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Terry Miller Leventhal Kline Management, Inc. 127 University Avenue Berkeley California 94710

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Presentation on theme: "Terry Miller Leventhal Kline Management, Inc. 127 University Avenue Berkeley California 94710"— Presentation transcript:

1 Terry Miller Leventhal Kline Management, Inc. 127 University Avenue Berkeley California Public Support Tests : Context & Calculation [in the era of the New 990] AICPA NPF08 Session 51

2 Overview of Session Context – Calculation – Alternatives & Considerations Overview of Session Definition of Public Charity Who cares? Why does it matter? Types of Public Charities Public Support Test formulas: New 990 – Big Changes! Public Support Test formula: 509(a)(1)/170(b)(1)(A)(vi) Public Support Test formula: 509(a)(2) Reporting: Common Technical Errors Reporting & Planning: Common Substantive Errors Other Tax Planning Tips & Special Topics 1

3 Definition of Public Charity 501(c)(3) = Private Foundation by default Must pass test to Qualify as NON-private foundation known as public charity (PC) Private Foundations (PF) generally answer to donors: narrowly funded, narrowly controlled, ergo, highly regulated to ensure public benefit 2

4 Who cares? Why does it matter? Private Foundation Obscure difficult Form 990PF Difficult to get grants from PFs Only easy grants are to PCs Lobbying prohibited Most insider transactions prohibited Lower deductibility: valuation Lower deductibility: % AGI Minimum payout Tax on investments Prohibition on certain investments Public Charity Easier Form 990 (cheaper prep) Possible to get PF grants PC may grant to any entity for charitable work Lobbying: generous limits Insider transactions must be reasonable Deductibility usually FMV Deductibility higher % AGI No minimum No such tax No prohibition; prudence only 3 Answer: Rules & Regulations! PC status is often vital to objectives…

5 Types of Public Charities 509(a)(1) holds six tests: 170(b)(1)(A)(i) - (vi) (b)(1)(A)(i) – church (b)(1)(A)(ii) – school (b)(1)(A)(iii) – hospital or medical research organization (b)(1)(A)(iv) – support org to public college / university (b)(1)(A)(v) – governmental unit (b)(1)(A)(vi) – publicly supported through gift income (a)(2) – publicly supported through earned income (a)(3) – by connection to an (a)(1) or (a)(2) (Types I, II, III) (a)(4) – product safety testing There are nine primary types of public charity: 4

6 Public Support Tests: New 990 – Big Changes! 5-year measurement period; was 4-year Not nec. cash method: same as return; restate prior years Larger denominator: commercial income that escapes UBTI as not regularly carried on (other exclusions OK) NO ADVANCE RULING PERIOD – NO FORM 8734! IRS issues determination based on likely support No % calculation during first 5 years (though do table) Starting in 6 th year, failing test 2 consecutive years = immediate PF status Self-evaluation for facts & circumstances qualification for (a)(1)/170(b)(1)(A)(vi) charities New Part IV for certain explanations 5

7 Calculation: 509(a)(1) & 170(b)(1)(A)(vi) - 1/4 Basics (formula on next slide) 5 year measurement period 5 year startup time – 5 fiscal year ends from formation – tax planning – can be months – tax planning opportunity! – no calculation required until Year 6 Starting in Year 6 must calculate public support % Goal is > 1/3 public support If 1/10, then facts & circumstances to differentiate from narrow private foundation Sufficient support in one measurement period confers PC status on two years (current + next) 6.1

8 Calculation: 509(a)(1) & 170(b)(1)(A)(vi) - 2/4 Formula Detail: +Grants from 170(b)(1)(A)(vi) charities +Grants from governmental agencies +Gifts grants & contributions - up to 2% of the denominator from each private source (aggregate by family & business) +Tax revenues & government facilities furnished free that usually cost All income (counting NET UBI not gross), minus: Exempt function income (program svc revenue) Excl from UBI oth than becuz not regularly carried on Unusual grants Capital gains Tax paid on UBTI 6.2 Public Support Total Support

9 Calculation: 509(a)(1) & 170(b)(1)(A)(vi) - 3/4 Formula Result: If: public support / total support > 1/3 then: definitively public charity; but If: 1/10, then: look to facts & circumstances grey area; If: < 1/10, for 2 consecutive periods, then: revert PF 6.3 Facts & Circumstances: +Broad community-based board, not just insider donors +Fundraising efforts to broaden support +Substantial support from governmental agencies +Facilities or services made available to general public

10 Calculation: 509(a)(1) & 170(b)(1)(A)(vi) - 4/4 6.4 Unusual Grants: generally are substantial contributions and bequests from disinterested persons and are: Attracted because of the organizations publicly supported nature, Unusual and unexpected because of the amount, and Large enough to endanger the organizations status as normally meeting the 1/3 public support test. A grant that meets these requirements may be treated as an unusual grant even if the organization receives the funds over a period of years.

