What is the Public Support Test?
Of all the rules and regulations that govern nonprofit 501(c)(3) organizations, the rules pertaining to the public support test are among the least understood topics, especially by smaller organizations filing as public charities. Despite its lesser-known status, it is essential to understand the public support test, lest your organization lose its public charity status and the incentives to donors along with it. Losing it often means disaster for an organization. The public support test is the defining factor between what makes an organization a public charity rather than a private foundation. Maintaining this status is essential to supporting the thin margins that public charities operate on and supporting their fundraising goals that are successful through donor incentives.
How the Public Support Test Works
The public support test is a tool used by the IRS to differentiate between private foundations and public charities; each has different structures and functions and therefore receives different tax incentives. Private foundations are typically closely-governed, and the purpose of most private foundations is to fund the work of public charities. Private foundations can also be funded by a limited number of and related donors, such as a single-family. The size and diversity of donors are what differentiate a private foundation from a public charity. A public charity is required to have a broad base of public support which is tested by the public support test. The public support test states that at least 1/3 (33.3%) of donations must be given by donors who give less than 2% of the nonprofit’s overall receipts. There are a few exceptions to the test: gifts received from other donative public charities, government sources (grants, contracts, etc.), and revenues from goods or services can count toward the public support test in support of diversity of donors. In a simple example, an organization that receives $1 million in donor support must receive at least $333,000 from donors each giving less than $20,000.
Why Does Your Organization Need to Pass the Public Support Test?
This may seem like an odd and unnecessarily complex rule, but it works to make sure organizations are not structured like a foundation while benefiting from a 501(c)(3) public charity status. If a public charity fails the public support test, it has one more chance to retain its status before being downgraded to a foundation. If it still has the public support of at least 10%, it can then undertake the facts and circumstances test which is a subjective request to the IRS on the organization’s Form 990 to allow the organization to retain its public charity status. The organization must claim that it is operating as a charity, not a foundation and that they are actively working to get their public support percentage back up to 33%. If the IRS finds their claim reasonable, it often allows a temporary stay of public charity status pending improvement of public support, but organizations that drop below 10% public support will be downgraded.
Many people use the term foundation, charity, or even 501(c)(3) interchangeably but the specific designation matters legally and strategically for nonprofit organizations. Losing public charity status when it is the preferred choice of an organization can seriously challenge and even close down an organization. The main reason an organization organizes and files as a private foundation rather than a public charity is because of control. A private foundation can be controlled by related individuals, often families or even by an individual. Because of the opportunity for strict control by few and related individuals, the organization accepts disadvantaged deductibility limits compared to public charities. For this reason, a nonprofit organized as a public charity but filing as a private foundation is at a disadvantage by missing out on higher donor tax-deductibility giving limits.
While the public support test ensures that nonprofits that reap the benefits of public charity status are in fact public charities, it also directs nonprofits to issues that should always be on their radar, curating a diverse and dynamic donor base. Understanding the value of an organization’s donor population as well as constantly working to improve it, bolsters a nonprofit’s financial health and supplements the quality of the public support it receives. Vigilantly growing a donor network and auditing the health of your organization is essential to remaining a financially and legally viable public charity.
Ready to launch your nonprofit or small business to a new level of efficiency and success? Reach out to the consultants at NMBL Strategies to learn more about how we put our 30+ years of nonprofit and small business executive experience into action. Contact us today!
