IRS Manual for Determination of Public Charity Status

This document is the complete extract from the determination of public charity status section of the IRS procedure and guideline used by federal agents to evaluate your tax exemption application (it is the manual that IRS agents use to evaluate your application) . This text is invaluable because it pin points what they are exactly looking for in your application. It is also of utmost importance that exempt organizations read this manual and familiarize themselves with the laws and limitation involved in fundraising activities, which non-compliance  to these laws can result in revocation of the exempt status of the organization.

Determination of Public Charity Status


  1. For an organization to be described as a public charity exempt under IRC § 501(c)(3), it must meet both the organizational and operational test, not permit earnings to inure to the benefit of private individuals, not engage substantially in legislative activities, and not engage in any political activity. Therefore, an examination will consist of procedures designed to verify compliance with these requirements.
  2. The examiner’s responsibility is to ensure the organization under examination meets these requirements and continues to qualify as exempt from Federal income tax under IRC § section 501(c)(3).


  1. The intent of this IRM section is to provide guidance to the examiner in verifying the correctness of an organization’s private foundation status under IRC § 501(c)(3). It does not contain a detailed technical discussion regarding the components of the public support tests. See IRM 7.26 for technical instruction.
  2. In the examination of a publicly supported IRC § 501(c)(3) organization, the examiner should not simply accept the organization’s current classification status but rather ascertain that it continues to qualify under its current status.

Foundation Status

  1. IRC § 509(a) provides that all organizations, foreign and domestic, described in IRC § 501(c)(3) are “private foundations” except for those described in IRC § 509(a)(1), (2), (3), or (4).”Public charities” is the generic term given to the excepted organizations.


All IRC § 501(c)(3) organizations are either private foundations or public charities. All IRC § 501(c)(3) organizations are presumed to be private foundations unless they are described in IRC § 509(a)(1), (2), (3), or (4).

  1. Public Support Organizations described in IRC §§ 509(a)(1) and 170(b)(1)(A)(i), (ii), (iii), and (v) are public charities without having to meet the general public or government financial support tests to establish their status as public charities.
  2. Organizations described in IRC §§ 509(a)(1) and 170(b)(1)(A)(iv) have to meet a public support test, but it is not discussed in this section. See Rev. Rul. 82-132, 1982-2 C.B. 107.
  3. While organizations described in IRC §§ 509(a)(3) and (4) must show that they are organized and operated for the purposes pursuant to their respective code sections, they are not required to meet certain public support tests in order to be excluded from private foundation classification.
  4. Two classifications of organizations remain that must show they meet the prescribed public support test(s) in order to be excluded from private foundation classification:
    • IRC § 170(b)(1)(A)(vi)
    • IRC § 509(a)(2)

Foundation Status 509(a)(1)

  1. This code section excludes from private foundation classification those organizations described in IRC §§ 170(b)(1)(A)(i) through (vi). The following are examples of organizations described in the referenced code sections:
    • IRC § 170(b)(1)(A)(i) – Churches
    • IRC § 170(b)(1)(A)(ii) – Schools
    • IRC § 170(b)(1)(A)(iii) – Hospitals
    • IRC § 170(b)(1)(A)(iv) – Endowment funds for a state university’s library
    • IRC § 170(b)(1)(A)(v) – Governmental entities
    • IRC § 170(b)(1)(A()vi) – Publicly supported charities, e.g. United Way


IRC § 509(a)(1) organizations engage in inherently public activities.

Foundation Status 509(a)(2)

  1. This code section excludes from private foundation classification those publicly supported organizations that receive more than one-third of support from gifts, grants, contributions, membership fees, and certain gross receipts but not more than one-third from gross investment income and net unrelated business taxable income.


IRC § 509(a)(2) organizations are supported primarily by exempt function income. Exempt function income is described as funds derived from an activity which is not an unrelated trade or business.

Foundation Status 509(a)(3)

  1. This code section excludes from private foundation classification those organizations that, in general, support organizations described in IRC § 509(a)(1) or (2), although they themselves are not publicly supported.

Foundation Status 509(a)(4)

  1. This code section excludes from private foundation classification those organizations that are organized and operated for the purpose of testing products for public safety. An example of this type of organization is an organization that performs safety tests for pleasure boats and boating equipment. Rev. Rul. 65-61, 1965-1 C.B. 231.

Non-Private Foundation Classification Status

  1. As a general rule, the Service gives an organization the “highest” foundation classification status for which it qualifies. The following list depicts the hierarchy of code sections describing an organization exempt from private foundation classification and Federal income tax, ranked in order of most advantageous classification to the least.
    1. IRC § 509(a)(1) and IRC § 170(b)(1)(A)(i) – Not required to apply to the Service for recognition of exempt status and not required to file Form 990/990-EZ.
    2. IRC § 509(a)(1) and IRC §§ 170(b)(1)(A)(ii), (iii), (v) Exempt from some excise taxes, however unrelated business income tax (UBIT) is applicable. No requirement to meet a public support test.
    3. IRC § 509(a)(1) and IRC § 170(b)(1)(A)(iv), (vi) – A private foundation can terminate its exempt status without taxable consequences by distributing its net assets to an entity described in these code sections. Higher dollar limitations apply to contributions made by individuals and corporations. These organizations can have an organization described in IRC § 509(a)(3) supporting it.
    4. IRC § 509(a)(2) – These organizations can have an organization described in IRC § 509(a)(3) supporting it.
    5. IRC § 509(a)(3) – Not a private foundation. No public support test required but required to meet certain organizational and operational tests related to the organization it supports. It can also be an organization exempt under IRC §§ 501(c)(4), (5), or (6) if it also would be described in IRC § 501(c)(3) and § 509(a)(2).
    6. IRC § 509(a)(4) – Not a private foundation. Its purpose is to conduct tests for public safety.

IRC §§ 509(a)(1) and 170(b)(1)(A)(vi) Guidelines

  1. An organization described in IRC §§ 509(a)(1) and 170(b)(1)(A)(vi) is one that:
    • Is referred to in IRC § 170(c)(2) and
    • Normally receives a substantial part of its support from governmental units, direct or indirect contributions from the general public, or a combination of these sources.
  2. Normally means the organization meets the support computation test for the aggregate of the four taxable years preceding the year under examination. If it satisfies the test, it is considered as also having met it for the current and next taxable year. Treas. Reg. § 1.170A-9(e)(4)(i).
  3. The terms gifts and contributions in the context of the public support test have the same meaning as they have under IRC § 170(c). Any payment of money or transfer of property without adequate consideration is defined as a gift or contribution. Where payment is made in exchange for admissions, merchandise sales, services performed or facilities furnished to the donor, payment is considered a gift or contribution only to the extent it exceeds the value of the exchange.
  4. Where property constitutes the gift or contribution, the amount includible in computing public support is the property’s fair market value or rental value on the date the donor makes the gift. Treas. Reg. § 1.509(a)-3(f)(2).
  5. The public support test is satisfied by meeting either a 33 1/3 percent test or alternatively, a facts and circumstances 10 percent test.The amount of public support that is includible for purposes of the test(s) is modified by limiting contributions, gifts and grants from certain individuals, corporations, trusts and organizations to two percent of total support.
  6. For purposes of verification during an examination, generally the examiner should use the mechanical test to compute the organization’s public support and total support based upon its four preceding taxable years’ income. Treas. Reg. § 1.170A-9(e)(4)(i), (ii)(iii). See Exhibit 4.76.3-1 for ramifications of the normally meets rule.
  7. The mechanical test is a fractional computation. The numerator consists of the organization’spublic support (subject to certain limitations and exclusions), as defined in the Code and Treasury Regulations. Treas. Reg. § 170A-9(e).
  8. The denominator consists of the organization’s total support (also subject to some exclusions).

Public Support

  1. The following amounts are qualifying public support includible in the numerator:
    • Contributions, gifts, bequests (direct or indirect) from the general public (individuals, corporations, trusts)1
    • Contributions from organizations described in IRC § 170(b)(1)(A) (other than clauses (vii) and (viii)) if organization would also qualify under IRC § 170(b)(1)(A)(vi)1
    • Contributions, gifts, grants from organizations described in IRC § 170(b)(1)(A)(1)(vi)1
    • Contributions, gifts, grants from organizations described in IRC § 509(a)(2) 2
    • Contributions, gifts, grants from organizations described in IRC § 509(a)(3) 2
    • Contributions, gifts, grants from private foundations described in IRC § 509(a) 2
    • Contributions, gifts, grants from other organizations described in IRC § 501(c) (e.g., civic organization, union, business league) 2
    • Support from governmental units 1
    • Tax revenues levied for the benefit of the organization
    • Membership fees (for purposes of organization’s support only)2

1 See percent limitation discussion in IRM Otherwise, included in full.
2 Two percent limit applies.

  1. The following amounts are not public support and are not includible in the numerator:
    • Contribution of services for which no deduction is allowed
    • Membership fees from related activities (such as admission fees)
    • Income from an unrelated trade or business (whether or not taxable per IRC § 513)
    • Investment income, interest, dividends, rents, royalties
    • Capital gains
    • Value of any exemptions from tax (federal, state, local)
    • Loan repayments
    • Unusual grants

Total support

  1. Total support for purposes of calculating the denominator in this test Includes:
    • 100% of contributions, gifts, bequests (direct or indirect) from the general public (individuals, corporations, trusts)
    • 100% of contributions from organizations described in IRC § 170(b)(1)(A) organizations (other than clauses (vii) and (viii)) if organization would also qualify under IRC § 170(b)(1)(A)(vi)
    • 100% of contributions, gifts, grants from organizations described in IRC § 170(b)(1)(A)(vi)
    • 100% of contributions, gifts, grants from organizations described in IRC § 509(a)(2)
    • 100% of contributions, gifts, grants from organizations described in IRC § 509(a)(3)
    • 100% of contributions, gifts, grants from private foundations described in IRC § 509(a)
    • 100% of contributions, gifts, grants from other IRC § 501(c) organizations (e.g., civic organization, union, business league)
    • All support from governmental units
    • Tax revenues levied for the benefit of the organization
    • 100% of membership fees (if made for organization’s support only)
    • Net income from unrelated activities, whether taxable or not under IRC § 513
    • Gross investment income, interest, dividends, rents, royalties
    • Value of services or facilities furnished by a governmental unit without charge
  2. The following are excluded from the total support denominator:
    • Contribution of services for which no deduction is allowed
    • Unusual grants
    • Income from organization’s activities constituting its basis for exemption (e.g., theater admissions of an exempt performing arts organization)
    • Government support for carrying out a related activity
    • Capital gains
    • Contributions of non-deductible services
    • Value of any exemptions from tax (federal, state, local)
    • Loan proceeds or repayments

Two Percent Limitation

  1. To the extent that a single donor’s contribution exceeds 2 percent of an organization’s total support, it is not considered public support. Therefore, the excess is excluded from the numerator of the public support fraction. However, the entire amount of the contribution is included in the denominator of the fraction. Treas. Reg. § 1.170A-9(e)(6)(i).
  2. The 2 percent limitation also applies to any person(s) or entity related to the donor in a manner described in IRC § 4946(a)(1)(C) through (G) as if made by the donor. For example, a husband and wife would be treated as one person for purposes of the 2 percent limitation.
  3. In general, the 2 percent limitation does not apply to support from:
    • Other IRC § 170(b)(1)(A)(vi) organizations
    • Governmental units referred to in IRC 170(c)(1)
    • Organizations that normally receive substantially all support from direct or indirect general public contributions, are described in IRC § 170(c)(2), and would qualify for IRC § 170(b)(1)(A)(vi). See Rev. Rul. 78-95, 1978-1 C.B. 71.
  4. Exception: If a contribution, gift or grant from a governmental unit, another IRC § 170(b)(1)(A)(vi) organization, or a IRC § 170(c)(2) organization is earmarked for the recipient organization (commonly referred to as a ” pass-through” ), it is also subject to the 2 percent limitation.

Facts and Circumstances Test

  1. When an organization fails to meet the 33 and 1/3% publicly supported test, the examiner must then evaluate its IRC §§ 509(a)(1) and 170(b)(1)(A)(vi) status based on the facts and circumstances test described in Treas. Reg. § 1.170A-9(e)(3). However, first the organization must meet the 10% or more public support test.
  2. If an organization receives at least 10 percent (but less than 33 1/3 percent) of its total support from contributions made directly or indirectly by the general public or from governmental units, then the examiner can look to the facts and circumstances test to determine if the requisite public support characteristics are present.
  3. Once the 10 percent test has been satisfied, factors to consider when analyzing whether the organization meets the facts and circumstances test include:
    • Ability to attract public support
    • Percentage of public support above the 10 percent threshold
    • Sources of support
    • Representative governing body
    • Availability of facilities or services
  4. The examiner will want to expand on these concepts by weighing factors listed in Exhibit 4.76.3-2 and considering the following:
  1. Does the organization receive support from a representative number of people or members of a single family?
  2. Are its activities limited to a particular region or a specialized field that would limit the sources of support?
  3. Does the organization’s governing body represent broad interests of the general public rather than private interests of a limited number of donors?
  4. Does the organization disseminate its programs, seminars, benefits, etc. to the general public? Is the general public familiar with the organization’s specific mission?
  5. Are facilities and services provided directly to the general public on a continual basis?
  6. Does the organization receive a significant part of its funding from a public charity or governmental agency that holds the organization accountable as a condition of its funding?
  1. There are no set procedures for the compilation of facts and circumstances. Here are some suggestions to assist the examiner in making a determination under the facts and circumstances test:

.                    Interview of the organization’s officials. Do they have plans to expand the organization’s support base? If so, how do they expect to accomplish that?

  1. Interview officials and review board of director or committee meeting minutes. Does the organization have a long-range plan to broaden the field to which it appeals?
  2. Find out whether the board includes public officials or people employed by public officials, experts in the organization’s field of operations, community leaders or officers voted in by a broad based membership.
  3. Read the organization’s publications and consider how it makes itself and its mission known to the public.
  4. Interview those responsible for the accounting functions within the organization. To whom do they provide financial statements and reports?
  1. An interview of the organization’s officials can suffice if it is close to meeting the 33 1/3% public support test and in the examiner’s judgment, the organization is likely to qualify for the higher status. In more ambiguous circumstances, the examiner should secure written statements from the organization augmented by any copies of fund-raising literature as substantiation in the event of an adverse determination of exempt status.
  2. In the case of membership organizations, the examiner should consider the following:

.                    Does the organization solicit dues to enroll a substantial number of persons in only a narrow community/area or a particular profession or field of interest?

