2.5.0 Non-Private Foundations

2.5.1 Statutory Framework

Pursuant to IRC §509(a), charitable organizations can qualify as non-private foundations (public charities) based upon a number of specific provisions, qualifications or purposes. To achieve non-private status, these organizations must meet the tests set forth in IRC §§509(a)(1), (2), (3), or (4). Interestingly, IRC §509(a)(1) does not provide any operative guidance, but instead contains a cross-reference to organizations described in IRC §170(b)(1)(A) [other than clauses (vii) and (viii)]. These IRC §170(b)(1)(A) organizations are certain specific types of organizations and organizations that normally receive a substantial part of their support directly or indirectly from the general public. [See Exhibit 2.1]

Exhibit 2.1

2.5.2 IRC Section 509(a)(1)/170(b)(1)(A)—Organizations

1. Organizations Formed and Operated for Specific Purposes
   1. Churches

      1. A church, convention of churches, or association of churches, is a public charity. [IRC §170(b)(1)(A)(i)] Probably reflecting the special status of churches under the First Amendment, churches are public charities irrespective of their sources of support. They do not have to file for recognition of tax-exempt status, like most other charities. They do not have to file Form 990 returns of organizations exempt from tax, but they are not allowed to lobby, even within the IRC §501(h) safe harbor limitations that apply to other charities.

      2. It is possible to have a religious, religious-educational, or religious-charitable organization that is eligible for tax-exempt status, but does not meet the IRS definition of a church. [See Foundation of Human Understanding, 88 TC 1341 (1987)] Such organizations do need to apply for recognition of tax-exempt status. If the practitioner is unsure, it is prudent to apply for recognition and determine for certain if the organization is recognized as a church.

   2. Schools

      1. A school is an educational organization that normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils and students in attendance at the place where its educational activities are regularly conducted. [IRC §170(b)(1)(A)(ii)]

      2. Educational organizations that do not meet the definition of school can still be exempt under IRC §501(c)(3), but they do not have the special public charity status granted by subsection (A)(ii). Educational organizations can still achieve non-private status under other tests.

      3. Private schools must demonstrate that they have a racially non-discriminatory policy. They have special affirmative requirements to publicize and demonstrate non-discriminatory policies that do not apply to other charities.

   3. Hospitals

      1. A hospital, the principal purposes or functions of which are to provide medical or hospital care or medical education and research, or a medical research organization directly engaged in medical research in conjunction with a hospital, is a public entity. [IRC §170(b)(1)(A)(iii)]

      2. It should be noted that, under IRC §501(e), certain cooperative hospital service organizations that perform centralized services for tax-exempt hospitals are also tax-exempt. It is important to note that the services that can be conducted on a cooperative basis are limited to those specifically listed in the Internal Revenue Code, such as warehousing, billing, food services, and laboratory. Services that are not listed cannot be conducted on a tax-exempt basis by cooperative hospital service organizations. For example, laundry service does not qualify, even though a tax-exempt hospital could do its own laundry as part of its hospital operation. [Rev. Rul. 69-160, 1969-1 CB 147]

   4. Organizations Operated for Benefit of College or University Owned or Operated by Governmental Unit

      An organization operated for the benefit of a college or university owned or operated by a governmental unit achieves non-private status. [IRC §170(b)(1)(A)(iv)]

   5. Governmental Units

      A governmental unit is a public charity, according to IRC §170(b)(1)(A)(v).

2. Publicly Supported Organizations
   1. General

      Publicly supported covers any IRC §501(c)(3) organization that normally receives a substantial part of its support (exclusive of income received in the exercise or performance of its charitable, educational, or other purpose, constituting the basis for its tax-exemption) from a governmental unit or from direct or indirect contributions from the general public. [IRC §170(b)(1)(A)(vi)] Unlike the other categories, these publicly supported organizations are not limited to a specific purpose (such as churches) but can be any IRC §501(c)(3) tax-exempt organization as long as the sources of support meet the test.

   2. Substantial Support

      1. The term substantial support means either: (a) one-third or more of the support is derived from governmental units or contributions from the general public; or (b) at least 10 percent of the support is derived from governmental units or contributions from the general public.

