In the nonprofit sector, the words “charity” and “foundation” often are used interchangeably. However, underlying these terms is a legal concept critical to most 501(c)(3) tax-exempt organizations. Each 501(c)(3) is classified by the IRS as either a “public charity” or a “private foundation.” This classification has significant implications for the organization as it impacts the degree of tax-deductibility of contributions it receives as well as determines which rules will regulate its operations. So, what is really in a name, and why is it important?
What is a Private Foundation?
All 501(c)(3) organizations are classified by the IRS as private foundations by default unless they can prove that they qualify as a public charity. A private foundation is generally a charitable organization that:
- Receives funding from only one or a limited number of sources, such as a single-family or corporation.
- Devotes its energies to grantmaking rather than operating its own charitable programs.
- Is supported by income from its investments as opposed to seeking charitable donations.
What is a Public Charity?
Public charities are often more public facing than private foundations as they typically operate programs that directly serve the public and have boards that are representative of the communities they serve. There are three ways for an organization to qualify as a public charity:
- Nonprofit schools, hospitals (including research organizations affiliated with hospitals), churches and church auxiliaries, and most supporting organizations are public charities by default.
- Satisfy a public support test demonstrating that the organization receives a substantial part (typically at least one-third unless the organization satisfies a 10% facts and circumstances test) of its financial support from contributions from the general public, government grants or other public sources.
- Satisfy a public support test demonstrating that the organization receives a substantial part (at least one-third) of its financial support from a combination of gross receipts from activities related to its exempt functions, membership fees, contributions, and grants and no more than one-third of its income is derived from investment.
The tests are not at all straightforward. They require complicated calculations using the “Support Schedules” included in Schedule A (IRS Form 990 or 990-EZ).
Why Does Private Foundation versus Public Charity Make a Difference?
There are some key distinctions between a private foundation and a public charity:
- A public charity enjoys higher donor tax-deductible giving limits than a private foundation (typically 60% of the donor’s adjusted gross income (“AGI”) for cash gifts to a public charity as opposed to 30% of AGI for cash gifts to a private foundation).
- A private foundation may not financially support or engage in ANY lobbying activity, whereas a public charity may participate in limited permissible amounts.
- A public charity can provide grants to any organization or individual in furtherance of its exempt purposes whereas a private foundation may only distribute grants to public charities or government entities, except in certain circumstances.
- Because they are typically managed by a small group and less open to public scrutiny, private foundations are subject to greater regulation, must pay an excise tax on net income, and have a minimum annual distribution requirement.
The Law Firm for Non-Profits is well-versed in the nuances of the public support tests and can assist your organization in determining its correct classification as well as calculating current and projected public support. Contact us to learn more or to schedule a consultation.