The IRS recently reviewed their thinking on the intersection between donor advised funds (DAFs) and the public support test. You can check the details in full here.
To briefly summarize, the notice issued by the IRS is an indication that it is “considering developing proposed regulations” in this area. Namely, a change in how contributions from DAFs would be treated when a nonprofit calculates its public support percentage.
The change has not yet become regulation but any proposed changes to the public support test should interest you as a nonprofit. After all, even small changes can impact you greatly as an organization…
The Existing Public Support Test
The IRS likes to see when a nonprofit receives a broad base of public support.
If you complete the Part II public support test on Form 990 Schedule A, you can receive unlimited contributions from other public charities and government agencies, and all of these amounts will count as public support.
However, contributions that you receive from a private foundation, business, or individual only count as public support to the extent that the donor’s contributions do not exceed 2 percent of your charity’s total support for the most recent five-year period (ending with the last day of the tax year currently being filed).
Such donors can give more than 2 percent of your charity’s total support. However, these excess amounts are not considered ‘public support’ and will lower your overall public support percentage.
How do you pass the public support test currently?
Nonprofits generally “pass” the public support test by achieving one of two thresholds:
- If your public support is at 33.33 percent or higher, no further questions will be asked.
- If your nonprofit’s public support is below 33.33 percent, the IRS will give you the benefit of the doubt if you can demonstrate that you qualify as a public charity despite your low public support percentage. Under this approach, your public support must be at least 10 percent AND you must prepare and submit a “10 Percent Facts & Circumstances” statement in which you describe your “continuous and bona fide” fundraising program, sources of support, and the diversity of your governing board.
Essentially, if your public support percentage is in this gray area between 10 percent and 33.33 percent, the IRS wants to make sure that you are representing the “broad interests of the public” and that you are actively conducting program activities that benefit the general public.
If you do not satisfy the 33.33 percent test this year but did in the prior year, there is a one-year grace period before you must provide a 10 Percent Facts and Circumstances statement.
If your nonprofit cannot satisfy the public support test under one of the methods described above and the one-year grace period has passed, you will lose your public charity status and be treated as a private foundation.
A proposed change to the public support test
At issue under the new IRS considerations is the scenario where a nonprofit receives substantial support through DAFs held by other public charities (e.g. community foundations).
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Example:
Assume Donor A donates $1,000,000 to their DAF at Community Foundation X and, in turn, advises Community Foundation X to grant $1,000,000 to Charity Z.
Currently, the entire $1,000,000 would count as public support when Charity Z calculates its public support percentage.
However, assume Donor A instead donates $1,000,000 directly to Charity Z, without going through the DAF. Only a portion of the million dollars (i.e. the amount within the 2 percent threshold described earlier) will count as public support.
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What the IRS is now taking issue with is that a nonprofit’s public support percentage might be significantly altered, simply as a result of how a donation is processed, citing a “potential for abuse”.
Hence, the IRS is proposing that such contributions are treated as coming directly from the original donor-advisor, essentially ignoring the roles of the sponsoring organization and the DAF.
On the flip side, however, is the notion that organizations who sponsor DAFs maintain “exclusive legal control” over the DAF, meaning that they retain the right to veto a donor-advisor’s request to grant funds to a specific nonprofit.
These community foundations, who themselves must demonstrate that they represent the “broad interests of the general public” by passing the public support test, are not merely a pass-through vehicle responsible for processing a transaction.
One might argue that these gatekeeping responsibilities of sponsoring organizations should count for something when considering whether grants from DAFs should be treated as public support.
How could this change impact your nonprofit?
The proposed change could have the effect of significantly lowering the public support percentage of your nonprofit.
In the worst-case scenario, if you currently satisfy the 33.33 percent test or the 10 Percent Facts and Circumstances test, you may find that your public charity status is threatened.
The proposed change is more likely to affect your organization if you struggle with a low public support percentage and/or receive significant funding from DAFs.
If you find yourself in this position, work closely with your nonprofit tax advisors to assess the potential impact and plan accordingly. We recommend pro forma public support projections that address different scenarios.
And, of course, if you have any further questions about the proposed IRS changes, contact us here.
