1. Nonprofit Organizations Class Nine: Public Charities – Corrected 4/16/04 Michael V. Bourland Michelle Coleman-Johnson Bourland, Wall & Wenzel, P.C.

2. Types of Public Charities “Traditional” public charities – Section 509(a)(1);170(b)(1)(A)(i)-(v) “Traditional” public charities – Section 509(a)(1);170(b)(1)(A)(i)-(v) –By definition or activity Publicly supported charities Publicly supported charities –509(a)(1);170(b)(1)(A)(vi) “donative” public charities –509(a)(2) “gross receipts” or “service provider” public charities Supporting Organizations – 509(a)(3) Supporting Organizations – 509(a)(3)

3. “Traditional” Public Charities - 170(b)(1)(A) (i) Church or convention of churches (i) Church or convention of churches (ii) Educational organization (ii) Educational organization –Must normally maintain a regular faculty and curriculum and normally have a regularly enrolled body of students in attendance at the place where educational activities are regularly carried on (iii) hospital/medical research facility (iii) hospital/medical research facility

4. “Traditional” public charities - 170(b)(1)(A) (iv) organizations that support or benefit of state college or university (iv) organizations that support or benefit of state college or university (v) governmental unit (v) governmental unit (vi) “donative” public charity (vi) “donative” public charity

5. “Donative” Public Charity Referenced in 509(a)(1) and 170(b)(1)(A)(vi) Referenced in 509(a)(1) and 170(b)(1)(A)(vi) Does not provide services Does not provide services Must meet public support test Must meet public support test Example: Community Foundation Example: Community Foundation

6. Support Test for 509(a)(1) Public Charity Must receive a substantial part of its support from the public or governmental units Must receive a substantial part of its support from the public or governmental units Two “either/or” tests Two “either/or” tests –Mechanical Test –Facts and Circumstances Test

7. Mechanical Test for 509(a)(1) Must normally receive at least 33 1/3% of total support from the public Must normally receive at least 33 1/3% of total support from the public –Numerator (Public Support): gifts and grants from private donors, private foundations and corporations gifts and grants from private donors, private foundations and corporations Gifts and grants from public donors (governmental agencies or certain other publicly supported charities) Gifts and grants from public donors (governmental agencies or certain other publicly supported charities) Membership fees Membership fees Tax revenues levied on behalf of the organization Tax revenues levied on behalf of the organization Governmental services/facilities provided without charge Governmental services/facilities provided without charge

8. Mechanical Test Denominator (Total Support) Denominator (Total Support) –Includes everything BUT: Gross receipts income Gross receipts income Unusual grants Unusual grants Voluntary services Voluntary services Capital gains Capital gains In other words, these items are excluded from the support fraction entirely In other words, these items are excluded from the support fraction entirely

9. Large Gifts – Special Rules If a gift exceeds 2% of the organization’s total support for the taxable period If a gift exceeds 2% of the organization’s total support for the taxable period –Total gift is included as Total Support –Only the portion up to the 2% is included in Public Support Gifts from disqualified persons Gifts from disqualified persons –Counted as total support/public support in accordance with rules above

10. Facts and Circumstances Test If the mechanical test cannot be met, the organization may be considered publicly supported if it normally receives a substantial part (10% or more) of its support from the public/governmental units and demonstrates other facts and circumstances that it is organized and operated to attract public/government support (see Treas. Reg. 1.170A-9) If the mechanical test cannot be met, the organization may be considered publicly supported if it normally receives a substantial part (10% or more) of its support from the public/governmental units and demonstrates other facts and circumstances that it is organized and operated to attract public/government support (see Treas. Reg. 1.170A-9)

11. “Service Provider” Public Charity Described in 509(a)(2) Described in 509(a)(2) Generally has members Generally has members Provides services or has “gross receipts” Provides services or has “gross receipts” Must meet public support test Must meet public support test Example: Scout Organizations Example: Scout Organizations

12. Support Test – 509(a)(2) “gross receipts” or “service provider” public charity must meet the “gross receipts” or “service provider” public charity must meet the –“more than 1/3” support test –“not more than 1/3” support test

13. “More than 1/3” Support Test Must normally receive more than 1/3 of its support from the public Must normally receive more than 1/3 of its support from the public –Numerator (Public Support) Amounts from governmental units Amounts from governmental units Amounts from other than disqualified persons Amounts from other than disqualified persons Amounts received from other public charities, but not from other 509(a)(2) or supporting organizations Amounts received from other public charities, but not from other 509(a)(2) or supporting organizations Gross receipts Gross receipts

14. “More than 1/3” Support Test Denominator (Total Support) Denominator (Total Support) –Includes everything BUT: Unusual grants Unusual grants Voluntary services Voluntary services Capital gains Capital gains In other words, these items are excluded from the support fraction entirely Total Support In other words, these items are excluded from the support fraction entirely Total Support