  1. Is the organization’s membership fee structure designed to make membership available to a broad cross-section of the interested public?
  2. Are the organization’s activities likely to appeal to a broad cross section of the public?
  1. Regardless of the method by which the examiner compiles facts and circumstances, they must be documented as part of the public support test in the case file workpapers.

IRC §§ 509(a)(1) and 170(b)(1)(A)(vi) Issues

  1. Identifying Unusual Grants – An unusual grant may be excluded from both the numerator and denominator of the applicable support test under IRC § 170(b)(1)(A)(vi). The intent of the unusual grant exclusion is to exclude substantial contributions and bequests from disinterested parties that are attracted by reason of the publicly supported nature of the organization. If significant in amount, it may make the difference between a public or private foundation determination. Therefore, its proper identification is important. See Exhibit 4.76.3-3 for factors that weigh in favor of or against the income being classified as an unusual grant. To assist in determination of questionable grant classification, the examiner’s audit steps should include the following:
    1. Ask whether the organization has received a private letter ruling concerning the unusual grant. (Representatives frequently request rulings in this area.)
    2. Secure any correspondence or documentation that accompanied the grant. Was the contribution a bequest or an inter vivos transfer? A bequest is more indicative that the amount met the requirement to be”unusual” or unexpected. Documentation should also disclose whether material restrictions or conditions have been imposed by the transfer of the gift or grant
    3. Review organizing documents and the organization’s minutes to determine the relationship of the donor to the organization. Did the grant come from a truly disinterested party? Contributions from non-related parties are given more favorable consideration than those from individuals with prior and/or close involvement with the organization.
    4. Review the minutes and the cash receipts journal to determine if the contributor directly or indirectly exercises control over the organization.
    5. Review any notes to the organization’s audited financial statements and lists of contributors to determine whether the organization continually relies on unusual grants to fund an organization’s operating expenses. This may lead the examiner to conclude that the organization cannot reasonably be expected to attract future support from the general public.
  2. Distinguishing Between Contributions and Gross Receipts – It is important to note that gross receipts derived from a related trade or business (e.g., admissions to performances) are excluded from the numerator and the denominator when calculating the public support test for IRC §§ 509(a)(1) and 170(b)(1)(A)(vi). However, if the income is derived from an unrelated trade or business, it is excluded from the numerator but included in the denominator for total support. The examiner should apply the rules of IRC § 513 and Treas. Reg. § 1.513-1(d) to determine whether the support is or is not related to the organization’s exempt purpose.
  3. Amounts Paid Under Government Contract – Generally, governmental support is not subject to the two percent limitation and is includible in full in both the numerator and the denominator for the public support test, but there is an exception. If a donor makes an indirect contribution (one earmarked for the benefit of a particular recipient) through a governmental unit, the contribution is subject to the two percent limitation. In that case, the publicly supported organization or governmental unit is acting as a conduit, so the contribution is treated as having been made by the original donor. The examiner should also consider whether or not the government grant is given to the organization for the purpose of carrying out the organization’s exempt purposes. If that is the case, the grant amount is excluded from in its entirety from the numerator and the denominator.
  4. Assignment of Income in Old Age Homes and Public Support – There has been considerable litigation involving old age homes and public support. See Williams Home, Inc. v. United States and Miller Home, Inc. v. United States, 540 F. Supp. 310 (W.D. Va. 1982). The courts ultimately concluded that assets assigned to the homes by the applicants were exempt function income and did not represent public support. Significant points raised in the issue were:
    1. The transfer of assets was due to the insistence of the home rather than any disinterested generosity from the applicants.
    2. Treas. Reg. § 1.170A-9(e)(3)(i) (facts and circumstances test requiring that an organization receive at least 10 percent of its income from public contributions ) was valid; although the court did note even though the regulations were not contemporaneous with the enactment of IRC § 170, they were contemporaneous with and necessary to the enactment and purposes of IRC § 509.
    3. Treatment of Gaming Income In Public Support Determinations – In determining if an organization is described in IRC § 170(b)(1)(A)(vi), gross receipts not from an unrelated trade or business, including, for example, bingo receipts which are non-taxable under IRC § 513(f) are generally excluded from public support computations. See IRM 4.76.50 for further discussion.
  5. IRC § 513(i) and Sponsorship – Treas. Reg. § 170A-9(e)(6)(i) was amended in 2002 to reflect the final regulations regarding corporate sponsorship payments to exempt organizations. It states that the term “contributions” includes qualified sponsorship payments (as defined in Treas. Reg. § 1.513-4) in the form of money or property but not services.
    1. Treas. Reg. § 1.513-4, published at 67 Fed. Reg. 20,433 (April 25, 2002), provides that a qualified sponsorship payment is one made by anyone engaged in a trade or business and one for which there is no arrangement or expectation that a substantial benefit will be received in return for the payment. It does not matter whether or not the sponsored activity is related to the organization’s exempt activity, nor whether the activity is temporary or permanent.
    2. Payment means money, transfer of property, or performance of services.


Qualified sponsorship payment per Treas. Reg. § 1.513-4 includes the value of services performed, but public support does not include such value per IRC § 170A-9(e)(6)(i).

    1. “Substantial benefit” means other than the use or acknowledgment of the sponsor’s name or logo in connection with the activity and other than certain goods or services that have an insubstantial value.
    2. “Benefits” include: (1) advertising, (2) exclusive provider arrangements (as defined in Treas. Reg. § 1.513-4(c)(2)(vi)(B)), (3) goods, facilities, services or other privileges, (4) exclusive or nonexclusive rights to use an intangible asset (e.g., trademark, patent, logo, or designation).
    3. Treas. Reg. § 1.513-4(c)(2) describes a “substantial return benefit” that can be disregarded. However, if the aggregate “fair market value” of all benefits provided to the sponsor (payor) in the exempt organization’s taxable year equals 2% or more of the total amount of the payment, the entire payment amount is considered a substantial benefit, not just the excess of the 2%.
    4. The final regulations provide that in determining whether the 2% threshold has been exceeded in any year, all return benefits (other than use or acknowledgment) must be considered. Therefore, when the examiner reviews sources of income relative to the public support test for IRC § 170(b)(1)(A)(vi), he/she should look at any corporate sponsorship payments received during the pertinent taxable year(s) and consider whether there were any return benefits. If so, is there is a viable issue to pursue?


An exempt organization received $100,000 in a qualified sponsorship payment during its fiscal year ending 12/31/01. Certain return benefits to the payor were included in that amount. The agent determined $900 was the fair market value for advertising (as defined in Treas. Reg. § 513-4(c)(2)(v)), and $500 was the fair market value for a license (as defined in Treas. Reg. § 1.513-4(c)(2)(vi)(B)). The aggregate fair market value of return benefits to the payor in FY 01 was $1,400, which was less than 2% of the $100,000 payment received ($2,000). Therefore, $1,400 is considered a disregarded benefit amount for purposes of Treas. Reg. § 1.513-4(c)(2)(ii). The total payment amount of $100,000 is included in the public support test for IRC § 170(b)(1)(A)(vi).


The same facts as in the previous example, except the agent determined the advertising’s fair market value was $5,000, and the license’s was $10,000. Since the aggregate fair market value of return benefits to the payor was $15,000, they exceeded 2% of the $100,000 ($2,000) and are not considered disregarded benefits. Therefore, the qualified corporate sponsorship payment for purposes of the public support test for IRC § 170(b)(1)(A)(vi) is $85,000 ($100,000 total payment less $15,000 substantial benefits)

    1. See Exhibit 4.76.3-4 for a summary of these rules.

Examination of Books and Records

  1. When examining the books and records to determine public support, the examiner should:
    1. Verify the correct classification of gifts, grants and contributions on the organization’s financial statements.
    2. Note any exceptions to gross receipts classification on the IRC § 509(a)(1) workpapers for possible further consideration. For example, if the organization’s financial statements and contracts reveal the contributions are really gross receipts (e.g., admissions to performances), the organization may then only be eligible for public foundation status under IRC § 509(a) (2).
    3. Examine the cash receipts journal and review correspondence by members to confirm that membership fees were without consideration, i.e. thank-you letters indicating income from admissions, merchandise, services or the use of facilities, which may indicate gross receipts versus contributions.
    4. Review any correspondence files that accompanied contributions by publicly supported organizations to ensure contributions were not earmarked for the recipient.
    5. Include tax revenues levied for the benefit of the organization or expended on behalf of the organization as well as the value of in-kind services or facilities from a governmental entity. (For example, this is found commonly in volunteer fire and rescue organizations.)
    6. Use contributors’ correspondence and consult Pub. 78 to workpapers regarding which contributors hold a public charity status to determine if certain gifts, grants and contributions from governmental and public charity sources are exempt from the 2% limitation in the public support test.
  2. See Exhibit 4.76-5, for a sample support test computation worksheet.

IRC § 509(a)(2) Guidelines

  1. An organization described in IRC § 509(a)(2) has a similar basis for public charity status as one described in IRC §§ 509(a)(1) and 170(b)(1)(A)(vi). Many of the same factors discussed in IRM 4.76.4 apply to an IRC § 509(a)(2) public charity as well, such as the definition of normally, the treatment of unusual grants, and use of the cash basis of accounting to calculate the public support test. The public support tests for IRC § 509(a)(2) status are designed to insure an organization is responsive to the general public rather than a limited number of donors or other persons.
  2. An organization described in IRC § 509(a)(2) is one that:
    • Typically derives most of its gross receipts from an activity related to its exempt function and
    • Receives less than 33 1/3 percent of its total support from investment income and unrelated business income.
  3. While organizations claiming IRC §§ 509(a)(1) and 170(b)(1)(vi) status only have to satisfy one test, organizations claiming IRC § 509(a)(2) status must satisfy two tests:
  1. It must normally receive more than one-third of its support from any combination of gifts, grants, contributions, membership fees, and gross receipts from permitted sources, and
  2. It must not receive more than one-third of its support gross investment income and unrelated business income less tax imposed by IRC § 511.
  1. Normally means the organization meets the support test in the aggregate for the four taxable years preceding the year under examination. If it does, it is considered as having met it for the current and succeeding taxable year. Treas. Reg. § 1.509(a)-3(c).
  2. The terms gifts and contributions in the context of the public support test have the same meaning as they have under IRC § 170(c). Any payment of money or transfer of property without adequate consideration is defined as a gift or contribution. Where payment is made in exchange for admissions, merchandise sales, services performed or facilities furnished to the donor, payment is considered a gift or contribution only to the extent it exceeds the value of the exchange.
  3. Where property constitutes the gift or contribution, the amount includible in computing public support is the property’s fair market value or rental value on the date the donor makes the gift. Treas. Reg. § 1.509(a)-3(f)(2).
  4. The examiner generally should verify the organization’s foundation status by using the mechanical test to compute the organization’s public support and total support based on its current and four preceding taxable years’ income. See Exhibit 4.76.3-6 for ramifications of the normally meets rule.
  5. The mechanical test is a fractional computation. The numerator represents the organization’s public support (subject to certain limitations and exclusions), as defined in the Code and Treasury Regulations. Treas. Reg. § 1.509(a)-3(a)(2) and (3).
  6. The denominator is the organization’s total support (also subject to some exclusions).

Public Support – Permitted Sources

  1. First, the organization must normally receive more than one-third of its support in each taxable year from any combination of “permitted sources” per Treas. Reg. § 1.509(a)-3(2). These sources are counted as public support and are included in the numerator of the support calculation:
    • Contributions, gifts, bequests (direct or indirect) from the general public (individuals, corporations, trusts)1
    • Contributions from organizations described in IRC § 170(b)(1)(A) (other than clauses (vii) and (viii)) and governmental units (for public benefit)
    • Contributions, gifts, grants from organizations described in IRC § 509(a)(2) or (3)1
    • Contributions, gifts, grants from private foundations described in IRC § 509(a)1
    • Contributions, gifts, grants from other organizations described in IRC § 501(c) (e.g., civic organization, union, business league) 1
    • Governmental unit support from contracts or grants (for government’s benefit or to carry out related activity)1, 2
    • Membership fees (for admissions, merchandise, etc.) 1, 2
    • Membership fees (to provide support only)
    • Gross receipts from a related activity (e.g., admission fees, merchandise sales, services performed, furnishing facilities)1, 2
    • Rents (related activity or other) 1, 2
    • Taxes levied for benefit of the organization

1 Does not include amounts received from disqualified persons defined in IRC § 4946(a)(1).
2 See $5000/1 percent limitation discussion in IRM

  1. The following amounts are not public support and are not includible in the numerator:
  1. Dividends and interest
  2. Unusual grants
  3. Unrelated business income (net).
  4. Capital gains
  5. Loan proceeds.
  6. Amounts from disqualified persons
  1. Treas. Reg. § 509(a)-3(a)(2) excludes disqualified person (with respect to the organization) from “permitted sources” that go into the public support calculation.
    • IRC § 4946(a)(1) defines disqualified person.
    • Among other terms, the definition includes a substantial contributor.
    • IRC § 507(d)(2) defines a substantial contributor as an individual, trust, estate, partnership, association, company or corporation who contributed or bequeathed an aggregate of $5,000 (providing the $5,000 is more than two percent of cumulative contributions the organization received before its taxable year-end in which the contribution is received).
    • From the date a person first meets the $5,000 and two percent test, he remains a substantial contributor, even if his contributions become less than 2 percent of total contributions in years hence. Treas. Reg. § 1.507-6(b)(1).
    • An organization described in IRC §§ 509(a)(1), (2) or (3) is not a substantial contributor. Treas. Reg. § 1.507-6(a)(2).
    • Example: Individual A makes a $3,500 contribution to organization B on September 30, 2000. A makes another $3,500 contribution to B on March 31, 2002. During its entire existence through December 31, 2002, B has received a total of $250,000 in contributions from all sources.
    • Conclusion: A is a substantial contributor to B as of March 31, 2002, the first date on which his contributions met the $5,000 and two percent test. A’s $3,500 contribution will be excluded entirely from the numerator of B’s public support test for taxable year ending December 31, 2002 because the A is now a substantial contributor and thus, a disqualified person. However, A’s $3,500 contribution on March 31, 2002 is included in B’s denominator as part of total support for taxable year December 31, 2002.
    • Note: Do not confuse the $5,000/ two percent test for substantial contributor with the $5,000/one percent test relating to gross receipts from related activities described in IRM

Total Support

  1. Total support for purposes of calculating the denominator in this test includes:
    • 100% of contributions, gifts, bequests (direct or indirect) from the general public (individuals, corporations, trusts)
    • 100% of contributions from organizations described in IRC § 170(b)(1)(A) (other than clauses (vii) and viii) and governmental units (for public benefit)
    • 100% of contributions, gifts, grants from organizations described in IRC § 509(a)(2) or (3)
    • 100% of contributions, gifts, grants from private foundations described in IRC § 509(a)
    • 100% of contributions, gifts, grants from other organizations described in IRC 501(c) (e.g., civic organization, union, business league)
    • All governmental unit support
    • All membership fees
    • Gross receipts from all related activities
    • All rents (related activity or other)
    • Taxes levied for benefit of the organization
    • Total amounts received from disqualified persons
  2. The following are excluded from the total support denominator:
    • Unusual grants
    • Dividends and interest
    • Capital gains
    • Loan proceeds

$5,000 or One Percent Limitation

  1. Gross receipts from related activities (not unrelated trade or business per IRC § 513(a)) are counted as public support in the numerator for purposes of the 33 1/3 percent test of IRC 509(a)(2), but there are limitations.
  2. If the related activities generate receipts from one person, bureau, or similar agency of an IRC § 170(c)(1) governmental unit, only $5,000 or one percent (whichever is greater) of the organization’s total support in any taxable year can be included. The limitation is applied on a year to year basis and is not cumulative. The entire amount, however, is included in the total support, or denominator. IRC § 509(a)(2)(A)(ii).

