Read this if you are a charitable organization.
Charitable organizations are as diverse as the causes they represent. Most notably, tax-exempt senior living organizations can run the gamut of organization types with various unique filing requirements. While some people might be aware that senior living organizations can either be for-profit or not-for-profit, many may not know that the not-for-profit group has its own wide range of entities recognized by the IRS. This article will go into detail on the types of charitable organizations out there and the differences between them.
The two overarching categories in the charitable world are public charities and private foundations. Private foundations are then further classified as either operating or non-operating and include some beneficial provisions for organizations that hold the designation of an exempt operating foundation.
Public charities
The first thing that comes to mind for most people when they think of charitable or not-for-profit organizations is 501(c)(3) public charities. Public charities must annually file Form 990, 990-EZ, or 990-N with the IRS. Form 990 and 990-EZ include a public charity schedule where the filing organization must disclose the Internal Revenue Code (IRC) that it derives its public charity status from. Furthermore, many public charities must also complete and pass one of two support tests on the schedule.
Most senior living organizations which file Form 990 or 990-EZ receive their exemption under IRC Section 509(a)(2). This section describes an organization that normally receives (1) more than 33 1/3% of its support from contributions, membership fees, and gross receipts from activities related to its exempt functions; and (2) no more than 33 1/3% of its support from gross investment income and unrelated business taxable income.
Public charities which derive their public charity status from IRC Section 509(a)(2) must complete and pass the Schedule A, Part III public support test. The public support test looks at the activities of the public charity in aggregate over the most recent five tax years. New organizations must complete the test but do not report a percentage in the first five years of existence and, as such, cannot fail the support test during this time.
Alternatively, if a public charity fails the Schedule A Part III test, it is eligible to complete the Part II test instead. A public charity completing Part II must demonstrate it normally receives a substantial part of its support from a governmental unit or the general public.
Private foundations
If a public charity fails its public support test for two consecutive years, it automatically becomes a private foundation. Additionally, organizations applying for exemption can request to be designated a private foundation from inception. Private foundations file Form 990-PF. Many private foundations are non-operating and primarily serve to hold investments and make grants or donations to public charities or other recipients as allowed by the IRS.
Private foundations must pay a flat 1.39% excise tax on their net investment income annually and are also required to meet minimum distribution requirements. Private foundations are also subject to stricter guidelines regarding their expenditures and other transactions with interested persons, as well as excess business holdings. Failure to comply with these rules can result in excise taxes being imposed both on the organization as well as its foundation managers.
Operating foundations
Some private foundations with substantial operations can be classified as operating foundations as described in IRC Section 4942(j)(3) and (j)(5). Operating foundations must complete a four-year test and pass either in aggregate or in three of the four most recent years individually. Operating foundations are not subject to the minimum distribution requirements of non-operating foundations.
IRC Section 4942(j)(3) operating foundations must complete and pass both an income test as well as one of three supplemental tests, either the “Assets”, “Endowment” or “Support” test. IRC Section 4942(j)(5) operating foundations must only complete and pass the “Endowment” test—they do not need to complete the income test or any other supplemental test.
If an organization does not pass the operating foundation test in a given year, it is classified as a non-operating foundation for that year and remains so until it passes the test again. While a foundation is designated as a non-operating foundation, it is subject to the minimum distribution requirements.
Exempt operating foundations
Finally, exempt operating foundations, as defined in section 4940(d)(2), are not only exempt from minimum distribution requirements as (j)(3) and (j)(5) operating foundations, but they are also exempt from the 1.39% net investment income tax. To receive the designation, an organization must be granted this status by the IRS and meet the following requirements each year it claims the exempt operating foundation status:
- Qualify as an operating foundation.
- Qualify as a publicly supported organization for at least 10 years or have been an operating foundation as of January 1, 1983.
- Have no officers that are disqualified individuals.
- Have a governing body comprised of individuals that are broadly representative of the general public and at least 75% are not disqualified individuals.
A private foundation can also transition into a public charity. To accomplish this, a private foundation must notify the IRS prior to beginning a 60-month termination period during which it must act as a public charity. At the end of the 60-month period, it must demonstrate that it now would pass a public support test.
The rules and regulations surrounding exempt organizations are vast and complex. Should you have any questions regarding your organization or would like to discuss tax planning, our not-for-profit tax team of dedicated tax professionals is happy to help.