IRS Public Support Test: "Tipping"
Tipping and Public Charity Status
"Tipping" refers to an overly-large grant (made by a private foundation or individual contributor) to a tax-exempt not-for-profit organization that qualifies as a "public charity" under IRS rules and regulations. Public charity status is beneficial to tax-exempt organizations since it avoids numerous excise taxes and maximizes the tax deductions for contributions made by donors to the organization. Tipping can interfere with the public charity status of the recipient organization because the large dollar amount may cause certain IRS tests to be violated.
Public charity status generally requires one-third of the organization's support to come from the general public and/or governmental sources (the "public support test"). Large grants can easily upset this ratio, causing a loss of public charity status. In a year when a large grant is received which would otherwise violate this one-third public support test, an alternative test (called the "facts and circumstances" test) may be used to preserve public charity status. This test drops the public support to 10% and requires certain other subjective factors to be met. The subjective aspect of the test is whether the charity's operational and fund-raising activities are designed to attract support from the government, the general public and other charitable organizations.
Applying the Tests
Both the "public support test" and the "facts and circumstances test" are determined by adding up the support received over the organization's first four years (or the life span of the charity, whichever is less). If either test is met based on years 1 through 4, the organization qualifies as a public charity for years 5 and 6, unless substantial changes in its character, purposes, or method of operations have occurred during years 5 and 6. Under both tests, a single donor's contributions, no matter how large, can only be counted as part of public support in an amount not exceeding 2% of the organization's total support. Also, "unusual grants", if certain criteria are met, may be entirely ignored in these calculations.
If the tests are met during this initial 4 to 6 year period, the organization will retain public charity status unless a "material change" in support occurs so that the organization no longer "normally" meets either test.
Impact of Tipping on the Charity
Failing these tests and losing public charity status could impact the level of deductibility of individual donor contributions and would cause other charitable donors (foundations) to potentially have "taxable expenditures". In addition, tipping a public charity would terminate the charity's exemption from excise taxes (the 2% and 1 % tax on investment income, the tax on failure to distribute 5% of assets annually; and the taxes on taxable expenditures).
Impact of Tipping on the Grantmaker
Generally, foundations are not penalized when one of their grants tips a charity into private foundation tax status if: the grantee organization provides the foundation with a valid IRS determination letter when the grant is awarded, the foundation is unaware of any current or planned revocation of the letter by the IRS, and the foundation does not directly or indirectly control the grantee.
Advance Ruling Available for New Organizations
New organizations can generally request an advance ruling from IRS that can offer protection to donors during the advance ruling period, which can be as long as six years, depending on the situation. The benefit of an advance ruling is that the charity is deemed to be a public charity from its inception, and donors will get public charity treatment for their donations, even if ultimately the organization does not qualify.
Tests Reapplied at End of Advance Ruling Period
At the end of the advance ruling period, the charity either qualifies as a public charity (based on its activities during the ruling period), in which case there is no problem, or it does not qualify, in which case certain taxes that apply to private foundations would be imposed upon the charity (including the 2% or 1 % investment income tax). New charities should strongly consider applying for an advance ruling, giving it up to six years to plan for these "tipping" issues, and allowing potential donors to participate from the outset without any adverse consequences.
Consult Your Tax Advisor
Every public charity should regularly consult its tax advisor to ensure that its public charity status is protected. If your charity is presented with large contributions and/or your pool of contributors is small, this ongoing qualification process could create challenging planning issues that must be continually be monitored.
The Dyson Foundation is providing the above for informational purposes only, and recommends that you contact your tax or legal advisor to determine the impact on your organization.
In addition, you may learn more about the public support test by visiting these and other web pages:
Internal Revenue ServiceInternal Revenue ServiceInternal Revenue Service
The Council on Foundations – Foundation News & Commentary article