TAX PENALTIES

CORRECTION

TAX ABATEMENT

THIRD-TIER EXCISE TAX REGIME

SUMMARY

Chapter 8 - BUSINESS HOLDINGS RULES

GENERAL RULES

BUSINESS ENTERPRISES

PASSIVE INCOME BUSINESSES

INVESTMENT PARTNERSHIPS

PERCENTAGE LIMITATIONS

PERMITTED AND EXCESS HOLDINGS

FUNCTIONALLY RELATED BUSINESSES

IMPOSITION OF EXCISE TAX PENALTIES

CORRECTION

TAX ABATEMENT

THIRD-TIER TAX REGIME

UNRELATED BUSINESS LAW STATUTORY FRAMEWORK

AFFECTED TAX-EXEMPT ORGANIZATIONS

CONDUCT OF BUSINESS

REGULARLY CARRIED ON BUSINESSES

RELATED OR UNRELATED?

UNRELATED BUSINESS TAXABLE INCOME

EXCEPTED ACTIVITIES

EXCEPTED INCOME

EXCEPTIONS TO EXCEPTIONS

FOUNDATIONS AND UNRELATED BUSINESS RULES

SUMMARY

Chapter 9 - CHARITABLE GIVING

BASIC CONCEPTS

DEFINING CHARITABLE GIFT

QUALIFIED DONEES

GIFTS OF PROPERTY

LIMITATIONS ON DEDUCTIBILITY

DEDUCTION REDUCTION RULES

QUALIFIED APPRECIATED STOCK

TWICE-BASIS DEDUCTIONS

PARTIAL-INTEREST GIFTS

GIFTS OF OR USING INSURANCE

PLANNED GIVING

SUMMARY

Chapter 10 - REPORTING AND DISCLOSURE REQUIREMENTS

FEDERAL TAX LAW REPORTING BASICS

FORM 990-PF

FORM 990-T

FORM 990

FORM 990-N

STATE LAW REQUIREMENTS

FEDERAL TAX LAW DISCLOSURE REQUIREMENTS

FILING REQUIREMENTS AND TAX-EXEMPT STATUS

ELECTRONIC FILING

SUMMARY

Chapter 11 - ALTERNATIVES TO PRIVATE FOUNDATIONS

FACTORS TO CONSIDER

PRIVATE FOUNDATIONS

PUBLIC CHARITIES IN GENERAL

SUPPORTING ORGANIZATIONS

CREATIVE USES OF SUPPORTING ORGANIZATIONS

IRS SHELL GAME

DONOR-ADVISED FUNDS IN GENERAL

GIFTS REVISTED

DONOR-ADVISED FUNDS’ STATUTORY CRITERIA

MORE ABOUT DONOR-ADVISED FUNDS

QUICK COMPARATIVE ANALYSIS

SUMMARY

Chapter 12 - GOVERNANCE PRINCIPLES AND TRUSTEE LIABILITY

BASICS OF GOVERNANCE PRINCIPLES

EMERGING CONCEPTS

NONPROFIT GOVERNANCE PRINCIPLES

IRS DRAFT OF GOOD GOVERNANCE PRINCIPLES

REDESIGNED ANNUAL INFORMATION RETURN

SUBSEQUENT IRS GUIDANCE

BOARD MEMBER RESPONSIBILITIES

LAWSUITS AGAINST NONPROFIT ORGANIZATIONS

INDIVIDUALS AS DEFENDANTS

PROTECTION AGAINST PERSONAL LIABILITY

MANAGEMENT COMPANIES

WATCHDOG AGENCIES

SUMMARY

Index

Copyright© 2008 by John Wiley & Sons, Inc. All rights reserved.

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Preface

This book came into existence principally because it wanted to join its companions, the books Nonprofit Law Made Easy and Charitable Giving Law Made Easy. (It was also fueled by a desire to distill private foundation law, so as to help trustees, directors, and management of foundations obtain some grasp of this complex body of law.) In format, style, and length, it parallels its siblings. The hope is that these three books, in tandem, will be of assistance in guiding nonlawyers through the maze of law concerning private foundations, other types of nonprofit tax-exempt organizations, and charitable giving.

This book also, however, blatantly mimics still another Wiley book (the one that started it all): Not-for-Profit Accounting Made Easy. Lawyers and accountants in the nonprofit realm populate overlapping universes, so these three companion volumes about the law are a natural fit with the book on nonprofit accounting rules.

As was noted in the preface to Nonprofit Law Made Easy, I have never had the opportunity to discuss this accounting book with its author, Warren Ruppel. I cannot imagine, nonetheless, that he extracted as much enjoyment from this writing process as I did. After years of writing technical (and long) books about various aspects of nonprofit law, writing the private foundation, nonprofit organizations, and charitable giving books with this approach was pure pleasure. The biggest challenge, not surprisingly, was the decisions as to what to include and what to leave out. This book thus reflects my take on what constitutes the fundamentals of the law concerning private foundations.

In any event, I had an easier time of it than Mr. Ruppel did. He had to create his book; I had merely to imitate it. The substance obviously is different but the format is unabashedly copied. Consequently, the three law books are about the same length as his, there are likewise a dozen chapters in each, every chapter of these books opens with an inventory of what is coming and ends with a chapter summary, and there are no footnotes. (The lack of footnotes came the closest to derogating from the pleasure of writing these books.) The three books share a similar dust jacket. So Mr. Ruppel and Wiley designed the original vessel; I poured my descriptions of the law into it.

Back to this matter of what to include and what to exclude. I included in this book the absolute basics, namely, a description of the differences between a private foundation and a public charity, and the special foundation rules concerning mandatory payouts, prohibited expenditures, self-dealing, excess business holdings, and jeopardizing investments. But, wanting to do more, I added prudent investment standards to the chapter on jeopardizing investments and blended the unrelated business rules into the chapter on excess business holdings. A chapter on charitable giving law is provided, tilted toward the unique aspects of giving to private foundations.

