The public support test is a mathematical test on the organization’s funding that proves that it has diverse enough funding to be considered a public charity (vs. a private foundation).*
In order to avoid being a private foundation, an organization can be a certain type of institution (church, school, hospital), qualify as a supporting organization to another public charity, or meet one of the mathematical support tests. For new organizations, recent changes in regulations allow them to qualify as a public charity for the first five years of their existence if they can show on the Form 1023 (application for exemption for 501(c)(3)s) that it is reasonable that they would receive the required public support during that five year period.
There are two public support tests that an organization can use:
Public/Government Support Test (under §§170(b)(1)(A)(vi) and 509(a)(1) – aka the 1/3 test
This test is for organizations that receive most of their funding from grants and contributions from the public. In order to satisfy this test, a charity must receive at least 1/3 of its total income from government grants, grants from other public charities (classified under §170(b)(1)(A)(vi)), and donations from the general public. However, this test is made more difficult to pass because there is a limit on amounts that can be included in the numerator (public support). Any amounts from other public charities can be included in full, but amounts from all other sources can only be included to the extent they do not exceed 2% of the organization’s total support (which is the denominator). For organizations trying to pass this test, their public support percentage can drop as low as 10% if they can demonstrate, with reference to specific facts and circumstances, that they are operated more like a public charity than a private foundation (they are working to attract public support).
If an organization does not meet the above test, they can try an alternate test:
Exempt Function Income Test (under §509(a)(2)) aka the Gross Receipts Test
This test was designed for charities that sell services or materials to the public – and thus most of their income comes from these activities rather than donations or investment income. A charity will pass this test if it normally receives at least 1/3 of its total income from government grants, grants from other public charities, from members of the public, or from revenues generated by activities within the organization’s exempt purpose. Charities under this test are subject to a different limit on amounts that can be included in the numerator. Contributions from sources that are not public charities are included in the numerator to the extent that they do not exceed either 1% of the organization’s total support or $5,000 (whichever is greater). Organizations under this test are subject to an additional limitation – which is that no more than 1/3 of the organization’s income can come from investments.
There are other factors that play into these tests that are outside of the scope of the simple (ha! I know, this likely doesn’t sound simple) explanation I have provided above. For example, certain unusual grants can be excluded from both the numerator and denominator in calculating the public support test. Additionally, when considering large donors, amounts from certain related family members, and from businesses and their major owners are combined and treated as coming from one source.
Why should you care? Well, for organizations claiming public charity status that are not those certain types of institutions (churches, schools, hospitals) and are not supporting organizations, the public support test is filled out annually on the organization’s Form 990. Organizations that are concerned about their public support level (and thus continuing qualification as a public charity) should contact competent counsel to ensure that they don’t fall into private foundation status.
*Public charity status is often the preferred status because private foundations are subject to more strict contribution deductibility limits, and are subject to a series of excise taxes intended to ensure that the foundation’s investments and distributions are directed toward charitable activities: they must pay a 2% tax on investment income; they are required to make annual distributions; they are prohibited from lobbying; and prohibited from self-dealing, having excess business holdings, making jeopardizing investments, and certain prohibited non-US expenditures.