15. Large Contributions Receipts from Disqualified Persons Receipts from Disqualified Persons –Not counted at all as Public Support, but included in Total Support –DPs include Substantial Contributors Any person who has contributed more than $5,000 if this amount is more than 2% of all gifts received by the organization since its creation (and family members, etc. of SC) Any person who has contributed more than $5,000 if this amount is more than 2% of all gifts received by the organization since its creation (and family members, etc. of SC)

16. Gross Receipts Admissions Admissions Sales of merchandise Sales of merchandise Performance of services Performance of services Furnishing of facilities Furnishing of facilities Counted as Public Support only to the extent the amount received from each individual does not exceed $5,000 or 1% of the Total Support for the year Counted as Public Support only to the extent the amount received from each individual does not exceed $5,000 or 1% of the Total Support for the year Public Support does not include UBTI Public Support does not include UBTI

17. “Not More Than 1/3” Support Test No more than 1/3 of total support from gross investment income plus the excess of UBTI over the amount of tax imposed on such UBTI No more than 1/3 of total support from gross investment income plus the excess of UBTI over the amount of tax imposed on such UBTI

18. “Normally”/Unusual Grants “Normally” “Normally” –Initially a 5 year advance ruling period –Thereafter, a 4 year moving average Unusual Grants Unusual Grants –There is criteria in the Treas. Regs. that provide guidance on what is an unusual grant. Unusual grants can be excluded from the support fraction

19. Major Distinctions 509(a)(1)509(a)(2) Gifts from DPs included in public support, up to the 2% threshold Gifts from DPs included in public support, up to the 2% threshold Substantial contributor is determined over taxable period (4 years) Substantial contributor is determined over taxable period (4 years) “at least” 1/3 “at least” 1/3 Gifts from DPs excluded from public support Gifts from DPs excluded from public support Substantial contributor is determined from inception of organization Substantial contributor is determined from inception of organization “more than 1/3” “more than 1/3”

20. Supporting Organizations Described in 509(a)(3) Described in 509(a)(3) Three Types Three Types –Type I – Parent/Child Relationship –Type II – Brother/Sister Relationship Type III Must not be controlled by a disqualified person Must not be controlled by a disqualified person

21. Organizational Test Org Docs must Org Docs must –State that purposes of the organization are limited to the purposes or one or more benefited public charities –Not expressly empower the SO to engage in activities that do not further the charitable purposes of the benefited charity –Designate by class or purpose or by name the public charities to be benefited –Not authorize the SO to benefit any other public or private charity or charities

22. Operational Test Must be “operated exclusively” for the support of the supported organizations Must be “operated exclusively” for the support of the supported organizations –“permissible beneficiary” requirement Providing for the charitable class benefited by the specified public charity Providing for the charitable class benefited by the specified public charity –“permissible activity” requirement Pay to the supported organization or use funds to carry on an independent activity that supports or benefits the supported organization Pay to the supported organization or use funds to carry on an independent activity that supports or benefits the supported organization

23. Type I Supporting Org Operated, supervised or controlled by one or more publicly supported organizations Operated, supervised or controlled by one or more publicly supported organizations –Control by publicly supported org –Majority of officers, directors, trustees appointed by supported org –Purposes must be similar to and no broader than that of supported org –Specified organization requirement Designate by name in governing docs Designate by name in governing docs Designate by class in governing docs Designate by class in governing docs Or Or Have historic and continuing relationship with supported org and by virtue of this relationship have developed a substantial identity of interest between the orgs Have historic and continuing relationship with supported org and by virtue of this relationship have developed a substantial identity of interest between the orgs

24. Type II Supporting Org Supervised or controlled in connection with publicly supported charity Supervised or controlled in connection with publicly supported charity –Common supervision or control Such that SO will be responsive to needs and requirements of supported org Such that SO will be responsive to needs and requirements of supported org –Mere making of payments not enough of a connection

25. Type III Supporting Org “Operated in Connection With” one or more publicly supported charities “Operated in Connection With” one or more publicly supported charities –Must specify organization by name –Not permitted to substitute supported organizations, unless predicated on something out of organization’s control –Most risky relationship, must meet two additional tests

26. Responsiveness Test Alternative I – Must have Alternative I – Must have 1.“appointee requirement” One or more officers, directors or trustees appointed by supported org One or more officers, directors or trustees appointed by supported org 2.OR “common director requirement” One or more common director/trustee/officer One or more common director/trustee/officer 3.OR “close and continuous requirement” Close working relationship Close working relationship 4.AND “significant voice requirement” By reason of 1,2, or 3, the publicly supported org has a significant voice in the investment policies of the SO, the timing of grants, etc., and directing the use of income or assets of the SO By reason of 1,2, or 3, the publicly supported org has a significant voice in the investment policies of the SO, the timing of grants, etc., and directing the use of income or assets of the SO