Being unable to stop there, I toyed with some new law and emerging concepts. As to the former, I looked at supporting organizations (heavily and wrongfully damaged by 2006 legislation) and donor-advised funds, and offered comparisons to private foundations. As to the latter, I ventured into the realm of emerging principles as to governance and traditional rules as to liability, and treated them from the singular perspective of foundations.

Nonprofit law continues to be as dynamic as law can get; consequently, trying to capture what appears to be the basics of elements of this law at any point in time can be tricky business. Congress, the Treasury Department, the IRS, the courts, and others in federal and state government are certain to contribute their share of new law. For the sake of the private foundation community, I hope coming law changes are not too tough on foundations, which are a meaningful component of the nonprofit sector and our society in general, and an important part of American philanthropy.

As a nonaccountant in the nonprofit field, I am glad to have Not-for-Profit Accounting Made Easy as a guide to the basics of the accounting rules and principles applicable to nonprofit organizations. I have once again tried to emulate Mr. Ruppel’s work, to provide an equally valuable volume for the nonlawyer who needs a grounding in private foundation law.

I extend my thanks to Dexter Gasque, senior production editor, and to Susan McDermott, senior editor, for their support and assistance in creating this book.

Bruce R. HopkinsOctober, 2008

About the Author

Bruce R. Hopkins is a senior partner in the law firm of Polsinelli Shalton Flanigan Suelthaus PC, practicing in the firm’s Kansas City, Missouri, and Washington, D.C., offices. He specializes in the representation of private foundations and other tax-exempt organizations. His practice ranges over the entirety of law matters involving exempt organizations, with emphasis on the formation of nonprofit organizations, acquisition of recognition of tax-exempt status for them, the private inurement and private benefit doctrines, the intermediate sanctions rules, legislative and political campaign activities issues, public charity and private foundation rules, unrelated business planning, use of exempt and for-profit subsidiaries, joint venture planning, tax shelter involvement, review of annual information returns, Internet communications developments, the law of charitable giving (including planned giving), and fundraising law issues.

Mr. Hopkins served as Chair of the Committee on Exempt Organizations, Tax Section, American Bar Association; Chair, Section of Taxation, National Association of College and University Attorneys; and President, Planned Giving Study Group of Greater Washington, D.C.

Mr. Hopkins is the series editor of Wiley’s Nonprofit Law, Finance, and Management Series. In addition to Private Foundation Law Made Easy, he is the author of The Law of Tax-Exempt Organizations, Ninth Edition; the Planning Guide for the Law of Tax-Exempt Organizations: Strategies and Commentaries ; IRS Audits of Tax-Exempt Organizations: Policies, Practices, and Procedures; The Tax Law of Charitable Giving, Third Edition; The Law of Fundraising, Third Edition; The Tax Law of Associations; The Tax Law of Unrelated Business for Nonprofit Organizations; The Nonprofits’ Guide to Internet Communications Law; The Law of Intermediate Sanctions: A Guide for Nonprofits; Starting and Managing a Nonprofit Organization: A Legal Guide, Fifth Edition; Nonprofit Law Made Easy; Charitable Giving Law Made Easy; 650 Essential Nonprofit Law Questions Answered ; The First Legal Answer Book for Fund-Raisers; The Second Legal Answer Book for Fund-Raisers; The Legal Answer Book for Nonprofit Organizations; The Second Legal Answer Book for Nonprofit Organizations; and The Nonprofit Law Dictionary; and is the co-author, with Jody Blazek, of Private Foundations: Tax Law and Compliance, Third Edition; also with Ms. Blazek, The Legal Answer Book for Private Foundations; with Thomas K. Hyatt, of The Law of Tax-Exempt Healthcare Organizations, Third Edition; with David O. Middlebrook, of Nonprofit Law for Religious Organizations: Essential Questions & Answers; and with Douglas K. Anning, Virginia C. Gross, and Thomas K. Schenkelberg, The New Form 990: Law, Policy, and Preparation. He also writes Bruce R. Hopkins’ Nonprofit Counsel, a monthly newsletter, published by John Wiley & Sons.

Mr. Hopkins received the 2007 Outstanding Nonprofit Lawyer Award (Vanguard Lifetime Achievement Award) from the American Bar Association, Section of Business Law, Committee on Nonprofit Corporations. He is listed in The Best Lawyers in America, Nonprofit Organizations/Charities Law, 2007-2008.

Mr. Hopkins has served as a member of the adjunct faculty at the George Washington University National Law Center and the University of Missouri-Kansas City, teaching courses on the law of tax-exempt organizations. He currently teaches that course as a member of the adjunct faculty at the University of Kansas School of Law.

Mr. Hopkins earned his JD and LLM degrees at the George Washington University National Law Center and his BA at the University of Michigan. He is a member of the bars of the District of Columbia and the state of Missouri.

1

PRIVATE FOUNDATIONS AND PUBLIC CHARITIES

The purpose of this chapter is to explain the distinctions between private foundations and public charities. There are, however, different types of private foundations and likewise different types of public charities. Specifically, this chapter will:

• Provide a generic and a technical definition of the term private foundation .

• Explain the terms private operating foundations, exempt operating foundations, conduit private foundations, and nonexempt charitable trusts.

• Explain the concept of a public charity.

• Define the public charities that are the institutions.

• Define the public charities that are the donative publicly supported charities .

• Define the public charities that are the service provider publicly supported charities.

• Provide a comparative analysis of publicly supported charities.

• Define the public charities that are supporting organizations.

• Define the public charities that test for public safety.

• Summarize the rules as to the excise tax on net investment income.

• Explain the significance of the private foundation-public charity dichotomy.

• Review some of the most recent IRS statistics on these subjects.

