The terms of nonprofit entities can be so confusing … public charity … private foundation … private nonoperating foundations … private operating foundations … public charities that act as foundations. What are they, and how do you tell which is which?
The Internal Revenue Code distinguishes Section 501(c)(3) nonprofit organizations into various tax categories, including private foundations and public charities.
The term “foundation” can be especially confusing, since a nonprofit organization can use the term in its name, even it is not an official private foundation.
Difference between public charity and private foundation
What is a Public Charity?
A public charity is a charitable organization that (a) has broad public support, (b) actively functions to support another public charity, or (c) is devoted exclusively to testing for public safety. Many public charities rely on contributions from the general public. Donations to public charities are fully tax deductible to the extent of the law.
Public charities are the organizations people usually think of when they hear the word charity. These nonprofits’ missions range from helping the poor to easing community tensions to advancing religion, education, or science. Some examples are churches, universities, hospitals, and medical research groups.
A public charity is either “publicly supported” (derives a substantial portion of its support from the public) or functions to “support” one or more organizations that are public charities. More on these supporting organizations here: What is a Supporting Organization?
What is a Private Foundation?
Private foundations are charitable organizations that do not qualify as public charities. In practice, they usually are nonprofits that were established with funds from a single source or specific sources, such as family or corporate money – instead of funding from the general public.
Although contributions to private foundations technically are tax deductible, many of these nonprofits do not accept donations. Instead, private foundations usually invest their principal funding, then distribute the income from investments for charitable purposes. Many have endowments.
Private foundations generally use these funds to make grants or gifts to other nonprofit organizations. In this way, they help charitable, educational, religious, or other causes that help the public.
The IRS recognizes two types of private foundations: private nonoperating foundations and private operating foundations. Although the IRS uses a number of criteria to distinguish between the two, in practice, the key difference between a private nonoperating foundation and a private operating foundation is how each distributes its income:
- A private nonoperating foundation grants money to other charitable organizations. This is the more common type of private foundation. These foundations do not directly perform any charitable programs or services.
- A private operating foundation distributes funds to its own programs that exist for charitable purposes.
Both types of private foundations are subject to certain restrictions and requirements. For example, they must distribute a specific portion of their income for charitable purposes each year (approximately 5%), they cannot do business with their major contributors, they are subject to excise taxes and can face penalties for self-dealing, making risky investments, and for failing to distribute adequate funds to charitable endeavors, among other regulations.
Every U.S. and foreign charity that qualifies under Section 501(c)(3) of the Internal Revenue Service Code as tax-exempt is considered a private foundation unless it demonstrates to the IRS that it falls into another category. Broadly speaking, organizations that are not “private foundations” are considered “public charities.”
Public Charities That Act as Foundations
A number of nonprofits that grant money to public charities are actually public charities themselves. Community foundations and the United Way are examples of such organizations. Many of these nonprofits accept tax-deductible contributions to fund their grantmaking programs.
Why is the Word “Foundation” So Confusing?
Not every organization that uses the word “foundation” in its name is a private foundation, and the word “foundation” has no legal meaning in and of itself. To look further to discover an organization’s actual tax-category, review the organization’s IRS filings: public charities will file Form 990; private foundations file Form 990-PF.
Resources
IRS: Types of Tax-Exempt Organizations
IRS: Private Foundations
IRS: Exemption Requirements – Section 501(c)(3) Organizations
Does A Nonprofit File Tax Returns?
The Cullinane Law Group can help you understand the difference between a public charity and a private foundation and help you determine the best structure for your organization. We set up and maintain strong and legally compliant nonprofits that have solid bases for long-term success. We provide risk management and offer practical solutions for sound governance. We help nonprofits, foundations, religious organizations, and social entrepreneurs throughout the United States who seek to create positive change.
