How to Establish Public Charity Status for Your Nonprofit
The IRS applies several measures to determine whether a nonprofit organization is a public charity. Generally, for a nonprofit to be considered a public charity, it must receive one-third of its revenues from public sources. It's complicated, but, fundamentally, it comes down to how much of your organizational income you get from the public.
A 501(c)(3) nonprofit organization wanting to be considered a public charity will undergo what's referred to as the public support test. To pass this test, the nonprofit needs to demonstrate, over a four-year average, that one-third of its revenue comes from contributions from the general public, support from government agencies, or grants from organizations that get their support from the public, such as United Way.
So if your organization's average revenue is $60,000 per year and at least $20,000 a year comes from donations, state grants, and support from United Way, you're home free. Your nonprofit will be considered a public charity under code sections 509(a)(1) and 170(b)(1)(A)(vi).
But what if your organization doesn't get a third of its revenue from the public? Fortunately, it may be able to qualify under another test that gives more leeway on the percentage of public support. Under this test, only 10 percent of total revenue needs to come from public categories. But your organization also must demonstrate that it has an ongoing fundraising program that's reaching out for more public donations.
Other factors also are considered. If the nonprofit's contributions come in many small gifts rather than a few large ones, it's more likely to be given public charity status. It's even better if your organization's board of directors is broadly representative of the community. And if the organization makes its facility available to the general public, that's another feather in its cap.
A 501(c)(3) organization that expects to get a substantial portion of its revenues from fees related to its exempt purpose (but less than one-third of revenues from investment income) may qualify as a public charity under code section 501(a)(2).
When you get to Part X of Form 1023, you need to check a box indicating which public charity classification you seek. If you aren't sure — and, frankly, who would be? — you can let the IRS decide which category you fit by selecting the "i" box.
Take schools as an example. To apply as a school, you have to submit Schedule B. Your school must provide regular instruction and have a student body and a faculty. In other words, you can't just start an organization and call it a school.
Every IRS rule has an exception or two, and qualifying as a public charity is, well, no exception. Churches, schools, hospitals, public safety testing organizations, and a few others are automatically considered public charities. If you have an intense interest in this rule, read Chapter 3 of IRS Publication 557, which is available at www.irs.gov.
If you think your organization falls into one of these categories, check the appropriate box in Part X, line 5 (a through f) and answer the questions on the appropriate schedule included with Form 1023. This is not advised unless you're absolutely certain that you know what you're doing. If you need further advice regarding these categories, consult an attorney.
Until recently, a newly established nonprofit organization applying for a tax exemption usually requested an "advance ruling" on its public charity status. Typically, the IRS granted "temporary" public charity status for a period of five years. After this five-year period, the IRS reviewed the sources of the nonprofit's support over the previous years and, if the public support test was met, issued a "definitive" ruling of public charity status.
The advance ruling period has been eliminated. Organizations seeking to be classified as public charities will be considered as such if they can demonstrate in their Form 1023 application that the status is a reasonable expectation for the future. The public charity status is considered permanent unless and until substantial changes are seen in the organization's sources of support.
When you download Form 1023 and its instructions, be sure to include any change notices that describe new regulations and new instructions. Sometimes revisions to IRS forms lag behind changes in the regulations. Always be certain you're working with the most recent information.