You may be aware that every U.S. and foreign charity that is recognized by the IRS and qualifies under Section 501(c)(3) of the Internal Revenue Service Code as tax-exempt is classified as either a private foundation or a public charity. You may also understand that they differ in how they’re funded and operated, but do you know all the specific benefits and drawbacks of private foundations and public charities?
Private Foundation Overview
A private foundation is a nonprofit charitable entity that is generally created by a single benefactor, usually an individual or a business, that gives money or assets to the foundation – often in a single endowment. These assets are invested and some of the assets must be paid each year as grants to individuals or other charities in accordance with the foundation’s charitable purpose.
If the private foundation’s investments generate a consistent, stable and reliable return, most private foundations will grant a correspondingly consistent, stable, and reliable amount (or increasing amount) to selected charities.
Benefits of Private Foundation vs. Public Charity
The donors to private foundations enjoy a high degree of control over the charity. There are no requirements for the foundation’s board of directors. It can, if desired, consist entirely of the donor’s family members and be beholden entirely to the donor. Those responsible for running the foundation have full autonomy in deciding whom or what organizations to support and can make any and all investment decisions without oversight.
Private foundations also have expansive freedom to determine who can receive donations and how the money is distributed. The foundation can make grants to individuals or organizations, in addition to the option of directly operating its own charitable programs.
Private foundations provide specific tax savings and financial benefits for donors:
- Donors receive an income tax deduction for any amount of cash they contribute to a private foundation up to 30% of adjusted gross income (AGI).
- Donors may avoid paying capital gains taxes by donating highly appreciated assets to the private foundation.
- Most assets contributed to a private foundation are excluded from the donor’s estate and, as a result, are not subject to either federal or state estate taxes.
Finally, private foundations can be set up with the intent to exist in perpetuity, which makes them a popular way to establish a charitable legacy.
Public Charity Overview
What sets a public charity apart as a charitable vehicle is that it uses publicly collected funds to directly support its charitable initiatives. The IRS requires that a public charity receive at least one-third of its contributions from the general public or meet the 10% facts and circumstances test where the charity can establish that “under all the facts and circumstances, it normally receives a substantial part of its support from governmental units or the general public.”
The charity may also receive income from activities that further the organization’s exempt purposes, or actively function in a supporting relationship to one or more existing public charities. As defined by the IRS, public charities include most churches, hospitals, and qualified medical research organizations affiliated with hospitals, schools, colleges, and universities.
In general, public charities have an active program of fundraising and will receive contributions from many sources, including the general public, governmental agencies, corporations, private foundations, or even other public charities.
Benefits of Public Charity vs. Private Foundation
One of the biggest benefits of public charities is they have higher donor tax-deductibility giving limits than private foundations. Whereas a donor’s contributions to private foundations are limited to 30% of AGI for cash and 20% of AGI for long-term publicly traded appreciated securities, donations by individuals to public charities have higher AGI limits of 50% for cash donations and 30% for most non-cash donations.
Public charities do not have to rely solely on support from the donor, as they have the ability to attract support and donations from other public charities and private foundations.
All section 501(c)(3) organizations are presumed to be private foundations unless they request, and qualify for, a ruling or determination by the IRS as a public charity.
Beyond these direct comparisons, there are other important considerations to be aware of when considering both private foundations and public charities.
- Private foundations can be established as either operating foundations or non-operating foundations:
- – Operating foundations are directly involved in operating a charitable project or enterprise such as a museum, zoo, or library in a continuing and sustaining manner.
- – Non-operating foundations don’t usually run their own programs, but instead give back by making grants to public charities, individuals, and organizations.
- While private foundations offer a means to establish a legacy of giving and provide additional tax benefits and tax shelters for larger estates, these benefits also apply to donor-advised funds, which are considered a type of public charity.
- Private foundations are subject to various operating restrictions and will incur excise taxes for failure to comply with those restrictions. Public charities risk losing their 501(c)(3) exempt status if they violate operating restrictions and may also incur penalty excise taxes on individuals who receive excess benefit transactions.
- Both private foundations and public charities have specific requirements to establish, remain in compliance with government regulations, file tax forms, and address significant events. For a high-level overview of the different requirements that occur over the lifetime of these charitable organizations, see the following graphical representations from the IRS:
There are many considerations when selecting how to establish a legacy of giving. If you feel that a private foundation could be the right vehicle for your charitable giving, or would like to discuss other ways to give, contact us.
IRS, “Charities and Nonprofits, https://www.irs.gov/charities-and-nonprofits
IRS, Life Cycle of a Public Charity, https://www.irs.gov/charities-non-profits/charitable-organizations/life-cycle-of-a-public-charityIRS, Life Cycle of a Private Foundation, https://www.irs.gov/charities-non-profits/private-foundations/life-cycle-of-a-private-foundation