PRIVATE FOUNDATIONDEFINED

A private foundation is a form of tax-exempt charitable organization. In this context, the term charitable includes program undertakings that are classified as educational, scientific, and religious. Generically, however, a private foundation typically has four other characteristics:

1. A private foundation is usually funded from a single source, often an individual, a family, or a corporation.

2. This funding is usually a one-time occasion, by means of a sizeable charitable contribution. While a private foundation may receive an ongoing flow of gifts, that is a rarity.

3. The year-by-year revenue derived by a private foundation is almost always in the form of investment income earned on their assets (also known as principal or corpus).

4. The typical private foundation makes grants for charitable purposes to other persons (individuals and/or organizations), rather than conduct its own programs.

The private aspect of the concept of a private foundation, then, principally reflects the nature of its financial support, particularly its initial funding. The private nature of a foundation, however, is often reflected in its governing board structure (see Chapter 12).

Because private foundations are generally exempt from federal income tax, the term private foundation appears in the Internal Revenue Code. This technical tax law definition, however, does not match the generic definition. Congress could have crafted a definition of private foundation in accord with the four unique attributes of foundations but it elected another approach. The reason for this distinction is rooted in the history of private foundation law, which came into being in 1969.

When most of the law as to private foundations was created in that year, Congress was in a horrific anti-foundation mood. The antipathy toward foundations at that time was substantial, largely because members of Congress were being regaled with tales of foundation abuse (mostly apocryphal) and many were in a populist mind-set, with foundations seen as playthings (and pocketbooks) of the wealthy. Consequently, when fashioning a definition of the term private foundation, Congress was careful to write it in such a way as to minimize the likelihood that crafty tax lawyers would find ways around the foundation laws.

Thus, the technical definition of private foundation has two key characteristics:

1. Despite the fact that the Internal Revenue Code purports to define the term, it does not. Instead, the Code defines what a private foundation isn’t. (A private foundation is a tax-exempt charitable organization that is not a public charity.)

2. A unique feature in the law causes every tax-exempt charity in the United States to be presumed to be a private foundation. Among other outcomes, this forces nearly all charities that are not private foundations to convince the Internal Revenue Service of that fact and be officially classified as public entities. Put another way, a charitable organization that cannot, or subsequently fails to, qualify as a public charity is, by operation of law, a private foundation.

PRIVATE OPERATING FOUNDATIONS

As noted, one of the characteristics of a conventional private foundation is that it is a grant-maker. That is, the typical foundation serves as a funder of the charitable programs of other organizations. There are some private foundations, however, that, instead of grant-making, use their funds principally to administer their own charitable programs. This type of private foundation is known as a private operating foundation, with the word operating intended to convey this feature of internal program operations (rather than external funding). (These foundations are exempt from the standard income distribution requirement [see Chapter 4].) Some museums, libraries, housing and health care facilities, and scientific research entities, for example, are structured as private operating foundations. To qualify as an operating foundation, a private foundation must meet an income test and one of three other tests: an assets test, an endowment test, or a support test.

A private foundation satisfies the income test if it expends at least 85% of the lesser of its (1) minimum investment return (which, as explained in Chapter 4, is an amount equal to 5% of the foundation’s investment assets) or (2) adjusted net income for the direct, active conduct of charitable activities. Adjusted net income is the amount of income from charitable functions, investment activities, set-asides, unrelated business, and short-term capital gains that exceeded the cost incurred in earning the income.

To meet the assets test, a private foundation must directly use at least 65% of its assets for the active conduct of charitable activities. Satisfaction of the endowment test requires that the foundation regularly make distributions for the active conduct of charitable activities in an amount not less than two-thirds of its minimum investment return. To meet the support test, a private foundation must regularly receive substantially all of its support (other than from gross investment income) from the public or from five or more qualifying exempt organizations; receive no more than 25% of its support (other than from gross investment income) from any one qualifying exempt organization; and receive no more than 50% of its support in the form of gross investment income.

EXEMPT OPERATING FOUNDATIONS

Certain private operating foundations are exempt from the excise tax on net investment income paid by most private foundations (discussed later in this chapter). This type of operating foundation must maintain public support for a minimum of 10 years; maintain a governing body at all times that is broadly representative of the public, where no more than 25% of that board consists of disqualified individuals; and not have at any time during the year an officer who is a disqualified individual. These foundations are also exempt from the expenditure responsibility requirements (see Chapter 5).

CONDUIT FOUNDATIONS

A conduit private foundation is not a separate category of private foundation; it is a standard private foundation that, under certain circumstances, is regarded as a public charity for charitable contribution deduction purposes. A foundation functions as a conduit when it makes qualifying distributions (see Chapter 4) that are treated as distributions from its corpus in an amount equal to 100% of all contributions received in the year involved, whether as money or property. These distributions, to qualify, must be made not later than the 15th day of the third month after the close of the foundation’s tax year in which the contributions were received. The foundation must not have any remaining undistributed income for the year.

These distributions are treated as made first out of contributions of property and then out of contributions of money received by the private foundation in the year involved. The distributions cannot be made to an organization controlled, directly or indirectly, by the distributing foundation or by one or more disqualified persons (see Chapter 2) with respect to the foundation or to a private foundation that is not a private operating foundation.

NONEXEMPT CHARITABLE TRUSTS

Nonexempt charitable trusts are trusts that are not tax exempt but are treated as private foundations for federal tax law purposes. These trusts are funded and operated in nearly identical fashion as exempt private foundations. This type of trust has exclusively charitable interests; donors to them are allowed to claim a tax deduction for charitable contributions. Unlike private foundations, nonexempt charitable trusts are required to pay an annual tax on income that is not distributed for charitable purposes.

CONCEPT OF PUBLIC CHARITY

The dichotomy thus established in the Internal Revenue Code forces every U.S. charity to be classified as a public charity or a private foundation. This is by no means an equal division, in that, while there are millions of public charities, there are about 80,000 private foundations. (This disparity as to numbers, however, is not reflected in any balancing of the volume of federal tax law concerning charitable organizations; there are many pages of rules in the Internal Revenue Code that are applicable only to private foundations.)