One-Third Limit On Gross Investment Income and Unrelated Business Income

  1. The second test an organization must meet to be described in IRC § 509(a)(2) is the gross investment income and unrelated business income test. IRC § 509(a)(2)(B). It will meet this test only if it does not normally receive more than one-third of its total support from gross investment income and unrelated business taxable income (less applicable IRC § 511 tax).
  2. Gross investment income is defined in IRC § 509(e) as income from interest, dividends, rents and royalties but net of any tax imposed by IRC § 511.
  3. Unrelated business taxable income is defined in IRC § 512 as gross income from a trade or business that is not substantially related to the organization’s exempt purposes.
  4. The examiner should verify that the organization meets this test by calculating the total gross investment income plus unrelated business taxable income (less IRC § 511 tax imposed on either) as the numerator divided by the organization’s total support as the denominator. If the result is not more than one-third of total support, the organization will meet the second test for IRC § 509(a)(2) classification.

IRC § 509(a)(2) Issues

  1. Contributions or Gifts vs. Gross Receipts – A payment may sometimes be part gift and part payment for merchandise, admissions, services, or use of facilities. The payment is classified as a gift or contribution to the extent it exceeds the value of what is received, and the remainder is classified as support from gross receipts under IRC § 509(a)(2)(A)(ii).
  2. Grants vs. Gross Receipts – The distinction between a grant and gross receipts is important because a grant is considered a permitted source for purposes of public support, as such, it is included in full in the numerator of the support fraction. On the other hand, gross receipts are subject to the $5,000/one percent limitation. Typically, a grant is paid to encourage the recipient organization to carry on its exempt activities. Sometimes the payor imposes terms and conditions on its use to insure that the funds will be used in a manner compatible with the payor’s own programs and to make sure it results in public benefit.
    1. The examiner should be alert to misclassifications of grants and gross receipts. Making the distinction between the two can be problematic. For instance, payor restrictions on the grant does not automatically disqualify the payment as public support. The examiner should look to whether the organization must provide some sort of service or facility in exchange for the payment; if so, the payment is considered gross receipts and not a grant. See Treas. Reg. § 1.509(a)-3.


An organization that provides medical care receives $10,000 income in Medicare payments based on individual patients. The Medicare payments constitute gross receipts because the individual patients receive a benefit from services the organization provided. Thus, the $10,000 is includible in the numerator of the public support test only to the extent that it does not exceed the greater of $5,000 or one percent of the organization’s total support for that year. By contrast, if the same organization receives $10,000 from a governmental agency to refurbish the patients’ rooms, the income is includible in full for the public support test numerator because it is for the organization’s general exempt activities. See Rev. Rul. 83–153, 1983-2 C.B. 48.

  1. Membership Fees vs. Gross Receipts – The fact that a membership organization provides services, admissions, facilities, or merchandise to its members as part of its overall activities will not, in itself, result in the classification of fees received from members as gross receipts subject to the $5,000 or one percent limit.
    1. Treas. Reg. § 1.509(a)-3(h)(1) defines membership fees as gross receipts if the fees are a means of selling admissions, merchandise, services, or the use of facilities (in the course of a related activity) to people who have no common interest in the organization except the benefit they receive in return for the fee.
    2. On the other hand, to the extent that the basic purpose for making the payment is to provide support for the organization, rather than to purchase admissions, merchandise, services, or the use of facilities, the income received from the payment constitutes membership fees. Reg. § 1.509(a)-3(h).
  2. Gross Receipts from Thrift Shops – Gross receipts from IRC §§ 513(a)(1), (2), or (3) activities are treated as gross receipts from related activities and, therefore, subject to the $5,000 or one percent limitation. In general, such activities relate to thrift shops, university or hospital convenience shops, and businesses operated by charitable organizations where substantially all work is performed by volunteers. Treas. Reg. § 1.509(a)-3(1).
  3. Gross Receipts from a Governmental Unit’s Bureau or Agency – The $5,000 or one percent limitation under IRC § 509(a)(2)(A)(ii) applies separately to gross receipts an organization receives from each bureau or similar agency of a governmental unit. Therefore, the definition of what constitutes a bureau or similar agency of a governmental unit is important.
    1. A governmental unit described in IRC § 170(c)(1) includes a state, a possession of the United States, or any political subdivision of any of the foregoing, or the United States or the District of Columbia.
    2. Under Treas. Reg. § 1.509(a)-3(i)(1), the term bureau means a unit functioning at the operating level of government. A bureau is descriptive of a subdivision of a department of government. The term does not usually include a level of government that is basically policymaking or administrative.
    3. Example: In State X, the Department of Mental Health is an operational state agency under the Department of Public Health. Thus, it is considered a bureau. Gross receipts from the Department of Mental Health, as a bureau, are subject to the $5,000 or one percent limit.
  4. Payments Under CACFP – “Sponsoring organizations” under the United States Department of Agriculture’s Child and Adult Care Food Program (CACFP) receive the following payments: (a) payments for meals; (b) administrative payments; (c) one time start-up payments to develop or expand successful CACFP operations in day care homes.
    1. All such payments under CACFP are support to the payee organization to carry out its exempt purposes.
    2. For purposes of public support under IRC § 509(a)(2), meal payments are gross receipts and calculated as public support in a manner similar to the medicare payments. As such, they are subject to the $5,000/one percent limitation.
    3. By contrast, administrative expense reimbursements and start-up payments are treated as government grants. See Treas. Reg. §§ 1.509(a)-3(g)(2) and 1.170A-9(e)(8).
  5. Gross Investment Income or Unrelated Business Taxable Income vs. Gross Receipts – In certain situations, it may become necessary to distinguish gross investment income or unrelated business taxable income from a related activity’s gross receipts. For example, if an IRC § 501(c)(3) organization’s exempt purpose is to furnish facilities for a rental fee or to provide loans to a particular class of persons (e.g., aged, sick, or needy persons), the income received from those persons will be considered gross receipts from a related exempt activity rather than from gross investment income or unrelated business taxable activity
  6. Earmarked Funds From IRC § 509(a)(1) Organizations – A grant received from a public charity described in IRC § 509(a)(1) is fully includible in computing the public support numerator of the 33 1/3 percent support test of IRC § 509(a)(2)(A). However, an indirect contribution (one earmarked by the donor for the benefit of a particular recipient) from a donor to the public charity retains its character. Therefore, if a donor who is a substantial contributor (as defined in IRC § 507(d)(2)) with respect to the ultimate recipient makes an indirect contribution through a public charity, the amount is excluded from the numerator of the support fraction. Treas. Reg. § 1.509(a)-3(j).
  7. Treatment of Gaming Income In Public Support Determinations – In verifying whether or not an organization is still described in IRC § 509(a)(2), gross receipts from gaming activities are included in both the denominator and numerator of the support test, provided the activity is not an unrelated trade or business. See IRM 4.76.50 for further discussion.

Examination of Books and Records

  1. The initial interview with a membership organization should include questions designed to review reasons organizations receive membership fees in order to properly classify the receipts. Likewise, a review of the organization’s minutes may reveal whether the membership fees go toward general support of the organization or purchase of a benefit.
  2. The examiner should check gross receipts and grants to ensure they have not been erroneously reported together on the same line of Form 990 or 990-EZ.
  3. Keeping in mind the importance of distinguishing between grants and gross receipts, the examiner must be aware that the organization would avoid the $5,000 and one percent limitation on support if payments are misclassified as grants rather than gross receipts. Reviewing the organization’s correspondence is one method that lends itself to uncovering proper identification of the receipts.
  4. Review and analyze contracts that generate gross receipts to the organization. In the IRC § 509(a)(2) support test, an organization can include related activity gross receipts received from any one individual, corporation or governmental unit that do not exceed the greater of $5,000 or one percent of its total support. The gross receipts $5,000 and one percent limitation is applied on a year to year basis and is not cumulative. The examiner must be aware that some contracts with government agencies provide payments on behalf of an individual rather than to the general public as a whole and are subject to the $5,000/one percent limitation. For example, if a contract provides medicare receipts for each patient, the examiner would request from the organization a list of patients who received $5,000 or the applicable one percent amount to test the public support limitation.
  5. See Exhibit 4.76-7, which is a sample support test computation worksheet.

IRC § 509(a)(1) vs. IRC § 509(a)(2)

  1. If an organization meets the public support tests for IRC § 509(a)(1) (as an organization described in IRC § 170(b)(1)(A)(vi)) and IRC § 509(a)(2), it will be treated as described in IRC 509(a)(1). Treas. Reg. § 1.509(a)-6).
  2. IRC § 509(a)(2) classification has the following disadvantages:
    1. Under IRC § 507(b)(1)(A), a private foundation may terminate its status without incurring the tax imposed by IRC § 507(c) if it distributes all of its net assets to one or more organizations described in IRC §§ 170(b)(1)(A)(i) through (vi) and the organization(s) has been in existence with the same foundation status for a continuous period of at least 60 calendar months immediately preceding the distribution. See Treas. Reg. § 1.507-2(a)(1).
    2. If an IRC § 509(a) organization makes a contribution or grant to an organization claiming non-private foundation status under IRC § 509(a)(2), it must be considered for purposes of the $5,000 or 2 percent limitation. Under such circumstances their contributions or grants generally would not constitute support from permitted sources to the organization claiming non-private foundation status for the purposes of the support test under IRC § 509(a)(2).
    3. An IRC § 509(a)(2) organization is limited to a deduction that cannot exceed 30% of adjusted gross income for donations of capital gain property to another IRC § 509(a)(2) organization. See IRC §§ 170(b)(1)(B) and 170(b)(1)(c).
  3. For a summary and comparison of public support, total support, and limitations for each test under IRC §§ 509(a)(1)/170(b)(1)(A)(vi) and 509(a)(2), see Exhibit 4.76.3-8

IRC § 509(a)(3) Guidelines

  1. An IRC § 501(c)(3) organization that cannot meet the public support tests of IRC §§ 509(a)(1) or 509(a)(2) but wishes to be classified as other than a private foundation may meet one of the three relationship tests as a supporting organization under IRC § 509(a)(3). Additionally, it must meet an organizational, operational, and control test. See Exhibit 4.76.3-9. The three possible relationships are as follows:
    1. Operated, supervised or controlled by (Treas. Reg. § 1.509(a)-4(g))
    2. Supervised or controlled in connection with (Treas. Reg. § 1.509(a)-4(h))
    3. Operated in connection with (Treas. Reg. § 1.509 (a)-4(i))

Relationship Test Guidelines

  1. Operated, supervised or controlled by – The first relationship (also known as the “parent-subsidiary relationship)” requires a majority of the IRC § 509(a)(3) organization’s governing body to be appointed or elected by the members of an IRC §§ 509(a)(1) or (2) organization’s body acting in their official capacity. Therefore, the examiner must interview the organization to verify that a majority of the organization’s board of directors has been elected by properly authorized officials of the supported organization. The examiner should then review the governing documents. The supported organization’s ability to yield such control should always be documented within the governing documents or official minutes.
  2. Supervised or controlled in connection with – The second relationship (also known as the “brother-sister relationship)” requires a common supervision or control by the persons supervising or controlling both the supporting organization and the publicly supported organization. The examiner would likewise review the governing documents after interviewing the organization to verify that a majority of the board members of the IRC § 509(a)(3) supporting organization are also on the supported organization’s board. This will insure that the supporting organization will be responsive to the need and requirements of the publicly supported organization.
  3. Operated in connection with – The third relationship has a two pronged requirement:
    1. The Responsiveness Test – The publicly supported organization must have a significant voice in the policies of the supporting organization by reason of the connection between the two organizations. This test itself has two parts. Treas. Reg. § 1.509(a)-4(i)(2).
    2. The Integral Part Test – The supporting organization maintains a significant involvement in the operation of the publicly supported organization, which in turn depends on the supporting organization for the type of support it provides. Treas. Reg. § 1.509(a)-4(i)(3).

