509(a) Tax Status Explained

Determining the correct tax status of your business or organization is incredibly important. Without it, you won't be able to establish your:

• Filling requirements
• Eligible deductions and credits
• Correct tax rate

What is 509(a)?

Organizations that are classified as 501(c)(3) tax exemption status are further classified by the government as one of five types under code section 509(a) of the Internal Revenue Code. These categories include private foundation status and four different types with public charity status. According to the Internal Revenue Code, any organization not classified as a public charity is designated as a private operating foundation or private non-operating foundation. While private foundations typically receive money from a small number of donors, public charities are organizations that receive a significant amount of their revenue from the public or government. To remain a public charity, at least one-third of revenue must be from a broad base of public support. When you complete Form 1023 to file for 501(c)(3) status, you’ll be asked questions in Part X that the Internal Revenue Service (IRS) will use to classify your organization.

509(a) vs 501(c)(3)

Subdivisions of 509(a) are specific types of 501(c)(3) organizations. Typically, 501(c)(3) organizations are considered to be private until they meet specific criteria to become a public charity, which means obtaining a 509(a) status. There are unique requirements to operating a private or public charity, from allowable funding sources to taxes. 

509(a) Subdivisions

There are specific criteria your organization must meet to qualify for 509(a) status. Use the following guide to learn more about: 

• 509(a)(1)
• 509(a)(2)
• 509(a)(3)
• 509(a)(4)

509(a)(1)

Public-supported charities that receive funding in the form of cash and other donations from donors, parishioners, and other parties may qualify for 509(a)(1) status. Organizations that seek this status include: 

• Churches
• Schools
• Hospitals

509(a)(2)

Prospective organizations must pass two distinct tests to qualify for 509(a)(2) status.

1. The first test determines whether an organization receives more than one-third of its funding from the general public in the form of gifts, contributions, membership fees, or sums paid for the performance of an exempt function.
2. The second test focuses on limiting an organization's funding from gross investment income and certain unrelated trade or business income to no more than one-third of its overall funding.

509(a)(3)

Charities that support other exempt organizations for an exempt purpose are called supporting organizations. This organization type is able to achieve 509(a)(3) status. To qualify, the organization being supported will have a supervisory role within the supporting organization or closely monitor its operations. Supporting a public charity without this oversight component typically isn't enough to qualify for 509(a)(3) status.

509(a)(4)

To achieve 509(a)(4) status, the organization must conduct tests for public safety. Qualifying public safety testing is diverse and can range from electronics to motorboats. The general public and government are the typical funding sources for organizations with 509(a)(4) status. 

509(a) Public Support Test

The public support test is a way to prove to the IRS that an organization is a public charity. It consists of two parts, Public Support and Total Support, which are calculated based on the charity's previous five years of operation. Public charities with statuses 509(a)(1) and 509(a)(2) must submit proof via IRS Form 990 that 33.3% or more of funding was from the public. 

Public Support Test for 509(a)(1)

The public support test for organizations with 509(a)(1) status typically receives revenue from donations. Donations and contributions from public sources such as individuals, corporations, and other charities qualify. However, there is an exception. If a donor contributes more than 2%, it is considered an excess contribution and would not be counted toward the public support necessary to pass the test.

Public Support Test for 509(a)(2)

The public support test for organizations with 509(a)(2) status typically receives program service revenue in the form of tuition, event admission, membership dues, and other fees associated with their mission. However, like the public support test for organizations with 509(a)(1) status, there are exceptions. Like 509(a)(1) organizations, if a donor contributes more than 2%, it is considered an excess contribution and would not be counted toward public support. There is also a limitation for significant contributors. If a person has contributed more than 2% of an organization's revenue since it was established, those contributions can no longer be counted as public support. Public charities and certain government units are typically exempt from this rule. 

509(a) Facts and Circumstances Test

Organizations that fail to meet the public support test revenue threshold can use the facts and circumstances test instead. To pass this test, an organization's public support must not fall below 10%. It must also submit a plan to the IRS detailing how it will return to the 33.3% threshold. Organizations with less than 10% of public support for two consecutive years will lose public status and revert back to a private foundation. These are facts and circumstances the IRS considers: 

Percentage of Public Support

When evaluating a submission, the IRS might consider the percentage of public support and funding sources. The higher the percentage of public support, the less information the IRS requires for an organization to maintain its status. Funds secured from the government may also be considered. 

Supporters’ Base

The IRS evaluates an organization's base to demonstrate if it is publicly supported. They look at the organization's maturity, type, and whether its mission would attract a wide or narrow support base. 

Public Interest and Governing Body

The IRS also considers organizations with a governing body representing the public interest. Such bodies can be comprised of community members, business leaders, public officials, and others. 

Community Participation

Those who sponsor or participate in an organization's activities, such as a specialized expert, local political official, business leader, etc., may impact the IRS's facts and circumstance test deliberations.

Providing Public Benefit

Organizations that regularly provide a distinct public benefit increase their chances of passing the facts and circumstances test. Examples that may qualify include a museum with free admission to the community, a public concert series, and pro bono services to community members in need. Organizations with ongoing programs in place meant to improve communities are also considered.

Conclusion

Maintaining a charitable organization's 509(a) status can be a lot of work, especially if you're relatively new to the non-profit space. A mistake has the potential to set you back and deter current and future public support, which is why many organizations trust 1-800Accountant, America’s leading virtual accounting firm for small businesses, with their financial work. Whether it's tax preparation and bookkeeping for non-profits, tax advisory, entity formation, or any of our professional accounting services, we have the affordable solutions you need to ensure your non-profit remains compliant. Schedule a quick consultation–usually 30 minutes or less to learn more.