Form 1023 Part X (10) Public Charity Status & Private Foundations Explained
Form 1023 Part X – Public Charity Status
Part X (10) of the Form 1023 should have been at the top of the form 1023 application, but somehow ended up at the bottom. By filing the form 1023, you are petitioning the IRS to determine if you are eligible to be exempt from paying all or portion of you federal taxes. You are also letting the IRS know how you receive your income, and based on that information, the IRS will determine which sub category of the section 501 of the Internal Revenue Code you qualify under. The subcategories are:
- Private Foundations and Operating Private Foundations
- Public Charities
Here is the complete section from the IRS training manual for the agents who will determine your status. I’m giving you the ultimate answer sheet to your exams so you need to put in some effort and read the IRS manual for Determination of Public Charity Status a few times to familiarize yourself with what IRS is looking for. Do not proceed with the next chapter unless you have read this document.
In a nutshell, Private Foundations are generally treated less favorably than Public Charities. Why? The key to being a public charity is the support from the general public. Congress thought that the need to keep raising money from the general public would keep public charities honest. By contrast, Congress though that private foundations, living off the income from a large fund, controlled by a select few, with no need to demonstrate their good works to the public, would not keep honest without regulation. And they were right.
Private Foundations pay 1%-2% tax on net investment income and are subject to various prohibitions on transactions between themselves, and those who control them, including their directors. They are prohibited from lobbying, and pay taxes on any lobbying expenses, which, along with other prohibited expenditures, are known as taxable expenditures. Foundations are also subject to other regulations not applicable to public charities.
The deductibility of gifts to private foundations is somewhat more limited than to other than private foundations. Their donors’ identities are subject to public disclosure and, in general, foundations have more extensive reporting obligations. (Operating foundations that carry on charitable activity other than grant making are slightly less heavily regulated.)
To qualify as a public charity under the Internal Revenue Code, your nonprofit organization must meet the public charity test of 1/3 or 10%.
Public Charity Test of 1/3 or 10%
Example of 10% Public Charity Test:
Each of 11 directors gives Small Charity, Inc. $100.
Major Donor buys Small Charity, Inc. office furniture of $10,000.
Total support: $11,100.
2% of $11,100 = $220.
Major Donor’s contribution counts for only $220 of the numerator.
Equation: $1,100 (directors) + $220 (Major Donor) = 11.89% “public support” $11,100
Result: Small Charity, Inc. would fail the “1/3” test and have to argue it met the “10% + facts and circumstances” test in order to remain under 509(a)(1).
Example of 1/3 Public Charity Test:
Each of the 11 directors gives Small Charity, Inc. $100 for a total of $1,100.
The Community Foundation for Greater New Haven (a publicly supported organization) gives Small Charity, Inc. $2,000.
Total support: $3,100.
2% of $3,100 = $62
The equation is $62 x 11 directors + $2,000 = 86.5% $3,100
Result: Small Charity, Inc. passes the 1/3 support test with flying colors.
Of course refer to your Form 1023 instruction published by the IRS for the complete definition.
So how do you know if you are not a private foundation? The organization is not a private foundation because it is: (excluding, governmental churches, schools and hospitals)
- 509(a)(3)—an organization supporting either one or more organizations described in line 5a through c, f, g, or h or a publicly supported section 501(c)(4), (5), or (6) organization. Complete and attach Schedule D.
- 509(a)(4)—an organization organized and operated exclusively for testing for public safety.
- 509(a)(1) and 170(b)(1)(A)(vi)—an organization that receives a substantial part of its financial support in the form of contributions from publicly supported organizations, from a governmental unit, or from the general public.
- 509(a)(2)—an organization that normally receives not more than one-third of its financial support from gross investment income and receives more than one-third of its financial support from contributions, membership fees, and gross receipts from activities related to its exempt functions (subject to certain exceptions).
Every year the IRS adds changes and small instructions to the form 1023. Make sure you read these instructions on what sections you need to skip, while they revise the form.