For an organization to be excluded from private foundation status as an organization described in IRC 509(a)(2), it must normally receive more than one-third of its support from any combination of gifts, grants, contributions, membership fees, and gross receipts from permitted sources, and not more than one-third of its support from gross investment income and the excess of the amount of unrelated business taxable income over the amount of taxes imposed by IRC 511.

Reg. 1.509(a)–6 states that if an organization is described in both IRC 509(a)(1) (an organization described in IRC 170(b)(1)(A) other than in clauses (vii) and (viii)) and IRC 509(a)(2), the organization will be treated as described in IRC 509(a)(1).

For purposes of the one-third support test, support is includible in the numerator of the fraction only to the extent it comes from permitted sources. Permitted sources include —

Since disqualified persons are not permitted sources, support derived therefrom is wholly excluded from the numerator of the fraction.

A further limitation on includible support applies with respect to gross receipts from admissions, sales, performance of services, or furnishing of facilities related to an activity which is not an unrelated trade or business that are received from any one person or governmental unit.

Reg. 1.509(a)–3(k) provides that in the computation of the one-third support test, support is determined solely on the cash receipts and disbursements method of accounting described in IRC 446(c)(1) so that, for example, a grant payable over a term of years is includible in the support fraction of the recipient organization only to the extent actually received. See Regs. 1.509(a)–3(b)(2) for an illustration of an application of the one-third support test.

The terms "gifts" and "contributions" , for purposes of the one-third support test, have the same meaning as they have under IRC 170(c), and they also include bequests, legacies, devises, and transfers within the meaning of IRC 2055 or 2106(a)(2). Thus, any payment of money or transfer of property without adequate consideration is considered a "gift" or "contribution" . Where payment is made or property transferred as consideration for admissions, sales of merchandise, performance of services, or furnishing of facilities to the donor, the payment or transfer will not be considered a "gift" or "contribution" to the extent of the value of the quid pro quo. See Reg. 1.509(a)–3(f) and Rev. Rul. 67–246, 1967–2 C.B. 104.

The amount of the gift, grant, or contribution of property, or use of such property, that is includible in computing support is the property’s fair market value or rental value at the date the gift is made. Reg. 1.509(a)–3(f)(2).

Payments from permitted sources that are classified as grants are included in full in the numerator of the support fraction. If the payments are classified as gross receipts, they are included in the numerator only to the extent that the amount received from any person or governmental unit does not exceed the greater of $5,000 or one percent of the organization’s total support.

A payment is normally considered a grant if paid to encourage the recipient organization to carry on programs or activities in furtherance of the recipient’s exempt purposes even if the payee of the grant receives an incidental benefit. Terms and conditions may be imposed on the grant by the payor to insure that the funds will be used in a manner compatible with the payor’s programs and result in public benefit. However, the imposition of terms and conditions and the possibility of benefits resulting to the grantor will sometimes make it difficult to distinguish a grant from other amounts received as gross receipts from the carrying on of exempt activities. See Reg. 1.509(a)–3(g)(1).

Reg. 1.509(a)–3(g)(2) states that if a payment requires the recipient organization to provide a specific service, facility, or product that serves the direct and immediate needs of the payor, such payment is considered gross receipts to the payee and not a grant. Furthermore, where the specific service, facility, or product received by the payor is one that is usually provided by a profit-making organization in its normal course of business, that fact is considered evidence that the payment constitutes gross receipts.

This provision also states that payments made research leading to the development of tangible products for the use or benefit of the payor will generally be considered gross receipts, whereas payment for basic research in the physical or social sciences will generally be considered a grant. See Reg. 1.509(a)–3(g)(3) for two examples which illustrate the distinction between grants and gross receipts.

The fact that the agreement pursuant to which payment is made is designated a "contract" or a "grant" is not controlling for purposes of classifying a payment as a grant or gross receipt under IRC 509(a)(2).

