When we meet with a nonprofit organization that may need accounting or audit services, one of the first inquiries we make is to ask about their nonprofit status, as determined by the IRS. While we find that over 95% of the organizations are classified as a public charity under 501(c)(3) (and not as a private foundation under 501(c)(3)), we also find that many nonprofits are either using the incorrect public support classification on Schedule A of the Form 990, or they are incorrectly calculating the public support percentage on the Schedule A. If an organization’s public support falls below 33%, that organization can lose their public support status. So, knowing your public charity status and knowing how to calculate your public support really matters.
When most organizations initially apply for 501(c)(3) status, they generally want to be considered a public charity, not a private foundation. Outside of certain exceptions (hospitals, schools, governmental units, college foundations, and community trusts), there are three main categories of public charity status for most nonprofits under 501(c)(3). Which status you fall under will determine if you need to calculate your public support and how it’s done.
Main Categories of Publicly Supported 501(c)(3) Organizations
This public charity status is generally reserved for those nonprofit organizations who receive their support from the general public or from a governmental unit. So, those organizations that rely primarily on support (donations, grants, etc) fall under 509(a)(1). An example of a 509(a)(1) organization would be a homeless shelter. Your IRS determination letter may also refer to 170(b)(a)(A)(vi), which falls under this 509(a)(1) category.
This status includes those organizations who receive more than 1/3 of their support from a variety of sources, including gross receipts for services rendered, membership dues, and contributions. Nonprofit substance abuse treatment centers would typically fall under 509(a)(2) since they receive both revenue (from services rendered) and support (from contributions).
This status is less common and is for those nonprofits that are organized and operated exclusively for the benefit of another public charity. If the aforementioned substance abuse treatment center under 509(a)(2) had a separate foundation that was used as a fund-raising arm for the center, that foundation would likely be classified under 509(a)(3).
The Public Support Calculation
While 509(a)(3) organizations do not calculate their public support on an annual basis, 509(a)(1) and 509(a)(2) organizations are required to do so. While the calculation is a bit different between these two public charity types, the main thrust behind the calculation is driven by the IRS’s desire to see that your nonprofit has diversified funding and that it’s not, for example, a tax haven for one or two high-net worth donors.
If you are a nonprofit that continues to receive a very large annual donation from one or two individual donors and that amount is a high percentage of your overall support, your public charity status may be in jeopardy, whether you know this or not. This is because your annual calculation has a “floor” and any amounts that exceed that floor are removed from the numerator of your calculation. The remaining support is divided by your total revenue and support (your denominator) resulting in your public support percentage. We have seen countless situations where a nonprofit has been reporting their Schedule A public support percentage at 100% for years, only to found out that the correct calculation is 20% or 30%. If this describes your situation, the 10% facts and circumstances test may allow you a short-term reprieve from this situation until you can get your public support above 33%.
The Schedule A of your Form 990 is arguably one of the most important areas of your 990. If you haven’t looked at how your organization (or how your CPA) calculates your public support percentage, it might be a good idea to review this calculation to ensure your organization will remain a public charity.