Examining the Responsiveness and Integral Part Tests

  1. Responsiveness Test – Part 1 (Treas. Reg. § 1.509(a)-(4)(i)(2)(ii))
    1. The examiner must verify that one or more officers, directors or trustees of the supporting organization are elected or appointed by the officers, directors or trustees of the publicly supported organizations, OR
    2. The examiner must verify that one or more members of the governing bodies of the publicly supported organizations are also officers, directors or trustees of, or hold other important offices in the supporting organization, OR
    3. The examiner must document the extent to which the officers, directors, or trustees of the supporting organization maintain a close and continuous working relationship with the officers, directors, or trustees of the publicly supported organizations, AND
  2. By reason of a, b or c above, the examiner can document that the officers, directors or trustees of the publicly supported organization have a significant voice in the investment policies of the supporting organization, the timing of grants, the manner of making them, and in otherwise directing the use of its income or assets.
  3. Responsiveness Test Part 2 – Otherwise, the Responsiveness Test can be met under Treas. Reg. § 1.509(a)-(4)(i)(2)(iii). All three parts must be satisfied:
    1. The examiner must verify that the supporting organization is a charitable trust under State law.
    2. The examiner must verify that each publicly supported organization must be a named beneficiary under the supporting organization’s governing instrument.
    3. The supported organization must have the power to enforce the trust and compel an accounting under State law. (Normally, if the examiner can verify requirements (a) and(b), requirement (c) is automatically met by State law)
  4. Integral Part Test – This test will be met only if the supporting organization maintains a significant involvement in the operations of one or more publicly supported organizations, which are in turn dependent upon the supporting organization for the type of support it provides. There are four ways to meet this test:
    1. Method One – Treas. Reg. § 1.509(a)-4(i)(3)(ii) only applies in situations where the supporting organization actually engages in activities that benefit the supported organization. The activities engaged in, for, or on behalf of the publicly supported organization are those that perform the functions or carry out the purposes of such organization. The publicly supported organization itself would normally be engaged in these activities, but for the involvement of the supporting organization. Therefore, the examiner must perform an activity analysis to document that the organization actually shares the functions of its supported organization.


The organization performs printing or publishing functions on behalf of a college, as opposed to merely making grants to the college, a publicly supported organization.

    1. Method Two – Treas. Reg. § 1.509(a)-4(i)(3)(iii) provides for the transferring of income and a two prong test: (1) The supporting organization must pay substantially all (at least 85 percent) of its income to or for the use of one or more publicly supported organizations. (2) The amount of support received by one or more of the publicly supported organizations must be sufficient to insure the attentiveness of such organization to the publicly supported organization. Thus, the examiner should compare the amount of support provided to the organization’s total support. If the examiner can document that the organization pays out at least 85 percent of its income to its publicly supported organization and that amount exceeds 10 percent of the recipients total support, he/she can conclude in the workpapers the organization transfers a sufficient amount of its income and donates an amount large enough to insure the attentiveness of the recipient.


If the percentage of support test is not met, there are still two exceptions to meeting method two. The attentiveness test can still be met if the support is earmarked for a particular program of the beneficiary. If the supported organization is very large, the examiner can still document that the specific program meets the attentiveness test if it pays all of its income and its expenses of conducting the program are substantial. Treas. Reg. § 509(a)-4(i)(3)(b)). Finally, if the percentage of support test is not met, the attentiveness requirement can be met on a facts and circumstances basis. The examiner must list factors such as the number of beneficiaries, the length and nature of the relationship with the beneficiaries as well as acceptable evidence of actual attentiveness. Treas. Reg. § 1.509(a)-4(i)(3)(d).

    1. Method Three – Treas. Reg. § 1.509(a)-4(i)(iii) applies to organizations that met the integral part test in the past but can no longer do so because the supported organization has grown too large. Requirements include proof that the organization met the integral part test for five years and its failure to do so in the current year is attributable to inability to provide sufficient support. Additionally, there must be a history of an ongoing relationship between the two organizations.
    2. Method Four – Treas. Reg. § 1.509(a)-4(i)(4) applies only to trusts created prior to November 20, 1970 that have not received any support since that date and the trustee has no discretion to vary amounts payable to beneficiaries. Many of these entities have exhausted their giving programs and dissolved.

Organizational Test Guidelines

  1. Assuming that one of the three relationship tests have been made, the examiner must then document the fact that the organization’s governing instrument meets the general requirements. Treas. Reg. §§ 1.509(a)-4(c) and (d) list four requirements, two positive and two negative:
    1. The first requirement limits the organization’s purposes to one or more of those set forth in IRC § 509(a)(3)(A). The examiner must ensure the presence of a statement that the organization is organized and operated exclusively for the benefit of a publicly supported organization.
    2. The second requirement calls for the supporting organization to specify the publicly supported organizations on whose behalf it will operate.


If no actual organizations are named, the examiner can consider an exception that satisfies the requirement by allowing supported organizations to be specified by class or purpose. For example, the requirement is satisfied if the organization states it is organized to support animal rescue organizations within Chenango County.

    1. The third requirement is a negative one which states that the organization cannot empower itself to engage in activities not in furtherance of its stated purposes. The examiner must review the organization’s governing document to verify that the purposes in the organization’s governing instrument are no broader than those in the supported organization’s articles of incorporation. (If the supported organization is exempt under IRC §§ 501(c)(4), (5) or (6), the supporting organization’s purposes must merely have articles requiring it to carry on charitable activities within the meaning of IRC § 170(c)(2)).
    2. The fourth and final requirement is a restriction. The organization must not be empowered to support or benefit any organization other than those publicly supported organizations already specified.

Operational Test Guidelines

  1. After establishing the fact that the supporting organization is properly organized, the examiner then should ensure it meets the operational test described in Treas. Reg. §1.509(a)-4(e). The operational test is concerned with two areas:
    1. Permissible Beneficiaries – Treas. Reg. § 1.509(a)-4(e)(1) allows payments to be made to organizations other than the specified publicly supported organization: (1) payment is a grant to a member of a charitable class benefited by the specified publicly supported organization; (2) payment is made to another organization meeting one of the three relationship tests; (3) the payment is made to a college or university that is an instrumentality or a government agency. To verify that payments were made only to permissible beneficiaries, the examiner should ask pertinent questions and review documentation, e.g. meeting minutes and cash disbursements
    2. Permissible Activities – Treas. Reg. § 1.509(a)-4(e)(3) describes permissible independent programs. The supporting organization may carry on its own programs designed to support or benefit the specified publicly supported organization. The examiner should then conduct an operational survey to determine if the activities actually serve the exempt purposes of its beneficiary. Supporting organizations may also engage in fund raising activities, such as solicitations, fund raising dinners and unrelated trade or business to raise funds for the publicly supported organizations or their permissible beneficiaries.

Control Test Guidelines

  1. In order to qualify for IRC § 509(a)(3) classification, Treas. Reg.§ 1.509(a)-4(j) requires the organization to satisfy a final test, called the control test. It is designed to preclude the supporting organization’s being controlled, directly or indirectly, by disqualified persons as defined in IRC § 4946. Disqualified persons include the following:
    • Substantial contributor
    • Foundation manager of a private foundation
    • Certain 20% owners
    • Family members
    • Corporations, partnerships , etc.
  2. The examiner must look at whether disqualified persons may, by combining their voting powers and their positions of authority, require the supporting organization to engage, or decline to engage, in an act that significantly affects the operations of the supporting organization. Using documents such as the board minutes, the examiner can look for situations where the disqualified persons have either 50 percent of the voting power or the veto power over the supporting organization’s activities. Treas. Reg. § 1.509(a)-4(j)(2).
  3. Note that the Internal Revenue Code not only forbids direct control but indirect control as well. All pertinent facts and circumstances must be taken into consideration to determine if a disqualified person does in fact indirectly control an organization. This includes considering the nature, diversity, and income yield of the organization’s holdings, the length of time particular stocks, securities and other assets held, and the manner of exercising voting rights with respect to stocks in which members of its governing body have some interest. Treas. Reg. § 1.509(a)-4(j)(1). (See Rev. Rule. 80-207, 1980-2 C.B. 193, for a more detailed discussion.)

IRC § 509(a)(4) Foundation Classification

  1. IRC § 509(a)(4) excludes from private foundation classification an organization that is organized and operated exclusively for public safety. The definition of “testing for public safety” includes testing of consumer products, such as electrical products, to determine if they are safe for the general public’s use. Few of these organizations are recognized as exempt because they are described in IRC § 509(a)(4). Many have been denied exemption on the basis that their activities actually served private interests such as manufacturers and shippers. Certain clinical drug testers also have sought exemption recognition but have been denied on the basis that a drug is not a “consumer product” until it is approved for marketing by the FDA.

Foundation Status – Workpaper Documentation

  1. If it is obvious the organization is publicly supported (e.g. a United Way organization or community orchestra), it is not usually necessary to make an in-depth public support verification. An error in such an organization’s calculation is unlikely to result in a foundation status change. However, the examiner should create a workpaper for the file showing he/she considered the foundation status and reason for reaching the stated conclusion.
  2. Any change or modification from the current classification that the examiner proposes is considered adverse and treated as an unagreed case. Nevertheless, the examiner should attempt to obtain a signed Form 6018, “Consent to Proposed Adverse Action,” for the proposed change or modification. A signed form is not binding, but it does indicate the taxpayer’s position.
  3. In the case of a modification from current classification, the examiner may find Publication 557, “Tax Exempt Status for Your Organization” , useful when explaining the proposal to the taxpayer.
  4. If the examiner fails to consider foundation status for more than just the year under examination, he/she can reach an incorrect conclusion. If the organization satisfies the aggregate support test for the four prior years, it will be considered as “normally publicly supported” in the current and subsequent years. However, if it fails the four-year test, the examiner then must look to special rules designed to give the organization public charity status if it met the computation in past years and may meet the test again in a subsequent year. See Treas. Reg. §§ 1.170A-9(e)(4)(iii), Treas. Reg. § 1.509(a)-3(c)(ii), Exhibits 4.76-1 and 4.76-6.
  5. If the organization does not meet the public support test of either IRC §§ 170(b)(1)(A)(vi) or 509(a)(2), the examiner should give consideration under section IRC §§ 509(a)(3), 509(a)(4), and all other sections of IRC § 170(b), annotating the workpapers accordingly.
  6. The examiner must document all computations, considerations and conclusions reached in the workpapers, whether he/she determines that the existing status is correct or proposes a change.
  7. The workpapers and any report issued should reflect that the Service has granted the organization the most advantageous foundation classification for which it qualifies.

Inurement, Private Benefit and Excess Benefit Transactions (IRC § 4958)

  1. An entity will not qualify as a charitable organization exempt from Federal income tax under IRC § 501(c)(3) unless, among the other requirements, it meets the operational test.
  2. IRC § 501(c)(3) exempts corporations and any community chest, fund, or foundation, organized and operated exclusively for religious…purposes,…no part of the net earnings of which inures to the benefit of any private shareholder or individual.
  3. Treas. Reg. § 1.501(c)(3)-1(c)(2) states that, an organization is not operated exclusively for one or more exempt purposes if its net earnings inure in whole or in part to the benefit of private shareholders or individuals. Inurement is concerned with the direct transfer of income or provision of services unrelated to exempt purposes.
  4. Treas. Reg. § 1.501(a)-1(c) defines a private shareholder or individual as those persons having a personal and private interest in the activities of an organization. In general, a private shareholder or individual is considered an “insider” with respect to the exempt organization.
  5. The prohibition of private benefit is found in part in Treas. Reg. § 1.501(c)(3)-1(d)(1)(ii), which provides that an organization is not organized or operated exclusively for one or more exempt purposes unless it serves a public rather than a private interest. The burden is on the organization to establish that it is not organized and operated for the benefit of private interests such as designated individuals, the creator or his family, shareholders of the organization, or persons controlled, directly or indirectly, by private interests. The organization’s activities must be broad enough in scope to confer a public benefit versus serving to benefit only a few.
  6. IRC § 4958 addresses the inurement proscription. It imposes an excise tax, commonly known as “intermediate sanctions” , on excess benefit transactions between a “disqualified person” and a tax-exempt organization described in IRC §§ 501(c)(3) or (4). On January 22, 2002 the Treasury Department issued final regulations under IRC § 4958. Although IRC § 501(c)(3) still provides for loss of exemption in the case of any private inurement, the legislative history shows that IRC § 4958 was enacted to impose a sanction in those cases where an excess benefit does not rise to a level where it calls into question the organization’s tax exempt organization status. Revocation of exempt status still would occur when the organization no longer meets the operational test as a charitable organization.H. Rep. No. 506, 104th Congress, 2d Sess. 53, 59 note 15 (1996).
  7. A disqualified person is defined in Treas. Reg. § 53.4958-3 as a person in a position to exercise substantial influence over the affairs of the organization at anytime during the five-year period before the benefit transaction in question occurred. Family members and entities controlled by the disqualified person are also considered disqualified persons.
  8. An “excess benefit transaction” is one in which the organization provides an economic benefit, directly or indirectly, to or for the use of the disqualified person, and the value of the benefit provided exceeds the value of the consideration received in return. Treas. Reg. § 53.4958-4.