An organization’s receipt of fees from members may be classified, depending on the particular facts, either as gross receipts or membership fees with the attendant result on the support fraction previously discussed. As a general rule, if an organization uses membership fees as a means of selling admissions, merchandise, services, or the use of facilities to the general public, who have no common goal (other than the purchase), then the income received from such fees from related activities constitutes gross receipts; however, to the extent the basic purpose for making the payment is to provide support for the organization rather than to purchase admissions, merchandise, etc., the income received from such fees constitutes membership fees, Reg. 1.509(a)–3(h).

IRC 509(a)(2)(A)(ii) provides that gross receipts from related activities (activities that are not unrelated trade or business within the general rule of IRC 513(a)) are includible in the numerator of the one-third support test of IRC 509(a)(2)(A) only to the extent that the amount received from any person or any bureau or similar agency of a governmental unit described in IRC 170(c)(1) does not exceed the greater of $5,000 or one percent of the organization’s total support in any taxable year.

Gross receipts from IRC 513(a)(1), (2), or (3) activities are treated as gross receipts from related activities and, therefore, subject to the $5,000 or one percent limitation. In general, such activities relate to thrift shops, university or hospital convenience shops, and businesses operated by charitable organizations where substantially all work is performed by volunteers. See Reg. 1.509(a)–3(1).

While a grant received from an organization described in IRC 509(a)(1) (public charity) is fully includible in computing the numerator of the one-third support test of IRC 509(a)(2)(A), an indirect contribution (one which is expressly or impliedly earmarked by the donor as being for, or for the benefit of, a particular recipient) from one of the public charity’s donors retains its character as a contribution from such donor. Thus, if a donor who is a substantial contributor (as defined in IRC 507(d)(2)) with respect to the ultimate recipient makes an indirect contribution through a public charity, such amount is excluded from the numerator of the support fraction. See Reg. 1.509(a)–3(j).

For an organization to be excluded from private foundation status by reason of IRC 509(a)(2), in addition to the one-third support test it must also meet the gross investment income and unrelated business income test set forth in IRC 509(a)(2)(B). An organization will meet this test only if it normally receives not more than one-third of its total support (as defined in IRC 509(d)) in each taxable year from gross investment income (as defined in IRC 509(e)), and from the excess of unrelated business taxable income over IRC 511 tax imposed.

IRC 509(e) provides that the term "gross investment income" means the gross amounts of income from interest, dividends, rents, and royalties, but not including any such income to the extent included in computing the tax imposed under IRC 511.

Unrelated business taxable income, as defined in IRC 512, includes gross income derived from any trade or business which is not substantially related to the exercise or performance by an organization of its charitable function or purpose constituting the basis for its exemption under IRC 501(c)(3), with certain exceptions.

Where an organization rents facilities or lends funds to a charitable class of persons in fulfillment of its overall exempt purposes, the income derived is considered gross receipts from a related activity rather than gross investment income or unrelated business taxable income. Consequently, such gross receipts that are related to exempt purposes would not enter into the numerator of the one-third gross investment income test. Reg. 1.509(a)–3(m)(1).

Both the test prescribed under IRC 509(a)(2)(A) (requiring at least one-third of support from gifts, grants, contributions, membership fees and "gross receipts" ) and the test prescribed under IRC 509(a)(2)(B) (requiring that not more than one-third of support be derived from investment income and unrelated business taxable income) are to be computed on the basis of the organization’s normal sources of support. See Reg. 1.509(a)–3(c)(6) for an example which illustrates application of the normal support rule.

An organization will be considered as "normally" meeting these tests for its current taxable year and the taxable year immediately succeeding its current taxable year, if, for the four taxable years immediately preceding the current taxable year it meets both tests based on an aggregate of the results in the four year taxable period.

Because an organization will be considered to be described under IRC 509(a)(2) for the two taxable years following a computation period in which it satisfies the support tests, it follows that after an organization once meets the support tests for a computation period it must thereafter fail these tests for two consecutive taxable years before it will fail qualification under IRC 509(a)(2).

Where, for example, an organization meets the support tests of IRC 509(a)(2)(A) and (B) for a computation period of taxable years 1990 through 1993, it would be considered to be described under IRC 509(a)(2) for taxable years 1994 and 1995. It will continue to be described under IRC 509(a)(2) for taxable year 1995 even if it fails to meet the tests of IRC 509(a)(2)(A) and (B) for a computation period of taxable years 1991 through 1994.

