When a Donation Can Actually Hurt You
Do you know if your organization is a public charity or private foundation? Are you certain? Did you know that a public charity can be recategorized as a private foundation by the IRS?
Does this even matter? Yes, it does.
In the world of nonprofits, how the IRS categorizes your organization is a very important matter. If your organization was categorized by the IRS as a 501(c)(3), then you know that this gives you some perks. For instance, you are not required to pay tax on income you receive, and your donors receive a tax deduction for their gifts when they receive no benefit in return. However, the IRS’s classification of your organization does not stop here.
Every charity classified as a 501(c)(3) charitable organization is automatically categorized as a private foundation unless it demonstrates to the IRS that it has passed the public support test.
The public support test is the mechanism by which the IRS determines if a charity has sufficient financial support from the general public, the government, or other public charities. Public charities receive many more benefits than private foundations. Private foundations are subject to taxation on income, have greater restrictions that regulate their operations, deductibility of donations can be limited, and have more complex reporting obligations. In the eyes of the IRS, private foundation versus public charity has nothing to do with operating programs or being a grantmaker, but rather is wholly determined by who financially supports the entity.
To be categorized as a public charity, the organization must demonstrate that it: 1.) either receives at least one-third of its financial support from the general public, other public charities, and the government (called the “33 1/3 test”); 2.) or that it receives at least 10% of its financial support from the general public, other public charities, and the government AND meets other criteria (called the “facts and circumstances test”). This information will be spelled out in Schedule A of the Form 990, and you can also learn in detail what these facts and circumstances are here.
So, what does this mean for your organization? If your charity is fairly new, the IRS gives you 5 years to build up your public support base. After 5 years, you will need to demonstrate sufficient public support. If your organization has been operating as a public charity for quite some time, that does not mean you are off the hook. Each year you must demonstrate a sufficiently wide base of public support. It is important that you keep this in mind when seeking grants and large donations, as those could have a significant impact on your classification, and “tip” you into a private foundation classification. Determining your percentage of public support is quite complicated, so working with a qualified professional is imperative. A great explanation of how to determine your numbers can be found here.
Meticulous record-keeping and working with someone who truly understands the public support test and IRS regulations will ensure that your nonprofit organization is able to continue providing its programs and services to your target populations. This may seem daunting, but Legal for Good is here to help you! Contact us if you’d like to schedule a free consultation to discuss your needs.