Inurement vs. Private Benefit

  1. It is important for the examiner to differentiate between “private inurement” and “private benefit.” The two terms are closely related and often are used interchangeably. However, they are two separate issues. Not treating them as such is not only erroneous but also can lead to incorrect conclusions. Since the enactment of IRC § 4958, it has become even more crucial to know the difference between them. The first key is that inurement applies to those who are”inside,” or in control, of the organization, whereas private benefit applies to a broader base. Private benefit encompasses those who are not only inside but also “outside” the organization. Thus, all inurement is private benefit, but not all private benefit is inurement.
  2. The second key the examiner needs to understand is that inurement means an insider (whether an individual or an entity) takes from the exempt organization’s profits in some manner that benefits him/herself. On the other hand, the private benefit doctrine focuses on the organization’s primary activities and how charitable they are. What are the activities? How broad is the class of persons they benefit? Does the class represent the community at large, or is there private benefit to certain individuals or entities? If private benefit exists, is it merely incidental, or does it preclude the public at large?
  3. The third key in the comparison of private inurement and private benefit is the consequence of each. With regard to private inurement, any taking of the profits (net earnings) is fatal to exemption; the concept does not even go as far as looking at the quality of the organization’s charitable activities. By contrast, in considering private benefit, questions about activities, whom they benefit, and how representative of the public the beneficiaries are address the charitable aspects of activities and thus, how substantial any private benefit is. If it is insubstantial, the private benefit may not be fatal to exemption.
  4. The distinguishing factors are summarized in the table below.
Private InurementPrivate Benefit
Insider (private shareholder or individual in a position to control) benefit is prohibited.Private benefit may also accrue to anyone outside the charitable class.
Net earnings cannot benefit a private shareholder or individual.Substantial benefits can be conferred upon a private individual or class of individuals.
IRC § 501(c)(3) prohibits any inurement.Private benefit cannot be substantial.
  1. Example: In American Campaign Academy v. Commissioner, 92 T.C. 1053 (1989), the court distinguished between inurement and private benefit in denying declaratory judgment to a school that trained individuals to fill positions in political campaigns. The Service contended the entity did not meet the operational test for IRC § 501(c)(3) because it engaged in activities that served private interests versus a public purpose. The organization argued the Service incorrectly applied the private benefit analysis, that the Republican party and candidates could not be construed as insiders of its organization. The court said the entity was comparing the language of Treas. Reg. § 1.501(c)(3)-1(d)(1)(ii) limiting private benefit to the statutory and regulatory language in IRC § 501(c)(3) prohibiting inurement of net earnings to private shareholders and individuals. “Petitioner misconstrues the overlapping characteristics of the private benefit and private inurement prohibitions [which do not target the same class]. We have consistently recognized that while [the two] share common and often overlapping elements, the two are distinct requirements which must independently be satisfied.” The court also stated the presence of private inurement violates both prohibitions, but the absence of inurement does not mean the absence of private benefit. Ultimately, the court ruled the organization was not entitled to exemption under IRC § 501(a) because it was operated for the benefit of private interests and more than an insubstantial part of its activities furthered a nonexempt purpose.

Private Inurement

  1. Despite the explicit prohibition of inurement, neither Internal Revenue Code nor the Treasury Regulations defines it. The prohibition of inurement was not contained in the original act that recognized certain corporations as exempt from Federal income tax (Tariff Act of 1894, ch. 349, § 32, 28 Stat. 509, 556 (1894)), indicating that perhaps it was a concept so obvious it need not be mentioned. The Tariff Act of 1909 made reference to inurement, and the Revenue Act of 1918 changed net income to net earnings. Otherwise, the phrase has remained unchanged.
  2. The concept of private inurement contemplates a transaction between the exempt organization and an individual who is an insider. An insider, by virtue of his or her position within the organization, has the ability to influence or control application of the organization’s net earnings. Although the Internal Revenue Code and Treasury Regulations do not specify or define insider relative to inurement, the Service has adopted the viewpoint that the prohibition relates only to insider-controlled benefits. Rev. Rul. 66-259, 1966-2 C.B. 214. The Service found no private inurement where an exempt hospital compensated a hospital-based radiologist on the basis of a fixed percentage of the income of the radiology department. The conclusion was reached, in pertinent part, because the radiologist did not control the organization.
  3. There is nothing in IRC § 501(c)(3) to prohibit dealings between a charitable organization and its insiders (those in controlling positions) as long as those dealings are at arm’s length, in good faith, and reasonable. For example, if an organization pays a reasonable compensation to its founder for services rendered, that is not inurement. However, when the interests of the charity are sacrificed to the private interests of the founder or those in control, exemption is precluded because the organization is serving private interests.
  4. The courts have broadly construed the term net earnings to include more than gross receipts minus disbursements as shown on the organization’s books and records. Consider the following:
    • Excessive compensation – Church of Scientology, 823 F.2d 1310 (9th Cir. 1987)
    • Interest-free, unsecured loans and payment of personal expenses – John Marshall Law School v. U.S., 228 Ct. Cl. 902 (1981)
    • Excessive rents and improvements made on real estate owned by insiders – Texas Trade School v. Commissioner, 272 F.2d 168 (5th Cir. 1959)
    • Reports and surveys furnished to members – General Contractors’ Ass’n v. U.S., 202 F.2d 633 (7th Cir. 1953)
    • Services to members – Chattanooga Auto Club v. Commissioner, 182 F.2d 551 (6th Cir. 1950)
  5. The Service primarily has relied on revenue rulings and case law to interpret the meaning of private inurement within the context of specific cases. Even though the issue seems to be a “facts and circumstances” test, there are certain common principles that can be identified. Court renderings have generally fallen into several broad categories of private inurement.
  6. One category is rather easily identified. Inurement can take the form of questionable transactions that have no causal relationship to the organization’s exempt purposes but result in some benefit to an insider, whether or not the insider provides goods and services of commensurate value to the entity. The insider is in a position to exercise control over the organization’s net earnings as if they were his/her own by using them at will rather than within limitations of an employer-employee or fiduciary capacity. In effect, the insider is using the public’s “net earnings” for his/her own benefit. The examiner usually can recognize this type of inurement issue by its egregious qualities.
    • Example: John Marshall Law School and John Marshall University v. United States, 228 Ct. Cl. 902 (1981). The court held that personal expenses paid on behalf of the family controlling a law school were not part of reasonable compensation. The plaintiff argued that if these payments had been included in salary, the salary still would be reasonable. However, the court said the expenses were not paid as additional salary or treated as compensation on the corporate books. Instead, they were paid at the insider’s discretion. He was free to make personal use of the corporate funds for himself and family when and if he chose to do so. The court upheld the Commissioner in the revocation of the school’s exempt status based on inurement.
    • Example: The Founding Church of Scientology v. United States, 412 F.2d 1197 (Ct. Cl. 1969). The court reasoned that even if the salary paid to the organization’s founder was reasonable, absence of a suitable explanation for other payments made to and for his family and him disqualified the organization for tax-exempt status. “If in fact a loan or other payment in addition to salary is a disguised distribution or benefit from the net earnings, the character of the payment is not changed by the fact that the recipient’s salary, if increased by the amount of the distribution or benefit, would still have been reasonable.” The court ruled the plaintiff was not entitled to recover payment of deficiency.
  7. A second category of inurement is fairly straightforward. Inurement exists when an insider receives a return benefit from the exempt organization that is greater than the value of the goods and services provided to it. A private shareholder or individual benefits from the expenditure of the organization’s funds (“net earnings” ) in some manner when a payment is not reasonable for what the organization gets in exchange, meaning the organization either has paid too much or charged too little. In either case, monies that should have been expended for exempt (“public” ) purposes went to private inurement. The examiner’s dilemma in this instance is establishing the inurement issue by determining what is reasonable. “Reasonableness ” is an issue that has posed problems for the courts as well because it is not a concept that easily lends itself to preciseness or measurement.


Anclote Psychiatric Center, Inc. v. Commissioner, T.C. Memo 1998-273. An exempt psychiatric hospital’s officers and directors sought to convert the organization to a for-profit and sell it to an entity the board created. The question before the court was whether the sale price was close enough to fair market value to conclude there was no inurement. “…recognizing what is fair market value presents an inherently imprecise issue, we see our task as one of determining whether the sale price was within a reasonable range…Our task is not unlike that which we face when inurement depends upon a determination whether payments of compensation are excessive or reasonable.”


The court said while fair market value is important, it is not a definite figure that can be compared to a sale price and thus, automatically measure inurement. Even two appraisers can disagree on what is “fair market value.” Among other factors, inadequate arm’s length negotiations could affect the sale price and give rise to inurement if the value received is not “reasonably ” within range of the value transferred. In the instant case, the organization’s sale price to the insiders was more than $1 million under a fair market value and outside any “reasonable” range. The court ruled that tax-exempt status was properly revoked based on private inurement

  1. A third category of inurement does not hinge upon the reasonableness of expenditure amounts or whether they were made for the organization’s exempt purposes. Private inurement also can occur where an exempt organization and a taxable entity are structured so closely that an insider benefits financially from the arrangement. This type of inurement is not always obvious because the exempt organization may be paying a reasonable amount for services provided and carrying on exempt activities. Therefore, the examiner must analyze carefully the actual substance of transactions between the entities to determine where the true benefit lies and if the exempt organization’s net earnings are reduced in a way that benefits a private individual or entity that can be considered an insider.


Housing Pioneers, Inc. v. Commissioner, 58 F.3d 401 (9th Cir. 1995). The organization’s purpose was to provide affordable housing for low income and handicapped persons. The organization entered into an agreement with a for-profit partnership to participate in a project whereby the for-profit’s property would be exempt from property tax. As part of the agreement, the for-profit loaned money to the exempt to buy an interest in and become a general partner. Part of the property tax savings was to go to the general partnership to keep rents low and part to the exempt organization for its charitable purposes. The court ruled that even though the tax reductions were to be used exclusively to make rents affordable, private inurement was present. Federal income tax advantages and property tax reductions resulted in inurement at least indirectly to the benefit of the non-exempt partners (two of whom were insiders with respect to the exempt entity) because their partnerships were relieved of maintaining rents at a level sufficient to cover operating expenses that would otherwise have to be paid out of partnership capital.

Private Benefit

  1. The private benefit standard does not derive its authority from the portion of the statute prohibiting inurement of net earnings. Rather, it is based on the operational test in IRC § 501(c)(3) requiring an organization to operate exclusively for exempt purposes. However, “operated exclusively” has two meanings, both of which are contained in Treas. Reg. § 1.501(c)(3)-1(c)(1). It provides that an organization will be regarded as operated exclusively only if it engages “primarily” in activities that accomplish one or more exempt purposes such as those specified in IRC § 501(c)(3) and that it will not be so regarded if more than an “insubstantial” part of its activities does not further an exempt purpose.
  2. Furthermore, Treas. Reg. § 1.501(c)(3)-1(d)(1)(ii) holds that an organization is not organized or operated exclusively for one or more exempt purposes unless it serves a public rather than a private interest. Therefore the activities of an organization exempt under IRC § 501(c)(3) must benefit the general public in a way that distinguishes it from a for-profit corporation, the latter of which serves shareholders (private interests). Serving the public is a basic tenet of the law of charity whose purpose is to ensure that those who constitute the “public” benefit equally.
  3. Treas. Reg. § 1.501(c)(3)-1(d)(1)(ii) goes on to specify the organization must establish it is not organized or operated for the benefit of private interests, “such as designated individuals, the creator or his family, shareholders of the organization, or persons controlled, directly or indirectly, by such private interests. ” If the organization’s founder, his family, or persons in control (“insiders” ) benefit in some way (typically economically, which involves net earnings), it would result in the inurement proscription. Consequently, it can be said that all inurement is also private benefit.
  4. On the other hand, if other individuals or entities not classified as insiders receive a benefit that does not further the organization’s exempt purposes, the result is “private benefit.” The beneficiaries are not insiders who are in control, but they benefit in some manner that is not considered public either. Thus, it can be said that not all private benefit is inurement.
  5. To identify and develop the issue, the examiner must analyze whether the benefit conferred is classified as inurement (recipient is an insider) or as private benefit (recipient is an outsider). This is a functional test of sorts. The examiner must look to the reality of who is in control of the organization and its operations from within, rather than a person’s or entity’s place on an organizational chart. An insider can be the founder, his family, an employee, a board of directors member, a related corporation, or even a fund-raiser. On the other hand, an outsider can be a specified individual, a class of individuals, a for-profit corporation, a joint venture, or a fund-raiser. Consider the court’s finding in the following cases.


United Cancer Council v. Commissioner, 165 F.3d 1173 (7th Cir. 1999). The court reversed and remanded the Tax Court’s ruling to uphold revocation of an organization exempt under IRC § 501(c)(3) based on inurement. It found nothing in the facts to support the fund-raisers seizing control of the exempt organization, thereby becoming an insider, triggering the inurement provision, and destroying exemption. The court stated there was no diversion of charitable earnings to board members or other insiders. The court pondered a different argument: suppose the exempt organization paid the fund-raiser twice as much as it actually charged for its services, so half of the annual fund-raising expense was like a gift to the fund-raiser. Then it could be argued the organization was operated substantially for the private benefit of the fund-raiser. The court suggested enforcing the tax law in this way could address the problem of a charitable organization’s expenditures that are extravagant but do not inure to the benefit of insiders. “That in fact is the IRS’s alternative ground for revoking the exemption.”


Redlands Surgical Services v. Commissioner , 113 T.C. 47 (1999), aff’d, 242 F.3d 904 (9th Cir. 2001). At issue was whether Redlands Surgical Services should be recognized as exempt from Federal income tax based on its activities. The entity was a wholly owned subsidiary of an exempt health care system. It participated as co-general partner with a for-profit corporation; the latter was general partner of a partnership that operated an ambulatory surgery center. The organization argued it met the operational test under IRC. § 501(c)(3) because its surgery center activities furthered exempt purposes by promoting health and providing access to surgical care for the community based on medical need, not the ability to pay. The Service contended that it was not operated exclusively for charitable purposes because it operated for the benefit of private parties and failed to benefit a broad cross-section of the community. Based on all the facts and circumstances, the court held that the organization had ceded effective control of the partnerships’ and the surgery center’s activities to for-profit parties, conferring significant private benefits on them. Therefore, it was not operated exclusively for charitable purposes within the meaning of IRC. § 501(c)(3)


Retired Teachers Legal Defense Fund, Inc. v. Commissioner, 78 T.C. 280 (1982). At issue was whether the organization was organized and operated exclusively for one or more exempt purposes within the meaning of IRC § 501(c)(3) or served private interests. Membership for a fee was open to any retiree of the New York City Teachers’ Retirement System receiving a pension, of whom there were approximately 25,000. The organization argued that “benefit,” as used in Treas. Reg. § 1.501(c)(3)-1(d)(1)(ii), is vague and contains no guidelines. The court disagreed, citing the Black’s Law Dictionary definition as “advantage; profit; fruit; privilege; gain; interest.” The court stated the organization ignored “private” as used in conjunction with “benefit” in the Treasury Regulations. The fundamental reason for granting an organization tax exemption is that it serves a public benefit…The [beneficiaries] of petitioner’s organization and operation are the retirees of the system. Although approximately one-third of its members are poor and disabled, and although the term “charitable” includes “relief of the poor and distressed” , over two-thirds of its members do not fall within this classification. Thus, the organization was denied recognition as exempt under IRC § 501(c)(3).

