Public Charity vs. Private Foundation
May 26th, 2009 | 
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Tonight’s title match: In the red corner, numbering 948,954, representing over half of all 501(c)(3) organizations, are public charities. And in the blue corner, numbering 108,594, having increased 54% since 1998, are the 501(c)(3)s known as private foundations. Both competitors bring a long and varied history into the ring. Though greatly outnumbered by public charities, private foundations bring a lot to the contest. Let’s take a closer look at the differences, and similarities, between these title contenders.
Many people have a layman’s understanding of the difference between public charities and private foundations: Public charities are understood to perform charitable work, while private foundations support the work of public charities. That grassroots definition is, in practice, mostly true. The specifics, however, are slightly more complicated.
Public charities. Public charities represent the largest share of active, 501(c)(3) organizations. Those starting a new organization usually prefer public charity status, not just because it better describes the organization’s purpose. Public charities also enjoy some advantages over private foundations: higher donor tax-deductible giving limits, the ability to attract support from other public charities and private foundations, as well as a $25,000 income threshold to trigger annual Form 990 filing (private foundations file Form 990-PF regardless of income). In fact, an applicant for 501(c)(3) status must prove why it should be considered a public charity, lest they be considered a private foundation by default.
Like the layman’s definition, public charities typically carry out some type of direct, charitable activity. Examples include churches, private schools, homeless shelters, etc…the list of possibilities is nearly endless. The true definition of a public charity, though, goes well beyond the programs and into the realm of structure and revenue source. As for structure, in order to qualify for (and keep) public charity status, a 501(c)(3) must be organized for exclusively 501(c)(3) purposes. The IRS requires certain language to be in a public charity’s articles of incorporation explicitly restricting its activities to such. In addition, a public charity must represent the public interest by having a diversified board of directors. More than 50% of the board must be unrelated by blood, marriage or outside business co-ownership and not be compensated as employees of the organization. We are often asked where that is in the “code” and, frankly, it isn’t there…at least not verbatim. It is an extrapolation of the IRS’s requirement that governance of a public charity be at arms-length and without private benefit (inurement) to insiders. As such, the IRS requires that a quorum of board members be possible who have no personal stake, either directly or potentially through relationship. Finally comes the income, or source of revenue, test. Public charities must be supported by the general public. For that to be true, a significant amount of revenue, at least 33%, must come from relatively small donors (those who give less than 2% of the organization’s income), from other public charities or the government. While that is significant, that leaves 67% to potentially come from other, less diverse sources.
Private foundations. While being considered a private foundation could simply be a fall-back position of not qualifying for public charity status via either the organizational or income test (or both), it is most often a choice that is made. There are reasons why someone would choose foundation status over public charity. Chief among those is control. In exchange for somewhat disadvantaged deductibility limits to donors, mandatory Form 990-PF filings, and minimum annual asset distributions (5% each year), private foundations can be controlled by related parties and be funded by a relatively small group…even one individual or family (think Bill and Melinda Gates Foundation). This is often more than enough trade off for those starting a foundation. One thing that is not different for private foundations is the requirement that it be organized for exclusively charitable purposes.
There is even a third type of 501(c)(3), the private operating foundation. This is best thought of as a hybrid of the other two, most often a private foundation with direct program services like that operated by public charities. The rules are strict, as control can be like that of private foundations, but with some of the benefits of public charities. There are relatively few of these organizations around. You typically only see these under rather unique circumstances.
At the end of the contest, it is a tie. There really is no winner. It completely depends on each organization’s programs, plans and intentions. Ding, ding!
Posted in Education, Managing a Nonprofit, Starting a nonprofit | 
Tags: 501(c)(3), donations, Form 990, IRS, private foundation, public charity, Starting a nonprofit
Is the private foundation like an irrevocable trust? I’m interested in trusts and would like to know more. Are charitable trusts and public charities the same thing?
They are not the same thing. A trust is a type of entity, not a type of tax-exempt or 501(c)(3) status. Corporations, trusts and unincorporated associations can all seek tax-exemption as a private foundation or a public charity.
For a Private Foundation, what are the disadvantages of deductibility limits to donors
That really depends upon the donor. The IRS allows taxpayers who itemize their deductions to write off donations to public charities up to 50% of their income. For private foundations, the limit is 30%. But how many taxpayers give 30% of their income to charity, much less 50%? As you can see, the deductibility limitations impact only a handful of very generous individuals.