As noted, a private foundation is a tax-exempt charitable organization that is not a public charity. The Code “definition” of private foundation focuses on the meaning of the term public charity. There are many categories of public charities. From a big-picture standpoint, however, there are four types of public charities: the institutions, publicly supported charities, supporting organizations, and (of minor import) public safety testing organizations.

As will be seen, public charities tend to be organizations with inherently public activity, entities that are financially supported by the public, or entities that have a close operating relationship with one or more other public charities. The term public can, however, be misleading; it is not used in the sense of a governmental entity (department, agency, etc.). The confusion is emblematic in the notion that a private school is a public charity. (Governmental entities are public charities.)

Most private foundations confine their grant-making to public charities. Therefore, it is essential (to avoid tax penalties [see Chapter 4]) that foundations having that approach understand the various ways in which a tax-exempt charitable organization can also be a public charity.

INSTITUTIONS

A category of public charity is loosely defined as institutions. These are entities that have inherently public activity. Embraced by the ambit of the institutions are churches, certain other religious organizations, schools, colleges, universities, hospitals, medical research organizations, and governmental units.

Churches

A church (including a synagogue and a mosque) is a public charity. The federal tax law is imprecise in defining this term, largely due to constitutional law (First Amendment) constraints. Although the term is not defined in the Internal Revenue Code, the IRS formulated criteria that it uses to ascertain whether a religious organization constitutes a church. Originally, these criteria (unveiled in 1977) were in a list of 14 elements, not all of which needed to be satisfied. These elements include:

• A distinct legal existence

• A recognized creed and form of worship

• An ecclesiastical government

• A formal code of doctrine and discipline

• A distinct religious history

• A literature of its own

• Established places of worship

• Regular congregations

• Regular religious services

• Schools for the religious instruction of youth and preparation of its ministers

Over the ensuing years, however, the IRS has added criteria and become more rigid (and inconsistent) in its interpretation of the term church. It is currently the position of this agency that, to be a church, an organization must—in addition to being religious—have a defined congregation of worshippers, an established place of worship, and regular religious services. Some of the criteria in the original 14-element list have been downgraded in importance, as being common to tax-exempt organizations in general.

Associations and Conventions of Churches

Some religious entities are public charities because all of their members are churches. An association of churches is a church-membership entity where the membership is confined to churches in a state. A convention of churches is a church-membership entity where the membership embraces a multistate region of the United States or perhaps the entire nation.

Educational Institutions

An educational institution is a public charity. The concept of what is educational is much broader than educational institution, so it is insufficient for these purposes that an organization is merely educational in nature. To be an educational institution, an organization must normally maintain a regular faculty and curriculum, and normally have a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly carried on. This type of institution is generically a school; consequently, it must have as its primary function the presentation of formal instruction.

Educational institutions that qualify for public charity status include primary, secondary, preparatory, and high schools and colleges and universities. (Public schools are public charities by virtue of being units of government.) An organization cannot achieve public charity status as an operating educational institution where it is engaged in educational (institution-type) and educational (non-institution-type) activities, unless the latter activities are merely incidental to the former. For example, an organization cannot qualify as this type of public charity if its primary function is the operation of a museum, rather than the presentation of formal instruction.

A university generally is an institution of higher learning with teaching and research facilities, comprising an undergraduate school that awards bachelor’s degrees and a graduate school and professional schools that award master’s or doctor’s degrees. A college is generally referred to as a school of higher learning that grants bachelor’s degrees in liberal arts or sciences; the term is also frequently used to describe undergraduate divisions or schools of a university that offer courses and grant degrees in a particular field. The term school is defined as a division of a university offering courses of instruction in a particular profession; the term is also applicable to institutions of learning at the primary and secondary levels of education.

An organization may be regarded as presenting formal instruction even though it lacks a formal course program or formal classroom instruction. For example, an organization that conducted a survival course was classified as a public charity, even though its course periods were only 26 days and it used outdoor facilities more than classrooms; it had a regular curriculum, faculty, and student body. By contrast, an organization, the primary activity of which was providing specialized instruction by correspondence and a five- to ten-day seminar program of personal instruction for students who completed the correspondence course, did not qualify as an operating educational institution.

Even if an organization qualifies as a school or other type of formal educational institution, it will not be able to achieve public charity (or tax-exempt) status if it maintains racially discriminatory admissions policies or if it benefits private interests to more than an insubstantial extent. As an illustration of the latter, an otherwise qualifying school that trained individuals for careers as political campaign professionals was denied exempt status because of the private benefit accruing to a national political party and its candidates, inasmuch as nearly all of the school’s graduates became employed by or consultants to the party’s candidates.

Hospitals

A tax-exempt organization, the principal purpose or functions of which are the provision of medical or hospital care, medical education, or medical research, if the organization is a hospital, is a public charity. The term hospital includes exempt federal government hospitals; state, county, and municipal hospitals that are instrumentalities of governmental units; rehabilitation institutions; outpatient clinics; extended-care facilities or community mental health or drug treatment centers; and cooperative hospital service organizations. This term does not include convalescent homes, homes for children or the elderly, or institutions whose principal purpose or function is to train disabled individuals to pursue a vocation, nor does it include free clinics for animals. The term medical care includes the treatment of any physical or mental disability or condition, whether on an inpatient or outpatient basis, as long as the cost of the treatment is deductible by the individual treated.

Medical Research Organizations

A medical research organization directly engaged in the continuous active conduct of medical research in conjunction with a public charity hospital can qualify as a public charity. The term medical research means the conduct of investigations, experiments, and studies to discover, develop, or verify knowledge relating to the causes, diagnosis, treatment, prevention, or control of physical or mental diseases and impairments of human beings. To qualify, an organization must have the appropriate equipment and professional personnel necessary to carry out its principal function. Medical research encompasses the associated disciplines spanning the biological, social, and behavioral sciences.