27. Responsiveness Test Alternative II Alternatively, responsiveness may be shown Alternatively, responsiveness may be shown –SO is a trust under state law –Each specified supported org is a named beneficiary under the trust’s governing instrument –And supported org has power to enforce the trust and compel accounting under state law

28. Integral Part Test Two Alternatives Two Alternatives –“But For” Test “but for” the activities of the SO, the supported organization would carry on the activity itself “but for” the activities of the SO, the supported organization would carry on the activity itself –Or “Substantially All Income” Test Must pay substantially all income (85%) Must pay substantially all income (85%) –Must ensure attentiveness –Substantial amount of SO’s total support must go to one or more of the supported charities “Sufficient Part of Total Support” Test “Sufficient Part of Total Support” Test

29. “Sufficient Part of Total Support” Must represent a sufficient part of supported organization’s total support to ensure attentiveness Must represent a sufficient part of supported organization’s total support to ensure attentiveness Must be such that the supported organization will be attentive to the SO – needs to be a substantial activity Must be such that the supported organization will be attentive to the SO – needs to be a substantial activity

30. Community Foundations “donative public charity” “donative public charity” Treas. Reg. 1.170A-9 lists additional requirements Treas. Reg. 1.170A-9 lists additional requirements –Commonly known as Community Foundation, Community Trust or Community Fund –Common governing instrument –Common governing body –Governing body needs these powers Variance power Variance power Power to replace trustee, custodian or agent for breach of fiduciary duty Power to replace trustee, custodian or agent for breach of fiduciary duty Must commit itself to reasonable return on investments Must commit itself to reasonable return on investments Must prepare periodic financial reports treating component funds as funds of the organization Must prepare periodic financial reports treating component funds as funds of the organization

31. Component Funds If fund is a separate legal entity (trust) the community foundation must meet single entity requirements If fund is a separate legal entity (trust) the community foundation must meet single entity requirements If a separate legal entity, must subject itself to common governing instrument of community foundation If a separate legal entity, must subject itself to common governing instrument of community foundation May not be directly or indirectly subjected by the donor to any material restriction or condition May not be directly or indirectly subjected by the donor to any material restriction or condition

32. Donor Advised Funds No definition in IRC or Treas Regs No definition in IRC or Treas Regs Donor creates fund with CF and makes periodic recommendations regarding distribution of funds Donor creates fund with CF and makes periodic recommendations regarding distribution of funds Donor may recommend but not require Donor may recommend but not require

33. Field of Interest Funds May instruct CF to limit the use of funds to a specific charitable purpose May instruct CF to limit the use of funds to a specific charitable purpose –Ex. Art, AIDS/Cancer Research, youth services, etc.

34. Intermediate Sanctions Public charities are not subject to the private foundation excise taxes under IRC 4940-4945 Public charities are not subject to the private foundation excise taxes under IRC 4940-4945 Instead, subject to “intermediate sanctions,” the rules regarding excess benefit transactions set forth in IRC 4958 and Treas Regs 53.4958-1 through 53-4958-8 Instead, subject to “intermediate sanctions,” the rules regarding excess benefit transactions set forth in IRC 4958 and Treas Regs 53.4958-1 through 53-4958-8

35. Excess Benefit Transaction Transactions between public charity and Disqualified Person must be at fair market value Transactions between public charity and Disqualified Person must be at fair market value Any excess benefit is subject to an excise tax Any excess benefit is subject to an excise tax

36. Tax Imposed On Disqualified Person On Disqualified Person –25% of excess benefit –200% of excess benefit if not corrected On Managers On Managers –10% of excess benefit

37. Disqualified Person Difference from DP for private foundation purposes Difference from DP for private foundation purposes Defined as any person who is in a position to exercise substantial influence over the affairs of the charity at any time during a 5 year period ending on date of transaction Defined as any person who is in a position to exercise substantial influence over the affairs of the charity at any time during a 5 year period ending on date of transaction –Similar family/business attribution rules to PF

38. Who has substantial influence? Presidents, CEOs, COOs Presidents, CEOs, COOs Treasurer and CFOs Treasurer and CFOs Persons with material financial interest in a provider sponsored organization (nonprofit hospital) Persons with material financial interest in a provider sponsored organization (nonprofit hospital)

39. Deemed Not to Have Substantial Influence Tax exempt organizations listed in 501(c)(3) Tax exempt organizations listed in 501(c)(3) Certain 501(c)(4) organizations Certain 501(c)(4) organizations Employees receiving economic benefits of less than a specified amount in a taxable year Employees receiving economic benefits of less than a specified amount in a taxable year Facts and Circumstances govern in other instances Facts and Circumstances govern in other instances

40. What is reasonable? All payments to a DP must be reasonable All payments to a DP must be reasonable Organization can create a presumption of reasonableness by following certain procedures Organization can create a presumption of reasonableness by following certain procedures –Transaction approved by authorized body –Based on comparability data –Adequately documented