In the nonprofit community, the words “public charity” and “foundation” often are used interchangeably. However, there is an important legal distinction between the two types of tax-exempt organizations. For starters, it is helpful to understand that every 501(c)(3) tax-exempt organization is classified by the IRS as either a “public charity” or a “private foundation.” This classification has important implications for the organization as it impacts the degree of tax-deductibility of contributions it receives and also determines which rules will regulate its ongoing operations. Here is a quick summary of how the two types of organizations differ from a compliance perspective.
All 501(c)(3) organizations are classified by the IRS as private foundations by default unless they can establish that they qualify as a public charity. A private foundation is generally defined as a charitable organization that:
- receives its funding from only one or a limited number of sources, such as a single individual, family, trust or business entity;
- devotes its activities to grant-making rather than operating its own charitable programs (with certain exceptions to this rule); and
- is supported by income from its investments as opposed to charitable fundraising.
Public charities typically operate programs that directly serve the public and are led by a board of directors that are representative of the communities they serve. There are three ways for an organization to qualify as a public charity:
- nonprofit schools, 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; or
- 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). Consulting with an accountant who has experience working with nonprofit organizations is advisable.
More Stringent Compliance Requirements Apply to Private Foundations
- 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 meet a minimum annual distribution requirement.
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