- What is tipping?
- Does this mean my charity will lose its tax-exempt status?
- How can I avoid tipping for my public charity?
- How does tipping affect the grantor?
1. What is tipping?
Tipping occurs when a public charity can no longer meet the public charity support test required by the IRS for two successive tax years. If this happens then the public charity will be reclassified as a private foundation. The most common example of this is when a public charity receives a large grant from a private foundation which "tips" the public charity into private foundation status.
2. Does this mean my charity will lose its tax-exempt status?
No. Reclassification to a private foundation does not revoke the charity's tax-exempt status. It will still be exempt from federal income taxes under IRC Section 501(c)(3). However, as a private foundation, it will become subject to IRS regulations governing those entities such as excise taxes, minimum distribution requirements, and various other federal excise taxes that may be imposed on private foundations. It will also need to begin filing the more burdensome annual return, IRS Form 990-PF.
3. How can I avoid tipping for my public charity?
The public support test is a complex formula that evaluates the sources of support to a public charity. A public charity must demonstrate that it receives a minimum of 33 1/3% of its support from public sources in order to pass this test. There are many exceptions that may apply to the calculation that will work in favor of the charity. For example, gifts from other public charities are exempt from the 2% limitation placed on other sources of support and count in full towards the public support percentage. Another beneficial exemption pertains to "unusual grants" which can be excluded from the public support calculation altogether.
If a public charity does not pass the public support test for a given year, it may still pass what is referred to as the "facts and circumstances" test. This test lowers the percentage of public support required to maintain public charity status down to a minimum of 10%. If a public charity demonstrates this percentage of support it may be able to pass the facts and circumstances test if it can also show that it exhibits sufficient characteristics of publicly supported organizations. Factors in support of a favorable determination include:
- Public support percentage well above 10%. The closer the public support percentage is to 33 1/3%, the better.
- Support from a "representative number of persons". As an example, support from members of a single family would not be a representative number of persons.
- Broad based board of directors
- Facilities and programs that are easily accessible and open to the general public
- Published materials that are made available to the general public
- Participation in the charity's programs by civic and community leaders or public officials
- Definitive programs that conduct community work
- Significant support from other public charities or governmental agencies to which the charity is accountable
- If the charity is a membership organization, attempts to enroll a substantial number of persons representative of a broad swath of the general public, including dues/rates that can attract a large number of members
Careful evaluation of the charity's sources of support and the public nature of its programs and board of directors should be made to determine if it will be able to meet either the public support test or the facts and circumstances test described above. If the charity cannot meet either of these tests, and tipping is the result of a large grant, it may be possible to negotiate with the grantor to spread the grant out over a number of years. Because the public support calculations are based upon donations to the charity over a number of consecutive tax years, this can help to minimize the negative impact on the charity's public support calculations and may prevent tipping.
4. How does tipping affect the grantor?
If the grantor is a private foundation, the foundation may be less likely to make the grant due to the additional expenditure responsibility requirements necessary when making a grant to an entity that is not a public charity.
If the grantor is a private individual, reclassification to private foundation status may impact the tax-deductibility of his/her donation.
Finally, donor advised funds are prohibited from making grants to most types of private foundations.