Expansion on Private Foundations

In the late 1960s, Congress introduced the private foundation rules into the Internal Revenue Code.  Congress was concerned that some charities were controlled by only a few people who were using these groups to improperly advance their private interests.  In these circumstances, such charities were abusing their exempt status.  Generally, under the private foundation rules, § 501(c)(3) groups that receive support from relatively few sources are deemed to be private foundations, and private foundations are more closely regulated than those § 501(c)(3) groups that are not private foundations.  Generally, these latter groups, which we call public charities in the text, are § 501(c)(3) groups which receive broad public support.

Generally, if a group is deemed to be a private foundation, philanthropies will be less likely to make grants to it.  Furthermore, individuals are less likely to contribute to private foundations real and tangible property and securities not listed on a public market.  In addition, private foundations must pay a small excise tax on their investment income.  Private foundations are also subject to strict self-dealing rules and subject to a virtual prohibition on lobbying activities.

All charities that are exempt from federal income taxation under § 501(c)(3) of the Code are then classified as public charities or private foundations pursuant to §509 of the Code.  This classification as a public charity or private foundation is of critical importance to donors of every kind.  §501(c)(3) groups that qualify under §§ 509(a)(1), (2) or (3) of the Code are not private foundations.  (Otherwise stated, they are public charities.)  509(a)(1) groups are divided into what in the text we called per se organizations, namely, schools, churches, and hospitals and those organizations which normally receive a substantial part of their support from what is referred to as public support.  For the latter group, public support consists of support from governmental agencies and community foundations and contributions from the general public to the extent that they do not exceed 2% of total support.  In effect a fraction is set up, called the public support fraction, and if the public support fraction is 1/3rd or more, the group passes the "mechanical" public support test and needs show no more.  If, however, the group has a public support fraction of more than 10% and less than 33 1/3% and it can show sufficient "facts and circumstances" pointing to its public nature, such as having a board made up of governmental officials and letting its facilities be used by the public, it will pass the public support test and qualify as a 509(a)(1) group.  Note that for §509(a)(1) groups, exempt function income (e.g., income from tuition or ticket sales) and capital gains are excluded from both the numerator and denominator of the public support fraction.  Unusual grants, such as a one-time start-up grant, are also excluded from the numerator and denominator of the public support fraction.

§509(a)(2) groups are organizations that normally receive a substantial part of their support from exempt function income, grants from governmental agencies and contributions from the public.  Here are some of the differences between a §509(a)(1) and (a)(2) group. For a §509(a)(2) group, the numerator of the public support fraction includes gross receipts from exempt function income in both the numerator and denominator.  Note, however, that if any such receipt exceeds $5,000 or 1% of total support for the year, it will not be included in the numerator to the extent of such excess.  Furthermore, the public support fraction must equal at least 33 1/3%, i.e., no 10% "facts and circumstances" test is available.  In addition, investment income plus certain net unrelated business income for a 509(a)(2) group cannot exceed 33 1/3% of support.  Finally, for a 509(a)(2) group, contributions from "disqualified persons" are not included in the numerator.  Disqualified persons include directors and officers or family of such persons and "substantial contributors." A substantial contributor is anyone who has contributed an aggregate amount of more than $5,000 if such amount is more than 2% of total contributions received by the organization before the close of its fiscal year.  Note that it is 2%, etc., of all contributions ever received by the organization rather than 2% total of support received during the taxable year, as is the case under 509(a)(1).

We have noted that so long as an organization normally receives the right amount of public support, it will qualify as a public charity.  An organization will be considered as normally receiving such support for its current year and the next one if, for the four years immediately preceding the current year, it met the applicable public support test.

509(a)(3) groups, called supporting organizations, are attached to §509(a)(1) or (a)(2) groups.  Generally, these groups must be set up to benefit and must be controlled by the supported organization, i.e., the §509(a)(1) or (a)(2) groups to which they are attached.   509(a)(3) groups do not need to meet any public support test and at the same time enjoy all the advantages of a public charity.

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