Applying for 501(c)(3) status as a public charity can seem like a daunting task. We often get questions about what type of public charity an entity falls under. Three of the more common types of public charities are those organized under sections 509(a)(1) and 170(b)(1)(A)(vi) [referred to in this article as a 509(a)(1) entity for simplicity], 509(a)(2), or 509(a)(3) of the Internal Revenue Code. Which one is the right type for you to choose on the application for exemption?
These organizations are considered publicly supported charities because of the nature of their sources of revenue. Organizations that fall under this category typically receive large amounts of aid from the government, donations from the public, or other types of public sources.
An organization can be classified as a 509(a)(1) public charity by one of two methods. The first method is known as the one-thirds test, meaning at least one-third of the total revenue generated by the charity must come from the government or through public donations; this amount is measured over a five-year period. The second method is the facts and circumstances test which conducts a five-factor test to determine if your charity can properly be classified as a publicly supported charity. The test looks at the percentage of financial support from each source (at least 10% must come from public sources), the representative governing body, the availability of public services or facilities, and other factors for membership organizations. If your organization qualifies under 509(a)(1), public charity status may be granted for your nonprofit.
If your organization cannot satisfy either of the tests to be classified as a 509(a)(1) public charity, registering as a 509(a)(2) public charity, typically service providing organizations, may be the way to go. Here, two tests must be met in order to qualify. First, income from investments and unrelated business taxable income cannot exceed one-third of the organization’s total revenue. Second, more than one-third of the total revenue must come from any combination of gifts, grants, contributions, membership fees, and gross receipts from admissions, sales of merchandise, performance of services, or furnishing of facilities. In the event your organization cannot qualify as a 509(a)(1), this option may be a good way to ensure your tax exempt status as a public charity.
A 509(a)(3) public charity is considered to be a supporting organization. These are charities whose sole purpose is to support other charities, often through activities such as fundraising. Another common way to support other charities is to be listed as a private foundation; however, listing as a 509(a)(3) comes with a less strict regulatory regime compared to a private foundation.
These organizations act somewhat like a subsidiary would in a traditional corporate setup, and typically have a close relationship with the organization they support. To qualify as a 509(a)(3) entity, three tests must be met. The organizational test requires the entity to be organized exclusively for the benefit of, to perform the functions of, or to carry out the purposes of one or more publicly supported organizations. The operational test requires the entity to be engaged solely in activities that support or benefit the identified publicly supported charity or charities. Lastly, the relationship with the publicly supported charities must be one in which the publicly supported charity has control or supervision over the 509(a)(3) entity. The level of oversight required will be dependent upon whether your 509(a)(3) is classified as Type I, II, or III. The types of 509(a)(3) entities will be discussed in a future article.
If you believe you qualify as a public charity but are unsure of the specific public charity designation, the Colorado Nonprofit Legal Center can help you find the right fit and guide you through the application process. Reach out today with any questions you have about the differences between 509(a)(1), (2), and (3) entities.
By Justin Vanderveer