  1. The Treasury Regulations regarding the private benefit doctrine do not speak to net earnings but rather to exempt purposes, which are inferred from the type of activities it carries out and for whom. For example, a common private benefit issue involves a charitable organization’s requiring a membership, and only those who pay to become members are granted the rights to its benefits. If it provides benefits only to the members who paid for these privileges, the result is a select group set apart from the public, and private benefit may result. However, if the organization provides the benefits (providing they are charitable) to anyone without a membership requirement, a special group does not exist. Thus, the organization’s benefits serve the public, and there likely is no private benefit issue.
  2. On the other hand, sometimes a public charity by its very nature benefits particular individuals in order to achieve its charitable purposes. The courts have recognized that a single activity can serve both an exempt and a nonexempt purpose. For example, an educational organization confers primary private benefit by instructing or training an individual for the purpose of improving and developing his or her capabilities. (See Bob Jones University v. United States, 103 S. Ct. 2017 and the cases cited therein.) A hospital confers private benefit on an individual patient through the process of health care. This type of private benefit is often referred to as “incidental ” or “permissible.” To be incidental, a private benefit must occur as a necessary result of the activity that benefits the public at large. In other words, the benefit to the public cannot be achieved without indirectly or unintentionally benefitting private individuals.
  3. Even if a certain amount of incidental or permissible private benefit is allowed without jeopardizing exempt status, the issue sometimes arises of how much is too much. If an organization is carrying out its exempt purposes for the benefit of the public yet private benefit is present, the examiner must weigh all facts and circumstances.
  4. Private benefit conferred by an activity must be balanced only against the public benefit conferred by that activity or arrangement, not the overall good accomplished by the organization. Therefore, the examiner must first identify how and to what degree the activity benefits the public, followed by determining if the private benefit is an unavoidable side effect of the activity. If the public benefit outweighs the indirect private benefit, it can be considered permissible. However, if an argument can be made that the activity’s public benefit is subordinate to private benefit, then the private benefit can destroy exemption.


Sonora Community Hosp. v. Commissioner, 46 T.C. 519 (1966), aff’d, 397 F.2d 814 (9th Cir. 1968). The court considered whether more than incidental private benefit accrued to physicians from the activities of a hospital. Two doctors who previously had owned and founded the hospital facilities in question shared in the fees from the privately-operated laboratory and x-ray departments within the hospital, even though they performed no associated services. The Tax Court ruled this demonstrated that the hospital was operated to a considerable extent for the private benefit of the two founding doctors, rather than exclusively as a charitable organization. The court found it unnecessary to decide whether the arrangement constituted inurement of hospital net earnings to the doctors because it was satisfied the resulting private benefit was enough to prevent exemption.

  1. The examiner also must be able to distinguish between private benefit issues and unrelated taxable business income issues. Unlike private benefit, unrelated trade or business does not normally jeopardize exempt status unless it rises to the level of questioning whether the organization is operated primarily for commercial or exempt purposes. As long it is primarily engaged in related activities, the organization’s only consequence is a tax liability for its unrelated business income as imposed by IRC § 511. On the other hand, private benefit can result in revocation regardless of its insubstantiality. Therefore, it is important that the examiner properly identify the classification of a questionable activity.

IRC § 4958 Intermediate Sanctions

  1. An additional tax is imposed on the disqualified person if correction is not made within the taxable period. The primary objective of IRC § 4958 is to impose a sanction on the influential person involved rather than punish the organization itself by revoking its exempt status, providing it is properly carrying out its exempt purposes otherwise. The section is also meant to encourage correction of the excess benefit transaction.
  2. It is worth emphasizing here that there is nothing to preclude the examiner from proposing assessment of excise taxes on the disqualified person under IRC § 4958 and proposing revocation of the exempt organization if that is his/her determination.
  3. As the examiner will note, the wording and definitions of IRC § 4958 are based on private inurement, not private benefit, which is why making the distinction between the two is imperative to correctly identify the issue.
  4. The taxes IRC § 4958 imposes are summarized as follows:
IRC SectionRateImposed on…For…
4958(a)(1)25% 1Disqualified personEngaging in excess benefit transaction
4958(a)(2)10%2Organization manager(s)Knowingly participating in the transaction
4958(b)200% 1Disqualified personFailure to correct within the taxable period
1 Percentage of the amount of the excess benefit not corrected
2 Limited to $10,000
  1. For rules relating to “abatement” of taxes on an excess benefit transaction that is corrected within the correction period (as defined in IRC § 4963(e)), See IRC §§ 4961(a), 4962(a) and the related Treasury Regulations. By providing for abatement, the Internal Revenue Code encourages the disqualified person to make correction of excess benefits.


This section is not meant to be all-inclusive on the issue of IRC § 4958 application but rather highlights important concepts for purposes of examination. See IRM 7.27.30 for an in-depth discussion of examination and safe harbor guidelines for taxes on excess benefit transactions.

IRC § 4958 Definitions

  1. As with IRC § 4941, becoming familiar with the terminology used in IRC § 4958 is crucial. Although worded similarly, each section has its own distinctive definitions. Listed below are some of the most important ones in IRC § 4958.
  2. An excess benefit transaction is any economic benefit a disqualified person receives from an applicable exempt organization’s net earnings as a result of prohibited inurement. Although IRC § 4958 does not define “economic,” Treas. Reg. § 53.4958-4(a)-(1) describes the amount as all consideration and benefits exchanged between a disqualified person and the applicable tax-exempt organization and/or all entities the organization controls. Put simply, excess benefit means the value of the economic benefit the disqualified person received exceeds the value of consideration (cash, property, benefits, or services) the exempt organization received. Only the excess is subject to the initial and additional taxes imposed by IRC § 4958.
  3. An applicable organization is one described in IRC § 501(c)(3) or (4) that was exempt any time in the five-year period before the excess benefit transaction occurred. This is called the “Lookback Rule,” and the five-year period is called the “Lookback Period.” If the transaction occurred before September 14, 2000, the Lookback Period begins on September 14, 1995 (the effective date of IRC § 4958) and ends on the date the excess benefit transaction occurred. The following are not applicable tax-exempt organizations:
    • A private foundation
    • A governmental entity not subject to taxation
    • A foreign organization exempt under IRC §§ 501(3)(3) or (4) that receives substantially all support from sources outside the United States
    • An IRC §§ 501(c)(3) or (4) entity whose exemption was never recognized
    • An IRC §§ 501(c)(3) or (4) entity that was revoked (unless the revocation was based on private inurement or private benefit, which could include revocation based on the Lookback Rule).
  4. disqualified person is any person in a position to exercise substantial influence over the affairs of the organization at anytime in the Lookback Period. It is not necessary that the person actually exercise substantial influence, only that he/she is in a position to do so. Per Treas. Reg. § 53.4958-3, this includes persons who hold any of the following powers, responsibilities, or interests:
    • Family members of the disqualified person
    • Entities controlled by the disqualified person (owning more than 35 percent voting power)
    • A voting member of the governing body
    • A person with ultimate responsibility to implement the governing body’s decisions, to supervise management, to carry out administration or operation of the organization, i.e., president, chief executive officer, chief operating officer
    • A person with ultimate responsibility for managing the finances of the organization, i.e., treasurer, chief financial officer
    • Persons with a material financial interest in a provider-sponsored organization
  5. Other persons may or may not meet the definition of disqualified person. Treas. Reg. § 53.49-3(e)(2) gives facts and circumstances that are not all inclusive but tend to show a person does have substantial influence over the organization’s affairs:
    • The organization’s founder
    • A substantial contributor
    • A person whose compensation is based on revenues from activities of the organization the person controls
    • A person who has or shares authority to control a substantial part of the organization’s capital expenditures, operating budget, or employees’ compensation
    • A person who manages activities that are a substantial portion of the organization’s overall activities, assets, income or expenses
    • A person who owns a controlling interest in a corporation, partnership or trust that is a disqualified person
    • A person who is a non-stock organization controlled directly or indirectly by one or more disqualified persons.
  6. A disqualified person is not:
    • An IRC 501(c)(3) or (4) organization
    • A employee of the organization who receives economic benefit of a specific amount within a taxable year, i.e. $85,000 in 2001, unless that employee is a family member of the disqualified person, someone who can exercise substantial influence (as described), or a substantial contributor to the organization
  7. Treas. Reg. § 53.4958-3(e)(3) gives facts and circumstances that are not all inclusive but tend to show a person does not have substantial influence over the organization’s affairs.
  8. foundation manager is defined in Treas. Reg. § 53.4958-1(d)(2) as any officer, director, or trustee of the organization, or any individual having powers or responsibilities similar to such persons, regardless of title. A person is an officer if its organizing documents (articles of incorporation, or other documents such as the nonprofit bylaws) designate him/her, or if the person regularly exercises authority to make administrative or policy decisions for the organization.
  9. An organization manager participates in an excess benefit transaction knowingly if he/she:
    • Has actual knowledge of sufficient facts that the transaction would be an excess benefit transaction
    • Is aware the transaction may constitute an excess benefit transaction and
    • Negligently fails to make reasonable attempts to determine if the transaction is an excess benefit transaction or is aware it is
  10. There are exceptions to knowing, even if a transaction is subsequently found to be an excess benefit transaction:
    • The foundation manager relied on a professional’s advice after making full disclosure of all relevant facts
    • The foundation manager relied on the fact that the requirements for “rebuttable presumption” of reasonableness have been satisfied.
  11. Willful means the participation was voluntary, conscious and intentional.
  12. Reasonable cause means the organization manager exercised responsibility with ordinary business care and prudence.
  13. If an organization meets three requirements, the transaction is presumed to be reasonable and at fair market value. This is called”rebuttable presumption” , and the requirements are:
    • Advance approval by an authorized body
    • The authorized body obtained and relied on appropriate comparative data before making the determination
    • It concurrently documented the basis for its determination
  14. The taxable period begins when the excess benefit transaction occurred and ends on the earlier of:
  1. Mailing a notice of deficiency to the disqualified person regarding the 25% tax, or
  2. Assessment of the 25% tax on the disqualified person.
  1. IRC § 4958(f)(6) provides that an excess benefit transaction is “corrected” by undoing it to the extent possible and taking any additional measures necessary to place the organization into a financial position that is not worse than it would be if the disqualified person had acted under the highest fiduciary standards.
  2. IRC § 4961 and Treas. Reg. § 53.4958-1(c)(2)(iii) outline circumstances under which the 25% tax may be abated and the 200% tax must be abated. By providing for abatement, the Internal Revenue Code encourages the disqualified person to make correction of excess benefits.

Statute of Limitation Considerations

  1. The period of limitations for assessing IRC § 4958 excise taxes against the disqualified person and foundation manager begins when the organization files its Form 990 for the period in which the excess benefit transaction occurred or when the Form 990 is due, whichever is later.
  2. The period ends either three years or six years from that date.
  3. Three Years – If the organization filed Form 990 for the period in which the excess benefit transaction occurred and adequately reported the excess benefit on the return, the period of limitations ends three years later.
  4. Six Years – If the organization filed Form 990 for the period in which the excess benefit transaction occurred but did not adequately report the excess benefit transaction on the return, the period of limitations ends six years later.
  5. Note: The Service has the burden of proof as to whether or not the organization’s Form 990 was insufficient to apprise the Service of the existence and nature of an excess benefit transaction with a disqualified person and participation by an organization manager. Therefore, the examiner must consult with Area Counsel regarding whether or not the six-year limitations period applies.
  6. Form 990 was not Filed– The period of limitations has not begun to run, so there is no statute date.
  7. Extending the Period of Limitations – Liability for IRC § 4958 excise taxes is that of the disqualified person or foundation manager, each of whom is deemed a separate taxpayer. Therefore, the Service and each disqualified person or foundation manager may agree to extend the period of limitations by executing a separate Form 872. Each 872 relates to each person’s own tax year, not the year of the organization. The examiner must be vigilant in recognizing that the period of limitations begins with the filing of Form 990, which may be a different tax year than that of the disqualified person or foundation manager.


  1. One of the most difficult jobs for the examiner is to determine if an excess benefit transaction has occurred. Obviously, part of making the determination is to know the value of the transaction itself, which will tell the examiner if it is excessive or not. In general, excess benefit transactions involve the transfer of property or payments for services. If the issue is property (including the right to use property), the Treasury Regulations provide that the value is fair market value for purposes of IRC § 4958. If the issue is compensation, the value is the amount that would ordinarily be paid for like services by like enterprises under like circumstances, otherwise known as “reasonable compensation” . IRC § 162 standards apply in determining reasonableness of compensation.
  2. In the case of fair market value of property, the examiner may want to consider a referral to Engineering. This should be done as early in the development of the issue as possible. See IRM 4.75.13.
  3. To determine if an excess benefit transaction has occurred, the examiner must take into account all consideration and benefits exchanged between a disqualified person and the applicable exempt organization as well as any entities it controls. However, virtually any economic benefits that are excluded from income under IRC § 132 also are disregarded for purposes of IRC § 4958. Treas. Reg. § 53.4958-4(a)(4).
  4. Examples of economic benefits included in determining the value of services rendered and whether the compensation is reasonable or not are:
    • Cash and non-cash compensation (salary, fees, bonuses, severance payments, deferred compensation)
    • Payment of liability insurance premiums
    • Other payments on behalf of the disqualified person (penalties, tax expenses, civil proceeding expenses, expenses resulting from an act or failure to act)
    • Other compensatory benefits (expense allowances or reimbursements paid under anonaccountableplan, such as travel or auto expenses)
    • Foregone or below-market interest on loans

IRC § 4958 Issues

  1. Though certainly not all-inclusive, the list below shows examples of transactions between an applicable exempt organization and disqualified person that could be IRC § 4958 issues:
    • Payment of a disqualified person’s personal expenses by the exempt organization
    • Use by the disqualified person of the exempt organization’s vehicles for personal reasons
    • Use by the disqualified person of the exempt organization’s real property for personal reasons
    • Lease of property owned by the disqualified person to the exempt organization in exchange for rent
    • Whether or not amounts received by the disqualified person from the exempt organization are loans
    • Whether or not amounts received by the disqualified person from the exempt organization are loan repayments
    • Payment of personal expenses for a disqualified person’s family members
    • Payment of expenses of a for-profit corporation owned by the disqualified person
    • Amounts embezzled from an exempt organization by a disqualified person (Treas. Reg. § 53.4958-4(c)(1))
    • Revenue-sharing arrangements between the exempt organization and disqualified person
    • Transfer of assets from an exempt organization to a for-profit organization controlled by the disqualified person