An organization, to be a public charity under these rules, must have the conduct of medical research as its principal purpose or function and be primarily engaged in the continuous active conduct of medical research in conjunction with a qualified hospital. The organization need not be formally affiliated with an exempt hospital to be considered primarily engaged in the active conduct of medical research in conjunction with the hospital. There must, however, be a joint effort on the part of the research organization and the hospital to maintain close cooperation in the active conduct of the medical research. An organization is not considered to be primarily engaged directly in the continuous active conduct of medical research unless it, during a computation period, devotes more than one-half of its assets to the continuous active conduct of medical research or it expends funds equaling at least 3.5% of the fair market value of its endowment for the continuous active conduct of medical research.

If an organization’s primary purpose is to disburse funds to other organizations for the conduct of research by them or to extend research grants or scholarships to others, it is not considered directly engaged in the active conduct of medical research.

Public College Support Foundations

Public charity status is accorded to certain organizations providing support for public (governmental) colleges and universities. This type of organization must normally receive a substantial part of its support (exclusive of income received in the performance of its tax-exempt activities) from the United States and/or direct or indirect contributions from the public. It must be organized and operated exclusively to receive, hold, invest, and administer property and to make expenditures to or for the benefit of a college or university that is a public charity and that is an agency or instrumentality of a state or political subdivision of a state, or that is owned or operated by a state or political subdivision or by an agency or instrumentality of one or more states or political subdivisions.

These expenditures include those made for any one or more of the regular functions of these colleges and universities, such as the acquisition and maintenance of real property comprising part of the campus; the construction of college or university buildings; the acquisition and maintenance of equipment and furnishings used for or in conjunction with regular functions of these colleges and universities; or expenditures for scholarships, libraries, and student loans.

Governmental Units

The United States, possessions of the United States, the District of Columbia, states, and their political subdivisions are classified as governmental units, which are public charities. This type of a unit qualifies as a public charity without regard to its sources of support, partly because it is responsive to all citizens. The concept of a governmental unit also embraces government instrumentalities, agencies, and entities referenced by similar terms.

Other Institutions

One of the many anomalies of the federal tax law is that some of the charitable institutions in U.S. society that are not generically private foundations are not accorded a public charity classification, unlike churches, schools, hospitals, and the like. Organizations in this position include museums, libraries, and organizations that operate orchestras and operas. To be public charities, these entities must be publicly supported or (much less likely) be structured as supporting organizations (as discussed later in this chapter). Some of these types of organizations are private operating foundations or exempt operating foundations (as discussed previously in this chapter).

DONATIVE PUBLICLY SUPPORTED ORGANIZATIONS

A way for a tax-exempt charitable organization to be a public charity is to receive its financial support from a suitable number of sources. A publicly supported charity is the antithesis of a private foundation, in that a foundation customarily derives its funding from one source, whereas a publicly supported charitable organization is (by definition) primarily or wholly supported by the public. One type of publicly supported charity—the donative type—is an organization the revenues of which are in the form of a range of contributions and grants.

General Rules

An organization is a donative publicly supported entity if it is a tax-exempt charitable organization that normally receives a substantial part (defined later in this section) of its support (other than income from the performance of one or more exempt functions) from a governmental unit or from direct or indirect contributions from the public. It is this focus on support in the form of gifts and grants that causes this type of organization to be considered a donative one.

Organizations that qualify as donative publicly supported entities generally are organizations such as 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 group; organizations providing some other direct service to the public; and organizations such as the American National Red Cross or that conduct federated fundraising campaigns.

The principal way for an organization to be a publicly supported charity under these rules is for it to normally derive at least one-third of its financial support from qualifying contributions and grants. (This one-third threshold is the definition of the phrase substantial part in this context.) Thus, an organization classified as this type of publicly supported charity must maintain a support fraction, the denominator of which is total gift and grant support received during the computation period (defined later in this chapter) and the numerator of which is the amount of support qualifying in connection with the one-third standard from eligible public and/or governmental sources for the period. The cash basis method of accounting is used in making these calculations.

2% Rule

A 2% ceiling is generally imposed on contributions and grants in determining public support. Only this threshold amount of a particular gift or grant is counted as public support, under this rule, irrespective of whether the contributor or grantor is an individual, corporation, trust, private foundation, or other type of entity (taking into account amounts given by related parties). In computing public support in this manner, the IRS has traditionally used a four-year measuring period, consisting of the organization’s most recent four years. Beginning with the 2008 tax year, however, the measuring period is the organization’s most recent five years.

An illustration will undoubtedly be helpful. Consider a charitable organization that received total gift and grant support in the amount of $1 million during the measuring period. In that instance, all contributions and grants up to $20,000 each are counted as public support (the total of them being the numerator of the support fraction). The amount of all gifts and grants during the period comprise the denominator of that fraction. If a person gave, for example, $80,000 during the measuring period, only $20,000 is public support from that source for that period. This organization thus must receive, during the period, at least $333,334 in contributions or grants of $20,000 or less each. It could receive $666,666 from one source and $10,000 each from 34 sources, or $20,000 each from 17 sources, for example.

A meaningful exception to this rule is available. Support received by a donative publicly supported charity from governmental units and/or other donative publicly supported charities is considered to be a form of indirect contributions from the public (in that these grantors are regarded as conduits of direct public support). This type of support is public support in its entirety. That is, this form of funding is not limited by the 2% rule. The same is true with respect to support from charitable organizations that satisfy the donative publicly supported organization definition, even though they are classified as some other form of public charity (such as a church).

For these purposes, the legal nature of the donors and/or grantors is not relevant. That is, in addition to individuals, charities, and governments, public support can be derived from for-profit entities (such as corporations and partnerships) and nonprofit entities (including various forms of charitable and noncharitable tax-exempt organizations). In another example of the English language failing in this regard, private foundations can be sources of public support. Generally, the fact that contributions or grants are restricted or earmarked does not detract from their qualification as public support.

