To be a public charity, an organization must meet one of the Internal Revenue Code Section 509(a) tests. This article focuses on the first listed test, Section 509(a)(1). The alternative 509(a)(2) test will be discussed in a future article.

509(a)(1) vs. 509(a)(2) Tests

Generally speaking, the public support tests under 509(a)(1) and (a)(2) are designed to make sure that a 501(c)(3) organization has a sufficiently broad base of support to be classified as a public charity and not a private foundation.

There are a number of benefits to qualifying as an (a)(1) organization rather than as an (a)(2) organization, including:

• In calculating public support, an (a)(1) organization only excludes excess contributions, as explained below, from substantial donors.
• There is an exception from the 2 percent cap, as explained below, for government and certain other 509(a)(1) donors.
• There is an alternative 10 percent “facts and circumstances” test, which acts as a safety net in achieving public charity status, but does not apply under 509(a)(2).
• There is no separate public charity calculation restriction on investment income.

509(a)(1) Test

The criteria for being a 509(a)(1) public charity are not included in Code Section 509(a)(1). 509(a)(1) simply refers to organizations described in Section 170(b)(1)(A)(i)-(vi).

Code Section 170(b)(1)(A)(i)-(v) includes subsections for churches, schools, hospitals and governmental units. These organizations are treated as public charities based upon the nature of the organizations’ activities.

Section 170(b)(1)(A)(vi) determines public charity status based on an organization’s sources of support. Going forward, we will refer to 509(a)(1) when describing these 170(b)(1)(A)(vi) entities.

There are two applicable tests under 509(a)(1). First, if the entity’s public support is greater than 33.33 percent, it is automatically classified as a public charity. However, even if public support is less than 33.33 percent, it may still qualify as a public charity under the subjective 10 percent “facts and circumstances” test.

Because the 509(a)(1) test does not include fees from the performance of activities related to an organization’s exempt purpose – referred to interchangeably as fees, fees for services, or gross receipts – in the support calculation, it is often necessary to first determine whether certain revenues, which may be labeled as “grants,” are even included in the calculation.

To distinguish whether a grant is a contribution or a fee (and therefore excluded in the calculation), the regulations state that contributions confer no or limited benefit to the donor, while fees demonstrate a primary benefit to the donor.

A grant is defined as an amount given to an organization that is intended to encourage the grantee organization to carry on its exempt purpose. Fees, on the other hand, serve direct and immediate needs of the payor rather than conferring a benefit upon the general public. Fees would include sales or services, while a grant would be used specifically to help the organization in executing its exempt purpose or mission.

Thus, a grant could state that the recipient must produce 1 million educational booklets. If the booklets are then distributed by the charity to the
general public, the primary benefit is to the non-grantor (the general public), and the revenues are considered to be contributions. If the booklets are to be delivered back to the grantor, who will then decide what to do with the booklets, then the primary benefit has been provided to the payor, and the revenues are treated as fees.

’Good’ vs. ’Bad’ Support

As noted above, fees are not included in either the numerator or denominator of the calculation. Described below is the treatment of contributions in computing the public support of a 509(a)(1) entity. The testing period for the 509(a)(1) public support test is five years: the current filing year and the preceding four years. In determining whether an entity has sufficient “public support,” the calculation requires that you identify those contributions that are not considered “good” support.

To arrive at the desired greater-than-33.33 percent threshold, only this “good” money goes into the numerator, while all contributions go into the denominator. The amount from a single donor received during the five-year testing period that exceeds 2 percent of the total support of an organization over the five-year period is not “good” money.

Importantly, the regulations provide that amounts from the U.S. government or political subdivisions (states, cities, etc.) and other 509(a)(1)/170(b)(1)(A)(vi) organizations are not subject to this 2 percent limit.

Assume that an organization had $50 million in support over a five-year test period. Two percent of that is $1 million. If an individual, corporation or private foundation donor gave $3.5 million over the testing period, all of the donor’s contributions would go into the denominator, but only $1 million would be “good” money and included in the numerator.

Thus, large amounts from single donors can have a very significant negative impact on the percentage of public support. However, if the $3 million contribution came from a U.S. governmental unit or 509(a)(1) organization, the entire amount would be classified as good money.

Although the code and regulations specify domestic governments, Rev. Ruling 74-435 concludes that foreign government support to a foreign charity is treated as government support for the (a)(1) test. It is unclear whether, based on the ability to exclude foreign government funding, excluding organizations made up of foreign governments, such as the United Nations or the World Bank, might be considered. But contributions from foreign charities appear to be subject to the 2 percent limit, unless there are treaty provisions providing otherwise.

This determination of public support is made on Part II of Schedule A of the Form 990. If Section C, line 14 (current year) or line 15 (prior year) is 33.33 percent or more, then the organization is deemed to have sufficient public support to be a public charity. Thus, an organization that passes the test in one year is considered a public charity for that year and the following year.

An organization may fail to qualify by not meeting the objective 33.33 percent public support test. In these instances, an organization may turn to the subjective “facts and circumstances” test to attempt to be qualified as a 509(a)(1) organization.

© 2015

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