Where you often see the limits coming into play is with family foundations. The Smith family sets up a private foundation and intends to fund it themselves. The Smiths are rather well off and plan to seed the foundation with a big chunk of money. While their donation is not limited, the deductibility of it is. But even that is not the end of the story. The IRS allows amounts that exceed the limit to be carried over to future years.
We are forming a non profit and are looking for assistance in the kind of non profit to begin. We will be conducting various services that are specifically targeted for the community and townships we assist, but want to know if the Private Foundation is the way to go. The main reason we need the 501(c)3 is for the Grants we need to make the programs work as well as to qualify for a lot of the government assistance we seek. Also we will be getting donations and need to provide the write off for our donors. My concern is making the wrong choice and not having the ability to get Grants and Subsidies for the Housing we will be building to help the families we intend to provide for. What is the suggestion?
Regards,
Hector Alvarez
Affordable Green Properties
From your description, private foundation status is not likely your best choice. Most organizations that need the funding sources you describe…and have ongoing direct programs will want to form a public charity. I recommend you call and speak with one of our team members to get a better feel for what you should do. There is no cost to inquire. Good luck!
Are there reporting advantages, from the non-profit organization’s perspective, to being a public charity instead of a private foundation? Specifically, do you have to supply more information (or different types) if you are a private foundation? Thank you.
I should clarify — assume that the non-profit receives less than 25K and can file a 990-EZ. Thanks.
There are distinct differences in the reporting requirements for public charities compared with private foundations. Public charities are only required to file a detailed return if gross revenue exceeds an average of $25,000 (see our Form 990 web page for details on calculating that average). Private foundations must file a Form 990-PF regardless of income. In general, Form 990-PF is somewhat more difficult to deal with, though any Form 990 is not picnic.
All that being said, the relative reporting requirements should have little to no basis in what designation most properly categorizes a particular organization.
We are considering establishing several ventures and of the few a second hand (educational workshop) shop/store in addition to a new church. These entities would give and help generate proceeds to our church of which I am the founder. Which organizational outline would be best for the business’, ventures and the church of the 501(c)3’s Public charity, Private foundation, or a private operating foundation. Would the charity purpose change to that of a 501(c)4, 501(c)6, 501(c)7… I am trying to be careful as well as cautious with all of the new State and IRS changes for churches and non-profit charities and I do not want to make any errors that cause us to be audited. I believe in the saying “measure twice, cut once”. Some mistakes can be costly to fix without penalty to say the say the least to invite any undesired attention from Uncle Sam.
The answer really depends upon a number of factors not included in your question. Here’s a thumbnail sketch:
Churches are by definition 501(c)(3) public charities. The business ventures, well, that’s another story. The devil is in the details…maybe literally
. I highly recommend you read our blog articles that deal with unrelated business income. You can click on that topic on the right hand side column of the blog. Then, get professional assistance in setting this operation up. Yours definitely does not sound like a DIY project!
We are looking to start a developmental center that provides educational programs (a school), mental health counseling, and related therapies for children with disabilities and their families. We are currently filling out our 1023 form, but are unsure how to proceed. The building we are currently using is fine for now, but we want to be in a new building (specifically built/contracted for us) in 3-5 years. Should we include the plans for a new building in our forms and just file as a foundation? Or should we remain filing as a public charity and just create a foundation later on down the line?
Thanks!
Barby…I cannot begin to address your questions in a written reply. Way too fact dependent. Also, from what you are saying your purpose is, and the nature of your questions, I have serious concerns about you attempting the Form 1023 on your own. It is a difficult task in any circumstance. I think yours will be especially so. I’m not always this blunt, but you need to call and speak with one of our reps about this. I think you will save yourselves much headache.
A family member who was not employed or insured has been recently diagnosed with stage 3 cancer. We are looking into doing a private foundation, but don’t know if this would qualify being that it would only benefit one person. Also, would we qualify for government grants?
I’m sorry to hear about your situation. Having dealt with that in my own family, it isn’t an easy thing.
As to your question…This is one we get asked a lot. Unfortunately a foundation/charity cannot be set up to benefit one individual. The best bet is to set up a “fund” at a bank that people can donate to (with the understanding that it is not tax deductible). If you want to be able to offer tax deductibility, the best thing to do is to ask your church (or another charity you are familiar with) to “sponsor” this project. That way, donations can be given to the charity designated to the need you described. That method requires the charity in question to be willing to manage this as a project of theirs. If that is not possible, just set up the fund.