      2. In addition, the organization must be operated in such a manner as to generally attract public support, based upon a facts-and-circumstances test. The facts and circumstances include the percentage of public support, the breadth or diversity of public support, representation of the general public on the governing body of the organization, the provision of services to the general public, and any other relevant circumstances. Contributions of more than two percent of the organization’s total support from any one person or related persons does not count as general public support. [Treas. Reg. §1.170A-9(e)]

   3. Support

      For the purposes of this test, support includes charitable contributions, membership fees, gross income from passive investments and unrelated business income (net of the unrelated business income tax), net income from other unrelated business activities, tax revenues levied for the benefit of or spent on behalf of the organization, the value of services or facilities furnished by a governmental unit to the organization without charge, and all other income except for capital gain or loss, and not including exempt purpose receipts. [Treas. Reg. §1.170A-9(e)(7)(i) and IRC §509(d)] Thus, an organization that receives $100,000 in support for a computation period clearly qualifies as a public charity if it received $10,000 from the government, $10,000 in charitable contributions and membership fees of less than $2,000 each, and $15,000 from other public charities (for example, the local United Way). Contributions from other public charities are considered to be indirect public support, so the aggregate support from contributions from the general public, contributions from the government, and contributions indirectly from the general public would be $35,000, or more than one-third of the total support.

   4. Unusual Grants

      1. Obviously, one big grant from one individual could undermine the public support test. Therefore, in determining whether or not an organization is supported by the general public, the organization may exclude unusual grants. [Treas. Reg. §1.170A-9(e)(6)(ii)] Unusual grants are excluded entirely from the support test both from the numerator and the denominator. They are not counted as good or public support, but they are not counted as part of total support so they do not cause the organization to need additional public support to offset the unusual grant.

      2. An unusual grant is an amount that is attracted to the organization by reason of the publicly supported nature of the organization, is unusual or unexpected with respect to the amount of the contribution, and, by reason of the size of the contribution, adversely affects the non-private status of the organization under the support tests. [Treas. Reg. §1.509(A)-3(c)(3)] The factors used in determining whether or not a particular contribution can be excluded in the measure of support include whether or not the contribution was made by any person or persons who created the organization or had previously made substantial contributions, whether or not the contribution is a bequest or any inter vivos transfer, whether or not the contribution was in the form of cash, readily marketable securities, or assets that further the exempt purposes of the organization, whether or not the organization is actively carrying on a program of public solicitation and exempt activities, whether or not the organization has already been able to attract a significant amount of public support, whether or not the organization can reasonably be expected to attract a significant amount of public support in the future, whether or not prior to the time of receipt of the unusual grant the organization was able to meet the support tests without the benefit of any exclusions from unusual grants, whether or not the organization has a representative public governing body, and whether or not there are any material restrictions or conditions imposed in connection with the gift. All pertinent facts and circumstances are taken into consideration, and no single factor is necessarily determinative. [Treas. Reg. §1.509(A)-3(c)(4)]

      3. Statutory Note

         While IRC §170(b)(1)(A) provides the classification definitions for IRC §509(a)(1), the statutory purpose of this subsection is to provide limitation rules with respect to the charitable contribution deduction of IRC §170(c). Non-private foundations are subject to more favorable contribution deduction rules than are private foundations. An examination of IRC §170(b)(1)(A) reveals that the more favorable rules apply to: (a) the non-private foundations actually described in subsections (b)(1)(A)(i) through (vi); (b) other non-private foundations that qualify under IRC §§509(a)(2) or (3) (see 2.5.3 and 2.5.4); and (c) a special class of private foundation, the private operating foundation, discussed in 3.6.3.

2.5.3 IRC Section 509(a)(2)—Organizations Supported by the Public and by Exempt Receipts

1. Definition of Support

   IRC §509(a)(2) non-private foundations are classified according to rules that are not entirely dissimilar to IRC §509(a)(1) organizations, but the positive test as to sources of support is somewhat different, and there is also a negative test with respect to excessive impermissible support. The definition of support for applying these tests is the same as for IRC §509(a)(1) organizations except that an additional source of support is added—gross receipts from admissions, sales of merchandise, performance of services, or furnishing of facilities in any activity that is not an unrelated trade or business. [IRC §509(d)(2)] Thus, in addition to considering contributions received and investment income, support also includes the organization’s receipts from the conduct of its exempt purpose business, such as museum admissions for a museum, receipts from the sale of symphony tickets for a symphony, or tuition for an educational organization.

