1. Proud InsideNGO Industry Partner Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium Stephen J. Kelin, CPA, JD Richard J. Locastro, CPA, JD Nonprofit Tax Principals December 14, 2011

2. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium S TEPHEN J. K ELIN, CPA, JD R ICHARD J. L OCASTRO, CPA, JD Nonprofit tax principals at Gelman, Rosenberg & Freedman, CPAs Combined 55+ years of experience providing tax services to tax- exempt organizations, private foundations, colleges, healthcare organizations, museums and other large nonprofit institutions Co-lead the firm’s consulting and tax compliance services to more than 600 nonprofit clients Coordinate tax planning, return preparation and representation on IRS audits Monitor changing statutory and regulatory environments concerning reporting and operational requirements 2

3. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium Agenda Private Foundations Versus Public Charities 509 (a)(1) Test 509 (a)(2) Test 509(a)(3) Test – Supporting Organizations 3

4. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium Are You a Private Foundation? General Rule ― …, the term “private foundation” means a domestic or foreign organization described in section 501(c) other than – (emphasis added) IRC Section 509(a) 4

5. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium Private Foundation Rules 4940 – Excise Tax Investment Income 4941 – Self Dealing 4942 – Minimum Distributions 4943 – Excess Business Holdings 4944 – Jeopardizing Investments 4945 – Taxable Expenditures 4946, 4947, 4948 – Special Rules 5

6. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium Minimum Distributions IRC section 4942(g) – Qualifying Distributions Defined ( 1) …, the term “qualifying distribution” means (A) any amount … paid to accomplish one or more purposes described in section 170(c)(2)(B) … other than any contribution to … a private foundation which is not an operating foundation (emphasis added) 6

7. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium Private Foundation “Exceptions” 509(a)(1) – “Contribution-based” organizations ??? – Described in 170(b)(1)(A) [other than clauses (vii) and (viii)] 509(a)(2)– “Fee-based” organizations (???) 509(a)(3)– Supporting organizations 509(a)(4)– Testing for the public safety 7

8. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium Definition of a Public Charity A public charity is defined under IRC § 509(a)(1) as an organization described in § 170(b)(1)(A) other than in clauses (vii) and (viii) - (certain private foundations; and (a)(2) & (a)(3) entities); § 170(b)(1)(A)(i)-(v) includes churches, schools, hospitals and governmental units No support test required 8

9. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium Qualification for 509(a)(1) – 170(b)(1)(A)(vi) Normally receives a substantial part of its support from a governmental unit referred to in subsection (c)(1) or from direct or indirect contributions from the general public “Normally” is a five-year rolling average 9

10. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium Qualification for 509(a)(1) – 170(b)(1)(A)(vi) (cont.) “Substantial part” is generally 33 1/3% or 10% or more under the “facts and circumstances” test “Support” for § 509(a)(1) test does not include income in exercise of its exempt purpose (program service fees) Realized gains not included in numerator or denominator 10

11. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium “Benefits” of (a)(1) test over (a)(2) test Substantial donors Only excludes excess over 2% threshold Exception for government and other (a)(1) donors from 2% cap “Facts and circumstances” test has 10% safety net threshold No restriction on investment income Benefit for heavily endowed organizations 11

12. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium Eligibility for 509(a)(1) Not eligible if it receives: Almost all of its support from gross receipts An insignificant amount of contributions from government and general public Regulatory example: 1% from contributions is not more than insignificant Conclusion: must be > 1% (10%??) and can be <50% (doesn’t say “majority”) 12

13. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium Eligibility for 509(a)(1) (cont.) Grants vs. Gross Receipts [Reg. 1.509(a)-3(g)] Designation by parties as “grant” or “contract” is not controlling Grant normally made to encourage grantee to carry on exempt activities 13

14. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium Eligibility for 509(a)(1 ) (cont.) Serve direct and immediate needs of payor rather than confer a benefit upon the general public Sales/services delivered to government Service to public funded by government 14 Gross Receipts

15. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium Eligibility for 509(a)(1) (cont.) Dues New Form 990 and instructions require allocation among: Contributions (general support of organization) Fees for service (direct benefit to payor) Part contributions and part fees Fees portion treated like other fees (ignored) 15

16. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium 509(a)(1) – 170(b)(1)(A)(vi) Not all contributions are good support! Numerator does not include excess amount from a person greater than 2% of the revenue over the five year testing period Amounts from governments and other § 509(a)(1) – 170(b)(1)(a)(vi) publicly supported organizations are not limited 16

17. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium Example: § 509(a)(1) organization had total support for 2006-2010 of $60,000,000 (excluding gross exempt-purpose receipts) Any amount from a donor who gave over $1,200,000 (2%) is not “good” money 17 509(a)(1) – 170(b)(1)(A)(vi) (cont.)

18. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium 509(a)(1) – 170(b)(1)(A)(vi) (cont.) During testing period: Only “good money” goes in numerator 18 GiftGood Money Corp A10,000,0001,200,000 Individual X1,900,0001,200,000 Individual Y900,000 DC Government3,000,000

19. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium Unusual Grants Contributions may be excluded from both the numerator and denominator 19

20. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium Unusual Grants (cont.) Intended for gifts/bequests from disinterested parties which are: – Attracted by publicly supported nature of organization; – “Unusual or unexpected” with respect to the amount; and – Would, by reason of their size, adversely affect public charity status 20

21. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium Unusual Grants: Factors to Consider “All pertinent facts and circumstances,” including: Person is creator or previous substantial contributor of organization (unfavorable) Bequest (favorable) vs. lifetime gift Gift was in furtherance of exempt purpose of organization, such as painting to museum (favorable) 21

22. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium Unusual Grants: Factors to Consider (cont.) Whether the organization has previously conducted public solicitations and programming and been successful (favorable) Reasonable expectation to attract future public support (favorable) Prior success at passing 1/3 test (favorable) Whether contributor or related party continues to exercise control over the organization (unfavorable) 22

23. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium Unusual Grants: Factors to Consider (cont.) 23 Whether there is a representative governing body (favorable) Whether there are material conditions for restrictions on the gift (unfavorable?)

24. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium Unusual Grants Reliance on public charity status Can rely on IRS records, unless grantor was responsible for or aware of substantial or material change Can request written confirmation from charity that grant will not “tip” the charity Can request IRS ruling as to “unusual” prior to receipt of gift 24

25. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium Facts and Circumstances Test Available if public support is less than 33 1/3%, but at least 10%: Test is “subjective” Measures both financial and non-financial factors 25

26. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium Facts and Circumstances Test (cont.) Must: Public support is 10% or higher Be organized to attract public support Continuous and bona fide program for solicitation of public funds (includes government funding) 26

27. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium Facts and Circumstances Test (cont.) And subjective factors: % of public support – closer to 33% (favorable); closer to 10% (unfavorable) “Representative number” of donors who are not single family Representative governing body: public officials, subject matter expertise, community leaders 27

28. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium Facts and Circumstances Test (cont.) And subjective factors: Availability of public facilities or services, public participation in programs, and For membership organizations, broad solicitation or revenue, members and programming 28

29. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium Form 990 Schedule A Part II Examples – See Slides 29

30. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium Foreign Government Support Rev Rul 75-435 Foreign government support of a foreign organization is treated as government support for (a)(1) test Reg. Section 1.509(a)-2 GCM 38327 (1980) – Rev Rul is inconsistent with Code section 170(c)(1) – United States or political subdivision 30

31. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium Rev Rul remains “unrevoked” Impact on government support of domestic organization? If foreign goverment support is okay, how about: United Nations World Bank International Monetary Fund (IMF) 31 Foreign Government Support (cont.)

32. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium How to Treat Contributions from Foreign Charities 2% limit does not apply to contributions from organizations described in § 170(b)(1)(A)(vi) Requirement that organization be created or organized in the U.S. (See § 170(c)(2)) Treas. Reg. § 1.509(a)-2(a) provides that an organization may qualify even if organized outside the U.S. 32

33. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium How to Treat Contributions from Foreign Charities (cont.) Mexico and Canada treaties have provisions for reciprocal recognition of § 501(c)(3) status Can this be used to include all support as good support? 33

34. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium §509(a)(2) Test 34

35. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium Form 990 Schedule A Part III: § 509(a)(2) Test Mechanics Must have more than 33 1/3% public support and Not more than 33 1/3% investment income percentage Investment income percentage is the total of interest, dividends, rents, royalties and UBTI from business acquired after June 30, 1975 over total support No facts and circumstances test available under this test 35

36. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium Public Support (numerator) includes: Gifts, grants and contributions Membership fees Gross receipts from activities that are not an unrelated trade or business under §513 Admissions Merchandise sold or services performed or Facilities furnished 36 Form 990 Schedule A Part III: § 509(a)(2) Test Mechanics (cont.)

37. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium Total Support (denominator) includes public support and: Interest, dividends, rents, royalties UBTI (less taxes) from business acquired after June 30, 1975 Net income form unrelated business activities not included in above – whether or not regularly carried on Other income 37 Form 990 Schedule A Part III: § 509(a)(2) Test Mechanics (cont.)

38. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium Note: Income from the sale of capital assets is excluded from both public support and total support 38 Form 990 Schedule A Part III: § 509(a)(2) Test Mechanics (cont.)

39. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium Not All Support is Good Support § 509(a)(2) – the following are not included in the numerator as good support: All contributions, membership fees or gross receipts from a disqualified person AND Amounts from gross receipts in carrying out the organization’s exempt purpose received from a person (other than a disqualified person) that exceed the > of $5,000 or 1% of the support for the year 39

40. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium Disqualified person includes substantial contributors, officers, directors or trustees A substantial contributor is person who contributes more than $5,000 if the amount is more than 2% of the total contributions received by the organization through the end of the taxable year (from inception of the organization!) 40 Not All Support is Good Support (cont.)

41. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium Important Notes IRC § 507(d)(2)(C) outlines rules to cease being a substantial contributor and includes: Ten years of no contributions by individual or related persons and contributor and related persons cannot be a “foundation manager” Contributions must be insignificant when compared to at least one other person 41

42. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium The exclusion on gross receipts in excess of 1% of support for the year includes amounts from federal government agencies/bureaus and §170(b)(1)(A)(i)-(vi) organizations Unlike the § 509(a)(1) test, not all government/ § 509(a)(1) money is good 42 Important Notes (cont.)

43. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium Contributions versus gross receipts Distinction is important because all contributions are good money except for those from DPs All gross receipts are subject to the limitation > of $5,000 or 1% of the support for the year If the payment is serving the direct and immediate needs of the payor – it’s gross receipts If the payment is primarily to provide a direct benefit to the general public – it’s a grant 43 Important Notes (cont.)

44. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium Gross receipts from activities that are not unrelated activities under § 513 are included in public support § 513 exclusions include: Volunteer exception Donated goods exception Convenience exception Trade show exception 44 Unrelated Business Activities

45. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium UBTI (less taxes) from businesses acquired after June 30, 1975 is included in total support Net income from unrelated activities, whether or not regularly carried on, is also included in total support 45 Unrelated Business Activities (cont.) Question: How to report gross/net proceeds from fundraising events?

46. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium Investment Income Percentage Not more than 33 1/3% Total of interest, dividends, rents, royalties and UBTI from business acquired after June 30, 1975 over total support Capital gains and losses are excluded from both the numerator and denominator 46

47. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium Form 990 Schedule A Part III Examples – See Slides 47

48. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium §509(a)(3) Supporting Organizations 48

49. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium Supporting Organizations (SO) Carry out their exempt purpose by supporting other exempt organizations Usually supports a §509(a)(1) or (a)(2) organization but can also support a §501(c)(4), (5) or (6) organization Must be organized and operated for §501(c)(3) purposes 49

50. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium Supporting Organizations (cont.) Must be organized and operated exclusively for the benefit of, to perform the functions of, or to carry out the purpose of one or more specified organizations described in §509(a)(1) or (2) Can’t be controlled directly or indirectly by DPs other than foundation managers 50

51. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium Supporting Organizations (cont.) Must have one of the following relationships with an organization described in §509(a)(1) or (2): Operated, supervised or controlled by (Type I); Supervised or controlled in connection with (Type II); or Operated in connection with (Type III) 51

52. Understanding the Public Support Test and What it Means to Your Public Charity GWSCPA’s Not-for-Profit Symposium Supporting Organizations (cont.) Type III SOs must meet a: Notification requirement Responsiveness test and Integral part test Type III SOs are categorized as either Functionally integrated or Other (non-functionally integrated) Non-functionally integrated SOs are subject to payout requirements and other operational restrictions 52

53. Stephen J. Kelin, CPA, JD skelin@grfcpa.com Richard J. Locastro, CPA, JD rlocastro@grfcpa.com Phone: (301)951-9090 Website: www.grfcpa.comwww.grfcpa.com Questions & Answers 4550 Montgomery Avenue, Suite 650N Bethesda, MD 20814