Nonetheless, the 2% limitation applies with respect to support received from a donative publicly supported charitable organization or governmental unit if the support represents an amount that was expressly or impliedly earmarked by a donor or grantor to the publicly supported organization or unit of government as being for or for the benefit of the organization asserting status as a publicly supported charitable organization.

Support Test

A matter that can be of considerable significance in determining whether a charitable organization can qualify as a donative publicly supported entity is the meaning of the term support. For this purpose, support means amounts received in the form of, as noted, contributions (including corporate sponsorships) and grants, along with net income from unrelated business activities (see Chapter 8), gross investment income, tax revenues levied for the benefit of the organization and paid to or expended on behalf of the organization, and the value of services or facilities (exclusive of services or facilities generally furnished to the public without charge) furnished by a governmental unit to the organization without charge. All of these items comprise the denominator of the support fraction. (The larger the denominator, the greater the amount of public support that is allowed by the 2% threshold.) Support does not include gain from the disposition of property that is gain from the sale or exchange of a capital asset; the value of exemption from any federal, state, or local tax or any similar benefit; or funding in the form of a loan.

In constructing the support fraction, an organization must exclude from the numerator and the denominator any amounts received from the exercise or performance of its exempt purpose or function and contributions of services for which a charitable contribution deduction is not allowable. An organization will not be treated as meeting this support test, however, if it receives almost all of its support in the form of gross receipts from related activities and an insignificant amount of its support from governmental units and/or the public. Moreover, the organization can exclude from the numerator and the denominator of the support fraction an amount equal to one or more unusual grants (discussed later in this chapter).

Concept ofNormally

In computing the support fraction, the organization’s support that is normally received must be reviewed. This means that the organization must meet the one-third support test for a period encompassing the five tax years immediately preceding the year involved, on an aggregate basis. (Prior to 2008, this measuring period was four years.) When this is accomplished, the organization is considered as meeting the one-third support test for its current tax year and for the tax year immediately succeeding its current tax year. For example, if an organization’s current tax year is calendar year 2009, the computation period for measuring public support pursuant to these rules is calendar years 2004-2008; if the support fraction requirement is satisfied on the basis of the support received over this five-year period, the organization satisfies this support test for 2009 and 2010. (A five-year period for meeting this support test is available for organizations during the initial five years of their existence.)

Unusual Contributions or Grants

Under the unusual grant rule, a contribution or grant may be excluded from the public support fraction. A gift or grant is unusual if it is an unexpected and substantial amount attracted by the public nature of the organization and received from a disinterested party. (Thus, this term is somewhat of a misnomer. The exception is not confined to grants and the operative word should be unexpected, not unusual.)

A number of factors are taken into account in this regard; no single factor is determinative. The positive factors follow, with their opposites (negative factors) in parentheses:

• The contribution or grant is from a person with no connection to the charitable organization. (The contribution or grant is received from a person who created the organization, is a substantial contributor (see Chapter 2) to it, is a board member, an officer, or is related to one of these persons.)

• The gift or grant is in the form of cash, marketable securities, or property that furthers the organization’s exempt purposes. An example of the latter is a gift of a painting to a museum. (The property is illiquid, difficult to dispose of, and/or not suitable in relation to the organization’s functions.)

• No material restrictions or conditions are placed on the transfer.

• The organization attracts a significant amount of support to pay its operating expenses on a regular basis, and the gift or grant adds to an endowment or pays for capital items. (The gift or grant is used for operating expenses for several years; nothing is added to an endowment.)

• The gift is a bequest. (The gift is an inter vivos [lifetime] transfer.)

• An active fundraising program attracts significant public support. (Gift and grant solicitation programs are limited or unsuccessful.)

• A representative and broad-based governing body controls the organization. (Related parties are in control.)

• Prior to the receipts of the unusual grant, the organization qualified as a publicly supported entity. (The unusual grant exclusion was relied on in the past to satisfy the test.)

Facts-and-Circumstances Test

One of the defects of the donative organization support rules is that organizations that are not private foundations in a generic sense, because they have many of the attributes of a public organization, may nonetheless be classified as private foundations because they cannot meet the somewhat mechanical one-third support test. Charitable organizations with this dilemma can include entities such as museums and libraries that heavily rely on their endowments for financial support and thus have little or no need for contributions and grants. Although the statutory law is silent on the point, the tax regulations somewhat ameliorate this rigidity of the general rule by means of a facts-and-circumstances test.

The history of an organization’s programmatic and fundraising efforts, and other factors, can be considered as an alternative to the rather strict mechanical formula for qualifying as a public charity under the general donative publicly support charitable organization rules. These factors must be present for this test to be met:

• Public support (computed pursuant to the general rule) must be at least 10% of the total support, and the higher the better.

• The organization must have an active “continuous and bona fide” fundraising program designed to attract new and additional public and governmental support. Consideration will be given to the fact that, in its early years of existence, the charitable organization may limit the scope of its gift and grant solicitations to those persons deemed most likely to provide seed money in an amount sufficient to enable it to commence its charitable activities and expand its solicitation program.

• Other favorable factors must be present, such as:

• The composition of the organization’s governing board is representative of broad public interests.

• Support is derived from governmental and other sources representative of the public.

• Facilities and programs are made available to the public.

• The organization’s programs appeal to a broad range of the public.

As to the governing board factor, the organization’s public charity status will be enhanced where it has a governing body that represents the interests of the public, rather than the personal or private interests of a limited number of donors. This can be accomplished by the election of board members by a broad-based membership or by having the board composed of public officials, individuals having particular expertise in the field or discipline involved, community leaders, and the like.

As noted, one of the important elements of this facts-and-circumstances test is the availability of facilities or services to the public. Example of entities meeting this standard are a museum that holds its building open to the public, a symphony orchestra that gives public performances, a conservation organization that provides services to the public through the distribution of educational materials, and a home for the elderly that provides domiciliary or nursing services for members of the public.

