terry miller leventhal kline management, inc. 127 university avenue berkeley california 94710 ...

Terry MillerLeventhal Kline Management, Inc.

127 University AvenueBerkeley California 94710

www.philanthropicadvisor.org [email protected] [email protected]

Public Support Tests :Context & Calculation

[in the era of the New 990]

AICPA NPF08 Session 51

Overview of Session

Context – Calculation – Alternatives & Considerations Overview of Session Definition of Public Charity Who cares? Why does it matter? Types of Public Charities Public Support Test formulas: New 990 – Big Changes! Public Support Test formula: 509(a)(1)/170(b)(1)(A)(vi) Public Support Test formula: 509(a)(2) Reporting: Common Technical Errors Reporting & Planning: Common Substantive Errors Other Tax Planning Tips & Special Topics

1

Definition of Public Charity

501(c)(3) = Private Foundation by default

Must pass test to Qualify as “NON-private

foundation” known as public charity (“PC”)

Private Foundations (“PF”) generally answer to

donors: narrowly funded, narrowly controlled,

ergo, highly regulated to ensure public benefit

2

Who cares?Why does it matter?

Private Foundation Obscure difficult Form 990PF Difficult to get grants from PFs Only easy grants are to PCs

Lobbying prohibited Most insider transactions

prohibited Lower deductibility: valuation Lower deductibility: % AGI Minimum payout Tax on investments Prohibition on certain

investments

Public Charity Easier Form 990 (cheaper prep) Possible to get PF grants PC may grant to any entity for

charitable work Lobbying: generous limits Insider transactions must be

reasonable Deductibility usually FMV Deductibility higher % AGI No minimum No such tax No prohibition; prudence only

3

Answer: Rules & Regulations! PC status is often vital to objectives…

Types of Public Charities

509(a)(1) holds six tests: 170(b)(1)(A)(i) - (vi)

1. 170(b)(1)(A)(i) – church

2. 170(b)(1)(A)(ii) – school

3. 170(b)(1)(A)(iii) – hospital or medical research organization

4. 170(b)(1)(A)(iv) – support org to public college / university

5. 170(b)(1)(A)(v) – governmental unit

6. 170(b)(1)(A)(vi) – publicly supported through gift income

7. 509(a)(2) – publicly supported through earned income

8. 509(a)(3) – by connection to an (a)(1) or (a)(2) (Types I, II, III)

9. 509(a)(4) – product safety testing

There are nine primary types of public charity:

4

Public Support Tests: New 990 – Big Changes!

5-year measurement period; was 4-year

Not nec. cash method: same as return; restate prior years

Larger denominator: commercial income that escapes UBTI

as “not regularly carried on” (other exclusions OK)

NO ADVANCE RULING PERIOD – NO FORM 8734! IRS issues determination based on likely support No % calculation during first 5 years (though do table) Starting in 6th year, failing test 2 consecutive years =

immediate PF status Self-evaluation for “facts & circumstances” qualification for

(a)(1)/170(b)(1)(A)(vi) charities

New Part IV for certain explanations5

Calculation: 509(a)(1) & 170(b)(1)(A)(vi) - 1/4

Basics (formula on next slide)

5 year measurement period

5 year startup time – 5 fiscal year ends from formation – tax

planning – can be 49-60 months – tax planning opportunity! – no

calculation required until Year 6

Starting in Year 6 must calculate public support %

Goal is > 1/3 public support If <1/3 but >1/10, then “facts & circumstances” to differentiate from

narrow private foundation

Sufficient support in one measurement period confers PC status

on two years (current + next)

6.1


Formula Detail:+ Grants from 170(b)(1)(A)(vi) charities+ Grants from governmental agencies+ Gifts grants & contributions - up to 2% of the denominator

from each private source (aggregate by family & business)+ Tax revenues & government facilities furnished free that

usually cost• All income (counting NET UBI not gross), minus:

─ Exempt function income (program svc revenue)─ Excl from UBI oth than becuz not regularly carried on─ Unusual grants─ Capital gains─ Tax paid on UBTI 6.2

Public S

upportT

otal Support


Formula Result:If: public support / total support > 1/3 then: definitively public charity; butIf: < 1/3, but > 1/10, then: look to facts & circumstances “grey area;”If: < 1/10, for 2 consecutive periods, then: revert PF

6.3

• Facts & Circumstances:+ Broad community-based board, not just insider donors+ Fundraising efforts to broaden support+ Substantial support from governmental agencies+ Facilities or services made available to general public


6.4

• Unusual Grants: generally are substantial contributions and bequests from disinterested persons and are:

Attracted because of the organization’s publicly

supported nature,

Unusual and unexpected because of the amount, and

Large enough to endanger the organization’s status as

normally meeting the 1/3 public support test.

A grant that meets these requirements may be treated as

an unusual grant even if the organization receives the

funds over a period of years.

