By Swetha Gopalakrishnan

Nonprofit organizations (NPOs) are corporate entities established to benefit the public rather than private individuals. Also known as 501(c)(3) organizations, NPOs operate exclusively for tax-exempt reasons, which may include religious, charitable, educational, literary, and scientific purposes.¹

NPOs have different compliance requirements based on whether they are classified as public charities or private foundations. Public charities tend to be more popular with NPO founders, but they face some stringent eligibility rules. To qualify for and maintain federal tax-exempt status, public charities must meet certain rigorous criteria.² Meet with a trusted attorney to ensure your organization complies with all public charity requirements.

What are the differences between private foundations and public charities?

Many founders of NPOs prefer to classify their organizations as public charities because they enjoy some advantages over private foundations.

The main differences between private foundations and public charities are where they get their funding, and what they can do with it:

• Public charities:
  • Must receive a minimum percentage of their funding from the public.
  • Can receive funding from private foundations and other public charities.
  • Normally fund charitable activities directly.
• Private foundations:
  • Often funded by one individual or organization.
  • Tend to fund public charities.

Because of their public nature, public charities have higher tax-deductible giving limits for donors. They also enjoy more flexibility in tax filing requirements at an organizational level.

How can npos qualify as public charities?

It is more difficult to meet the criteria of a public charity than a private foundation. All 501(c)(3) organizations are automatically categorized as private foundations until they can meet the requirements of public charities.

NPOs can qualify as public charities in one of the following three ways:

• By starting an organization that automatically qualifies as a public charity, such as a hospital, school, church, educational institution, certain organizations that support a public college or university, or governmental units.
• By establishing an organization that supports another public charity or charities, or
• By qualifying as a publicly supported organization. An organization must pass one of two public support tests to qualify.³

How can NPOs be classified as supporting organizations? 

A supporting organization is an NPO that supports one or more public charities.⁴ Contributions to supporting organizations are given the same favorable income tax treatment as contributions made to other types of public charities.

To be classified as a supporting organization, an organization must:

• Be organized and operated exclusively for the benefit of one or more public charities,
• Be operated, supervised, or controlled by or in connection with one or more public charities, and
• Not be controlled directly or indirectly by one or more disqualified persons, other than foundation managers.⁵

What are the funding requirments for public charities?

A public charity must receive a substantial portion of its total support from public donations during each five-year period.⁶ This test is conducted on an annual basis and examines the support received by the organization during the current tax year and the four prior tax years. Organizations must pass the public support test each year to maintain public charity status.

Public organizations must receive revenue from the public that is:

• At least one-third of their total revenue, or
• Less than one-third but more than 10% of their total revenue if they also pass a facts-and-circumstances test.

Public support generally includes contributions, grants, and membership dues received for general support of the organization, and fees received from the public related to the organization’s mission-driven activities, including admissions, sales of merchandise, performance of services, and/or furnishing of facilities.⁷ In addition, the organization can receive no more than one-third of its support from gross investment income and unrelated taxable income.

How can an NPO satisfy the public support test?

To perform the public support test, an organization must divide its total public support by its total revenue. The result must be at least one-third, or 33 1/3 percent.

Organizations will also need to understand:

• What is included in total support.
• What is included in total public support.
• The measuring period used to determine whether an organization "normally" receives public support.

What is the 10% facts-and-circumstances test?

If an organization’s public support makes up less than one-third but more than 10% of its total support, it may still qualify as a public charity under the facts-and-circumstances test. To satisfy the facts-and-circumstances test, the organization must be organized and operated to continually attract new public or governmental support.

Additional factors are considered in the facts-and-circumstances test, including:

1. Percentage of financial support: A higher percentage of public support reduces the need for an organization to meet the requirements below.
2. Sources of support: An organization will be viewed more favorably if most of its public support comes from multiple governmental units or from many unrelated people instead of from a smaller, interconnected group of individuals.
3. Representative governing body: The organization’s governing body should represent the public’s broad interests, instead of a small number of people’s private interests.
4. Direct services for public benefit: If the organization continually provides facilities or services directly for public benefit, it will be more positively assessed.
5. Additional factors:
   • The organization solicits dues-paying members from a considerable number of people in the community.
   • Membership dues make membership available to a broad group of the interested public, not just a limited number of people, and
   • The organization’s activities appeal to people that have a similar broad common interest or purpose.

Conclusion

It can be complicated for nonprofit organizations to maintain public charity status. It is important to seek advice from knowledgeable attorneys to help navigate these compliance concerns. Contact your experienced Chugh, LLP legal team for further assistance.

¹ https://www.irs.gov/charities-non-profits/types-of-tax-exempt-organizations.
² Under one of 25 subsections of Section 501(c) of the Internal Revenue Code.
³ Sections 509(a)(1) and 170(b)(1)(A)(vi), and Section 509(a)(2) on an ongoing basis.
⁴ IRC sections 509(a)(1) or 509(a)(2).
⁵ IRC Section 4946.
⁶ Sections 509(a)(1) and 170(b)(1)(A)(vi).
⁷ Section 509(a)(2).