If your nonprofit is just starting or in its early years, you might dream of a big grant that can cover most of your costs. But be careful what you wish for. The IRS's "public support test" looks at whether too much of your funding comes from a single source.
If it does, the IRS might change your status from public charity to private foundation. This effect is commonly referred to as "tipping."
The change from public charity to private foundation would subject your nonprofit to a series of complex legalities and payout requirements which public charities do not need to meet. The public support test is administered within the nonprofit's first five years using the organization's tax returns from the first four years.
According to the IRS, an organization is a publicly supported charity if it meets one of two tests:
1. The organization receives a substantial part of its support in the form of contributions from publicly supported organizations, governmental units, and/or the general public. Example: A human service organization whose revenue is generated through widespread public fundraising campaigns, federated fundraising drives, or government grants is a publicly supported charity.
2. The organization receives no more than one-third of its support from gross investment income and more than one-third of its support from contributions, membership fees, and gross receipts from activities related to its exempt functions. Examples: A membership-fee organization...or an arts group with box office revenue is a publicly supported charity.
An organization that meets the public support test for a tax year is treated as a publicly supported charity for that year and the succeeding year, regardless of its actual support for the succeeding year. For example, if an organization meets the public support test for the 2014 tax year, it is classified as a public charity for the 2014 and 2015 tax years. If, however, the organization does not meet the public support test for 2016 (as well as 2015), it will be reclassified as a private foundation starting at the beginning of the 2016 tax year....An organization should contact the IRS if it believes that private foundation excise taxes and/or penalties should not be asserted against it due to its unexpected failure to meet the public support test.
IRS Pub. 557: Tax-Exempt Status for Your Organization has a section titled, "Qualifying as Publicly Supported" that describes how to look at where your organization's funding comes from and calculate your level of public support.
Also, most handbooks on establishing a nonprofit organization have a section on calculating public support. The Everything Nonprofit Toolkit, for example, has a section called "Public and Private Funding." Borrow this book through our digital collection on Overdrive.
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