Issues

Nine issues can arise in computing the public support component (the numerator) of the support fraction for donative publicly supported organizations. They are:

1. Proper calculation of the denominator of the support fraction

2. Whether a payment constitutes a contribution or a grant

3. Whether a membership fee can be treated as a contribution rather than a payment for services

4. Whether a payment pursuant to a contract is a grant rather than revenue from a related activity (exempt function revenue)

5. Whether a grant is from another donative publicly supported charity (or a charity described in the rules)

6. Whether a grant from a publicly supported charity or governmental unit is a pass-through transfer from another grantor

7. Whether a grant constitutes an unusual grant

8. Whether an organization is primarily dependent on gross receipts from related activities

9. Whether the organization needs to rely on the facts-and-circumstances test

The fourth item warrants additional mention. When the term contract is used in this context, it usually connotes a payment for services rendered or goods provided, which means that the funds involved are exempt function revenue and thus must be excluded from the support fraction. Confusion can arise because a grant is often the subject of a contract, although in that setting the term used usually is agreement. While sometimes it is difficult to differentiate between the two, a grant is a payment made to a charitable organization to enable it to operate one or more programs, while a payment pursuant to a contract is for the acquisition of a good or service.

The principal point with these issues is that the resolution of them can materially affect the construct of the support fraction and thus the public support percentage. Sometimes, an organization will want to exclude a large amount from the fraction (such as a payment made in accordance with a contract) so as to increase the support percentage. It is not uncommon for a support fraction to be improperly computed, so that the resulting public support percentage is below the one-third threshold. It can be a great joy for a tax lawyer to review a draft of an anemic public support fraction calculation, and discover, for example, that a grant that was limited by the 2% threshold can in fact be counted in full as public support (issue 5) or that a large grant can in fact be excluded from the fraction as an unusual grant (issue 7), thereby enabling the charitable organization to report a public support ratio that is considerably in excess of the one-third minimum.

Community Foundations

In the world of charities, the term foundation is often used in conjunction with an organization that is not a private foundation. An illustration of this word interplay is the community foundation, which usually is a donative publicly supported charity. These foundations almost always attract, receive, and depend on financial support from members of the public on a regular, recurring basis. Community foundations are designed to attract large contributions of a capital or endowment nature, with the gifts often received and maintained in separate trusts or funds. These entities are generally identified with a particular community and are controlled by a representative group of persons in that area.

For classification as a public charity, however, a community foundation wants to be regarded as a single entity, rather than an aggregation of funds. To be treated as a component part of a community foundation, a trust or fund must be created by gift or similar transfer and may not be subjected by the transferor to any material restriction. A community foundation must, to be considered a single entity, be appropriately named, be so structured as to subject its funds to a common governing instrument, have a common governing body, and prepare periodic financial reports that treat all funds held by the foundation as its assets. The board of a community foundation must have the power to modify any restriction on the distribution of funds where it is inconsistent with the charitable needs of the community, must commit itself to the exercise of its powers in the best interests of the foundation, and must commit itself to seeing that the funds are invested in accordance with standards of fiduciary conduct.

A private foundation may make a grant to a designated fund within a community foundation (often a donor-advised fund [see Chapter 11]). The private foundation can receive a payout credit (see Chapter 4) for this type of grant, even though it acquires the ability to make recommendations as to distributions to other charitable organizations from the fund, as long as there are no prohibited material restrictions. Grants of this nature are regarded as made to the community foundation as an entity and not to a discrete fund.

SERVICE PROVIDER PUBLICLY SUPPORTED ORGANIZATIONS

The second way that a tax-exempt charitable organization can be a publicly supported entity is to be a service provider organization. As is the case with the donative organization rules, qualification for public charity status focuses on sources of revenue, although there are considerable differences between the two ways to compute public support. Public support in this context includes gifts and grants, but also includes forms of exempt function revenue. Thus, this type of publicly supported charity usually has a major portion of its support in the form of fees and like charges derived from the conduct of its programs, such as exempt dues-based entities, theaters, arts organizations, educational publishers, day care centers, and animal shelters.

A two-part support test must be met for an organization to qualify as this type of publicly supported charity:

• Investment income cannot exceed one-third of total support. Total support basically is all of the organization’s gross revenue normally received (discussed later in this chapter), other than capital gains and the value of exemptions from local, state, and federal taxes.

• More than one-third of total support must be a combination of:

• Contributions, grants, and membership dues from sources other than disqualified persons (see Chapter 2)

• Admission fees to exempt function facilities or activities, such as payments for theater tickets, access to a museum or historical site, seminars, lectures, and athletic events

• Fees for performance of services, such as day care fees, counseling fees, testing fees, laboratory fees, library fines, animal neutering charges, and athletic activity fees

• Sales of merchandise related to the organization’s exempt purpose, including books and other educational literature, pharmaceuticals and medical devices, handicrafts, reproductions and copies of original works of art, byproducts of a blood bank, and goods produced by disabled workers

Exempt function revenue from one source may not be treated as public support to the extent it is in excess of $5,000 or 1% of the total support of the organization, whichever is higher.

Permitted Sources

Generally, to be public support under these rules, the support must be derived from permitted sources. Consequently, a charitable organization seeking to qualify as a publicly supported entity under these rules must construct a support fraction, with the amount of support from permitted sources constituting the numerator of the fraction and the total amount of support being the fraction’s denominator.

Permitted sources are certain public and publicly supported charitable organizations, governmental units, and persons other than disqualified persons (see Chapter 2) with respect to the organization. Thus, in general, support (other than from disqualified persons) from another service provider publicly supported organization, a supporting organization (see below), any other tax-exempt organization (other than the institutions and donative publicly supported organizations, a for-profit organization, or an individual constitutes public support for this type of organization, albeit limited in some instances (see next section). The cash basis method of accounting is used in making these determinations.