2. Tests of Support

   1. The positive and negative support tests are both based upon the same measure of support.

      1. In order to qualify under IRC §509(a)(2), the organization must meet a positive test of receiving one-third of its support from two qualifying sources:

         1. Contributions, gifts and grants from other than disqualified persons; and

         2. Receipts from the performance of the organization’s exempt purposes, from other than disqualified persons, except only the greater of $5,000 or one percent of total support for the year may be derived from any one person or from any one bureau or government agency.

            For the purposes of this rule, disqualified persons include substantial contributors, foundation managers, and certain affiliated organizations or family members by attribution. The positive test is an absolute one-third test. Unlike IRC §509(a)(1), there is no alternative test of ten percent plus facts and circumstances.

      2. In addition to the positive test, an organization does not qualify under IRC §509(a)(2) if more than one-third of its support is derived from gross investment income and net after-tax unrelated business taxable income.

   2. As in the case of IRC §509(a)(1) organizations, unusual grants are not counted in the determination of support.

      Example 2.1

      If a museum had total support in the amount of $100,000, and received $20,000 from museum admissions, $20,000 in contributions from the general public, $10,000 from investment income, and $50,000 in contributions from a single disqualified person, it would qualify as a non-private foundation under IRC §509(a)(2). By adding the $20,000 in museum admissions and $20,000 in contributions from the general public, it would satisfy the one-third positive test. It would also pass the negative test because its passive investment income would be only $10,000, or less than one-third of its total support. It is interesting to compare this result with IRC §509(a)(1). Under that provision, the museum would not satisfy the absolute one-third test, and would be forced to rely on the alternative test of ten percent public support plus facts and circumstances. The fact that a single disqualified person provided half of the organization’s gross receipts might constitute a negative factor under the facts-and-circumstances test.

2.5.4 IRC Section 509(a)(3)—Supporting Organizations

1. General

   A supporting organization is a not-for-profit tax-exempt organization that is organized, and at all times thereafter operated, exclusively for the benefit of, to perform the functions of, or to carry out the purposes of one or more specified organizations that are already established as non-private foundations by meeting the requirements of IRC §§509(a)(1) or (a)(2). A supporting organization must be operated, supervised or controlled by or in connection with one or more of these non-private foundations, and it must not be controlled directly or indirectly by one or more disqualified persons (as defined in IRC §4946, such as substantial contributors or their families or related entities), other than foundation managers. Thus, if an organization is established and operated to support and help a non-private foundation, it achieves non-private status by virtue of the relationship.

   1. Organizational Test

      1. In order to meet the organizational test of IRC §509(a)(3), the organizational documents should limit the purposes of the supporting, organization to the purposes of benefiting, supporting, or performing the functions of a non-private foundation. [IRC §509(a)(3)(A) and Treas. Reg. §1.509(a)-4(c)] The stated purposes should not empower the supporting organization to engage in activities that are not in furtherance of assisting the supported non-private foundations. Normally, the organizational documents should specifically name the organization or organizations that are to be supported or assisted. [Treas. Regs. §§1.509(a)-4(c) and (d)]

      2. There are certain limited exceptions to actually naming the organization or organizations to be supported. The supporting organization does not fail the organizational test solely because its governing documents permit the substitution of one publicly supported organization within a designated class for another in the same or a different class designated in the organizational documents, permit the supporting organization to operate for the benefit of a new or additional publicly supported organization of the same or a different class designated in the organizational documents, or permit the supporting organization to vary the amount of its support among different publicly supported organizations. [Treas. Reg. §1.509(a)-4(d)(3)]

      3. If the supporting organization is organized and operated to support one or more publicly supported organizations, and it is operated in connection with the supported organization [see 2.5.4.1(C)], there are additional exceptions to actually naming the organization or organizations to be supported. These exceptions allow designation of the supported organization by class or purpose, provided that the class includes the supported organization or its affiliated or related organizations that actually control the IRC §509(a)(3) supporting organization. The governing documents may allow a substitution of organizations within this designated class. The organizational documents may allow for support of a new organization entering the designated class of organizations and may allow the supporting organization’s support to vary within this class of designated organizations. [Treas. Reg. §1.509(a)-4(d)]

      4. Obviously, failure to actually name the supported organization requires qualification under complicated exceptions. If substitution of the supported organizations or general designation by class is sufficiently important, the practitioner needs to work carefully through the rules set forth in Treas. Reg. §§1.509(a)-4(d), especially (2), (3) and (4).

