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Stephen J. Kelin, CPA, JD Richard J. Locastro, CPA, JD

Stephen J. Kelin, CPA, JD Richard J. Locastro, CPA, JD. Nonprofit tax principals at Gelman, Rosenberg & Freedman, CPAs

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Stephen J. Kelin, CPA, JD Richard J. Locastro, CPA, JD

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  1. Stephen J. Kelin, CPA, JDRichard J. Locastro, CPA, JD • Nonprofit tax principals at Gelman, Rosenberg & Freedman, CPAs • Combined 55+ years of experience providing tax services to tax-exempt organizations, private foundations, colleges, healthcare organizations, museums and other large nonprofit institutions • Co-lead the firm’s consulting and tax compliance services to more than 600 nonprofit clients • Coordinate tax planning, return preparation and representation on IRS audits • Monitor changing statutory and regulatory environments concerning reporting and operational requirements

  2. Agenda • Private Foundations Versus Public Charities • 509 (a)(1) Test • 509 (a)(2) Test • 509(a)(3) Test – Supporting Organizations

  3. Are You a Private Foundation? IRC Section 509(a) • General Rule ― …, the term “private foundation” means a domestic or foreign organization described in section 501(c) other than – (emphasis added)

  4. Private Foundation Rules • 4940 – Excise Tax Investment Income • 4941 – Self Dealing • 4942 – Minimum Distributions • 4943 – Excess Business Holdings • 4944 – Jeopardizing Investments • 4945 – Taxable Expenditures • 4946, 4947, 4948 – Special Rules

  5. Minimum Distributions • IRC section 4942(g) – Qualifying Distributions Defined • (1) …, the term “qualifying distribution” means • (A) any amount … paid to accomplish one or more purposes described in section 170(c)(2)(B) … other than any contribution to … a private foundation which is not an operating foundation (emphasis added)

  6. Private Foundation “Exceptions” • 509(a)(1) – “Contribution-based” organizations ??? • Described in 170(b)(1)(A) [other than clauses (vii) and (viii)] • 509(a)(2)– “Fee-based” organizations (???) • 509(a)(3)– Supporting organizations • 509(a)(4)– Testing for the public safety

  7. Definition of a Public Charity • A public charity is defined under IRC § 509(a)(1) as an organization described in § 170(b)(1)(A) other than in clauses (vii) and (viii) - (certain private foundations; and (a)(2) & (a)(3) entities); • § 170(b)(1)(A)(i)-(v) includes churches, schools, hospitals and governmental units • No support test required

  8. Qualification for 509(a)(1) – 170(b)(1)(A)(vi) • Normally receives a substantial part of its support from a governmental unit referred to in subsection (c)(1) or from direct or indirect contributions from the general public • “Normally” is a five-year rolling average

  9. Qualification for 509(a)(1) – 170(b)(1)(A)(vi)(cont.) • “Substantial part” is generally 33 1/3% or 10% or more under the “facts and circumstances” test • “Support” for § 509(a)(1) test does not include income in exercise of its exempt purpose (program service fees) • Realized gains not included in numerator or denominator

  10. “Benefits” of (a)(1) test over (a)(2) test • Substantial donors • Only excludes excess over 2% threshold • Exception for government and other (a)(1) donors from 2% cap • “Facts and circumstances” test has 10% safety net threshold • No restriction on investment income • Benefit for heavily endowed organizations

  11. Eligibility for 509(a)(1) • Not eligible if it receives: • Almost all of its support from gross receipts • An insignificant amount of contributions from government and general public • Regulatory example: 1% from contributions is not more than insignificant • Conclusion: must be > 1% (10%??) and can be <50% (doesn’t say “majority”)

  12. Eligibility for 509(a)(1) (cont.) • Grants vs. Gross Receipts [Reg. 1.509(a)-3(g)] • Designation by parties as “grant” or “contract” is not controlling • Grant normally made to encourage grantee to carry on exempt activities

  13. Eligibility for 509(a)(1) (cont.) Gross Receipts • Serve direct and immediate needs of payor rather than confer a benefit upon the general public • Sales/services delivered to government • Service to public funded by government