Support

The term support means (in addition to the categories of public support, which may include corporate sponsorships) (1) net income from any unrelated business (see Chapter 8), (2) gross investment income, (3) tax revenues levied for the benefit of the organization and either paid to or expended on behalf of the organization, and (4) the value of services or facilities (other than services or facilities generally furnished to the public without charge) furnished by a governmental unit. These items of support are combined to constitute the denominator of the support fraction.

The concept of support does not include (1) any gain from the disposition of a capital asset; (2) the value of local, state, and/or federal tax exemptions or similar benefits, and (3) the proceeds of a loan.

Limitations on Support

The support taken into account in determining the numerator of the support test under these rules must come from permitted sources. Thus, transfers from disqualified persons (see Chapter 2) cannot qualify as public support under the service provider publicly supported organizations rules. The fact that a contribution or grant is restricted or earmarked does not detract from its qualification as public support.

In determining the amount of support in the form of gross receipts that is allowable in calculating the numerator of this support fraction, gross receipts from related activities (other than membership fees) from any person or from any bureau or similar agency of a governmental unit are includible in any tax year only to the extent that these receipts do not exceed the greater of $5,000 or 1% of the organization’s total support for that year.

The phrase bureau or similar agency of a government means a specialized operating (rather than a policy-making or administrative) unit of the executive, judicial, or legislative branch of a government, usually a subdivision of a department of a government. Therefore, an organization receiving gross receipts (a grant) from both a policy-making or administrative unit of a government (e.g., the Agency for International Development [AID]) and an operational unit of a government’s department (e.g., the Bureau for Latin America, an operating unit within AID) is treated as receiving gross receipts from two sources, with the amount from each agency separately subject to the $5,000/1% limitation.

A somewhat similar permitted sources limitation excludes support from a disqualified person, including a substantial contributor (see Chapter 2). In general, a substantial contributor is a person who contributes, grants, or bequeaths an aggregate amount of more than $5,000 to a charitable organization, where that amount is more than 2% of the total contributions, grants, and bequests received by the organization before the close of its tax year in which the contribution or the like from the person is received. As noted, however, grants from governmental units and certain public charities are not subject to this limitation.

The federal tax law defines and distinguishes the various forms of support referenced in the service provided publicly supported organizations rules: contributions or gross receipts, grant or gross receipts, membership fees, gross receipts or gross investment income, and grant or indirect contribution. For example, the term gross receipts means amounts received from the conduct of an activity related to an exempt function where a specific service, facility, or product is provided to serve the direct and immediate needs of the payor; a grant is an amount paid to confer a direct benefit for the public. A payment of money or transfer of property without adequate consideration generally is a contribution or a grant. The furnishing of facilities for a rental fee or the making of loans in furtherance of an exempt purpose will likely give rise to gross receipts rather than gross investment income. The fact that a membership organization provides services, facilities, and the like to its members as part of its overall activities will not result in the fees received from members being treated as gross receipts rather than membership fees.

Investment Income Test

An organization, to be classified as a service provider publicly supported charity, must normally receive no more than one-third of its support from (1) gross investment income, including interest, dividends, royalties, rent, and payments with respect to securities loans, and (2) any excess of the amount of unrelated business taxable income over the amount of tax on that income. To qualify under this test, an organization must construct a gross investment income fraction, with the amount of gross investment income and any unrelated income (net of the tax paid on it) constituting the numerator of the fraction and the total amount of support being the denominator. On occasion, there may be an issue as to whether a revenue item is a gross receipt from the performance of an exempt function or is gross investment income.

Concept of Normally

These public support and investment income tests are computed on the basis of the nature of the organization’s normal sources of support. An organization is considered as normally receiving at least one-third of its support from permitted sources and no more than one-third of its support from gross investment income for its current tax year and immediately succeeding tax year if, for the measuring period, the aggregate amount of support received over the period from permitted sources is more than one-third of its total support and the aggregate amount of support over the period from gross investment income is not more than one-third of its total support.

In computing support under these rules, the IRS has traditionally used a four-year measuring period, involving the organization’s most recent years. Beginning with the 2008 tax year, however, the measuring period is the organization’s most recent five years. For example, if an organization’s current tax year is calendar year 2009, the computation period for measuring support pursuant to these rules is calendar years 2004-2008; if the support fraction is satisfied on the basis of the support received over this five-year period, the organization satisfies this support test for 2009 and 2010. (A five-year period for meeting these support tests has long been available for organizations during the initial five years of their existence.)

Issues

The issues that arise in connection with calculation of public support under the service provider publicly supported organization rules are somewhat the same as those that can emerge in the donative publicly supported organization context (“discussed previously”). Of the nine issues in that setting, numbers 1 through 4 and 7 apply equally here. (A facts-and-circumstances test is not available for service provider entities.) There are five other potential issues (and thus a total of ten issues) for service provider publicly supported organizations:

1. Accurate identification of the organization’s disqualified persons (see Chapter 2)

2. Correct computation of exempt function revenue

3. Correct application of the 1% rule

4. Whether a grant is from another service provider publicly supported organization (or a charity described in the rules)

5. Correct ascertainment of gross investment income

COMPARATIVE ANALYSIS OF PUBLICLY SUPPORTED CHARITIES

The two principal types of publicly supported charities can simultaneously meet both public support tests if they have a broad base of financial support in the form of contributions and grants. Indeed, many charities can easily satisfy either test at any time.

A significant deviation arises, however, concerning the matter of exempt function revenue. In the case of donative publicly supported charities, exempt function revenue is omitted from the fraction and too much of it can prevent or cause loss of public charity status. By contrast, some or all of exempt function revenue can be public support for service provider publicly supported charities. This distinction is one of the principal determinants for a charitable organization in deciding which category of publicly supported charity is appropriate. A dues-based charitable organization, for example, would almost always select the service provider publicly supported charity classification.