   2. Drafting Provisions

      As in the case of meeting the organizational tests for IRC §501(c)(3) status, organizational language for a supporting organization must fit into the context of the appropriate corporation, trust or association. Nevertheless, specimen language that has been recognized by the Internal Revenue Service includes the following:

      1. The [corporation, trust, association] shall be organized and operated to support the charitable purposes and programs of Charity A and Charity B.

      2. Except as otherwise provided herein, the [corporation, trust, association] shall make distributions of income, not less often than _______, in equal parts to Charity A and Charity B. [Organizational documents may establish procedures for distribution of capital gains, distribution of principal, or accumulation of income for the benefit of Charity A and Charity B.]

      3. If either Charity A or Charity B shall cease to exist or cease to be recognized as an organization exempt from income tax under IRC §501(c)(3), and if the governing [board, trustees] of the [corporation, trust, association] shall determine that the charitable programs of such discontinued charity are being continued by a successor organization that is a charitable organization recognized as exempt from income tax under IRC §501(c)(3), including, without limitation, any successor to such charity by merger, purchase, acquisition, or distribution, then the [corporation, trust, association] may thereafter make distributions to such successor in the same manner as it would have made distributions for the discontinued charity. If no such successor charitable beneficiary shall exist, then the [corporation, trust, association] shall thereafter make all of its distributions to and for the support of the supported charity, either Charity A or Charity B, which shall be continuing as an operational charitable organization recognized as exempt from tax under IRC §501(c)(3).

   3. Operational Test

      Just as a charitable organization under IRC §501(c)(3) must be both organized for the proper purposes and, in fact, operated for the proper purposes, supporting organizations must be both organized and operated within the specifications of the Internal Revenue Code and Treasury Regulations. Treasury Regulation §1.509(a)-4(e) describes the operational tests. A supporting organization is regarded as operated exclusively to support one or more specified publicly supported organizations only if it engages exclusively and solely in activities that support or benefit the specified publicly supported organizations. It must maintain one or more relationships with the supported organization described in the Treasury Regulations.

      1. The supporting organization must be operated, supervised, or controlled by the supported organization, as more fully described in Treasury Regulation §1.509(a)-4(g).

      2. The supporting organization must be supervised or controlled in connection with the supported organization as more fully described in Treasury Regulation §1.509(a)-4(h).

      3. A supporting organization can be operated in connection with the supported organization as more fully described in Treasury Regulation §1.509(a)-4(i).

         The operated in connectionm with test has two sub-tests, both of which must be met. One is the responsiveness test, which provides that the supporting organization is responsive to the needs or demands of the publicly supported organizations. The other sub-test is the integral part test, which provides that the supporting organization must maintain a significant involvement in the operations of the publicly supported organization and that the publicly supported organization must be dependent upon the supporting organization for the type of support that it provides.

2. Disqualification

   Even if the supporting organization meets the required affirmative tests, there are two ways, sometimes overlooked, in which the not-for-profit organization can be disqualified from IRC §509(a)(3) treatment.

   1. Disqualified Persons

      A supporting organization may not be controlled directly or indirectly by disqualified persons, other than foundation managers. Thus, if a family-established foundation attempts to seek non-private status through IRC §509(a)(3), it fails if a majority of the board of directors or voting membership is made up of members of the family making the contributions.

   2. Avoidance or Attribution with Respect to IRC Section 509(a)(2) Organizations

      Obviously, IRC §509(a)(3) provides a vehicle to assist IRC §509(a)(2) organizations in qualifying. These IRC §509(a)(2) organizations have a negative test with respect to investment income. Theoretically, this could be avoided by spinning investment assets into an IRC §509(a)(3) supporting organization. Unfortunately, this imaginative technique does not work. Treasury Regulation §1.509(a)-5(a) provides that income received from supporting organizations and certain trusts is characterized as gross investment income to the extent that the supporting organization derived the income from investments. If the supporting organization is created for avoidance purposes, the income of the supporting organization is again attributed to the supported organization.

A not-for-profit organization that is organized and operated exclusively for testing for the public safety is not a private foundation. Interestingly, this is the only functionally non-private status actually listed under IRC §509(a), as contrasted to the cross-reference to IRC §170(b)(1)(A).