Previously, new organizations with less than one-third public support could request a definitive public charity ruling on the basis of a “10 percent plus facts and circumstances” test at the time they filed Form 8734 (the support schedule for an advance ruling period). However, under recent guidance by the Internal Revenue Service, the advance ruling period and Form 8734 are eliminated, and organizations with less than one-third public support, as well as private foundations seeking reclassification as public charities, are unsure how to proceed. The American Bar Association (ABA) has called for the IRS to add additional examples illustrating the application of the “10 percent plus facts and circumstances test” exempt organizations can use to establish that they are publicly supported. The ABA also would like to see a revenue ruling issued providing examples of the application of the test.  

Public Charity Classification

To be classified as a public charity, an organization must show that it has broad support from the general public, rather than getting its funding from just a small number of donors. One of the tests for determining public support is to show that one-third of its funding comes from individuals, corporate and foundation grants, and other public charities. Donations from any one source may not exceed 2 percent. A second test allows the organization to prove it is publicly supported by showing that donations that are considered to be acceptable come to more than 10 percent of the charity’s total revenue. Additionally, other criteria must be met, such as continuity in fundraising and a board of directors that is representative of the community.

Former Rules

Under former rules, organizations had some assurance that the IRS would not try to reclassify them as private foundations, as long as facts and circumstances presented to the IRS at the time of the filing of Form 8734 remained unchanged. Moreover, Form 8734 could be used to seek reclassification as a public charity from inception, providing for a refund of any private foundation taxes previously imposed, in cases in which an organization mistakenly applied for recognition of exemption as a private foundation while consistently meeting the public support test.  

Temporary Rules

Temporary and proposed rules (T.D. 9423) implemented the redesigned Form 990 and eliminated the advance ruling period for new exempt organizations. While the temporary rules considered that an organization might seek a ruling or determination letter on public charity status at any time, they fail to describe the process for requesting the ruling or determination letter. In question is whether an organization seeking a determination letter will be required to submit a formal private letter ruling request and pay the substantial user fee.  

New Accounting Method

Another change under the temporary rules requires that organizations calculate their public support by using their normal method of accounting rather than the cash method. Public support is determined over a five-year period consisting of the current year and the prior four years. Thus, the change requires accrual method organizations to recalculate and report their public support for prior years 2004 through 2007 on the accrual method when they file their 2008 Forms 990. According to the ABA, this might affect the ability of some small and mid-size charitable organizations

to qualify as publicly supported, particularly in the short term. Under the accrual method, the present value of a large multiyear grant is considered public support in the year the grant commitment is made whereas, under the cash method, it would be considered public support as the funds are received. The accrual method is not limited to large organizations. This could create the potential problem of organizations failing the public support test on the accrual method but meeting it using the cash method. Commentators have recommended extending the transition rule in the temporary regulations for one or two more years and expressly allowing organizations to continue to use the cash method for purposes of applying the transition rule.