Calculation: 509(a)(2) - 1/3

Basics are similar to (a)(1) (formula on next slide)

5 year measurement period

5 year startup time – 5 fiscal year ends from formation –

can be 49-60 months – no calculation required until Yr 6

Starting in Year 6 must calculate public support %

Goal is > 1/3 public support Sufficient support in one measurement period confers PC

status on two years (current + next)

(Investment Income + After Tax UBI) must be < 1/3

NO facts & circumstances alternative!

7.1

Calculation: 509 (a)(2) - 2/3

Formula Detail:+ Fees: exempt function income from entities that are NOT

disqualified persons, up to the GREATER of $5,000 or 1% of Total Support – in a given SINGLE YEAR (not 5)

+ Grants from 509(a)(1) public charities+ Grants from Government agencies+ Gifts from other sources NOT disqualified persons+ Tax revenues & government facilities furnished free

• All income (counting NET UBI not gross), minus:─ Unusual grants (same definition as in (a)(1))─ Excl from UBI oth than becuz not regularly carried on─ Capital gains─ Tax paid on UBTI 7.2

Public S

upportT

otal Support

Calculation: 509(a)(2) - 3/3

Formula Result:If: public support / total support > 1/3,AND If: (investment income + after tax UBI) < 1/3 then: definitively public charity; If NOT: then, revert to PF status

7.3

Disqualified Person (relatively permanent – 10 yr):– Substantial contributors – gifts exceeding $5K or 2% of

total gift income over entire organization history– Owner of >20% of a substantial contributor– Foundation mgr (of the charity) – ofcr, dir, key employee– Family members of other disqualified persons– Certain related entities

Common Technical Errors

Wrong periods reported

Wrong accounting method (was cash method required)

now same method as return; restate prior years

Confusion about which entities subject to 2% limitation lack of family aggregation treatment of public entities as subject to 2% limit treatment of PFs as NOT subject to 2% limit guessing

Wrong status box checked [(a)(2) description reads more

accessibly – lay or bad research error]

8

Reporting & Planning:Common Substantive Errors

Confusing fees v. donations especially government awards also special events – earned v. donated portion membership dues – typically donative NOT earned for

a (c)(3) “Other Income” is drag on public support – could often be

netted against expense Fear of “facts & circumstances” – inexperienced preparers

consider (a)(1) <1/3 to be failure and recommend 990-PF Confusion about initial funding from fiscal sponsor or

parent in spinoff (usually NOT subject to 2%) Confusion about definition of “unusual grants”

9

Other Tax Planning Tips & Special Topics - 1/4

STRATEGY TIPS - 1: Scope is Everything – do quick test first – if at ~60% don’t

sweat the details; if at 34% then DO sweat the details

Three alternatives to consider if approaching failure:1. Supporting Organization 509(a)(3)

tax planning / strategic advantages in some cases loss of control (even more since PPA) increasing scrutiny, especially Type III and maybe Type II legal advice needed – not a D.I.Y. project

2. Private Operating Foundation (“POF”) narrowly supported, broadly operated still many PF constraints, but offers PC level deductibility complex tests (3 options), each with two parts & many nuances

3. Advisory Committee to a Sponsored Project

10.1


STRATEGY TIPS – 2: Publicly supported (a)(1) is MUCH BETTER than (a)(2) due

to flexibility; switching does not require permission For an (a)(1), do a check at ~3.5 years, in case facts &

circumstances will be important; gives time to act Choose formation date to get longest first five “years” (e.g.

incorporate just AFTER FYE, not just before) Capital Gains don’t count in the denominator of (a)(1)

charities; if tight, manage investments to generate gains not interest & dividends (including distributed LT Gains)

How much % of income from fees is too much to pass (a)(1) test? Current regs say only that 100/1 is too much. Experts? 90/1 maybe 95/1

10.2


PLANNING: Funds from subsidiary for-profits and from (a)(3) supporting

organizations are treated unfavorably, as disqualified persons (subject to 2% limit for (a)(1) and not public support for (a)(2) )

PFs may convert to PCs by filing for a “private foundation termination” [IRC §507(b)(1)(B)]. (Not clear how this will change with no more advance ruling period.)

Switching publicly supported (a)(1) to (a)(2) (or back) is just about checking the box

Publicly supported (a)(1) & (2)’s may convert to (a)(3)’s at least going forward if not retroactive – requires planning ahead and governance changes.

10.3


SPECIAL TOPICS:

Words: how to technically describe? (501(c)(3) v. 509(a)(1) confusion) Say “a 501(c)(3) charity which is” “a publicly supported 509(a)(1) charity” or “a 509(a)(1) and 170(b)(1)(A)(vi) public charity”. Won’t matter to anyone but PFs.

Words: “total support” is a misnomer because it includes some revenue – “support” v. “revenue” is sadly ignored too often

“Failure” is not fatal. PF’s are still tax-deductible 501(c)(3) charities which can pay insiders for working. No grants income, no lobbying, no other payments to insiders, some tax, but no public support test to fool with.

Failing the test in the 6th year will not ordinarily jeopardize deductions, but will subject charity to investment income tax (only 2%) – other PF constraints apply only going forward.

10.4

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