In the prior post in this series, we explored why public support matters and how failure to satisfy the IRS public support rules can result in unintended reclassification as a private foundation. Before an organization can assess whether it is meeting the applicable public support test, however, it must first understand which public support rules apply.
Not all public charities are evaluated under the same framework. The Internal Revenue Code recognizes two primary categories of public charities that are subject to public support testing, and each reflects a different funding model with distinct compliance considerations.
For boards, executive directors, and finance committees, understanding this distinction is a critical step in monitoring compliance and making informed strategic decisions.
The Two Public Charity Classifications Subject to Public Support Testing
Most public charities subject to public support testing fall into one of two categories under the Internal Revenue Code:
- Donor Supported Entities, described in Section 170(b)(1)(A)(vi); and
- Related Revenue Entities, described in Section 509(a)(2).
An organization’s classification is determined by the IRS at the time it is recognized as tax-exempt and is reflected in its IRS determination letter. That classification dictates which public support test applies and how public support is calculated. However, this is not a permanent classification as its status can shift based on an organization’s revenue mix over a rolling five-year period.
Donor Supported Entities – Section 170(b)(1)(A)(vi)
Organizations described under Section 170(b)(1)(A)(vi) are often referred to as Donor Supported public charities. These organizations are expected to receive a substantial portion of their overall support from:
- Contributions from the general public
- Grants from governmental units (federal, state, or local)
- Donations from other publicly supported organizations
Many traditional charitable organizations fall into this category, including social service providers, educational organizations, community-based nonprofits, and grant-funded charities.
The 33 1/3%Test for Donor Supported Entities: These organizations must generally receive at least 33 1/3% of their total support from the public. Crucially, major gifts from individuals, corporations, or private foundations are subject to a 2% limit: any amount from a single donor that exceeds 2% of the organization’s total support is excluded from the public support count. The detailed rules and nuances of this test will be explored further in future posts in this blog series.
The purpose of the test for Donor Supported Entities is to determine whether support is sufficiently broad and diversified. Public support is intended to reflect engagement from the community at large, rather than reliance on a small number of donors or funding sources. Large or concentrated contributions may therefore have a disproportionate impact on compliance, even when such gifts are mission-critical.
Related Revenue Entities – Section 509(a)(2)
Organizations described under Section 509(a)(2) are commonly referred to as related revenue entities. These organizations typically rely on a combination of charitable support and exempt function income—revenue generated from activities that directly further their exempt purpose.
Examples include museums, performing arts organizations, membership-based nonprofits, and organizations that generate revenue through admissions, program fees, or services closely tied to their mission, such as nonprofit healthcare providers.
The 33 1/3% Test for Related Revenue Entities Test: These organizations must generally receive: (1) at least 33 1/3% of their total support from the public in the form of gifts, grants, or gross receipts from program revenue); and (2) not more than 33 1/3% of total support from gross investment income and unrelated business taxable income (UBIT).
This test also features certain critical exclusions, namely:
- For program revenue, receipts from any single source count toward public support only up to $5,000 or 1% of total support, whichever is greater. This prevents over-reliance on a single large client or government contract.
- Disqualified Persons: Contributions from officers, directors, and substantial contributors do not count as public support.
We will discuss this test in greater detail in future posts in this blog series as well.
As the tests indicate, unlike Donor Supported Entities, certain program-related revenues may be counted toward both public support and total support for 509(a)(2) organizations. At the same time, these organizations are subject to additional limitations, including restrictions on the amount of investment income they may receive and limits on support derived from certain insiders or “disqualified persons.”
Why the Distinction Is Significant
Although both categories qualify as public charities, the public support rules are not interchangeable. Funding strategies that are appropriate for one category may create compliance risks for the other.
For example:
- A Donor Supported Entity may face challenges when it receives a significant portion of its funding from a small number of donors.
- A Donor Supported Entity receiving a massive influx of ticket sales (program revenue) might fail its test because program revenue is excluded from its public support numerator. It may need to switch to 509(a)(2) status.
- A Related Revenue Entity may jeopardize its status if investment income or revenue from certain sources exceeds permissible thresholds.
As organizations evolve, shifts in fundraising strategy, earned revenue, or investment activity can unintentionally push an organization closer to the margins of its applicable public support test.
Confirming an Organization’s Classification
An organization’s public charity classification is typically indicated in the upper right-hand corner of its IRS determination letter. New organizations may rely on this classification during their initial years of operation, but they must continue to meet the applicable public support requirements on an ongoing basis, as it is calculated and reported annually on Schedule A of its Form 990.
Because funding models often change over time, organizations should periodically review whether their revenue sources remain aligned with their classification and whether their activities continue to support compliance with the applicable public support test.
Looking Ahead
Understanding which public support category applies to an organization is essential before attempting to calculate public support or evaluate compliance risk. Rather than assume historical revenue patterns will continue and risk “tipping” into private foundation status, organizations that proactively model their public support tests can better maintain their public charity status and build financial resilience.
In the next post in this series, we will examine how the IRS measures public support, including the five-year computation period and how timing and funding patterns can affect an organization’s public charity status.
NOTE: The information contained herein is not intended to be legal advice, and the reader should know that no attorney-client relationship or privilege is formed by the posting or reading of this article, which is also not intended to solicit business.
Casey Summar, Managing Partner
The Law Firm for Non-Profits
1812 W. Burbank Blvd., #7445
Burbank, CA 91506