Public Charity: Public Support Tests Part II: 509(a)(2)

A 501(c)(3) organization is presumed to be a private foundation unless it qualifies as a public charity. Part I of this post discussed how an organization can qualify as a public charity under one of two 509(a)(1) tests, either the one-third support test or the facts and circumstances test. Alternatively, an organization can qualify as a public charity under Section 509(a)(2) if it receives a substantial part of its income from activities related to the performance of the organization’s exempt purpose (i.e., related earned income) rather than from donations or investment income.

In order to qualify as a public charity under Section 509(a)(2), an organization (1) must normally receive more than one-third of its support from any combination of gifts, grants, contributions, membership fees, and gross receipts from certain permitted sources described below, and (2) must not receive more than one-third of its support from gross investment income and unrelated business income less tax. An organization must meet these tests – the One-Third Support Test and Not-More-Than-One-Third Support Test – in the aggregate over a five-year measuring period including the current taxable year and four prior taxable years.

To determine if an organization qualifies under 509(a)(2), three figures must be computed:

  1. Total support;
  2. Percentage of public support, which must exceed 33 1/3 percent of total support; and
  3. Percentage of investment income, which may not exceed 33 1/3 percent of the total.

Total Support

The sum of the following items, for the period in question, is the denominator of the fraction for computing both the percentage of public support and the percentage of investment income, further detailed below:

  •  Gifts, grants, contributions, and membership fees received
  • Gross receipts from admissions, merchandise sold or services performed, furnishing of facilities, or other business activities related to the charity’s exempt purposes
  • Gross investment income
  • Net income from unrelated business activities
  • Excluding: unusual grants

Percentage of Public Support


                        PUBLIC SUPPORT     

                       —————————              =    1/3 OR GREATER

                        TOTAL SUPPORT

An organization will be treated as a public charity under 509(a)(2) for its current year and the next taxable year if, over the five-year measuring period, one-third or more of its total support is public support, which generally includes donations, membership fees, gross receipts from admission, sales, performance of services, or furnishing of facilities related to an activity which is not an unrelated trade or business. There are, however, limitations with respect to what is included as public support. For example:

  • Gifts, grants, bequests, and gross receipts from the performance of exempt functions, if from a disqualified person, should not be included in the numerator. A disqualified person is generally defined to include a director, officer, substantial contributor (whose gifts to the charity exceed the greater of $5,000 or 2% of the total amount of donations received by the charity from its formation through the end of the taxable year in which the gift is made), owner of an entity that is a substantial contributor, and family members and 35% controlled entities of any of the foregoing.
  • Gross receipt amounts from the performance of exempt functions from government units, 509(a)(1) public charities, and individuals/entities that have not become disqualified persons as of the end of the taxable year may only be included in a taxable year up to the greater of $5,000 or 1% of the total support received by the charity in that taxable year.

Note that when computing the public support fraction, the entire amount of donations, membership fees, and exempt functions gross receipts for the period in question must be included in the denominator (total support), despite the limitations to such amounts in the numerator (public support). Unusual grants are excluded from this calculation.

It is important to note that the one-third public support test under 509(a)(2) is different from the one-third public support test under 509(a)(1). Both public support and total support are defined differently. In addition, there is no backup facts and circumstances test for organizations that have less than one-third public support under 509(a)(2).

If an organization is going to be making grants, it should understand the difference to its grantees between receiving a grant from a 509(a)(1) and a 509(a)(2) organization with respect to its characterization as public support. Contributions from organizations that qualify under 509(a)(1)/170(b)(1)(A)(vi) may be counted fully as public support, whereas contributions from other sources (including 509(a)(2) charities) are subject to a 2% cap as discussed in Part I.

Percentage of Investment Income


                    INVESTMENT INCOME

                       —————————              =    LESS THAN 1/3

                        TOTAL SUPPORT


Under 509(a)(2), an organization may not receive more than one-third of its total support from gross investment income and unrelated business income activities. Very generally, gross investment income is defined in the Internal Revenue Code as gross amounts of income from interest, dividends, rents, and royalties, excluding capital gains. Unrelated business taxable income includes net income derived from any trade or business which is not substantially related to the organization’s exempt purpose, keeping in mind certain applicable exceptions (e.g., volunteer, convenience, and donated good exceptions).

Therefore, at the end of each measuring period, the charity must compute a fraction with its total support as the denominator, and a numerator of gross amounts of income from interest, dividends, rents, and royalties, excluding capital gains, and any excess amount of unrelated business taxable income over the amount of tax imposed on that income.