Introduction
In the prior post in this series, we examined the 33⅓% public support test and the 2% limitation rule governing donor-supported public charities under Section 170(b)(1)(A)(vi) of the Internal Revenue Code (“IRC”). However, many nonprofits are supported by earned revenue including program fees, and memberships. This article turns to a distinct framework, the public support test applicable to Related Revenue Entities under Section 509(a)(2) of the IRC, and examines how earned revenue from purpose-related activities fits into the public support calculation.
For nonprofit leaders overseeing museums, performing arts organizations, membership associations, and other Related Revenue Entities, understanding how the Section 509(a)(2) test operates, and how it differs critically from the Section 170(b)(1)(A)(vi) framework, is essential to maintaining public charity status and avoiding unintended reclassification as a private foundation.
What Counts as Earned Revenue
Under Section 509(a)(2), the term “gross receipts from exempt function activities” refers to amounts received from the performance of an organization’s exempt purpose; that is, income derived from activities that directly further the charitable, educational, scientific, or other purpose for which the organization was formed. Common earned revenue examples include the following:
• Program service fees
• Event tickets
• Membership dues
• Educational workshops or services
When this income is tied directly to the nonprofit’s purpose and comes from a broad base, it may count toward public support.
The Section 509(a)(2) Two-Prong Test
Unlike Section 170(b)(1)(A)(vi), which excludes program service revenue from the public support numerator entirely, Section 509(a)(2) counts gross receipts from exempt function activities toward public support. Specifically, to maintain public charity status under Section 509(a)(2), an organization must satisfy two independent tests measured over the same rolling five-year computation period:
- The organization must receive more than 33⅓% of its total support from a combination of (i) gifts, grants, and contributions, and (ii) gross receipts from exempt function activities (subject to the per-source cap discussed below). This is the public support floor that requires a meaningful portion of the organization’s total support comes from broad public engagement.
- The organization must receive no more than 33⅓% of its total support from gross investment income (interest, dividends, rents, royalties) and net unrelated business taxable income. This is the investment income ceiling that ensures organizations primarily reliant on passive income cannot qualify as Related Revenue Entities.
It is this two-prong structure that makes Section 509(a)(2) well-suited for organizations that serve the public directly through fee-based programs or services. An arts organization selling tickets, a clinic charging program fees, or a community organization collecting dues can all count that revenue toward the public support floor, provided the amounts are widely received rather than concentrated among a few payors.
When the Section 509(a)(2) Test May Present a Challenge
The Section 509(a)(2) framework contains several critical limitations that organizations must understand to avoid inadvertently jeopardizing their public charity status including:
- Per-source cap: Receipts from any single payor count toward public support only up to $5,000 or 1% of total support for the five-year period, whichever is greater (Treasury Regulation § 1.509(a)-3(f)). This prevents any single large client, government contract, or institutional payor from dominating the numerator.
- Exclusion of gifts from certain insiders:Contributions from “disqualified persons”—a defined category that includes the organization’s officers, directors, trustees, and substantial contributors—are excluded entirely from the public support numerator for Section 509(a)(2) organizations.
- Limitation on investment and UBTI: If gross investment income and net UBTI together exceed 33⅓% of total support, the organization will fail the second prong of the test regardless of how strong its public support ratio is.
Planning for Compliance
As organizations scale their programs and diversify revenue streams, what began as straightforward program revenue can become more complex. New service lines may generate revenue that does not qualify as gross receipts from exempt function activities. Investment portfolios may grow to the point where the 33⅓% investment income ceiling becomes a genuine constraint. And what was once a broad payor base may become concentrated as certain contracts or clients grow disproportionately.
To maintain public charity status, Related Revenue Entities should:
- Review revenue annually and project future classification by modeling Schedule A of IRS Form 990
- Ensure income is properly categorized
- Evaluate whether revenue generating activities remain program-related
- Consult advisors prior to expanding programs
- Consider whether a change in public charity classification (from Section 509(a)(2) to Section 170(b)(1)(A)(vi), or vice versa) may be necessary
Conclusion
Earned revenue can strengthen a nonprofit’s financial position, but its impact on public support must be considered. Understanding the public support test for Related Revenue Entities under Section 509(a)(2) of the IRC is critical to planning for growth and sustainability.
Continue the Series
In our previous article, we discussed how nonprofits maintain their classification and why donor diversity plays a critical role in compliance:
Staying Public: How Nonprofits Maintain Their Public Charity Status
In the final post of the series, we will explore what happens when a nonprofit fails to satisfy the public support tests, including the impact of reclassification as a private foundation and the steps organizations can take to regain public charity status.
NOTE: The information contained herein is not intended to be legal advice, and the reader should know that no attorney-client relationship or privilege is formed by the posting or reading of this article, which is also not intended to solicit business.
Casey Summar, Managing Partner
The Law Firm for Non-Profits
1812 W. Burbank Blvd., #7445
Burbank, CA 91506