501(c)(3) or 509(a)? Your public charity is both.

Today is the Big Share! Don’t miss the opportunity to support 70 local nonprofits dedicated to building a fair, just community and protecting the environment through this Community Shares of Wisconsin online giving event: http://www.thebigshare.org. Thanks to Community Shares and their Big Share partner, Madison Community Foundation, for hosting this event to support the important work of these organizations.

And there will be another big share (of information) this week at the annual Wisconsin Nonprofit Association Conference: http://wisconsinnonprofits.org/Conference2015 , which is taking place in Madison on Thursday.

With today’s focus on charitable donations to 501(c)(3) organizations, I want to take an opportunity to explain an issue that comes up at least weekly in our office.

Client says: “We are a 501(c)(3) organization. Why does our IRS determination letter reference 509(a)? We don’t want to be a 509(a) organization.”

Melissa or Jessica say: “Any 501(c)(3) organization that qualifies as a “public charity” has a sub-designation under Section 509(a) of the Internal Revenue Code.”

Here’s a short explanation of this mysterious designation and a primer on what it means to be a public charity versus a private foundation.

Generally, 501(c)(3) organizations are presumed to be private foundations until they prove that they are public charities.  Public charities are either “publicly supported” or function to “support” another public charity (e.g., a foundation set up to support a hospital).

Public charities have the advantage of allowing donors to deduct donations from their individual taxes with a higher cap than private foundations, can accept donations from a wider range of donors, and have different, mostly less-burdensome compliance requirements than private foundations.

To qualify as a public charity an organization must meet the requirements for one of the three categories under Section 509(a) of the tax code.  Briefly, organizations that receive most revenue from gifts and grants are classified are “509(a)(1) organizations,” which is the most common type of public charity.  Organizations that rely primarily on earned revenue are classified under Section 509(a)(2).  Groups with a 509(a)(3) designation are known as “supporting organizations” because of their relationship to and support for other public charities.  Organizations that don’t meet one of these tests under 509(a) fall into the default category of “private foundations.”

Private foundations can be a good vehicle for setting up a nonprofit when the source of revenue is limited and the founders want to maintain control.  However, private foundations do have some additional requirements and restrictions.  For example, they are subject to a 5% payout rule and are prohibited from having “excess business holdings.”  They are also subject to a 2% tax on net investment income, which can be reduced to 1% if the payout rule is met.  In addition, all private foundations must file a full annual report (Form 990-PF), regardless of the size of revenue.

For more details and information about the differences between public charities and private foundations, see the links below:

Share Big today!