Many philanthropically minded clients have established their own private foundations to support charitable causes they believe in now, and to serve as a vehicle for giving for future generations of their family. While many family foundations flourish for multiple generations, many others struggle to survive for a single generation after the founders are gone. In the latter cases, the governing body (e.g., Board of Directors, Trustees, etc.) of the organization may start to consider terminating its status as a private foundation under Section 507[1]. Clients currently serving as directors or trustees should be aware that termination does not necessarily mean shutting down their organization, as one of the ways to terminate a private foundation is to convert to a public charity.[2]

In order to convert from a private foundation to a public charity, the private foundation must operate as a public charity as described in 509(a)(1), (2), or (3) for a continuous 60-month period, commencing on the first day of the tax year after it notifies the Internal Revenue Service (“IRS”) of its intent to terminate as a private foundation (the “Termination Period”).[3] In general, in order to qualify as a public charity, an organization must fall into one of the following three categories: (1) “per se public charities,” such as churches, schools, and hospitals, that qualify by virtue of the nature of their activities; (2) “publicly supported public charities” that qualify because they receive a substantial amount of their support from the public; or (3) “supporting organizations” that qualify as public charities because they support one or more of the organizations described in (1) and (2).[4]

In order to qualify as a publicly supported public charity, an organization must satisfy one of two public support tests. The first public support test is found in Sections 509(a)(1) and 170(b)(1)(A)(vi) and applies to organizations that receive a “substantial” part of their support from public contributions (“Traditional Public Charity”).

In order to qualify as a Traditional Public Charity, an organization must receive, over a five-year period, at least one-third (1/3) of its total support from public support.[5] Public support includes gifts and contributions from governmental units, the general public, and other public charities. However, not all support received from the public is fully counted as public support. For example, contributions from a single donor and related parties (such as family members) count as public support only to the extent they do not exceed two percent of total support. To illustrate this point, if, over a five-year period, an organization has total support of one million dollars, of which $100,000 is from a single donor and her family, only $20,000 (i.e., two percent of one million dollars) of the family’s contribution will be counted as public support.

Alternatively, if an organization cannot meet the one-third support test, it can still qualify as a Traditional Public Charity by meeting a 10 percent facts and circumstances test.[6] Under the facts and circumstances test, at least 10 percent of the organization’s total support must be public support and the organization must demonstrate that it is organized and operated to attract new and additional public contributions on a continuing basis.[7]

The second public support test is found in Section 509(a)(2) and applies to organizations that primarily derive their revenue from program services (“Gross Receipts Charity”). In order to qualify as a Gross Receipts Charity, an organization must receive, over a five-year period, more than one-third (1/3) of its total support from public support (which includes membership fees and certain gross receipts from related activities), while no more than one-third (1/3) of its total support can come from its investment income.[8] Importantly, amounts received from certain “disqualified persons,” including officers, directors, and substantial contributors, are completely excluded from public support for purposes of this test.

The private foundation must notify the IRS of its intention to operate as a public charity prior to the beginning of the Termination Period by filing Form 8940, Request for Miscellaneous Determination.[9] The Form 8940 must contain certain information, including, without limitation, a statement of the organization’s intention to terminate its private foundation status, the Section under which the organization will seek classification as a public charity, and the date the Termination Period begins.

An organization may request an advance ruling from the IRS on the termination of its private foundation status. This is typically done because donors may rely on the advance ruling that they are making a contribution to a public charity, which is helpful if the organization is applying for classification as a publicly supported public charity.[10] In order to request an advance ruling, the organization must provide additional information to the IRS, including, for example, a description of the organization’s past, current, and proposed activities, and how it will satisfy the requirements of a public charity, as well as a proposed budget covering the Termination Period.[11] The IRS will only consider an advance ruling request if it includes a signed consent on Form 872-B to extend the time to assess Section 4940 excise taxes on the organization.[12]

After the Termination Period is complete, the organization has 90 days to file another Form 8940 with the IRS stating that it has complied with the requirements to become a public charity.[13]

[1] Unless otherwise stated, all “Section” references are to the Internal Revenue Code of 1986, as amended (the “Code”).

[2] Section 507(b)(1)(B).

[3] Id.

[4] Section 509(a)(4) includes additional types of public charities that are organized and operated exclusively for testing for public safety. Converting from a private foundation to a supporting organization is less common than converting to a per se public charity or publicly supported public charity and is thus not discussed in this post.

[5] Sections 509(a)(1), 170(b)(1)(A)(vi).

[6] Id.

[7] Id.

[8] Section 509(a)(2), Treas. Reg. § 1.509(a)-3.

[9] Treas. Reg. §1.507-2(b)(1)(ii)

[10] Treas. Reg. § 1.507-2(d)(3)

[11] Treas. Reg. §1.507-2(d)(2).

[12] Treas. Reg. § 1.507-2(d)(5).

[13] Treas. Reg. §1.507-2(b)(4).