Generally, an organization’s applicable computation period consists of the four taxable years immediately preceding its current taxable year. However, different rules are applied for new organizations and for organizations which have experienced material changes in their sources of support.

An organization that has not completed four taxable years may, if it has completed at least one taxable year consisting of eight months, substitute the taxable years it has been in existence for the four year period described in IRM 7.26.4.4.1 above to compute whether the support received in that abbreviated period satisfies the one-third support and one-third gross investment and unrelated business income tests of IRC 509(a)(2). If, by substituting in this fashion, a new organization can satisfy these tests then, even though it has not completed four taxable years, it will be considered an organization that normally meets such tests and, therefore, described in IRC 509(a)(2) beginning with its first taxable year. See Reg. 1.509(a)–3(c)(1)(iv).

An organization that has completed at least one taxable year consisting of eight months may, alternatively, choose to apply for an advance determination of foundation status as a newly created organization, under the rules set forth in IRM 7.26.4.7.

A determination that an organization is described in IRC 509(a)(2) because it is considered to have normally met the one-third support, and gross investment and unrelated business income tests of IRC 509(a)(2)(A) and (B) is effective for each taxable year of the computation period plus the two taxable years immediately succeeding the computation period. An exception to this pattern occurs if for the current taxable year there are "substantial and material" changes in the organization’s sources of support (other than a change arising from an unusual grant as described in IRM 7.26.4.6.

In the year in which a substantial and material change occurs, the organization’s satisfaction of its normal support rule is determined on the basis of a new computation period consisting of the taxable year of the substantial and material change and the four immediately preceding taxable years. See Reg. 1.509(a)–3(c)(1)(ii).

In the case of a new organization, one with fewer than five completed taxable years, the computation period encompasses the year of the substantial and material change and, in lieu of the four immediately preceding taxable years, all of the organization’s prior years of existence. See Reg. 1.509(a)–3(c)(1)(iv).

An example of a substantial and material change is the receipt of an unusually large contribution or bequest which is not excluded from support as an unusual grant under See Reg. 1.509(a)–3(c)(3).

Reg. 1.509(a)–3(c)(1)(iii)(a) provides that where an organization ceases to be described in IRC 509(a)(2) because of a substantial and material change in its sources of support, the organization’s status with respect to grantors and contributors will not be affected for purposes of IRC sections 170, 507, 545(b)(2), 556(b)(2), 642(c), 4942, 4945, 2055, 2106(a)(2), and 2522 until notice of change of status under IRC 509(a)(2) is made public (public notice is usually set forth in the Internal Revenue Bulletin) unless:

If, prior to making a grant or contribution, a grantor obtains a written statement signed by a responsible officer of the recipient organization that such grant will not result in a substantial and material change leading to loss of the organization’s status under IRC 509(a)(2), the grantor will not be considered responsible for, or aware of, any substantial or material change. The written statement must include information, including pertinent financial data for the four preceding years, to assure a reasonably prudent person that the grant or contribution will not result in loss of status under IRC 509(a)(2). Reg. 1.509(a)–3(c)(1)(iii)(b).

However, this provision does not apply if a reasonable doubt exists as to the effect of a grant on the organization’s support or if the grantor is a founder, creator, or foundation manager. In such cases, the recipient organization may apply to the Internal Revenue Service for a ruling (under conditions set forth in Regs. 1.509(a)–3(c)(5)(ii)) as to the effect a particular grant will have on its status under IRC 509(a)(2), thereby, if the ruling is favorable, protecting the grantor.

Rev. Proc. 81–6, 1981–1 C.B. 620, provides guidelines to determine whether a grantor or contributor will be considered responsible for a substantial and material change in support. This Rev. Proc. was amplified by Rev. Proc. 89–23, 1989–1C.B. 844.