  14. Eligibility for 509(a)(1) (cont.) • Dues • New Form 990 and instructions require allocation among: • Contributions (general support of organization) • Fees for service (direct benefit to payor) • Part contributions and part fees • Fees portion treated like other fees (ignored)

  15. 509(a)(1) – 170(b)(1)(A)(vi)Not all contributions are good support! • Numerator does not include excess amount from a person greater than 2% of the revenue over the five year testing period • Amounts from governments and other § 509(a)(1) – 170(b)(1)(a)(vi) publicly supported organizations are not limited

  16. 509(a)(1) – 170(b)(1)(A)(vi) (cont.) Example: • § 509(a)(1) organization had total support for 2006-2010 of $60,000,000 (excluding gross exempt-purpose receipts) • Any amount from a donor who gave over $1,200,000 (2%) is not “good” money

  17. 509(a)(1) – 170(b)(1)(A)(vi) (cont.) • During testing period: Only “good money” goes in numerator

  18. Unusual Grants • Contributions may be excluded from both the numerator and denominator

  19. Unusual Grants (cont.) • Intended for gifts/bequests from disinterested parties which are: • Attracted by publicly supported nature of organization; • “Unusual or unexpected” with respect to the amount; and • Would, by reason of their size, adversely affect public charity status

  20. Unusual Grants: Factors to Consider • “All pertinent facts and circumstances,” including: • Person is creator or previous substantial contributor of organization (unfavorable) • Bequest (favorable) vs. lifetime gift • Gift was in furtherance of exempt purpose of organization, such as painting to museum (favorable)

  21. Unusual Grants: Factors to Consider (cont.) • Whether the organization has previously conducted public solicitations and programming and been successful (favorable) • Reasonable expectation to attract future public support (favorable) • Prior success at passing 1/3 test (favorable) • Whether contributor or related party continues to exercise control over the organization (unfavorable)

  22. Unusual Grants: Factors to Consider (cont.) • Whether there is a representative governing body (favorable) • Whether there are material conditions for restrictions on the gift (unfavorable?)

  23. Unusual Grants • Reliance on public charity status • Can rely on IRS records, unless grantor was responsible for or aware of substantial or material change • Can request written confirmation from charity that grant will not “tip” the charity • Can request IRS ruling as to “unusual” prior to receipt of gift

  24. Facts and Circumstances Test Available if public support is less than 33 1/3%, but at least 10%: • Test is “subjective” • Measures both financial and non-financial factors

  25. Facts and Circumstances Test (cont.) • Must: • Public support is 10% or higher • Be organized to attract public support • Continuous and bona fide program for solicitation of public funds (includes government funding)

  26. Facts and Circumstances Test (cont.) • And subjective factors: • % of public support – closer to 33% (favorable); closer to 10% (unfavorable) • “Representative number” of donors who are not single family • Representative governing body: public officials, subject matter expertise, community leaders

  27. Facts and Circumstances Test (cont.) • And subjective factors: • Availability of public facilities or services, public participation in programs, and • For membership organizations, broad solicitation or revenue, members and programming

  28. Form 990 Schedule A Part II Examples – See Slides

  29. Foreign Government Support • Rev Rul 75-435 • Foreign government support of a foreign organization is treated as government support for (a)(1) test • Reg. Section 1.509(a)-2 • GCM 38327 (1980) – Rev Rul is inconsistent with Code section 170(c)(1) – United States or political subdivision

  30. Foreign Government Support (cont.) • Rev Rul remains “unrevoked” • Impact on government support of domestic organization? • If foreign goverment support is okay, how about: • United Nations • World Bank • International Monetary Fund (IMF)

  31. How to Treat Contributions from Foreign Charities • 2% limit does not apply to contributions from organizations described in § 170(b)(1)(A)(vi) • Requirement that organization be created or organized in the U.S. (See § 170(c)(2)) • Treas. Reg. § 1.509(a)-2(a) provides that an organization may qualify even if organized outside the U.S.