Hospitals Providing Financial Assistance to Staff Physicians Involving Electronic Health Records

  1. The purpose of this subsection is to provide a directive for handling examination and exemption application cases involving hospitals that provide physicians who have staff privileges at those hospitals (“medical staff physicians” ) with financial assistance to acquire and implement software that is used predominantly for creating, maintaining, transmitting, or receiving electronic health records (“EHR” ) for their patients.
  2. Many hospitals described in IRC 501(c)(3) plan to establish interoperable EHR systems to improve the effectiveness and efficiency of their medical care and to reduce medical errors. Some hospitals believe that their medical staff physicians need a financial incentive to acquire and implement EHR software that would allow the physicians to connect to the hospitals’ EHR systems. On August 8, 2006, the U.S. Department of Health and Human Services (“HHS” ) issued final regulations (see 42 C.F.R. Section 411.357 and 42 C.F.R. Section 1001.952) (“HHS EHR Regulations” ) that allow hospitals to provide, within specific parameters, EHR software and technical support services (“Health IT Items and Services” ) to their medical staff physicians without violating the federal anti-kickback law, 42 USC §1320a-7b, and physician self-referral law, 42 USC §1395nn.
  3. We will not treat the benefits a hospital provides to its medical staff physicians as impermissible private benefit or inurement in violation of IRC 501(c)(3) if the benefits fall within the range of Health IT Items and Services that are permissible under the HHS EHR Regulations and the hospital operates in the manner described below.
  4. A hospital that is otherwise described in section 501(c)(3) enters into Health IT Subsidy agreements with its medical staff physicians for the provision of Health IT Items and Services at a discount (“Health IT Subsidy Arrangements” ). These Health IT Subsidy Arrangements require both the hospital and the participating physicians to comply with the HHS EHR Regulations on a continuing basis. The Health IT Subsidy Arrangements provide that, to the extent permitted by law, the hospital may access all of the electronic medical records created by a physician using the Health IT Items and Services subsidized by the hospital. The hospital ensures that the Health IT Items and Services are available to all of its medical staff physicians. The hospital provides the same level of subsidy to all of its medical staff physicians or varies the level of subsidy by applying criteria related to meeting the health care needs of the community.
  5. These procedures do not apply to a hospital that allows its earnings to inure to the benefit of one or more medical staff physicians through arrangements that are other than Health IT Subsidy Arrangements, because the hospital would not be considered to be described in section 501(c)(3).
  6. For further information, see Q&A on Hospitals’ Health IT Subsidy Arrangements with Medical Staff Physicians at Exhibit 4.76.3-12.

Examination of Books and Records

  1. The following are some suggested audit steps the examiner can take to identify and develop issues of inurement, private benefit, and intermediate sanctions:
  2. Review Form 990 carefully for items that could indicate issues. (See Exhibit 4.76.3-10.)
  3. Review salaries paid to those controlling the organization and to other key employees. To determine if they are reasonable consider factors such as:
    • Duties performed
    • Amount and type of responsibility
    • Time devoted to duties
    • Special knowledge and experience
    • Individual ability
    • Previous training
    • Compensation paid in prior years
    • Prevailing economic conditions
    • Living conditions of the particular locality
    • The type of activities carried out by the organization and its size.
  4. Reconcile salaries paid by the organization to wages reflected on Forms W-2 of the employees. What was included in taxable income?
  5. Request copies of employment contracts or compensation packages as deemed pertinent. Check the date and the specific compensation the organization intended to pay.
  6. Review disbursements. Be alert for payment of expenses paid by the exempt organization to or for the benefit of an officer or employee that may not be reflected as wages on Form W-2.
  7. Consider the status of the recipients to determine who meets the various criteria of an insider, an outsider, a disqualified person with respect to the organization.
  8. Review other compensation amounts, including fringe benefits. Determine if they are excludable from the recipient’s gross income under IRC § 132 or includible under IRC § 61. Look closely at such reimbursements as travel expenses. Was the payment made under a non-accountable plan? If so, determine if the amounts paid meet the ordinary and necessary requirements of IRC § 162. Was the amount included on Form W-2?
  9. Determine if there were any sales or exchanges of property. If so, were there any insiders, disqualified persons, foundation managers involved? Was the sale or exchange at fair market value?
  10. Analyze the composition of the organization’s assets. Did an insider, disqualified person, foundation manager have personal use of any of them? For example, a vehicle may be used for personal and business travel. If personal use was involved, was an amount included on the Form W-2?
  11. Analyze fund-raising agreements to determine if they are at arm’s length. Consider the method of raising funds and whether such income is subject to unrelated business tax. Does the fund-raiser exercise control over the organization in any manner?
  12. Determine if there are entities related to the exempt organization. Analyze the structure of any transactions between the related entities and the exempt organization. Are they at arm’s length, fair market value, exclusive?
  13. See Exhibit 4.76.3-11 for a list of steps to help identify and analyze excess benefit transactions subject to IRC § 4958 taxes.

Legislative Activities Guidelines

  1. IRC § 501(c)(3) states that no substantial part of the activities of an otherwise qualified organization may be the carrying on of propaganda or otherwise attempting to influence legislation. Organizations whose lobbying activities disqualify them from recognition of exemption under IRC § 501(c)(3) are action organizations. Treas. Reg. § 1.501(c)(3)-1(c)(3)(vi) provides that an organization is an action organization if it has the following characteristics:
    1. Its primary objective (as distinguished from an incidental objective) can be attained only by legislation or defeat of proposed legislation and;
    2. It advocates or campaigns for the attainment of its primary objective as opposed to engaging in nonpartisan analysis, study or research and making the results available to the public.


An organization was formed to assist the governor-elect of a state. It screened and selected appointive office applicants, prepared the party platform’s legislative message and program for presentation to the legislature. Since the organization could accomplish its main purpose only through legislation, it was ruled an action organization. Rev. Rul. 74-117, 1974-117, 1974-1 C.B. 128.

Direct Lobbying and Grass Roots Legislation

  1. “Direct lobbying” is the attempt to influence legislation through communication with any member or employee of a legislative body, with a government official or other employee who can participate in formulation of the legislation. The key is that the communication’s principal purpose must be to influence legislation.
  2. “Grass roots lobbying” involves the organization’s urging members of the public to contact legislators to support, oppose, or propose a piece of legislation. The examiner needs to determine if the organization is engaged in grass roots lobbying and if so, to what extent. He/she can perform audit steps such as interviewing its officers regarding any activities that further the entity’s legislative interests, reviewing official minutes, publications and financial records, and considering the following;
    1. Have there been paid articles and advertisements in newspapers or magazines that promote the organization’s legislative interests?
    2. Did the organization engage in commentaries through television, cable, radio or other public communications?
    3. Did it publicize or disseminate its position on certain legislation in articles or publications?
    4. Has it made direct mailings or internet campaigns that encourage the public to contact legislators regarding its position?
  3. The examiner should analyze expenses to determine if the entity made disbursements for any of the following:
    1. Contributions to organizations engaged in legislative activities.
    2. Payments to lobbyists or other intermediaries on behalf of the organization itself or as a subordinate to a national regional or state parent organization.


Payments may be disguised as charges to legal, professional or advertising fees.

    1. Dues to parent, state or national organizations for legislative activities. This activity might be attributed to the subsidiary organization via payment of dues.

IRC § 501(h) Election and IRC § 4911 Excise Tax on Excess Lobbying Expenses

  1. When there is strong evidence of legislative activity, the examiner will then determine whether the organization has made a lobbying election under IRC § 501(h) by filing Form 5768, Election to Make Legislative Expenditures. This election subjects the organization to the lobbying expenditures test of IRC § 4911. An eligible public charity, through an election, may choose to have its legislative activities measured by an expenditures test that sets relatively specific expenditure limits and lends more concreteness to the uncertain standards of IRC § 501(c)(3). The examiner will then analyze disbursements to determine if:
    1. The sliding scale limits for nontaxable lobbying and grassroots expenditures have been exceeded. (The maximum lobbying nontaxable amount is $1,000,000.)
    2. Affiliated organizations have included their disbursements in the total to determine if the nontaxable amounts have been exceeded.
    3. Lobbying expenditures over a four year period exceed 150 percent of the lobbying nontaxable amount; or
    4. Grass roots expenditures over a four year period exceed 150 percent of the grassroots nontaxable amount.


If the limits of c) or d) above are exceeded, the examiner will then consider revocation. (Note that once revoked, the organization cannot then apply for IRC § 501(c)(4) status.) There is no determination required, however, for the first, second, or third year of election as long as the expenditures are not over the ceiling amounts. If a ceiling amount is exceeded, the determination is recomputed using prior years, even if they were prior to an election. (Omit all years in which the organization was not exempt under IRC § 501(c)(3). See Treas. Reg. § 1.501(h)-3(b)(2)).

  1. Should the organization exceed its limits for direct and/or grassroots lobbying expenditures, it will then be subject to an excise tax equal to 25% of the excess expenditures, as imposed by IRC § 4911(a). If the organization becomes liable for the excise tax imposed by IRC § 4911(a), the examiner will then attempt to securing a delinquent Form 4720, “Return of Certain Excise Taxes on Charities and Other Persons Under Chapters 41 and 42 of the Internal Revenue Code,” and collect the tax due.
  2. IRC § 4911(d)(2) specifies activities which are not considered to be influencing legislation:
    1. Making available the results of nonpartisan analysis, study, or research.
    2. Providing technical advice or assistance to a governmental body, a committee or other subdivision of it in response to a written request by the body or subdivision.
    3. Appearances before, or communications to, any legislative body with respect to a possible decision of the body that might affect the organization’s existence, powers, duties, tax exempt status, or the deduction of contributions to the organization.
    4. Communications between the organization and its bona fide members about legislation or proposed legislation of direct interest to the organization and its members as long as the organization does not encourage the member to take commensurate action.
    5. Certain communications with members or employees of legislative bodies.
  3. The examiner should be aware that the following organizations are ineligible to make an IRC § 501(h) election:
    1. Churches or conventions or associations of churches as described in IRC § 170(b)(1)(A)(i), including integrated auxiliaries, convention or association of churches,
    2. Organizations described in IRC § 501(c)(3) that are affiliated with at least one church, convention or association of churches, or an integrated auxiliary (an “affiliated group” within the meaning of IRC § 4911(f)(2)),
    3. Organizations that are public charities because they are a supporting organization described in IRC § 509(a)(3),
    4. Organizations engaged in testing for public safety described in IRC § 509(a)(4),
    5. Private foundations.
  4. The election under IRC § 501(h) is effective beginning with the organization’s taxable year in which it files Form 5768.


An eligible organization with a taxable year ending December 31, 2002 files Form 5768, making the IRC § 501(h) election on August 31, 2002. The organization’s IRC § 501(h) election is effective for all taxable years beginning January 1, 2002. (A loss of exemption will automatically revoke the election.)

  1. An organization’s election may be revoked voluntarily or involuntarily. Voluntary revocation of election is made by filing a notice with the appropriate Service Center listed on Form 5768. Under IRC § 501(h)(6)(B), a voluntary revocation is effective beginning with the first taxable year after the taxable year in which the notice is filed, and the organization becomes subject to the “substantial part” test at that time.

Nonelecting Organizations

  1. If the examiner determines that the organization engaged in legislative activity but did not elect the provisions of IRC § 501(h), it will remain subject to the substantial part test.
  2. A determination of whether or not an organization is substantially engaged in legislative activity is a question of facts and circumstances. (The courts have found that a percentage test is not the only measure of substantiality.)
  3. Substantial is measured not only by the funds spent on the activity but by the time and effort expended as well. The examiner should consider:
    1. The amount of effort expended by the organization’s membership when they are urged to act. (Keep in mind that a single article in an organization’s publication requesting legislative action might trigger thousands of members to contact their legislators, but the expense may be minimal.)
    2. The time, effort and money expended on reaching or developing a position on whether to support or oppose particular legislation.
  4. The examiner should also:
    1. Analyze all direct and indirect expenses attributable to legislative activities.
    2. Find out what the organization’s definition of lobbying is and make sure it complies with the law.
    3. Review time sheets or whatever activity report the organization uses to determine the time the staff spent on lobbying activities (in other words, check the organization’s computation to make sure it is reasonable.)


Just because the dollar limits are high, the examiner should not ignore them. The organization may have misclassified disbursements for grassroots activities as exempt activities. Since the grassroots amount is only 25 percent of the lobbying amount, it is easier to exceed the grassroots amount. The examiner will solicit Form 4720 if either of the limits were exceeded.

Exceptions to Revocation

  1. Under IRC § 501(c)(3) there are certain circumstances where nonpartisan analysis, study, research, or discussion of matters pertaining to legislation, may be educational and do not constitute attempts to influence legislation. While the examiner may initially determine the organization is substantially engaged in legislative activity and revocation seems likely, the following rulings should be researched if applicable:
    1. League of Women Voters of the United States v. United States,180 F.Supp. 379 (Ct. Cl.1960). The time spent discussing public issues, formulating and agreeing upon positions, and studying them in preparation for adopting a position was taken into account. It was compared to the other activities in determining the substantiality of the attempts to influence legislation. Research, discussion and other back-up activities may not always be considered part of attempting to influence legislation.
    2. In Rev. Rul. 72-513, 1972-2 C.B. 246, .a school exempt under IRC § 501(c)(3) that made its staff available to serve on a school newspaper that published opinion on legislative and political matters was not attempting to influence legislation or participate in political activities. The process of gathering news, doing research, analyzing data, writing and editing material for the newspaper dealing with legislative and political topics furthered the education of the students.
    3. In Rev. Rul. 64-195, 1964-2 C.B. 138, an organization conducted research on legislation and disseminated materials to the public. The ruling concluded, “it is clear that the instant organization does not participate in any way in the presentation of any proposed bills to the State Legislature or advocate either approval or disapproval of the proposed constitutional amendment by the electorate. Its primary activity in connection with court reform is the study, research, and assembling of materials on a nonpartisan basis and the dissemination of such materials to the public.” The examiner should inquire about the purpose of the analysis, study or discussion. Ask if it furthers a partisan end, and will the organization be involved in advocating adoption or rejection of the legislation.
    4. When a membership organization is involved, it is often necessary to determine whether a lobbying activity is attributable to the organization or is merely the act of the individual. On one hand, actions of a person in excess of his official authority should not be considered those of the exempt organization (i.e.; a school or a church) as a general rule. However, if the organization allows contempt for authority to go unpunished, it implies ratification of the act. When trying to determine if an individual ‘s acts may be attributed to an organization , there are no clear set of rules or guidelines. Relevant indicators include whether statements appear on the organization’s official letterhead, whether the board of directors of the organization endorsed a questionable act, what are the organization’s stated policies and intentions to support particular acts, and whether the organization tried to explain or disassociated itself from the act.