Reg. 1.509(a)–3(c)(3) describes these excludable grants, generally, as grants that are substantial and unexpected and received from disinterested parties who are attracted to support the organization by reason of its publicly supported nature. They are grants which, by reason of their size, would adversely affect the status of the organization as normally meeting the one-third support test. Such contributions may be excluded from both numerator and denominator of the one-third support fraction but must also be excluded from the denominator of the one-third gross investment and unrelated business income fraction.

Under this provision, grants considered excludable as unusual grants that are payable to an organization over a period of years can be excluded from that organization’s support computation in the amount actually received in each taxable year. In this context, amounts of investment income earned by a recipient organization from an unusual grant do not qualify as part of the unusual grant that may be excluded.

Although all facts and circumstances are to be taken into account in determining whether a contribution may be excluded as an unusual grant, Reg. 1.509(a)–3(c)(4)(i) through (ix) specify certain important factors to consider.

Reg. 1.509(a)–3(c)(5)(ii) provides procedures by which a potential grantee may obtain advance assurance that a particular grant or contribution will be excluded as an unusual grant.

By setting forth guidelines by which particular grants or contributions will be considered unusual grants, Rev. Proc. 81–7, 1981–1 C.B. 621, provides a means by which a potential grantor may have advance assurance that it is not responsible for substantial and material changes in a potential grantee’s support.

Reg. 1.509(a)–3(d)(1) provides for an advance ruling period of two or three years depending on the length of the first tax year. Regs. 1.509(a)–4(i) provide for an extended advance ruling of an additional three years. A new five year period replaces both the two or three year advance ruling period and the extended advance ruling period for organizations applying on Form 1023.

A newly created organization subject to the five year advance ruling period may request a ruling or determination letter that it will be treated as an IRC 509(a)(2) organization for its first five taxable years. This request must be filed with a consent to extend the statute (Form 872–C) that in effect states the organization will be subject to IRC section 4940 taxes if it fails to qualify as not a private foundation during the five year advance ruling period.

Several factors will be used to determine whether there is a reasonable expectation that the organization will meet the public support test at the end of its advance ruling period.

Reg. 1.509(a)–3(d)(2) provides that in determining whether an organization can reasonably be expected to meet the one-third support and gross investment and unrelated business income tests so as to qualify for an advance ruling or determination letter:

An organization, and grantors, or contributors to the organization may generally rely on an advance determination letter or ruling that the organization will be "treated as" an organization described in IRC 509(a)(2) until 90 days after the advance ruling period ends. If information needed to establish the organization’s IRC 509(a)(2) status is submitted within the 90 day period, reliance is extended until the Service issues a determination letter or ruling.

Reg. 1.509(a)–3(e)(2) provides that an organization and its grantors and contributors may rely on an advance ruling for all purposes except IRC 507(d) and IRC 4940.

This means that if it is subsequently determined that an organization was a private foundation from its inception, then the provisions of IRC 507(d), which defines "aggregate tax benefits" and "substantial contributors" with respect to private foundations, and IRC 4940, which imposes excise taxes on the net investment income of private foundations, are applicable from the organization’s inception.

Under certain narrow circumstances, gifts or grants might be treated as gross investment income.

For purposes of the gross investment and unrelated business income test of IRC 509(a)(2)(B), certain portions of an organization’s receipts from the following organizations will retain their character as gross investment income:

Income deemed distributed prior to gifts—In applying the rules of paragraph (1) above, all income which is characterized as gross investment income in the possession of the distributing organization is deemed to be distributed first by the distributing organization before the distributee organization may treat any of the amounts received as gifts or contributions from the organization described in 1(a) or (b) above.

Proration of gross investment income—If an organization described in paragraph (1)(a) or (b) above makes distributions to more than one organization, the amount of its gross investment income deemed distributed is prorated among the distributees.

Certain goods, services, and facilities treated as gross investment income—In applying the rule on retained character of investment income, amounts paid by an organization for the direct benefit of an organization seeking IRC 509(a)(2) status (rather than for the direct benefit of the general public) are treated in the same manner as amounts received by the distributee organization and are treated as gross investment income of the distributee to the extent that such amounts are characterized as gross investment income in the possession of the organization spending such amounts.