  32. How to Treat Contributions from Foreign Charities (cont.) • Mexico and Canada treaties have provisions for reciprocal recognition of § 501(c)(3) status • Can this be used to include all support as good support?

  33. §509(a)(2) Test

  34. Form 990 Schedule A Part III: § 509(a)(2) Test Mechanics • Must have more than 33 1/3% public support and • Not more than 33 1/3% investment income percentage • Investment income percentage is the total of interest, dividends, rents, royalties and UBTI from business acquired after June 30, 1975 over total support • No facts and circumstances test available under this test

  35. Form 990 Schedule A Part III: § 509(a)(2) Test Mechanics (cont.) • Public Support (numerator) includes: • Gifts, grants and contributions • Membership fees • Gross receipts from activities that are not an unrelated trade or business under §513 • Admissions • Merchandise sold or services performed or • Facilities furnished

  36. Form 990 Schedule A Part III: § 509(a)(2) Test Mechanics (cont.) • Total Support (denominator) includes public support and: • Interest, dividends, rents, royalties • UBTI (less taxes) from business acquired after June 30, 1975 • Net income form unrelated business activities not included in above – whether or not regularly carried on • Other income

  37. Form 990 Schedule A Part III: § 509(a)(2) Test Mechanics (cont.) Note: Income from the sale of capital assets is excluded from both public support and total support

  38. Not All Support is Good Support • § 509(a)(2) – the following are not included in the numerator as good support: • All contributions, membership fees or gross receipts from a disqualified person AND • Amounts from gross receipts in carrying out the organization’s exempt purpose received from a person (other than a disqualified person) that exceed the > of $5,000 or 1% of the support for the year

  39. Not All Support is Good Support (cont.) • Disqualified person includes substantial contributors, officers, directors or trustees • A substantial contributor is person who contributes more than $5,000 if the amount is more than 2% of the total contributions received by the organization through the end of the taxable year (from inception of the organization!)

  40. Important Notes • IRC § 507(d)(2)(C) outlines rules to cease being a substantial contributor and includes: • Ten years of no contributions by individual or related persons and contributor and related persons cannot be a “foundation manager” • Contributions must be insignificant when compared to at least one other person

  41. Important Notes (cont.) • The exclusion on gross receipts in excess of 1% of support for the year includes amounts from federal government agencies/bureaus and §170(b)(1)(A)(i)-(vi) organizations • Unlike the § 509(a)(1) test, not all government/ § 509(a)(1) money is good

  42. Important Notes (cont.) • Contributions versus gross receipts • Distinction is important because all contributions are good money except for those from DPs • All gross receipts are subject to the limitation > of $5,000 or 1% of the support for the year • If the payment is serving the direct and immediate needs of the payor – it’s gross receipts • If the payment is primarily to provide a direct benefit to the general public – it’s a grant

  43. Unrelated Business Activities • Gross receipts from activities that are not unrelated activities under § 513 are included in public support • § 513 exclusions include: • Volunteer exception • Donated goods exception • Convenience exception • Trade show exception

  44. Unrelated Business Activities (cont.) • UBTI (less taxes) from businesses acquired after June 30, 1975 is included in total support • Net income from unrelated activities, whether or not regularly carried on, is also included in total support • Question: How to report gross/net proceeds from fundraising events?

  45. Investment Income Percentage • Not more than 33 1/3% • Total of interest, dividends, rents, royalties and UBTI from business acquired after June 30, 1975 over total support • Capital gains and losses are excluded from both the numerator and denominator

  46. Form 990 Schedule A Part III Examples – See Slides

  47. §509(a)(3) Supporting Organizations

  48. Supporting Organizations (SO) • Carry out their exempt purpose by supporting other exempt organizations • Usually supports a §509(a)(1) or (a)(2) organization but can also support a §501(c)(4), (5) or (6) organization • Must be organized and operated for §501(c)(3) purposes

  49. Supporting Organizations (cont.) • Must be organized and operated exclusively for the benefit of, to perform the functions of, or to carry out the purpose of one or more specified organizations described in §509(a)(1) or (2) • Can’t be controlled directly or indirectly by DPs other than foundation managers

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