Not all public charities are alike, and not all rely on the same sources of funding. While many nonprofit leaders understand the basic requirements for qualification under Section 501(c)(3) of the Internal Revenue Code (“IRC”), fewer appreciate the ongoing obligation to maintain public charity status through compliance with the IRS public support rules.
For boards, executive directors, and finance committees, understanding how public support is measured, and why it matters, is essential to avoiding “tipping” into private foundation status, which can significantly affect an organization’s operations, fundraising, and long-term sustainability.
Public Charity Status Versus Private Foundation Status
Organizations recognized as tax-exempt under Section 501(c)(3) are classified by the IRS as either public charities or private foundations. Although both are exempt from federal income tax on income related to their exempt purpose, the distinction carries important legal and practical implications.
Public charities generally benefit from greater flexibility in fundraising and grantmaking, broader eligibility for foundation support, and more favorable tax treatment for donors (e.g., higher adjusted gross income deductibility limits). Private foundations, by contrast, are subject to strict excise taxes on net investment income, mandatory annual distribution requirements (the 5% payout rule), stricter self-dealing rules under IRC Section 4941, and increased reporting and compliance obligations.
For most nonprofits, maintaining public charity status is critical to fulfilling their mission effectively, as the administrative burden of private foundation status can be substantial.
What the IRS Means by “Public Support”
The IRS uses public support tests to evaluate whether an organization is supported by a sufficiently broad segment of the public or governmental sources, rather than by a limited number of donors or by investment income. Public charities can be further categorized into two categories: (1) those often described as Donor Supported Entities that normally receive a substantial part of their support from the government or public contributions, described by section 170(b)(1)(A)(vi) of the IRC, or (2) those often described as Related Revenue Entities that receive at least one-third of their support from a combination of contributions, grants, and revenue from programs fulfilling their exempt function and less than one-third of their support from investment income and unrelated business activities, described by section 509(a)(2) of the IRC.
Public support is not determined by a single year of activity. Instead, it is calculated over a rolling, five-year period (documented on Schedule A of Form 990) and considers both the sources and composition of an organization’s funding. The objective is to ensure that public charities remain accountable to the communities they serve and are not operating in a manner more consistent with private foundations.
Why Public Support Is an Ongoing Requirement
A common misconception among nonprofit leaders is that public charity status, once granted, is permanent. In reality, organizations must continue to satisfy applicable public support tests year after year.
Changes in fundraising patterns, the receipt of large or concentrated gifts (which may be subject to the 2% cap under the 509(a)(1) test that will be discussed in a later blog post), declines in public contributions, or increased reliance on investment income can all affect an organization’s public support calculation. Without careful monitoring, these shifts can place an organization at risk of failing a public support test.
If an organization fails to meet the applicable test for two consecutive years, the IRS will reclassify it as a private foundation retroactive to the beginning of the second year—often without the organization realizing the issue until after the fact.
The Consequences of Reclassification
Reclassification as a private foundation does not eliminate an organization’s 501(c)(3) tax-exempt status, but it can dramatically restructure how the organization operates. Consequences may include liability for excise taxes, reduced deductibility of donations for contributors, restrictions on grantmaking, and heightened administrative and compliance burdens.
Because reversal of private foundation status is a rare and difficult multi-year process, preventing reclassification through proactive planning and oversight is far preferable to attempting corrective action after the fact.
Looking Ahead
This article is the first in a six part series examining the IRS public support tests and how they apply to different types of public charities. Future posts will address how public support is calculated, the different tests that apply depending on an organization’s structure, and practical strategies nonprofit leaders can use to monitor compliance and reduce risk.
Understanding public support requirements is a critical component of sound nonprofit governance. With informed planning and ongoing review, organizations can protect their public charity status while continuing to advance their missions with confidence.
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