IRC § 4912 Excise Tax on Disqualifying Lobbying Expenditures

  1. Effective for tax years beginning after December 22, 1987, IRC § 4912 imposes a tax of 5 percent on the lobbying expenditures of an organization whose tax exempt status was revoked due to a substantial amount of lobbying activity. The tax does not apply to the following:
    1. Charitable organizations which have made the IRC § 501(h) election,
    2. Churches or certain church-related organizations that are not eligible to make the IRC § 501(h) election,
    3. Private foundations.
  2. Tax imposed under IRC § 4912 is an excise tax described in IRC Chapter 41 (Public Charities). Organizations and individuals with a tax liability under this section should file Form 4720. (Such persons will be jointly and severally liable under the Internal Revenue Code.) IRC § 4912 is subject to deficiency procedures. Penalties relating to failure to file, failure to pay tax due, negligence and civil fraud may apply.
  3. IRC § 4912 imposes a similar tax on any organization manager (basically its officers and directors) who permits the expenditure, knowing that it will jeopardize the organization’s exempt status.

Political Activities Guidelines

  1. There is an absolute prohibition on all IRC § 501(c)(3) organizations from participating or intervening in any political campaign. Even an insubstantial amount of political activity can lead to the revocation of the organization’s exempt status. Examples of political activity include:
    1. Publication of written or printed statements or oral statements made on behalf of, or in opposition to a candidate for public office (Treas. Reg. 1.501(c)(3)-1(3)(iii));
    2. Payments to a political candidate for speeches or other services;
    3. Travel expenses of a candidate;
    4. Expenses incurred in conducting polls, surveys, or other studies;
    5. Preparing papers or other material for use by a candidate;
    6. Expenses of advertising, publicity, and fund-raising for a candidate; and
    7. Any other expense that has the primary purpose of promoting public recognition, or otherwise primarily accruing to the benefit of an individual.
  2. A candidate for public office is defined as an individual who offers himself or herself or is proposed by others as a contestant for an elective public office, whether such office is national, state, or local. Treas. Reg. 1.501(c)(3)-1(c)(3)(iii)).


It does not matter if the candidate is not endorsed by a political party or if the office is not contested by a political party. In Rev. Rul. 67-71, 1967-1 CB 125, school board candidates were held to be candidates for public office despite the fact that no candidates were affiliated with any political party.

  1. Attempting to influence the senate confirmation of an individual nominated to serve as a federal judge does not constitute intervention or participation in a political campaign within the meaning of IRC § 501(c)(3) because a federal judgeship is an appointive office rather than an elective one. Notice 88-76, 1988-27 I.R.B. 34.


However, such expenditures are subject to the tax imposed by IRC § 527(b) on political expenditures.

Political vs. Educational Activities

  1. While some activities and disbursements are obviously political in nature, others may initially appear political to the examiner but actually are educational. Certain “voter education” activities conducted in a non-partisan manner by an IRC § 501(c)(3) organization may not constitute prohibited political activity. Consider the following:
    1. Rev. Rul. 86-95, 1986-2 C.B. 73 states that public forums do not constitute participation or intervention in any political campaign within the meaning of IRC § 501(c)(3). An IRC § 501(c)(3) organization conducted the public forums in a congressional district during a congressional election campaign. All legally qualified congressional candidates were invited to participate; they discussed topics that covered a broad range of issues of interest to the public. Questions were prepared and presented by a nonpartisan, independent panel; and each candidate received an equal opportunity to present his or her views on each issue discussed. The facts and circumstances established that both the format and content of the forums were presented in a neutral manner.
    2. Rev. Rul. 78-248, 1978-1 C.B. 154, Situation 1 held an organization was exempt under IRC § 501(c)(3) that annually prepared and made generally available to the public a compilation of voting records of all members of Congress on major legislative issues involving a wide range of subjects. The publication contained no editorial opinion, and its contents and structure did not imply approval or disapproval of any Congressional members or their voting records.
    3. Rev. Rul. 78-248, 1978-1 C.B. 154, Situation 2, an organization distributed a questionnaire to all candidates for governor in a particular state. The ruling held the organization to be exempt under IRC § 501(c)(3). The questionnaire solicited a brief statement of each candidate’s position on a wide variety of issues which were published in a voter’s guide made generally available to the public. Neither the questionnaire nor the voter’s guide, in content or structure, evidenced a bias or preference with respect to the views of any candidate or group of candidates.
    4. Rev. Rul. 80-282, 1980-2 C.B. 178 – An IRC § 501(c)(3) organization which monitored and reported on governmental activities and developments it considered to be of important social interest is not participating or intervening in any political campaign. It published and distributed a non-partisan newsletter to interested members and others, who numbered only a few thousand nationwide. The newsletter was politically non-partisan and consisted of congressional incumbents’ voting records on selective issues, along with an expression of the organization’s position on the issues. The publication occurred after congressional adjournment and was not geared to the timing of any federal election.
  2. On the other hand, other voter education activities may indeed constitute political. Consider the following:
    1. An organization that sent a questionnaire to candidates for major public offices and used the responses to prepare a voter’s guide that was distributed during an election campaign. It was held not to be exempt under IRC § 501(c)(3) since some of the questions evidenced a bias on certain issues. Rev. Rul. 78-248, 1978-1 C.B. 154, Situation 3.
    2. An organization that published and distributed to the public a voter’s guide containing voting records of members of Congress on the single issue of land conservation was held not to be exempt under IRC § 501(c)(3) because the emphasis on one area of concern indicated a partisan purpose and constituted a proscribed political activity. Rev. Rul. 78-248, 1978-1 C.B. 154, Situation 4.
    3. A bar association did not qualify under IRC § 501(c)(3) because its practice of rating and publishing the ratings of candidates for elective judicial office constituted intervention in a political campaign, although it comprised only a small portion of the association’s total activities, was clearly in the public interest, and was conducted on a nonpartisan basis. The Association of the Bar of the City of New York v. Commissioner, 858 F.2d 876, 881 (1988).

Public Discussion of Political Issues

  1. An organization that conducted public forums, lectures, and debates on controversial social, political, and international questions was held to be educational. Although the speakers were frequently controversial, the organization adopted an unbiased position. Rev. Rul. 66-256, 1966-2 C.B. 210.
  2. An organization that operated a broadcasting station was not participating in political activities by providing reasonable air time equally available to all legally qualified candidates for election to public office in compliance with the Federal Communications Act of 1934. The organization neither endorsed a candidate nor any viewpoint expressed by a candidate. Rev. Rul. 74-574, 1974-2 C.B.161.
  3. An organization formed to elevate the standards of ethics and morality in the conduct of political campaigns disseminated information concerning general campaign practices, furnished teaching aids to political science and civics teachers, and publicized its proposed code of fair campaign practices without soliciting the signing or endorsement of the code by candidates. It qualified as an educational organization under IRC § 501(c)(3). Rev. Rul.76-456, 1976-2 C.B. 151.

Examination Procedures

  1. Most organizations are aware of the prohibition. However, during the examination process, if the examiner finds evidence of political activity but no overt transactions, he/she may need to look at more subtle sources to substantiate the evidence. Some suggestions are:
    1. Reading the organization’s minutes and newsletters for mention of a political figure or a political event. (Note: some organizations maintain a publicity file.)
    2. Review of the cash disbursements journal along with the corresponding cancelled checks to determine possible payments to politicians, political parties, political action committees (PACs), bogus trade associations, legal firms diverted to political trustee accounts as well as other organizations.
    3. Review of agreements and contracts entered into by the organization to determine possible lending or sharing of equipment , facilities or employees.


Upon a review of the organization’s minutes, the examiner notices a political figure is featured in the minutes. The agent makes a note of the month that the discussion takes place and reviews the cash disbursements for that month and the months following that date. Noting a questionable expenditure, the examiner then asks for the actual check, which was in the amount of $700, to determine the payee and to look at the endorsement. He/she then traces the payment to the general ledger to determine how it was recorded. Since there was an indication the payment was for services of an independent contractor, the examiner requests to see the person’s contract with the organization and Form 1099.

    1. Perusal of local newspapers for announcements regarding political events sponsored by the organization.
    2. Testing expense reimbursements for any political contributions.
    3. Checking supplier invoices for any evidence of overbilling (an excess may be used for political purposes)
    4. Testing payroll accounts for evidence of any employees who may have worked on political campaigns on company time.
  1. Although an organization may not be directly conducting any political activities themselves, an examiner may discover evidence of support for a political campaign through an affiliated organization. Typical conduits are organizations described in IRC § 501(c)(4), (5), or (6) because they are permitted to engage in some political activity. The organization may be making grants, lending equipment, facilities, employees, or members to these affiliates for political endeavors.

Disqualification Under IRC § 501(c)(4)

  1. Any organization (except for churches, conventions of churches, etc.) that ceases to qualify under IRC § 501(c)(3) by reason of participating in, or intervening in, any political campaign on behalf of, or in opposition to, any candidate for public office is precluded from exempt recognition under IRC §501(c)(4).

Effect of IRC § 527

  1. IRC §527 enables an IRC § 501(c) organization to set up a separately segregated fund to carry out the political activities of the IRC § 501(c) organization. The IRC § 501(c) organization is subject to tax on any amount that it spends on the selection, nomination, election or appointment of a candidate for public office but only to the extent of its net investment income. IRC § 527(f)(3).


IRC §527 was not intendedto affect the prohibition against IRC § 501(c)(3) organizations engaging in political activities. Thus, notwithstanding IRC 527, charities may not engage in political activities on behalf of, or in opposition to candidates for elective public office nor may they set up separately segregated to engage in such activities without endangering their IRC § 501(c)(3) status.

Resolution of Political Activities and IRC § 4955

  1. Depending on the facts and circumstances, engaging in political activity can result in:
    1. The loss of exempt status.
    2. The imposition of the IRC § 4955 tax.
    3. Both the loss of exempt status and imposition of the IRC § 4955 tax.
  2. Congress enacted IRC § 4955 in 1987, which subjected IRC § 501(c)(3) organizations that make political expenditures to an excise tax as follows:
IRC SectionRate of Amount Involved1Imposed OnAct2
4955(a)110%OrganizationMaking political expenditures
4955(b)1100%OrganizationNot correcting the expenditure within the taxable period
4955(a)22.5% (maximum of $5,000)Organization ManagerAgreeing to make the expenditure, knowing that it is a political expenditure
4955(b)250% (maximum of $10,000)Organization ManagerRefusing to correct a political expenditure
1 The taxable period begins on the date the expenditure is made, and ends on the date the 90 day letter is mailed for the first tier tax orthe date of the first tier tax assessment, whichever comes first.
2 The initial tax can be abated if the organization can establish that its making the expenditure was not willful and flagrant.
  1. Under IRC § 4955(d)(2) certain expenditures of candidate-controlled organizations are considered political expenditures for the purpose of the tax imposed by IRC § 4955. A candidate-controlled organization is an organization formed primarily for the purpose of promoting the candidacy or prospective candidacy of an individual for public office or one that is effectively controlled by a candidate or prospective candidate for political purposes. An organization is effectively controlled by the candidate if the candidate “has a continuing, substantial involvement in the day-to-day operations or management of the operation.” The expenditures of such an organization, amounts paid or incurred for any of the following purposes are considered political expenditures:
    1. Amounts paid to or incurred by the candidate for speeches or other services,
    2. Travel expenses of the candidate,
    3. Expenses for conducting polls, surveys or other studies, or preparing papers or other materials for use by the candidate,
    4. Expenses for advertising, publicity and fund-raising for the candidate,
    5. Any other expense that has the primary effect of promoting public recognition or otherwise primarily accruing to the benefit of the candidate.
  2. In general, the examiner should apply the IRC § 4955 sanction instead of proposing revocation,if, based on the facts and circumstances, the examiner determines:
    1. The violation was found to be unintentional,
    2. The expenditure involved a relatively small amount,
    3. The organization corrected the violation and adopted procedures to assure that similar expenditure would not be made in the future. (If the organization makes a correction, the first tier tax may be abated.)

Flagrant Violations under IRC § 6852 and IRC § 7409

  1. In certain situations, Congress found examination and enforcement procedures did not deter an IRC § 501(c)(3) organization from flagrantly violating the political campaign prohibition. Accordingly, it enacted IRC § 6852 and IRC § 7409, authorizing the Service to take further measures.
  2. Under IRC § 6852, the Service is authorized to make an immediate determination and assessment of income tax or tax imposed by IRC § 4955 for the current taxable year and the immediately preceding taxable year.


For this purpose, the organization’s current taxable year is treated as if the organization terminated its exempt status on the date the tax liability is determined. Any taxes assessed under IRC § 6852 against the organization or its managers become due and payable immediately.

  1. Under IRC § 7409, the Service can seek an injunction (a civil action) to bar political expenditures by an IRC § 501(c)(3) organization but only after it has notified the organization it will seek an injunction if the organization does not immediately cease such expenditures. The Commissioner personally must determine the organization flagrantly participated in a political campaign and an injunction is the appropriate measure to prevent further abuse.


The Service also may seek such other injunctive relief as may be appropriate to ensure that the organization’s funds are preserved for IRC § 501(c)(3) purposes.


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IRS Form 1023 Application Review