11 Calculation: 509(a)(2)- 1/3 Basics are similar to (a)(1) (formula on next slide) 5 year measurement period 5 year startup time – 5 fiscal year ends from formation – can be months – no calculation required until Yr 6 Starting in Year 6 must calculate public support % Goal is > 1/3 public support Sufficient support in one measurement period confers PC status on two years (current + next) (Investment Income + After Tax UBI) must be < 1/3 NO facts & circumstances alternative! 7.1

12 Calculation: 509 (a)(2)- 2/3 Formula Detail: +Fees: exempt function income from entities that are NOT disqualified persons, up to the GREATER of $5,000 or 1% of Total Support – in a given SINGLE YEAR (not 5) +Grants from 509(a)(1) public charities +Grants from Government agencies +Gifts from other sources NOT disqualified persons +Tax revenues & government facilities furnished free All income (counting NET UBI not gross), minus: Unusual grants (same definition as in (a)(1)) Excl from UBI oth than becuz not regularly carried on Capital gains Tax paid on UBTI 7.2 Public Support Total Support

13 Calculation: 509(a)(2) - 3/3 Formula Result: If: public support / total support > 1/3, AND If: (investment income + after tax UBI) < 1/3 then: definitively public charity; If NOT: then, revert to PF status 7.3 Disqualified Person (relatively permanent – 10 yr): –Substantial contributors – gifts exceeding $5K or 2% of total gift income over entire organization history –Owner of >20% of a substantial contributor –Foundation mgr (of the charity) – ofcr, dir, key employee –Family members of other disqualified persons –Certain related entities

14 Common Technical Errors Wrong periods reported Wrong accounting method (was cash method required) now same method as return; restate prior years Confusion about which entities subject to 2% limitation lack of family aggregation treatment of public entities as subject to 2% limit treatment of PFs as NOT subject to 2% limit guessing Wrong status box checked [(a)(2) description reads more accessibly – lay or bad research error] 8

15 Reporting & Planning: Common Substantive Errors Confusing fees v. donations especially government awards also special events – earned v. donated portion membership dues – typically donative NOT earned for a (c)(3) Other Income is drag on public support – could often be netted against expense Fear of facts & circumstances – inexperienced preparers consider (a)(1) <1/3 to be failure and recommend 990-PF Confusion about initial funding from fiscal sponsor or parent in spinoff (usually NOT subject to 2%) Confusion about definition of unusual grants 9

16 Other Tax Planning Tips & Special Topics - 1/4 STRATEGY TIPS - 1: Scope is Everything – do quick test first – if at ~60% dont sweat the details; if at 34% then DO sweat the details Three alternatives to consider if approaching failure: 1. Supporting Organization 509(a)(3) tax planning / strategic advantages in some cases loss of control (even more since PPA) increasing scrutiny, especially Type III and maybe Type II legal advice needed – not a D.I.Y. project 2. Private Operating Foundation (POF) narrowly supported, broadly operated still many PF constraints, but offers PC level deductibility complex tests (3 options), each with two parts & many nuances 3. Advisory Committee to a Sponsored Project 10.1

17 Other Tax Planning Tips & Special Topics - 2/4 STRATEGY TIPS – 2: Publicly supported (a)(1) is MUCH BETTER than (a)(2) due to flexibility; switching does not require permission For an (a)(1), do a check at ~3.5 years, in case facts & circumstances will be important; gives time to act Choose formation date to get longest first five years (e.g. incorporate just AFTER FYE, not just before) Capital Gains dont count in the denominator of (a)(1) charities; if tight, manage investments to generate gains not interest & dividends (including distributed LT Gains) How much % of income from fees is too much to pass (a)(1) test? Current regs say only that 100/1 is too much. Experts? 90/1 maybe 95/1 10.2

18 Other Tax Planning Tips & Special Topics - 3/4 PLANNING: Funds from subsidiary for-profits and from (a)(3) supporting organizations are treated unfavorably, as disqualified persons (subject to 2% limit for (a)(1) and not public support for (a)(2) ) PFs may convert to PCs by filing for a private foundation termination [IRC §507(b)(1)(B)]. (Not clear how this will change with no more advance ruling period.) Switching publicly supported (a)(1) to (a)(2) (or back) is just about checking the box Publicly supported (a)(1) & (2)s may convert to (a)(3)s at least going forward if not retroactive – requires planning ahead and governance changes. 10.3

19 Other Tax Planning Tips & Special Topics - 4/4 SPECIAL TOPICS : Words: how to technically describe? (501(c)(3) v. 509(a)(1) confusion) Say a 501(c)(3) charity which is a publicly supported 509(a)(1) charity or a 509(a)(1) and 170(b)(1)(A)(vi) public charity. Wont matter to anyone but PFs. Words: total support is a misnomer because it includes some revenue – support v. revenue is sadly ignored too often Failure is not fatal. PFs are still tax-deductible 501(c)(3) charities which can pay insiders for working. No grants income, no lobbying, no other payments to insiders, some tax, but no public support test to fool with. Failing the test in the 6 th year will not ordinarily jeopardize deductions, but will subject charity to investment income tax (only 2%) – other PF constraints apply only going forward. 10.4


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